Federal Tax Alert the - National Society of Tax Professionals · 2016-09-01 · 2uly / augus j T 2016 [email protected] The Federal Tax alerT Nina Tross, MBA, EA nna Tross, MBA, i eA

The Federal Tax alerT [email protected] july / augusT 2016 1

Blueprint for Tax Reform

continued on page 3

In This IssueIn The news

Blueprint for Tax reform ..... 1

The Cohan rule: still good after all These years .......... 6

PRACTICe MAnAGeMenTIrs May revise Forms to require sole Owner of disregarded entity to Provide eIN ....................... 5

Irs enforcement Budget .... 10

FRoM The BenChTaxpayer had COd Income but Was entitled to exclude it under Insolvency exception ......................... 7

Married Couple unreported Income and unsubstantiated deductions denied............. 9

eTCeTeRAa Timely Tip from ennis T. Pea: What is sec. 199? ...... 8

InFoRMATIonNsTP Calendar ................. 3 Tax hotline ....................... 3NsTP Member Benefits ....... 4Fall update seminars ........11

NaTIONal sOCIeTy of Tax PrOFessIONals

Federal Tax Alertjuly / august 2016

the

on June 24, 2016 House Republicans released a new installment of "A

Better Way - Our Vision for a Confident America," containing a number of tax reform proposals. The document (blueprint) is meant to serve as the basis of tax reform legislation which will be ready for legislative action in 2017. It reflects several months of deliberation by the Tax Reform Tax Force, led by Ways and Means Committee Chairman Kevin Brady (TX-R), which was charged earlier this year with delivering a strategy to create jobs, grow the economy, and raise wages by reducing rates, removing special interest carve-outs, and making our broken tax code simpler and fairer.

Among its provisions regarding individual taxpayers the blueprint would:• simplify, flatten and lower tax rates for

families and individuals, reducing both the top rate (to 33%) and the number of brackets (to three);

• provide for reduced and progressive tax rates on capital gains, dividends and interest income;

• eliminate the alternative minimum tax (AMT);

• consolidate a number of existing family tax benefits into a larger standard deduction and a larger child and dependent tax credit;

• continue the earned income tax credit (EITC), but look for ways to improve it;

• simplify tax benefits for higher education;

• eliminate all itemized deductions except the mortgage interest deduction and charitable contribution deduction;

• continue current tax incentives for retirement savings; and

• repeal the estate and generation-skipping transfer taxes.

Business tax provisions in the blueprint include:• creating a new business rate for small

businesses that are organized as sole proprietorships or pass-through entities instead of taxing them at individual rates;

• reducing the corporate tax rate to 20%;

• providing for immediate expensing of the cost of business investments;

• allowing interest expense to be deducted only against interest income, with any net interest expense carried forward and allowed as a deduction against net interest income in future years (with special rules that will apply for financial services companies);

• allowing net operating losses (NOLs) to be carried forward indefinitely and increased by an interest factor, and eliminating NOL carrybacks;

• retaining the research credit (but evaluating options to make it more effective);

• eliminating unspecified special interest deductions and credits;

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2 july / augusT 2016 [email protected] The Federal Tax alerT

Nina Tross, MBA, EAnina Tross, MBA, eA

Paul La Monaca, CPA, MSTPaul la Monaca, CPA, MsT

from the edIToRs

The IRS Tax Forums are in process and NSTP has been representing your

concerns with the IRS staff and other stakeholders. Come and visit our booth in the National Tax Forum Exhibit Hall just to say hi and to share your concerns and issues with the IRS.

We are presenting two sessions during the Tax Forums:

1. Schedule C Issues Facing the Tax Professional which discusses the complex and difficult federal income tax issues facing both the new and seasoned tax professional when preparing the Schedule C, Profit or Loss from Business. The course includes issues such as:

• what the tax professional should understand about the “tax gap” as it relates to Schedule C filers;

• when and how revenues and expenses are to be reported;

• understanding the make-up of the Schedule C and the reporting requirements; and

• the challenges, limitations and opportunities for filing the Schedule C as it relates to the rest of the individual taxpayer’s Form 1040.; and

2. The Tax Professional’s Guide to Understanding the Importance of the Substantiation of Business Expense Deductions which provides tax professionals with information to educate their clients on the importance of understanding what is and what is not an allowable business expense, as well as how to determine what is an “ordinary and necessary” expense under Internal Revenue Code (IRC) 162. The course will discuss the proper substantiation for verifying deductions and the importance of good record keeping for tax purposes.

The main concern of the IRS Commissioner Koskinen remains identity theft and refund fraud. There is still considerable activity

in this area and several one page Fact Sheets will be issued by the IRS to assist tax practitioners with monitoring fraudulent activity within their tax practice.

Two specific strategies that you can be utilizing right now is to monitor the number of Form 1040 returns filed under your PTIN; and the total number of returns filed under your EFIN.

Following, we are providing the steps to take in order to monitor the number of returns that are being filed under your identification numbers.

A. Information is available in the online PTIN system for tax return preparers who meet both of the following criteria, you must:

Have a professional credential (Enrolled Agent, Certified Public Accountant , Attorney, Enrolled Retirement Plan Agent, or Enrolled Actuary) or are an Annual Filing Season Program participant, and

Have had at least fifty Form 1040 series tax returns processed in the current year

However, it is important to monitor this information even if you do not prepare returns or only prepare a small number of returns. No data will be shown if less than 50 returns have been processed with your PTIN. If your record shows an unusual number of returns then there may be unauthorized use of your PTIN.

