Newsletters

A "phase two" tax reform outline could be unveiled by House GOP tax writers by August. Republicans have started to increase their tax meetings related to the effort, House Ways and Means Committee Chairman Kevin Brady, R-Tex., told reporters on June 13.

A "phase two" tax reform outline could be unveiled by House GOP tax writers by August. Republicans have started to increase their tax meetings related to the effort, House Ways and Means Committee Chairman Kevin Brady, R-Tex., told reporters on June 13.

Tax Reform "2.0" Timeline

The precise timing of a "phase two" tax reform bill or discussion draft release remains "to-be-determined," a House Ways and Means Committee spokesperson told Wolters Kluwer on June 14. However, Brady told reporters he expects to see a legislative package outlined before the House’s August recess.

Previously, White House Legislative Affairs Director Marc Short predicted a late-summer release of the House’s tax bill. Further, House Majority Leader Kevin McCarthy, R-Calif., has predicted that the House will approve the measure before midterm elections in November.

Individual Tax Cuts

Brady reiterated to reporters that "phase two" will focus on the individual side of the tax code. Moreover, making permanent the individual tax cuts enacted under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) will be the "centerpiece" of a " phase two" bill, Brady reportedly said. Additionally, Republican tax writers are considering proposals that would streamline the retirement savings process, a Ways and Means spokesperson previously told Wolters Kluwer.

Phase Two Fate Uncertain

The next major tax bill’s fate in the Senate remains uncertain. At least nine Democratic votes will be needed to reach the Senate’s 60-vote threshold. Brady has said he is hopeful for Democratic support.

However, Democratic lawmakers in the House and Senate remain largely opposed to the TCJA. Democrats have criticized the TCJA for primarily benefiting corporations. However, House Republicans are hopeful for bipartisan support on a new measure that focuses primarily on individual tax cuts.

A bipartisan group of House and Senate lawmakers have introduced companion Historic Rehabilitation Tax Credit (HTC) bills. The measure aims to strengthen the HTC by encouraging investment and minimizing administrative burdens, according to the lawmakers.

A bipartisan group of House and Senate lawmakers have introduced companion Historic Rehabilitation Tax Credit (HTC) bills. The measure aims to strengthen the HTC by encouraging investment and minimizing administrative burdens, according to the lawmakers.

Rehabilitation Credit

As amended by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), the rehabilitation credit under Code Sec. 47 is limited to 20 percent of qualified rehabilitation expenditures (QREs) of the taxpayer for qualified rehabilitated buildings. The credit is claimed ratably over a five-year period beginning in the tax year in which the rehabilitated building is placed in service. A "qualified rehabilitated building" (QRB) is a building and its structural components for which depreciation is allowable, and that has been substantially rehabilitated and placed in service before the beginning of the rehabilitation. The building must be a certified historic structure, but any expenditure attributable to rehabilitation of the structure is not a QRE unless it is a certified rehabilitation.

Property is considered substantially rehabilitated only if the expenditures during an elected 24-month measurement period (60-month period for phased rehabilitations) ending with or within the tax year are greater than the adjusted basis of the property or $5,000.

Basis-Adjustment Requirement

The bipartisan Historic Tax Credit Enhancement Bill, introduced June 13, would eliminate the existing basis-adjustment requirement. Eliminating this requirement would "bring the HTC in line with other tax credits claimed over multiple years," according to a joint press release by the bill’s sponsors.

The measure was introduced by Sens. Bill Cassidy, R-La., Ben Cardin, D-Md., and Susan Collins, R-Me., and Reps. Darin LaHood, R-Ill., and Earl Blumenauer, D-Ore. "Protecting this credit was one of my top priorities in tax reform, and I’m glad there is bipartisan support for making it even better," Cassidy said in the joint press release. Cardin praised the measure for helping to create economic growth.

Improved HTC

Likewise, Collins said the bill would make the HTC easier to use as well as create economic development across the country. Additionally, an improved HTC would create jobs, according to Blumenauer. "Strengthening the Historic Tax Credit will further revitalize American cities while creating local jobs and spurring economic development in communities large and small," Blumenauer said.

House tax writers have moved two bills through committee. The bills focus on IRS hiring and the tax treatment of mutual ditch irrigation companies. The House Ways and Means Committee approved the measures in a June 21 markup.

House tax writers have moved two bills through committee. The bills focus on IRS hiring and the tax treatment of mutual ditch irrigation companies. The House Ways and Means Committee approved the measures in a June 21 markup.

IRS Hiring

The Ensuring Integrity in the IRS Workforce bill (HR 3500) would set certain restrictions on the IRS’s hiring policy. The bipartisan bill would amend Code Sec. 7804 to prohibit the rehiring of any employee previously dismissed for certain misconduct issues.

The bill comes after two Treasury Inspector General for Tax Administration (TIGTA) reports noted that the IRS rehired hundreds of former employees with conduct violations. Over 200 of the more than 2,000 former employees rehired between January 2015 and March 2016 were previously terminated from the IRS for a substantiated conduct or performance issue, according to a July 2017 TIGTA report. Inspector General J. Russell George previously told lawmakers that the particular IRS hiring process is "bad decision making."

The bill, sponsored by Reps. Kristi Noem, R-S.D., and Kyrsten Sinema, D-Ariz., originally passed the House with bipartisan support in the 114th Congress. However, the Senate never took up the measure. Also, Sen. Richard Burr, R-N.C., introduced a related bill in the Senate.

