Tax Research Instructor's Manual

TAX RESEARCH By Barbara Karlin

Fourth Edition

INSTRUCTOR’S GUIDE

By Barbara H. Karlin Golden Gate University

TABLE OF CONTENTS

KEY CONCEPTS AND PRACTICAL APPLICATIONS CHAPTER 1 - OVERVIEW OF TAX RESEARCH 1 CHAPTER 2 – THE INTERNAL REVENUE CODE 8 CHAPTER 3 – TREASURY INTERPRETATIONS 24 CHAPTER 4 - JUDICIAL INTERPRETATIONS 56 CHAPTER 5 - USING REFERENCE SERVICES AND OTHER SECONDARY

SOURCES 97

CHAPTER 6 - CULMINATION OF THE TAX RESEARCH PROCESS 114 CHAPTER 7 - COMMUNICATING RESEARCH RESULTS 127 CHAPTER 8 - OVERVIEW OF TAX PROCEDURE 130 CHAPTER 9 - OVERVIEW OF STATE TAX RESEARCH 139

INTEGRATED CASE STUDIES

Case Study A 143 Case Study B 146 Case Study C 154 Case Study D 159 Case Study E 165 Case Study F 169 Case Study G 173 Case Study H 178 Case Study I 184 Case Study J 189 Case Study K 192 Case Study L 196

Case Study M 199 Case Study N 204 Case Study O 207 Case Study P 210

Test Problem Bank 215 Test Problem Answers 236

PREFACE This guide is intended to help the instructor address the research questions that follow each chapter. Much effort has been made to ensure that the answers are as complete and accurate as possible. However, due to the dynamic nature of tax law, as time passes, Congress amends the Code, the Treasury issues new Regulations and the courts continue producing cases. Please use this guide as a starting point with that fact in mind. Those seeking additional instructor tools such as PowerPoint slides and exams may wish to go to the following Web address where such tools can be found: http://www.prenhall.com/karlin.

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KEY CONCEPTS AND

PRACTICAL APPLICATIONS CHAPTER 1 - OVERVIEW OF TAX RESEARCH KEY CONCEPTS (1-21) 1. Definitions:

a. Tax planning occurs when a tax question arises before all the facts are established. In this case, research results may play a significant role in planning a future transaction. In a tax planning situation, it is important for the researcher to determine precisely what the taxpayer wishes to accomplish. The researcher can then examine the law and provide the taxpayer with useful information about whether it is possible to attain these goals, and if possible, how they might be achieved.

b. A fact is something that is real or actual. A fact is different from an opinion. (See

pages 7-9)

c. A conclusion is an opinion. A conclusion may result from reviewing facts or the law. It is important to distinguish a conclusion from a fact. (See pages 7-9)

d. A fact is relevant when it affects the application of the tax laws. An irrelevant

fact is one that, even if altered, would have no impact on the application of the tax laws. (See pages 7-9)

e. A primary source is the most authoritative form of tax resource. Usually,

researchers should base their conclusions only on primary sources. Only authorized governmental bodies such as Congress (the Internal Revenue Code), the Treasury Department and the judiciary generate primary sources. (See pages 11-13)

f. A secondary source may be very useful in the research process, but it is not

authoritative. Examples of secondary sources include reference services, treatises, textbooks and journal articles.

g. IRC stands for the Internal Revenue Code. It is the central primary source in tax

research. Most of the tax laws are found in the Internal Revenue Code.

h. A reference service is a type of secondary source of information for the tax researcher. A reference service, among other things, provides references to potentially relevant primary authority.

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Key Concepts and Practical Applications

i. Employers often use time budgets to indicate the approximate amount of time the researcher should expect to spend on a research project. Unfortunately, because they are guesstimates, they are often not as accurate as one would like. However, they may provide a helpful guide regarding how exhaustive the research effort should be. If the researcher finds she will likely exceed the allotted time budget, it is advisable to consult with the person who prepared the budget before performing more research.

2. The purpose of tax research is to determine the tax implications of a certain set of facts,

or to answer a tax question. 3. The four basic steps in the tax research process are:

Step One - Gathering Relevant Facts *determine the relevant tax question *identify all the material facts Step Two -Researching *identify and read the pertinent resources *define the question if necessary and/or obtain additional facts Step Three - Analyzing *synthesize the information gathered *ponder what you have learned

*determine whether there is enough information and authority to render a conclusion

*conclude Step Four - Communicating *determine the appropriate form of communication *communicate your conclusions. 4. It is important to determine and remain focused on the research question throughout the

research process. Because there is so much information available to the researcher, it is easy to go astray and waste time material irrelevant to the research question. When the researcher determines the initial research question, he can review the material efficiently with an eye towards information that may help answer the question. By staying focused, the researcher can carefully eliminate that material not useful to the question. The researcher must also recognize the potential to amend the initial research question as he gains more information through the research process.

5. It is important to determine whether you have been asked to act in a planning role when

gathering facts and determining the research question for a variety of reasons. The expectations placed upon the researcher in a planning role may substantially differ from those expected of the researcher when asked to react to an established set of facts. In the

Overview of Tax Research 3


planning role, the researcher may be expected to provide creative suggestions as to how the taxpayer might accomplish his objectives. In addition, when planning, the researcher is in a potentially more vulnerable situation because the research results may directly impact the taxpayer’s actions. (See page 17)

6. A fact is something real, whereas a conclusion is an opinion which may or may not be

based on the facts or the law. It is important to recognize the difference between the two because the tax research must be based on the facts and the law only.

7. The research question often changes as the research process progresses. As the

researcher learns more about the relevant provisions in the Internal Revenue Code, it is likely that he will need to refine the research question. This may continue to occur with each step of the research process. (See pages 4-7)

8. The researcher may miss critical information and fail to identify a critical tax question if

she frames the research question too narrowly. While it is important to stay focused, it is also necessary to recognize that the initial research question may need to be expanded to cover additional issues identified through the research process.

9. A tax researcher’s role is varied. It may simply be to determine the appropriate way to

report a completed transaction on a tax return. Or, the researcher may be asked to justify a taxpayer’s position taken in a previously filed tax return. Another potential role for the research involves helping a taxpayer plan a future transaction. The researcher may be a creative advisor and educator. Ultimately, the researcher must also communicate the research results in the taxpayer.

Tax research of some sort is necessary whenever someone (client, employer or researcher) identifies a tax question requiring an answer. As a taxpayer’s advisor, sometimes the researcher is able to provide the taxpayer with a clear and definitive answer about the tax question, e.g,, “Yes, the position taken on a previous return was correct,” or, “You must report the salary income on your return.” However, in a planning mode, such straightforward results are not often possible. In the planning mode, although the taxpayer may expect the tax advisor to make the decision as to what the taxpayer should do, it is important that the tax advisor only educate the taxpayer so that the taxpayer can make the decision.

10. The researcher can gather relevant facts by questioning the taxpayer and reviewing

relevant documents. It is important to be aware of all the facts because the application of the law may change if any of the relevant facts change. Sometimes is it difficult for the researcher to gather all the relevant facts because the researcher may not know what are the relevant questions to ask and the taxpayer may not know what are the relevant facts to explain.

4 Chapter 1


11. The two sources of primary authority that provide interpretations of the Internal Revenue

Code are Treasury interpretations and judicial interpretations. 12. Reference services may help direct the researcher to relevant primary authority. 13. The researcher may base his research conclusion only on primary sources, not secondary

sources. In determining whether something is a primary source, it is helpful to consider the originator of the source. If either Congress, the Treasury Department or the courts authored the source, it is likely a primary source. Otherwise, the source is likely a secondary source.

14. Each research step requires the use of critical thinking. 15. The researcher may communicate research results either internally or externally. Internal

communications include letters to the file or office memos. External communications include letter to the taxpayer and letters to a taxing authority. Communication can take either oral or written form.

16. Sometimes, there is only one correct answer to a tax research question. However, many

times, there is no one correct answer. Instead, there may be a variety of potentially correct answers. This is because the tax law is complex and frequently subject to a variety of interpretations.

17. The tax researcher takes on the role of tax advocate in a variety of situations, the key one

being when representing the taxpayer before a taxing authority during an audit. 18. The researcher is typically in a tax planning situation when the facts can still be altered.

Tax planning typically does not occur when the facts are established and the researcher is asked to determine the appropriate reporting position. However, any possible change in the future actions of the taxpayer may trigger the research to become involved in tax planning. As a tax planner, the researcher must provide the taxpayer with guidance regarding the taxpayer’s options. Particularly because of the increased vulnerability to the tax researcher, it is important to recognize when tax planning is involved.

19. The standard required when signing a return or recommending a tax return position to a

taxpayer is that the position have a “realistic possibility of being sustained on its merits.” To satisfy this standard, the researcher must be able to show that after performing a reasonable and well-informed analysis, a knowledgeable person in tax law would conclude there is at least a one in three chance that the position will be upheld.

20. The tax researcher should be aware of the practical considerations of the need to be

accurate and time efficient, while considering the various standards of authority and the



amount of tax involved. The researcher must also create a proper record of the research performed.

21. Client files help refresh the researcher’s memory regarding the facts and research results

and reasoning. In addition, they help provide for continuity in the service provided to the taxpayer. A client file should include all relevant tax documents (tax returns, supporting documents, etc.), summaries of written and oral communications regarding client issues, office memos, supporting documentation for each research project, and any carryover schedules.

PRACTICAL APPLICATIONS (22-26) 22. a. If taxpayer purchased a ticket for the New Jersey lottery and won $1,000, an

initial question arises regarding whether the $1,000 will be considered income for federal income tax purposes and also state tax purposes. Potentially helpful additional information includes: when and if the taxpayer collected the cash, type of taxpayer (individual or something else), and method of accounting the taxpayer uses.

b. Taxpayer’s payment of $5,000 to his former wife triggers the initial tax question

as to whether the taxpayer is entitled to a deduction for the $5,000 payment for either federal or state tax purposes. It would be helpful to know more about what generated the payment (e.g., was it required under a divorce decree or was it voluntary), and the specific terms controlling the payment.

c. Taxpayer’s payment of $1,000 to a lawyer for advice triggers the initial question

as to whether the payment might qualify as a tax deduction for either federal or state tax purposes. Necessary additional information includes the nature of the services performed by the lawyer for the taxpayer and the date of payment.

23. a. Although this set of facts seems at first to be rather complete, there is still a good

deal of relevant information missing: the date of the divorce; number of children; children’s ages; divorce decree and specific wording requiring the $10,000 payment; if it is determined by the researcher that a portion of the $10,000 is actually child support, another relevant piece of necessary information is Mr. K’s history of payments - has he kept up with them or is he behind? [§71(c)(3)] In addition, if the payments are made within the first three years of the divorce, there may be a frontloading issue which requires a knowledge of the history of payments made. [§71(f)]

b. Additional potential sources of information or documents include: prior tax returns and any divorce documents available.

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c. Relevant facts include the amount of payments and the fact they are made

monthly. Irrelevant facts include Mr. K’s occupation and age. d. Unless the student is very familiar with the rules under §71, the student will not

yet be able to identify all the facts necessary to fully address the research question. Not until the law is examined will the student be able to appreciate all the relevant facts and know all the relevant questions to ask.

e. The students most likely will identify the initial question as “Is the $10,000

income to Mrs. K?” That’s the first step in identifying the question. But as the student begins to discover more about the law, for example that there is a different tax impact depending on whether the amounts are alimony or child support, the question begins to be more refined. One of the first refinements would be to determine what portion of the $10,000 is alimony and what part is “child support.” There are several additional layers of refinements as the student digs deeper into the Code Section.

f. The taxpayer’s desired result is to avoid being required to recognize as income the

$10,000. Clearly the researcher should be aware of this. However, since the facts are already set, the desired result is not quite as important as in a planning setting.

g. The students should recognize that this is not a planning research problem. The

facts are already entirely set. It could turn into a planning situation if, as a result of the information the researcher provides to Mrs. K, she decides she wants to change the facts by, for instance, revisiting in court how the amounts are to be structured.

h. The same laws apply and in the same manner if the dollar amount is reduced,

except perhaps for the frontloading rules in §71(f). However, the need to be quick about the research is underscored because the researcher is looking at a maximum taxable income amount of $1200. It doesn’t make practical sense to research the question so thoroughly that the research bill is as high as the income.

24. a. The researcher’s role in this situation is to determine the tax treatment, then

educate the client and report the appropriate tax treatment of the free parking. Planning may occur for future parking arrangements, but the central role at this juncture is to accurately determine the tax impact of the current arrangement.

b. The researcher will need to ascertain all the relevant facts as they exist, research

the status of the current law on the subject, determine the appropriate tax



treatment in this situation, and communicate the results to the taxpayer.

c. Some of the questions include the dollar amount involved, the location of the parking lot, the employment relationship of the taxpayer, the law firm’s policies regarding the provision of this benefit to its employees, etc.

d. The initial research question is “What is the tax impact of free parking provided

by a law firm to its employee (if the facts bear this out) or partner (if these are the facts)?”

e. The students will not understand at this junction the impact that this has on the tax

treatment. However, because the Code provisions in Section 132 treat parking benefits differently depending upon whether someone is a partner or an employee, this underlines the importance of finding out all potentially relevant facts in the initial client interview. (IRC Section 132(f)(1)(C) and (5)(C) provide that parking reimbursements or free parking up to $175 per month provided by an employer to an employee will be excluded from taxable income.) Thus to accurately answer the research question, the researcher will need to understand the employment relationship of the taxpayer to the law firm. If the taxpayer, upon hearing that the parking benefits represent taxable income, pretends that she did not inform the researcher of the information, ethical issues now arise. Chapter 6 explores this in more detail, but suffice it to say that in this situation, the researcher is obligated under various regulatory rules and guidelines to honestly report the benefits as income.

25. This question provides a good opportunity for the student to explore the subject of

managing their work through files. There is no one right answer here. However, some possible files include a tax return file, a working paper file (that includes all the supporting analysis), an important documents file (that includes company bylaws, etc.), and perhaps a correspondence file. Page 22 of the text lists some of the documents that the student might consider including in the files.

26. The initial role of the researcher is to determine the tax treatment of the specific sale.

However, the role may quickly change into more of a planning role as the researcher addresses potential future tax strategies regarding future stock transactions. Facts necessary to address the initial question regarding tax treatment of the sale include purchase dates and prices of the shares sold as well as the sales price. Broker statements will need to be gathered.

INTEGRATED CASE STUDIES - see solutions at page 140

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CHAPTER 2 – THE INTERNAL REVENUE CODE

KEY CONCEPTS (1-17)

1. Definitions

a. Legislative Committee Reports provide a record of the decisions made in each legislative committee. They can be helpful in providing guidance regarding legislative intent.

b. The Joint Committee on Taxation is a nonlegislative committee whose staff

help draft bills and committee reports. It also writes the “Blue Book.” c. The “Blue Book” is an explanation of new law prepared by the Joint Committee

on Taxation. It is considered primary authority.

d. USC stands for “United States Code.” It embodies all the statutory law passed by Congress.

e. Title 26 of the United States Code is also known as the Internal Revenue Code.

f. Flush language is language that appears to not clearly belong to the Code

provision directly preceding it. Its margins are to the far left.

g. Sunset provisions are typically found at the end of a Code Section and provide for the section’s termination at a specific date. If Congress wishes to continue the provision, it must do so through legislation.

h. Terms of art are words that have a special meaning when used in the IRC. Most

tax research involves determining the meaning of a “term of art” in the context of a particular factual situation.

i. IRC Section 7701 is the definitional section of the IRC. It provides definitions

for a wide variety of terms used.

j. Limiting language is language that limits the application of a Code provision to a particular portion of the Code. For example, the language “For purposes of this Part,” is limiting language.

k. Transition provisions are provisions within the Code indicating the application

date and terms of a particular Code provision. This occurs whenever a new Code provision is passed.

2. New tax bills must first begin in the House Ways and Means committee. The Senate

Finance is the second Congressional committee to examine a potential tax bill. The


The Internal Revenue Code 9


Conference Committee is a committee made up of members of the other two committees and is called into action when the Senate bill differs from that produced by the House of Representatives.

3. The legislative process generates committee reports from the three legislative

committees. These reports can be useful in helping the researcher determine the Congressional intent behind a particular Code provision.

4. Students can keep informed about current tax legislative activities through review of

publications that discuss this topic (BNA daily journals, newspapers, etc.). 5. Committee Reports of new legislation are easiest to locate through the publications made

available by the primary tax publishers. Finding Committee Reports reflecting older legislation is more challenging. The major tax reference services also provide excerpts of the committee reports. For legislative history prior to the 1954 Code, Siedman’s Legislative History of the Federal Income Tax Laws includes committee reports, hearings, and debates for selected legislation from 1861 to 1954. To find legislative history of enacted legislation after 1954, a service published by the Bureau of National Affairs called Primary Sources may be helpful. The table of contents is arranged by Code Section. Tax Analysts’ web-based Federal Tax Library also provides committee reports for all tax acts since 1981. The major tax services (CCH and RIA) provide selected portions of committee reports through their multi-volumed reference services. These are available in paper and electronically

6. The Internal Revenue Code is divided into many divisions. The largest division is a

subtitle, followed by Chapters, Subchapters, Parts, Subparts, and finally Sections. Each major topic has its own Subchapter. Understanding the organization of the Code helps make research more efficient and increases the researcher’s confidence that he has found all possible applicable Code Sections.

7. Three possible methods of citing the Internal Revenue Code include: IRC Section; The

Internal Revenue Code of 1986 as amended; Code §. 8. a. Information returns and records b. Employment taxes; Federal Insurance Contributions; Deduction of tax from

wages c. Financing of Presidential Election Campaigns; Presidential Election Campaign d. Income taxes; Accounting Periods and Methods of Accounting, Methods of

Accounting, Taxable year for which deductions taken 9. Through the table of contents, index or by knowing the relevant Code Section. 10. The connecting word is or. This means that if any of the listed items are satisfied, the

expenditure is considered political lobbying and is not deductible. If the items were

10 Chapter 2


connected with an and, each of the items would need to be fulfilled in order to be penalized under these provisions.

11. “Taxpayer Bill of Rights 2." This was enacted July 30, 1996. This information is located

in the back of the CCH softbound IRC volumes and in the front of the RIA softbound volumes.

12. “Economic Growth and Tax Relief Reconciliation Act of 2001.” It became law on June

7, 2001. In the back of the CCH Code volumes. 13. Historical notes to a Code Section can be helpful in providing information about

historical changes to Code provisions. This information may help the researcher better understand the language used in the current Code provision. The notes often also provide important information about transition dates.

14. The Internal Revenue Code can be found in the following: * Softbound paper version published by both RIA and CCH challenges: must purchase new version regularly to ensure currentness benefits: easy to access * As part of the larger hardbound reference services published by RIA and CCH challenges: fragmented throughout the reporter service; less portable. benefits: updated throughout the year as revisions are made. * On the Internet on publicly accessible addresses challenges: usually outdated; often contains mistakes benefits: free * Electronically either on the Internet or CD-ROM through proprietary fee-based services challenges: cost benefits: easy to cut and paste; current 15. IRC Section 162 is part of Title 26; Subtitle A (Income Taxes); Chapter 1 (normal taxes); Subchapter B (Computation of Taxable Income). 16. IRC Section 162 includes the following: a. 16 Subsections: (a) General (b) Charitable Contributions and Gifts (c) Illegal Bribes and Kickbacks (d) Capital Contributions to Federal National Mortgage Association (e) Denial of deduction for certain lobbying and political expenditures (f) Fines and penalties (g) Treble damage payments under the antitrust laws (h) State legislators’ travel expenses away from home (i) Repealed (j) Certain foreign advertising expenses



(k) Stock redemption expenses (l) Special rules for health insurance costs of self-employed individuals (m) Certain excessive employee remuneration (n) Special rule for certain group health plans (o) Treatment of certain reimbursed expenses of rural mail carriers. (p) Cross references b. Paragraphs within subsection (d) include: (1) General (2) Carryforward of disallowed interest (3) Investment interest (4) Net investment income (5) Property held for investment (6) Phase-in of disallowance c. Subparagraphs within IRC Section 162(d)(3) include: (A) General (B) Exceptions (C) Personal property used in short sale 17. IRC Section 7805 provides that the Secretary of the Treasury Department shall prescribe

all rules and regulations necessary to enforce the Internal Revenue Code. It also discusses the retroactivity of regulations and the duration of temporary regulations.

PRACTICAL APPLICATIONS (18-55) 18. The correct way to cite the bolded sentence is “IRC Section 280G(b)(2)(C)(ii).” 19. The correct way to cite the bolded sentence is “the flush language of IRC Section

460(b).” 20. a. Corporation’s ability to deduct mining and exploration costs - Section 381(c)(10). [CCH code index topic “mining and exploration costs.”]

b. Taxation of Social Security benefits of nonresident aliens - Section 871(a)(3). CCH - “Nonresident aliens...then Social Security benefits, taxation of.”]

c. Definition of “Head of Household” - Section 2(b)(1). [CCH - “Head of Household, defined.”]

d. Valuation of a gift - Section 2512. [CCH - “Gifts, valuation of” or “Valuation of

gifts.”]

e. Sick pay benefits of employees - Sections 104-106. [CCH – “Employees, sick benefits” or “Sick pay.”]

12 Chapter 2


f. Deductibility of face lift - Section 213(d)(9). [CCH - “Cosmetic surgery, medical expenses.”]

g. Bad debt reserves - Section 593. [CCH - “Reserves (bad debt)” or “Bad Debt

(reserves).”]

h. Statute of limitations for filing an amended return - Section 6501(c)(7). [CCH - “Returns” - amended - statute of limitations.”]

i. Withholding requirements for tip income - Section 3402(k). [CCH - “Tips” -

(Withholding). Or “Withholding of income tax on wages” -(tips)]

j. Penalties for tax fraud - Section 6663. [CCH - “Penalties”- fraud.] 21. Subtitle B. 22. Subtitle 1 (Income Taxes); Chapter 1 (Normal Taxes and Surtaxes); Subchapter L

(Insurance Companies). Section 816 defines an insurance company. 23. a. Tax on prohibited transactions of pension plan fiduciaries (Sec. 4975)

b. Definition of the Generation Skipping Tax (Sec. 2611)

c. Definition of “Adjusted Basis” in determining gain from sale of asset (Sec. 1011-1012)

d. Taxation of contributions made to a partnership (Sec. 721-724)

e. Limitations on assessment and collection (Sec. 6501)

24. a. Deduction of interest paid on loans used for education (Sec. 221)

b. Deduction of corporation’s start-up and organizational expenses (Sec. 248–not to be confused by 195...although table of contents makes it confusing)

c. Deduction of “qualified tuition” (Section 222)

d. Definition of a life insurance contract (Section 7702)

e. Payment of estimated income tax (Sec. 6315)

25. a. IRC §280G - Golden Parachute Payments (nondeductibility)

b. IRC §3102 - Deduction of federal insurance taxes from wages



c. IRC §68 - Limitation on deductibility of certain types of itemized deductions 26. a. IRC §1223 – First sentence contains the words For purposes of this subtitle

(limiting language); Section 1223(1) contains numerous terms of art (e.g., exchange, property, sale); Section 1223(1)(A) contains pinballing to another Code Section as well as the connecting word and; Section 1223(8) provides transitional rules; Section 1223(11) has flush language that uses the measuring words more than 1 year; Section 1223(16) provides cross references. It will be helpful to note to the students that the numbering in this Code Section differs from the norm in that the Subsections are numeric rather than alphabetic.

b. IRC §117 – The first sentence of Section 117(b) contains the limiting language

For purposes of this section; Section 117(a) contains several terms of art (e.g., qualified scholarship, individual, candidate for a degree, educational organization); Section 117(a) pinballs the student to another Code Section; Section 117(b) contains the connecting word and.

c. IRC §1239 – Section 1239(b) contains the limiting language For purposes of

subsection (a); Section 1239(a) contains several terms of art (e.g., sale, exchange, property, related persons, etc.); Section 1239(b) uses the connecting word and; Section 1239(b)(2) pinballs the student to another Code Section; Section 1239(c)(A) uses the measuring terms more than 50 percent.

27. a. IRC §179 – Section 179(d)(1) uses the limiting language For purposes of this

section; Section 179(a) contains several terms of art (e.g., cost, Section 179 property, expense, etc.); Section 179(b)(3)(B)(i) contains the connecting word or; Section 179(b)(4)(B) contains the measuring language 50 percent (not more than or in excess of); Section 179(d)(1) pinballs the student to another Code Section. This is also an opportunity to illustrate that Code Section 179 is an entirely different section than Code Section 179A.

b. §280F – Section 280F(a)(1)(B)(iv) provides the limiting language For purposes of

this subtitle; Section 280F(a) contains several terms of art (e.g., taxable year, passenger automobile, recovery period); Section 280F(a)(2) contains the connecting word and as well as pinballing the student to another Code Section; Section 280F(b)(3) contains the measuring language exceeds 50 percent.

c. §168 – Section 168(b) contains the limiting language For purposes of this section;

Section 168(a) contains several terms of art (e.g., depreciation, tangible property, applicable depreciation method, etc.); Section 168(b)(2) contains the connecting term or as well as a pinball to another Code Section; Section 168(d)(3) contains the measuring term exceed; Section 168(f)(5) contains transitional rules. This is a good Code Section to point out the lengthy historical amendments following the Section.

14 Chapter 2


28. The IRC is replete with examples literally almost every Code Section contains at least one example of limiting language. The purpose of this exercise is to underline the significance of paying attention to limiting language. Because the language seems so nonsubstantive, students tend to simply ignore the language as unimportant.

29. Same answer as #28. 30. Section 172(c) defined the term net operating loss. 31. Code Section 168(e)(2)(A)(i) defines this term as “any building or structure if 80 percent

or more of the gross rental income from such building or structure for the taxable year is rental income from dwelling units.” The provisions that follow define some, but not all, of the terms of art in this provision such as dwelling unit.

32. This is a challenging question for the student. They should ultimately land on the words

“substantial risk of forfeiture” as the key words in the taxpayer’s situation. If the stock is subject to “substantial risk of forfeiture,” Sam has no income in the current year. However if he has no “substantial risk of forfeiture,” he has current income. One of the points in this exercise is for the student to appreciate that although there are numerous other terms of art in this provision, the only one requiring special research in this situation are the words “substantial risk of forfeiture.” It is the set of facts that determines which words in the Code need further analysis. The facts in this situation which cause these words to be critical is the potential loss of the stock should Sam be convicted of a crime. The research question moves from “is the stock income” to “is the stock subject to substantial risk of forfeiture?”

“Substantial risk of forfeiture” is defined somewhat in IRC Section 83(c)(1). This definition is not really sufficient to enable the student to determine whether the stock is subject to a substantial risk of forfeiture. When we get to Chapter 3, the students will have the opportunity to read the regulations which are clear in explaining that the risk of being convicted of a crime is not substantial enough to be considered a “substantial risk of forfeiture.” Therefore, Sam does have income in the year he receives the stock.

33. Now the key term of art is “property.” Does property include cash? The Code does not

clarify the meaning of this term for purposes of this section. The regulations indicate that cash is not considered “property” for purposes of Section 83, although it is considered “property” when that word is used in other Code Sections. (For example Section 1041). This illustrates to the student that the facts drive the determination of what portion of the Code requires focus. In addition, this is an important illustration of the fact that the same word may have two different and conflicting definitions depending on what Code Section it is used in.

34. a. Trust income tax – Subchapter I b. Partnership tax – Subchapter K



c. Corporate tax – Subchapter C d. Calculation of individual taxable income – Subchapter B 35. This Code Section was generated by P.L. 105-34, Section 1454(a) (The Taxpayer Relief

Act of 1997). All of the Committee Reports offer the same authoritative value regarding this provision because the House and Senate’s reports are the same. The Conference Committee Report simply indicates that the conference agreement follows the House and Senate Bill, with some technical modifications. Students can begin to locate this information after consulting with the historical amendments that follow the Code Section which identify the applicable Public Law and Section number. From there, the easiest method of research is to locate one of the softbound volumes containing the history of the act (given the relative recency of the act, students may be able to find this information in their library). If this is not available, students can locate the reports using the electronic online libraries; however, this is somewhat challenging and will likely lead to some frustration. This is a good lesson in why it is useful to keep those softbound legislative summaries.

36. Code Section 213 allows a deduction to Sam of $50 per night [flush language of Code

Section 213(d)(2)]. Sam appears to satisfy all the requirements for the deduction set forth in Section 213(d)(2) since the amount paid for the lodging does not appear to be lavish or extravagant, was incurred while away from home primarily for...medical care, and the medical care was provided by a licensed physician in a hospital (we assume it was licensed) and there was no significant element of personal pleasure...

37. Mary will have to recognize the full $3,000 as income. Code Section 74(c)(1) seems to

provide an exclusion for the award. However, that provision refers to Code Section 274(j) for the definition of an employee achievement award. Students who assume that Mary’s award is an employee achievement award will miss this question. Code Section 274(j) provides a very narrow definition of the term to include only awards given for length of service or safety achievement [Section 274(j)(3)(A)].

38. No, the trust is not entitled to the Section 179 deduction per Section 179(d)(4). 39. The provision was added to the Code Section in 1993 by P.L. 103-66, Sec. 1343(a). This

provision applies to property converted on or after 9/1/91. This question provides the student with the opportunity to research using the Code’s historical amendments.

40. Students should find researching into the current pending legislation interesting. In

addition, this provides an opportunity for a substantive discussion (if desired) on some of the pending tax bills.

41. Costs incurred in searching for a new residence ceased being deductible as moving

expenses beginning after December 31, 1993. This change was as result of P.L. 103-66.

16 Chapter 2


42. a. No, per Section 121(f) which provides for an election by the taxpayer not to have the Code Section apply.

b. Yes, per Section 121(d)(5) which refers to Section 1033 for additional rules.

c. No, per Section 121(b)(3)(A) which states that the exclusion is not allowed if

there was any other sale for which the exclusion applied during the prior 2 years ending on the date of the second sale.

43. No. The student must look at the historical amendments which indicate that the

provisions only apply to sales AFTER May 6, 1997

There was a $125,000 exclusion for TP’s over 55 years old.

The provision was enacted by P.L. 105-34, Sec. 312(a). This process will enable the students to practice researching legislative history.

44. P.L. 107-16 amended Code Section 2001 to change the rate to 49% in 2003, going down

by 1% each year through 2009. 45. a. Relevant facts include: motive for travel, travel expenses, actual travel plans.

b. The research question is whether she will be able to take a deduction for her travel costs.

c. Code Section 274(m)(2) specifically disallows this form of educational deduction.

46. This problem illustrates a number of challenges: pinballing, measuring words, and

attempting to understand the often-times convoluted way things are written. In addition, it is critical in this problem that the student always keep in mind the research question, otherwise she will end up reading all sorts of provisions that never actually apply!

Students may identify the initial research question as “Do the passive loss rules apply to the C Corporation?” The question at this point has nothing to do with what the actual passive loss rules are. This becomes relevant only if they determine the answer to their initial research question is “yes.”

The student first gets to the critical Code Section (§469) using either their knowledge, the index (“passive losses”) or the table of contents. The critical language in §469 begins in §469(a)(1) with “If for any taxable year the taxpayer is described in paragraph (2).” The rest of paragraph (1) becomes irrelevant for the moment. It is only relevant if the students decides that Corporation C is a “taxpayer described in paragraph (2).” The word if is key.



IRC §469(a)(2) lists three types of taxpayers. If Corporation C is any one of these types of taxpayers, then the passive loss provisions apply and the student must go back to the beginning. So now the hunt is to determine whether Corporation C fits into either of the three categories. Note that the connector in the list is and.

The facts do not lead one to believe that Corporation C is an individual, estate or trust [§469(a)(2)(A)]. The facts indicate that Corporation C is definitely not a personal service corporation, thus [§469(a)(2)(C)] also does not apply. But Corporation C might fit into [§469(a)(2)(B)] and be considered a closely held C corporation.

Now the research question becomes more refined for the moment: Is Corporation C a closely held C corporation for purposes of applying §469? To answer this, the student needs to look for the definition of the term closely held C corporation. By skimming through §469, the student should land upon §469(j)(1) as the place which provides the definition of this term. [Note that some students may get waylaid and read other subsections which seem relevant since some do start discussing the passive loss rules for closely held corporations. However, this is a useful learning process...if the student has always at the forefront the research question, the student in the skimming process will skip the information that discusses the passive loss rules for a closely held C corp.]

IRC §469(j)(1) informs the student that a closely held C corporation is any C corporation described in Code Section 465(a)(1)(B). Now the student must go read that provision, always remembering the reason why he/she is reading it. IRC §465(a)(1)(B) send the reader to yet another code section for the definition: IRC §542(a)(2)!

§542(a)(2) is a very difficult code section to read. After studying it, the students should conclude their facts are such that Corporation C is NOT a closely held C corporation for purposes of §469. (It should be pointed out that there may be different meanings for the term closely held C corporation but that this definition applies to the term when used in §469.) Once deciphered, the provision says that in order to meet the stock ownership requirements (which the student has been told by the code is the test for whether an entity is a closely held company for the passive lass rules), the following must exist: more than 50% of the stock is owned by 5 or fewer people (“not more than 5 individuals”). Because in the facts each shareholder owns 10% of the company, 5 people only own 50%. The provision states that more than 50% must be owned by 5 or fewer people. So in no event can Corporation C’s facts fulfill this requirement. Therefore, Corporation C is NOT a closely held corporation for purposes of §469 and therefore the company does not need to worry about the passive loss rules!

18 Chapter 2


47. Yes, per Code Section 7701(a)(26) which states that a trade or business includes the performance of the functions of a public office.

48. The research question is: “Can the company deduct the costs of demolition. If not, can

the costs be depreciated in some way?” The student will find the pertinent Code Section [IRC §280B] if the student looks for the word demolition in the index. It might be noticed that CCH’s index is a bit misleading here because it refers only to demolition of historic structures. Students can also discover the provision by going through the table of contents and finding the disallowance in Part IX of Subchapter B. It is good to note here that whenever researching to determine if something is deductible, the student should first look to see if there is a provision allowing the deduction, but then should always look to see if there is a specific provision that makes the item not deductible. In this case, the table of contents doesn’t lead to a clear allowance for the deduction in the allowing code sections (§161 et seq.), but a disallowance is clearly located in Part IX.

IRC §280B provides clear authority that demolition expenses are not deductible and must be capitalized to the land. This Code Section is fairly easy to read and doesn’t appear to leave any doubt about the correct answer. However, in the next chapter, students will be able to remember the definiteness of this Code Section and be surprised by how outdated the Regulations can be. The Regulations contradict this provision, but were written long before this provision came into effect.

49. The research question is “Can the president exclude the value of the free parking or must

he consider the value as taxable income?” In this situation, the students will most likely not find the index to the Code very helpful: neither parking or benefits or employee benefits can be located in the index. Unless the students know to look up the term fringe benefits, they will not be able to get far with the index. On the other hand, the table of contents is very useful in this situation. Students will browse through Subchapter B, skimming the specific inclusions portion and then the specific exclusions portion. They should land on IRC §132 as a possible pertinent section.

If the student is accessing the Code using an electronic format, she might very well take advantage of the ability of the computer to search through the Code to find where parking is mentioned. Because this word is not used frequently in the IRC, in this case they will be able to quickly arrive at not only the correct Code Section but the specific provision within that Code Section that addresses the issue.

This problem helps illustrate the need to apply the logical skimming technique discussed in the chapter. The student starts by reading carefully §132(a). From this, the student should identify that it is paragraph 5 (qualified transportation fringe) that looks most relevant. §132(a)(5) indicates that qualified transportation fringes are excluded from gross income. Thus, the new research question is whether the free parking provided to the president is considered a qualified transportation fringe. They should have skimmed each of the subsection headings until they find the one on qualified transportation fringes



- §132(f).

§132(f)(1)(C) indicates that qualified parking provided by an employer to an employee is a qualified transportation fringe. Because the president is receiving the parking as an employee from the company (or employer), the next question is whether the parking provided to the president is qualified parking. Reading on, the student sees the limitation on any exclusion (should the parking be qualified) in §132(f)(2)(B). That provision states that the exclusion shall not exceed $175 per month. [Students will notice several apparently duplicate provisions regarding the dollar limitation. This provides the student with an opportunity to see the importance of the effective date rules contained in these provisions.] It is also important to note here that the IRC frequently has “inflation” provisions hidden somewhere in the Code Section which provides for an adjustment of dollar amounts on an annual basis. Students should be aware that whenever dollar amounts are used in the IRC, they need to determine whether those amounts are to be adjusted for inflation. In this case, further perusal of the Code Section reveals §132(f)(6) which indicates the parking dollar limitation is to be adjusted annually for inflation. Next obvious question of the students - how do you discover what the adjusted amount is? The adjusted amount is never in the IRC. Rather, it is published yearly by the Treasury in announcements which they will learn about in the next chapter.

So the student knows that perhaps the entire amount of the parking will be excluded - if the parking is qualified parking. Skimming through §132(f), she should find the definition for “qualified parking” in §132(f)(5)(C). Upon reading the definition, the student will realize that more information is needed to accurately answer the research question since the definition anticipates the parking is provided on or near the business premises of the employer. Assuming this is the case, the value of the free parking is excludable. [Note that some students may have a very hard time reading the definition of qualified parking. It is defined as parking provided to an employee on or near the business premises of the employer or ... What follows the or are requirements if the employee commutes to work. Sometimes students fail to spot that or and believe that the additional requirements (in a commuter highway vehicle or car pool) must be satisfied.

50. a. Using either the index or the table of contents, the student should find the

applicable IRC section with ease – IRC §163. This section is an excellent example of the bandaging effect that has taken place over the years which results in the poor organization of Code Sections within the section itself. It is also an example of the need to read a Code Section to the end using the logical skimming approach. IRC §163(a) provides a general rule which appears to allow fully the deduction of all the interest. The language does not suggest any exceptions to the general provision allowing deduction for interest paid. However, IRC §163(h) provides much more detailed rules for this type of interest (in addition to destroying the general rule stated in IRC §163(a) by instead indicating that no personal interest is deductible unless). Therefore, the student must skim through each of the subsections until they bump into §163(h).