To access Returns Filed Per PTIN information, follow these steps:

1. Visit www.irs.gov/ptin and log into your PTIN account.

2. From the Main Menu, find “Additional Activities”.

3. Under Additional Activities, select “View Returns Filed Per PTIN”.

4. A chart labeled Returns Per PTIN should appear.

5. A count of individual income tax returns filed and processed in the current year will be displayed.

The information in the Returns per PTIN chart is updated weekly. If the number of returns processed is significantly more than the number of tax returns you have prepared and you suspect possible misuse of your PTIN, complete and submit Form 14157, Complaint: Tax Return Preparer, to the IRS.

B.Anyone can verify their EFIN through e-Services. If you do not have an e-Services account, than your first step would be to go onto e-Services and register for an account.

Once you have logged into your e-Services account, follow these steps to verify the number of returns electronically filed with the IRS:

1. Select your name,

2. In the left banner, select ‘Application’,

3. In the left banner, select ‘e-File Application’,

4. Select your name again,

5. In the listing, select ‘EFIN Status’ and on this screen you can see the number of returns filed based on return type.

Help safeguard your EFIN. During the filing season, check on your EFIN status to ensure that your EFIN is not being used by others improperly. Your e-file application will help verify the volume received by the IRS which you can match to your records. The statistics are updated weekly. Should you see a higher volume than you transmitted, please contact the e-help Desk at 866-255-0654.

Congress is still tinkering with the Tax Code and on page 1 we cover the newest “Blueprint for Tax Reform.” And on page 6 we review the Cohan Rule, still alive and well after all the years.


Technical Tax advice provided by NSTP Hotline staff is based upon specific information conveyed by the member. Members should take special care in relying upon recommendations and opinions that reflect the understanding of the Hotline staff member. NSTP and the Hotline staff are not responsible for misapplication of information given. Members are responsible for the ultimate verification and application of any information provided by NSTP.

NOTICe • TAX hoTlIne • dIreCT lINe: 360-695-0556

January 1 – January 31, 2016Monday–Friday

9:00 aM – 2:00 PM Pst 10:00 aM – 3:00 PM Mst 11:00 aM – 4:00 PM Cst 12:00 PM – 5:00 PM Est

February 2 – April 16, 2016Monday, Tuesday & Thursday

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April 16 – december 31, 2016Monday, wednesday & Friday


The Federal Tax Alert is published 6 times a year by the National society of tax Professionals.

MAIlInG AddRess: the Federal tax alert 11700 NE 95th st., suite 100, Vancouver, Wa 98682

TelePhone: 800-367-8130

edIToRs:

Paul la Monaca, CPa, [email protected]

Nina tross, MBa, Ea [email protected]

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Opinions expressed in The Federal Tax Alert are those of the editors and contributors.

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2016August 23 – 25, 2016

IRs Tax ForumNational Harbor, MD

August 29, 2016:

Annual Federal Tax Refresher (AFTR) CourseOrlando, Fl

August 30 – september 1, 2016

IRs Tax ForumOrlando, Fl

september 12, 2016:

Annual Federal Tax Refresher (AFTR) Coursesan Diego, Ca

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For information on NstP classes and events, go to nsTP.org and click ‘Education’.

• shifting to a territorial tax system;

• moving toward a consumption-based tax approach;

• providing a 100% exemption for dividends from foreign subsidiaries; and

• simplifying international tax rules including elimination of most of the subpart F rules.

Finally, the blueprint suggests a number of IRs reforms, including provisions to:

• streamline the agency and center it on three major units: one for families and individuals, one for business and a new small claims court unit that would be independent of IRS and designed to allow routine disputes to be resolved more quickly;

• reform IRS leadership so that it is headed by an Administrator appointed by the President with the consent and advice of the Senate for a single 3-year term;

• have a new singular "Service First" mission;

• commit to taxpayer assistance; and

• make other improvements designed to promote efficiency and an (effective use of taxpayer resources.

n

Blueprint for Tax Reform continued from page 1


• Tax Hotline: our members are never charged a fee for use of the Tax Hotline regardless of the number of times you contact us.

• NSTP Dividend Reward Points: Dividend reward points are earned each time you make a purchase with NSTP whether membership, live events, self-study or materials. Dividend points are automatically deposited into your rewards account and accumulated for you. One dividend point is earned for every dollar spent with NSTP. The dividend points never expire as long as your membership in NSTP continues. Your dividend points can then be “spent” on CPE courses and other educational materials. When you don’t have enough points to qualify

to receive your entire course for free, you can purchase the rest of the credits at a specified per credit hour rate. This purchase also earns dividend reward points and your rewards account keeps growing!

• Federal Tax Alert technical newsletter (6 Issues)

• Tax Client Newsletter (3 Issues). Brand with your own logo and send to your customers

• Weekly Update email (52 issues) keeps you current and up-to-date

• Federal Tax Update Seminars across the country at member rate to prepare for the upcoming tax season, including ACA information

• Webinars with CE credits: members get reduced price

• Member rate for Ethics, Special Topics and Executive Session Workshops in Williamsburg, VA and Napa, CA

• NSTP Tax Research Service: member rate for expanded research services. You will be provided with a written report including tax sources, tax code and tax law cites as appropriate

• Professional Liability Insurance at group rates

• Beautiful Membership Certificate (suitable for framing) acknowledging your membership in the National Society of Tax Professionals

Are you Aware of your nsTP Member Benefits?