"If a person is fired for falsifying information or mishandling sensitive taxpayer data, it’s common sense that individuals should not be rehired," Noem said in a June 21 press release. "Nonetheless, the IRS has done this repeatedly."

Agriculture Tax Reform

Additionally, the Ways and Means Committee approved the Water and Agriculture Tax Reform bill (HR 519). The bill aims to facilitate water leasing and transfers to promote conservation and efficiency. HR 519 would amend the "tax treatment of mutual water storage and delivery companies so that they can maintain their nonprofit status even if more than 15 percent of their revenue comes from nonmembers," according to a June 21 press release by the bill’s sponsor, Rep. Ken Buck, R-Colo.

HR 519 and HR 3500 are now headed to the House floor.

The American Bar Association (ABA) Section of Taxation has expressed concerns to top Senate tax writers about certain congressional IRS reform efforts. The ABA Section of Taxation sent a June 6 letter to Senate Finance Committee (SFC) Chairman Orrin G. Hatch, R-Utah and ranking member Ron Wyden, D-Ore., regarding the House-approved bipartisan Taxpayer First Act (HR 5444).

The American Bar Association (ABA) Section of Taxation has expressed concerns to top Senate tax writers about certain congressional IRS reform efforts. The ABA Section of Taxation sent a June 6 letter to Senate Finance Committee (SFC) Chairman Orrin G. Hatch, R-Utah and ranking member Ron Wyden, D-Ore., regarding the House-approved bipartisan Taxpayer First Act (HR 5444).

IRS Reform

"The administrative reforms included in the House bills are a welcome step forward," Hatch previously told Wolters Kluwer. The House passed a package of bills in April, which aims to restructure the IRS for the first time in 20 years. Hatch told Wolters Kluwer that he is looking forward to working with his colleagues to find a path forward that reflects both House and Senate views on IRS reform.

While the SFC considers the House’s IRS reform package, the ABA Section of Taxation has asked Senate tax writers to consider certain suggestions to enhance IRS restructuring efforts. "We appreciate that Congress has turned its attention to the relationship between taxpayers and the agency charged with the assessment and collection of taxes," the letter said. The ABA Section of Taxation agrees with most of the House-proposed changes but has concerns with certain aspects of the bill, the letter noted.

Appeals

The House bill, HR 5444, proposes the establishment of an independent Office of Appeals along with a "generally available" right to appeal for taxpayers. While the letter to Hatch and Wyden supports a statutory right to appeals, among other things, it expresses concern that the IRS could limit certain taxpayer’s access to an appeal. "To the extent that the Service wishes to deny appeal rights to taxpayers, it should be required to articulate objective standards for when appeals will not be available, so that any Service determination to deny appeal rights can be measured against those standards," the letter said.

Additionally, the letter proposes that Congress remove certain limiting words from the bill’s provisions that discuss taxpayers’ rights to access case files. Currently, the bill states that only "specified taxpayers" will automatically be provided access to their case files. The ABA Section of Taxation urges Congress to allow all taxpayers access to information in their case file, regardless of income thresholds.

Senate Timeline

As for when the SFC will release its anticipated amendments to the House-approved IRS reform package remains unclear. The Senate’s legislative efforts toward restructuring the IRS are expected among lawmakers to be bipartisan.

The U.S. Supreme Court has determined that nonqualified employee stock options are not taxable compensation under the Railroad Retirement Tax Act (RRTA). The term "money remuneration" in the Act unambiguously excludes "stock."

The U.S. Supreme Court has determined that nonqualified employee stock options are not taxable compensation under the Railroad Retirement Tax Act (RRTA). The term "money remuneration" in the Act unambiguously excludes "stock."

Background

Several railroads filed a refund claim for overpaid Railroad Retirement taxes. The railroads claimed they overpaid their taxes because they included the value of employee stock options when calculating the tax.

The IRS denied the refund request. The IRS argued that stock options were taxable "money remuneration" under the RRTA because stock can be easily converted into money.

The railroads replied that stock options are not money. Moreover, they argued that when Congress passed the RRTA, it sought to mimic existing industry pension practices. Generally, those practices ignored in-kind benefits like food, lodging, and railroad tickets.

Stock Options Not Money

When Congress adopted the RRTA in 1937, it understood "money" as "currency issued by a recognized authority as a medium of exchange." Stock options do not fall within this definition.

Further, while stock can be bought or sold for money, it is not usually considered a medium of exchange. Few people value goods and services using stock, or buy groceries or pay rent with stock.

Also, adding the word remuneration did not alter the meaning of the word money. Thus, "any form of money remuneration" indicated that Congress wanted to tax money compensation. It did not indicate that Congress wanted to tax things, like stock, that are not money.

Statutory Context

Moreover, the broader statutory context pointed to the same conclusion. For example, the 1939 Internal Revenue Code treated money and stock differently. However, the Federal Insurance Contribution Act taxes all remuneration, including benefits paid in a medium other than cash.

Further, a contemporaneous IRS rule explained that the RRTA taxed all money compensation. The rule lists examples like salaries, wages, commissions and bonuses. It also included things that could be used as money, like scrip. However, the rule did not suggest that stock was taxable compensation.

Thus, Congress knew the difference between money and other forms of compensation. The choice of Congress to use the narrower term for railroad pensions had to be respected.

Reversing and remanding CA-7, 2017-2 ustc ¶50,295.