20 Chapter 2


Once finding §163(h), the student should see that IRC §163(h)(2)(D) indicates that “qualified residence interest” is still a deductible type of interest. Now the research question becomes more refined and is “is the interest paid by taxpayer ‘qualified residence interest”?

IRC §163(h)(3) defines this term to include interest paid on “acquisition indebtedness” with respect to any “qualified residence” of the taxpayer. Thus two new questions are whether the interest the taxpayer paid was “acquisition indebtedness” and whether the homes are “qualified residences.”

“Acquisition indebtedness” is defined in IRC §163(h)(3)(B) and after careful reading appears to apply to the debt paid on both homes with the facts given. The remaining question is whether both homes are “qualified residences.” Further skimming reveals that IRC §163(h)(4)(1) defines a qualified residence to include the “principal residence” within the meaning of IRC §121 AND one other residence “which is used by the taxpayer as a residence (within the meaning of section 280A(d)(1).” [Note that in the CCH codes, the cite actually reads “§163(h)(5)[4]”. This is because CCH is reflecting the official number of the Code paragraph (“5") which is erroneous. The accurate number is “4," which CCH also reflects. RIA’s code simply reports the paragraph as it should be without noting the formal erroneous numbering.]

Next the student must determine that the first home is indeed the taxpayer’s principal residence by seeing how that term is defined in Section 121. Next, the student must read IRC §280A(d)(1) to determine whether the second home also qualifies. IRC §280A(d)(1) defines use as a residence to include any dwelling unit used for personal purposes (we can assume from the facts that taxpayer’s use is personal) for a period of time “which exceeds the greater of 14 days or 10% of the days rented.” Taxpayer’s personal use is 30 days. He rents the house for 10 days. Thus, 14 days is greater than 10% of the rental days (10% of 10 = 1). Because the taxpayer’s personal use (30 days) exceeds 14 days, the house is considered a residence for purposes of IRC §280A(d). We are able to use this definition for purposes of IRC §163(h) even though there is limiting language because IRC §163(h) directs us to use this definition.

Therefore, both houses are qualified residences, both debts are acquisition indebtedness and neither debt exceeds the dollar limitations found in IRC §163(h)(3); therefore, all the interest is deductible.

b. This question requires the student to apply the rule that you must always skim to the end of the applicable section. At first glance, the student will think that the new facts result in a failure of the second home to be considered a qualified



residence because it fails the test in IRC §280A(d)(1) since 14 days of personal use does not exceed 14 days. However, more thorough reading of IRC §163(h)(5) reveals an exception to this rule in IRC §163(h)(5)(A)(iii). This provision states that “for purposes of clause (i)(II)” [limiting language that refers to the second home definition we just discussed], a home will still be considered a residence even if it fails the IRC §280A(d)(1) test if the taxpayer does not rent the house at any time. Therefore, the home remains a qualified residence under these circumstances and the interest on the debt is deductible.

c. Assume for this question that the current balance on the mortgage is $1,500,000. Also

assume there is no second home. Now the student should discover the provisions in IRC §163(h)(3)(B)(ii) that impose a $1,000,000 limitation on the total amount of acquisition indebtedness. This would appear to indicate that only a portion of the interest on the first home is deductible. However, further reading uncovers an exception to this dollar limitation when the initial debt was acquired prior to 1987 [IRC §163(h)(3)(D)]. Therefore, all the interest is deductible.

51. At the initial stage, students probably will not be able to closely articulate the research

question unless they understand what the vacation home deduction rules provide. So the initial question for most will be “do the vacation rules apply when a cousin uses a home for personal use?” As students learn more about the vacation home deduction rules, the question will be refined further.

If the students were asked to do the previous question, most of them should be able to

recognize the code section that is applicable since they just spent some time in it -- §280A. Otherwise, students can arrive at the section by using the index or looking at the table of contents.

The initial question is not what are the vacation home deduction rules, but do they apply in the given factual situation? Thus, the student should not be struggling to determine what the rules are at this point. The general rule states however the general rule and provides important information to the researcher. §280A(a) says that “...no deduction...shall be allowed with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence.” The student should eventually determine that §280A(d)(1) is relevant because it discusses what a “residence” is and states that it all depends on the number of days the taxpayer “personally used” the home. Now the student’s research question can be narrowed to “is the personal use of a cousin considered to be personal use by the taxpayer?”

§280A(d)(2) defines “personal use” to include the use of persons other than the taxpayer in three different situations. §280A(d)(2)(A) states that the personal use of “any member of the family (as defined in section 267(c)(4)) of the taxpayer” is considered to be personal use of the taxpayer. Study of §267(c)(4) indicates that a cousin is not a “member of the family.”

22 Chapter 2


However, this is not the end of the research. It turns out that the personal use of the cousin will be attributed to the taxpayer under §280A(d)(2)(C) because this provision includes the use of “any individual...unless ... the dwelling unit is rented for a rental which...is fair rental.” Because the cousin uses the house for free, such use is considered the personal use of the taxpayer.

52. With the changed facts, the critical provision is §280A(d)(2)(A) which attributes the

nephew’s personal use even though he is paying fair rental value is he is considered “a family member” of Sue. Studying §267(c)(4), the student should conclude that the nephew is not a “family member” of Sue’s.

53. a. John has $20,000 of debt relief which represents potential gross income. Code

Section 108(a)(1)(B) provides for the exclusion from income of debt relief if the debtor was “insolvent” immediately prior to the relief of debt. The exclusion cannot exceed the amount of the insolvency. Code Section 108(d)(3) defines insolvency as the amount a person’s liabilities exceed the fair market value of their assets immediately prior to the discharge. John is insolvent by $15,000 (300,000-[235,000+50,000]. John will be able to exclude $15,000 of the $20,000 debt relief income. He must recognize $5,000 as income.

b. Because John excluded $15,000 of the debt relief due to insolvency, Code Section

108(b) suggests that he has to reduce his basis by that amount. However, Code Section 1017(b)(2) provides additional limitations on the amount the basis needs to be reduced if after the discharge, liabilities still exceed the basis of the assets. Applying Code Section 1017(b)(2) results in the requirement that John will not have to reduce his basis at all because the basis in his assets after discharge does not exceed the liabilities after discharge [basis of assets after discharge = $70,000 (150,000-30,000 cash paid) minus liabilities after discharge = $250,000 (300,000-50,000 discharged debt]. Note that students sometimes need to be reminded that John does not want to have the basis in his assets reduced! So the Code Section 1017(b)(2)’s limitation may provide him with a desired benefit. Also note that students tend not to go to Code Section 1017(b)(2) and instead stop at Code Section 108(b)(2)(E). This provides a good lesson in the need to follow the “pinballing.”

c. Students should see that Code Section 108(b)(5) allows John the ability to avoid

reducing the NOL under the regular Section 108(b) ordering rules, and instead reduce his basis. Here it is critical to point out to the student that by making the Section 108(b)(5) election, the benefits of Code Section 1017(b)(2) are waived [see the last sentence in Section 1017(b)(2)].

54. The applicable Code Section in this situation is IRC §127 which provides for the

exclusion of up to $5,250 in educational benefits resulting from a qualified educational



assistance program. A few important items to note to the students when examining this Code Section include the sunset provisions now in the historical notes and the frequency of amendments in Subsection (c). It will be useful to have the students examine these historical amendments and discuss them briefly.

55. This question involves the tax treatment of income resulting from the relief of debt.

Either through the table of contents or through the index, students should locate IRC §108. After a good deal of careful skimming, students should discover that IRC §108(e)(2) applies in this situation and allows Susan to exclude the $6,000 in relieved rent, since these payments would have resulted in a tax deduction had she made them.

INTEGRATED CASE STUDIES - see solutions beginning on page 140

24 Chapter 3


CHAPTER 3 B TREASURY INTERPRETATIONS KEY CONCEPTS (1-22) 1. Definitions

a. Proposed Regulations represent the form Regulations first take before they are

made final. (See page 122) b. Temporary Regulations are a special form of Regulation issued when the

Treasury determines that is it necessary to provide binding authority while the regulations are also in the proposed form. (See pages 122-123)

c. Final Regulations are the most authoritative form of Treasury interpretation.

(See pages 118-123) d. The preamble to regulations provide useful introductory and contextual

information about the specific regulation. Although their formal authority is unclear, preambles are widely viewed as useful sources of information. (See page 121)

e. 26 CFR stands for Title 26 of the Code of Federal Regulations. This represents

the regulations that interpret the Internal Revenue Code. f. The Internal Revenue Bulletin is a weekly publication of the Internal Revenue

Service that contains, among other things, newly issued regulations. (See page 126)

g. The Cumulative Bulletin is a semiannual service containing most of the

documents issued in the IRB. (See page 126) h. Revenue Rulings are Treasury interpretations that offer guidance regarding the

appropriate application of the IRC to a specific set of facts. (See pages 131-139) i. Revenue Procedures are Treasury pronouncements offering procedural guidance

regarding certain tax matters. (See page 141) j. A citator is a tool published by a variety of tax publishers. The citator enables

the researcher to identify court decisions, Revenue Rulings and Revenue Procedures that have cited a particular case decision or ruling or procedure. (See pages 136-140)

k. Private Letter Rulings are Treasury interpretations issued by the National office

in response to a taxpayer request for a ruling regarding the tax treatment of a

Treasury Interpretations 25


prospective transaction. (See page 143) l. Technical Advice Memoranda are Treasury interpretations issued by the

National office of the Treasury as a result of internal confusion regarding the appropriate tax treatment of a transaction that has already occurred. (See pages 143)

m. Field Service Advice Memoranda are similar to letter rulings. However, the

Office of Chief Counsel issues FSAs in response to requests from IRS personnel such as revenue agents and field attorneys. The IRS states that FSAs are intended only to assist in resolving matters. They do not represent the IRS=s final position on matters.

n. Determination Letters are interpretations similar to Letter Rulings except they

are issued by an IRS District Director rather than the National office. (See page 146)

o. General Counsel Memoranda are issued by the Chief Counsel=s office in the

IRS as internal guidance for the preparation of rulings. (See page 147) p. IRS Announcements are issued by the National Office of the IRS to provide

quick interpretive guidance, prior to the issuance of a Revenue Ruling. (See page 148)

q. IRS News Releases provide general information to the public regarding recently

published regulations and IRS forms and instructions. The news releases generally do not provide significant substantive information and are not usually considered authoritative.

r. IRS Publications are publications of the IRS directed at the general public

explaining in lay terms the application of particular Code provisions. (See page 149)

s. Actions on Decisions are internal IRS communications in response to a court

decision. (See pages 149-150) t. Acquiescences and nonacquiescences are internal communications by the IRS

indicating its acceptance or nonacceptance of a Tax Court decision. An acquiescence indicates that the IRS will not continue to pursue its position taken in the litigation leading to the decision. An acquiescence does not necessarily indicate approval of the court=s rationale. A nonacquiescence indicates that it is the IRS=s intention to continue applying its previous position regardless of the court decision. Acquiescences and nonacquiescences are published in the Internal

26 Chapter 3


Revenue Bulletin and the Cumulative Bulletin, usually in the form of a revenue ruling. In addition, each citator provides information as to whether the IRS issued an acquiescence.

2. The researcher must pay attention to Treasury interpretations because it is the IRS that

taxpayers must first deal with. If the researcher finds an authoritative treasury interpretation directly on point and supportive of the taxpayer=s position, taxpayer doesn=t have much to worry about. However, if there is an authoritative treasury interpretation negative to the taxpayer=s position, a helpful court case is comforting but requires the taxpayer to litigate should he get audited.

3. The researcher should first always try to find the answer to the research question in the

IRC. But when the IRC does not sufficiently answer the research question, the Treasury Regulations are the next source to examine. Unfortunately, the researcher cannot expect the Regulations to always provide the research answer. Sometimes there is no Regulation interpreting the IRC section; other times the Regulation provision is obsolete; and yet other times, the regulation just doesn=t address the issue at hand.

4. Regulations frequently conflict with the provisions of the Code. When a Code Section is

amended, the Regulation interpreting the section is not concurrently amended. In fact, the Code Section may be amended several times with no corresponding change made to the regulations.

5. To ensure the reliability of a Regulation, the researcher must make sure that there have

been no changes made to the Code Section not reflected in the Regulation. There are a number of ways of accomplishing this. In the print reference materials, the publishers post warnings immediately prior to any obsolete regulation. This is also true in the electronic context and with RIA=s softbound regulation volumes. If the researcher uses CCH=s softbound regulation volumes, the table at the front of the regulations provides this information.

6. Treasury Regulations can be found in the multi-volumed services published by RIA and

CCH, in the same publishers= softbound Regulations, on the public Internet and in most of the fee-based Internet tax services.

7. Treasury Regulations and Revenue Rulings are different in both their level of authority

and their intent. Regulations provide very authoritative generic guidelines regarding the application of a Code Section. Revenue Rulings provide guidelines with respect to a specific set of facts, rather than a generic discussion. As a result, Revenue Rulings are generally less authoritative since they are fact specific.

8. A Revenue Ruling provides the greatest amount of authority when the facts in the

Revenue Ruling are materially the same as those involved in the situation being



researched. 9. The central components of a Revenue Ruling include: An anonymous explanation of the

facts, a discussion of the relevant authority (including Code, Regulations, Revenue Rulings and case law), a conclusion regarding how the law applies to the facts, and a statement about any impact on previously issued rulings.

10. Rev. Rul. 97-54, 1997-1 CB 25:

Rev. Rul. = Revenue Ruling; 97-54, = the year (97) and number of the ruling; 1997-1 = the first volume in the Cumulative Bulletin for 1997; C.B. = Cumulative Bulletin; 25 = Page number in that volume.

Rev. Rul. 99-20, 1999-5 I.R.B. 10:

Rev. Rul. = Revenue Ruling; 99-20, = the year (99) and number of the ruling; 1999-5 = the fifth issue of the Internal Revenue Bulletin for 1999; IRB. = Internal Revenue Bulletin; 10 = Page number in that issue.

11. To ensure the reliability of a Revenue Ruling, the researcher must citate the ruling. 12. The citator does not inform the researcher of all documents that are related to the research

issue because that is not its intent. It is intended only to identify those documents that have cited the document upon which the researcher wishes to rely.

13. The difference between a Letter Ruling and a Revenue Ruling is both one of level of

authority and intent. A Letter Ruling is intended only to speak to the particular transaction the requester of the ruling discusses. Likewise, a Letter Ruling is primarily authoritative only with regard to that transaction. A Revenue Ruling has broader application, speaking to all situations with facts similar to those in the Revenue Ruling.

14. The IRS Bulletin Index-Digest System can be used for this purpose since it identifies

Rulings by Code Section. 15. PLR = Private Letter Ruling;

2000 = Represents the year of the ruling 45 = Represents the week within the year 300 = Represents the ruling number within that week

16. Most research issues are answered through research in the reference services and reading

the relevant cases and revenue rulings they refer you to. But if there still remains a question even after reading all pertinent cases and Revenue Rulings, Private Letter Rulings provide another possible source for an answer.

Reference services do not provide thorough referencing to relevant Letter Rulings. Therefore, to find relevant Letter Rulings, the researcher must separately research into

28 Chapter 3


Letter Rulings. Electronic databases provide the best vehicle for this type of research. The researcher must use the search mechanism available on the electronic database they are using.

17. Searching for a Code Section cite or a Regulation cite results in the most comprehensive

list of relevant Letter Rulings. This is because every Letter Ruling refers to the relevant Code Section and also to the relevant Regulation. So a search for these items results in a list of all the Letter Rulings dealing with the pertinent Code Section. Searching for key words may enable the researcher to find a pertinent Letter Ruling. However, using key words creates a danger of inadvertently eliminating a potentially useful document by using a word or combination of words in a slightly different way than the ruling. Because electronic searching is literal, the search lists only the rulings actually using the exact words in the search. Therefore, key word searches should be used with that danger in mind.

18. When the IRS acquiesces to a court decision, it puts the researcher at ease that the IRS

will no longer challenge positions taken contrary to the court decision. However, when the IRS issues a nonacquiescence, it places the researcher on alert that even though the court decision may be helpful to the taxpayer, the Service does not intend to abide by the ruling in future transactions.

19. The Code represents statutory law written by Congress, whereas Regulations are simply

interpretations of the Code issued by the Treasury Department. 20. A Revenue Ruling provides interpretative guidance with respect to the application of the

Code to a specific set of fact. Revenue Procedures are not factual specific and instead offer procedure guidance.

21. The Service issues an internal reaction through an Action on Decision indicating how the

Service believes it will respond to a court decision. It may then issue either an acquiescence (indicating concurrence with the decision) or a nonacquiescence (indicating it will continue to disagree with the court=s decision).

22. Through the method of citating a case. PRACTICAL APPLICATIONS (23-63) 23. Treas. Reg. Section 1.132-5(a)(1)(v)(B). 24. a. Treas. Reg. Section 1.162-1 provides quite a bit of information regarding what

types of expenses might constitute business expenses. However, it provides no information helping to interpret the terms ordinary and necessary.

b. Treas. Reg. Section 1.183-2 provides a great deal of information regarding the



term activity not engaged in for profit. It provides a list of factors to be considered in making this determination.

c. There are no Final or Temporary Regulations interpreting Section 280A. Some

students may discover that there are Proposed Regulations interpreting this section.

25. Rev. Rul. 96-150, 1996-2 C.B. 225 26. Rev. Proc. 99-5, 1999-5 IRB 10 (or IRB1995-5, 10) 27. a. Rev. Rul. 95-20, 1991-1 C.B. 163

b. Rev. Rul. 91-14, 1991-1 C.B. 18

c. Rev. Rul. 72-604, 1972-2 C.B. 35

d. Rev. Rul. 57-441, 1957-2 C.B. 45 (it is not appropriate to cite to the IRB once the document has been placed in the Cumulative Bulletin)

e. Rev. Proc.2003-19, 2003-5 IRB 371 (or IRB 2003-5,371)

f. Rev. Proc. 96-1, 1996-1 C.B. 385

28. a. Rev. Rul. 71-301, 1971-2 CB 256 B This was made obsolete by Rev. Rul.

95-21, 1995-1 C.B. 131 and also was cited in Babin vs. Commission, 94-1 USTC &50,224.

b. Rev. Rul. 62-199, 1962-2 CB 38 B Still an authoritative Revenue Ruling.

c. Rev. Rul. 87-41, 1987-1 CB 296 - Still an authoritative Revenue Ruling.

d. Rev. Rul. 54-14, 1994-1 CB 129 - obsoleted by Rev. Rul. 89-119, 1989-2 CB 275.

29. a. Rev. Proc. 96-1, 1996-1 CB 385 B Superceded by Rev. Proc. 97-1 which

in turn was superceded by Rev. Proc. 98-1 and again by Rev. Proc. 99-1, and every year since. The first Revenue Procedure issued each year is on the same subject and supercedes the one issued in the prior year. This is the one thing the researcher can always rely on!

b. Rev. Proc. 79-63, 1978-2 CB 578 B Superceded by Rev. Proc. 92-85

which was then further modified by several subsequent Revenue

30 Chapter 3


Procedures before being made obsolete by Treasury Decision 8680.

c. Rev. Proc. 87-41, 1987-2 CB 515 B Superceded by Rev. Proc. 88-49 which was superceded by Rev. Proc. 89-44 which was superceded by 90-43, again obsoleted by Rev. Proc. 91-33 which was obsoleted by Rev. Proc. 92-46 which was superceded by Rev. Proc. 93-31 which was superceded by Rev. Proc. 94-43 which is currently authoritative.

d. Rev. Proc. 98-5, 1998-1 IRB 155 B Superceded by Rev. Proc. 99-5 and the

fifth revenue procedure each year. Therefore, as of this writing, Rev. Proc. 2008-5 is the authoritative procedure.

30. a. Rev. Rul. 2003-12, IRB 2003-3, 283

Facts: This revenue ruling addresses the tax treatment of payments made by states, charitable organizations or employers to victims of disasters. Situation 1 deals with taxpayers receiving grants from a state to pay for medical expenses and temporary housing. Situation 2 addresses the situation where a charitable organization makes the same type of payments. The third situation deals with an employer making the payments.

Issue: Are payments received by an individual to assist in medical expenses and temporary housing in a disaster situation includible in income?

Holding: The service held that in all three situations the amounts are excludible. When the state and employer makes the payments, the Service held that Section 139 offers the exclusion. When a charitable organization makes the payments, the court held that Section 102 is the exclusion section.

b. Rev. Rul. 95-58, 1995-2 CB 191

Facts: 1. The decedent created a trust for the benefit of others and designated an independent corporate fiduciary as trustee. The trustee possesses broad discretionary powers of distribution. The decedent reserved the right to remove and replace the corporate trustee with another independent corporate trustee. 2. The decedent created a trust and appointed family members as the trustee with discretionary powers of distribution. The decedent reserved the right to remove and replace the trustee with successor trustees who were not related or subordinate to the decedent. Three years later, the trust was amended to eliminate both the decedent=s power to remove and replace the trustees and the decedent=s eligibility to receive discretionary distributions.

Issue:



IRC Section 2038(a)(1), in general, provides that the value of the gross estate includes the value of all property to the extent of any interest in the property that was transferred by the decedent (for less than adequate consideration) if the decedent held a power, exercisable alone or in conjunction with any person, to change the enjoyment of the property through the exercise of a power to alter, amend or revoke. The issue here is whether a grantor's reservation of an unqualified power to remove a trustee and appoint a new trustee, other than the grantor, is tantamount to a reservation by the grantor of the trustee's discretionary powers of distribution.

Holding: Even if the decedent possessed the power to remove the trustee and appoint an individual or successor trustee that was not related or subordinate to the decedent, the decedent would not have retained a trustee's discretionary control over trust income.

c. Rev. Rul. Rev Rul 2006-57, 2006-47 IRB 911

Issue

Whether employer-provided transportation benefits provided through smartcards, debit or credit cards, or other electronic media are excluded from gross income under IRC §§132(a)(5) and 132(f).

Facts

The ruling discusses four situations. In summary, situation 1 involves the employer providing to its employees transportation benefits in an amount not exceeding $105 each month through smartcards. The smartcards are plastic cards containing a memory chip that stores certain information including the serial number of the card and the value of the fare media stored on the card. The amount stored as fare media on the smartcard is not authorized to be used to purchase anything other than the fare. The employer makes monthly payments to the transit company selling the cards on behalf of its employees who participate in the transportation benefit program. The employer does not require its employees to substantiate their use of the smartcards.

Situation 2- In summary, the facts are very similar to situation 1 except that the employer pays a debit-card provider for cards for its employees that can only be used at transportation merchant terminals. All other facts are the for the most part the same.

Situation 3 is for the most part the same as situation 1 and 2, except that the cards have the potential for being used for a greater variety of charges. In addition, the

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employee is required to substantiate that the expenses were used for transportation. (Many details are provided for this situation – so a researcher dealing with a similar situation would certainly need to review more carefully the text of the ruling.)

Situation 4 - The facts are the same as in Situation 3, except that the employees are not required to substantiate that the charges were used for transportation expenses even though on the card the instructions are that the charge must be limited to this. In fact, an employee could end up charging for something that is not transportation, and the employer would be paying for it, believing that it is transportation charges.

Law (the full-text of this portion of the revenue ruling follows below)

Section 61(a)(1) of the Code provides that, except as otherwise provided in subtitle A, gross income includes compensation for services, including fees, commissions, fringe benefits, and similar items.

Section 132(a)(5) provides that any fringe benefit that is a qualified transportation fringe is excluded from gross income. Section 132(f)(1) provides that the term “qualified transportation fringe” means (1) transportation in a commuter highway vehicle between home and work, (2) any transit pass, and (3) qualified parking. The amount of the fringe benefit which may be excluded from gross income and wages for 2006 is limited to $105 per month for the aggregate of transportation in a commuter highway vehicle and transit passes, and $205 per month for qualified parking. See § 132(f)(2); Rev. Proc. 2005-70, 2005-47 I.R.B. 979, § 3.12.

Section 132(f)(5)(A) provides that a transit pass is any pass, token, farecard, voucher or similar item entitling a person to transportation (or transportation at a reduced price) if such transportation is on mass transit facilities or is provided by any person in the business of transporting persons for compensation or hire in a commuter highway vehicle. See § 132(f)(5)(B) for the definition of a commuter highway vehicle.

Section 132(f)(3) provides that a qualified transportation fringe includes a cash reimbursement by an employer to an employee for transit benefits. However, a qualified transportation fringe includes a cash reimbursement by an employer to an employee for a transit pass only if a voucher or similar item that may be exchanged only for a transit pass is not readily available for direct distribution by the employer to the employee.

Section 1.132-9(b) Q/A-16(b)(1) of the Income Tax Regulations provides that if a voucher or similar item is readily available, the requirement that a voucher or similar item be distributed in-kind by the employer is satisfied if the voucher is distributed by the employer or by another person on behalf of the employer (for



example, if a transit operator credits amounts to the employee's fare card as a result of payments made to the operator by the employer).

Section 1.132-9(b) Q/A-16(b)(2) provides that a transit system voucher is an instrument that may be purchased by employers from a voucher provider that is accepted by one or more mass transit operators in an area as fare media or in exchange for faremedia. Under § 1.132-9(b) Q/A-16(b)(3), a voucher provider is any person in the trade or business of selling transit system vouchers to employers, or any transit system or transit system operator that sells vouchers to employers for the purpose of direct distribution to employees.

Section 1.132-9(b) Q/A-16(b)(4) provides that a voucher or similar item is readily available for direct distribution by an employer to employees if and only if the employer can obtain it from a voucher provider that does not impose fare media charges greater than 1 percent of the average annual value of the voucher for a transit system, and does not impose other restrictions causing the voucher not to be considered readily available. See § 1.132-9(b) Q/A-16(b)(5) and (b)(6).

Section 1.132-9(b) Q/A-16(a) provides that the term qualified transportation fringe includes cash reimbursement for transportation in a commuter highway vehicle, transit passes (if permitted), and qualified parking, provided the reimbursement is made under a bona fide reimbursement arrangement. A payment made before the date an expense has been incurred or paid is not a reimbursement. In addition, a bona fide reimbursement arrangement does not include an arrangement that is dependent solely on the employee certifying in advance that the employee will incur expenses at some future date. Under § 1.132-9(b) Q/A-16(c), whether a reimbursement is made under a bona fide reimbursement arrangement depends upon the facts and circumstances. The employer must implement reasonable procedures to ensure that the amount equal to the reimbursement was incurred for transportation in a commuter highway vehicle, transit passes, or qualified parking. Section 1.132-9(b) Q/A-16(d) provides that reasonable reimbursement procedures include the collection of receipts from employees or obtaining employee certifications in appropriate circumstances. The regulations provide that obtaining an employee's certification is a reasonable reimbursement procedure if receipts are not provided by the seller in the ordinary course of business, and if the employer has no reason to doubt the employee's certification.

Section 1.132-9(b) Q/A-18 provides that there are no employee substantiation requirements if an employer distributes a transit pass (including a voucher or similar item) in-kind to the employer's employees.

Federal Insurance Contributions Act (FICA) taxes, Federal Unemployment Tax Act (FUTA) taxes, and Federal income tax withholding are imposed on “wages.” See §§ 3101, 3111, 3121(a), 3301, 3306(b), 3402, and 3401(a). Section 3121(a)

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defines “wages” for FICA purposes as all remuneration for employment including the cash value of all remuneration (including benefits) paid in any medium other than cash, with certain specific exceptions. Sections 3306(b) and 3401(a) define “wages” similarly for FUTA and Federal income tax withholding purposes respectively.

Section 3121(a)(20) excepts from the definition of “wages” for FICA tax purposes any benefit provided to or on behalf of an employee if, at the time such benefit is provided, it is reasonable to believe that the employee will be able to exclude such benefit from gross income under § 132. Sections 3306(b)(16) and 3401(a)(19) provide similar exclusions for FUTA and Federal income tax withholding purposes respectively.

Analysis

In Situation 1, the fare media value stored on the smartcards is useable only as fare media for transit system X. Thus, the smartcard qualifies as a transit system voucher under § 1.132-9(b) Q/A-16(b)(2) distributed in-kind by A to its employees. In addition, the amount allocated to each employee's smartcard is within the amount specified by § 132(f)(2)(A). Accordingly, the value of the fare media provided by A to its employees through the use of the smartcards is excluded from the employees' gross income as a qualified transportation fringe benefit within the meaning of § 132(a)(5) without requiring the employees to substantiate their use of the smartcards.

In Situation 2, the terminal-restricted debit card provided by B to its employees qualifies as a transit system voucher under § 1.132-9(b) Q/A-16(b)(2) because it can be used only at merchant terminals at points of sale at which only fare media for transit system Y can be purchased. In addition, the amount allocated to each employee's debit card each month is within the amount specified by § 132(f)(2)(A). Therefore, the value of the fare media provided by B to its employees through the use of the terminal-restricted debit cards is excluded from its employees' gross income as a qualified transportation fringe benefit within the meaning of § 132(a)(5) without requiring the employees to substantiate their use of the debit cards.

In Situation 3, the debit card provided by C to its employees does not qualify as a transit system voucher under § 1.132-9(b) Q/A-16(b)(2) because it is possible that a MCC-restricted debit card may be used to purchase items other than transit passes. A merchant properly classified to accept the debit card as payment may sell merchandise other than transit passes, and there is nothing in the debit card technology which prevents its use to purchase things other than transit passes.

Because a voucher or similar item exchangeable only for fare media is not readily available to C for direct distribution to its employees, § 132(f)(3) permits C to



provide qualified transportation benefits in the form of cash reimbursements for transit pass expenses, but only if the reimbursements are provided under a bona fide reimbursement arrangement. With respect to expenses incurred during the first month an employee participates in the transportation benefit program, and with respect to expenses not paid using the MCC-restricted debit card, C has implemented reasonable substantiation procedures as described in § 1.132-9 Q/A-16(c). With respect to expenses paid using the MCC-restricted debit card, C receives periodic statements providing information on the purchases made with the debit card, including the identity of the seller, and the date and amount of the debit card transactions. In addition, for the first month an employee uses the MCC-restricted debit card, C requires that the employee certify that the card was used only to purchase fare media. C does not require monthly certifications with respect to recurring items if the item described in the periodic statement matches with respect to seller and time period items that have previously been substantiated as transit pass expenses. However, C requires at least an annual recertification from each employee that the debit card was used only to purchase fare media. Prior to remitting an amount to Q as reimbursement for transit pass expenses for an employee, C examines the periodic statements describing debit card transactions in combination with employee certifications to determine the transit pass expenses incurred by each employee through the use of the debit card. C provides funds to Q to be electronically allocated to the debit cards only as reimbursements for substantiated transit pass expenses that have been incurred and substantiated in this fashion. Based on the facts and circumstances, C has established a bona fide reimbursement arrangement for transit passes within the meaning of § 1.132-9 Q/A-16(c). In addition, the amount of the monthly benefit is within the amount specified by § 132(f)(2)(A). Therefore, the value of the fare media provided by C to its employees through the use of the MCC-restricted debit cards is excluded from its employees' gross income as a qualified transportation fringe benefit within the meaning of § 132(a)(5).

In Situation 4, as discussed above, the MCC-restricted debit card does not qualify as a transit system voucher under § 1.132-9(b) Q/A-16(b)(2). Because a voucher or similar item is not otherwise readily available to C, C may provide qualified transportation fringe benefits in the form of cash reimbursements for transit passes under a bona fide reimbursement arrangement. C provides the debit cards in advance, requiring its employees to certify that they will use the cards exclusively to purchase transit passes. This arrangement does not constitute a bona fide reimbursement arrangement under § 1.132-9(b) Q/A-16(c) because it provides for advances rather than reimbursements and because it relies solely on employee certifications provided before the expense is incurred. Those certifications, standing alone, do not provide the substantiation of expenses incurred necessary for there to be a bona fide reimbursement arrangement. Because C is providing restricted-use debit cards that are not transit system vouchers, and because C is not reimbursing its employees for fare media expenses

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under a bona fide reimbursement arrangement, the amounts C provides to its employees through the use of the MCC-restricted debit cards are included in its employees' gross income and wages.

Holdings

In summary, the service held that the value of transit pass benefits provided by the employees through the use of the smartcards, terminal restricted debit cards, MCC-restricted debit cards is excluded from gross income under § 132(a)(5) and from wages for employment tax purposes. However the amounts provided by its employees through the use of the MCC-restricted debit cards are not excluded from gross income under § 132(a)(5) and are wages for employment tax purposes.

Effective Date

This revenue ruling is effective January 1, 2008. However the procedure indicates that the ruling may be relied onth respect to transactions occurring prior to January 1, 2008.

d. Rev. Rul. 57-374, 1957-2 CB 69

The entire ruling consists of the following statement: AWhere an individual refuses to accept an all-expense paid vacation trip he won as a prize in a contest, the fair market value of the trip is not includible in his gross income for Federal income tax purposes.@

31. a. Rev. Proc. 2002-12, 2002-3 IRB 374 (or IRB 2002-3, 374)

This procedure provides a safe harbor accounting method to taxpayers engaged in the trade or business of operating a restaurant or tavern. Taxpayers are permitted to account for smallwares in the same manner as materials and supplies that are not incidental under Reg. '1.162-3.

b. Rev. Proc. 98-1, 1998-1 IRB 7

This is an extremely lengthy Revenue Procedure which has already been superceded by the first Revenue Procedure issued in the current year. (Issued annually.) This revenue procedure explains how the Internal Revenue Service gives guidance to taxpayers. It explains the kinds of guidance and the manner in which guidance is requested by taxpayers and provided by the Service. It covers such subjects as the issuance of Letter Rulings, Determination Letters, and Revenue Rulings.



c. Rev. Proc. 95-35, 1995-2 CB 391

Students should realize that this Revenue Procedure has already been superceded. In part, it provides that Aexempt organizations, other than Code Sec. 501(c)(3) organizations, that pay or incur nondeductible lobbying expenditures are required by Code Sec. 6033(e)(1) to notify their members of a reasonable estimate of the portion of their dues that is allocable to those expenditures. Organizations that fail to provide such notices or that underestimate the actual amount of dues allocable to nondeductible lobbying expenditures will be subject to tax on the aggregate amount of dues allocable to the expenditures made during the tax year that was not reported on the notices. The IRS has issued procedures that enumerate the specific circumstances in which certain exempt organizations will be deemed to satisfy the requirements of Code Sec. 6033(e)(3). These organizations will not be required to comply with the reporting and notice rules. In addition, other organizations have been provided with guidance on how to satisfy the Code Sec. 6033(e)(3) requirements.@

This revenue procedure provides guidance to organizations exempt from taxation under '501(a) of the Internal Revenue Code on the application of amendments made to ''162(e) and 6033(e) by '13222 by the Omnibus Budget Reconciliation Act of 1993.@

d. Rev. Proc. 75-21, 1975-1 CB 715

The purpose of this Revenue Procedure is Ato set forth guidelines that the Internal Revenue Service will use for advance ruling purposes in determining whether certain transactions purporting to be leases of property are, in fact, leases for Federal income tax purposes. The type of transaction covered by this Revenue Procedure is commonly called a >leveraged lease.= Such a lease transaction generally involves three parties: a lessor, a lessee and a lender to the lessor. In general, these leases are net leases, the lease term covers a substantial part of the useful life of the leased property, and the lessee's payments to the lessor are sufficient to discharge the lessor's payments to the lender.@

32. a. Rev. Proc. 86-15, 1986-1 CB 554 B Regarding publication standards of rulings (this has been superceded).

b. Rev. Rul. 85-87, 1985-1 CB 268 B Treatment of loss on the sale of corporate stock, otherwise allowable under section 165, if, within 30 days of the sale of stock, the taxpayer sold an option with respect to the stock and, based on the objective factors at the time the put was sold, there was no substantial likelihood that the put would not be exercised.

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c. Rev. Rul.2001-60, 2001-53 IRB 643 (or IRB 2001-53, 643) - How land preparation costs incurred in construction of golf course greens can be depreciated under Section 167.

d. Rev. Proc. 96-9, 1996-1 CB 575 B How to request an early IRS referral of one or more disputed issues from Examination to Appeals.

33. Revenue Ruling 79-72, 1979-1 CB 278. Using electronic databases, the student can

search for a Revenue Ruling in 1979 having the key word time deposit. 34. a. Rev. Rul. 95-20, 1995-1 CB 163

b. Rev. Rul. 91-14, 1991-1 CB 18

c. Rev. Rul. 72-604, 1972-2 CB 35

35. Rev. Proc. 98-25, 1998-11 IRB 7 (or IRB 1998-11, 7)

a. This procedure is about the basic requirements it considers to be essential in cases where a taxpayer's records are maintained within an Automatic Data Processing (ADP) system.

b. It modified and superceded Rev. Proc. 91-59.

c. Through citating it, the student can determine that the procedure is still

authoritative. (As of June 2002.) 36. This regulation was not updated by the changes made in 1982 to IRC Section 165(c)(3)

by Public Law 97-248. This law substantially changed the way the allowed deduction is determined. The Regulations indicate the deduction is determined by reducing the actual amount of the loss (in no event greater than the basis of the property) by $100. The IRC now provides that the deduction must also be reduced by 10% of the taxpayer=s adjusted gross income. Quite a difference!

37. Treas. Reg. Section 163-10T does not reflect at least two public laws. They are P.L. 100-

203 and P.L. 100-647. P.L 100-203 limited acquisition interest indebtedness to $1,000,000 and removed qualified medical expenses and qualified education expenses from qualified indebtedness. In addition, P.L. 100-647 alters the definition of investment income and provides a phase-in of the investment income disallowance ending in 1990.

38. Announcement 98-18, 1998-10 IRB 44 (IRB 1998-10, 44) solicits comments regarding

issues arising from conversion to the euro to determine the appropriate scope and content of published guidance. Specifically, it asks for comments on the following:

A1. Whether a qualified business unit (QBU), as defined in section 989(a), with a legacy



functional currency that is converted to the euro will have changed its functional currency under section 985 and regulations thereunder and the implications of any such change (e.g., whether Treas. Reg. '1 ,985-5 adequately addresses necessary adjustments, the treatment of unrealized currency gains and losses, and the appropriate timing of any such change).2. Whether the conversion of a legacy currency to the euro creates a realization event with respect to a financial instrument denominated in a legacy currency and the appropriate time to recognize any resulting gain or loss.@

39. Notice 99-37, 1999-30 IRB 124 B describes the reporting requirements for educational

institutions and people who receive payments of student loan interest. 40. Letter Ruling 200203010 (Oct. 24, 2001)

Facts: The taxpayer is an organizational consultant who conducts business activities as a sole proprietorship. The business activities involve consulting work, including work redesign and re-engineering, team building, training, and management coaching. The taxpayer also conducts leadership development workshops. The workshops are for employees of large companies and involves physical challenges that potentially place the employees at risk.