from the nsTP BoARd PResIdenT

summer of 2016 is in full swing for NSTP members. The kids are out of

school and family vacations are being enjoyed or anxiously awaited. For the many who decided to get away in May, shortly after Tax Season concluded, and traveled to NSTP’s Cabo San Lucas, MX Retreat and Conference, we know you thoroughly enjoyed yourselves and benefited from 15 hours of quality CE to boot. You worked long hard hours during tax season and earned every bit of your enjoyment. Three days of 5 hour classes, ending by 1PM, at an ALL-INCLUSIVE resort with two pools, meals, refreshment bars and of course the scenic marina with Pacific clear waters. Yes, and lots of sun and more fun than one can imagine topped off with a fabulous sunset cruise on one of Cabo’s most luxurious super catamarans with plenty of room for everyone and their guests, NSTP conferees did it up right for the second year in a row. What more could you ask for? If you missed it, then plan on it now for next year. Sign up early! Remember, the month of May is off-season in Cabo, so travel and hotel rates are lower than normal. Come check it out. I look forward to seeing you next year in Cabo!

Extension season is also in full swing and NSTP’s Federal Tax Hotline is available to all members throughout the Summer & Fall months to help you channel your way through the rough waters of completing returns. Help is only a phone call away. With this in mind, in order for NSTP to facilitate all member calls efficiently,

we ask that before you call, take time to understand your issue, carefully lay out your facts from your client, review the IRS publications and form instructions to narrow your questions, then call the Tax Hotline. If you’re more efficient so are we and that’s a recipe for success. Who benefits…you and your clients do.

This past year, we’ve also added a “Paid Research” program that members and nonmembers alike can take advantage of when a simple few minute verbal call just isn’t enough teeth to satisfy your hunger for the right answer. Details of this service can be found on the NSTP website, http://www.nstp.org/expanded_research_hotline.php. It’s worth every penny and you can rebill it to your clients so it virtually can be “no cost to you.”

How else may your tax questions be answered, you may ask? NSTP has live CE classes, regularly scheduled webinars and CE materials taught live, all of which are available for purchase on our website. Sign up for all the incredible courses and help make yourself a greater resource to your clients and perhaps just as important, potential clients. Get the competitive edge over your neighboring tax services. Thinking that may be too expensive for all those courses. Sign up for NSTP’s Executive Membership. One flat annual membership fee enables you unlimited NSTP live courses and webinars. Take yourself to the next level. Visit www.NSTP.Org for more details and limitations.

Finally, I’d like to put a call out for those who would like to give back to the profession and NSTP by volunteering for a committee. Currently, there are two committees seeking volunteers: 1) the Board Advisory Committee and 2) the Membership Committee. NSTP is a member-based organization for the benefit of the “members.” It is your involvement that makes your organization the best! Call or email the office to volunteer. Your contact information will be forwarded to the committee chairperson. Not enough time for a committee, no problem. Reach out to us via email at [email protected] with your thoughts, comments, recommendations, changes, etc. We read and listen to all.

NSTP has been serving you since 1985 and it will continue to be here to see you successfully through your retirement and the generations to follow. The National Society of Tax Professionals is, The Premier Choice for tax professionals.

Keith E. Huebel, CPAKeith e. huebel, CPA NSTP President of the Board


PrACtICe mANAGemeNt

IRs May Revise Forms to Require sole owner of disregarded entity to Provide eInProgram Manager Technical Advice 2016-008

A Program Manager Technical Advice (PMTA) has concluded that IRS has

the authority to modify tax return forms and instructions under §6011(a)and Reg. §1.6011-1(a) to require the sole owner of a disregarded entity to provide the entity’s Employee Identification Number (EIN) on the owner’s tax return, and suggested potential revision to the relevant forms and instructions in order to promote effective tax administration. However, the PMTA found that a return filed without the additional EIN would still be a valid return for purposes of the statute of limitations and failure to file penalties.

Background of IRs’s authority to require information reporting: Under the Code, taxpayers themselves are the source of information necessary to compute the tax and are required to report information that the IRS considers relevant in doing so. Requirements for making and filing tax returns are found in §6011(a)and Reg. §1.6011-1(a), which generally provide that any person liable for any tax imposed by the Code must file a return and that includes the information required by the forms and IRS regulations. In addition, under §6011(b) the IRS is authorized to require taxpayers to include on their returns the information necessary to properly identify the taxpayer.

Background on disregarded entities: Under the ‘check-the-box’ rules at Reg. §301.7701-1 an eligible entity that has a single owner and is not treated as a corporation is disregarded as an entity separate from its owners. (Reg. §301.7701-2(c)(2)(i))

Reg. §301.7701-2(a) states that the activities of a disregarded entity are treated the same as a sole proprietorship. The income earned by a disregarded entity must be reported on the owner’s income tax return and reported under the owner’s Taxpayer Identification Number (TIN)

(Reg. §301.6109-1(h)). However, disregarded entities can use an EIN for other purposes, such as for reporting employment taxes and other business taxes. (Reg. §301.6109-1(d)(4)(ii))

Compliance Issues: Allowing a taxpayer to use two types of identification numbers (TINs and EINs) may cause problems for IRS in associating different types of returns with a single taxpayer. If a disregarded entity has an EIN, then it typically does not appear on the owner’s tax return. Certain information returns such as Forms 1099 that reflect income earned by a disregarded entity may reflect the entity’s EIN and not the owner’s TIN. This makes matching the income reported on such an information return to what is reported on an income tax return much more difficult.

In light of the above, the PMTA specifically addresses whether IRS can, under existing regulations, change tax return forms and instructions to require the sole owner of a disregarded entity to provide the disregarded entity’s EIN on the owner’s tax return.