A member of the Miccosukee Tribe of Indians of Florida had to pay federal income tax on distributions of gaming income that she and her family received from the tribe. The payments were taxable income under the Indian Gaming Revenue Act, rather than Indian general welfare benefits that were excluded from tax under Code Sec. 139E. Both the taxpayer and the tribe were bound by the decision.

A member of the Miccosukee Tribe of Indians of Florida had to pay federal income tax on distributions of gaming income that she and her family received from the tribe. The payments were taxable income under the Indian Gaming Revenue Act, rather than Indian general welfare benefits that were excluded from tax under Code Sec. 139E. Both the taxpayer and the tribe were bound by the decision.

Tribal Distributions

The Miccosukee Tribe distributed income to its members in quarterly payments. Historically, these payments were in the $20 to $25 range. In 1990, however, the tribe opened a gaming center that offered high-stakes bingo, poker, and video pull-tab machines. The tribe’s income, and its distributions to its members, increased substantially.

Each quarter, the tribe used the revenue of the gaming activities to fund per capita distributions to its members. But the tribe disregarded its federal tax obligations on these distributions. It neither reported the distributions nor withheld taxes on them. The tribe also told its members not to discuss the payments with outsiders, not to report them to credit card agencies, and not to cash the distribution checks in places that would report them to the IRS.

For the tax year at issue, the taxpayer received a total of $272,000, which represented payments for herself, her husband, and her two children. She did not file a tax return or pay any income tax for that year.

After the IRS assessed tax, interest and penalties against her, the taxpayer attempted to file a late return that reported the $272,000 as nontaxable income. She did not pay any of her assessment. The tribe intervened in her case as a matter of right.

District Court Decision

The District Court agreed with the IRS that the payments were distributions of gaming income that were fully taxable to the taxpayer. Most of the funds came from the gaming operation. The taxpayer and the tribe did not show what portion may have come from other, nontaxable sources.

Although the $272,000 included payments on behalf of the taxpayer’s husband and children, the taxpayer was responsible for tax on the entire amount. The tribe was structured as a matriarchy. Thus, the taxpayer was the head of her household, and the payments were all made available to her. She also spent all of the payments on household expenses, and she had reported all of the payments as her income when she tried to file a late return.

IGRA vs GWEA

The main issue on appeal was whether the tribe’s distributions were covered by the Indian Gaming Revenue Act or the Tribal General Welfare Exclusion Act.

The Indian Gaming Revenue Act (IGRA) was passed in 1988. It allows an Indian tribe to engage in gaming and distribute the revenue to members on a per capita basis. It also explicitly includes those distributions in a tribe member’s taxable income.

Code Sec. 139E was enacted in 2014 as part of the Tribal General Welfare Exclusion Act (GWEA). It excludes from federal taxation any payment made or services provided to or on behalf of an Indian tribe member under an Indian tribal government program. To be excludible, benefits provided under the program must be for the promotion of general welfare.

The court held that the exemption for Indian general welfare benefits under Code Sec. 139Edoes not apply to the per capita payments an Indian tribe makes from gaming revenue.

The taxpayer and the tribe claimed that GWEA effectively amended IGRA because it was more recent. The court disagreed, clarifying that IGRA applied only to gaming income, while GWEA was a law of general application. Thus, under the rules of statutory construction, IGRA continued to apply to distributions of gaming income because it was more specific than GWEA.

The court also rejected the characterization of the payments as distributions of the tribe’s tax revenues rather than its gaming income. The tax did not affect the nature of the gaming income. Instead, it was merely a mechanism to collect the income and distribute it to members.

The distributions also were not nontaxable income from Indian land, because they did not come directly from the use of the reservation land or its resources. Instead, the distributions came from improvements and related business activities–that is, gambling in the casino.

Effect on the Tribe

The tribe argued that it should not be included in the District Court’s judgment. However, the tribe had intervened as a matter of right because, if the court determined the payments were taxable, the tribe would have to report them and withhold income tax from them.

As an intervenor, the tribe had the same status as an original party. It also fully participated in the trial by arguing motions, attending depositions, presenting evidence, and examining witnesses. Thus, it was bound by the District Court’s judgment.

Affirming a DC Fla. decision, 2016-2 ustc ¶50,474.

An individual shareholder of an S corporation restaurant operator was not allowed to claim FICA tip credits under Code Sec. 45B that the S corporation did not claim. The shareholder could not unilaterally and retroactively nullify the S corporation’s election to deduct FICA tip taxes.

An individual shareholder of an S corporation restaurant operator was not allowed to claim FICA tip credits under Code Sec. 45B that the S corporation did not claim. The shareholder could not unilaterally and retroactively nullify the S corporation’s election to deduct FICA tip taxes.

Background

The restaurants owned by the S corporation had hired “tipped employees” whose earnings came partly from customer tips. The S corporation was required to pay taxes on these tips as part of its FICA tax payments. For the two tax years at issue, the S corporation did not claim any FICA tip credits. Instead, the S corporation deducted its payments of the FICA tip taxes on its Forms 1120S, and did not later amend those returns.

On his amended Forms 1040 for those tax years, the shareholder claimed he was entitled to flowthrough FICA tip credits with respect to his interest in the S corporation.