During one of the trainings, a client was seriously injured. At the time of the accident, the taxpayer was insured on a general commercial liability insurance policy issued to the facility where the activity occurred. The injured person sued the taxpayer and the facility. The taxpayer was not able to pay for her defense.

The taxpayer entered into a Settlement Agreement with the plaintiff, before a judgment was entered. Under the terms of the Settlement Agreement, the plaintiff agreed to provide the taxpayer with a covenant to stay execution of any judgment. The taxpayer agreed to allow the action to proceed to trial. The Settlement Agreement provided that the plaintiff will receive 90% of any net proceeds obtained as a result of final judgment by the court. The taxpayer will receive 10% of such proceeds. Net proceeds includes all money recovered after deducting any federal, state or local taxes on the amounts recovered less attorneys fees and costs.

The trial court entered judgment for Plaintiff and against the taxpayer.

The taxpayer hired attorneys to sue the insurance company who was refusing to pay for the damages. The attorneys agreed to represent both the taxpayer and the plaintiff for a contingent fee of 30 percent of any recovery after payment of costs. The attorneys filed a lawsuit against the insurer in court, claiming that the insurer had breached its duty to defend the taxpayer and the plaintiff. The court held that the insurer was liable for the entire judgment that was previously entered in favor of the plaintiff and against the taxpayer.

LAW AND ANALYSIS Applying general principles of IRC Section 61(a), the service

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held that the taxpayer must recognize the proceeds received. Regarding the inclusion of attorneys fees in the award, the service held that AGenerally, when settlement proceeds are included in gross income, taxpayers must include in income the portion that is paid to their attorneys pursuant to contingency fee arrangements.@ The taxpayer also sought advice from the Service as to the taxability of the portion of the insurance proceeds taxpayer paid to the plaintiff. The Service held this to be includible. It stated:

AUnder the anticipatory assignment of income doctrine, a taxpayer who earns or otherwise creates a right to receive income will be taxed on any gain realized from it, if the taxpayer has the right to receive the income or if, based on the realities and substance of the events, the receipt of the income is practically certain to occur (i.e., whether the right basically had become a fixed right), even if the taxpayer transfers the right before receiving the income. . . It was solely your lawsuit against Insurer that created the right to receive the Insurance Proceeds. Under the Settlement Agreement, Plaintiff's lien (like that of Attorneys' lien under the Contingent Fee Agreement) attached only to the fruits of the judgment against Insured. Accordingly, the portion of the Insurance Proceeds that was retained by Plaintiff following the General Release is includible in your income in the year 20XX.@

The Service examined the issue of the deductibility of the attorneys fees. The following is the text of the Services discussion on this issue:

In Old Town Corporation v. Commissioner, 37 T.C. 845 (1962) [CCH Dec.

25,340 ], acq. , 1962-2 C.B. 5, the Tax Court analyzed whether payments made by a corporation to settle a claim asserted against one of its employee/directors constituted an ordinary and necessary business expense, or whether a portion of that payment constituted a voluntary payment by the corporation on behalf of its employee/director. The court recognized that, to be "ordinary", the expenses need only be an accepted means of defense against a lawsuit affecting the safety of the business. However, to be considered "necessary", the taxpayer must illustrate that it may be liable for those expenses and that it had sufficient business motive for paying those expenses. Specifically, the court indicated that the taxpayer must show that: (1) it was not entirely confident that the claims against it would not succeed; (2) the payments in question were made for the purpose of avoiding the claims against it; and (3) a reasonable person would have determined that settlement of such claim was necessary.

Generally, amounts paid in settlement of lawsuits are currently deductible if the

acts that gave rise to the litigation were performed in the ordinary conduct of the taxpayer's business. See, e.g., Federation Bank & Trust Co. v. Commissioner, 27 T.C. 960 (1957) [CCH Dec. 22,290 ] (allowing petitioner to deduct amounts paid in settlement of legal proceedings charging petitioner with mismanagement in



liquidation of assets); Rev. Rul. 80-211 , 1980-2 C.B. 57 (allowing a corporation to deduct amounts paid as punitive damages that arose from a civil lawsuit against the corporation for breach of contract and fraud in connection with the ordinary conduct of its business activities); Rev. Rul. 79-208, 1979-2 C.B. 79 (permitting taxpayer to deduct payments to settle lawsuit and obtain a release from claims under a franchise agreement).

Similarly, amounts paid for legal expenses in connection with litigation are

allowed as a business expense where such litigation is directly connected to, or proximately results from, the conduct of a taxpayer's business.@

Based on the above position, the Service held that the attorneys fees were deductible under IRC Section 162. The Service also address the application of the alternative minimum tax rules in this situation stating:

Section 56(b)(1)(A)(i) provides that in determining the amount of the alternative

minimum taxable income of any taxpayer (other than a corporation), no deduction shall be allowed for any miscellaneous itemized deduction (as defined in '67(b) ).

In general, legal expenses are considered miscellaneous itemized deductions if

they are determined to be itemized deductions that are not specifically enumerated in '67(b) . Benci-Woodward v. Commissioner, 219 F.3d 941 (9th Cir. 2000) [2000-2 USTC &50,595] (legal fees incurred as an expense of employment); Alexander v. Commissioner, 72 F.3d 938 (1st Cir. 1995) [96-1 USTC &50,011 ] (legal fees incurred in action against former employer for breach of contract). However, your legal fees at issue are not itemized deductions but ordinary and necessary business expenses deductible under '162 . Accordingly, your legal expenses are not subject to the alternative minimum tax disallowance rules imposed by '56(b) in the year 20XX.

41. Letter Ruling 9827040, April 7, 1998 (full text follows)

Under state law, each member of the instructional staff and every other employee of a district school system employed on a full-time basis in the state's public schools earns one day of sick leave for each month of employment with the school system. An employee is entitled to take sick leave only when necessary because of sickness as prescribed by the statute. Sick leave that is not used is accumulated from year to year and employees receive a lump sum payment at retirement representing the accumulated sick leave.In order to satisfy its obligation to pay employees for accumulated sick leave, the district will adopt a qualified defined contribution plan (the "Plan") and will establish and make contributions to an associated trust that is qualified under section 401(a) of the Code. At the inception of the Plan, the District will contribute an amount of the converted sick pay for each eligible employee who has accumulated sick leave at the end of the

42 Chapter 3


school year that is no greater than the maximum contribution permitted under the Code and state law. After the District's existing sick leave obligations have been contributed to the Plan, the District will make annual contributions to each individual account within the Plan in amounts for unused sick days for that year. Employees will neither be required, nor have the option, to make elective deferrals or employee contributions to the Plan. An employee will have no choice as to whether to participate in the Plan or as to whether or how much accumulated sick leave is contributed to the Plan. After the District has determined the amount of the annual contribution, the District may permit an employee to receive any accumulated sick leave that remains. An employee cannot elect in advance to receive in cash any amount of any sick leave that will be earned in the future. The employee is limited to receiving a cash payment for sick leave that has been earned and that has not been contributed to the Plan. An employee will not have an option to receive a payment of cash from the Plan prior to the normal distribution provisions under the Plan. Section 83(a) of the Code provides that the excess (if any) of the fair market value of property transferred in connection with the performance of services over the amount paid (if any) for the property is includible in the gross income of the person who performed the services for the first taxable year in which the property becomes transferrable or is not subject to a substantial risk of forfeiture.Section 83(e)(2) of the Code provides that section 83(a) does not apply to a transfer to a trust described in section 401(a).Section 402(a) of the Code provides that any amount actually distributed to any distributee by any employees' trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to the distributee in the taxable year of the distributee in which distributed.Section 1.402(a)-1(a)(1)(i) of the Income Tax Regulations provides that if an employer makes a contribution for the benefit of an employee to a trust described in section 401(a) of the Code for the taxable year of the employer which ends within or with a taxable year of the trust for which the trust is exempt under section 501(a) of the Code, the employee is not required to include such contribution in gross income except for the year or years in which such contribution is distributed or made available to him. It is immaterial in the case of contributions to an exempt trust whether the employee's rights in the contributions to the trust are forfeitable or nonforfeitable either at the time the contribution is made to the trust or thereafter.Section 451(a) of the Code and section 1.451-1(a) of the regulations provide that an item of gross income is includible in gross income for the taxable year in which it is actually or constructively received by a taxpayer using the cash receipts and disbursements method of accounting. Under section 1.451-2(a) of the regulations, income is constructively received in the taxable year during which it is credited to a taxpayer's account or set apart or otherwise made available so that the taxpayer may draw on it at any time. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions.Rev. Rul. 75-539, 1975-2 C.B. 45, addressed two fact patterns under which sick leave accumulated by a retiring employee could be applied to the cost of accident and health insurance. In the first fact pattern, a retiring employee could receive a cash payment for accumulated sick leave or have the payment applied to the cost of the insurance.



The ruling concludes that unused sick leave credits that are received in cash are includible in the retiree's gross income under section 61 of the Code. Further, a retiree's ability to relinquish the right to the cash payment and have such an amount applied to the payment of health insurance premiums results in constructive receive of such amount under section 451 of the Code. In the second fact pattern, the employer will place accumulated sick leave credits in an escrow account to pay the health insurance premiums until such amounts are exhausted and the retiring employee cannot elect to receive accumulated sick leave in cash. The ruling concludes that, since the value of the accumulated unused sick leave credits is placed in escrow by the employer solely for the payment of health insurance premiums and may not in any event be received in cash by the employee or the employee's dependents or beneficiaries, such amounts are not constructively received under section 451 of the Code. Under the proposed arrangement, the conversion of accumulated, unused sick leave into a Plan contribution is automatic and mandatory. The employee's receipt of the accumulated sick leave is not constructively received because the employee cannot elect to receive accumulated sick leave in cash in lieu of receiving a contribution to the Plan. Under the assignment of income doctrine, a gratuitous anticipatory assignment of income does not shift the burden of taxation and the donor is taxable when the income is received by the donee. See, Helvering v. Horst, 311 U.S. 112 (1940) [40-2 USTC &9787], and Lucas v. Earl, 218 U.S. 111 (1930) [2 USTC &496]. In Commissioner v. P.G. Lake, Inc., 356 U.S. 260 (1958) [58-1 USTC &9428], the taxpayers assigned the right to a specified sum of money, payable out of a specified percentage or oil, or the proceeds received from the sale of such oil, if, as and when produced in return for cash. The Court concluded that, while the oil payments were interest in land, the consideration received for the oil payment rights was taxable as ordinary income because the lump sum consideration was essentially a substitute for what would otherwise be received at a future time as ordinary income. In other words, the taxpayer converted future income into present income and was taxable on such present income. Under the proposed transaction, each employee's unused sick leave credits will be converted automatically into a contribution to the Plan. Distributions of amounts contributed will be subject to the rules for qualified defined contribution plans under the Code. Under no circumstances will an employee be eligible to receive any of the unused sick leave credits accumulated at the end of a school year in cash. Therefore, an employee cannot voluntarily forego future taxable income for consideration, and the plan contributions will not be a substitute for amounts the employee would otherwise receive as current compensation. Accordingly, the assignment of income doctrine will not apply to the proposed transaction.Based on the information submitted and representations made, we conclude that:1. The proposed mandatory conversion of unused sick leave accumulated at the end of the school year to an amount that is contributed to the Plan does not constitute a transfer of property for purposes of section 83 of the Code.2. Under the economic benefit doctrine and the constructive receipt doctrine of section 451 of the Code, the automatic conversion of unused accumulated sick leave to an amount that is contributed to the Plan will not create taxable income at the time of the conversion of accrued sick leave and the contribution to the Plan for the participants or their beneficiaries under the cash receipts and disbursements method of accounting.3. The conversion of unused accumulated sick leave will

44 Chapter 3


not create taxable income for the employees or their beneficiaries as an anticipatory assignment of income.This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that this ruling many not be used or cited as precedent. Except as specifically ruled on above, no opinion is expressed as to the federal tax consequences of the above transaction under any other provision of the Code. This ruling does not express an opinion regarding the qualified status of the profit sharing plan to which accumulated sick leave will be contributed, or on the qualified status of any defined contribution or defined benefit plan maintained by the District. 42. Letter Ruling 200204007 (October 17, 2001) (full text follows) Section 162(a) of the Code provides, in part, that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. In Old Town Corporation v. Commissioner, 37 T.C. 845 (1962) [CCH Dec. 25,340 ], acq. , 1962-2 C.B. 5, the Tax Court analyzed whether payments made by a corporation to settle a claim asserted against one of its employee/directors constituted an ordinary and necessary business expense, or whether a portion of that payment constituted a voluntary payment by the corporation on behalf of its employee/director. The court recognized that, to be "ordinary", the expenses need only be an accepted means of defense against a lawsuit affecting the safety of the business. However, to be considered "necessary", the taxpayer must illustrate that it may be liable for those expenses and that it had sufficient business motive for paying those expenses. Specifically, the court indicated that the taxpayer must show that: (1) it was not entirely confident that the claims against it would not succeed; (2) the payments in question were made for the purpose of avoiding the claims against it; and (3) a reasonable person would have determined that settlement of such claim was necessary.

Generally, amounts paid in settlement of lawsuits are currently deductible if the acts that gave rise to the litigation were performed in the ordinary conduct of the taxpayer's business. See, e.g., Federation Bank & Trust Co. v. Commissioner, 27 T.C. 960 (1957) [CCH Dec. 22,290 ] (allowing petitioner to deduct amounts paid in settlement of legal proceedings charging petitioner with mismanagement in liquidation of assets); Rev. Rul. 80-211 , 1980-2 C.B. 57 (allowing a corporation to deduct amounts paid as punitive damages that arose from a civil lawsuit against the corporation for breach of contract and fraud in connection with the ordinary conduct of its business activities); Rev. Rul. 79-208 , 1979-2 C.B. 79 (permitting taxpayer to deduct payments to settle lawsuit and obtain a release from claims under a franchise agreement).

Similarly, amounts paid for legal expenses in connection with litigation are allowed as a business expense where such litigation is directly connected to, or proximately results from, the conduct of a taxpayer's business. See, e.g., Kornhauser v. United States, 276 U.S. 145 (1928) [1 USTC &284 ] (holding that taxpayer may currently deduct attorney fees paid in defense of a suit against him by former law partner); Ditmars v. Commissioner, 302 F.2d 481 (2nd Cir. 1962) [62-1 USTC &9421 ] (holding that taxpayer may currently deduct business related settlement and attorney fees paid in defense of a suit claiming taxpayer improperly charged brokerage commissions).



The portion of the Insurance Proceeds that you paid to Plaintiff ($s ) in accordance with

the terms of the Settlement Agreement, and the portion that you paid to Attorneys ($r ) in accordance with the Contingency Fee Agreement are ordinary and necessary business expenses under the standard articulated by the Tax Court in Old Town. The expenses were ordinary because such payments are an accepted means of defending B from liabilities that arose directly from B's conduct of the C workshops. The expenses are necessary because you made them to avoid claims or liability that might have resulted from Plaintiff's lawsuit against you. Finally, your decision to settle Plaintiff's lawsuit was reasonable in view of the fact that Insurer wrongfully withdrew from your defense against Plaintiff.

Accordingly, the amount of the Insurance Proceeds that you paid Plaintiff ($s ) under the Settlement Agreement, and that you paid Attorneys ($r ) under the Contingency Fee Agreement are deductible by B as trade or business expenses under '162 in the year 20XX.

Alternative Minimum Tax

You ask that we rule that your payments of $s to Plaintiff and $r to Attorneys are not subject to the alternative minimum tax imposed by '56(b) . Section 56(b)(1)(A)(i) provides that in determining the amount of the alternative minimum taxable income of any taxpayer (other than a corporation), no deduction shall be allowed for any miscellaneous itemized deduction (as defined in '67(b) ).

In general, legal expenses are considered miscellaneous itemized deductions if they are determined to be itemized deductions that are not specifically enumerated in '67(b) . Benci-Woodward v. Commissioner, 219 F.3d 941 (9th Cir. 2000) [2000-2 USTC &50,595] (legal fees incurred as an expense of employment); Alexander v. Commissioner, 72 F.3d 938 (1st Cir. 1995) [96-1 USTC &50,011 ] (legal fees incurred in action against former employer for breach of contract). However, your legal fees at issue are not itemized deductions but ordinary and necessary business expenses deductible under '162 . Accordingly, your legal expenses are not subject to the alternative minimum tax disallowance rules imposed by '56(b) in the year 20XX. HOLDINGS We conclude as follows: (1) You are required to include in your gross income in year 20XX the total Insurance Proceeds of $q paid by Insured in order to settle your lawsuit and pursuant to the terms of the General Release. (2) You may not exclude $r from your gross income in year 20XX, which was the portion of the Insurance Proceeds (plus statutory interest) that you used to pay your Attorneys' fees pursuant to the terms of the Contingent Fee Agreement. (3) You may not exclude $s from your gross income in year 20XX, which was the portion of the Insurance Proceeds that you used to pay Plaintiff pursuant to the terms of the Settlement Agreement. (4) Your Attorneys' fees in the amount of $r is deductible by B in year 20XX as a trade or

46 Chapter 3


business expense under '162 . (5) Your payment to Plaintiff in the amount of $s is deductible by B in year 20XX as a trade or business expense under '162 . (6) Your payments of $s to Plaintiff and $r to Attorneys are not subject to the alternative minimum tax imposed by '56(b) . CAVEATS:A copy of this letter must be attached to any income tax return to which it is relevant. We enclose a copy of the letter for this purpose. Also enclosed is a copy of the letter ruling showing the deletions proposed to be made in the letter when it is disclosed under '6110 of the Internal Revenue Code. Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any item discussed or referenced in this letter. This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent. 43. Letter Ruling 200450005

Facts: Taxpayer manufactures cars and SUVs. It leases vehicles to consumers through a subsidiary. The leasing company regularly disposes of leased vehicles and replaces them with new vehicles as leases expire and customer demand changes .

The leasing company has two categories of vehicles. When a lease is complete, it is usually sold to the former lessee or the dealer – they are then referred to as relinquished vehicles. Sometimes, the leasing company acquires vehicles recently leased from a dealer. These vehicles are known as replacement vehicles. The leasing company treats the disposition of a relinquished vehicle and the acquisition of a replacement vehicle as a like-kind exchange. The vehicles include cars and SUVs. Taxpayer wants the two types of vehicles to be considered like-kind under Section 1031. Issue: Are passenger cars and sport utility vehicles (SUVs) like-kind property for purposes of Section 1031?

Holding: The IRS held that the two properties are like-kind even though they are quality. The service determined that the key to like-kind is the nature and character of property, not the quality. They held that the autos and SUVs are not different in character or nature.

44. Rev. Proc. 89-14, 1989-1 CB 814 is still reliable authority. The Revenue Procedure

restates the objectives and sets forth the standards for the publication of Revenue Rulings and Revenue Procedures in the Internal Revenue Bulletin.

45. a. Rev. Rul. 56-135, 1956-1 CB 92 B revoked by Rev. Rul 81-160

b. Rev. Rul 62-180, 1962-2 CB 52 B authoritative



c. Rev. Rul. 62-213, 1962-2 CB 59 B revoked by Rev. Rul 83-3

46. a. Rev. Proc. 86-15, 1986-1 CB 544 B Superceded by Rev. Proc. 89-14

b. Rev. Proc. 67-6, 1967-1 CB 576 B Made obsolete by Rev. Rul. 80-367

c. Rev. Proc. 74-17, 1974-1 CB 438 B Superceded by Rev. Proc. 89-12 47. The Service did acquiesce to the results in Mary Furner, 393 F. 2d 292 (CA 7, 1968) in

Rev. Rul. 68-591, 1968-2 CB 73. The easiest method for finding this information is through the RIA Citator.

48. The Service issued a nonacquiescence to the results of Roemer, 716 F.2d 693 (CA 9,

1983) in Rev. Rul. 85-143, 1985-2 CB 55. The easiest method for finding this information is through the RIA Citator.

49. The Service acquiesced to the results of George Gross, 23 TC 756 (1955) in Rev. Rul.

57-357, 1957-2 CB 901. The easiest method for finding this information is through the RIA Citator.

50. The Service did not issue either an acquiescence or a nonacquiescence to the results of

Warren Jones Company vs. Commissioner, 60 TC 663 (1973). Instead, the Service appealed the Tax Court decision. The Ninth Circuit Court of Appeals, in Warren Jones Company vs. Commissioner, 524 F2d 788 agreed with the Service=s position and reversed the decision of the Tax Court. The easiest method for finding this information is through the RIA Citator. (However, students might complain that the Web-based RIA Citator did not enable the students to easily locate the Ninth Circuit decision. The Citator reference to that case contains a typographical error resulting in a link to an unrelated case. In this situation, students have to use their heads to determine other methods of locating the case using Checkpoint).

51. Letter Ruling 200521003 (full-text follows)

Medical expense deductions—tuition at special school—medically handicapped children—dyslexia.

Headnote:

Tuition for taxpayer's dependant children diagnosed with dyslexia to attend specialized school was deductible medical expense under Code Sec. 213(a); for years children begin enrollment and continue to be diagnosed as medically handicapped. Children's attendance at school was principally to receive medical care in form of special education to cope with dyslexia, which is condition that handicaps their ability to learn.

48 Chapter 3


Reference(s): ¶ 2135.10(5); Code Sec. 213;

(… text omitted) Release Date: 5/27/2005



Dear [Redacted Text]

You requested a ruling on the deductibility of tuition for your children as a medical care expense under section 213(a) of the Internal Revenue Code. The rulings in this letter are based on representations made in your letters of July 20 and October 22, 2004.

RULINGS:

Child A's tuition at School X is a medical care expense deductible under section 213(a) for the years Child A began and continues to be diagnosed as medically handicapped, beginning in Year 1.

Child B's tuition at School X is a medical care expense deductible under section 213(a) for the years Child A began and continues to be diagnosed as medically handicapped, beginning in Year 2.

FACTS:

Child A and Child B are your dependents, under section 152(a). Both children have been diagnosed as having disabilities caused by medical conditions including dyslexia that handicap their ability to learn. School X provides each handicapped child with a program of special education designed to enable the child to deal with the medical handicaps and move on to study at a regular school.

DISCUSSION:

A taxpayer may deduct expenses paid during the taxable year for medical care of the taxpayer, spouse, or dependent, within the limits of section 213. Medical care includes amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting a structure or function of the body. Section 213(d)(1)(A). Only expenses incurred primarily for medical care are deductible. Section 1.213- 1(e)(1)(ii) of the Income Tax Regulations.

Helping the student overcome a physical or mental handicap and move on to normal education and living is the essence of special education. Normal education is not medical care because it is not designed to help someone overcome a medical disability. Thus, a physician or other qualified professional must diagnose a medical condition requiring special education to correct the condition for that education to be medical care. The school need not employ physicians to provide that special education, but must have professional staff competent to design and supervise a curriculum providing medical care. Overcoming the learning disabilities must be a principal reason for attending the school, and any ordinary education received must be incidental to the special education provided. Special education thus includes teaching Braille to a visually-impaired person, teaching lip reading to a hearing-impaired person, giving remedial language training to correct a condition caused by a birth defect, or overcoming other disabilities. Section 1.213-1(e)(1)(v)(a); Rev. Rul. 70-285, 1970-1 C.B. 52. Dyslexia can be sufficiently severe as to be such a handicap. Rev. Rul. 69-607, 1969-2 C.B. 40.

50 Chapter 3


You requested a ruling that School X is a “special school” tuition at which is deductible, but this is not the standard under section 1.213-1(e)(1)(v)(a). Deductibility of tuition depends on exactly what the school provides an individual because a school can have a normal education program for most students, and a special education program for those who need it. Thus, a school can be “special” for one student but not for another.

Based on your representations, we conclude that Child A and Child B are attending School X principally to receive medical care in the form of special education in those years each child is diagnosed as having a medical condition that handicaps that child's ability to learn. You must attach a copy of this letter to any income tax return to which it is relevant.

CAVEATS:

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination. This letter ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative. 52. Rev. Rul. 2002-4, IRB.2002-4, 398 or Rev. Rul. 2002-4, 2002-4 IRB 398. 53. a. IRC Section 162

Rev. Rul. 2005-40, 2005-27 IRB 4 Rev. Rul. 2005-28, 2005-19 IRB 997 Rev. Rul. 2004-62, 2004-25 IRB 1072

b. IRC Section 351

Rev. Rul. 2003-51, 2003-1 CB 938. Other than that, there have been no rulings more recent than 1999.

c. IRC Section 280A

Rev. Rul. 2004-32, 2004-12 IRB 621. Other than that, there have been no rulings more recent that 1994.

54. a. By electronically searching the Letter Ruling database for either Sec. 165(c)(3) or

Section 165(c)(3), one post-1990 Letter Ruling (as of August 2004) results: Private Letter Ruling 9226003 (December 1991)

b. Through electronic searching, the student can locate hundreds of Letter Rulings of Section 1033, many issued after 1990.



c. Through electronic searching, the student can locate many letter rulings addressing investment interest under Section 163. As of August 2005, the most recent ruling was 200503004.

55. There are several public laws that impact the scholarship provisions of IRC Section 117

that are not reflected in the following final regulations for that section. As of 2008, they were: Regulation Public Law (Regulation not updated for) '1.117-1 94-445, 96-541, 98-369, 99-514, 100-647 '1.117-2 94-455, 96-541, 98-369, 99-514, 100-647 '1.117-3 94-455, 96-541, 98-369, 99-514, 100-647 '1.117-4 99-514, 100-647 '1.117-5 99-514, 100-647 The main change imposed by P.L. 100-647 is that the current word Ashall@ in IRC '117(d)(4) was Amay.@ P.L. 99-514 amended the provisions so that reimbursement for travel, research and clerical help is no longer excluded.

56. The Treasury Decision that issued Treas. Reg. '1.117-2 was T.D. 6186, 6-29-56.

Amended by T.D. 6782, 12-23-64. 57. The Treasury Decision that issued Treas. Reg. '1.83 -7 was T.D. 7554, 7-21-78. 58. This gets the students into seeing how dangerous the Regulations can be because of the

significant number of them that are outdated, including the Regulations in this area. The students first use examine Code '71(b)(2)(D) which says there cannot be a liability to make the payments after the payee=s death. If the student then goes to the Regulation Section 1.71-1T, they find that question and answer #11 seems to clearly say it is not alimony unless the decree specifically says the payments must cease at payee=s death. (Note that these are also old temporary Regulations.) Students must discover through one of the methods discussed in the chapter that this particular Regulation has not been updated for law changes. If they go back to the historical comments following '71, they will see that the Code Section used to require specific language to that effect, but that it was removed. Therefore, the categorization of the amounts as alimony depend on whether, in reality, there is a liability to pay after the payee=s death. This will depend upon state law. In most states, the liability ceases upon the death of the payee.

59. Facts:

Taxpayer paid $2,000 for liposuction surgery, an expense not covered by insurance.

Issue: Is the expense allowable as a deduction under IRC '213?

Conclusion and Reasoning:

52 Chapter 3


The cost of the liposuction procedure is not deductible. IRC '213(a) provides that medical expenses paid during the year, not compensated for by insurance, are deductible to the extent that such expense exceeds 7.5 percent of adjusted gross income. IRC '213(d)(9) provides that the term "medical care" generally does not include cosmetic surgery or other similar procedures, unless the surgery or procedure is necessary to ameliorate a deformity arising from, or directly related to, a congenital abnormality, a personal injury resulting from an accident or trauma, or disfiguring disease. IRC '213(d)(9) defines the term "cosmetic surgery" to mean any procedure which is directed at improving the patient's appearance and does not meaningfully promote the proper function of the body or prevent or treat illness or disease. This conclusion is supported by IRS Publication 502 which specifically identifies liposuction as a non-deductible item.

. 60. The IRC and Regulations indicate the following regarding revoking a previous S

Corporation election: '1362(d)(1)(A): An election under subsection (a) may be terminated by revocation. '1362(d)(1)(B): An election may be revoked only if shareholders holding more than one-half of the shares of stock of the corporation on the day the revocation is made consent to the revocation.



Treas. Reg. '1.1362-2(1): An election made under '1362(a) is terminated if the corporation revokes the election for any taxable year of the corporation for which the election is effective, including the first taxable year. A revocation may be made only with the consent of shareholders who, at the time the election is made, hold more than one-half of the number of issued and outstanding shares of stock (including nonvoting stock) of the corporation. Treas. Reg. '1.1362-6(a): An election statement made under this section must identify the election being made, set forth the name, address, and taxpayer identification number of the corporation, and be signed by a person authorized to sign the return required to be filed under '6037.

61. Facts:

Taxpayer is stationed at the military base at Ford Ord, California. This base was one of those selected for closure. As a result, taxpayer was transferred to a base in Virginia. Taxpayer received the following reimbursement from the government:

* $10,000 dislocation allowance to help with the move * $500 temporary lodging for five days. * $2,000 to reimburse for two months of lease payments before permanent housing

was found.

Issue: Must taxpayer include in income the reimbursements?

Conclusion and Reasoning: IRC Section 82 provides that there shall be included in gross income (as compensation for services) any amount received as a payment for reimbursement of expenses of moving from one residence to another residence that is attributable to employment. There is no direct exclusion for such reimbursements for military personnel. This is supported by Rev. Rul. 76-2, 1976-1 CB 82 which held that temporary lodging allowances paid to Armed Forces personnel after 1971 in connection with change in their permanent duty station are income under Code Sec. 82. Rev. Rul. 76-362, 1976-2 CB 413 held that a dislocation allowance received by a member of the military in connection with a change in his duty station is income.

However, amounts which would have been deductible under IRC '217 can be excluded under IRC '132(a)(6). [Note that this provision was added subsequent to the Revenue Rulings cited above.] IRC '217 defines the term Amoving expenses@ to include the reasonable expense of moving household goods and personal effects from the old to the new residence, and traveling (including lodging) from the old residence to the new place of residence. Therefore, any reimbursed moving costs of the taxpayer will be excluded. However, the remaining reimbursements will have to be recognized as income because they do not fit into the definition of moving expenses under IRC '217.

54 Chapter 3


Facts: Taxpayer studies tax law at a university on a part-time basis. He works full-time in the tax department of a large accounting firm and anticipates that the classes will help him become more productive and efficient in his work. Unfortunately, his employer, although supportive of his attending classes, is not reimbursing the taxpayer for any of the $10,000 tuition costs.

Issue: Can the taxpayer take a deduction for his educational expenses?

Conclusion and Reasoning: Students should be able to come to a tentative conclusion regarding this question, although to reach a more conclusive answer, additional research is necessary. The key Code Section is '162(a) and the related Regulations. Treas. Reg. '162-5(a) states that deductible education expenses must be incurred in carrying on a trade or business. To show this, the expenses must meet one of the following two requirements: Maintain or improves skills required by the individual in his employment or trade business or meet the express requirements of the individual=s employer. Taxpayer appears to satisfy this requirement since it can be argued that he is improving his job skills. The Regulations also state that the education cannot prepare the taxpayer for a Anew trade or business.@ However, the Regulations go on to state that a change of duties does not rise to the level of a Anew trade or business.@ The students most likely will conclude that the expenses appear to satisfy the Regulation requirements.

62. Facts:

Taxpayer worked for ABC Corporation for 15 years. This year, the company has experienced some financial difficulties and laid off the taxpayer. The company has a very generous health insurance program which provides coverage to all employees, even those who have retired or been laid off within the last two years. The company continues to pay all health insurance premiums for the employee's health insurance even after his layoff date. Prior to being laid off, the company never included in taxpayer's income the value of the health premiums.

Issue: IRC '106 excludes from gross income payments made on behalf of employees for health insurance. Does the fact that taxpayer was laid off preclude application of this provision?

Conclusion: Based on Rev. Rul. 85-121, 1985-2 C.B. 57, taxpayer will be treated as an Aemployee@ for purposes of IRC '106. Therefore, the premium payments may be excluded from income. The facts in taxpayer=s situation do not materially differ from those in the ruling.




56 Chapter 4


CHAPTER 4 - JUDICIAL INTERPRETATIONS KEY CONCEPTS (1-21) 1. Definitions

a. Cases are decisions by the courts that apply the law to a specific set of facts.

These may also be called Ajudicial interpretations@ because they represent how the courts believe the law should be applied.

b. There are three lower courts which decide matters relevant to Federal tax laws:

United States Tax Court, United States District Court, and the United States Court of Federal Claims. These courts have the lowest level of authority to the researcher. From this court, the losing party may appeal to a higher court.

c. The United States Tax Court is one of the courts a taxpayer may petition to

when it has a disagreement with the Internal Revenue Service regarding a tax issue. It is the only court in which the taxpayer can file before paying the taxes the IRS asserts are due. The court sits in Washington, D.C., although the judges Aride circuit@ throughout the country. Judges are appointed for 15-year terms by the President of the United States.

d. Taxpayers may also file a claim for a refund in The United States Federal

District Court. This court is the only one offering the taxpayer the option of a jury trial. However, the taxpayer must first pay the amount of taxes assessed by the IRS before filing in this court.

e. The Claims Court handles cases involving matters for which the U.S.

Constitution or Federal statue require monetary payment. The Court is located in Washington, D.C., but judges travel to hear cases throughout the country. A jury trial is not available in Claims Court and the taxpayer must prepay the alleged tax due before filing. This is the least common court for filing suit by the taxpayer.

f. .Each Circuit Court has jurisdiction over a specific geographic territory. These

courts hear appeals from the lower courts. The country is divided into eleven numbered circuits plus the District of Columbia (Federal) Circuit. The Federal Circuit Court also handles appeals from the Claims Court.

g. The Tax Court publishes decisions in memo form when the issues involved are

simply factual variations on issues of law already clearly decided. These are called Tax Court Memoranda.

h. Regular Tax Court decisions usually address fresh questions regarding the

Code. Regular decisions are slightly more authoritative than memo decisions.

Judicial Interpretations 57


i. When a party wishes to appeal the decision of the appellate court and have the

Supreme Court hear the case, the party must file a Writ of Certiorari.

j. When a court in a new case disagrees with a decision it made in an previous case, it Aoverrules@ the prior decision.

k. When a higher court disagrees with a decision made by a lower court in the same

case, it Areverses@ the lower court decision.

l. Vacating a decision means that the prior decision is undone or removed.

m. Remanding a case involves sending the case back to a lower court for further review and consideration.

n. The AGolsen@ rule requires the Tax Court to follow the holding of the circuit

having jurisdiction over the parties involved in the current case, even if the Tax Court disagrees with the holding.

o. USTC represents the tax case service published by Commerce Clearing House.

The letters stand for AUnited States Tax Cases.@

p. AFTR represents the tax case service published by Research Institute of America. The letters stand for AAmerican Federal Tax Reports.@

q.. When the Tax Court has not determined the actual dollar effect of its

determination and it requires the application of ARule 155,@ the IRS will make the actual calculations of the amount due.

r. An Aen banc@ decision is one rendered by all the judges in a court.

s. The respondent in a case is the person who is defending his/her position before

the court. (As opposed to the petitioner, who is the party bringing the case to the court.)

t. Pro se indicates that the party is representing himself without an attorney.

u. When judges hypothesize about how the court would hold if the facts were changed,

their statements are considered dicta.

v. When a citation includes a case reference to more than one reporter, it is called a Aparallel@ citation.

58 Chapter 4


w. Citating a case provides information regarding the history of the case as well a list of other cases, Revenue Rulings and Revenue Procedures that cited the case in its decision.

2. When the Supreme court denies ACert,@ it indicates to the researcher that the decision in

the Circuit Court of Appeals is final and fully authoritative. When the Supreme Court grants ACert,@ the decision of the Appeals Court no longer provides much comfortable authority because of the possibility that the decision will be reversed by the Supreme Court.

3. It is possible to find two cases, both involving nearly identical facts, where the courts

issue opposite conclusions. Because the application of the Internal Revenue Code is not an exact science, two or more reasonable persons can disagree regarding what is the correct application of the law. The researcher must consider the jurisdiction of the courts rendering the decisions. If the facts of the two cases are identical, the most authoritative decision is the one rendered by the court having jurisdiction over the taxpayer. Other relevant factors include the level of the court and the court=s reasoning. Usually, however, the facts are different in some way, opening up the possibility of exploring the impact of the distinguishing facts. Adverse decisions should not be ignored.

4. The factors relevant in determining which cases are important are: level of authority,

jurisdiction of the court, factual similarity, Code Section at issue, logic of analysis. 5. The difference between an Aofficial reporter@ and an Aunofficial reporter@ is that

unofficial reporters in the tax field only contain tax cases and are thus easier to obtain than official reporters which contain all court decisions, tax and nontax. In formal documents, the official cite should be used. It is good practice to also include a parallel Aunofficial@ cite.

a. Regular Tax Court decision:

Official: Temporary: 100 TC __, No. 5 (1992) Permanent: 100 TC 405 (1992)

Unofficial: Not appropriate Memorandum decision:

CCH 70 TCM 500 (1998) RIA 1998 P-H Memo TC &98,005

b. U.S. District Court

Official: 800 F. Supp. 300 (1992) Unofficial: CCH 92-2 USTC &500 (SDNY, 1992)

RIA 50 AFTR2d 92-6000 (SDNY, 1992)

c. U.S. Appellate Court



Official: 100 F.2d 500 (1992) Unofficial: CCH 92-2 USTC &500 (CA 2, 1992)

RIA 50 AFTR2d 92-6000 (CA 2, 1992)

d. U.S. Supreme Court Official: 50 U.S. 200 (1992) Unofficial: CCH 92-2 USTC &500 (S.Ct., 1992)

RIA 50 AFTR2d 92-6000 (S.Ct., 1992) 6. The two Federal tax case services are CCH=s United States Tax Cases (USTC), and

RIA=s American Federal Tax Reports (AFTR). They provide the tax practitioner access to all cases other than Tax Court cases.