Forms and instructions can require including eIn: The PMTA citing IRS’s broad authority to require taxpayers to report certain information concludes that tax return forms and instructions can be modified under §6011(a)and Reg. §1.6011-1(a) to require the sole owner of a disregarded entity to provide the disregarded entity’s EIN on the owner’s tax return. The PMTA notes that the IRS is authorized to require the use of TINs on returns because it is necessary and helpful in securing proper identification of the filer. TINs enable IRS to identity in its records the type of taxpayer as well as the taxpayer’s account information. Nothing in the TIN regulations prevent the IRS from requiring the owner of a disregarded entity to report all the EINs used in its business dealings on the owner’s tax return.

Return would still be valid without eIn: While the PMTA found that IRS has the authority to require the sole owner of a disregarded entity to provide the disregarded entity’s EIN on the owner’s tax return, the failure to do so would neither invalidate the return for statute of limitation purposes nor make the filer subject to failure to file penalty. Case law provides that to be deemed a return, a document filed with IRS must: (1) contain sufficient data to calculate the taxpayer’s tax liability, (2) purport to be a return, (3) must be a reasonable attempt to satisfy the requirements of the tax law, and (4) be signed under penalty of perjury. (See, e.g. Beard, (1984) 82 TC 766) Generally, the omission of the taxpayer’s identification number does not render a return invalid. (U.S. v. Grabinski, (CA 8 1984) 53 AFTR 2d 84-710)

Possible future revision of forms: Requiring the owner of a disregarded entity to include the EINs of his disregarded entities that have them, according to the PMTA would assist in tax administration and would not be burdensome for the owner. The PMTA suggested that the individual who requested this advice coordinate with Forms and Publications in revising the relevant forms and instructions.

n


IN the NeWS

The Cohan Rule: still Good After All These yearsWhat is the Cohan Rule?

George M. Cohan was a very well-known Broadway star in the early 1900s (his most famous performance is Give My Regards to Broadway). Interestingly, his legacy is also closely connected to tax law. Cohan was audited by the IRS and was told that he was not allowed to deduct many of his business and entertainment related expenses because he did not keep all of the necessary receipts. Mr. Cohan appealed this ruling and the courts actually sided with him, forcing the IRS has to accept estimates of his expenses. The Cohan rule is based on a Second Circuit decision from 1930 in which George M. Cohan, a great entertainer but a lousy bookkeeper, claimed substantial travel and entertainment expenses but could not provide adequate records (Cohan, 39 F.2d 540 (2d Cir. 1930)). The Cohan Rule is now a law that allows taxpayers to deduct some of their business-related expenses even if the receipts have been lost or misplaced so long as they are reasonable and credible.

How does the Cohan Rule work with the IRS?

Based on the Cohan ruling, the IRS must allow a business owner to deduct some of the business expenses, even if you do not have each and every receipt to back them up. The idea is that you incur expenses as you run your business, which are not, cannot or were not always documented. Keep in mind, however, that the IRS expects that you to provide credible evidence of these expenses and while you might not have an actual receipt, you can also show pertinent records like calendar notice, canceled checks, or other notes to indicate that you are not fabricating this expense.

While the Cohan Rule allows the taxpay-er to deduct some reasonable expenses even without receipts, there is a catch. If you do not have receipts, you may not be reimbursed for the full amount of your expenses. The IRS will only allow you to deduct the least amount of money that you could have possibly spent, not the entire sum.

Today, Cohan would lose his battle

because the Code has subsequently been amended by the addition of Sec. 274(d), which requires substantiation for travel, entertainment, business gifts, and expenses with respect to listed property. These expenses must be appropriately documented in order to be allowable as a business expense.

Can you use the Cohan Rule?If you are the subject of an audit and do not feel that the auditor is giving you credit for deductions that are legitimate (but that you do not have documenta-tion to support), you can certainly bring up the Cohan Rule. You also have every right to appeal an audit and raise this issue in court. The IRS is not required to grant you these deductions, but it is certainly worth a try. You may find that you end up getting credit for a portion of your deductions.

Credible Testimony Allows Some Deductions Under the Cohan Rule:In Arizago, T.C. Memo 2016-57, the feasibility of the Cohan Rule was tested again with the IRS and was found to be a reasonable defense to allow a portion of ordinary and reasonable business expenses.

The taxpayer operated a restaurant as a sole proprietorship. He had another full-time job, so he could only devote a few hours a day to the restaurant. He hired a part-time chef, a dishwasher, and at least one waitress. He paid all of his workers in cash. His then girlfriend kept the books and did some manual work in the restau-rant. She later left him and took some of the business records with her.

For the tax year at issue, the taxpayer reported on Schedule C gross receipts of $21,280. He reported no cost of goods sold. Under supplies, he reported a de-duction of $9,258. He reported no wag-es. Instead, he claimed a deduction of

$5,620 for contract labor.

The IRS disallowed the deduction for supplies and contract labor for lack of substantiation. At trial, the taxpayer provided no docu-mentation to substantiate these deductions because he testified that his ex-girl-friend had absconded with most of the records. He tes-tified that the deduction for supplies included the food and other items that should

have gone into his cost of goods sold. He also testified that the deduction for con-tract labor was the cash compensation he had paid his cook, his dishwasher, and his waitress.

The IRS also disallowed an advertising deduction of $2,880 for lack of sub-stantiation. At trial, the taxpayer sub-mitted a copy of a full-page advertise-ment from the local Spanish language newspaper featuring a photo of the tax-payer, his then girlfriend, and his chef, urging people to dine at his restaurant. The taxpayer testified that this ad ran monthly for at least part of the year and that it cost $100 per month.