FICA Tip Credit

Code Sec. 45B allows an employer working in the food and beverage industry to claim business tax credits for the portion of the FICA taxes—i.e., social security and Medicare taxes—that it paid on employee tips in excess of the minimum wage. The employer must have employees who receive tips from customers for providing food or beverages for consumption, and must be deemed to have paid FICA taxes on the tips in excess of the minimum wage. The employer must not have already claimed a deduction for the FICA tax payment. An employer claims its FICA tip credits on Form 8846.

Here, when the S corporation chose to deduct its FICA tax payments, it had made an election not to claim any FICA tip credits. The S corporation never claimed or intended to claim FICA tip credits. Based on this reporting position, the shareholder was not entitled to any flowthrough FICA tip credits for either tax year.

S Corporation Elections

Under Code Sec. 1363(c) and its regulations, elections that affect the computation of items derived from an S corporation generally must be made by the S corporation, not separately by its shareholders. There are two exceptions: the shareholder claims any elections (1) for the deduction and recapture of certain mining exploration expenditures, and (2) for foreign tax credits.

In this case, the shareholder argued in effect that the S corporation’s election to deduct FICA tax payments could be changed unilaterally by his request, made in his capacity as a shareholder, that the S corporation amend its returns to claim the FICA tip credit. The shareholder’s position was rejected based on the plain text of Code Sec. 1363(c), and of Code Sec. 45B(d), which states that the credit does not apply to a taxpayer if the taxpayer elects to have the credit provision not apply.

Further, the Tax Court stated that it refused to create a new precedent that would give each individual shareholder the power to change an S corporation’s tax election unilaterally. Such a change, stated the court, would not only affect the tax liabilities of the requesting shareholder, but could also affect the tax liabilities of the shareholders who have not consented to the change.

The Treasury Department and the IRS have issued final regulations that:

• prevent a corporate partner from avoiding corporate-level gain through transactions with a partnership involving equity interests of the partner or certain related entities;
• allow consolidated group members that are partners in the same partnership to aggregate their bases in stock distributed by the partnership for purposes of limiting the application of rules that might otherwise cause basis reduction or gain recognition; and
• require certain corporations that engage in gain elimination transactions to reduce the basis of corporate assets or to recognize gain.

The Treasury Department and the IRS have issued final regulations that:

• prevent a corporate partner from avoiding corporate-level gain through transactions with a partnership involving equity interests of the partner or certain related entities;
• allow consolidated group members that are partners in the same partnership to aggregate their bases in stock distributed by the partnership for purposes of limiting the application of rules that might otherwise cause basis reduction or gain recognition; and
• require certain corporations that engage in gain elimination transactions to reduce the basis of corporate assets or to recognize gain.

The Treasury Decision adopts as final certain rules set forth in proposed regulations issued in 2015, under Code Sec. 337(d) (with only minor, nonsubstantive clarifications) ( NPRM REG-149518-03), and Code Sec. 732(f) ( NPRM REG-138759-14).

The final regulations affect partnerships and their partners, and apply to transactions occurring on or after June 12, 2015. The regulations are effective on June 8, 2018.

Acquisition of Interest in Stock to Avoid Gain on Appreciated Property

A corporation that distributes appreciated property to its shareholders has to recognize gain under Code Secs. 311(b) and 336(a) as if the property were sold to the shareholders for its fair market value. However, taxpayers have tried to postpone or avoiding the recognition of that gain.

For example, if a corporation exchanges appreciated property for its own stock, the corporation would recognize gain on the exchange. But corporations have tried to avoid recognizing that gain by, for example, taking these steps:

• the corporation enters into a partnership and contributes appreciated property;
• the partnership acquires stock of that corporate partner; then
• the partnership makes a liquidating distribution of the stock to the corporate partner.

The final regulations under Code Sec. 337(d) aim to prevent a corporate partner from avoiding gain recognition when it acquires or increases its interest in stock held by a partnership in exchange for appreciated property. Under the final regulations, a corporate partner may recognize gain when it is treated as acquiring or increasing its interest in stock of the corporate partner held by a partnership in exchange for appreciated property in a manner that avoids gain recognition under Code Sec. 311(b) or Code Sec. 336(a). The final regulations also provide exceptions under which a corporate partner is not required to recognize gain.

Limit on Basis Reduction or Gain Recognition for Consolidated Group Members

The final regulations limit rules that cause basis reduction or gain recognition for consolidated group members that are partners in the same partnership. Code Sec. 732(f)limits the basis of a distributed corporation’s property if—

• a corporate partner receives a distribution from a partnership of stock in another corporation (distributed corporation);
• the corporate partner has control of the distributed corporation, defined as ownership of stock meeting the requirements of Code Sec. 1504(a)(2), immediately after the distribution or at any time thereafter (control requirement); and
• the partnership’s basis in the stock immediately before the distribution exceeded the corporate partner’s basis in the stock immediately after the distribution.

Under these circumstances, the basis of the distributed corporation’s property must be reduced by this excess. Further, the corporate partner must recognize gain to the extent that the basis of the distributed corporation’s property cannot be reduced.

In applying this rule, the final regulations allow the bases of consolidated group members to be aggregated if when two conditions are met: (1) two or more of the corporate partners receive a distribution of stock in a distributed corporation from the partnership; and (2) the distributed corporation is or becomes a member of the distributee partners’ consolidated group after the distribution.

Elimination Transactions

Final regulations restrict corporate partners from entering into gain elimination transactions. They focus on attempts to eliminate gain in the stock of a distributed corporation while avoiding the effects of a basis step-down in transactions. Under the regulations, in the event of a gain elimination transaction, Code Sec. 732(f) will apply as though the corporate partner acquired control of the distributed corporation immediately before the gain elimination transaction.