7. The researcher must citate a case to ensure its reliability. 8. All Federal tax cases, other than the Tax Court, can be found in either the United States

Tax Cases (CCH) or American Federal Tax Reports (RIA). 9. You determine whether a case is under appeal or if a Writ of Certiorari has been filed by

using the citator. 10. A researcher may need to study a lower court opinion even when the opinion was

appealed when the appellate decision simply upholds the lower opinion with no detailed explanation or reasoning. In addition, a particular issue may not have been appealed and addressed in the appellate decision. In this case, the research interested in the non-appealed issue will need to consult the lower court decision.

11. Every case contains the following elements:

Case title, housekeeping notations, information about legal representations of the parties, description of the facts, identification of the key issues, court=s opinion

The steps to most efficiently read a case are:

*Ensure the case has facts similar to your case by first skimming and then reading more thoroughly if warranted. *Review the judge=s decision. *Focus on the opinion.

12. A headnote is a brief summary of the case preceding the text of the case itself. Headnotes

are helpful in initially determining if cases are pertinent. They also help inform the reader what to expect in a full reading.

13. Id is used in place of fully citing an authority when there is no intervening cite since the

last time the authority was cited in full. Id should be used only after a sentence, not

60 Chapter 4


within a sentence. Supra is used when you wish to cite authority that you have previously cited in full, but another cite has fallen in between. Cite the case name, then Supra. This may be used either at the end of a sentence or mid-sentence.

14. A court=s holding is the reasoning and decision concerning the case at hand. Dictum is rumination on what the holding might be if the facts were different. 15. When a court changes its position on one of its previously rulings, it overrules the

previous decision. When a court is reviewing a decision of a lower court, the court must decide whether to uphold the decision or reverse it. When the court disagrees with the lower court decision, it reverses the decision.

16. A precedent is a previous case decided by the court or by another court possessing

appellate jurisdiction over the court reviewing the matter. The application of the precedence doctrine results in a court system in which a court that decided an earlier case must follow the reasoning in that case, or, if it disagrees with its earlier decision, overrule it. Other courts in the same jurisdiction are also expected to abide by the previous case. The doctrine of precedential authority requires courts to follow prior cases only to the extent the issues and material facts of the prior case are essentially the same as those involved in the case before the court. To the extent a court finds a material difference in the facts, the court may reach a different conclusion, so long as its conclusion is not inconsistent with the previous ruling=s decision. Therefore, when analyzing a case, you should carefully note instances where the court distinguishes the facts before it from the facts involved in a previous decision. Although courts may examine case law issued outside their jurisdiction, such cases are not considered precedents. Thus, the courts are not obligated to follow these decisions.

17. A citator provides the name of the case and full official and unofficial cites as well as a

list of cases and other rulings that have cited the case. RIA=s citator also includes information regarding whether the citing cases affirmed, overruled, or questioned the cited case. Citating is critical to ensure that potential authority has not been severely reduced in its value as a result of subsequent events or cases.

18. This entry from the citator informs the researcher that the case was decided by the

Supreme Court which upheld (affirmed) the decision of the Court of Appeals for the 8th Circuit. The citator also provides both the official and unofficial cite of the case. The entry indicates the location in the CCH Reporter service where this case is discussed (this will be covered in more detail in the next chapter). From the long list of cases, the citator also informs the researcher that this case has been frequently cited by subsequent cases. Through skimming the list of citing cases, the researcher should select the most recent cases and those generated by the highest court as ones to read to ensure that the case is still authoritative. Any decision having jurisdiction over the researcher=s current



research question should also be read. Using these guidelines, the researcher will probably want to skim the Marrin case since it appears to be the most recent appellate decision. The researcher may also want to skim Andrew Crispo Gallery, Inc. because it is an appellate decision as well as any other cases in the jurisdiction the researcher=s facts involve.

19. * Orange Tangerine, 101 TC 59 (1991) -

Name of the case: Orange Tangerine Volume: 101 Service: Tax Court Reports First page of case: 59 Year: 1991

* Rotten Apricot, 90 TCM 3000 (1998) - Name of the case: Rotten Apricot Volume: 90 Service: Tax Court Memorandum decisions published by CCH Year: 1998

* Rotten Apricot, RIA T.C. Memo Dec. &97,200 (1997) - Name of the case: Rotten Apricot Service: Tax. Court Memo Decisions published by RIA Case paragraph: &97,200 Year: 1997

* Apple v. Commissioner, 72-2 USTC &198 (CA 9, 1972) - Name of the case: Apple v. Commissioner Year-Volume: 72-2 Service: United States Tax Cases (CCH Service) Paragraph number: 198 Court: 9th Circuit of Appeals Year: 1972

* Plum v. Commissioner, 5 AFTR3d 97-200 (S.Ct., 1997) - Name of the case: Plum v. Commissioner Volume: 5 Service: American Federal Tax Reports, third series Beginning paragraph: 200 Court: Supreme Court Year: 1997

20. The following U.S. Circuit Court of Appeal has authority over:

a. Hawaii - 9th

62 Chapter 4


b. Texas - 5th c. Illinois - 7th d. Florida - 11th

21. The following U.S. Circuit Court of Appeal has authority over:

a. New Jersey- 3rd b. California - 9th c. Colorado - 10th d. Arkansas - 8th

PRACTICAL APPLICATIONS (22-43) 22. a. Charles K. Chapman and Margaret O. Chapman v. United States of America, 74-

1 USTC &9233 .

b. Sutherland Lumber-Southwest, 88 AFTR2d 2001-5026 (CA 8, 2001)

c. Champion Spark Plug Co. v. Commissioner, 30 TC 298 (1958)

23. a. Charles W. Walker, 101 TC 537 (1993)

b. Charles Walker c. Tax Court

d. No, the taxpayer represented himself.

e.. Hill City, South Dakota

f. The tax years at issue are 1986, 1987, and 1988.

g. December 13, 1993

h.. Federal income taxes of $1,185, $1,236, and $706 for the tax years 1986, 1987, and 1988

i. ''1402 and 162.

j. The court ruled partly for the taxpayer and partly for the service.

k. Judge Ruwe

l. The case is still authoritative, although the Service announced that it will not



follow the ruling. (Rev. Rul. 99-7, I.R.B. 1999-5, 4) 24. Locate and read the Pettet case at 97-2 USTC &50,948 (EDNC, 1997)

a. Elizabeth S. Pettet, Administrator of the Estate of Rosa N. Bullard v. United States of America, 80 AFTR2d 97-7987; 97-2 USTC & 50,948

b. Elizabeth Pettet

c. Eastern District of North Carolina

d. No, the taxpayer represented herself.

e.. North Carolina

f. 1990 and 1991

g. 1997

h $12,500 monthly as alimony for the years of 1990 and 1991

i. Section 71

j. The taxpayer

k. Judge Fox

l. Using the citator, it can be determined that the case is still authoritative.

25. a. Warren Richard Follum v. Comm, 128 F.3d 118, 97-2 USTC &50,889 80 AFTR2d 97-7779 (CA 2, 1997)

b. The taxpayer

c. Circuit Court of Appeals, 2nd Circuit

d. No

e.. New York

f. 1990-1993

g. 1997

64 Chapter 4


h No specific dollar amount was specified.

i. Section 6212

j. For the IRS

k. Kearse, Miner, and Cabranes, Circuit Judges

l. Using the citator, it can be determined that the case is still authoritative. 26. a. John L. Seymour v. Commissioner, 109 TC 279 (1997)

b. Taxpayer

c. Tax Court

d. Yes

e.. Palm Beach Gardens, Florida

f. 1992 and 1993

g. 1997

h 1992 - $116,819; 1993 - $100,290

i. ''163, 1041, and 6654

j. For the taxpayer in part and the Commissioner in part

k. Judge Ruwe

l. From consulting the citator, it can be determined that the case is still authoritative. This case is cited favorably in two subsequent cases.

27. a. Kelly M. O=Gilvie v. U.S., 66 F.3d 1550, 76 AFTR2d 95-6752; 95-2 USTC &50,508.

b. Taxpayer

c. 10th Circuit Court of Appeals

d. Kansas



e. 1988

f. 1995

g. $2500

h. Primarily Section 104

i. The IRS

j. Moore and Logan, Circuit Judges. (Daugherty, District Judge, sitting by designation)

k. No

l. No

m. By referring to the citator, the student can determine that this decision was upheld

by the Supreme Court in 1996. 28. a. The United States v. Kirby Lumber Company, 284 US 1; 2 USTC &814 (1931)

b. The United States c. Supreme Court of the United States d. No location is noted. e. 1923 f. 1931 g. $137,521.30 h. Section 213, under Revenue Act of 1921 which is now Section 61 i. The United States j. Judge Holmes k. No l. No

66 Chapter 4


m. By consulting the citator, the student can determine that this case still authoritative

29. a. Timothy Quaschnick v. Commissioner, 69 TCM 1781 (1995) or TC Memo 1995- 45. Judge Nims. b. Bernard Furey v. Commissioner, 69 TCM 1655 or TC Memo 1995-15. The ruling judge was Judge Wolfe, a special trial judge

c. Allied-Signal, Inc. v. Commissioner, 54 F3d 767, 95-1 USTC &50,151; 75 AFTR2d 95-1287. Circuit Court Judge Cowen.

d. Therese A. Burke v. U.S, 504 US 229; 92-1 USTC &50,254; 71 AFTR2d 93-1705 (S.Ct., 1993) The ruling judges were Merritt, Jones, and Wellford 30. John F. Tupper, 134 F.3rd 444 (CA 1, 1998).

a. 98-1 USTC &50,148 (CCH); and 81 AFTR2d 98-430 (RIA)

b-f. See full text at page 74

g. The case is still authoritative. 31. Brinley v. Commissioner, 782 F.2d 1326.

a. Brinley v. Commission, 86-1 USTC & 9247 (CCH); Brinley v. Commission, 57 AFTR2d 86-857 (RIA)


32. Corn Products Refining Co. vs. Commissioner, 350 US 46 (S.Ct., 1955)

a. Corn Products Refining Co., v. Commissioner, 350 US 46, 55-2 USTC & 9746; Corn Products Refining Co., v. Commissioner, 47 AFTR 1789


g. This case has been cited by many cases. Although it has been questioned, it has

not been overruled. 33. Two appellate courts have cited Ruth Bohan vs. Commissioner, 456 F.2d 851. They are

both 8th circuit cases: Daniel Harold Wiese v. U.S., 55 AFTR 2d 85-537 and Sue Ann Hunter v. U.S., 46 AFTR 2d 80-6164.

34. a. Henry Hills, 76 TC 484 is a tax court decision. This was appealed to the Circuit

Court of Appeals, 11th circuit. Miller vs. Commissioner, 733 F2d 400; 84-1



USTC &9451; 53 AFTR2d 84-1252 was decided by the 6th circuit.

b In each of the cases, the taxpayer is an individual who suffered a loss to personal property. In Hills, the loss was caused by a burglary. In Miller, the loss was caused by an accident to a boat. Taxpayers held insurance that covered the losses. However, taxpayers chose not to file an insurance claim and instead take a deduction under IRC '165 for the loss.

c. The Code Section at issue is IRC '165 which states that a deduction may be

allowed for Alosses not compensated by insurance.@ The issue in these cases is whether that language precludes the deduction of a loss covered by insurance if no insurance proceeds are paid because the taxpayer did not file a claim.

d. Each case allowed the deduction to the taxpayer, stating that Anot compensated@

is different from Anot covered.@ Each case looks to Congressional intent by looking at the legislative history behind the use of the term Anot compensated.@ The courts conclude that Congress was aware of the difference between Anot compensated@ and Acovered@ and intentionally selected Anot compensated.@ Congress also looked to the Treasury Regulations which appear to anticipate disallowance of the loss only if the loss is not reimbursed. Each case looked at previous case law, particularly the case of Kentucky Utilities, which held with similar facts that the deduction would not be allowed. However, in that case, the taxpayer was a corporation. The courts distinguished the facts and stated that the reasoning of Kentucky Utilities when applied to the facts of the current cases allows for a deduction. Miller overruled Kentucky Utilities to the extent a deduction in Miller would not be supported by Kentucky Utilities.

e. The fun thing about this case study is that it is a good illustration of the play

between the legislature and the courts...how the legislature reacts to the court decisions. It also demonstrates how researchers must never stray too far from the Code since in this case the Code negates the impact of the cases when the taxpayer is an individual. It is also a good beginning to analytical thinking since the facts of the taxpayer are a bit different from the case law and the Code does not directly speak to the taxpayer=s situation. With this set of facts, students should note that the taxpayer is a corporation rather than an individual. The key fact is the same as the cases discussed above -- a loss was covered by insurance but no claim was filed. Students should discover IRC Section 165(h)(3)(E) which was added to the Code as a result of the cases discussed above and which denies a deduction for an individual who does not first file an insurance claim. Because the taxpayer in this situation is a corporation, students will need to discuss the significance of this difference. One strong suggestion is that had Congress intended to require the filing of a claim before a corporation is entitled to the deduction, the Code would not have singled out individual taxpayers. The

68 Chapter 4


omission of corporations under this provision would suggest that filing a claim is not required and that the reasoning of the two cases can be applied to the corporate taxpayer. This should evoke a good deal of discussion.

f. The cases involved an individual taxpayer. The facts in the research question

involve a corporate taxpayer. Both Miller and Hills did not see this as an important difference. However, some of the dissenting opinions discussed the importance of this difference.

35. a. Second Circuit Court of Appeals

b. Taxpayers were employees of a company and participants in that company=s retirement plan. The company reorganized and taxpayers were terminated. They brought suit under ERISA arguing that the employers partially terminated the company=s retirement plan, thereby entitling taxpayers to vest in some of the benefits.

c. IRC Section 411 d. The court concluded that there was no partial termination and relied upon

Treasury Regulations and two Revenue Rulings (Rev.Rul. 73-284, 1973-2 C.B. 137 and Rev.Rul. 72-510, 1972-2 C.B. 223).

e. Using the Weil case, the Internal Revenue Code and the Treasury Regulations,

address the following research question. Facts: Last year, Company X underwent a reorganization which involved moving its corporate headquarters from New York to California. Last year, the company had 375 employees. At the present time (December), the company employs only 280 people - a 25% reduction in the workforce. Of the 95 reduced positions, 42 were duplicate job positions and therefore were eliminated as part of the reorganization. The reduction also included 27 people who retired or voluntarily resigned. The remaining 26 positions were employees who were offered positions in California but chose not to relocate. Issue: ERISA requires that in order to receive favorable tax treatment, a retirement benefit plan must provide that accrued benefits to the extent funded are not forfeitable upon a Apartial termination@ of the plan. ERISA does not define Apartial termination.@ Does this reduction of employees constitute a partial termination of their pension plan so that the employees are entitled to the accrued benefits, even if they have not otherwise vested? (Students may not be able to identify the issue until they read the case since this is such a complicated area and involves ERISA. Although the ideal research method involves



starting with the IRC, this is a good example of how sometimes it takes quite a while and some digging before the researcher really grasps the issue.)

Conclusion and Reasoning: Treas. Reg. '1.401-6(b)(2) states that a determination as to whether there has been a partial termination of a plan should be made on the basis of all the facts and circumstances. The case of Weil v. Retirement Plan for the Terson Company, 85-1 USTC &9164 (CA 2, 1984), held that there may be a partial termination of a plan when 27% of the company work force was dismissed as a result of a company acquisition. The court looked to two Revenue Rulings which held that a partial termination occurs when a company dismisses a Asignificant number of employees@ in connection with a major corporate event. The court also looked to the Senate committee reports which stated that a partial termination might include a large reduction in the work force. The Weil case did not actually rule on whether the reduction and the surrounding facts were such that a partial termination did indeed occur. Rather, the court remanded the case back to the district court for consideration of the facts consistent with the court=s conclusions regarding what may trigger a partial termination.

Thus, students do not have enough to go on just from reading this case, although they now better understand the issue and probably spotted additional issues. For example, what is the impact of the voluntary resignation/retirement of some employees? Is a move a Amajor corporate event@? The subsequent history of the case is as follows: The District court held that there had been a termination, based on the fact that 33% of all plan participants were terminated. The Second Circuit reversed this (unpublished) decision. On a petition for rehearing, the Second Circuit reversed its earlier decision, concluding that the plan had been partially terminated. [91-1 USTC &50,247] In its earlier decision, the court had held that only vested employees should be considered in arriving at the percentage of employees terminated to determine whether such percentage was significant. Upon rehearing, the court held that in determining whether a significant number of the plan participants were discharged, both vested and nonvested employees must be considered. Thus the court held that there had been a partial termination.

36. a. The judges in the Supreme Court decision were split. Justice Stevens filed a dissenting opinion. (See short brief following)

b. The Revenue Ruling 94-24, 1994-1 CB 87 explained how the service will apply

the "relative importance" and "time" tests set forth in the Soliman case to determine whether an office in the home is the taxpayer's principal place of business for purposes of '280A(c)(1)(A). The Service will first apply the "relative importance" test, comparing the activities performed at each business location, to determine whether an office in the taxpayer's home is the taxpayer's principal place of business for purposes of '280A(c)(1)(A). If the relative importance test yields no definitive answer to the principal place of business inquiry (which may

70 Chapter 4


occur, for example, if the taxpayer delivers services or goods to customers both at the office in the taxpayer's home and elsewhere), the Service will look to the "time" test. However, as the Supreme Court specifically noted in Soliman, in some cases the application of the relative importance and time tests may result in a determination that there is no principal place of business for purposes of '280A(c)(1)(A).

c. Yes. Prior to 12/31/98, IRC '280A(c)(1)(A) requires that the dwelling unit must

be exclusively used on a regular basis as the principal place of business for any trade or business of the taxpayer. After 12/31/98, IRC '280A(c)(1)(A) defines the term of Aprincipal place of business@ to include a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business. These changes to IRC '280A would have allowed Mr. Soliman, an anesthesiologist, who spent 30 to 35 hours per week administering anesthesia and postoperative care in three hospitals to take the deduction under IRC '280A.

N.E. Soliman vs. Commissioner, 113 S. Ct. 701 (1993). Facts. Dr. Soliman was an anesthesiologist who spent between 30 and 35 hours a week with patients at three different hospitals. The hospitals did not provide Dr. Soliman with an office, so Soliman used an extra bedroom in his home exclusively as an office where he spent two to three hours daily performing administrative aspects of his work. On his 1983 tax return, the doctor took deductions for the portion of his condominium expenses and depreciation attributable to his home office. The IRS disallowed those deductions taking the position that the home office was not the doctor=s principal place of business. The court of appeals allowed the doctor the home office deduction. The IRS appealed.

Issue. What is required for a home office to be considered a principal place of business.

Conclusion: In order for a home office deduction to be allowed under I.R.C. section 280A(c)(1)(A), the office must be the taxpayer's "principal place of business." The court applied a new two-pronged test: the relative importance of the activities performed at each business location and the amount of time spent at each place. Clearly the doctor=s treatment of his patients at the hospitals is more important than his administrative activities to support his practice. Therefore the relative importance test results in failure of the home office to qualify as the principal residence. In addition, the doctor spent much more time at the hospital than his home office. Therefore the second test is failed as well. The home office was held not to be the principal residence and the deduction was disallowed.



37. Each of these authorities address the question of the ability to exclude certain types of awards granted in personal injury suits. At the time of the decisions, the language of IRC '104(a)(2) provided that Adamages received on account of personal injury@ were excluded. The issue became, what types of damages does this provision cover (compensatory and punitive?) and what constitutes a personal injury. In Roemer vs. Commissioner, 716 F2d 693 (9th Cir., 1983) the taxpayer was awarded damages as a result of a defamatory report issued by a credit company. In addition, the taxpayer was awarded punitive damages as a punishment to the credit company. The taxpayer excluded both awards. The IRS argued that Apersonal injury@ requires Aphysical@ injury. The court held that the definition of personal injury is not limited to physical, and looked to state Atort@ law to control whether something is a Apersonal injury.@ In doing so, the court held that it is most appropriate to look at the nature of the Acause of action,@ not just the nature of the damages that result. Because in the taxpayer=s state of residence (and in most states), defamation was a personal injury claim, the compensatory and punitive awards were held to be excluded.

The IRS refused to abide by the reasoning in Roemer, indicating in a nonacquiescence that it would continue to take the position that a Aphysical@ injury is necessary to apply the exclusion under IRC '104(a)(2). [Rev. Rul. 85-143, 1985-2 CB 55]. However, the courts continued to issue decisions applying the reasoning of Roemer. (See Threlkeld vs. Commissioner, 848 F2d 83; 88 USTC &9370; 61 AFTR2d 88-1287.) The Supreme Court in E.E. Schleier vs. Commissioner, 115 S.Ct. 2159; 95-1 USTC &150,309; 75 AFTR2d 95-2159 continued to apply the rationale that if something is a personal injury claim under state law, it is excludable. In that case, the exclusion was not allowed because the claim was filed under the Age Discrimination in Employment Act. The court held that such an action was not a personal injury action.

Congress responded to this controversy by amending IRC '104(a)(2) to state that the provision excluded Adamages (other than punitive damages) received...on account of personal physical injuries or physical sickness.@ With respect to punitive damages, Congress added the following provision in the flush language of IRC '104(a): A...For purposes of paragraph (2), emotional distress shall not be treated as a physical injury or physical sickness. The preceding sentence shall not apply to an amount of damages not in excess of the amount paid for medical care...attributable to emotional distress.@ The language in the amended section is poorly written and creates additional questions B what is a Aphysical injury or physical sickness?@ However, it is fairly clear that awards for defamation will only be excluded to the extent they are for physical injury resulting from the defamation. Damages compensating Aemotional distress@ will not be excluded unless it is to cover actual expenses incurred for medical care resulting from the distress. In addition, the Code now makes clear that punitive damages will not be excluded.

38. Duberstein vs. Commissioner, 363 U.S. 278 (1960), 5 AFTR2d 1626, 60-2 USTC &9515.

72 Chapter 4


IRC '102 was at issue. 39. In Board v. Commissioner, 51 F2d 73; 2 USTC &763; 10 AFTR 192, the Writ of

Certiorari was denied by the Supreme Court. This indicates to the researcher that the holding at the appellate level is final and therefore, to the extent on point, authoritative.

40. a. Davis vs. U.S., 495 U.S. 472; 90-1 USTC &50,270; 65 AFTR2d 90-1051:

Taxpayers paid certain amounts to their sons who were Mormon missionaries. They took a charitable deduction for such payments. The court held that funds could be deducted only by the person who directly incurred the expenses for the benefit of the charity. The language of the Code and its legislative history didn't support taxpayers' interpretation that their expenses would be deductible.

b. Barbara Ann Tudyman v. Commissioner, TC Memo 1996-215

This case dealt with a taxpayer's casualty loss for earthquake damage to their home. The court held that the taxpayer's use of cost-of-repair method was proper, but that the actual valuation was incorrect because the person valuing the home first saw property 5 years after the earthquake. Also, the taxpayer used the wrong year of purchase for personal items and didn't show basis in gifted or inherited property. The decrease in the home's FMV exceeded insurance recovery, and taxpayer didn't have reasonable prospect of recovery from insurance or the homeowners' association when she filed the return.

c. Sanford Reffett, 39 TC 869

A coal mine owner sued United Mine Workers for destruction of a mine. He entered into a contract with witnesses to pay 10% of any recovery to each witness if they would testify. After attorney fees, his attorney wrote him a check for the remaining settlement. Then the taxpayer endorsed the checks to the witnesses. The court held that a portion of recovery paid to witnesses under agreement signed by taxpayer includable in gross income.

d. Miller v. Comm., 2005-1 USTC &50,101

Taxpayers were employees of Microsoft and were granted stock options. They exercised the options using a loan which required the broker to liquidate the shares if the value of the shares went down. The value did go down and the broker did liquidate the shares. While holding the stock, the taxpayers would have been able to vote as shareholders and receive dividends and sell the stock. The court held that the exercise created a taxable event and that Section 83 does not require that the taxpayers are allowed to defer any income. The court rejected the taxpayers' argument that, under Reg. '1.83-3, they should not have been taxed on the value of the shares on the date of exercise because neither the risk of decline in value nor the beneficial ownership of the shares was transferred at that



time. The court held that since the broker was entitled to liquidate the shares if the taxpayers were unable to satisfy margin calls, the taxpayers had the ultimate risk of the shares' decline in value because they would either lose the shares or would have been required to put up other assets to satisfy margin calls. Therefore, both the risk of loss and the incidents of beneficial ownership were acquired by the taxpayers at the time they exercised the options.

41. a. Daniel E. Godfey v. Commissioner, TC Memo, 1998-51

The college tuition of a newspaper employee which was paid on his behalf for delivering newspapers for 3 years was includable in his gross income. The amount was not excluded under IRC '74(b) because the payment was not made directly to a charitable institution or awarded in recognition of one of the achievements spelled out in the Code Section. In addition, the taxpayer failed to show that he played no role in initiating the process that led to payment.

b. John DiFronzo v. Commissioner, 75 TCM 1693

AAn individual who was convicted of various charges arising out of his organized crime activities could deduct substantiated legal fees that he paid to his defense lawyer as ordinary and necessary business expenses. The taxpayer's planning of illegal activities with the intention of making a profit and furthering the interests of his organized crime family constituted a trade or business, and his participation in those activities was confirmed by his criminal conviction. As a married individual filing separately, the taxpayer could deduct only those substantiated legal fees that he alone had paid.@ (Taken from CCH headnote)

c. Huffman v. Commissioner, 67 TCM 2237 (1991)

AThe amount of attorney's fees awarded to an individual and the estate he represented as executor was determined on remand. The number of hours spent on the case was established by time charge records. However, the amounts submitted were reduced where various activities included in the one-time charge were determined to be unreasonable.@ (Taken from CCH headnote)

42. a. Robert and Nancy Pagliarulo v. Commissioner, 68 TCM 917

AP received worker's compensation benefits as a result of an injury sustained as a welder. In addition, P received interest pursuant to Massachusetts law on the amount of benefits accruing from the date P made a claim for benefits until the time P was paid the benefits. P excluded the interest received under sec. 104(a)(1), I.R.C.In the same year, Ps sold their principal residence and moved into a residence that they had purchased nearly four years previously. Ps excluded a portion of the gain realized on the sale of their residence pursuant to sec. 1034(a), I.R.C.1. Held: Sec. 104(a)(1), I.R.C., does not authorize exclusion of interest awarded pursuant to a State statute for the delayed payment of worker's compensation benefits. A (Taken from CCH headnote)

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b. Rosemary S. Kovacs, et al., 100 TC 124 (1993) AInterest on damages received in wrongful death action was includable in income. IRC '104 excludes only damages, not interest on damages. Also, damages and interest were recovered under separate state statutes. Periodic Payment Settlement Act of 1982, which clarified that periodic payments of personal injury damages are excludable, didn't make interest on damages excludable. Because interest wasn't excludable, attorneys' fees attributable to interest were deductible under IRC '212.@ (Taken from RIA Headnote)

c. Commissioner vs. Matheson, 82 F.2d 380 (CA 5, 1936) APetition for review of decision of Board of Tax Appeals. Basis to taxpayer upon sale of a part of the stocks acquired on August 27, 1930, from the estate of his father, which he accepted at a value of $497,400 in lieu of a $500,000 legacy ($2,600 cash having been paid him by the estate), is the proper portion of the agreed value of $497,400 (which was the value at the date of his father's death on May 15, 1930) although the market value was considerably lower on August 27, 1930. Since the taxpayer had the right to receive $497,400 and chose instead to take the stocks, there was an acquisition of the stock by purchase for the amount agreed upon. Affirming.@ (Taken from CCH Headnote)

43. Study the D.M. Clanton case.

a. Tax Court

b. Yes

c-i See text at page 89.

j. Justice Goldberg

k. The taxpayer (petitioner) lost. It was not appealed.

l. Buchanan, Mary A. v. U.S., 78 AFTR 2d 96-5002 44. In this exercise, students should be able to identify RIA as the citator providing the most

helpful information by listing those cases that followed or were favorable to the cited case, and those that were not. CCH=s citator simply lists the cases and requires the researcher to actually skim through the case to determine its impact.

a. Eisner v. McComber, 252 US 189; 3 AFTR 3020; 1 USTC &32

Status: Still authoritative. RIA Citator: Citing cases Cited favorably: O'Neill v U.S., 23 AFTR2d 69-1254 (CA6) [See 252 US 213-214, 3 AFTR 3026-3027] Cited generally: Proulx, Arthur A. v U.S., 43 AFTR2d 79-774



Cited favorably: Stelly, Charles W. v Comm., 56 AFTR2d 85-5229 (CA5) [See 252 US 207, 3 AFTR 3024] Cited favorably Counts, Jerry W. v Comm., 56 AFTR2d 85-6153 (CA11) Cited favorably Frantz, Leroy, Jr. v Comm., 57 AFTR2d 86-877 (CA2) [See 252 US 212, 3 AFTR 3026]

CCH Citator: Citing Cases: O=Neil CA-6, 69-1 USTC P 9372, 410 F2d 888 Proulx, 79-1 USTC P9218, 594 F2d 832. Stelly, CA-5, 85-1 USTC P 9436, 761 F2d 113 Counts, CA -11, 85-2 USTC P 9751, 774 F2d 426. Frantz, CA-2, 86-1 USTC P 9249, 784 F2d 119.

b. Harold Davis v. U.S., 495 U.S. 472; 90-1 USTC &50,270; 65 AFTR2d 90-1051

Status: Still authoritative. RIA Citator: Citing cases Cited favorably Richey, Lawrence M. v. U.S. I.R.S., 72 AFTR2d 93-6674 (CA9) Cited favorably Speck, Frederick E. v U.S., 71 AFTR2d 93-1443 [See 63 AFTR2d 89-404-A 861 F2d 564 n.l] Cited favorably Bailey, Garnet E. v. U.S., 80 AFTR2d 97-6939 (Ct Fed Cl) [See 63 AFTR2d 89-404-A, 861 F2d 564 n.1] Cited favorably Charron, Richard v. U.S., 80 AFTR2d 97-7011 (Ct Fed Cl) [See 63 AFTR2d 89-404-A, 861 F2d 564 n.1] Cited favorably Favell, Douglas R.,Jr. v. U.S., 80 AFTR2d 97-7069 (Ct Fed Cl) [See 63 AFTR2d 89-404-A, 861 F2d 564 n.1] CCH Citator: Citing casesRichey, CA-9, 93-2 USTC &50,647, 9 F3d 1407. Speck, 93-1 USTC &50,202, 28 FedCl 254. Charron, FedCl 97-2 USTC &50,903. Favell, FedCl 97-2 USTC &50,903. Price, FedCl, 97-2 USTC &50,903.

c. Sanford Reffett, 39 TC 869

Status: Still authoritative

RIA Citator: Citing Cases Cited favorably Goodall Est. of v Comm., 21 AFTR2d 819 (CA8) [See 39 TC 875] Cited generally Meyer, Leon R. & Lucile H., 46 TC 83 [See 39 TC 875] Cited favorably Bertolini, Raymond, Trucking Co., 1982 PH TC Memo 82-2862 [See 39 TC 879]

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Cited favorably Wells, John J., Inc., 1984 PH TC Memo 84-297 [See 39 TC 879] Reasoning followed Goodall; Gadlow, David B., Est. of, 50 TC 980

CCH Citator: Citing CasesGoodall Est., CA-8, 68-1 USTC P 9245, 391 F2d 775. Meyer, TC Dec. 27921, 46 TC 65. Bertolini, TC Dec. 39,474 (M), 45 TCM 44, TC Memo. 1982-643. Gadlow, TC, Dec. 29,158, 50 TC 975.



TEXT OF CASES SUPPORTING QUESTIONS 30-32 and QUESTION 43: John F. Tupper, 134 F.3rd 444 (CA 1, 1998), 98-1 USTC ¶50,148, 81 AFTR2d 98-430 ***text omitted Before TORRUELLA, Chief Judge, BOUDIN, Circuit Judge, and WOODLOCK, District Judge. Judge: TORRUELLA, Chief Judge: “The trustees of both a multiemployer pension plan trust and an annuity plan trust appeal a judgment from the district court. The court held that during 1986, 1987, and 1988, when the plans had failed to meet the requirements of the Employee Retirement Income Security Act (“ERISA”) and Internal Revenue Code (“I.R.C.”) section 401(a), the trusts could not qualify as exempt from taxation as “labor organizations” under I.R.C. section 501(c)(5). We affirm. Background The Plumbing, Pipe Fitting and Heating Contractors Association of Brockton and Vicinity (the “Employers”) and the Local Union 276 of the United Association of Journeymen and Apprentices of the Plumbing and Pipe Fitting Industry of the United States and Canada (the “Union”) entered into collective bargaining agreements in 1959 and 1983 providing for the creation of a defined benefit pension plan and a money purchase annuity plan respectively (the “plans”). According to the plans, half of the trustees of each plan trust are appointed by the Employers and half by the Union. The trustees are currently John F. Tupper, Robert S. Norvish, Raymond F. Brierly, Louis M. Colombo, Edward F. Cruz, and Dennis J. Cruz (the “trustees”). The trusts are funded entirely by employer contributions and exist solely to provide pension and annuity benefits for plan participants and beneficiaries. In 1974, after the pension plan had been in existence for fifteen years, ERISA was passed. See Pub. L. No. 93-406, 88 Stat. 829. ERISA resulted from a Congressional finding that pension benefits promised to employees were not being adequately protected. See ERISA section 2(a). Congress created a system of tax incentives and penalties in order to ensure protection of these funds. Pursuant to ERISA, a form containing certain information about a pension plan must be filed annually with the IRS in order to qualify the fund for tax exemption under I.R.C. section 401(a). See IRS Form 5500. The plans at issue in this case submitted these forms for 1986, 1987, and 1988. An Internal Revenue Service (“IRS”) audit for those three years revealed that the documents of the plans failed to meet the requirements of I.R.C. section 401(a) and found that the pension trust was not being operated in compliance with its plan. Consequently, the trustees paid over $450,000 in back taxes and then filed claims in federal court for refund, claiming entitlement to a tax exemption under various theories. All of those theories were eventually dismissed by the trustees' stipulation, save one somewhat novel claim which was the object of the district court's order and this appeal. The only question at issue in this case is whether the trusts, failing to meet


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ERISA standards, alternatively qualified for a tax exemption under I.R.C. section 501(c)(5) as “labor organizations.” The District Court of Massachusetts rejected a magistrate judge's recommendation that summary judgment be granted in favor of the trusts on this question, granting summary judgment in favor of the United States. This appeal followed. Discussion An award of summary judgment is reviewed de novo. See United Nat'l Ins. Co. v. Penuche's, Inc., 128 F.3d 28, 30 (1st Cir. 1997). We view the entire record in the light most hospitable to the party opposing summary judgment, indulging all reasonable inferences in that party's favor. See Ahern v. O'Donnell, 109 F.3d 809, 811 (1st Cir. 1997). However, taxpayers must prove unambiguously that they are entitled to exemptions. See United States v. Wells Fargo Bank, 485 U.S. 351, 354 [61 AFTR 2d 88-1345] (1988). Therefore, if “doubts are nicely balanced” regarding the applicability of a tax exemption, the exemption must be accorded its more limited interpretation. Troter v. Tennessee, 290 U.S. 354, 356 (1933). Thus, while factual doubts must be resolved in favor of the trustees in this case, legal ambiguities must be resolved in favor of the United States. We proceed with these standards in mind. It is tautological that, when asked to interpret a statute, a court first looks to the text of that statute. See Strickland v. Commissioner, Me. Dep't of Agric., 48 F.3d 12, 17 (1st Cir. 1995). If our query is not answered by the text, we skeptically examine legislative history in search of an “unmistakable expression of congressional intent” before considering agency interpretations or other devices of construction. See Id. Thus, we begin our analysis with I.R.C. section 501(c)(5), which provides a tax exemption for “labor organizations.” However, this term is not defined in the statute. Furthermore, the legislative history regarding this provision offers no insights into whether a pension trust established pursuant to collective bargaining and controlled jointly by the union and the employers was meant to be exempt from taxation. See Stichting Pensioenfonds Voor de Gezondheid v. United States, 129 F.3d 195, 198 [80 AFTR 2d 97-7735] (D.C. Cir. 1997) (“Stichting”) (noting that the text and legislative history of I.R.C. section 501(c)(5) provide “little help” in understanding the scope of the term “labor organization”). In their briefs, both the United States and the trustees candidly acknowledge that we must look beyond the I.R.C. for guidance in this case. We next turn to the Treasury Department's Regulations that have been adopted in order to elaborate upon the definition of the term “labor organization” in 501(c)(5). These regulations provide as follows: The organizations contemplated by section 501(c)(5) as entitled to exemption from income taxation are those which:(1) Have no net earnings inuring to the benefit of any member, and(2) Have as their objects the betterment of the conditions of those engaged in such pursuits [i.e., labor], the improvement of the grade of their products, and the development of a higher degree of efficiency in their respective occupations. 26 C.F.R. section 1.501(c)(5)-1(a) (1997). If these regulations were applied consistently by the



IRS, this case could be decided on the definition provided therein. Clearly the pension funds do not improve the grade of the workers' products or develop a higher degree of efficiency in the plumbing and pipefitting professions. However, while we accord due deference to all reasonable agency interpretations of a statute, see Strickland, 48 F.3d at 17, the IRS's interpretation of the I.R.C. is reflected in Treasury Regulations together with revenue rulings. See 26 C.F.R. section 1.6661-3 (1997). An examination of the IRS Revenue Rulings interpreting section 501(c)(5) reveals that these regulations are routinely applied so liberally as to render them virtually useless in the present case. In its Revenue Rulings, the IRS has held that “[a]n organization which is engaged in activities appropriate to a labor union, even though technically not a labor union itself, may qualify for exemption under section 501(c)(5).” Rev. Rul. 75-473, 1975-2 C.B. 213; see also Rev. Rul. 67-7, 1967-1 C.B. 137, 138. Over the years, pursuant to section 501(c)(5), the IRS has exempted a union stewardship trust, a union dispatch hall, and a union newspaper. See, respectively, Rev. Rul. 77- 5, 1977-1 C.B. 145; Rev. Rul. 75-473, 1975-2; Rev. Rul. 68-534, 1968-2 C.B. 217. Much like the trusts at issue, it is difficult indeed to see how these entities “improved the grade of workers' products” and “developed a higher degree of efficiency in their respective occupations” in accordance with the Treasury Regulations. The plan trusts, like the examples above, have no net earnings inuring to the benefit of any member, and, in a sense, have as their objects the betterment of the conditions of the union members participating in the plans. Against these background interpretations of the applicable Treasury Regulations, we must look elsewhere for guidance in deciding this case. The trustees urge this court to consider General Counsel Memoranda (“GCMs”) in order to establish that, pursuant to section 501(c)(5), the IRS has exempted entities similar to the plan trusts. GCMs are legal memoranda from the Office of Chief Counsel to the IRS prepared in response to a formal request for legal advice from the Assistant Commissioner (Technical). See Taxation With Representation Fund v. Internal Revenue Service, 646 F.2d 666, 669 [47 AFTR 2d 81-1026] (D.C. Cir. 1981). Completed GCMs are distributed to key officials within the IRS. See Id. at 670. The Office of Chief Counsel retains GCMs, and indexes and digests them as an in-house research tool. See Id. While the Internal Revenue Manual instructs IRS personnel not to use GCMs as precedents in the disposition of other cases, they may refer to GCMs for guidance in negotiations and in formulating a district office position on an issue. See Id. (citing Internal Revenue Manual section 4245.3). Furthermore, GCMs are extensively cross-referenced and updated to reflect current agency policy. See Id. at 682. As the D.C. Circuit has recognized, GCMs constitute the “working law” of the agency, and are thus of use to courts and taxpayers as a research tool providing a substantially consistent interpretation of the I.R.C. See Id. at 683. However, under the Treasury Regulations, GCMs do not establish precedent, and taxpayers cannot cite GCMs as authority against the United States in litigation. See 26 C.F.R. section 1.6661- 3(b)(2)(1997)(unlike Revenue Rulings, GCMs are not “authority”). This is precisely what the trustees seek to do. GCMs may be looked to as a research tool by any interested court or party, but they are not authority in this court. See Stichting, 129 F.3d at 200. When a reasonable regulation has been instituted pursuant to proper administrative procedures, federal courts must accord deference to the regulation. See Chevron v. Natural Resources Defense Council, 467 U.S. 837, 843 (1984); Cohen v. Brown University, 101 F.3d 155, 195 (1st Cir. 1996), cert. denied,


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117 S. Ct. 1469 (1997). We are thus precluded from considering GCMs in the manner urged by the trustees. Finding no definitive resolution of this issue in the text or history of section 501(c)(5), the Treasury Regulations, or precedential Revenue Rulings, we look at congressional treatment of jointly-controlled pension funds under other Internal Revenue Code provisions to see if the trustees' interpretation of the 501(c)(5) exemption is consistent with pronouncements about the taxation and regulation of such funds. Unfortunately for the taxpayers in this case, it is not. In the Revenue Act of 1962, Pub. L. No. 87-834, section 25, 76 Stat. 960, Congress enacted a provision that allowed a particular pension plan to qualify retroactively under section 401(a). In so doing, the Senate Finance Committee stated that “[u]nder present law, a pension trust is qualified for income tax exemption only if it meets certain requirements relating to coverage of employees and nondiscrimination of contributions or benefits.” S. Rep. No. 87-1881, at 300, reprinted in 1962-3 C.B. 707, 837. This statement implies that Congress intended section 401(a) as the only umbrella under which pension trusts might shield themselves from tax liability. Congress again spoke on this issue when enacting ERISA. The House Ways and Means Committee explained that employer-provided plans are “required to comply with the new coverage, vesting, and funding standards in order to qualify for the favored tax treatment [i.e. tax exemption] under the Internal Revenue Code.” H.R. Rep. No. 93-807 at 3, 31, reprinted in 1974-3 C.B. (Supp.) 238, 266. At the very least, these statements reveal that Congress was not anticipating a section 501(c)(5) “end run” around section 401(a)'s requirements for employer-provided pension funds. At most, these statements imply an affirmative intent to exclude these plans from the 501(c)(5) exemption. Furthermore, ERISA sections 413 (a) & (b) specifically include multiemployer- funded pension plans established pursuant to collective bargaining agreements as entities covered under the regulation. It is hard to imagine that Congress would have painstakingly designed ERISA, choosing to use a conditional tax exemption as the primary incentive to ensure compliance, and at the same time would offer tax exemptions to all jointly controlled pension plans as “labor organizations” under section 501(c)(5). As the Supreme Court has stated, federal courts are “reluctant to tamper with an enforcement scheme crafted with such evident care as the one in ERISA” and we see no need to do so here. Massachusetts Mut. Life Ins. Co. v. Russell, 473 U.S. 134, 147 (1985). Presented with no authority which clearly establishes an exemption under 501(c)(5) for the plan trusts at issue, and recognizing that such an interpretation would be at odds with, if not directly contrary to, the statements Congress has made regarding the proper taxation of such entities, we conclude that the trustees have failed to “unambiguously” establish their entitlement to a tax exemption. See also Stichting, 129 F.3d at 200 (reaching the same result). Conclusion For the reasons stated herein, the order of the district court is Affirmed.” ***Footnotes omitted.