Under IRC section 6001, taxpayers must maintain sufficient records to establish their claimed deductions. In certain circumstances, the court may approximate the amount of an expense if the taxpayer proves it was incurred but cannot substantiate the exact amount (Cohan, 2nd Cir., 1930). But the taxpayer must provide some basis for such an estimate. The failure to keep and produce appropriate records counts heavily against a taxpayer’s attempted proof.

The IRS conceded that the taxpayer conducted a restaurant business during the year and allowed deductions for other expenses the taxpayer incurred. In operating his restaurant, the taxpayer necessarily incurred labor costs for his cook, his dishwasher, and a waitress, as well as cost of goods sold for the food he served. In the absence of adequate documentation, the court ruled that it

continued on page 7


from the BeNCh

Taxpayer had Cod Income but was entitled to exclude it Under Insolvency exceptionNewman, TC Memo 2016-125TC Memo 2016-125

The Tax Court has ruled that a taxpayer who overdrew from his checking account and failed to reimburse the bank had cancellation of debt (COD) income to the extent of the unrepaid funds. However, the Court found that the taxpayer was not required to include the amount in gross income because he had outstanding student loans that rendered him insolvent in the year that the debt was cancelled.

Background. Code Sec. 61(a)(12) provides that gross income includes income from the cancellation of a debt (COD income). The year for which a taxpayer realizes COD income is a question of fact to be determined on the basis of the evidence. (Policy Holders Agency, Inc., (1963) 41 TC 4441 TC 44) A debt is deemed discharged the moment it becomes clear that the debt will never be repaid, and any “identifiable event” which fixes the loss with certainty may be taken into consideration in determining whether that moment has occurred. (Cozzi, (1987) 88 TC 43588 TC 435) The issuance of a Form 1099-C, Cancellation of Debt, is an identifiable event, but it is not dispositive of an intent to cancel indebtedness. (Owens, TC Memo 2002-253TC Memo 2002-253) Regs provide a rebuttable presumption that an identifiable event occurred in a calendar year if, during a testing period (generally 36 months) ending at the close of the year, the creditor has received no payments from the debtor. (Reg. § 1.6050P-1(b)(2)(iv))

There are, however, exceptions under which a taxpayer may not be required to include COD income in gross income. One such exception is in Code Sec. 108(a)(1)(B), which provides that a taxpayer may exclude COD income when the taxpayer is insolvent (the “insolvency exclusion”). A taxpayer is insolvent if all of the taxpayer’s liabilities exceed all of the taxpayer’s assets immediately before the discharge. Under the insolvency exclusion, a taxpayer is able to exclude the amount of discharged debt from gross income to the extent that the taxpayer’s liabilities exceed the fair market value of his or her assets.

Facts. In July 2008, Keith Newman, Jr. opened a checking account at Bank of America (BOA). Between July and Au-gust, Newman made $8,858 in deposits to the account, $8,500 of which was at-tributable to a single check drawn from another bank account he maintained at Wells Fargo. Shortly after making the ini-tial deposits, Newman withdrew $8,000 in cash from the BOA account. However, the initial $8,500 check he deposited into the BOA account did not clear and was later returned to Wells Fargo, caus-ing the BOA account to be overdrawn. Newman did not deposit funds in the BOA account to correct the negative balance, and BOA closed the account in August of 2008.

In 2011, Newman owned various items of personal property including furniture, clothes, and electronics of marginal value; he owned two watches valued at $500; and he owned a car

valued at $35,000. He also had several liabilities—he owed $35,000 on a car loan and $15,000 in student loans.

In December of 2011, BOA issued Newman a Form 1099-C for 2011 reporting COD income of $7,875. Newman did not report the $7,875 as income on his 2011 Federal income tax return, and on Nov. 12, 2013, IRS issued a notice of deficiency determining that the $7,875 of COD income constituted unreported gross income.

Taxpayer had COD income but didn’t have to include it. The Tax Court found that BOA didn’t receive any payments from Newman after August 2008, that the debt was presumed discharged in 2011 under Reg. § 1.6050P-1(b)(2)(iv), and that he didn’t rebut that presumption. Accordingly, he had COD income of $7,875, as reported by BOA.

However, the Court found that the COD income was excludable under Code Sec. 108(a)(1)(B). In 2011, Newman owned assets with a total value of $35,500 and was liable for debts totalling $50,000—a $14,500 excess of liabilities over assets. The Court found Newman’s testimony as to his assets and liabilities credible and thus found that he was entitled to exclude the full $7,875 of COD income.

References: For cancellation of debt income, see FTC 2d/FIN ¶ J-7000; United States Tax Reporter ¶ 614.114; TaxDesk ¶ 186,001; TG ¶ 12890.

could estimate these expenses under the Cohan rule, bearing heavily against the taxpayer because of his failure to maintain adequate records.

The court disallowed the $9,258 deduction for supplies and the $5,620 deduction for contract labor. In their

place, the court allowed a $6,000 deduction for cost of goods sold and a $4,000 deduction for wages. The court also reduced the deduction for advertising from $2,880 to $500, based upon the fact that he paid $100 per month for the ad for part of the year.

NoTE FRoM THE EDIToR: Generally, auditors cannot consider the Cohan Rule in the ordinary process of an audit. The matter must be taken to appeals or tax court for the taxpayer to receive consideration under the Cohan Rule.

n

The Cohan Rule continued from page 6


etCeterA

A TiMely TiP froM ennis T. PeA

WHat is seC. 199:DOMEstiC PRODuCtiON

aCtiVitiEs DEDuCtiON?