Future Proposed Regs?

The Treasury and IRS are considering publishing a new notice of proposed rulemaking to propose more substantive amendments to the final 337(d) regulations, and to allow for additional public comment with respect to proposals in response to certain comments received, further reflection by the Treasury IRS, and concerns raised by practitioners.

Participants in the Son of BOSS tax shelter have maintained their perfect losing record in the Tax Court. Thus, another Son-of-Boss deal has failed to produce its promised loss deductions.

Participants in the Son of BOSS tax shelter have maintained their perfect losing record in the Tax Court. Thus, another Son-of-Boss deal has failed to produce its promised loss deductions.

Son-of-BOSS Arrangements

Son-of-BOSS is a variation of a slightly older tax shelter known as the "bond and options sales strategy," or BOSS. Son-of-BOSS transactions take many forms, but they all have one thing in common: Assets that are encumbered by significant liabilities must always be transferred to a partnership. The goal is to increase basis in that partnership or in the assets themselves.

The liabilities are usually obligations to buy securities. However, they are typically not completely fixed when they are transferred to the partnership.

This contingency is supposed to let the partnership treat the liabilities as uncertain. This, in turn, is supposed to let the partnership ignore the liabilities in computing basis. The result is supposed to give the partners basis in the partnership or in the assets themselves. This increased basis is supposed to translate into large loss deductions for the partners, all with no actual economic losses.

The Tax Court has yet to fall for the scheme.

Invalid Partnerships

The court has used several theories to reject Son-of-Boss losses. In this case, the court once again relied on the fact that the two partnerships involved in the transactions did not actually exist.

The partnerships were invalid because they were created only to carry out tax avoidance schemes. Thus, their members never intended to run any business through them.

The partnerships also failed the “prongified” test for determining whether the parties intended to, and did in fact, join together for the present conduct of an undertaking or enterprise. One managed to scrupulously adhere to the formal requirements for looking like a partnership. However, it did not display any objective indication of a mutual combination for the conduct of an ongoing enterprise.

The second partnership barely even went through the motions. It filed partnership returns and issued K-1s to its purported partners. However:

• There was no evidence the purported partners made any contributions to the partnership;
• The partnership did not have a formal operating agreement;
• The partnership did not conduct any business in its own name;
• There was no real profit for the partners to control or withdraw; and
• The partnership did not keep any books or records.

Since the partnerships were invalid, they were simply disregarded. Thus, the purported partners were treated as directly engaging in the partnerships’ activities and directly owning the partnerships’ property. This meant that the supposedly separate long and short options that were the heart of the transaction were actually a single-option spread. Thus the options were part of one contract, and they could not be separated to produce artificial losses.

Gross income is taxed to the person who earns it by performing services, or who owns the property that generates the income. Under the assignment of income doctrine, a taxpayer cannot avoid tax liability by assigning a right to income to someone else. The doctrine is invoked, for example, for assignments to creditors, family members, charities, and controlled entities. Thus, the income is taxable to the person who earned it, even if the person assigns the income to another and never personally receives the income. The doctrine can apply to both individuals and corporations.

Gross income is taxed to the person who earns it by performing services, or who owns the property that generates the income. Under the assignment of income doctrine, a taxpayer cannot avoid tax liability by assigning a right to income to someone else. The doctrine is invoked, for example, for assignments to creditors, family members, charities, and controlled entities. Thus, the income is taxable to the person who earned it, even if the person assigns the income to another and never personally receives the income. The doctrine can apply to both individuals and corporations.

A taxpayer cannot assign income that has already accrued from the property the taxpayer owns, and cannot avoid liability for tax on that income by assigning it to another person or entity. This result often applies to interest, dividends, rent, royalties, and trust income. The doctrine applies when the taxpayer's right to income has ripened so that the receipt of income is practically certain to occur. Once a right to receive income has ripened, the taxpayer who earned it or otherwise created that right will be taxed on the income.

Similarly, under the anticipatory assignment of income doctrine, a taxpayer cannot shift tax liability by transferring property that is a fixed right to income. However, a taxpayer can assign future income by making an assignment of property for value or a bona fide gift of the underlying property.

The doctrine does not apply if a right to income is sold or exchanged for value. If a gift of income-producing property is made, income earned after the date of the gift is taxed to the donee of the gift. If a taxpayer assigns a claim to income that is contingent or uncertain, the assignee of the right is taxable on income that the assignee collects on the claim. If a taxpayer transfers appreciated property prior to a sale or exchange, the appreciation is income to the person owning the property at the time of the sale or exchange.

The mortgage interest deduction is widely used by the majority of individuals who itemize their deductions. In fact, the size of the average mortgage interest deduction alone persuades many taxpayers to itemize their deductions. It is not without cause, therefore, that two recent developments impacting the mortgage interest deserve being highlighted. These developments involve new reporting requirements designed to catch false or inflated deductions; and a case that effectively doubles the size of the mortgage interest deduction available to joint homeowners. But first, some basics.

The mortgage interest deduction is widely used by the majority of individuals who itemize their deductions. In fact, the size of the average mortgage interest deduction alone persuades many taxpayers to itemize their deductions. It is not without cause, therefore, that two recent developments impacting the mortgage interest deserve being highlighted. These developments involve new reporting requirements designed to catch false or inflated deductions; and a case that effectively doubles the size of the mortgage interest deduction available to joint homeowners. But first, some basics.