Brinley v. Commissioner, 782 F.2d 1326 ***language omitted Appeal from the Decision of the United States Tax Court Before Reynaldo G. GARZA, Henry A. POLITZ and Robert M. HILL, Circuit Judges. Judge: Reynaldo G. GARZA, Circuit Judge: Opinion “Appellants, Eldon and Mary Alice Brinley, and their son, Derry Brinley, are residents of Georgetown, Texas, and members of the Church of Jesus Christ of Latter Day Saints ("LDS Church"). The LDS Church operates a worldwide missionary program with more than 25,000 unsalaried missionaries proselytizing and performing other religious services in foreign countries and the United States. By letter dated August 16, 1977, the Church notified Derry Brinley that he had been "called" to serve as a full-time, ordained and unsalaried missionary for a period of two years in the area of Lansing, Michigan. A call to a mission on behalf of the LDS Church develops in part from the judgment and evaluation of local clergymen (called bishops or branch presidents) that a member of their congregation, having demonstrated his (or her) adherence to the faith and doctrines of the religion by observing its standards and commandments, is eligible for missionary service. During the mission the missionary engages in no other occupation. The LDS Church arranges for the finances to pay the expenses of its missionaries and provides them with budget directives, training, rules and regulations, and extensive supervision. In addition, the Church provides a partial payment for transportation to its missionary training center, to the headquarters of the mission area to be served and to return home at the end of the missionary's term of service. Although the funds for these expenses come from the membership at large, the Church requests that the missionary's daily incidental expenses (other than transportation expenses) be financed by the missionary from his savings or by his family members. According to the Brinley's, the LDS Church directed them to send a check in the amount of $170 to Murdock Travel, Inc., its designated travel agent, to help defray Derry Brinley's transportation expenses from Texas to the Church's missionary training center in Salt Lake City, Utah, and from Salt Lake City to Lansing. The Brinleys were also asked to contribute $86 toward Derry Brinley's boarding expenses at the missionary training center. During the latter part of 1977 the Brinleys issued additional checks to their son for expenses that he incurred at the missionary training center and for food, housing, transportation, proselytizing materials and other personal needs. On their joint income tax return for 1977 the Brinleys claimed a deduction of $942 for the moneys sent to sustain their son during the latter part of 1977. The Brinleys claimed the


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deduction under §170 of the Internal Revenue Code ("Code"), which provides in pertinent part: ((1)) General Rule. – There shall be allowed as a deduction any charitable contribution (as defined in subsection (c)) payment of which is made within the taxable year. A charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary. (c) Charitable contribution defined. – For the purpose of this section the term "charitable contribution" means a contribution or gift to or for the use of – ((2)) A corporation, trust, or community chest, fund or foundation – (B) organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes …. U.S.C. §170. 1 Although the LDS Church is an organization listed on the [pg. 86-859] Internal Revenue Service Publication No. 78. Cumulative List of Organizations, contributions to which are deductible under §170, Appellee, Commissioner of the Internal Revenue Service ("I.R.S."), disallowed the deduction. The Brinleys petitioned pro se for a redetermination of tax. In a Memorandum Opinion the Tax Court sustained the Commissioner's disallowance of the Brinleys' charitable contribution. The Brinleys, who by then had retained counsel, obtained review by the full court in the wake of White v. United States, 725 F.2d 1269; 53 AFTR2d 84-621 (10th Cir. 1984), which held that charitable donations virtually identical to those in the present case were deductible under the Code. The Tax Court unanimously reaffirmed its prior opinion and expressly disagreed with the Tenth Circuit's opinion in White. The court concluded that the Brinleys' deduction was improper because the funds contributed to their son and Murdock Travel were not placed under the "control" of the LDS Church. This appeal ensued. Analysis In White the Tenth Circuit held that parents' contributions sent directly to their son, while a full-time missionary in the service of the LDS Church, were deductible under §170 "because the expenditure primarily serves the church." White, 725 F.2d at 1272. The court specifically held that: [T]he control test … is not the appropriate test to determine the deductibility of payment of expenses of others who perform services to benefit a charity … the proper test, we hold, is the same as when the expenditure is for expenses personally incurred – whether the primary purpose is to further the aims of the charitable organization or to benefit the person whose expenses are being paid. Id. at 1271-72. The Brinleys urge this Court to follow White in rejecting the "control" test and in adopting the "primary benefit" test for determining whether expenses incurred in the rendition of services are "to or for the use of " a charity and, therefore, deductible. The government, on the other hand, contends that the primary benefit test is appropriate only where the taxpayer claiming the deduction actually renders the charitable services. According to the government, where the



person rendering the charitable services is not the taxpayer claiming the deduction, the expenses incidental to the rendition of the services are "to or for the use of" a charity only if the charitable organization has full control over the funds. Both sides rely on this Court's opinion in Winn v. Commissioner, 595 F.2d 1060; 44 AFTR2d 79-5076 (5th Cir. 1979), in support of their position. In Winn the taxpayers claimed a deduction for a $10,000 check payable to the "Sara Barry Fund" and given to Sara Barry's father (a Presbyterian minister) for deposit in her personal account. Sara Barry was sponsored by the Benoit Presbyterian Church and other Presbyterian churches to engage in missionary work in Korea. We held that a donor can earmark a contribution given to a qualified organization for specific [charitable] purposes without losing the right to claim a charitable deduction … [and that] … [s]uch a contribution still would be 'to or for the use of' a charitable entity despite the fact that the donor controlled which of the qualified entity's charitable purposes would receive the exclusive benefit of the gift. Winn, 595 F.2d at 1065. In so holding, we relied on Bauer v. United 449 F.Supp. 755 41 AFTR2d 78-1040] (W.D. La. 1978), 594 F.2d 44 ; 43 AFTR2d 79-1112] (5th Cir. 1979), which held that a charity need not have full control of the donated funds to satisfy the "for the use of" requirement. ***Cites omitted*** The government's contention that the LDS Church must have full control over the funds in question to support the Brinley's charitable contribution deduction must, therefore, be rejected. However, the fact that the LDS Church need not have full control of the funds does not, as the Brinleys urge, translate into a rejection of control as a test for determining whether expenses incurred in the rendition of services to charity are deductible under §170. This Court applied a control test in Winn and found that the Benoit Presbyterian Church had control over the taxpayer's donation. Proof that the church in Benoit sponsored 'Sara Barry Days' for the express purpose of collecting funds for this part of its work, that an officer of that church took the funds donated and dealt with them as the church wished, and that the funds went to the support of the work the church intended is sufficient to establish that the funds were donated for the use of the Benoit Presbyterian church. Winn, 595 F.2d at 1065. With the exception of White, none of the other authorities cited by the Brinleys require or support a rejection of control as a legitimate gauge for determining the deductibility of expenses incidental to charitable service. We must disagree with White to the extent that it so holds. Primary Benefit Test as an Appropriate Standard Nonetheless, we conclude that White is correct in holding that it was not necessary for the LDS Church to have control over the funds given directly to its missionaries in order to support charitable contribution deductions under §170. As the Brinleys correctly note, the standard in this Circuit for determining the deductibility of expenditures incurred in the service of charity is one of causation: "The charitable work must be the cause of the payment in order for the payment to be deductible." Orr v. United States, 343 F.2d 553, 557; 15 AFTR2d 641 (5th Cir. 1965).


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In Orr the taxpayer owned an automobile that he used exclusively for charitable purposes. He sold that automobile and acquired another which he used, in part, for non-charitable purposes. We noted that the taxpayer was entitled to full charitable deductions for the expenses of the vehicle used solely for charitable purposes, but that the expenses of the second vehicle, which would have been made if no charitable work had been done (e.g., insurance premiums), were not deductible. "The words 'gift to or for the use of' will not stretch to include payments which the taxpayer would have made for non-charitable reasons." Orr, 434 F.2d 557. We conclude, as a general matter, that charitable work is the cause of an expenditure if the charity is the primary beneficiary of the expenditure. The government contends that the primary benefit approach should not be applied in the present case for several reasons. First, it claims that the Brinleys' payments are non-deductible expenditures within the meaning of §262 of the Code 4 because they were made to a private individual and not to a qualified recipient under §170. We find no merit in this argument. Section 1.262-2(c) of the Regulations states that "[c]ertain items of a personal, living, or family nature are deductible to the extent provided under … (5) Section 170 (charitable, etc., contributions and gifts)." The government's argument that the Brinley's contributions are nondeductible in the absence of control because they were, in fact, given directly to their son and not the Church obscures and begs the basic question: whether these payments are expenditures incident to the rendition of services to a charity within the meaning of §170 and §1.170A-1(g) of the Regulations and, therefore, deductible. The government next asserts that whenever a taxpayer donates funds to an individual representing a charity or earmarks funds donated to a charity for a specified individual a control test must be applied to assure the taxpayer's charitable intent. The government reasons that charitable intent is assured, and that a "gift to or for the use of" a charitable organization is made, only where the donor's contribution to a charity is indefinite. We agree that deductible donations to a charitable organization must not be restricted for the benefit of a particular individual. See Tripp v. Commissioner, 337 F.2d 432, 14 AFTR2d 5810] (7th Cir. 1964); (payments to a college scholarship fund that were earmarked for a particular individual were for the benefit of the student and not deductible); Fausner v. 55 T.C. 620 (1971) (payments to parochial schools attended by taxpayer's children were not acts of detached and disinterested generosity, but were for the anticipated benefit of those children); Thomason v. 2 T.C. 441 (1943) (denying a deduction for a donation to a qualified welfare agency to pay for the schooling of a specific individual). A different situation arises, however, where an individual contributes services to a qualified organization. In these circumstances "indefiniteness" is not a relevant consideration, since both the donor and beneficiary (the charity) are ascertained. While §170 prohibits deductions for the value of services rendered, "unreimbursed expenditures made incident to the rendition of services … may constitute a deductible contribution." 26 C.F.R. §1.170A-1(g). Moreover, as we noted in Orr, charitable intent is also an irrelevant consideration: "[s]ince the test is one of causation, the taxpayer's motivation is irrelevant to the determination whether the payment is a charitable contribution." Orr, 343 F.2d at 557.



The government next contends that §1.170A-1(g) of the Regulations, by its terms, does not apply to payments made to cover the expenses incurred incident to another taxpayer's service to charity. The government claims that to hold otherwise would result in a merger of parents and son into a single taxpaying unit. In addition, the government fears that a liberal construction of §1.170A-1(g) will result in at least two specific abuses of the income tax system: (1) a double deduction for a single expenditure, i.e., one deduction by the taxpayer making the payment and another by the taxpayer rendering the service; and (2) a shifting of deductions from individuals in low-income tax brackets to individuals in high-income tax brackets. Although we share some of the government's concerns, we find nothing on the face of §1.170A-1(g) that expressly limits deductions for expenditures incurred in the rendition of charitable work to the person who actually performs the service. Moreover, it does not necessarily follow that allowing the Brinleys to deduct the funds which they advanced to their son to finance his charitable work will result in a merger of separate taxpaying units, a shifting of deductions from lower to higher income tax brackets, double deductions or other abuses of the income tax laws. We conclude that rigorous application of a primary benefit analysis precludes serious possibility of abuse. As applied to the case at bar, the Brinleys' contributions would be deductible under §170 only if they can show that each payment to Derry Brinley or a third party primarily benefited the LDS Church. Thus, while expenditures for proselytizing materials and out-of-pocket transportation expenses incurred in performing missionary work would be for the benefit of the Church and deductible, recreation and personal expenditures would be primarily for the benefit of the individual missionary and non-deductible. Public policy requires that the taxpayer have the administrative burden of proving that a particular payment primarily benefited a charitable organization and is, therefore, deductible under §170. Sampson v. Commissioner, 43 T.C.M. 1408 (1982) illustrates the point: Petitioners submitted in evidence two charts, one for 1973 and one for 1974. Each chart listed the checks which were allegedly used to fund the drug operations, the payee named on the check, and any notation on the check indicating its purpose. Most of the checks were made out to individual payees (other than petitioners). Several had notations such as 'undercover agent,' 'drugs,' and 'drug money.' These we conclude were expended for the purchase of information and drugs. Other checks, however, were made out to the Bell Telephone Company or to one of the petitioners without explanation, or bore notations such as 'surveillance equipment,' 'Kaw Korner,' or 'radio supplies.' Petitioners have not shown just what these checks were for and hence their amount is not allowable. Id. at 1414-15. 5 We cannot determine, on [pg. 86-862] the record before us, whether the whole or any part of the $942 claimed by the Brinleys primarily benefited the LDS Church. "Away From Home" Limitation The government finally contends that, notwithstanding a primary benefit analysis, the Brinleys cannot claim a deduction for expenditures related to Derry Brinley's meals and lodging because such expenditures were not "necessarily incurred while away from home in the course of performing donated services." 26 C.F.R. §1.170A-1(g). The government notes that "the phrase


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while 'away from home' has the same meaning as the phrase is used for purposes of section 162 and the regulations thereunder." Id. Section 162 provides in part: (a) In general – There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including – (2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business …. In discussing the phrase "away from home" within the meaning of §162(a)(2) we have stated that The question of whether a taxpayer is away from home within the meaning of section 162(a)(2) is essentially a question of fact to be determined from all the facts and circumstances of the case, but the principles that guide the decision have long been established. A taxpayer's home, for purposes of section 162(a)(2), means the vicinity of his principal place of employment and not where his personal residence is located, if such residence is located in a different place from his principal place of employment. When a taxpayer who maintains a residence in the vicinity of his principal place of employment is required to travel to a different location for temporary work, he is considered to be 'away from home'. A taxpayer who accepts permanent or indefinite employment in a location different from that of his residence, however, is considered to have moved his tax home to the new location, and is therefore no longer considered away from home. A job may be considered indefinite or permanent if, under all the circumstances, it appears likely to last beyond a short period of time, even if there is no firm commitment that it will do so. A job which is temporary at the outset, may become permanent or indefinite by a change of circumstances or merely the passage of time. Finally, an itinerant worker who maintains no permanent residence is never considered away from home because he has no home to be away from. ***citations omitted*** Applying the "away from home" concept in the context of §170, we must conclude that Derry Brinley's tax home during the period of his service to the LDS Church was in Lansing, Michigan, and therefore, that his donated services were not performed away from home. Consequently, the Brinleys' expenditures for Derry Brinley's meals and lodging are not deductible under §170. Cf. Ford v. Commissioner, 227 F.2d 297, 299 (5th Cir. 1955) (denying deductions for meals and lodging during a two-year absence from home); Jones, 444 F.2d at 510 (approving Ford). Control Test as an Appropriate Standard A showing that a particular payment primarily benefited the individual missionary would not, however, preclude a charitable deduction for the donor provided the charitable organization had control over the funds. As noted earlier, control of the $10,000 payment in Winn, supra, was sufficient to establish that the funds were donated "for the use of" the Benoit Presbyterian Church. See Winn, 595 F.2d at 1065. Once it was determined that the funds were within the control of the Benoit Church it became irrelevant whether any or all of the $10,000 contribution primarily benefited the church or Sara Barry, or whether part of the payment covered expenditures for meals and lodging not "away from home." Thus, the Brinley's would be entitled to deduct their $942 in payments if the LDS church had control over the funds.



To have control over donated funds is to have discretion as to their use. Thus, funds donated to a charitable organization with the restriction from the donor that the funds be used for the benefit of some private individual are not deductible. See Tripp v. Commissioner, 337 F.2d 432, 435-36, 14 AFTR2d 5810] (7th Cir. 1964); Thomason v. Commissioner, 2 T.C. 441, 443-444 (1943). In these cases the charitable organization did not solicit donations for specific charitable purposes and had no control and discretion as to the use of the donated funds. A different situation arises, however, where the charitable organization solicits funds for a specific charitable purpose. In these circumstances the charity has control and discretion because it has created a specific charitable cause and has solicited funds in support of that cause. Thus, in Winn it was essential that the Benoit Presbyterian Church established a "Sara Barry Fund" and sponsored "Sara Barry Days" for the express purpose of collecting funds to support Sara Barry's missionary work in Korea. The fact that an officer of that church (Sara Barry's father) had possession of the donated funds did contribute to the degree of the church's control. However, full control in the form of actual or physical possession of the donation was not crucial to our finding that the Benoit Church "dealt with [the funds] as the church wished." Winn, 595 F.2d at 1065. Thus, we conclude that a charitable organization's control is established where a specific charitable purpose is created and a donation is made in response to the charity's solicitation for funds in support of that purpose. The Brinleys contend that the Church exercised control over the funds in question. First, they assert that Derry Brinley was an agent of the LDS Church and that, therefore, a contribution given to Derry Brinley was a contribution within the control of the Church. Second, the Brinleys contend that the Church exercised control (1) by directing the Brinleys to make certain donations; (2) by requiring Derry Brinley to undertake certain expenses and to account for such expenses; and (3) by supervising and controlling Derry Brinley's daily activities while a full-time missionary. The Brinleys maintain that the case at bar is similar to Winn in all significant respects. We disagree. Derry Brinley's status as an agent of the LDS Church, though not irrelevant, is not a critical factor. The Brinleys have repeatedly cautioned this Court against exalting "form over substance" in arguing that Winn, supra, should not be construed to require actual or physical control over donated funds. We agree. Conversely, to hold that control is satisfied merely because Derry Brinley, albeit an agent of the Church, received the donated funds also raises "form over substance" and deviates from the real inquiry: whether the LDS Church had control over the funds and, therefore, discretion as to their use. Compare Cook v. Commissioner, 37 T.C.M. 771 (1978) (denying deduction for contributions to individual ministers on the ground that there was no evidence that the recipients spent the money on church-related activities) with Peace v. Commissioner, 43 T.C. 1 (1964) (allowing deduction for funds donated to a church mission society with the stipulation that specific amounts should go to each of four designated missionaries because "[a]n examination of the totality of the facts and evidence" demonstrated that the church retained control of the actual expenditure of the funds). As discussed above, Winn involved a specific church-established charitable purpose (Sara Barry's mission work in Korea) and a donation made (to the "Sara Barry Fund") in response to a


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Church-sponsored solicitation drive ("Sara Barry Days"), which was created to collect funds in support of that purpose. By contrast, the case at bar involves a general church-established charitable purpose (the LDS Church's worldwide missionary program) and a general, [pg. 86-864] ongoing solicitation of funds in support of over 25,000 missionaries rendering services for that charitable purpose. In contrast to the Benoit Presbyterian Church, the LDS Church did not establish a "Derry Brinley Fund" or "Derry Brinley Days" to collect funds for his mission work in Michigan. Derry Brinley constituted, at most,1/25,000 of the Church's worldwide missionary effort. We do not suggest that the LDS Church must divide its missionary structure and create 25,000 missionary projects to establish control over funds given in support of its missionaries. In fact, we conclude that control would be established in the present case, and that the Brinleys would be entitled to a charitable deduction, if the Brinleys can show that the Church requested them to make specific payments and that they responded to these specific requests. In other words, the Brinleys must demonstrate a "matching" between request and expenditure; contributions given in excess of the Church's request, however, would not be deductible. In this manner, the Church retains control and discretion as to the use of the donated funds. We cannot determine, on the record before us, whether the LDS Church had control over all or any part of the $942 claimed by the Brinleys. Conclusion In conclusion, we hold that the deductibility of expenditures incurred in the rendition of services to charity is essentially a question of fact to be determined from all the facts and circumstances on a case-by-case basis, and that a charitable deduction under §170 and §1.170A-1(g) of the Regulations may be taken if it meets either the control test or the primary benefit test or a combination of both. We reject the notion that the primary benefit test is to be applied to the exclusion of the control test, or vice-versa – regardless of whether the person rendering the services is the taxpayer claiming the deduction. Thus, we hold that the Tax Court erred in concluding that the LDS Church must exercise full control over funds sent directly to its missionaries in support of their mission work in order for the funds to be deductible under §170. The Brinleys' payments would be deductible if they primarily benefited the LDS Church or if the Church maintained discretion as to their use. The evidence in the record before us does not establish that the LDS Church had control over the Brinleys' payments or that any part thereof primarily benefited the Church. We conclude, however, that the evidence in this case could not have been adequately developed in the proceedings before the Tax Court because the court heard the Brinleys' pro se petition, while following and applying an erroneous legal standard – the "full control" test. Of course, we realize that the guidelines we announce were not before the court at the time of the Brinleys' trial. Nonetheless, justice requires that the Brinleys be given the opportunity to present evidence in light of the appropriate standard outlined above. Therefore, we vacate the Judgment of the Tax Court and remand for proceedings consistent with this opinion. Vacated and Remanded.



Corn Products Refining Co. vs. Commissioner, 350 US 46 (S.Ct., 1955) ***Language omitted*** “This case concerns the tax treatment to be accorded certain transactions in commodity futures. In the Tax Court, petitioner Corn Products Refining Company contended that its purchases and sales of corn futures in 1940 and 1942 were capital-asset transactions under § 117(a) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 117(a). It further contended that its futures transactions came within the "wash sales" provisions of § 118. The 1940 claim was disposed of on the ground that § 118 did not apply, but for the year 1942 both the Tax Court and the Court of Appeals for the Second Circuit, 215 F.2d 513, held that the futures were not capital assets under § 117. We granted certiorari, 348 U.S. 911, 75 S.Ct. 298, because of an asserted conflict with holdings in the Courts of Appeals for the Third, Fifth, and Sixth Circuits. Since we hold that these futures do not constitute capital assets in petitioner's hands, we do not reach the issue of whether the transactions were "wash sales." Petitioner is a nationally known manufacturer of products made from grain corn. It manufactures starch, syrup, sugar, and their byproducts, feeds and oil. Its average yearly grind of raw corn during the period 1937 through 1942 varied from thirty-five to sixty million bushels. Most of its products were sold under contracts requiring shipment in thirty days at a set price or at market price on the date of delivery, whichever was lower. It permitted cancellation of such contracts, but from experience it could calculate with some accuracy future orders that would remain firm. While it also sold to a few customers on long-term contracts involving substantial orders, these had little effect on the transactions here involved. In 1934 and again in 1936 droughts in the corn belt caused a sharp increase in the price of spot corn. With a storage capacity of only 2,300,000 bushels of corn, a bare three weeks' supply, Corn Products found itself unable to buy at a price which would permit its refined corn sugar, cerealose, to compete successfully with cane and beet sugar. To avoid a recurrence of this situation, petitioner, in 1937, began to establish a long position in corn futures "as a part of its corn buying program" and "as the most economical method of obtaining an adequate supply of raw corn" without entailing the expenditure of large sums for additional storage facilities. At harvest time each year it would buy futures when the price appeared favorable. It would take delivery on such contracts as it found necessary to its manufacturing operations and sell the remainder in early summer if no shortage was imminent. If shortages appeared, however, it sold futures only as it bought spot corn for grinding. In this manner it reached a balanced position with reference to any increase in spot corn prices. It made no effort to protect itself against a decline in prices. In 1940 it netted a profit of $680,587.39 in corn futures, but in 1942 it suffered a loss of $109,969.38. In computing its tax liability Corn Products reported these figures as ordinary profit and loss from its manufacturing operations for the respective years. It now contends that its futures were "capital assets" under § 117 and gains and losses therefrom should have been treated as arising from the sale of a capital asset. In support of this position it claims that its


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futures trading was separate and apart from its manufacturing operations and that in its futures transactions it was acting as a "legitimate capitalist". United States v. New York Coffee & Sugar Exchange, 263 U.S. 611, 619, 44 S.Ct. 225, 227, 68 L.Ed. 475. It denies that its futures transactions were "hedges" or "speculative" dealings as covered by the ruling of General Counsel Memorandum 17322, XV-2 Cum.Bull. 151, and claims that it is in truth "the forgotten man" of that administrative interpretation. Both the Tax Court and the Court of Appeals found petitioner's futures transactions to be an integral part of its business designed to protect its manufacturing operations against a price increase in its principal raw material and to assure a ready supply for future manufacturing requirements. Corn Products does not level a direct attack on these two-court findings but insists that its futures were "property" entitled to capital-asset treatment under § 117 and as such were distinct from its manufacturing business. We cannot agree. We find nothing in this record to support the contention that Corn Products' futures activity was separate and apart from its manufacturing operation. On the contrary, it appears that the transactions were vitally important to the company's business as a form of insurance against increases in the price of raw corn. Not only were the purchases initiated for just this reason, but the petitioner's sales policy, selling in the future at a fixed price or less, continued to leave it exceedingly vulnerable to rises in the price of corn. Further, the purchase of corn futures assured the company a source of supply which was admittedly cheaper than constructing additional storage facilities for raw corn. Under these facts it is difficult to imagine a program more closely geared to a company's manufacturing enterprise or more important to its successful operation. Likewise the claim of Corn Products that it was dealing in the market as a "legitimate capitalist" lacks support in the record. There can be no quarrel with a manufacturer's desire to protect itself against increasing costs of raw materials. Transactions which provide such protection are considered a legitimate form of insurance. United States v. New York Coffee & Sugar Exchange, 263, U.S. at page 619, 44 S.Ct. at page 227; Browne v. Thorn, 260 U.S. 137, 139-140, 43 S.Ct. 36, 37, 67 L.Ed. 171. However, in labeling its activity as that of the "legitimate capitalist" exercising "good judgment" in the futures market, petitioner ignores the testimony of its own officers that in entering that market the company was "trying to protect a part, of [its] manufacturing costs"; that its entry was not for the purpose of "speculating and buying and selling corn futures" but to fill an actual "need for the quantity of corn [bought] *** in order to cover *** what [products] we expected to market over a period of fifteen or eighteen months." It matters not whether the label be that of "legitimate capitalist" or "speculator"; this is not the talk of the capital investor but of the far-sighted manufacturer. For tax purposes petitioner's purchases have been found to "constitute an integral part of its manufacturing business" by both the Tax Court and the Court of Appeals, and on essentially factual questions the findings of two courts should not ordinarily be disturbed. Comstock v. Group of Institutional Investors, 335 U.S. 211, 214, 68 S.Ct. 1454, 1456, 92 L.Ed. 1911. Petitioner also makes much of the conclusion by both the Tax Court and the Court of Appeals that its transactions did not constitute "true hedging." It is true that Corn Products did not secure complete protection from its market operations. Under its sales policy petitioner could not guard against a fall in prices. It is clear, however, that petitioner feared the possibility of a price rise



more than that of a price decline. It therefore purchased partial insurance against its principal risk, and hoped to retain sufficient flexibility to avoid serious losses on a declining market. Nor can we find support for petitioner's contention that hedging is not within the exclusions of § 117(a). Admittedly, petitioner's corn futures do not come within the literal language of the exclusions set out in that section. They were not stock in trade, actual inventory, property held for sale to customers or depreciable property used in a trade or business. But the capital-asset provision of § 117 must not be so broadly applied as to defeat rather than further the purpose of Congress. Burnet v. Harmel, 287 U.S. 103, 108, 53 S.Ct. 74, 76, 77 L.Ed. 199. Congress intended that profits and losses arising from the everyday operation of a business be considered as ordinary income or loss rather than capital gain or loss. The preferential treatment provided by §117 applies to transactions in property which are not the normal source of business income. It was intended "to relieve the taxpayer from *** excessive tax burdens on gains resulting from a conversion of capital investments, and to remove the deterrent effect of those burdens on such conversions." Burnet v. Harmel, 287 U.S. at page 106, 53 S.Ct. at page 75. Since this section is an exception from the normal tax requirements of the Internal Revenue Code, the definition of a capital asset must be narrowly applied and its exclusions interpreted broadly. This is necessary to effectuate the basic congressional purpose. This Court has always construed narrowly the term "capital assets" in § 117. ***Cites omitted*** The problem of the appropriate tax treatment of hedging transactions first arose under the 1934 Tax Code revision. Thereafter the Treasury issued G.C.M. 17322, supra, distinguishing speculative transactions in commodity futures from hedging transactions. It held that hedging transactions were essentially to be regarded as insurance rather than a dealing in capital assets and that gains and losses therefrom were ordinary business gains and losses. The interpretation outlined in this memorandum has been consistently followed by the courts as well as the Commissioner. While it is true that this Court has not passed on its validity it has been well recognized for 20 years, and Congress has made no change in it though the Code has been re-enacted on three subsequent occasions. This bespeaks congressional approval. Helvering v. Winmill, 305 U.S. 79, 83, 59 S.Ct. 45, 46, 83 L.Ed. 52. Furthermore, Congress has since specifically recognized the hedging exception here under consideration in the short-sale rule of §1233(a) of the 1954 Code, 26 U.S.C.A. § 1233(a). We believe that the statute clearly refutes the contention of Corn Products. Moreover, it is significant to note that practical considerations lead to the same conclusion. To hold otherwise would permit those engaged in hedging transactions to transmute ordinary income into capital gain at will. The hedger may either sell the future and purchase in the spot market or take delivery under the future contract itself. But if a sale of the future created a capital transaction while delivery of the commodity under the same future did not, a loophole in the statute would be created and the purpose of Congress frustrated. The judgment is affirmed. Affirmed. Mr. Justice HARLAN took no part in the consideration or decision of this case.”


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Donald M. Clanton, et ux. v. Commissioner, TC Memo 1995-416, 70 TCM 534 (1995) GOLDBERG, Special Trial Judge: MEMORANDUM OPINION This case was heard pursuant to section 7443A(b)(3) and Rules 180, 181 and 182. Respondent determined deficiencies in petitioners' Federal income taxes for the taxable years 1989 and 1990 in the respective amounts of $957.55 and $990.40. Donald M. Clanton participated in the transactions at issue and he will be referred to herein as petitioner. The issues for decision are (1) whether petitioner's payments of a hospital bill on behalf of his father and a loan on behalf of his brother, pursuant to a guarantee, were deductible in 1989 as nonbusiness bad debts under section 166, and (2) if they were deductible in 1989, can the deduction be carried forward to 1990. Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated by this reference. Petitioners resided in Cypress, Texas, at the time their petition was filed. On December 26, 1975, petitioner's father Morris Clanton (Morris) suffered a heart attack and was admitted to the hospital for an extended period of time. Faced with growing medical bills, Morris asked petitioner to call John Currie (Mr. Currie), chairman of State National Bank in Big Spring, Texas, to request a loan. In response, John Currie sent a demand note (the State National note) that provided for a loan of $3,288.75, with an annual interest rate of 9-1/2 percent. After petitioner signed and returned the State National note, Mr. Currie wired the funds, which were used to pay the medical bills of petitioner's father. At the time petitioner signed the State National note and thereby assumed the obligation to repay the loan, the prognosis for his father was good. Prior to his heart attack, Morris was a truck driver and sold used cars part-time. At the time the State National note was signed by petitioner, Morris planned to resume working shortly after leaving the hospital. However, due to the steady deterioration of his health, Morris was unable to work at his former capacity and later stopped driving trucks altogether. Instead, Morris became more involved with the used car business. On January 25, 1978, petitioner paid off the State National note in full. Morris insisted that he would repay petitioner as soon as his health improved. Morris passed away in 1984 without repaying the debt and left no estate for probate. Thereafter, petitioner's mother assured petitioner that she intended to repay the debt. Petitioner's mother later remarried and, in December 1989, was faced with considerable nursing home bills for the care of her new husband. To date, petitioner has not been repaid.