This deduction, sometimes

also referred to as the “domestic manufacturing deduction,” “U.S. production activities deduction” or “domestic production deduction,” was instituted by the American Jobs Creation Act of 2004 (PL 108-357) effective for tax years beginning after 2004. It is allowed for both the regular tax and the alternative minimum tax for individuals; C corporations; farming cooperatives; and estates, trusts and their beneficiaries. The deduction is allowed to partners and the owners of S corporations (not to partnerships or the S corporations themselves).

The allowable deduction equals a percentage of the net income from eligible activities. The percentage was phased in from inception of the legislation to the present: 3% in 2005–2006; 6% for 2007–2009; and 9% after 2009. However, the amount of the deduction for any tax year may not exceed the taxpayer’s taxable income or, in the case of individuals, adjusted gross income. There is also a limitation of 50% of certain wages reported on Form W-2 that are attributable to domestic production.

Qualifying income includes:

The term “domestic production activity” cuts across a broad swath of businesses. The IRS has determined that businesses qualifying for the deduction must undertake work in one of the following categories:

• Construction performed in the United States.

• Electricity, potable water or natural gas produced in the United States.

• Films and videos produced at least 50% in the United States.

• Architectural or engineering services performed in the United States for domestic construction projects.

• The disposition of tangible personal property, sound recordings or computer software created or developed, in whole or in part, in the United States.

Certain exceptions apply. For example, rental income doesn’t qualify under the construction category, and sexually explicit films don’t qualify under the film production deduction. However, “tangible personal property” is an extremely broad category, and many businesses, from magazines and newspapers to home-based craft stores may qualify for the deduction.

Allowable deductions:

The first hurdle to qualifying for the deduction is that wages must be paid. If no wages are paid, there is no deduction; therefore a sole proprietor with no employees does not qualify.

• Cost of Goods Sold

For purposes of the DPAD, cost of goods sold includes the:

Cost of goods sold to customers, and

Adjusted basis of non-inventory property you sold or otherwise disposed of in your trade or business.

Generally, you must allocate your cost of goods sold between DPGR and non-DPGR using a reasonable method. If you use a method to allocate gross receipts between DPGR and non-DPGR, the use of a different method to allocate cost of goods sold won’t be considered reasonable, unless it is more accurate. However, if you qualify to use the small business simplified overall method you can use it to apportion both cost of goods sold and other deductions, expenses, and losses between DPGR and non-DPGR.

• Other Deductions, Expenses, or Losses

This will include all deductions, expenses, or losses (other than cost of goods sold and employee business expenses) from a trade or business.

Allocation and apportionment of other deductions, expenses, or losses: You can generally use one of the following three methods to allocate and apportion other trade or business deductions, expenses, or losses between DPGR and non-DPGR.

1. Small business simplified overall method: Under the small business simplified overall method, your total cost of goods sold and other deductions, expenses, and losses are ratably apportioned between DPGR and non-DPGR based on relative gross receipts. For businesses with annual gross receipts of $5 million or less.

2. Simplified deduction method: Under the simplified deduction method, your other trade or business deductions, expenses, or losses are ratably apportioned between DPGR and non-DPGR based on relative gross receipts. For businesses with business assets of $10 million or less; or annual gross receipts of $100 million or less.

3. Section 861 method: You don’t have to meet any tests to use the section 861 method. Under the section 861 method, you generally must apply the rules of the section 861 regulations to allocate and apportion other trade or business deductions, expenses, or losses between DPGR and non-DPGR.

Calculation steps…

In general, the computation involves the following steps:

continued on page 9


nn

1. Identify areas of potential qualified production activities: Determine whether the manufacture, production of tangible personal property and/or development of computer software occurred in the U.S. Then evaluate whether a product is held for sale, lease or license, or involves a hosting service.

2. Calculate domestic production gross receipts (DPGR): Allocate gross receipts between qualified and nonqualified production activities. The starting point of these reconciliations is usually the sales detail contained in the trial balance. The gross receipts should be allocated and/or apportioned at the item level.

3. Allocate cost of goods sold to DPGR: Allocate production costs between qualified and nonqualified activities. The starting point of these reconciliations is usually the cost-of-goods-sold detail contained in the trial balance.

4. If necessary, determine, allocate and apportion below-the-line expenses: Unless the taxpayer is eligible for the simplified deduction method described in Treas. Reg. § 1.199-4(e)(1) or the small business simplified overall method described in Treas. Reg. § 1.199-4(f)(1), it must use the principles of section 861 (specifies apportionment of certain items of gross income and deductions to sources within the U.S.) to allocate and apportion deductions that support or otherwise are related to a class of gross income. Expenses so allocated and apportioned include charitable contributions, research and development expenses, selling, general and administrative expenses, corporate/stewardship expenses and interest.

5. Calculate the deduction: Use sales and cost-of-sales data derived in steps 2 and 3, and taxable income data derived in step 4. The net taxable income of the qualified products should be aggregated and presented on the consolidated calculation by entity schedule. The lesser of the qualified production activities income (QPAI) or taxable income is then multiplied by the applicable percentage to determine the deduction, which is limited to 50% of wages paid to the taxpayer’s employees reported on Form W-2 during the calendar year ending during the tax year and that are allocable to DPGR.

