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Federal Tax Update - Aug. 4, 2014
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Ed Zollars from Nichols Patrick CPE delivers the weekly podcast on federal tax issues. For all of your CPE needs, please go to www.ficpa.org/cpe. This week’s podcast covers the following topics:
COURT ALLOWS FOR UNAVOIDABLE PERSONAL USE OF OFFICE PORTION OF STUDIO APARTMENT, GRANTS DEDUCTION
In the case of Miller v. Commissioner, TC Summary Opinion 2014-74, (http://ustaxcourt.gov/InOpHistoric/MillerSummary.Guy.SUM.WPD.pdf) the Tax Court dealt with the issue of whether a studio apartment of 700 square feet could qualify as an office in home for an employee. In particular, the IRS objected to the fact that there had been minimal personal use of the area of the apartment designated as the “office” area, something virtually impossible to avoid in 700 square foot studio apartment.
Laura Miller had been hired by a Los Angeles based public relations, marketing, and advertising services firm to be the entity’s account director in New York City. When she was hired Laura worked out of a client’s showroom, as the organization had no offices in New York City and Laura was the firm’s only employee. However, the employer’s relationship with that client ended up being terminated shortly after Laura was hired, so the employer asked her to work from her studio apartment until the firm could obtain commercial space in New York. However, the company never did obtain that space, so Laura continued to use her studio apartment as the company’s office in New York City.
Under IRC §280A(c)(1), one of the key requirements to obtain a deduction for office space in a taxpayer’s residence is that the area in question must be used exclusively on a regular basis as the taxpayer’s principal place of business. As well, as an employee this deduction will only be allowed if the exclusive use of the office space was for the convenience of the employer, rather than the employee. [IRC §280A(c)(1)]
The Tax Court was not troubled by a small amount of personal use (which arguably meant it was not “exclusively” used for business), finding it was “wholly attributable to “the practicalities of living in a studio apartment of such modest dimensions.” The Court cited to a 1981 decision in the case of Hughes v. Commissioner, TC Memo 1981-140 where the court accepted that that the taxpayer’s of space in his studio apartment to walk to and from his bathroom did not destroy the deduction.
However, unlike the Hughes case, in this case it was not suggested that her use was for such limited purposes.
The fact that the office in home was for the convenience of her employer was established by the fact that she regularly inquired about when the company would obtain commercial space in New York and was reassured it would be soon. As well, she was aware the Company was having a difficult time financially, particularly in keeping open a New York office, so she continued to accept the arrangement.
As is noted by reference to the Hughes case, this is not the first time that the IRS has allowed an office in home for a studio apartment. And, as was noted, the Court does recognize that the single room arrangement means that a very strict reading of “exclusive use” is not reasonable.
However, the Court has not been so accommodating outside of the studio apartment setting. For an example, see the case of Rayden v. Commissioner, TC Memo 2011-1. In that case the Court found:
Petitioner contends that 70-71 percent of his home was used exclusively and regularly for business during the 2004 tax year. As the Court did in Hefti , we find it implausible that the taxpayer and his family "had no social or personal life in any portion of the residence other than a few bedrooms and the kitchen." Id. During his testimony petitioner acknowledged a few occasional uses of other rooms for personal purposes during 2004. Nevertheless, because personal use was allegedly minimal compared with business use, petitioners contend that they should be allowed the claimed expense deduction. We appreciate petitioners' contention, but Congress has made it clear that this is not the law.
The Rayden court did allow for mere passage from one room to another without losing status as an office in home, but virtually any other use will cause loss of status. If there are actual walls between the rooms, the Court is likely to find it less plausible that personal use for other than mere passage from one room to another is unavoidable.
ADVISER'S ASSURANCE THAT INVESTMENT WOULD BE RETURNED WITHIN 60 DAYS FOUND TO PROVIDE CAUSE TO GRANT RELIEF FOR LATE ROLLOVER
In PLR 201431036 (http://www.irs.gov/irs-wd/201431036.pdf) the IRS granted relief from the 60 day rollover period to a taxpayer who intended to take funds out of the IRA to benefit from a short term investment opportunity—the type of situation that advisers might expect would not lead to an IRS waiver of the rollover period. As you might expect, though, the particular facts of this situation was likely key to obtaining relief.