On November 1, 1981, petitioner's brother Ronald Clanton (Ronald) executed a promissory note to Jersey Village Bank in the amount of $5,000 (the Jersey Village note), and petitioner signed as guarantor. Petitioner did not receive any cash or property in consideration of his guarantee. On March 2, 1982, petitioner was notified that the Jersey Village note was in default due to Ronald's failure to make payments. On the same day, petitioner brought the loan current by making a payment to the bank in the amount of $361.54. On March 4, 1982, after learning that his brother was in dire financial straits, petitioner paid the balance of $4,572.91. Petitioner and Ronald did not execute a written loan agreement or payment schedule. Ronald has been employed since 1986 by Freecom, Inc., in Big Spring, Texas. On his 1989 Federal income tax return, Ronald and his wife reported gross income in the amount of $45,526. At trial, Ronald testified: “I fully intend to be able to call my brother one of these days and see if I can make restitution with him.” Later, petitioner testified with respect to his brother's promise of repayment: “Well, I have a brother that is kind of like me and he keeps his word and I believe that someday he will keep his word if he ever gets back on his feet.” Petitioner has been self-employed as a certified public accountant in Houston, Texas, since 1978. On petitioners' 1989 Federal income tax return, petitioner claimed short-term capital losses for nonbusiness bad debts in the amounts of $4,250 for payment of the State National note and $5,000 for payment of the Jersey Village note. Due to the $3,000 limitation on short-term capital losses, petitioner carried over the remainder of the deduction to 1990. In her notice of deficiency, respondent disallowed the losses on the grounds that: (1) Petitioner's payment of the State National note did not create a bona fide debt; (2) petitioner's payment of the Jersey Village note in discharge of his guarantee is subject to the rules under section 1.166-9, Income Tax Regs., which petitioner fails to meet; and (3) petitioner has not proven that any debts at issue became worthless in 1989. Respondent's determination is presumed to be correct, and petitioner bears the burden of proving that the determination is erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111; 12 AFTR 1456 (1933). Section 166(a) provides that a deduction shall be allowed for any bad debt that becomes worthless within the taxable year. Business bad debts are deductible as ordinary losses to the extent of a taxpayer's adjusted basis in the debt. Sec. 166(b). Nonbusiness bad debts, defined as a debt other than (1) a debt created or acquired in connection with a taxpayer's trade or business, or (2) a debt whose loss was incurred in the taxpayer's trade or business, are treated as losses resulting from the sale or exchange of a short-term capital asset. Sec. 166(d). To claim a bad debt deduction for the payment of the State National note, petitioner must establish that (1) a bona fide debt existed between himself and his father, and (2) that the debt became worthless in 1989. A bona fide debt arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money. Sec. 1.166-1(c), Income Tax Regs. No deduction may be taken for money advanced without a reasonable expectation of repayment. Zimmerman v. United States, 318 F.2d 611, 613 (9th Cir. 1963). Intrafamily transactions are subject to close scrutiny. Caligiuri v. Commissioner, 549 F.2d 1155,


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1157 (8th Cir. 1977), affg. T.C. Memo. 1975-319; Perry v. Commissioner, 92 T.C. 470, 481 (1989), affd. without published opinion 912 F.2d 1466 (5th Cir. 1990). The presumption is that a transfer between family members is a gift. Perry v. Commissioner, supra at 481; Estate of Reynolds v. Commissioner, 55 T.C. 172, 201 (1970). This presumption may be rebutted by establishing that there existed a real expectation of repayment and an intent to enforce collection of the debt. To determine whether petitioner's payment of the State National note created a bona fide debt from his father to him, we consider the following nine factors: (1) Whether a note or other evidence of indebtedness exists; (2) whether interest is charged; (3) whether there is a fixed schedule for repayments; (4) whether any security or collateral is requested; (5) whether there is any written loan agreement; (6) whether a demand for repayment has been made; (7) whether the parties' records, if any, reflect the transaction as a loan; (8) whether any repayments have been made; and (9) whether the borrower [pg. 95-2518] was solvent at the time of the loan. Goldstein v. Commissioner, T.C. Memo. 1980- 273 (and cases cited therein). This determination depends upon all of the facts and circumstances, and no one fact is determinative. John Kelley Co. v. Commissioner, 326 U.S. 521 (1946). Petitioner argues that his payment of the State National note created a bona fide debt, which he reasonably expected his father to repay. He testified that when the loan was made by the bank, his father expected to return to work and to repay petitioner with the income earned. Petitioner testified that even after petitioner paid off the loan in full, his father planned to repay him at the bank interest rate. He concedes that no written evidence of a debt or loan agreement between himself and his father existed, but argues that it was customary in 1976, in Big Spring, Texas, to confirm a loan with nothing more than a handshake. He explained that if be had requested a written agreement or a schedule of repayment, it would have been a humiliating experience for them. While petitioner is to be commended for responding to the medical needs of his father, petitioner has failed to substantiate his claim to a bad debt deduction. See Trautwein v. Commissioner, T.C. Memo. 1975-262. Based on the record, we find that no bona fide debt was created between petitioner and his father. First, no written evidence of such a debt existed. As an accountant, petitioner could be expected to recognize the importance of having a promissory note or other document to evidence a loan. Second, petitioner's father made no repayments on the purported debt, and we are unable to determine whether interest would have been charged. Petitioner testified that his father repeatedly assured him that he would repay the money at the interest rate charged by the bank. However, we have no proof of this other than petitioner's self-serving testimony, and it is well established that we need not accept such testimony in the absence of corroborating evidence. Niedgrinhaus v. Commissioner, 99 T.C. 202, 212 (1992). Also, petitioner did not request, nor did he receive, security for the purported debt. He explained that his father's only resources were future earnings and his homestead, and, for this reason, no collateral was given. This is additional evidence of the unlikelihood that petitioner would ever be repaid. In light of the circumstances, we conclude that petitioner has failed to establish the existence of a



bona fide debt from his father to him. Respondent is sustained on this issue. With regard to the Jersey Village note, respondent concedes that petitioner's payment of the note, pursuant to his guarantee, created a bona fide debt between petitioner and his brother. Respondent argues, however, that section 1.166-9, Income Tax Regs., prevents petitioner from claiming a bad debt deduction with respect to the Jersey Village note. Petitioner contends that the regulation is invalid because its restrictions improperly limit the statute's treatment of nonbusiness bad debt deduction. Section 1.166-9(e)(1), Income Tax Regs., provides the following: Treatment as a worthless debt of a payment made by a taxpayer in discharge of part or all of the taxpayer's agreement to act as a guarantor, endorser, or indemnitor of an obligation is allowed only if the taxpayer demonstrates that reasonable consideration was received for entering into the agreement. ***language omitted*** Consideration received from a taxpayer's spouse or any individual listed in section 152(a) must be direct consideration in the form of cash or property. In other words, in order for a guarantor to be entitled to a worthless debt deduction where the underlying debtor is one of the individuals listed in section 152(a), the guarantor must receive direct consideration in the form of cash or property in exchange for entering into the guarantee agreement. The brother of a taxpayer is one of the individuals listed in section 152(a)(3). As we stated in Lair v. Commissioner, 95 T.C. 484, 491 (1990): This regulation was promulgated undoubtedly to reflect the views of the House Ways and Means Committee report relating to the bill which became the Tax Reform Act of 1976. H. Rept. 94-658 at 177 (1975), 1976-3 C.B. (Vol. 2) 701, 869. The regulation is obviously a limitation on all the other provisions of section 1.166-9 which might otherwise be applicable. The regulation was obviously intended to make unavailable a bad debt deduction (whether business or nonbusiness) where the guarantor was in substance gratuitously benefiting a member of a specified group, which consists of persons who could reasonably be considered as natural objects of the guarantor's bounty. See H. Rept. 94-658 at 177, supra. Cf. General Explanation of the Tax Reform Act of 1976, prepared by the Staff of the Joint Committee on Taxation at 157, 158 (1976), 1976-3 C.B. (Vol. 2) 145-146. *** Although the taxpayers in Lair did not challenge the validity of the regulation, we find the language quoted above aptly explains that the purpose of the regulation is to carry out the express intent of Congress at the time that section 166 was amended. Accordingly, we conclude that the regulation is valid and that petitioners must satisfy its requirements. Petitioner concedes that he received no cash or property in exchange for his guarantee agreement. He argues instead that he received consideration in the form of an improved business relationship with the bank. It appears that petitioner is arguing, at this point, that the guarantee payment created a business bad debt. The record does not support his argument. Petitioner's paramount motivation for guaranteeing the Jersey Village note was to assist his brother in his brother's time of financial need. An alleged improved relationship with the lender was, at most, a byproduct of the agreement. As such, we find that petitioner is not entitled to a bad debt deduction for his payment of the Jersey Village note on behalf of his brother.


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Even assuming, arguendo, that petitioner satisfied the requirements of section 1.166- 9, Income Tax Regs., he is entitled to a bad debt deduction only if he established that the debt became worthless in 1989. It is clear that partial worthlessness is insufficient. See Bodzy v. Commissioner, 321 F.2d 331 (5th Cir. 1963), revg. T.C. Memo. 1962-40. Generally, proof of worthlessness requires a showing of identifiable events demonstrating the lack of value of the debt and justifying abandonment of hope of recovery. ***Cites omitted*** Petitioner argues that the debt was worthless because Ronald repeatedly told him he was unable to pay, and whatever income his brother earned was consumed by taxes, support payments, and living expenses. We disagree. Ronald testified at trial that he intended to repay the debt as soon as he was financially able, and petitioner testified that he was confident his brother would repay the debt when his financial condition improved. Based on this testimony, and Ronald's gross income during the year at issue, we find that the debt did not become worthless in 1989. Inasmuch as we have decided that the payments in issue are not deductible as bad debts in 1989, we need not address whether petitioner may carry forward such a deduction to 1990. To reflect the foregoing, Decision will be entered for respondent.”



CHAPTER 5 - Using Reference Services and Other Secondary Sources KEY CONCEPTS (1-22) 1. Definitions

a Secondary sources are nonauthoritative interpretations that assist in understanding the law. Examples include: Reference Services, treatises and textbooks, journal articles and annual tax summaries.

b. References act as road-maps helping to identify relevant primary authority.

c. Annotations are entries in a tax service indicating a summary of a primary source

of tax law.

d. CCH stands for Commerce Clearing House, one of the large tax publishers.

e. RIA stands for Research Institute of America, one of the large tax publishers.

f. Bureau of National Affairs (BNA) publishes Tax Management Portfolios provide an in-depth analysis of tax topics.

g. Folio searching is an electronic search method that searches for the location of

each word separately. If two words are placed as the search terms, the system searches for a document with both words, regardless of their proximity to each other.

h. Boolean searching is an electronic search method based on word relationships

called “connectors.” If two words are placed as the search terms, the system considers those words as one term and will only identify documents where they reside side by side. The system allows the searcher to indicate the desired proximity of the two words to each other by using connectors. Common connectors are and and or.

i. Plain English searching enables the researcher to be less careful with the search

terms because the system automatically searches for words with similar meanings.

j. Lexis-Nexis is a large electronic database using primarily search functions as the research methodology. The database consists of the text of court cases, rulings, and selected law review articles. It also includes a business and complete law library.

k. Westlaw is a service similar to Lexis-Nexis (although with not quite as an

extensive tax reference), published by West Publishing Company.

l. Tax Analysts provide a relatively inexpensive tax library on CD-ROM and the Internet.


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m. Hypertext is a term describing a benefit when working online. Hypertext enables

the researcher to click the mouse on the word or phrase in hypertext and immediately link to the more detailed material. For example, if a case name is in hypertext, clicking on the case name may bring you directly to the full text of that case. Hypertext allows the researcher to move quickly through online libraries.

n. Treatises are texts that discuss a particular topic in detail.

o. The Master Tax Guide is a soft-bound book containing significant amounts of

information on tax matters. Both CCH and RIA publish this guide annually. 2. Two types of information that reference services provide include explanatory information

and cites to primary authority such as case law, Revenue Rulings and Revenue Procedures.

3. It unwise to base your research conclusion solely on what you read in a reference service

because the reference service is not primary authority but only secondary authority. It is not written by Congress, the Treasury or the courts and thus is not authoritative.

4. Reference services provide complete references to case law, Revenue Rulings and

Revenue Procedures. They provide selective (but not complete) references to other forms of treasury interpretations such as Letter Rulings.

5. You should not feel comfortable that the reference service will refer you to every relevant

Letter Ruling because these are only referred to selectively. To research Letter Rulings fully, you must separately research them using an electronic database.

6. In selecting the type of reference service that is best for a research project, the student

should consider factors such as familiarity with the Code Section being researched, complexity of the matter, personal preferences regarding reference services, and certainly, availability.

7. Each Code Section in the Code-oriented services includes the following:

*Text of Code Section *Excerpts of related legislative history *Text of Related Regulations *Explanations of Code Section *Table of topics for which there is an interpretive case or Revenue Ruling *Brief description of each interpretive case or Revenue Ruling followed by the complete

citation to that authority 8. The steps to take when using a Code-oriented service are:

* Identify the relevant volume * Locate the relevant text within that volume

Using Reference Services and Other Secondary Sources 99


* Determine what portion of the Code Section coverage to review * Study the pertinent section * Check current developments * Examine relevant primary authority

9. CCH’s Code-oriented service provides the items listed in #8 by issue within each Code

Section coverage. RIA does not group by issue, but lists all items in #8 together within the Code Section coverage.

10. It is important to skim through the entire table of annotations before reading the

annotations themselves because the most significant annotation may be towards the end of the list. If the researcher jumps from the first potentially relevant annotation to the full text of the cite, the researcher may forget to return to the list of annotations and thus may fail to discover the most significant reference.

11. The two central topically structured reference services available are RIA’s Federal Tax

Coordinator (available in print, CD-ROM and on the Internet) and CCH’s Federal Tax Service (available only electronically).

12. There are several methods the student can use to find the relevant volume of RIA’s:

* Using the index in the print service contained in the first volume, * Through the table of contents in the electronic service, or * Using electronic searching Federal Tax Coordinator.

13. To find the relevant BNA portfolios, a researcher can:

* Use the print service’s binder labeled “Tax Management Portfolio Index” which contains three indexes: key word, Code Section, and major topic. * Use the electronic database (on Lexis-Nexis) and search for key terms.

14. BNA portfolios offer an in-depth analysis of each portfolio topic, including history,

background of the topic, analysis of its application and potentially useful practical tools in the “working papers” section.

15. The inherent risk in electronic searching is that one might unknowingly eliminate

potentially important sources through misspelling or failing to search for the best terms. 16. The two types of search technologies are folio and Boolean searching. Folio searching is

the oldest, simplest and least sophisticated of the two searching forms. If you instruct the computer to search for one term, the computer searches through the designated database for every instance where that term appears. One limitation of this method is that it does not automatically search for the plural form of the word. To find a plural, you must either use a “wildcard” symbol which alerts the system that you wish to search for anything with the word as its root. Some of the folio services now have built-in systems augmenting the folio search to enable it to automatically search for plurals and other

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logical word endings. When searching for two or more terms using a folio search system, the system first identifies all the locations of the first term. Then it searches through the entire database again for the second term. Last, it compares the two lists and identifies the documents common to both. The search produces a list of documents containing both terms anywhere in the document, but not necessarily located side by side.

Boolean searching is based on word relationships called “connectors.” When searching for the terms “foreign income” (without the quotations), the computer will find only those documents with the two terms side by side. It will automatically also include any plurals. If you want to locate all documents with the two terms in the document without regard to their relative proximity, you can search for “foreign” and “income” (without the quotation marks). Boolean searching uses the following common connectors: and, or, within a designated number of words, (for example “w/10" means “within ten words of one another”). The computer follows the order of the connectors. In Boolean searching, you are able to search for phrases and individual terms concurrently.

17. Segment searching limits the search to a certain portion of a document, such as the case

title. The search is more efficient resulting in a better use of the researcher’s time. 18. Lexis-Nexis, Westlaw and Tax Analysts are reference services using electronic searching

as the main research tool. 19. Lexis-Nexis, CCH and RIA each contain at least one of the reference services as well as

all the primary tax authority. RIA also contains several tax treatises. All three also contain thorough state tax libraries. Each contain their own citator tool.

20. The tools available through electronic research include:

* Searching: All * Cut and paste: All * Hypertext: All * Keep list: CCH; RIA * Where am I: CCH; RIA * Research History: CCH; RIA

21. In addition to reference services, other secondary services available include:

* Treatises * Tax Summaries * Journals * Tax newsletters * Specialty services

22. To find tax articles relevant to your research, there are a few indexes available to help.

Two of the best are: Federal Tax Articles (by Commerce Clearing House) and Index to Federal Tax Articles (by Gersham Goldstein and published by Warren, Gorham and



Lamont). PRACTICAL APPLICATIONS (23-42) 23. Using the index, “S corporation” information can be found as follows (1999 editions.

Note that this may change with each new edition)

a. Volume 13, ¶32,011 of the Federal Tax Reporter, Commerce Clearing House

b. Volume 12, ¶13,609 of United States Tax Reporter, Research Institute of America

c. Vol. D, ¶1550 of Federal Tax Coordinator, Research Institute of America

24. On a partnership issue, the relevant volumes (1999) are:

a. Volume 9 of the Standard Federal Tax Reporter, Commerce Clearing House b. Volume 9 of the United States Tax Reporter, Research Institute of America c. Volume B of Federal Tax Coordinator, Research Institute of America 25. Regarding IRC Section 107, the annotations in the services are as follows. Note that this

will change frequently throughout the year, so these can only serve as a starting point. a. Standard Federal Tax Reporter, Commerce Clearing House : ¶6850.023 (.023,

07, .10, .16, .18, .17, .19, .21, .23, .25, .26, .27, .28, .31, .33, .34, .35, .37, .40, .50, .70, .95, .92)

b. United States Tax Reporter, Research Institute of America: ¶1075.01 Parsonage

exclusion in general – 7 (15, 20, 22, 25, 30, 35, 40); ¶1075.02 Minister of the gospel – 7 (10, 15, 20, 25, 30, 35, 50)

26. The relevant BNA Tax Management Portfolios include: a. Community property - Community Property by Huston, Price and Treacy. #802 in the Estate, Gift and Trust Portfolio series. b. IRC Section 179 - Depreciation by Maule. #531 of the Income Taxation series.

c. Irrevocable Intervivos trusts - Revocable and Irrevocable Trusts by Frank Berall. #468.

d. IRC Section 280A - Home Office and Vacation Homes by Lewicki. #547.

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27. This is a good opportunity for the students to use one of the federal tax articles digests. 28 Facts:

Taxpayer owns building A which he uses in his business. He would like to dispose of this building and move to another location to conduct business. He has identified building B as an ideal new location. He already has a buyer for building A. In fact, taxpayer and the interested buyer, Mr. X, have already signed a sales contract. No conditions of escrow have yet been satisfied. No money has changed hands. Escrow is to close in 60 days.

Someone suggested to the taxpayer that he exchange his property for the one he wants instead of selling his existing property and buying the newly located property.

Issue: Can the potential gain be excluded under IRC §1031 even though taxpayer already signed a contract to sell?

Conclusion: The transaction will be viewed as an exchange and not a sale. Therefore, the gain will be excluded under IRC §1031.

Reasoning: Students may find a number of cases to support this conclusion. The key case is Leslie Coupe v. Commission, 52 TC 394 (1969) which has very similar facts and stated: “It is now well settled that when a taxpayer who is holding property for productive use in a trade or business enters into an agreement to sell the property for cash, but before there is substantial implementation of the transaction, arranges to exchange the property for other property of like kind, he receives the nonrecognition benefits of section 1031.”

Students do not need to locate the Coupe case in order to come to this conclusion. However it is the case most on point and clearest in its ruling. Other cases students may find helpful include: Coastal Terminals, Inc. v. United States, 320 F.2d 333 (CA 4, 1963); James Alderson, 38 TC 215 (1962).

29. Facts:

Taxpayer is studying for her first CPA exam by taking a preparatory seminar. The seminar costs almost $1000. Taxpayer currently works in the tax department of an accounting firm that expects her to take and pass the exam. The firm, however, does not reimburse taxpayer for the costs.

Issue: Can taxpayer take a deduction for expenses incurred in taking a CPA preparation exam? IRC §162 provides for a deduction for ordinary and necessary expenses incurred in carrying on a trade or business. Treas. Regs. §1.162-5 provide that an educational expense will qualify as a deductible expense under this Code Section is the expense satisfies a series of tests: the education is for the purpose of improving the taxpayer’s



current job skills or, in the alternative, the education is required by the employer. Assuming the taxpayer can meet one of these requirements, the educational expense cannot qualify the taxpayer for a new trade or business or meet the minimum state licensing or qualification requirements. Do these expenses fulfill these regulation requirements so that the expenses will be deductible under IRC §162?

Conclusion and Reasoning: No, the expenses are not deductible under IRC §162.

Reasoning: The authority suggests that a review course such as the one taxpayer took fails both the requirement that the education not quality the taxpayer for a new trade or business and the requirement that the education not be to meet the minimum standards required by the state. Rev. Rul 69-292, 1969-1 CB 84, states that there is a significant difference between the types of tasks and activities which licensed or certified individuals and nonlicensed or noncertified individual are qualified to performs with the same profession. A review course for licensing exam leads to a new trade or business, and therefore, the costs are nondeductible. The Tax Court, in Browne, Alice, 73 TC 723 (1980), continued this position, holding that an unlicensed accountant-employee could not deduct the cost of courses that were prerequisites to taking the CPA exam. Other authority students may locate include: Rev Rul 72-450, 1972-2 CB 89; Glenn, William, Accountancy, 62 TC 270; 40 Cooper, Howard, 38 TCM 955 (1979).

30. Facts:

Corporation X suffered $10,000 in flood damage to its office building. Although the damage is covered by the company’s insurance policy, the company decides not to file an insurance claim for the loss because it fears that by making an insurance claim, the insurance company may cancel the policy at its next renewal date, thereby precluding coverage for potentially larger future losses.

Issue: Can company take a deduction for the $10,000 on its tax return if it did not file an insurance claim for insurance that would have covered the loss?

Conclusion and Reasoning: This is an example of a research question where there is no completely definitive answer. Most students will conclude that the company can take the deduction based on the argument that the prohibitive provision in the Code requiring the filing of a claim only applies to individuals. This is bolstered by the reasoning of the following cases: Henry Hill vs. Commissioner, 691 F2d 997; 82-2 USTC ¶9669; 50 AFTR2d 82-6070; Miller vs. Commissioner, 733 F2d 400; 84-1 USTC ¶9451; 53 AFTR2d 84-1252. Several other cases allow the deduction for individuals suffering the loss. Subsequent to these cases, IRC §165 was amended to require the filing of a claim by individuals. This should produce a good discussion about the impact this Code change has on the authority of the

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case law. There have been no cases decided on this issue dealing with a corporate loss under the amended provisions.

31. Facts:

Taxpayer studies tax law at a university on a part-time basis. He is diligently working towards a Masters degree in taxation. He is employed on a full-time basis in the auditing department of a large accounting firm and anticipates that the classes will help him with his auditing work. He believes the classes will also provide an opportunity for him to work in the tax department of the firm. Unfortunately, his employer, although supportive of his attending classes, is not willing to reimburse the taxpayer for any of the $10,000 tuition costs.

Issue:

Can the taxpayer take a deduction for his educational expenses. Treas. Regs. §1.162-5(a) allows the deduction of education expenses if the education maintains or improves skills required by the individual in his employer, or meets the requirement of his employer. They preclude a deduction if the expenses will qualify the taxpayer for a new trade or business. Do these expenses satisfy these requirements?

Conclusion and Reasoning: This is another research question with no clear-cut, absolutely correct answer. Most students will come to the conclusion that the expenses are deductible under IRC §162 using basic reasoning in applying the regulation requirements. There is no contra authority suggesting that “tax” is a different “trade or business” than auditing. The regulations state that a change of duties does not constitute a new trade or business if the new duties involve the same type of work in his present employment. If the students feel comfortable arguing that auditing and tax are in the same type of work, then they will support the deduction. It may also be useful here to point out the potential interpretation that can be drawn by the absence of case law disallowing such a deduction. The absence may suggest that the service has not challenged this deduction.

b. If the facts are changed so that the taxpayer decides to take a leave of absence

from his job in order to attend classes full-time and anticipates that he will be on a leave for 18 months, a new issue arises: are the expenses incurred while taxpayer is engaged in a trade or business so that the expenses will qualify under IRC §162? Case law has supported a deduction while the taxpayer is on a leave of absence as long as the leave is “temporary.” Mary Furner v. Commissioner, 68-1 USTC ¶9234 (CA 7). In Furner, the court held that a teacher who left her position to pursue a full-time graduate program in history was allowed to deduct the education costs even though she was not on a leave of absence but had left her teaching in order to return to school. The taxpayer also did not return to her prior position, but rather took a new position. The court held that the year of graduate study under the circumstances was a “normal incidence of carrying on the business of teaching.” The IRS acquiesced to the decision in this case and issued



Rev. Rul 68-591, 1968-2 CB 73 which states that a taxpayer can deduct educational expenses if the taxpayer temporarily ceases to engage actively in an occupation in order to purse a full-time graduate course to maintain or improve skills required in the occupation. Where taxpayer temporarily stops working, the IRS will treat the taxpayer as still engaged in a trade or business. The IRS provides a safe harbor time period when a suspension of work will be considered temporary. This safe harbor period is a year or less. A longer period may also be temporary depending on the facts and circumstances. Students may also have found contra authority: Rev. Rul 60-97, 1960-1 CB 69 stating that there is no deduction for expenses of education of a taxpayer who is not currently employed or otherwise engaged in a specific occupation. Also Cannon, John, (1980) TC Memo 1980-224, 40 TCM 541 which held that being a student is not a trade or business.

c. The deduction becomes quite problematic if the facts are changed so that the

taxpayer attends law school on a part-time basis while working at the accounting firm. Although the taxpayer and the firm believe that the law training will be useful to him in his work at the firm, courts have routinely held that law education qualifies a person for a new trade or business and is therefore nondeductible. See for example, Morton Taubman, 60 TC 814; Danielson v. Quinn, 482 F.Supp 275.

32. Facts:

Taxpayer is an airline attendant for Safe Air. As part of her job, the company requires her to wear a “uniform” consisting of a specific type of bright yellow shorts and top which she must purchase from a particular department store. Neither the shorts nor the shirt display any company logo on them. She is also required to wear a specific brand of high platform shoes. In order to be sufficiently prepared for travel, taxpayer purchases three sets of the outfit and two pairs of the shoes. Although not required, taxpayer also purchases a bright yellow handbag to match the outfit. The clothes are suitable for dry cleaning only. Taxpayer only wears these clothes when working. She personally believes the outfit is quite unattractive and does not at all conform with her taste in clothing or modern standards of equal respect for gender. For the current year, taxpayer spent the following on her work clothes:

Purchase of shorts and tops $350 Shoes $150 Drycleaning $100

Issue:

IRC §162(a) allows the deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Is the cost of uniform and shoes required by employer deductible as business expenses?

Conclusion and Reasoning: This question will also generate some controversy, although most students will probably

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reach some agreement. Students should have located Rev. Rul. 70-474, 1970-2 CB 34, which addresses the cost of the acquisition and maintenance of a uniform. The ruling holds that the costs are deductible as ordinary and necessary business expenses under §162 if the uniforms are specifically required as a condition of employment, and the uniforms are not of a type adaptable to general or continued usage to the extent they take the place of regular clothing. However, the deduction is not allowable if the uniform is suitable for ordinary wear. This last requirement is the one most challenging for the taxpayer, because some will argue that the uniform is suitable for ordinary wear. Whether the dry cleaning costs will be deductible depends upon the student’s conclusion regarding the deductibility of the uniform.

A case students should find to help them in their reasoning is Stiner, Carol v. U.S., 36 AFTR 2d 75-6217, 524 F2d 640, 75-2 USTC ¶9762 (CA10, 1975). That case held that the cost of shoes, boots, gloves, handbag and cosmetics are disallowed as a business expense because these items were not unusual or unique and were adaptable to general usage as ordinary clothing.

Students may also find the case of Douglas v. Commissioner, 38 TCM 901 (1979) and Cf. Yoemans v. Commissioner, 30 TC 757 (1958). Both of these cases addressed whether to apply a subjective or objective standard when determining the adaptability of the clothes to everyday usage. Both courts applied a subjective test.

33. Facts:

Taxpayer plays professional football in New York from July to January. During that time period, he lives in his home in New York. After football season, he lives in a Florida apartment for which he pays monthly rent. In Florida, taxpayer works full time as a physical therapist specializing in geriatric care. He has banking accounts in both locations, is registered to vote in New York, and has a New York driver's license. Taxpayer is single. He earns $2,000,000 a year from his football job and around $30,000 annually in his physical therapy position.

Issue: IRC §162(a)(2) provides for a deduction for expenses incurred in traveling away from home incurred in carrying on trade or business. However, IRC §262(a) disallows a deduction for personal, living and family expenses. Can taxpayer deduct his duplicate living expenses while away from home in pursuit of a trade or business for the purpose of §162(a)(2)?

Conclusion and Reasoning: The case of Andrews v. Commissioner, 91-1 USTC ¶50,211 is pertinent in attempting to address this question. The facts in that case are similar to those in the research question in that the taxpayer had two business and traveled between two homes to conduct the businesses. The Service argued that the taxpayer had two tax homes, so that none of the travel could be considered travel “away from home.” However the court held that an



individual only has one tax home. The challenge is to identify the central tax home so that the travel away from home can be identified. This includes meals and lodging as provided in IRC §162(a)(2). Living expenses duplicated as a result of business necessity are deductible, whereas those duplicated as a result of a personal choice are not deductible.

The court in Andrews held that the tax home is located where the taxpayer has his principal place of business. Factors such as time spent and the comparative amount of earnings at each location probably should be considered in determining which home is the primary home and thus the “tax home.” The duplicate expenses incurred at the “minor post of duty” are deductible as business necessities. Thus, students will probably conclude that the expenses of travel to one of the homes, as well as living expenses at the non tax-home are deductible.

34. Facts:

Sue paid her attorney $20,000 for his successful work in increasing the alimony payments she is entitled to receive from her ex-husband. Her ex-husband paid almost $15,000 in attorneys fees in an effort to keep the alimony payments at their previous level.

Issue:

What legal expenses, if any, are deductible by Sue? What legal expenses, if any, are deductible by her ex-husband?


Sue will most likely be entitled to a deduction for her $20,000 attorneys fees as a deduction under IRC §212. The key case supporting this conclusion is Marion R. Hesse v. Commissioner, Stanley H. Hesse v. Commissioner, 60 TC 685 which held that legal expenses incurred by the wife in obtaining alimony payments are deductible under Section. 212(1) since the payments received by the taxpayer were includable in her gross income under Section 71(a). Another case, Ruth Wild, 42 TC 706 takes the same position stating that any part of an attorney's fee and the part of the other costs paid in connection with a divorce, legal separation, written separation agreement, or a decree for support, which are properly attributable to the production or collection of amounts includible in gross income under section 71 are deductible by the wife under section 212. The court stated that in the facts before it, the deduction was claimed under IRC §212(1), which expressly provides for the deduction of expenses paid or incurred for the production or collection of income. Therefore, Sue is entitled to the deduction.

However, her ex-husband is not as fortunate. In Gilmore, 372 US 39, 11 AFTR 2d 758 63-1 USTC ¶9285, the Supreme Court disallowed a deduction for such expenses. The court in Gilmore held that expenses of husbands in connection with resisting money demands of their wives in divorce actions could not be deducted under section 212(2) as expenses paid for the management, conservation, or maintenance of property held for the production of income. This case has been followed by all subsequent court cases.

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35. Facts:

Fred is a professional musician. He performs with his electric guitar at various music halls. He has set up a special room in his house which is sound-proof and contains a variety of expensive recording and mixing equipment. He uses the room to practice. He does not use the room for anything else. His business records show he paid utilities and maintenance with respect to the room. He believes he should be entitled to deduct his costs, including an appropriate allowance for the depreciation of the room. What is Fred allowed to deduct and what limitations conceivably apply?

Issue: IRC §280A(c)(1)(A) permits the deduction of expenses “allocable to a portion of the dwelling unit which is exclusively used on a regular basis” as the “principal place of business for any trade or business of the taxpayer.” The flush language of the provision states that the term “principal place of business” includes a place which is used by the taxpayer for the “administrative or management activities” of the trade or business of the taxpayer “if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities.” IRC §280A(c)(5) contains the further limitation that any deductions must be limited to the excess of gross income derived from such use for the taxable year over those deductions allocable to such use, such as mortgage interest, which are permitted by the tax laws without reference to the business use concerned. The issue here is whether the home is the “principal place of business” of the taxpayer. Conclusion and Reasoning: This is a harder question to answer than first appears. From studying the Code, the student may conclude that the home is the principal place of business. However, case law reflects that this determination is quite controversial and is subject to a variety of tests. The case of Soliman v. Commissioner, 113 S.Ct. 701 (1993) established a test for determining whether a place constitutes someone’s principal place of business. Soliman involved a taxpayer who was an anesthesiologist who worked in a hospital and performed administrative work at an office in the home. The court held that the office did not qualify as the doctor’s principal place of business when applying the court’s tests. As a result, IRC §280A was amended to include the language regarding a place where administrative activities are performed. However, this language does not seem to apply in the current taxpayer’s situation, since the work done in the home is not of an administrative or management nature. This would seem to mean that the test under Soliman is applicable in the current situation. Soliman stated that both the relative importance of the activities performed at each location and the amount of time spent at each are the key factors in determining which location is the “principal” location. Even applying this test will not result in a concrete answer. Applying these factors to Sam, it is not at all clear how the court would rule. Both activities are mutually dependent - practice and performance. Students will most likely come down on both sides of the issue - some concluding that the home is his principal place of business and others



concluding differently.

Students may also locate a pre-Soliman case, Drucker v. Commissioner, 83-2 USTC ¶9550 which allows “principal place of business” treatment to a musician’s practice room in the home. In this case, the facts are slightly different because the taxpayers are employed by a symphony, whereas we have no such situation here. However, the reasoning, when applied to the taxpayer at issue, would result in the treatment of the office as a principal place of business.

The most important case for students to locate is Popov v. Commissioner, 2001-1 USTC ¶50,353 (CA 9, 2001). This case allowed a home office deduction to a professional violinist who both worked for the symphony and performed separate contract work. The taxpayer sed a portion of her home to practice the violin and make recordings. She spent 4-5 hours a day practicing in the room.. The court applied the two Soliman considerations (relative importance and time spent). The court could find no definitive answer when applying the relative importance test. However, because the taxpayer spent significantly more time practicing at home than performing, the court held that the test regarding relative time spent tipped the balance in favor of the taxpayer deduction.

36. Facts:

Taxpayer is currently enrolled as a full-time student in a graduate LL.M program in taxation. He graduated from law school in June, studied full-time for the Bar during the summer, and then immediately began the LL.M. classes in September. Taxpayer will pay $15,000 in tuition costs for the program during the current year. Taxpayer’s spouse will earn $50,000 in salary income this year. Will Taxpayer be able to deduct any of the LL.M. tuition costs?

Issue:

Code Section 162 provides for a deduction of expenses incurred in carrying on a trade or business. Treas. Regs. §1.162-5 states that educational expenses will be deductible business expenses if they were incurred to maintain or improve the taxpayer’s work skills. The issue here is whether the expenses satisfy this threshold requirement when the taxpayer has not yet begun working at the time the expenses are incurred.


From studying the regulations, students may tentatively conclude that the expenses are not deductible. However, because the regulations do not directly speak to the question, it is best for the students to go to the reference services to determine if an interpretation exists providing a more conclusive analysis. The courts have held that to get the deduction, a taxpayer must be established in a trade or business. (David M. Kohen, TC Memo 1982-625) Some cases that address facts very similar to taxpayers include: Richard M. Randick, TC Memo 1976-45 (deduction denied recent graduate of law school for costs of full-time graduate program in tax law. He wasn't in business of practicing law); Johnson v U.S., 332 F Supp 906, 27 AFTR2d 71-1239, 71-1 USTC ¶9347 (1971,

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DC LA) (lawyer denied deduction for costs of LL.M. in Taxation. Course taken to meet requirements of new specialty, practice of tax law); Patrick L. Johnston TC Memo 1978-257 (Legal profession. Deduction denied student-law clerk for law school expenses; studies not undertaken to retain salary and job); Albert C. Ruehmann III, TC Memo 1971-157 (deduction denied attorney for cost of last two quarters of law school. Completion of law school was required for law firm position). These cases provide support that under the taxpayer’s facts, no educational expense is allowed.

37. Facts:

University allows any student to work for the University no more than nineteen hours a week.

Issue:

IRC §3101(a) and (b) provides that the FICA taxes are imposed on an individual with respect to his employment. Is the student who works part-time for the university subject to FICA taxes?

Discussion and Reasoning: The University does not have an obligation to withhold the FICA taxes on the wages of the students under IRC §3111, if the students work for the University during the time they are enrolled. IRC §3101(a) and (b) provides that the Old Age, Survivors and Disability Insurance tax and the Medical Insurance tax is imposed on all wages. IRC §3121(a) defines “wages” as all remuneration for “employment.” However, IRC §3121(b)(10)(A) excepts from "employment" service performed in the employ of a school, college, or university if such service is performed by a student who is enrolled and is regularly attending classes at such school, college, or university. However, students who work while not enrolled will be subject to such taxes. According to Rev. Rul. 66-285, 1966-2 CB 455, students working for a college during the summer and who weren't enrolled during this period are employees.

38. Facts:

Mary is a professional tennis player, currently ranked #10 in the world. She has an endorsement contract with “Boring,” the leader in tennis shoe and equipment retail sales whose slogan is “Why do anything if you don’t have to?” Under the terms of the contract, Mary is required to wear Boring shoes and tennis attire and also use a Boring racket at all tournament play. As compensation, Boring provides Mary with all the shoes, attire and rackets she needs, free of charge.

Issue:

Per IRC §61, gross income means all income from whatever source derived. Is Mary required to include the retail value of the merchandise received from a retail company as compensation in exchange for her services?



Conclusion and Reasoning: Treas. Regs. §1.61-2(d)(1) provides that when a taxpayer receives goods or services in exchange for his services, the fair market value of the goods or services received is gross income. Where the services were rendered at a stipulated price, the stipulated price is presumed to be the fair market value of the compensation received in the absence of evidence to the contrary. The fair market value of the goods and services received in a barter transaction is the price normally charged by the transferring party. In the case of Rooney, David, 88 TC 523 (1987), a CPA firm that accepted goods and services from clients in exchange for accounting services had to include the goods and services in income at the normal retail price. Another interpretation students may find is Rev. Rul. 79-24, 1979-1 CB 60 which held that in barter exchanges, both parties to the exchange may realize gross income. Based on the bartering rules, Mary is required to include the retail value of the merchandise received as compensation in exchange for her services.

39. Facts:

Herbert Rain, a popular professional British golfer, has become known for the knickers he wears in each golf tournament. This attire has become his trademark, however he has no trademark protection under any applicable law. Nor is there any requirement under golfing rules that he wear anything other than “appropriate attire suitable to the profession.”

Issues:

IRC §162 allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Is the cost and maintenance expenses of the golfer’s attire deductible?

Conclusion and Reasoning: Students will likely vary in their conclusions, some holding that the costs are deductible and others holding they are not deductible. Rev. Rul 70-474, 1970-2 CB 34 held that the cost of acquisition and maintenance of uniforms is deductible if the uniform is specifically required by employment and not suitable for general and personal use. In the case of Mella, Cecil, 52 TCM 1216 (1986), the cost of tennis clothes and shoes worn by a tennis player at his employment as the head tennis pro at two private tennis clubs was disallowed because the clothes were also suitable for general and personal wear. Students may also locate a more recent case [Barnes, Thomas,64 TCM 1552 (1992), affd on other issues 21 F3d 1111 (CA9, 1994)], which also held that the cost of maintaining clothing suitable for everyday wear are nondeductible. The key fact that students may use to argue the expenses are deductible is the nature of the clothing - knickers. Are knickers suitable for everyday wear? If students conclude they are, they must then conclude the expenses are not deductible. If students conclude kickers are not suitable for everyday wear, they may conclude the expenses are deductible.