Form 8903, Domestic Production Activities Deduction, is used to calculate the deduction. The deduction is passed through to the shareholders of an S-Corp, the partners of a Partnership and the beneficiaries of a trust. The C-Corp files and uses the deduction on the corporate return. The deduction is subject to the following provisions: basis limits on a partner’s share of partnership losses; basis limits on a shareholder’s share of S corporation losses; at-risk rules; passive activity rules; and any other provision of the Internal Revenue Code.

ennIs T. PeA continued from page 8

Married Couple had Unreported Income and Unsubstantiated deductions denied with a negligence Penalty Imposed (Ericson, TCM), (June 2, 2016) J.A. Ericson, TC Memo. 2016-107, Dec. 60,621(M).

A tax preparer and his wife had unreported income and unsubstantiated business expense deductions reported on

their Form 1040. In addition, a §6662 negligence penalty was imposed because the taxpayers failed to maintain adequate records for the tax year. As a result, the IRS reconstructed the taxpayer's income using a bank account analysis. Since the taxpayers failed to show that the unreported income was not taxable, the IRS’s determination to include the amount in the taxpayer’s income was sustained by the Tax Court.

In addition, the taxpayers were not entitled to deduct unsubstantiated business expenses under §274. Both spouses operated separate sole proprietorships and the wife also claimed employee business expenses from her job as a nurse. The couple failed to maintain adequate business records such as (1) an account book, a log or a similar record and (2) documentary evidence, such as receipts, paid bills, or similar evidence sufficient to establish each element of an expenditure.

The taxpayers failed to show that they were entitled to any of their claimed deductions. While the IRS conceded that the taxpayers’ sole proprietorships were valid businesses and not hobbies and that they incurred deductible expenses, there was no evidence that they were entitled to a larger deduction than the IRS allowed. Their records did not establish that the taxpayers actually paid the wife’s claimed employee business expenses or, even if they did, the specific or approximate amounts of the expenses.

The taxpayers were liable for the §6662 imposition of accuracy-related penalty on underpayments for negligence because they failed to maintain adequate records for their sole proprietorships and failed to substantiate their reported expenses.

The husband had a business degree and had worked as an accountant but he had minimal tax preparation education and misunderstood many areas of tax law. Therefore, the IRS failed to prove that the taxpayers filed any return for the years at issue intending to conceal, mislead or otherwise prevent the collection of tax. As a result, the taxpayers were not liable for the §6663 imposition of fraud penalty because the IRS failed to show by clear and convincing evidence that: (1) the taxpayers underpaid their tax and (2) at least some part of each underpayment was due to fraud. The IRS failed to show that the husband exhibited a pattern of fraudulent conduct. None of the badges of fraud weighed against the taxpayers.

from the BeNCh


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PROGRAMS

The Congressional Budget Office (CBO) released a document titled “Estimating the Revenue Effects of Proposals to Increase Funding for Tax Enforcement.” It provides estimates of the return on investment (ROI) from boosting IRS funding targeted at enforcement, specifically looking at proposals laid out by President Obama in his FY 2016 budget. Overall, CBO projected that the proposed enforcement initiatives would result in net budgetary gains of $36.6 billion over a 10-year window. CBO estimates that the budget deficit will be $534 billion in FY 2016.

The “net tax gap” is defined as the differ-ence between the amount of tax that tax-payers should pay under the tax law and the amount they actually pay, voluntarily and as a result of enforcement actions. IRS estimates that the annual net tax gap from 2008 to 2010 was on average $406 billion ($447 billion in 2016 dollars).

The Senate Appropriations Committee recently approved an $11.2 billion budget for IRS in FY 2017 which is $300 million above that approved in the House, with the difference to be hashed out in conference and the ultimate budget likely to be well below the $12.3 billion requested by President Obama. Funding for IRS has fallen by 15% from 2010 through 2016 (in real dollars), with the biggest cuts in enforcement. However, enforcement still receives the largest share of IRS’s budget with approximately 43% of IRS’s 2016 budget going toward enforcement activities. Operations support will be 33% of the 2016 budget while taxpayer services will be 21%. Only 3% of the 2016 is for computer modernization.

CBO specifically looked at President Obama’s FY 2016 budget which con-tained a proposal to boost discretionary spending by $667 million to fund IRS

“program integrity initiatives,” approxi-mately $421 million of which was desig-nated for enforcement. Program integrity initiatives are essentially a mechanism to increase IRS’s base funding (beyond the amount budgeted by Congress) and target the use of extra funds towards revenue-generating initiatives.

As IRS funding declined, its cost of collecting an additional $100 of tax also declined from 53 cents in 2010 to 35 cents in 2015 according to IRS estimates.

The ROIs were broken down by enforcement initiative cost in 2016 and return on $1 of investment as follows:

• Prevent identity theft and refund fraud: cost of $2.7 million; ROI of 9.0.

• Increase audit coverage: cost of $150.7 million; ROI of 2.6.

PrACtICe mANAGemeNt

Congressional Budget office examines Impact of Increasing IRs’s enforcement Budget

continued on page 11


CoURSE DESCRIPTIoN: An in-depth study of federal tax law and tax updates for 2016 as related to federal taxes. Covered topics will include 2015 tax return preparation, new tax laws and recent developments. Participants will receive a textbook with detailed information, examples and selected draft IRS forms.

LEARNING oBjECTIvES: After completing this program, participants will be able to differentiate federal tax law changes from the previous year, identify updated forms and rule changes and apply rules of federal tax law to preparing tax returns.

noveMBeR 2016

3–4 ........Casper Wy

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deCeMBeR 2016

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• Improve audit coverage of large partnerships: costof $16.2 million; ROI of 2.7.

• Address international and offshore complianceissues: cost of $40.7 million; ROI of 1.2.