The taxpayer had been approached by their investment adviser regarding a short term investment opportunity. The adviser told them that they would provide the initial investment amount and would be paid back the principal and interest within the 60 day period, so the funds could then be redeposited into the IRA account. While the ruling does not say so, presumably the IRA funds represented either the only source the taxpayers had to make this investment or, at least, the source from which the funds would be easiest to obtain.
Unfortunately for the taxpayers, things did not go as expected for this investment. Rather, the taxpayers’ investment was stolen and then held up in litigation until after the expiration of the 60 day period.
The taxpayers approached the IRS seeking relief. The financial adviser provided a letter confirming that the taxpayers had relied upon his assurance that the funds would be returned within the 60 day window, something that ultimately did not take place.
In prior requests where the taxpayers ran into unexpected issues that held up funds they expected to have before the end of the 60 day period, the IRS has generally denied relief to the taxpayers, asserting that such an expected lack of funds is not one of the issues outlined in Revenue Procedure 2003-16 that would justify relief.
However, Revenue Procedure 2003-16 does provide that one justification for relief is an error committed by a financial institution. In this case, the IRS found that the adviser’s assurance that the funds would be returned within the 60 day window amounted to just such a financial institution error and the relief was granted.
To the author it appears clear that relief was granted based solely on the fact that the investment adviser was willing to provide a letter accepting blame for providing erroneous advice to the taxpayers. The result most likely would have been completely different (that is, no relief provided) if the taxpayers had discovered this investment opportunity on their own rather than having had the investment recommended by a financial adviser.
NO CURRENT DEDUCTION ALLOWED FOR UNREDEEMED PORTION OF CUSTOMER LOYALTY PROGRAM DISCOUNTS, AS FACT OF LIABILITY NOT YET ESTABLISHED
In the case of Giant Eagle Inc. v. Commissioner, TC Memo 2014-146, http://ustaxcourt.gov/InOpHistoric/GiantEagleMemo.Haines.TCM.WPD.pdf, the IRS and the taxpayer disagreed over whether the taxpayer could claim a deduction related to the unredeemed balance due on its customer rewards program.
Customers who made qualifying purchases at the taxpayer’s grocery stores would earn “fuelperks!” that were redeemable as a discount against gasoline purchased at gas stations owned by the taxpayer. The taxpayer was accruing the estimated redemption amount of such “fuelperks!” against its income as of the end of the year.
Generally the proportion of rewards that will eventually be redeemed by customers can be very accurately predicted by the issuer. And, generally, the entity will need to accrue that estimated redemption amount as a liability on the entity’s GAAP financial statements.
However under the tax law the potential liability has to generally satisfy the “all events” test under IRC §461 found at Reg. § 1.461-1(a)(2)(i) requires the taxpayer to show:
The IRS argued that the first of these requirements had not been met—until a customer purchases fuel, all events that establish the fact of the taxpayer’s liability have not yet been established.
The Tax Court looked at two key cases from the Supreme Court. In United States v. Gen. Dynamics Corp., 481 U.S. 239 (1987) the Supreme Court held that an employer could not deduct amounts due under its self-insured medical plan until employees had actually submitted claims. The court found that no liability existed until a claim was submitted, since for various reasons a person might not file a claim to which he/she is entitled.
Alternatively, in the case of United States v. Hughes Props., Inc., 476 U.S. 593 (1986) the Court found that a casino could deduct the outstanding liability for a progressive slot-machine jackpot where state law forbid the casino from reducing the payout on such a slot machine until it was actually paid out to someone. The fact that it might not be paid out for a long time, or perhaps never if the casino went out of business, did not cause the Court to find the fact of the liability had not been established, even though the casino could not know to whom the jackpot would eventually be paid.
The Court found that this case was more in line with the General Dynamics fact pattern—until customers actually bought gasoline, there was no liability.
The taxpayer then turned to a backup position they had—that their program was covered by the “trading stamps” regulation found at Reg. §1.451-1(a)(1). That regulation provides:
The cost to the taxpayer of merchandise, cash, and other property used for redemption in the taxable year,
The taxpayer argued their program was like the trading stamps described in the regulation.