Mortgage Interest Deduction Ground Rules

Mortgage interest — or "qualified residence interest" — is deductible by individual homeowners. Qualified residence interest generally includes interest paid or accrued during the tax year on debt secured by either the taxpayer's principal residence or a second dwelling unit of the taxpayer to the extent it is considered to be used as a residence (a "qualified residence").

Qualified residence interest comprises amounts paid or incurred on acquisition indebtedness and home equity indebtedness. Acquisition indebtedness is debt that is both:

1. secured by a qualified residence, and
2. incurred in acquiring, constructing or substantially improving the residence.

Home equity indebtedness is any debt secured by a qualified residence that is not acquisition indebtedness to the extent of the difference between the amount of outstanding acquisition indebtedness and the fair market value of the qualified residence.

A qualified residence for purposes of the home mortgage interest deduction can be the principal residence of the taxpayer, and one other residence selected by the taxpayer. In other words, the deduction is limited to interest payments on two homes.

Qualified residence interest is subject to several dollar limitations:

• The total acquisition indebtedness (principal) on which qualified residence interest is deductible is limited to $1 million ($500,000 in the case of married individuals filing separately).
• The total amount of home equity indebtedness (principal) taken into account in calculating deductible qualified residence interest may not exceed $100,000 ($50,000 in the case of married individuals filing separately).

Information reporting. Mortgage service providers have been required to report only the following information to the IRS annually with respect to individual borrower:

• the name and address of the borrower;
• the amount of interest received for the calendar year of the report; and
• the amount of points received for the calendar year and whether the points were paid directly by the borrower.

The amount of interest received by a mortgage service provider is reported on Form 1098, Mortgage Interest Statement, to the IRS. Form 1098 must also be furnished by the mortgage service provider to the payor on or before January 31 of the year following the calendar year in which the mortgage interest is received.

More Detailed Form 1098 Coming

The 2015 Surface Transportation Act (aka the Highway bill), which was signed into law on July 31, 2015, will require that Form 1098, Mortgage Interest Statement, filed with the IRS and provided to homeowners, include information on:

1. the amount of outstanding principal of the mortgage as of the beginning of the calendar year,
2. the address of the property securing the mortgage, and
3. the loan origination date.

These items are in addition to the information that parties were already required to provide to the IRS and payors under existing law.

The Government Accountability Office (GAO) had expressed concern that the information reported on Form 1098 is insufficient to allow the IRS to enforce compliance with the deductibility requirements for qualified residence interest. This criticism has included in particular, but not limited to, the dollar limitations imposed on acquisition indebtedness and home equity indebtedness.

While the modifications are intended to boost compliance with the deductibility requirements for qualified residence interest, they also impose a new burden on mortgage service providers. To give mortgage service providers time to reprogram their systems, the additional reporting requirements apply to returns and statements required to be furnished after December 31, 2016.

Joint Ownership

Another major development impacting on some homeowners’ mortgage interest deduction also took place this summer. Reversing the Tax Court, a panel of the Court of Appeals for the Ninth Circuit has found that when multiple unmarried taxpayers co-own a qualifying residence, the debt limit provisions apply per taxpayer and not per residence (Voss, CA-9, August 7, 2015). The question was one of first impression in the Ninth Circuit, the court observed.

Background. The taxpayers, registered domestic partners, obtained a mortgage to purchase a house (the Rancho Mirage property). In 2002, the taxpayer refinanced and obtained a new mortgage. That same year, the taxpayers purchased another house (the Beverly Hills property) with a mortgage, which they subsequently refinanced and obtained a home equity line of credit totaling $300,000. The total average balance of the two mortgages and the line of credit during the tax years at issue was approximately $2.7 million.

Both taxpayers filed separate income tax returns. Each individual claimed home mortgage interest deductions for interest paid on the two mortgages and the home equity line of credit. The IRS calculated each taxpayer’s mortgage interest deduction by applying a limitation ratio to the total amount of mortgage interest that each petitioner paid in each taxable year. The limitation ratio was the same for both: $1.1 million ($1 million of home acquisition debt plus $100,000 of home equity debt) over the entire average balance, for each tax year, on the Beverly Hills mortgage, the Beverly Hills home equity line of credit, and the Rancho Mirage mortgage. The taxpayers challenged the IRS’s calculations but the Tax Court ruled in favor of the agency.

Court’s analysis. Code Sec. 163(h)(3), the court found, provides that interest on a qualified residence, by a special carve-out, is not considered "personal interest," which would otherwise be nondeductible by taxpayers who are not corporations. A qualified residence is the taxpayer’s principal residence and one other residence of the taxpayer which is selected by the taxpayer for the tax year and which is used by the taxpayer as a residence.

The court further found the Tax Code limits the aggregate amount treated as acquisition indebtedness for any period to $1 million and the aggregate amount treated as home equity indebtedness for any period to $100,000. In the case of a married individual filing a separate return, the debt limits are reduced to $500,000 and $50,000.

Looking at the language of the Tax code, the court found that the debt limit provisions apply per taxpayer and not per residence. There was no reason not to extend this treatment to unmarried co-owners, the court concluded. Thus, each of the homeowners were entitled to the $1 million limit.

Whether this holding will hold up in jurisdictions other than the Ninth Circuit (California and other western states, including Hawaii), and whether it will apply to joint ownership situations for vacation homes, for example, remains to be tested.