• Enhance collection coverage: cost of $122.8million; ROI of 2.8.

• “Other initiatives”: cost of $87.5 million; ROI of 0.

• Overall, this was a total cost of $420.6 million,with an average ROI of 2.0 per $1 of investment.

President Obama also proposed continuing the 2016 enforcement initiatives throughout the entire 10-year budget period with the annual costs rising to $435 million in 2018 than staying at that level. CBO estimated that the average ROI on the increased funding for enforcement would gradually rise over three years, and that IRS would see improvements in both technology and staff over that same period as a result of the additional funding. However, CBO projected a drop in the ROI after 2018 as taxpayers found new ways to evade taxes. Specifically, it projected the annual ROIs from increased funding for enforcement initiatives as follows:

• Year 1 (2016): ROI of 2.0.

• Year 3 (2018): ROI of 6.4.

• Year 6 (2021): ROI of 5.9.

• Year 10 (2025): ROI of 5.2.

In addition to the increased funding for IRS enforcement initiatives described above, President Obama’s 2016 budget proposal also called for “further increases in new enforcement and compliance initiates each fiscal year from 2017 through 2020 and to sustain all of the new initiatives and inflationary costs via cap adjustments though fiscal year 2025.” The budget did not provide any details on the components of these future initiatives, and CBO concluded with respect to these undescribed initiatives that their overall ROI would likely decline over time as IRS “tackled more difficult types of tax evasion.” CBO provided the annual estimated ROIs from these additional initiatives as follows:

• Year 1 (2020): ROI of 1.5.• Year 3 (2022): ROI of 4.6.• Year 6 (2025): ROI of 4.2

Finally, CBO estimated the total 10-year net budgetary gains from the proposed increase in funding for IRS program integrity efforts. These efforts would require $18.7 billion in spending and would bring in $55.3 billion in revenues for net budgetary gains of $36.6 billion. CBO cautioned at the end of the document, however, that ROIs vary by the type of enforcement activity and therefore will be different depending on the specific features of each proposal.

2016 Federal Tax Update & Review Course

IRs enforcement Budget continued from page 10


The National society of Tax Professionals is registered with the National association of state Boards of accountancy (NasBa) as a sponsor of continuing professional education on the National registry of CPe sponsors. state boards of accountancy have final authority on the acceptance of individual courses for CPe credit. Complaints regarding registered sponsors may be submitted to the National registry of CPe sponsors through its website: www.learningmarket.org.

aPPROVED CONtiNuiNg EDuCatiON PROViDER

weBInAR CoURse CE MEMBER non

a understanding the Challenging Tax Issues Facing the Tax Professional When dealing With a sole Proprietorship 2 $39 $49

B Common Payroll Issues Facing the Tax Professional 2 $59 $69

C Introduction to the Irs Position on the requirements for same-sex Couples to File as a Married Couple 1 $39 $49

d Introduction to the Federal Income Tax Issues Of Filing Form 1041 For estates and Trusts 2 $39 $49

e Introduction to the Tax Issues unique to a C Corporation 2 $39 $49

F 2015 Federal Tax update & review Course (Not available after 10-31-2016) 8 $69 $89

g ethics for the Tax Professional in 2016 and Circular 230 Issues 2 $69 $89

gg ethics for the Tax Professional in 2016 and Circular 230 Issues (In spanish, Materials In english) 2 $69 $89

h Overview of The Various Methods of determining Basis of assets 2 $49 $59

I Introduction to the Federal Income Tax Issues Concerning Cancellation of debt and the reporting required When a Taxpayer receives a Form 1099-a and Form 1099-C 1 $39 $49

j Introduction to Passive activity loss Issues relating to real estate Transactions 1 $29 $49

K Issues Concerning the “repair regulations” on Tangible Property and The Impact on small Business 1 $29 $39

l Taking a Closer look at the Federal Income Tax Issues of the affordable Care act (aca): It’s Not going away! 2 $29 $39

M understanding the Importance of substantiating allowable Business expense deductions 2 $49 $59

N Introduction to the Federal Income Tax Issues of a decedent’s Final Form 1040, the estate, and the survivors 2 $49 $59

O Introduction and review of Worker Classification Issues: Independent Contractors vs. employee 2 $49 $59

P Choosing the Correct Filing status and determining Who is a Qualified dependent 1 $29 $39

Q schedule C Issues Facing the Tax Professional 2 $29 $39

r Introduction to estate, gift and Trust Tax Planning Issues 2 $49 $59

s reviewing the deductibility of Medical expenses and Taxes on schedule a of Form 1040 1 $29 $39

T Introduction to the Federal Income Tax Issues of divorced and separated Taxpayers 4 $79 $89

u Introduction and review of the Federal Income Tax Issues of §165 Casualty and Theft losses for Individual Taxpayers TBd

V The Tax Professional’s guide to the deductibility of Charitable Contributions and the Importance of Complying with the substantiation rules 2 $49 $59

W understanding the deductibility of §163 Interest on schedule a and applicable limitation Issues 1 $29 $39

x annual Federal Tax refresher Course (aFTr) 6 $169 $169

xx annual Federal Tax refresher Course (aFTr) (In spanish, Materials In english) 6 $169 $169

weBINARSVisit NSTP.org for a complete listing of all NSTP webinars.Webinars listed below run from April 29, 2016 - December 31, 2016

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Documents

Federal Tax Alert the - National Society of Tax Professionals · 2016-09-01 · 2uly / augus j T 2016 [email protected] The Federal Tax alerT Nina Tross, MBA, EA nna Tross, MBA, i eA