The Tax Court did not agree. Rather the Court found persuasive the position outlined by the IRS in Revenue Ruling 78-212 that a program of issuing discount coupons that were not directly redeemable in merchandise, cash or other property, but rather simply gave discounts, was not a program described by the above regulation. A customer generally needs to purchase product from the taxpayer (in this case gasoline) in order to obtain the benefit.
The taxpayer argued that if a customer obtained enough “fuelperks!” that he/she could end up a free tank of gas. The Court held that the mere possibility that someone could obtain the free tank wasn’t enough. As the Court pointed out, that still required another transaction, and obtaining a free tank depended on the price of fuel when redemption was sought, since each “fuelperk!” gave the customer a 10 cent per gallon reduction in price.
DRAFT FORM TO REPORT INDIVIDUAL SHARED RESPONSIBILITY PAYMENT EXEMPTION RELEASED BY IRS
The IRS has issued a draft version of the form to be used to claim an exemption from the individual shared responsibility payment for health care coverage imposed by IRC §5000A.
The nature of any exemption will be disclosed on Form 8965 the draft of which may be downloaded from http://www.irs.gov/pub/irs-dft/f8965--dft.pdf.
IRS RELEASES RECONCILIATION OF PREMIUM TAX CREDIT FORM
The IRS has issued a draft of the form to be used by taxpayers to reconcile their premium tax credit under IRC §36B with the amount of benefit they received during the year. Taxpayers may end receiving an additional credit or be required to pay back some of all of their assistance based on their actual 2014 income.
The draft from is found at http://www.irs.gov/pub/irs-dft/f8962--dft.pdf.
IRS RELEASES DRAFTS OF ACA INFORMATION REPORTING FORMS
The IRS has issued drafts of various reporting forms related to insurance coverage
An individual will be issued a Form 1095-B, the draft of which is available at http://www.irs.gov/pub/irs-dft/f1095b--dft.pdf.
Applicable large employers will also need to provide employees with information returns related to coverage. For such employers the new form will be Form 1095-C, a draft version of which is available at http://www.irs.gov/pub/irs-dft/f1095c--dft.pdf.
These forms will be transmitted to the IRS with a Form 1094-C the draft of which is available at http://www.irs.gov/pub/irs-dft/f1094c--dft.pdf.
For the 2014 tax year reporting on these forms is voluntary [Notice 2013-45], though such reporting will be mandatory for 2015 (with the Forms 1095 mailed to affected individuals in January 2016).
TAXPAYER FAILED TO SHOW REASONABLE CAUSE FOR LATE FILING OF TAX RETURN
What constitutes reasonable cause for late filing of a return? While you might think death would constitute a reasonable cause, the Court in the case of Estate of Stuller v. United States, USDC Cent. Dist. IL, Case No. 3:11-cv-03080, http://scholar.google.com/scholar_case?case=12944356091874452267&q=estate+of+Stuller&hl=en&as_sdt=806.
The case involved issues related to whether the Stullers had a profit motive for horse breeding business (the court found they did not) and the question of whether there existed reasonable cause for the late filing of the taxpayers’ 2003 tax return.
On January 6, 2003 a fire destroyed the Stuller’s home and Mr.Stuller died of injuries suffered in that fire on January 8, 2003. Mrs. Stuller developed double pneumonia and was hospitalized for a number of weeks. Due to the extensive damage of the home, Mrs. Stuller rented and lived in an apartment from February 1, 2003 until January 31, 2004. At that time she relocated into one of her rental properties.
The couple’s 2003 return was not filed until February 20, 2005, months after the extended due date of the couple’s 2003 tax return of October 15, 2004.
Mrs. Stuller argued that a number of factors had served to prevent her from timely filing that return. They included:
While an impressive list, the IRS noted counter-evidence that indicated there was not reasonable cause for late filing.
The Court sided with the IRS, finding that the taxpayers had not carried their burden to show reasonable cause. The mere existence of the tragedy was not, by itself, sufficient cause to justify late filing.
While the Court conceded that destruction of records could qualify in the proper situation, the taxpayers had shown that they had made a diligent but futile effort for an extended period before the deadline to locate records from which to prepare the return. Thus, the Court found that there was no reasonable cause demonstrated by the taxpayers for the late filing.
LAST UPDATED 8/4/2014