If you have any questions regarding how best to maximize your mortgage interest deduction, please do not hesitate to contact this office.

Many federal income taxes are paid from amounts that are withheld from payments to the taxpayer. For instance, amounts roughly equal to an employee's estimated tax liability are generally withheld from the employee's wages and paid over to the government by the employer. In contrast, estimated taxes are taxes that are paid throughout the year on income that is not subject to withholding. Individuals must make estimated tax payments if they are self-employed or their income derives from interest, dividends, investment gains, rents, alimony, or other funds that are not subject to withholding.

Many federal income taxes are paid from amounts that are withheld from payments to the taxpayer. For instance, amounts roughly equal to an employee's estimated tax liability are generally withheld from the employee's wages and paid over to the government by the employer. In contrast, estimated taxes are taxes that are paid throughout the year on income that is not subject to withholding. Individuals must make estimated tax payments if they are self-employed or their income derives from interest, dividends, investment gains, rents, alimony, or other funds that are not subject to withholding.

Estimated income tax payments are required from taxpayers who:

1. expect to owe at least $1,000 in tax for the year, after subtracting taxes that were paid through withholding and tax credits; and
2. expect that the amount of taxes to be paid during the year through other means will be less than the smaller of—
• 90% of the tax shown on the current year's tax return, or
• 100% of the tax shown on the previous year's return (the previous year's return must cover all 12 months). This 100-percent test increases to 110 percent if the taxpayer's AGI for the previous year exceeds $150,000.

U.S. citizens who have no tax liability for the current year are not required to make estimated tax payments.

Form 1040-ES. Taxpayers use Form 1040-ES to calculate, report and pay their estimated tax. The annual liability may be paid in quarterly installments that are due based upon the taxpayer's tax year. However, no payments are required until the taxpayer has income upon which tax will be owed. Taxpayers may also credit their overpayments from one year against the next year's estimated tax liability, rather than having them refunded.

Generally, the required installment is 25 percent of the required annual payment. However, a taxpayer who receives taxable income unevenly throughout the year can elect to pay either the required installment or an annualized income installment. The use of the annualized income installment method, provided on a worksheet contained in the instructions to Form 2210, Underpayment of Estimated Tax by Individuals and Fiduciaries, may reduce or eliminate any penalty for underpaid taxes.

Due Dates. For most individual taxpayers, the quarterly due dates for estimated tax payments are:

Penalties. A penalty generally applies when a taxpayer fails to make estimated tax payments, pays less than the required installment amount, or makes late payments. However, the IRS may waive the penalty if the underpayment was due to casualty, disaster or other unusual circumstances.

A business operated by two or more owners can elect to be taxed as a partnership by filing Form 8832, the Entity Classification Election form. A business is eligible to elect partnership status if it has two or more members and:

A business operated by two or more owners can elect to be taxed as a partnership by filing Form 8832, the Entity Classification Election form. A business is eligible to elect partnership status if it has two or more members and:

• is not registered as anything under state law,
• is a partnership, limited partnership, or limited liability partnership, or
• is a limited liability company.

Publicly traded businesses cannot elect to be treated as partnerships. They are automatically taxed as corporations.

Form 8832 allows a business to select its classification for tax purposes by checking the box on the form: partnership, corporation, or disregarded. If no check-the-box form is filed, the IRS will assume that the entity should be taxed as a partnership or disregarded as a separate entity. An LLC that makes no federal election will be taxed as a partnership if it has more than one member and disregarded if it has only one member. An LLC must make an affirmative election to be taxed as a corporation. The IRS language on Form 8832 uses the term "association" to describe an LLC taxed as a corporation.

Form 8832 has no particular due date. There is a space on the form (line 4) for the entity to note what date the election should take effect. The date named can be no earlier than 75 days before the form is filed, and no later than 12 months after the form is filed. It is most important to file Form 8832 within the first few months of operations if the entity desires a tax treatment that differs from the tax status the IRS will apply by default if no election is made.

A few businesses do not qualify to be partnerships for federal tax purposes. These are:

1. a business that is a corporation under state law,
2. a joint stock company (a corporation without limited liability),
3. an insurance company,
4. most banks,
5. an organization owned by a state or local government,
6. a tax-exempt organization
7. a real estate investment trust, or
8. a trust.

Although these businesses cannot be partnerships, they can be partners in a partnership (they can join together to form a partnership).

Of course, whether your business is best operated as a partnership, as a corporation or as another type of entity should not only be driven by short-term tax considerations. How you envision your business will develop over time, whether your business is asset or service intensive, and what personal financial stake you plan to take, among other factors, are all additional factors that should be considered.

The IRS expects to receive more than 150 million individual income tax returns this year and issue billions of dollars in refunds. That huge pool of refunds drives scam artists and criminals to steal taxpayer identities and claim fraudulent refunds. The IRS has many protections in place to discover false returns and refund claims, but taxpayers still need to be proactive.

The IRS expects to receive more than 150 million individual income tax returns this year and issue billions of dollars in refunds. That huge pool of refunds drives scam artists and criminals to steal taxpayer identities and claim fraudulent refunds. The IRS has many protections in place to discover false returns and refund claims, but taxpayers still need to be proactive.