40. Facts:

Mr. Future is the President of an established and successful company. The company pays

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Mr. Future $1,000,000 in salary each year. Mr. Future, a renowned philanthropist, has directed the Board of Directors to pay him nothing for the year and instead use the $1,000,000 to which he is otherwise entitled to create a scholarship fund. The fund, which he would help oversee, would be used to create scholarships to worthy high school students otherwise unable to afford college.

Issue: IRC §61 specifically includes into gross income for tax purposes compensation income. By redirecting his salary towards a scholarship fund, can Mr. Future avoid recognizing the $1 million as compensation income?

Conclusion and Reasoning: Applying the case law found and the “assignment of income” doctrine, Mr. Future may be required to recognize into income the $1 million. And, unless the foundation is a qualified charity for purposes of IRC §170, he will not be entitled to a charitable deduction for the amount. Even if the foundation is a qualified charity, Mr. Future will be subject to the contribution limitations found in IRC §170, although the exact that will be deductible depends on other income he may have. The case of Lucas v. Earl, 2 USTC ¶496 holds that the person who earns a salary must recognize it as income, and cannot assign the income to another (for tax purposes). Students may find one case, however, Giannini v. Commissioner, 129 F.2d 638 (1942) that did allow the taxpayer to not recognize salary income to which he was entitled but which he redirected.

41. Facts:

Kay is a member of a gang and has just been convicted of state drug possession charges, resisting arrest and assault and battery. Kay’s brother is a long time client of yours and asks you to prepare Kay’s federal income tax return. The district attorney submitted evidence to the court as to the amount of revenue Kay earned the current taxable year in her various criminal activities. Kay believes that she should be able to take a business deduction for her expenses related to engaging in her criminal enterprise, including her illicit drug laboratory costs and attorney defense fees.

Issues:

IRC §61(a) states that gross income includes all income from whatever sources. Is income from a criminal enterprise includable in gross income? If so, can she treat the expenses related to the enterprise as deductible trade or business expenses under IRC §162?

Conclusion and Reasoning: Kay must include the income she received from her criminal activities. Support for this conclusion can be found in the case of Wood, Glen et al v. U.S., (1988, DC LA) 62 AFTR 2d 88-5791, 693 F Supp 452, 88-2 USTC ¶9399, affd (1989, CA5) 63 AFTR 2d 89-709, 863 F2d 417, 89-1 USTC ¶9143, which held that taxpayer was required by the court to include the proceeds from marijuana sales, even though the taxpayer forfeited all



the proceeds to the government, because the taxpayer had complete control over the proceeds before the confiscation by the government. In addition, such income will be subject to self employment tax according to Hesse, Gerald, 58 TCM 199 (1989) which held that the illegal activity of buying and selling controlled substances is treated as a trade or business for self-employment tax purposes.

Kay will not be able to deduct her related expenses. IRC §280E disallows the deduction and credit for any amount paid or incurred during the taxable year in carrying on any trade or business which consists of trafficking in controlled substances. However, according to S Rept No. 97-494, Vol. I (PL 97-248) p. I-309, gross receipts from trafficking in illegal drugs are reduced by the cost of goods sold. Congress felt that to provide otherwise might raise Constitutional issues. Therefore, Kay may reduce her criminal activity income by the cost of the drugs. But the expenses of drug laboratory costs and attorney defense fees are disallowed as IRC §162 business expenses under IRC §280E. Students may locate a recent case, John DiFronzo, TC Memo 1998-41 which holds that a convicted member of an organized crime family may deduct the legal fees incurred in his defense involving conspiracy and fraud charges. The court in that case held that business expenses must be allowed even if the trade or business is illegal. However, the students should recognize that the DiFranzo case does not involve illegal drugs, and thus does not trigger application of IRC §280E.

42. Facts:

Jane has a very painful terminal disease and has learned that marijuana may assist in lessening the pain. Jane lives in a state in which it is legal to obtain and use the drug if under the direction of a medical doctor.

Issue:

Is the cost of marijuana a deductible medical expense under IRC §213? Conclusion and Reasoning: Jane cannot take a deduction for the amounts paid to acquire the marijuana. IRC §213(a) allows a deduction for expenses paid during the tax year for medical care of a taxpayer if they are not compensated by insurance. The deduction is allowed only to the extent that such expenses exceed 7.5 percent of adjusted gross income. Such expenses include “prescribed drugs.” IRC §213(a)(3) defines that the term “prescribed drug” as a drug which requires a prescription of a physician for its use by an individual. The regulations state that the deduction applies only to medicines and drugs which are legally procured. Treas. Regs. §1.213-1(e)(2). Rev. Rul. 97-9, 1997-9 CB 77 held that an amount paid to get a controlled substance (such as marijuana) for medical purposes, in violation of the federal Controlled Substances Act (CSA) (21 USC 801-971) is not legally procured and therefore not a deductible medical expense. This is true even if state law permits the drug’s use when prescribed by a physician and the taxpayer gets a prescription.


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CHAPTER 6 - CULMINATION OF THE TAX RESEARCH PROCESS KEY CONCEPTS (1-13) 1. Definitions

a. In Treasury Circular 230, the Treasury Department provides rules for those “who practice before the Internal Revenue Service.”

b. In Circular 230, “Practice Before the IRS” is defined very broadly to include

most aspects of tax practice.

c. Tax research standards assist the tax researcher in determining approriate approaches and behavior. Standards are contained in Treasury Circular 230, in the AICPA’s Statements on Responsibilities in Tax Practice and the Internal Revenue Code.

d. Under both Circular 230 (§10.34) and Reg. §1.6694-2(b) the “realistic

possibility” standard states that the practitioner may not sign a return nor advise a taxpayer to take a position on a return if the position does not have a “realistic possibility of being sustained on its merits.” A position has a “realistic possibility” if a person knowledgeable in tax law would conclude that the position has “approximately a one in three, or greater, likelihood of being sustained on its merits.”

e. Circular 230 and the AICPA’s Statements on Responsibilities in Tax Practice

require the tax practitioner to make “reasonable inquires” if taxpayer information appears to be incorrect, inconsistent, or incomplete.

f. Circular 230 requires the tax practitioner to exercise “due diligence” in

determining the correctness of the results communicated to the taxpayer. 2. The impact of failing to abide by the standards provided in Circular 230 is that the

practitioner may lose the ability to “practice before the IRS.” 3. The impact of failing to abide by the standards provided by the AICPA is that the CPA

may lose membership privileges. 4. The Treasury Regulations provide that the practitioner must believe that there is

“substantial authority” supporting the position sought to be taken. 5. See chart in chapter summary. 6. a. Circular 230 applies to anyone practicing before the IRS.

b. AICPA's Statements on Responsibilities in Tax Practice applies to CPAs.


Culmination of the Tax Research Process 115


7. It is important to know when the research is complete so that time is not wasted. 8. Pondering requires the researcher to critically analyze the authority located and apply it

to the research facts and issue. 9. In situations where the researcher has completed all the research steps but still does not

feel comfortable with the conclusion, the researcher may want to quickly review another reference service to ensure nothing was missed and may also wish to research the Letter Rulings.

10. When there is a Revenue Ruling that clearly states the taxpayer cannot do what he wants

to do, but there is a case with no jurisdiction over the taxpayer, the taxpayer has some options. If the taxpayer does not want to risk an audit, he will need to abide by the Revenue Ruling. However, because there is authority in the courts for the position he desires, he can also take that position. He should understand that there is considerable risk in doing so. If he should be audited, the IRS will likely not settle. If taxpayer wants to pursue the position, he will then be forced to litigate. Litigation is usually time consuming and can be fairly expensive. Although there is helpful case law, it is unclear what the courts in the taxpayer’s jurisdiction will hold since the court is not required to follow another circuit’s opinion. Therefore, after all the time and money, taxpayer may still lose.

11. The sources of research guidelines for the tax researcher include the IRC, the Treasury

Regulations, Treasury Circular 230 and regulations promulgated by the AICPA and ABA.

12. The researcher is required to refrain from recommending a certain tax position to a

taxpayer when there is no realistic possibility of the position being sustained on the merits.

13. Primary authority is the only type of authority a researcher may use to support a research

position. The Treasury Regulations make it clear that secondary authority cannot be used as the basis for a research conclusion.

PRACTICAL APPLICATIONS (14 -39) 14. Even though Mrs. K would like the researcher to forget she told you about the $10,000

she found in the park, the researcher is obligated under the ethical guidelines discussed in the chapter not to sign a return that omits such information.

15. The researcher should inform the client of the controversy. There is sufficient authority

to exclude the income in this situation. However, the client should know that excluding the income is not without risk since the Service may choose to audit the return and

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disallow the exclusion. The taxpayer may then have to determine whether the time and money necessary to litigate the issue is worth it. If the client chooses to litigate, it is probable that the court may rule in his favor, although there is always the risk that they will overrule their previous decision.

16. Given there is no authority other than an old Letter Ruling, whatever position is taken

involves a good deal of risk. With that said, if the taxpayer is willing to take the risk, there is no reason why the return should not report the income in the best light for the client.

17. It is very dangerous to rely simply on summaries of court cases provided in a reference

service. The actual cases must be read and analyzed. The summaries are not authoritative and are merely secondary authority. Given the importance of the research project and the amount involved, it would be well worth the researcher’s time to locate a library with the necessary resources.

18. The researcher should consider performing the following additional steps: Analyze the

Code and Regulations; review the reference service to ensure there are not other cases or Revenue Rulings perhaps more helpful; citate the cases that appear relevant as another way to find cases perhaps on point. If these steps still prove unhelpful, the researcher may want to research the Letter Rulings. If still empty-handed, the researcher will want to review other secondary sources to make sure nothing was missed in the initial research process and perhaps review relevant legislative history.

19. Possible additional steps that may be advisable include: Review of the Treasury

Regulations and review of a reference services, followed by an examination of the case law and Revenue Rulings discovered from this step. Any case law or Revenue Ruling on-point should be citated.

20. It would be advisable to examine the Code and Regulations because it may be that they

have changed subsequent to the issuance of the Revenue Ruling. If the Revenue Ruling appears to be interpreting the current Code language, then the researcher should citate it to ensure the Service has not changed its position. The researcher should also return to the reference service to determine whether case law also speaks to the issue.

21. The researcher must citate the cases before relying upon them. 22. The researcher will want to study other secondary sources - perhaps an annotated

reference service. It is possible that the relevant material was just not as easy to locate in the service used. By checking another service, the researcher can ascertain whether there is relevant authority previously missed or whether there simply is no authority. If no authority is found after review of at least one other reference service, other secondary sources may be helpful (articles, treatises). Researching the Letter Rulings and legislative history may also be necessary.



23. From research, it should be clear to the student that the value of the computer received is

income to Sam. The company that gave Sam the “gift” did so without the donative intent required by the case law. (See Duberstein v. Commissioner, 363 U.S. 278 (1960), 5 AFTR2d 1626, 60-2 USTC ¶9515.) The fact that the donor should have but failed to issue the requisite reporting forms does not excuse Sam from reporting the value of the computer as income. The researcher would not be able to sign Sam’s return if the value of the computer is not reported as income on the return. If the researcher is not preparing Sam’s return, the researcher is under no obligation to investigate whether Sam did indeed report the income. Nor is the researcher obligated to inform the IRS regarding this transaction.

24. The researcher can inform the client that there is authority for taking either position. He

should also be informed that the taxpayer is subject to risk of audit and litigation costs if the taxpayer takes the position contrary to the IRS’s. Because the taxpayer is not in the jurisdiction of the Montana court, the case does not offer “protection” to the taxpayer, although it provides authority for which a tax return position can be taken.

25. Clearly, based on the facts, Janet likely does not currently possess the competence to

engage in the corporate tax work contemplated. Further, as a solo practitioner, Janet would have a duty to her existing clients and, even if she were willing to undertake the significant learning process attendant to doing the corporate tax work, she would likely be compromising the work on existing client accounts. It would therefore be inappropriate for Janet to tackle such a significant job without a clearer showing of competency as to the matters contemplated.

26. Does the client have the right to rely upon the Patterson opinion? Under the facts, the

client does appear to be entitled to rely on the opinion letter, even though delays occurred in the real estate deal, some of which were not known to Patterson. By turning over the unsigned letter and giving the client carte blanche to sign it Patterson gave an open-ended comfort letter to the client. Although the Patterson firm=s work was likely correct at the time it was done, clearly, in light of the issuance subsequent Treasury regulations which apparently applied, the firm set itself up for malpractice liability. What should Patterson have done in lieu of the approach taken? It could have done a number of things. First, it could have held back its opinion letter until immediately prior to the closing, at which point it could have made sure of the status of applicable authority. Or, it could have issued a preliminary opinion based upon law in effect in May, subject to a bringdown certificate or opinion at the time the closing occurred. In this way the firm could issue initial comfort to the parties but remain assured that it would have a second look at the critical time of closing.

Please note: Questions 27 through 39 explore various fact patterns which are consistent

with Illustrations provided in the AICPA SSTSs and Interpretations as regards

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members. Students are asked to consider only these standards and the assignment requires that students access the AICPA website to review the standards. It should be noted that additional or overlapping standards may be imposed by Treasury Department Circular 230 or by applicable state licensing statutes, regulations or rules.

27. Eastman is clearly in violation of Illustration 1 of the Specific Illustrations under

Interpretation No. 1-1, ARealistic Possibility Standard@ of Statement on Standards for Tax Services No. 1, Tax Return Positions. Illustration 1 provides the following::

AIllustration 1. A taxpayer has engaged in a transaction that is adversely affected by a new statutory provision. Prior law supports a position favorable to the taxpayer. The taxpayer believes, and the member concurs, that the new statute is inequitable as applied to the taxpayer=s situation. The statute is constitutional, clearly drafted, and unambiguous. The legislative history discussing the new statute contains general comments that do not specifically address the taxpayer=s situation. 13. Conclusion. The member should recommend the return position supported by the new statute. A position contrary to a constitutional, clear, and unambiguous statute would ordinarily be considered a frivolous position.@

28. It appears that Fairfax should not recommend the position because she can not have a good faith belief that the tax return position being recommended has a realistic possibility of being sustained administratively or judicially on its merits, if challenged. Also, in light of the facts, the position appears is frivolous and likely would be so construed. Statement on Standards for Tax Services (SSTS) No. 1, Tax Return Positions, contains the standards a member should follow in recommending tax return positions and in preparing or signing tax returns. Under SSTS No. 1 AA member should not recommend that a tax return position be taken with respect to any item unless the member has a good faith belief that the position has a realistic possibility of being sustained administratively or judicially on its merits if challenged.@ Also, per item 3 of SSTS No. 1 AA member should not recommend a tax return position or prepare or sign a return reflecting a position that the member knows...[e]xploits the audit selection process of a taxing authority.@

As noted in Interpretation No. 1-1, ARealistic Possibility Standard@ of Statement on Standards for Tax Services No. 1, Tax Return Positions

A...a member should have a good-faith belief that the tax return position being recommended has a realistic possibility of being sustained administratively or judicially on its merits, if challenged. The standard contained in SSTS No. 1, paragraph 2a, is referred to here as the realistic possibility standard. If a member concludes that a tax return position does not meet the realistic possibility standard: a. The member may still recommend the position to the taxpayer if the position is



not frivolous, and the member recommends appropriate disclosure of the position; or b. The member may still prepare or sign a tax return containing the position, if the position is not frivolous, and the position is appropriately disclosed.

2. A frivolous position is one that is knowingly advanced in bad faith and is patently improper (see SSTS No. 1, paragraph 9). A member=s determination of whether information is appropriately disclosed on a tax return or claim for refund is based on the facts and circumstances of the particular case and the authorities regarding disclosure in the applicable jurisdiction (see SSTS No. 1,paragraph 10).@

29. This question deals with the problem faced by AICPA members where an erroneous

statute is enacted and IRS issues a notice indicating it will not follow certain aspects of the statute and that a technical correction will be sought. Per Illustration 4 of Interpretation No. 1-1, ARealistic Possibility Standard@ of Statement on Standards for Tax Services No. 1, Tax Return Positions the following applies: First, under Illustration 4 if ...@a taxpayer is faced with an issue involving the interpretation of a new statute...[and] [f]ollowing its passage, the statute was widely recognized to contain a drafting error, and a technical correction proposal has been introduced....@ AThe taxing authority issues a pronouncement indicating how it will administer the provision. The pronouncement interprets the statute in accordance with the proposed technical correction. The illustration concludes that A...[r]eturn positions based on either the existing statutory language or the taxing authority pronouncement satisfy the realistic possibility standard.@ A...A return position based on the proposed technical correction may be recommended if it is appropriately disclosed, since it is not frivolous.@ Consequently, it appears that Aston may utilize a position consistent with the statute for the NOL taxpayer and a position consistent with the IRS pronouncement for the other one.

30. Here the facts are the same as in Question 29 except no IRS notice is given indicating

that it will take an administrative position consistent with a technical correction of the statute. In this instance, despite Aston=s views that may have been arrived at based on substantial experience, Illustration 5 of Interpretation No. 1-1, ARealistic Possibility Standard@ of Statement on Standards for Tax Services No. 1, Tax Return Positions makes clear that A...[i]n the absence of a taxing authority pronouncement interpreting the statute in accordance with the technical correction, only a return position based on the existing statutory language will meet the realistic possibility standard.@

31. Illustration 8 of Interpretation No. 1-1, ARealistic Possibility Standard@ of Statement on

Standards for Tax Services No. 1, Tax Return Positions makes clear that where a taxing authority such as State X publishes a tax form which is incorrect, the member should not take a tax return consistent with achieving a member benefit under certain circumstances.

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Specifically, if the member knows that A... the taxing authority has published an announcement acknowledging the error, but completion of the form as published provides a benefit...a return position in accordance with the published form is a frivolous position.@ Under the illustration, the answer is unclear if there is no taxing authority pronouncement. Acknowledging the erroneous form. In this instance, if State X does not issue a pronouncement acknowledging the error, the interpretative illustration does not apply; provided, however, in the author=s view, if Baines knew of the error, it would appear inappropriate to take advantage of an obvious error in the form since that would appear to violate the general Agood faith belief@ standard imposed on members. A more interesting question arises where Baines did not know of the error in the form.

32. In this instance, State X has not made any error as regards its own tax returns. Rather, the

error has been made by Speedy Tax, a software company that Baines relies upon to produce correct software to generate State X forms. Although the SSTS interpretative illustration discuss the circumstance involving a State X error in its forms, under these facts the illustration does not apply. As a practitioner, Baines is responsible for insuring that tax returns are correctly applied. Notwithstanding, errors are made and here the errors were arguably made by both Speedy Tax and Baines. Consider the alternate circumstances: $ Baines filed the tax returns two months prior to their due date, but recognizing the

error, Speedy Tax updated its software program prior to the due date on its website accessible through an update service and promptly fired Wilson? In this instance, Baines neglected to update the return to consider software changes that were made prior to the filing due date. Nowadays, it is very common for software to be updated through the period prior to the due date and questions used in completing most commercial software programs (such as TurboTax) generally ask the tax professional whether an update should be considered prior to filing and often, immediately after the software installation. It is not uncommon for commercial software companies to issue tax return software prior to the time that a taxing authority issues its forms, thus requiring updates to the software after the forms= issuance. Students should be reminded that they, as tax professionals, are responsible for correctly preparing and filing tax returns and, although a tax service may be partially at fault, the tax professional is the fiduciary of the taxpayer who must act with competence and due care, not the service. Although Baines and the client may desire to file the returns early, in today=s ever changing tax world, the professional must consider whether it is appropriate to do so in cases where the law has been changed. At a minimum, Baines should review the computer generated forms to assure himself that the forms apply State X law appropriately. Since Baines has an active practice in State X, one would assume that he and his firm are aware of such changes. This problem often arises more frequently when a practitioner in another state is assisting the taxpayer to prepare and file numerous state returns. In conclusion, if and when Baines recognizes the



error or it comes to his attention on audit, the correction should be made. Consider whether Baines should be responsible for interest and penalties, further compliance costs, etc. assessed/incurred in rectifying the error.

$ Baines filed the tax returns two months prior to their due date, but later

recognizing the error, Baines considered the appropriateness of filing amended returns? Baines should notify the client and file amended returns consistent with State X rules.

$ In addition to the above, Baines must consider Statement on Standards for Tax

Services No. 6, Knowledge of Error: Return Preparation. Per SSTS No 6, paragraph number 3: AA member should inform the taxpayer promptly upon becoming aware of an error in a previously filed return.... A member should recommend the corrective measures to be taken. Such recommendation may be given orally. The member is not obligated to inform the taxing authority, and a member may not do so without the taxpayers permission, except when required by law.@ Among other issues, pursuant to numbered paragraph 6, 6. It is the taxpayers responsibility to decide whether to correct the error. If the taxpayer does not correct an error, a member should consider whether to continue a professional or employment relationship with the taxpayer. While recognizing that the taxpayer may not be required by statute to correct an error by filing an amended return, a member should consider whether a taxpayers decision not to file an amended return may predict future behavior that might require termination of the relationship.

33. General Concerns re: competency, scope of engagement and third party reliance.

Although students have been asked to only consider certain SSTs and interpretations, given the caveat that Ms. Peters feels uncomfortable with her knowledge of the mergers and acquisition field, she should consider whether she is the appropriate tax professional to assist Acme in making tax determinations. As noted in the text, an otherwise able tax practitioner is charged with the general responsibility of self-assessing whether he or she is competent to handle a particular tax matter. Further, it would seem advisable for her to make her more limited role clear to her client in the engagement letter. Since she likely has a broader engagement arrangement, she should be careful to narrow the scope of her work for purposes of the merger transaction to make clear her general lack of responsibility as regards making determinations in connection with the tax free nature of the merger and other matters associated therewith. These limits should be clearly expressed in a written communication which serves to amend the engagement letter. She should also consider making clear to her client and others that they may not disseminate any advice given by her so as to cause reliance on her advice by third party shareholders or other affected taxpayers. For example, she would want to be sure that the advice given to Acme regarding its tax returns in no way be relied upon by Acme shareholders as to whom she does not represent but who may be viewed as relying persons should they be

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provided with copies of Ms. Peters advice. Given the possibility of reliance by third parties in connection with this offering of securities that would likely be subject to Rule 10(b) concerns under the Securities and Exchange Act of 1934, as amended, and Rule 10(b)-5 thereunder, etc., special care must be taken to avoid potential unanticipated malpractice exposure.

Reliance on Nontax Legal Opinions. In any event, assuming Peters is comfortable with her representation of the taxpayer, Illustrations 14 and 15 of Interpretation No. 1-1, ARealistic Possibility Standard@ of Statement on Standards for Tax Services No. 1, Tax Return Positions deal with the circumstances pursuant to which a member may rely upon nontax and tax opinions in order to meet the realistic possibility standard. First, in reliance on a third party nontax legal opinion, such as the opinion concerning compliance of the proposed merger transaction with applicable state corporate and other laws, the member must use professional judgment to determine whether the legal opinion is facially Aunreasonable, unsubstantiated or unwarranted.@ [See Illustration 14]. In the author=s view, this may be more easily said than done because, after all, absent additional qualifications/licensure, etc., an AICPA member is not a local law legal expert. But, if Ms. Peters is familiar with the law firm and the quality of its lawyers and their work in similar AM and A@ transactions, she should feel justified in relying upon their work. If, on the other hand, she is not comfortable with the quality of the law firm=s work or conclusions, per illustration 14, she should consult with her own counsel before relying upon the opinion. Of course, she may also consider the appropriateness of discussing her concerns with the client and, if necessary, disengaging from the assignment.

Reliance on Investment Banking Valuation Fairness Opinion. It is very common in the M&A area that investment bankers issue fairness opinions as to target corporation and acquiring corporation valuation. As has happened in many instances, these fair values can significantly differ, particularly where parties are engaged in hostile takeovers and several parties compete for the same target corporation. Interestingly, illustration 14 does not apply to a third party nonlegal opinion such as an opinion regarding valuation but its principles would appear to be worthy of consideration in assessing whether Ms. Peters copuld reasonably rely on these third party opinions.

Reliance on Tax Opinion Issued By Tax Law Firm. First, note that Treasury Department Circular 230 considers the issuance of tax law opinions from a variety of perspectives and standards depending upon the nature of the opinion. Circular 230, which appears in the appendix to the text, is clearly a much more difficult document to read and understand when contrasted with the SSTSs although its scope is more narrow in certain respects. For example, Circular 230 only applies to federal tax practice matters. Having said that, Circular 230 provides a number



of arguably complex rules governing the tax professional issuing tax opinions, including so-called Areliance opinions@, in contrast to the professionals who, like Ms. Peters, are relying upon the opinions of others.

Notwithstanding, students were specifically asked to consider the SSTSs and interpretations only. Pursuant to Illustration 15 of Interpretation No. 1-1, ARealistic Possibility Standard@ of Statement on Standards for Tax Services No. 1, Tax Return Positions where A...[a] taxpayer has obtained from its attorney an opinion on the tax treatment of an item and requests that a member rely on the opinion....[t]he authorities on which a member may rely include well-reasoned sources of tax analysis. If a member is satisfied about the source, relevance, and persuasiveness of the legal opinion, a member may rely on that opinion when determining whether the realistic possibility standard has been met.@ Accordingly, it appears appropriate for Peters to rely upon the opinion of tax counsel that there is Asubstantial authority@ supporting tax free treatment to Acme and its shareholders. Note that the substantial authority standard is a higher threshold than the realistic possibility standard, so an opinion of substantial authority (or a more likely than not opinion) should be adequate to satisfy the illustration standard. [See numbered paragraph 5 to Interpretation No. 1-1, which states:

AThe realistic possibility standard is less stringent than the substantial authority standard and the more likely than not standard that apply under the Internal Revenue Code (IRC) to substantial understatements of liability by taxpayers. The realistic possibility standard is stricter than the reasonable basis standard that is in the IRC.@]

Interpretation No. 1-2, ATax Planning, of SSTS No. 1, Tax Return Positions.@ Note that this interpretation also applies and governs situations where ...@In assisting a taxpayer in a tax planning transaction in which the taxpayer has obtained an opinion from a third party, and the taxpayer is looking to the member for an evaluation of the opinion, the member should be satisfied as to the source, relevance, and persuasiveness of the opinion.@ In this regard, the member must consider A...whether the opinion indicates the third party did all of the following:

$ Established the relevant background facts, $ Considered the reasonableness of the assumptions and representations $ Applied the pertinent authorities to the relevant facts $ Considered the business purpose and economic substance of the

transaction, if relevant to the tax consequences of the transaction $ Arrived at a conclusion supported by the authorities

Finally, consider a question that is not asked. What if the state law opinion, the

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investment banking fairness opinion and the tax opinion are rendered by firms that are not engaged to do so by Acme but are nonetheless issued with due consideration that they may be relied upon by Acme? Illustrations 14 and 15 do not directly consider this circumstance, but since the SSTSs make clear in their Apreface@ in numbered paragraph 3 that: AThe SSTSs have been written in as simple and objective a manner as possible. However, by their nature, ethical standards provide for an appropriate range of behavior that recognizes the need for interpretations to meet a broad range of personal and professional situations. The SSTSs recognize this need by, in some sections, providing relatively subjective rules and by leaving certain terms undefined. These terms and concepts are generally rooted in tax concepts, and therefore should be readily understood by tax practitioners. It is, therefore, recognized that the enforcement of these rules, as part of the AICPA=s Code of Professional Conduct Rule 201,General Standards, and Rule 202, Compliance With Standards, will be undertaken with flexibility in mind and handled on a case-by-case basis. Members are expected to comply with them.@

34. Unfortunately, Wesley is not correct in following AICPA member standards. Per

Illustration 2 of Interpretation No. 1-2, ATax Planning, of SSTS No. 1, Tax Return Positions,@ if the tax code imposes penalties on tax shelters, as defined in such code, unless the taxpayer concludes that a position taken on a tax return associated with such a tax shelter is, more likely than not, the correct position, the member should inform the taxpayer of the penalty risks associated with the tax return position recommended with respect to any plan under consideration that satisfies the realistic possibility of success standard, but does not possess sufficient authority to satisfy the more likely than not standard. Hence, although Wesley may feel relieved that his clients are investing in tax shelters that achieve the realistic possibility of success standard, the standard achieved must be higher than that to avoid the requirement that Wesley disclose the penalty risks associated with the recommended tax return position.

35. Here the student has been asked to consider the standards set forth in SSTS No. 2--

Statement on Standards for Tax Services (SSTS) No. 2, Answers to Questions on Returns. Pursuant to SSTS No. 2 numbered paragraph 2, AA member should make a reasonable effort to obtain from the taxpayer the information necessary to provide appropriate answers to all questions on a tax return before signing as preparer.@ Under paragraph 4, reasonable grounds may exist whereby a member may omit an answer where A [t]he information is not readily available and the answer is not significant in terms of taxable income or loss, or the tax liability shown on the return.@ Here, based on the facts, the answer is not significant in terms of taxable income or loss, or the tax liability shown on the return. Notwithstanding, it=s not clear that the information is not readily available merely because the client is on vacation, and Walters should, in any event, consider whether the failure to include such information would render the return incomplete.



36. Per SSTS No. 3-- Statement on Standards for Tax Services (SSTS) No. 3, Certain Procedural Aspects of Preparing Returns,. Williams, as a tax return preparer, need not examine or verify supporting data. But, per the SSTS, A...a distinction should be made between (a) the need either to determine by inquiry that a specifically required condition, such as maintaining books and records or substantiating documentation, has been satisfied or to obtain information when the material furnished appears to be incorrect or incomplete and (b) the need for a member to examine underlying information. In fulfilling his or her obligation to exercise due diligence in preparing a return, a member may rely on information furnished by the taxpayer unless it appears to be incorrect, incomplete, or inconsistent. Although a member has certain responsibilities in exercising due diligence in preparing a return, the taxpayer has the ultimate responsibility for the contents of the return. Thus, if the taxpayer presents unsupported data in the form of lists of tax information, such as dividends and interest received, charitable contributions, and medical expenses, such information may be used in the preparation of a tax return without verification unless it appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known to a member.@

37. Per SSTS No. 4-- Statement on Standards for Tax Services (SSTS) No. 4, Use of

Estimates, estimates may be used. The SSTS provides that AWhen records are missing or precise information about a transaction is not available at the time the return must be filed, a member may prepare a tax return using a taxpayer=s estimates of the missing data.@ It goes on to say that AEstimated amounts should not be presented in a manner that provides a misleading impression about the degree of factual accuracy.@ Further, even though specific disclosure that an estimate is used is not generally required; however, such disclosure A...should be made in unusual circumstances where nondisclosure might mislead the taxing authority regarding the degree of accuracy of the return as a whole. In the SSTS, one example of an unusual circumstance is the situation where a taxpayer has died or is ill at the time the return must be filed. Other examples of unusual circumstances include where a taxpayer has not received a Schedule K-1 for a pass-through entity at the time the tax return is to be filed, where there is litigation pending that bears on the return. and where fire or computer failure has destroyed the relevant records.

38. Pursuant to AStatement on Standards for Tax Services No. 5, Departure From a Position

Previously Concluded in an Administrative Proceeding or Court Decision@ members may recommend a tax return position that departs from the position determined in an administrative proceeding or in a court decision with respect to the taxpayers prior return so long as a formal closing agreement was not entered into binding the taxpayer=s treatment of such items as to the current tax year. SSTS No. 5 goes on to state that a taxpayer is not bound to follow the tax treatment of an item as consented to in an earlier administrative proceeding, and among various reasons departures may be justified include circumstances as the following:

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Where--AThe determination in the administrative proceeding or the courts decision may have been caused by a lack of documentation. Supporting data for the later year may be appropriate.@

WhereBAA taxpayer may have yielded in the administrative proceeding for settlement purposes or not appealed the court decision, even though the position met the standards in SSTS No. 1.@

WhereCACourt decisions, rulings, or other authorities that are more favorable to a taxpayer=s current position may have developed since the prior administrative proceeding was concluded or the prior court decision was rendered.@

39. Under SSTS No. 8-- AStatement on Standards for Tax Services No. 8, Form and Content

of Advice to Taxpayers@, a member ordinarily has no duty to communicate with a taxpayer when subsequent developments affect advice previously provided, even if such advice relates to significant matters. Notwithstanding, a member does have a duty when Aassisting a taxpayer in implementing procedures or plans associated with the advice provided or when a member undertakes this obligation.[underlining added]@ . Based on the past oral statements made by Sarah to her client, it is not unreasonable for the client to assume that Sarah would have a continuing duty to communicate. Sarah has made a mistake in promising more than she can deliver and has likely violated member rules and committed professional malpractice., In any event, she will be left with an unhappy client who will likely terminate their relationship.

INTEGRATED CASE STUDIES - see solutions at page 140.

Communicating Research Results 127


CHAPTER 7 - COMMUNICATING RESEARCH RESULTS KEY CONCEPTS (1-10) 1. Definitions

a. An office memo to the file creates a record for the researcher of the research facts, issue, conclusion and reasoning.

b. A client opinion letter communicates the research results to the client in written

form. c. The purpose of a protest letter is to persuade the IRS of the appropriateness of

the taxpayer’s reporting position when questioned by the Service.

d. A Letter Ruling request seeks a letter from the taxing authority stating that the Service will agree with a certain tax position the taxpayer would like to take.

e. FIRAC stands for “Facts, Issue, Research, Argument, Conclusion” and is used by

some to structure both the analysis and reporting involved in a research project. 2. Internal communications consist of office memos in a variety of levels of formality. An

office memo should be done whenever significant research is performed. The office memo creates a record for the research performed. External communications include: * Client letters which report the research results to the client in writing. * Protest letters which represent the taxpayer’s response to a “thirty day letter” or other

adverse claim by a taxing authority. * Ruling requests which taxpayers often desire when the client anticipates a potentially

risky transaction. 3. An office memo to the file creates a record for the researcher regarding the research

performed. This is helpful as a mechanism for refreshing the researcher’s memory should this be required as well as to enable multiple parties to benefit from the research performed. The office memo should have a minimum of three parts: statement of the facts, statement of the issue, and a discussion of the writer’s conclusion and reasons for the conclusion, with all relevant authority cited.

4. The main elements of a client opinion letter include a statement of the scope of research

requested, a restatement of the relevant facts, a discussion of the key issue(s), a description of the relevant authority and their implication to the taxpayer’s situation, and a summary statement.

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5. A protest letter is written in response to a “thirty day letter” or other adverse claim by a taxing authority. The purpose of a protest letter is to persuade the IRS that the taxpayer’s reporting position in question is correct.

6. The factors that should be considered when making an oral presentation include: be

prepared, talk without reading your notes, establish eye contact (but don’t concentrate on one person) consider presentation aids, project voice, do not pace, avoid ‘ums,’ ‘you knows,’ avoid fidgeting.

7. A white paper is a comprehensive survey of applicable laws involved in a matter. 8. A long form opinion letter provides a well-reasoned analysis of the facts and applicable

laws that form the basis for the opinion(s) expressed. The short form letter simply provides an opinion.

9. Taxpayer may wish to seek a Letter Ruling whenever a future adverse tax position on a

proposed transaction by a taxing authority would be severe enough to consider not entering into the transaction.

10. The types of qualifications an opinion letter might include are: Limit the basis upon

which the letter was based, a limit on the persons who may properly rely upon the letter, a limit on the persons who may receive the letter or learn of its contents, limit any opinions expressed to ascertainable standards, limit any opinions expressed to the date the letter is issued. Limit any duty to update the letter, describe clearly any conditions that the letter is based upon that have not yet occurred.

PRACTICAL APPLICATIONS (11- 18) 11. The first sentence of a client opinion letter that reads as follows have some serious

deficiencies: "This is in response to your request that we review the tax implications of the transaction you described to us in recent telephone conversations." The letter should clearly restate the facts as understood by the researcher.

12. These statements are not only extremely dangerous to make, they do not add anything of

substance to the letter. A letter should never have this type of guarantee included. Many things can change – the Code, Regulations, case law. No one can reasonably say with any certainty that “the positions stated herein will always be correct."

13. See the research results in question 37, Chapter 5. 14. Student oral presentations can be arranged in teams or individually assigned. They can

be short or lengthy, depending on the instructor’s intent. It is helpful to videotape presentations so that students can learn from observing their performance.

Communicating Research Results 129


15. Same comments as #14. 16. Same comments as #14. This provides the student with another opportunity to research

Letter Rulings or read one of the daily or monthly tax reports. 17. Same comments as #14. This provides the student with another opportunity to research

Revenue Rulings or read one of the daily or monthly tax reports. 18. Same comments as #14. This provides the student with an opportunity to read one of the

daily or monthly tax reports and learn about pending tax legislation. INTEGRATED CASE STUDIES - see solutions at page 140.

130 Chapter 8


CHAPTER 8 - OVERVIEW OF TAX PROCEDURE KEY CONCEPTS (1-40) 1. Definitions:

a. The Internal Revenue Service Restructuring and Reform Act of 1998 was passed by Congress in an effort to change both the mission and structure of the IRS. The focus of the Act was to help create an IRS that is more efficient, responsive and respected and which serves the public and needs of the taxpayers.

b. The Secretary of the Treasury is the head of the Treasury Department

which is responsible for implementing and enforcing the federal tax laws. The Treasury Department oversees the Internal Revenue Service.

c. The Internal Revenue Service Commissioner is the head of the Internal

Revenue Service. This person is appointed by the President of the United States to a renewable five-year term.

d. The IRS Oversight Board was created by the 1998 Reform Act and is

part of the Treasury Department. The Board is to oversee the IRS - its administration, management conduct, direction and supervision of the tax laws. The Board must review and approve the organizational structure of the IRS. It includes nine members: six appointed by the President, the Secretary of Treasury, IRS Commissioner, and an IRS employee.

e. The Chief Counsel is the chief legal office for the IRS and the legal

advisor to the Commissioner. The President appoints the Chief Counsel who reports to the Commission and to the Treasury General Counsel.

f. The Treasury Inspector General for Tax Administration conducts

audits and investigations relating to the operations of the Treasury in order to promote efficiency and prevent fraud. This position is appointed by the President and was created by the 1998 Reform Act.

g. The National Taxpayer Advocate position was created by the 1998

Reform Act to assist taxpayers in resolving problems with the IRS. This person is appointed by the IRS Commissioner.

h. The statute of limitation is the time during which the taxing authority is

allowed to assess additional tax for a particular year. Once the statute of limitation has “run,” the return year is closed and the taxing authority (IRS or state agency) can not make an additional assessment.