Tax-related identity theft

Tax-related identity theft most often occurs when a criminal uses a stolen Social Security number to file a tax return claiming a fraudulent refund. Often, criminals will claim bogus tax credits or deductions to generate large refunds. Fraud is particularly prevalent for the earned income tax credit, residential energy credits and others. In many cases, the victims of tax-related identity theft only discover the crime when they file their genuine return with the IRS. By this time, all the taxpayer can do is to take steps to prevent a recurrence.

Being proactive

However, there are steps taxpayers can take to reduce the likelihood of being a victim of tax-related identity theft. Personal information must be kept confidential. This includes not only an individual's Social Security number (SSN) but other identification materials, such as bank and other financial account numbers, credit and debit card numbers, and medical and insurance information. Paper documents, including old tax returns if they were filed on paper returns, should be kept in a secure location. Documents that are no longer needed should be shredded.

Online information is especially vulnerable and should be protected by using firewalls, anti-spam/virus software, updating security patches and changing passwords frequently. Identity thieves are very skilled at leveraging whatever information they can find online to create a false tax return.

Impersonators

Criminals do not only steal a taxpayer's identity from documents. Telephone tax scams soared during the 2015 filing season. Indeed, a government watchdog reported that this year was a record high for telephone tax scams. These criminals impersonate IRS officials and threaten legal action unless a taxpayer immediately pays a purported tax debt. These criminals sound convincing when they call and use fake names and bogus IRS identification badge numbers. One sure sign of a telephone tax scam is a demand for payment by prepaid debit card. The IRS never demands payment using a prepaid debit card, nor does the IRS ask for credit or debit card numbers over the phone.

The IRS, the Treasury Inspector General for Tax Administration (TIGTA) and the Federal Tax Commission (FTC) are investigating telephone tax fraud. Individuals who have received these types of calls should alert the IRS, TIGTA or the FTC, even if they have not been victimized.

Tax-related identity theft is a time consuming process for victims so the best defense is a good offense. Please contact our office if you have any questions about tax-related identity theft.

An employer must withhold income taxes from compensation paid to common-law employees (but not from compensation paid to independent contractors). The amount withheld from an employee's wages is determined in part by the number of withholding exemptions and allowances the employee claims. Note that although the Tax Code and regulations distinguish between withholding exemptions and withholding allowances, the terms are interchangeable. The amount of reduction attributable to one withholding allowance is the same as that attributable to one withholding exemption. Form W-4 and most informal IRS publications refer to both as withholding allowances, probably to avoid confusion with the complete exemption from withholding for employees with no tax liability.

An employer must withhold income taxes from compensation paid to common-law employees (but not from compensation paid to independent contractors). The amount withheld from an employee's wages is determined in part by the number of withholding exemptions and allowances the employee claims. Note that although the Tax Code and regulations distinguish between "withholding exemptions" and "withholding allowances," the terms are interchangeable. The amount of reduction attributable to one withholding allowance is the same as that attributable to one withholding exemption. Form W-4 and most informal IRS publications refer to both as withholding allowances, probably to avoid confusion with the complete exemption from withholding for employees with no tax liability.

An employee may change the number of withholding exemptions and/or allowances she claims on Form W-4, Employee's Withholding Allowance Certificate. It is generally advisable for an employee to change his or her withholding so that it matches his or her projected federal tax liability as closely as possible. If an employer overwithholds through Form W-4 instructions, then the employee has essentially provided the IRS with an interest-free loan. If, on the other hand, the employer underwithholds, the employee could be liable for a large income tax bill at the end of the year, as well as interest and potential penalties.

How allowances affect withholding

For each exemption or allowance claimed, an amount equal to one personal exemption, prorated to the payroll period, is subtracted from the total amount of wages paid. This reduced amount, rather than the total wage amount, is subject to withholding. In other words, the personal exemption amount is $4,000 for 2015, meaning the prorated exemption amount for an employee receiving a biweekly paycheck is $153.85 ($4,000 divided by 26 paychecks per year) for 2015.

In addition, if an employee's expected income when offset by deductions and credits is low enough so that the employee will not have any income tax liability for the year, the employee may be able to claim a complete exemption from withholding.

Changing the amount withheld

Taxpayers may change the number of withholding allowances they claim based on their estimated and anticipated deductions, credits, and losses for the year.  For example, an employee who anticipates claiming a large number of itemized deductions and tax credits may wish to claim additional withholding allowances if the current number of withholding exemptions he is currently claiming for the year is too low and would result in overwithholding.

Withholding allowances are claimed on Form W-4, Employee's Withholding Allowance Certificate, with the withholding exemptions. An employer should have a Form W-4 on file for each employee. New employees generally must complete Form W-4 for their employer. Existing employees may update that Form W-4 at any time during the year, and should be encouraged to do so as early as possible in 2015 if they either owed significant taxes or received a large refund when filing their 2014 tax return.

The IRS provides an IRS Withholding Calculator at www.irs.gov/individuals that can help individuals to determine how many withholding allowances to claim on their Forms-W-4. In the alternative, employees can use the worksheets and tables that accompany the Form W-4 to compute the appropriate number of allowances.

Employers should note that a Form W-4 remains in effect until an employee provides a new one. If an employee does update her Form W-4, the employer should not adjust withholding for pay periods before the effective date of the new form. If an employee provides the employer with a Form W-4 that replaces an existing Form W-4, the employer should begin to withhold in accordance with the new Form W-4 no later than the start of the first payroll period ending on or after the 30th day from the date on which the employer received the replacement Form W-4.