Overview of Tax Procedure 131


i. Mitigation of statute of limitation results in the ability of the taxing

authority to audit a return for a year in which the statute of limitations has already run. Essentially, when there are special or “mitigating” circumstances, the statute of limitations will not protect the taxpayer from audit and assessment.

j. An IRS audit is the method used by the IRS to verify the accuracy of the

taxpayer’s return. Most audits involve erroneous computations and inconsistency with information returns filed by third parties such as banks and investment companies. These audits usually result in an IRS notice proposing an adjustment. Audits may also involve a request by the IRS for more specific information about a return position, and may involve a meeting between the Revenue Agent and the taxpayer and his representative.

k. The Revenue agent’s report follows an audit and identifies those issues

where there is continued disagreement between the taxpayer and the agent.

l. An IRS summons is a document requiring the taxpayer or a third party to produce records or testimony.

m. Form 870 is titled “Waiver of Restriction on Assessment and Collection

of Deficiency in Tax and Acceptance of Overassessment.” When the taxpayer signs this form, he is agreeing to pay the tax deficiency and not to contest the deficiency in Tax Court. The taxpayer is still entitled to pursue a refund claim, however.

n. A Closing agreement is the most formal and final method used to agree

to a final settlement with the IRS. The agreement is binding on both the IRS and the taxpayer.

o. The United States Tax Court is a court that hears only tax controversies.

Taxpayers may petition to this court within ninety days of receiving a Statutory Notice of Deficiency, prior to paying any deficiency amount. A decision by this court is appealable to the United States Court of Appeals.

p. The IRS issues a Statutory Notice of Deficiency at the conclusion of an

audit and after any protest determination to inform the taxpayer that the IRS has determined the taxpayer owes a certain amount of taxes. The taxpayer must either pay the taxes owed or petition for a hearing by the Tax Court within ninety days.

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q. An assessment of taxes by the IRS occurs after the ninety-day period following the statutory notice of deficiency if the taxpayer does not petition to the Tax Court.

r. A levy is the seizure of taxpayer assets by the IRS as a collection

mechanism.

s. Offers in compromise were not covered in the materials and so students will be unable to answer this question. (My error in including this question!) However, offers in compromise is a term used to describe a settlement whereby the taxpayer agrees to pay less than the full amount of the assessment.

t. Income tax return preparer is a person who prepares a tax return for

compensation. An income tax return preparer may also include a person who provides information and advice so that a return can be completed, even if the person does not actually place information on the return. A person who provides voluntary assistance under the volunteer Income Tax Assistance program (VITA) or who simply types or copies a return is not considered an “income tax return preparer.”

u. A privileged communication is one protected from disclosure by a

taxpayer’s attorney or tax advisor unless the taxpayer authorizes disclosure.

2. The tax system of the United States is a self-assessment system. This means that it is the

responsibility of the taxpayer to report income in accordance with the tax laws. The IRS then selectively reviews returns to ensure that taxpayers are accurately reporting their income and tax liability. Many other countries, including Britain, do not have systems relying on the taxpayers’ voluntary compliance to the tax laws. Rather, they use a system which places the primary burden on the government to determine the taxpayer’s tax liability and then request taxpayer payment of the taxes determined to be owing.

3. To be considered as “filed,” a completed tax return must include sufficient information to

compute the tax liability, be filed on the correct form, and be properly signed under penalty of perjury. Usually, the return must also include a Social Security number or taxpayer identification number.

4. The Code provides incentives to the taxpayer to comply with the tax laws primarily in the

form of the threat of the imposition of monetary penalties in the event of failure to comply. In addition, the statute of limitations commences once the return is filed.

5. A calendar-year individual taxpayer must file the individual income tax return no later

than midnight, April 15 (postmark) of the year following the calendar year. This time



can be extended for six months (and longer if the taxpayer is abroad) by filing a request on Form 4868 for a 4-month extension, followed by a 2 month extension request on Form 2688. The first 4 month extension (to August 15) is automatic if the request is filed; the final 2 month extension (to October 15) is discretionary.

6. If a corporation’s fiscal year closes on June 30, it must file its income tax return no later

than September 15 (on the 15th day of the 3rd month following the close of the year). The corporation may file a From 7004 to receive an automatic six-month extension to February 15.

7. If the filing date occurs on a Saturday, the return be filed by the following Monday. [IRC

§7503] 8. If an individual taxpayer does not have all the information necessary to file the tax return

by the due date, but anticipates an unpaid tax liability, she may file to extend the due date of the return. However, she must pay the anticipated liability with her extension request (Form 4868) no later than April 15. [IRC §6151]

9. The last date an individual calendar-year taxpayer’s tax return can be filed if all extension

requests are filed and granted is October 15, six months from the April 15 original due date. However, if the taxpayer is outside the country, this period may be increased.

10. The IRS reveals tax return information to other federal agencies and state agencies when

such disclosure is necessary to administer the tax laws. The return may also be disclosed to a person with a “material interest” in the return as this is narrowly defined by the Code. [IRC §6103].

11. The general statute of limitations is three years from the date the return is filed.

Therefore, the statute of limitations for an income tax return timely filed on April 15, XXX2 runs on April 15, XXX5. After that time, unless there are circumstances supporting a longer statute, the IRS may not assess additional tax for that tax return. If the return is not due until April 15, but the taxpayer files the return on February 1, XXX2, the statute still begins on the due date. Thus, the tax return is open for audit until April 15, XXX5.

12. The statute of limitations is six years if the taxpayer omitted income exceeding 25% of

the gross income reported on the return and the omission is not disclosed in the return. Filing a fraudulent or incomplete return results in an unlimited statute of limitations.

13. The IRS may simply notify the taxpayer of a proposed correction to a reported position.

This occurs where there appears to be a miscalculation on the return, or inconsistent reporting of amounts reported separately to the IRS by third parties (for example, dividend and interest amounts). The IRS may also perform an “office” audit which involves the taxpayer or his representative meeting with the Revenue Agent at IRS

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offices. A “field” examination often occurs with corporate return audits and involves a visit by the Revenue Agent to the taxpayer’s place of business.

14. The IRS may mail to the taxpayer a letter summarizing the Revenue Agent’s proposed

changes as a result of an audit. This “30-day letter” explains the proposed adjustments and informs the taxpayer of his appeal rights if he does not wish to accept the Revenue Agent’s findings. The taxpayer can choose to accept the adjustments and sign Form 870 indicating such. Or, the taxpayer can choose to do nothing, in which case the Service will mail to the taxpayer a statutory notice of deficiency indicating that tax will be assessed within ninety days. The last option the taxpayer has when receiving a “30-day letter” is to file a written protest to the findings of the Revenue Agent within 30 days of the issuance of the letter.

15. The IRS can investigate whether the taxpayer has complied with the tax laws by issuing a

summons to the taxpayer compelling the taxpayer to produce records and testimony. In addition, the IRS can summon any other appropriate person for relevant testimony. [IRC §7602] The IRS may also use search warrants to seize property they believe is evidence of the commission of a criminal offense and may even call a grand jury.

16. The IRS is entitled to institute a grand jury investigation regarding tax compliance when

the relevant facts cannot be gathered in a reasonable time through normal administrative processes or when the use of a grand jury will result in a more efficient investigation and will deter others from similar behavior.

17. If the taxpayer has not protested within 30 days of receiving the first notice indicating the

results of the audit, or, when the protest failed, the IRS begins the formal assessment process by mailing to the taxpayer a “Statutory Notice of Deficiency.” This is also referred to as the “90-day letter” because the taxpayer has a 90-day period to file a petition with the Tax Court appealing the findings of the IRS. If the taxpayer does not file a petition with the Tax Court within the 90-day period, the IRS will assess the tax and bill the taxpayer for the taxes due. If the taxpayer chooses to petition the Tax Court within the 90 days, the IRS may not assess or attempt to collect a deficiency until after the Tax Court decision.

18. A taxpayer may petition the U.S. Tax Court within 90 days of the date of the Statutory

Notice of Deficiency indicating a tax due. The Tax Court may also hear a case involving a refund claim denied by the IRS. To petition the Tax Court, the taxpayer must file a formal document (petition) that includes all pertinent taxpayer information, the date of the mailing of the Statutory Notice, a copy of the Notice, a stateament of the facts and the asserted errors made by the IRS.

19. Only those admitted to practice before the Tax Court may represent a taxpayer in a U.S.

Tax Court proceeding. This may include attorneys if they are in good standing with the



United States Supreme Court and non attorneys if they pass a comprehensive tax examination and are approved to practice before the Tax Court.

20. A taxpayer may request to have the Tax Court decide a case under the “small tax” case

procedures when the case involves a tax liability amount of $500,000 or less (including interest and penalties). A taxpayer may wish to choose this mechanism because the proceedings are less formal than the regular Tax Court proceedings and may enable the taxpayer to represent himself. In addition, the decision of the “small tax” case is final and not appealable by the IRS (nor by the taxpayer).

21. A “jeopardy assessment” is an IRS assessment without a Statutory Notice of Deficiency.

This may be appropriate when the IRS has reason to believe that collection of the proposed deficiency will be in jeopardy if a Statutory Notice is provided. This is also called a “termination assessment” and is only proper when the taxpayer appears to be ready to flee the county, put his property beyond the reach of the government, or about to become insolvent. When a jeopardy assessment is mailed, a Statutory Notice of Deficiency is still required to be mailed within 60 days of the jeopardy assessment. A jeopardy assessment entitles the IRS to seize or “levy” taxpayer property in order to satisfy the assessment amount.

22. Once the 90 days has passed from the date of the Statutory Notice of Deficiency, if the

taxpayer chose not to file in Tax Court, the taxpayer must pay the amount of taxes assessed. At this point, if the taxpayer disagrees with the position of the IRS, the only option available to the taxpayer is to file a claim for refund after the assessed tax is paid. This must be filed within either three years from the date of the retun or two years from the time the tax was paid, whichever is later. The refund claim must be filed on the appropriate form. (Individuals - Form 1040X; Corporations - Form 1120X). If the claim is denied, the taxpayer may then file for a refund in either the United States District Court or the United States Court of Federal Claims.

23. In order to be considered filed, a claim for refund must be on the appropriate form, be in

writing, specify the grounds upon which the claim is based, state the amount of the overpayment and be signed by the taxpayer.

24. The last day a claim for refund can be filed if the tax return was filed on April 15, year

XX02, and the tax (plus penalties) was paid on December 1, year XX06 is two years from the date the tax was paid, or December 1, XX08.

25. The last day a claim for refund can be filed when the return was filed and full payment

was made on February 15, year XX02 but the return was not due until April 15 of that year is three years from the due date of the return, or April 15, XX05.

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26. When a refund claim is denied by the IRS, the taxpayer has the choice of doing nothing, or filing a suit for refund in either the United States District Court or the United States Court of Federal Claims.

27. If the taxpayer wishes to file suit in court, the taxpayer may wish to consider the

advantages/disadvantages of a jury trial (only District Court allows for jury trial) and the decisions of the courts in previous similar cases.

28. When a party has the “burden of proof,” he must demonstrate that the required standard

of proof has been met by providing sufficient evidence to support his position. In criminal proceedings, the prosecutor must offer proof of guilt “beyond a reasonable doubt.” The highest civil standard of proof is “clear and convincing evidence” of the position. A common civil standard of proof is of “preponderance” of evidence supporting the position. Other possible standards require a position to be supported by “substantial” evidence

29. Prior to the 1998 Reform Act, the taxpayer usually carried the burden of proof that a

return position was correct. The 1998 Reform Act shifted the burden to the IRS in situations where the taxpayer presents credible evidence regarding an issue and also meets certain requirements spelled out in IRC §7491. The taxpayer must follow the Code’s substantiation and record-keeping requirements, cooperate with “reasonable requests” by the IRS for information and documents, and, for nonindividuals, have a certain net worth.

30. Attorneys fees may be awarded to a taxpayer when a taxpayer “substantially” prevails

with respect to the amount or issue of the litigation and the government is unable to establish that its position was “substantially justified.” [IRC §7430] Court costs may also be awarded when the taxpayer made an offer to the IRS which the IRS rejected and which is greater than the ultimate court judgment against the taxpayer. Attorneys fees may also be awarded when the taxpayer files suit for civil damages for unauthorized inspection or disclosure of tax returns.

31. To collect assessed taxes, the IRS first mails payment notices to the taxpayer. If the

taxpayer continues to pay the taxes owing, the IRS may attach a lien to the taxpayer’s property by filing a Notice of Federal Tax Lien. The government may also seize or levy the taxpayer’s assets. To do this, the service must receive internal approval to send a notice at least thirty days before the levy. When a levy is made, the taxpayer must surrender the property for immediate sale by the government. (See page 402)

32. According to the Treasury Regulations, “return preparation” for purposes of the penalty

provisions requires that a “substantial portion of a return” be prepared in return for compensation. Return preparation includes providing information and advice so that a return can be completed, even if the person does not actually place information on the return. A person who provides voluntary assistance under the volunteer Income Tax



Assistance program (VITA) or who simply types or copies a return is not considered an “income tax return preparer.”

33. A tax return preparer must provide the taxpayer with a copy of the return, sign the return

and accurately report the amount of tax liability. 34. If the tax return preparer fails to sign a tax return he prepared, the Code may impose on

the preparer a $50 penalty. 35. A tax return preparer who signs a return he knew reported a position with no “realistic

possibility of being sustained” and fails to disclose this fact on the return is subject to a $250 penalty unless the preparer can show that there was reasonable cause for the understatement. [IRC §6694]

36. A tax return preparer who intentionally ignores information reported to him by the

taxpayer in an attempt to understate the tax liability shown on the return is subject to a $1000 penalty. In addition, the IRS may seek to enjoin the preparer from practice before the IRS. [IRC §7407] This type of activity may be so severe that the preparer is subject to criminal sanctions imposed for “tax evasion.” Tax evasion is a felony and carries with it a possible fine up to $100,000 ($500,000 for a corporation) and/or imprisonment of up to five years. [IRC §7201]

37. Possible criminal charges a tax return preparer may be subject to include “tax evasion”

and the preparation of a fraudulent return. Evasion is the willful attempt to evade tax. (See #36 for discussion of penalties.) Fraudulent return preparation involves the assistance in the preparation of a return which is knowingly fraudulent or false as to a material matter.

38. Some of the penalties that can be imposed on the taxpayer for understating his tax

liability include: a penalty for negligence or disregard of the tax law. The penalty is usually 20% of the underpaid tax liability. There is also a penalty for the substantial understatement of tax due when the understatement exceeds the greater of 10% of the actual tax liability or $5,000.

39. The communications potentially protected by the attorney-client privilege include advice

on legal matters and communications made by a client to the attorney regarding a legal matter. This privilege was extended to “federally authorized tax practitioners” by the 1998 Reform act. Tax practitioners are only protected with respect to “tax advice.” For both privileges, the parties must intend for the communication to be kept confidential. Therefore, information intended to be included on a tax return may not be protected. There are also exceptions to the privilege. The philosophical support for the privilege is the recognition that it is important that a person be encouraged to be frank and fully disclose all necessary information to their attorney or tax advisor.

138 Chapter 8


40. A tax-related communication falls outside the protection of the privilege when it is not intended to be kept confidential (for example, items intended to be included on a tax return). In addition, because the privilege only applies to communications, the “work product” of the advisor may not be protected. Tax communications will not be privileged if there is evidence that the client or the advisor was engaged in fraudulent or criminal conduct.

Overview of State Tax Research 139


CHAPTER 9 - OVERVIEW OF STATE TAX RESEARCH

(Warning to instructors: Many of the questions in this chapter ask the student to discuss their state’s particular provisions. Therefore, many of the answers below simply indicate that it varies, depending on the state involved. You will want to make sure that you spend some extra time investigating the appropriate answers for your state!) KEY CONCEPTS (1-7) 1. It is important to be aware of state tax issues because each state has a tax system separate

and distinct from the federal tax system. For any given set of facts, there may be a state tax issue whether or not there is a federal tax issue requiring research.

2. There are a number of ways in which non-tax state laws may affect federal tax research.

Many Federal or state tax laws often defer to the provisions of state law to define the legal terms appropriate to a transaction while other tax laws often provide that state non-tax laws may be overridden in certain circumstances. For example, the community property laws of certain states may impact the application of an Internal Revenue Code provision. So might provisions in a state’s civil code, which may establish specific liabilities impacting the application of the Internal Revenue Code. State rules governing trusts and estates may affect federal tax application.

3. The types of tax issues that can arise concerning state taxes include the taxing

relationship between states. How is income from a company doing business in multiple states and/or multi-nationally taxed by the states? What portion of income can each state tax? When may a company be subject to the myriad of non-income taxes imposed by state and local governments? What tax credits or deductions, if any, are available to preclude the double taxation of the same income by one state versus another? Other state tax research issues revolve around each state’s specific income or other tax laws. Both their substantive and procedural application may be important.

4. The name of the general tax statute differs with each state. Both the name and the

administering agency can be easily identified using one of many sources, including the state’s tax statutes and the All States Tax Handbook published by both CCH and RIA.

5. This varies with every state. 6. This varies with every state. 7. This varies with every state.

140 Chapter 9


PRACTICAL APPLICATIONS (8-21) 8. This varies with every state. Students in states for which there is a summary reporter

equivalent to the Master Tax Guide will be best able to answer this question readily. 9. This varies with every state. The table of contents of the state taxing statutes and the All

States Tax Handbook are good sources for this information. 10. The All States Tax Handbook (Corporation Income - Rates, Returns, Payments) is an

excellent source for providing this information. If students arrive at an answer different from that provided below, it may be correct simply because of the fluid nature of state tax statutes. This will provide an opportunity to underscore how dynamic state taxation is. The three states with the highest corporate income tax rates are: Connecticut (10.5%), Pennsylvania (9.9%), Minnesota (9.8%). Washington, D..C., although not a state, has its own taxing statutes as though it were a state. Its rates place it second with an overall rate of 9.5% plus a 5% surtax.

11. The All States Tax Handbook (Charts - All states) is the best source of this information

for students not living in Texas. a. Texas imposes no individual income taxes. b. Texas has no corporate income or franchise tax, although it does have a capital

values franchise tax. c. Texas does have an inheritance and estate tax. d. Texas does have a generation-skipping transfer tax e. Texas does not have a gift tax.

12 The All States Tax Handbook (Corporation Income - Alternative Minimum Tax) is the

best source of this information for students not living in Iowa. Iowa has a corporate alternative minimum tax with a 7.2% rate of the Iowa alternative minimum taxable income.

13 The All States Tax Handbook (State Taxation of Partnerships) is the best source for this

information. a. Michigan - Partnerships are taxable and subject to the “single business tax.” They

must file returns if their gross receipts reach $250,000. b. North Carolina - Partnerships are exempt from tax, but must file an information

return if they have a place of business in the state. The manager must pay the tax on the distributive share of a non-resident partner.

c. Tennessee – Partnerships must pay tax on income from stocks, bonds, notes, and mortgages.

d. Wyoming has no income tax. 14. The All States Tax Handbook (State Taxation of S Corporations) is the best source of this

information. Most states do not need to file a separate state election to attain S

Integrated Case Studies 141


corporation status, but can simply use the federal election. However, the following states require the filing of a separate state election: Arkansas, Mississippi, New Jersey, New York, Pennsylvania, and Wisconsin.

15. The All States Tax Handbook (Miscellaneous Deductions) is the best source of this

information. a. Your state b. New Jersey - no NOL allowed. c. Arizona - There is no carryback of an NOL. However, there is allowed a 5-year

carryforward of an NOL, with a longer carry forward time for certain types of NOLs. (10 years for steel manufacturers, 15 years for medical companies.)

16. The All States Tax Handbook (Miscellaneous Deductions) is the best source of this

information. 17. a. Your state

b. California - No carryback. A 5-year carryforward is allowed for years beginning in 1987-1990 and 1993 and after. Many additional special rules.

c. Louisiana - Has different rules for individuals and corporations. For corporations, there is a 3-year carryback of the loss and a 15 year carryforward for losses incurred after 1983.

18. The All States Tax Handbook (Personal Income Taxes - rates, exemptions and reports) is

the best source of this information. (Information provided below represents 2005 rates. Rates do change which provides a good opportunity to discuss how fluid state taxation rules are.) a. Your state b. California - 9.3% (with a 1% surcharge on income in excess of $1 million) c. New York – 7.7%

19. The following states do not have a personal income tax: Alaska, Florida, Nevada, South

Dakota, Texas, Washington, and Wyoming. 20. The All States Tax Handbook (Monthly Calendars) is the best source of this information.

In the month of March, the filing dates for individuals and entities in the following states are:

a. Arkansas - March 1- Utilities must report property taxes.

March 15- Farmers’ final return and payment for income taxes due.

March 31- Corporations not receiving franchise tax return must file written request.

March 31 - Motor carriers must file report, including property tax report.

142 Chapter 9


b. Connecticut - March 1 - Dealers of motor vehicles pay annual license fee.

March 15 - Corporation must pay estimated tax installment for income tax.

March 31 - Report and delivery of property presumed to be abandoned due. March 31 - Snowmobile registration expires.

March 31 - Farmers’ refund claims for gas tax due. March 31 - Utilities’ financial reports due. March 31 - Public service utility companies must pay quarterly

installment of utilities control expenses.

c. Georgia - March 1 - Utilities must submit special franchise and property tax return. March 1 - Final return for personal income of farmers and fisherman due. March 15 - Report and payment due by corporate franchises. March 15 - Corporate income return and tax due.

21. Whether a state conforms to the IRC Section 121 first needs to be determined. Then, the

student needs to make sure that if the state does conform, that the dates are such that the current federal exemption is the same as the state exemption. Some states may not conform, in which case the student needs to determine what the tax treatment is.

22. The student will first want to determine whether the state has a provision equivalent to

IRC Section 179. Both the possible bonus depreciation and general depreciation rules will need to be explored.


INTEGRATED CASE STUDIES

Preface: The research discussed in the following section is based upon authority existing at the time of publication (February 2008). Clearly, changes to the Code, Treasury interpretations and case law will occur that will affect some of the following discussion. Therefore, the following research should be taken in that light as a starting point for the instructor only. Each case study presents sufficient facts to enable the student to research the issues. In Chapter 1, students are asked to identify additional questions they might like to ask the taxpayer. A fun technique is to have the instructor role-play as the taxpayer during the discussion of the Chapter 1 case studies. Having the students ask the taxpayer questions is useful in three ways: the instructor is able to embellish the facts as he/she sees appropriate; the students get experience interviewing a taxpayer and asking appropriately worded questions; the students begin to understand the importance of good listening skills. The latter benefit is particularly novel to most students in this setting. They may be all set with pen and paper to record every word the taxpayer says, only to discover that the taxpayer speaks quite a bit faster than the student can write! Students can practice writing quick notes to their questions, followed by more complete notes after the meeting. In any event, the instructor will need to add details to the facts as appropriate. Case Study A (Mr. Top and disability) Chapter 1:

a. The initial research question is “What is the tax treatment of the $25,000 of disability payments Mr. Top received.”

b. Additional facts needed include: the type of disability plan; who paid for it; who

are the payments from; how are the amounts calculated. [In order to accurately apply the relevant Code Sections – §§104, 105 – this information must be ascertained.]

c. Now the student will more readily understand why the facts identified in #b are

important.

d. If Mr. Top is self-employed, the student may draw the initial conclusion that he must have paid for the disability plan himself, and thus the entire $25,000 is excluded.

e. This new fact entirely changes the tax consequences of the disability payments.

Now, unless the special rules under IRC Section 105 apply, the $25,000 will be taxable income to Mr. Top. More facts are necessary to determine the application of Section 105. This illustrates the danger of making assumptions without establishing critical underlying facts.

f. This question simply allows the student to understand that researchers may bring their own perceptions and prejudices into the research process. With this


144 Integrated Case Studies

Integrated Case Studies

understanding, it is easier for the student to overcome the potential dangers this habit provides.

Chapter 2:

a. The following Code Sections are relevant in addressing this question: * IRC §104(a)(3) - gross income excludes amounts received through

accident or health insurance for personal injuries or sickness except for the deductions allowed as medical expenses.

* IRC §105(a) - gross income includes amounts received by an employee

through accident or health insurance for personal injuries or sickness to the extent such amount (1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (2) are paid by the employer

* IRC §105(c) - gross include does not include amounts paid for the

permanent less of ...a function of the body, etc.

b. Studying the relevant Code Sections should help the student refine the initial research question because the student should notice the different treatment of the payments depending upon whether they were paid by employee paid-for policies or employer paid-for policies. How are payments from a plan for which the taxpayer paid the premiums treated? Are payments made under a disability plan considered to be payments by an “accident or health insurance” plan? [IRC §104(a)(3)] How are payments from a plan for which the employer paid the premiums treated? [IRC §105]

Two additional questions also arise. Is it possible to exclude the employer plan payments under IRC §105(c) under the theory that a heart attack represents the “loss of use...of a function of the body?” If so, do the facts indicate whether IRC §105(c)(2) can be satisfied?

c-d. Unless students assume (very dangerous sometimes!) that the amounts received

under a disability plan will be treated as amounts received under an “accident or health insurance” plan, students will not be able to conclude that the Code adequately addresses the treatment of the $15,000 received by Mr. Top. Further research into the meaning of the words used in IRC §104(a)(3) is necessary. If students conclude that a disability plan does fit into this Code Section, they should conclude that the $15,000 paid from the employee’s personal disability plan for which he paid the premiums is fully excluded.



Students may conclude that the $10,000 payment received by Mr. Top from his employer-paid policy is likely includible in gross income under §105(a). However, further research is probably necessary to address the treatment of the $10,000 conclusively, since it may be possible that the IRS or the courts have found a heart attack fits within IRC §105(c)(1). This may be moot, however, because students may determine that the payments do not satisfy the requirement under IRC §105(c)(2). (Note to the students that both requirements must be met since they are connected with an and.) Also, it is possible that a portion of the $10,000 represents a medical expense reimbursement, in which case the amounts would be excluded under §105(b). This is a factual question which requires clarification from the client.

Chapter 3: a-d The Treasury Regulations do help address the question regarding whether

disability payments qualify as payments from an “accident or health insurance” policy under IRC §104(a)(3). Treas. Reg. §1.104-1(d) states in the second sentence that “Similar treatment is also accorded to amounts received under accident or health plans and amounts received from sickness or disability funds.” Therefore, the students can conclude at this point that the $15,000 paid to the taxpayer out of his personal disability plan is excluded. The Treasury Regulations do not provide helpful additional information to address the questions relating to the $10,000 payments made out of the employer-paid-for plan. Rather, the Regulations simply restate the requirements of the Internal Revenue Code Section. Therefore, the same questions remaining at the end of Chapter 2 require further research after reviewing the Treasury Regulations.

Chapter 4: No questions

Chapter 5: a-c The Internal Revenue Code provides substantial authority in addressing this

research question. It is clear that as long as a disability plan is considered an “accident and health insurance” plan, IRC §104(a)(3) excludes the $15,000 payment since the taxpayer personally paid the premiums for the plan. However, the $10,000 paid out of the plan the employer paid for will need to be included in income per IRC §105(a) which states that amounts received shall be included to the extent such amounts: “are attributable to contributions by the employer which were not includible in the gross income of the employee, or are paid by the employer.” Employer premiums are excluded under IRC §106, thus the payments from this plan are included.

The students should have researched the possible application of IRC §105(c). However, a few cases make it clear that this possible exclusion will not apply to



the taxpayer. The students should have found O.J. Hines, 72 TC 715, which held that a pilot, who had suffered a heart attack was not entitled to exclude amounts received under the airline's loss-of-license plan because the injury did not constitute the permanent loss of, or the loss of the use of, a member or function of the body. Students may have located a similar ruling in T.E. King, 71 TCM 2014.

d-e This is a good opportunity to discuss with the class the reference services they

used - what they liked and did not like, challenges and how they might be overcome. Requesting students to record the time they spent allows you to report back to them with the range of time required. Students can then learn whether they are within the normal range or outside. Performing research in a vacuum provides no input as to whether the researcher is unusually slow or speedy. This opportunity provides some nice feedback in this area.


Chapter 7: a. The student here needs to apply the general memo-writing skills addressed in the

chapter. The facts should only include those relevant, and should leave out irrelevant facts such as that the taxpayer telecommutes. The issues statement should be more refined than the issues formulated in Chapter 1. The issue statement should therefore go beyond simply asking whether the payments are treated as income. The conclusion and reasoning should include clear reference to the applicable Code Sections and a clear statement that the $15,000 will be excluded. There should be more discussion regarding the other $10,000 of payment, since the IRC doesn’t directly address that issue.

b. The student here needs to apply the general client-letter writing skills addressed in

the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. The biggest challenge for the student will be to state the research conclusions in a manner that the taxpayer can understand. Bottom line, the student’s letter should make it clear that the taxpayer does not need to report as income the $15,000 payment paid from his personal disability plan, however, the taxpayer will be required to report in income the $10,000 payment received from the employer’s plan. Cites to support these conclusions should be in footnote or in-between sentences only.

Case Study B (Bonus payments) Chapter 1:

a. Additional questions: How much is her annual compensation package (salary and



benefits)? What are the work expectations and performance of those she plans to give bonuses to do? How much is their current annual compensation package? How much does she intend the bonus to be - a fixed dollar amount or a % of net income? What are the salaries of others within the company who do the same work? How do the salaries compare to the salaries of similar positions outside of the company? Have they ever done a salary survey? Why did she select the specific four people she selected? Will the company pay the bonus in cash? When does she plan on having the company pay the bonus? Is the company an accrual basis company or cash basis? Does the company have a board of directors?

Note that the students are most likely not going to come up with most of these questions. (See question c below). But a brief listing of all the above questions will provide the student with an appreciation for the complexity of even a “simple” question about deductibility and the amount of information sometimes needed to adequately answer a research question.

In addition, you may want to role play with the students about how they would ask these questions of the taxpayer. Depending on the student’s substantive tax knowledge, some students may ask questions in a way too technical for the taxpayer to understand, using terms that only tax practitioners understand. Having the students practice asking questions in simple English can be a challenging but important exercise to the student.

b. Other potential sources: past tax returns, information about dividend history, job

descriptions, salary surveys, corporate bylaws, etc.

c. Through review of documents.

d. Only a few of the facts given are relevant to the issue of whether the proposed bonuses will be deductible. Actually, the only relevant facts given are that she plans to give a bonus to herself as president and 3 other top employees and that she desires that the bonuses be deductible by the company. The rest of the facts are irrelevant, although the student is not in a position to know this until he/she does some research.

e. Unless the student is familiar with the reasonable compensation rules under Internal Revenue Code §162, the student is not in a position to really know all the questions that need to be asked of the taxpayer at this stage. Once they learn more about what the law requires in order for the corporation to get the deduction, the student will be able to better identify the facts he/she needs to know in order to complete the research. This is a good opportunity for the student to appreciate the need to both get as much information as possible on the first interview or



discussion with the taxpayer and also recognize that a follow-up call to the taxpayer may be necessary to gather more facts once the research has begun.

. f. The initial question will probably be the very general question “Will the bonuses

be deductible?” The additional information indicates how the researcher refines the research question as more information is gathered. Now the initial question becomes more specific: “Will the bonuses be considered reasonable?” In addition, a new question now has to be answered: “What does an accrual-based company have to do to be entitled to a bonus deduction?” The student should begin to see that as the research continues, the questions will be further defined.

g. The taxpayer wants to have the company pay bonuses to the identified employees

and herself and have the bonuses be deductible so that the company will pay the least amount of taxes. The taxpayer expects the researcher to be creative and figure out a way for the company to pay the bonuses and receive the desired deduction. Because the facts are so open-ended, the researcher’s role is not to give a simple yes or no answer to the taxpayer. It is to help her structure the transaction to reach her desired result. When the researcher keeps this in mind, the focus is on how best to do the transaction, not on why it can’t work. This is a hard idea for the student to appreciate. I find that the student’s natural inclination is to search for the “why nots” instead of the “how tos.” This is an appropriate mentality for someone working for a taxing agency. It is not, however, the mentality that works best for the person practicing outside of a taxing authority! Of course a “how to” is not always available, but finding one should remain the tax advisor’s goal.

h. This is a planning type of situation because all the facts are not yet set. Some of

the facts are subject to change depending in large part on the researcher’s advice. For example, a fact not yet set is how much the bonuses will be. Another open fact is when the bonuses will be paid. The taxpayer will most likely determine how much the bonus amounts should be and when they should be paid, completely relying on the researcher’s advice. This should serve to underscore the importance of providing accurate advice.

i. Clearly, the researcher should not spend a tremendous amount of time researching

the question of deductibility. Although the researcher’s role as tax advisor requires accuracy in the advice rendered, regardless of the dollars involved, reality is that it does not make sense for Sue to have to pay the researcher more than the combined tax benefit received from a deduction.

j. No, the researcher should not be playing the decision maker. As much as the

taxpayer would like to place that burden on the researcher, it is not an appropriate



role for the tax advisor to take. Rather, it is the tax advisor’s responsibility to educate Sue on everything she must be aware of in order to determine the most appropriate amount of the bonus in her judgment. She needs to be informed of all the considerations the courts and Service will look at, all her options and all the risks. Then Sue decides.

Chapter 2:

a. The following Code Sections address the research question: * §162(a)(1) – A reasonable allowance for salaries or other compensation

for personal services actually rendered.

* §267(a)(2) – A deduction is not allowed until paid if the payment is to “related parties.”

* §267(b)(2) – defines a “related taxpayer”

* §404(a)(5) – Deferred compensation amounts are deductible in the taxable

year in which the amount is includible in the gross income of the employee.

* §446(a) – The amount of any deduction or credit allowed by this subtitle

shall be taken for the taxable year which is the proper year under the method of accounting used in computing taxable income.

* §451(a) – An item of gross income must be accounted for in the year of

receipt.

* §461(a) – A deduction must be taken in the taxable year which is proper under the method of accounting used.

b. Study of the Code Sections enables the researcher to pinpoint the questions:

* Are the bonus amounts “reasonable”? * How do bonuses fit into the deduction provisions for “compensation”? * If the bonuses are “reasonable,” when must they be paid? * Do the rules in IRC §404 apply in this circumstance?

c. The Code does not definitively address most of the research questions. However,

it does provide conclusive authority that the company will only be able to deduct the payment to Sue in the year the bonus is paid. It will not be able to accrue the deduction due to the fact that Sue owns “more than 50%” of the company’s stock and is therefore considered a related party for purposes of the rules set forth in IRC §267(b). The Code also provides support regarding the timing of the



recognition of income to the recipients. (IRC §451) The student must perform further research to definitively address the remaining questions.

d. In addition to the issues above, the student must address what factors should be

considered in determining whether a bonus is “reasonable”? What must the company do to ensure a deduction.

Chapter 3:

a. The following Treasury Regulations provide further guidance in this situation:

* §1.162-7(b)(3) - In any event, the allowance for compensation paid may not exceed what is reasonable under all the circumstances. In general, reasonable compensation is only that amount that would “ordinarily be paid for like services by like enterprises under like circumstances.”

* §1.162-9 - Bonuses to employees will constitute an allowable deduction

from gross income when such payments are made in good faith and as additional compensation for services actually rendered by the employees.

* §1.162-8 - Depending upon the circumstances, excessive compensation

may not be allowed to be deducted by payor, and will be treated as a dividend.

* §1.404(a)-1(b) - What constitutes a reasonable allowance includes

elements such as “the personal services actually rendered in prior years as well as the current year and all compensation ...paid to... such employee in prior years” and the current year. “Thus, a contribution which is in the nature of additional compensation for services performed in prior years may be deductible, even if the total of such contributions and other compensation for the current year would be in excess of reasonable compensation for services performed in the current year, provided that such total plus all compensation and contributions paid to or for such employee in prior years represents a reasonable allowance for all services rendered by the employee by the end of the current year.”

* §1.404(b)-1 - The deferred compensation rules are not confined to formal

deferred compensation plans, but includes any method of compensation having the effect of deferring compensation. If an employer on the accrual basis defers paying any compensation to an employee until a later year, the employer shall not be allowed a deduction until the year in which the compensation is paid. “This provision is not intended to cover the case where an employer on the accrual basis defers payment of compensation



after the year of accrual merely because of inability to pay such compensation...”

* §1.404(b)-1T(b)(1) - An arrangement will be presumed to be a deferral of

compensation to the “extent that compensation is received after the 15th day of the 3rd calendar month after the end of the employer’s taxable year in which the related services are rendered....Thus, for example, a bonus under a year-end bonus declaration is presumed to be paid under a plan....deferring the receipt of compensation, to the extent that the ...bonus is received beyond the applicable 2 ½ month period. Further, ...a year-end bonus received beyond the applicable 2 ½ month period by one employee shall be presumed to constitute payment under a plan...deferring the receipt of compensation for such employee even though...bonus payments to all other employees are not similarly treated because they are received within the 1 ½ month period.”

* §1.404(b)-1T(b)(2) - Taxpayer may rebut the presumption above by

showing the facts and circumstances are such that it was administratively or economically impracticable to avoid the deferral of the receipt by an employee, and that at the end of the employer’s taxable year, such impracticability was unforeseeable.”

b-d The Treasury Regulations provide some important answers regarding the timing

of any deduction. From analysis of the Code, students will have determined the timing for any payment made to Sue (See Chapter 2 above). However, from reading IRC §404 alone, it would appear that the payments made to the remaining recipients will also not be able to be accrued by the company until the year of payment. The Treasury Regulations provide that the company will be allowed an accrual for the other bonuses in the year prior to payment as long as the company makes the payments by March 15 of the next year. The Regulations also provide beginning information about the issue of reasonableness, although much more information is needed to make a more informed decision. The remainder of the questions require further research.

Chapter 4: a-b Mayson Manufacturing Company v. Commissioner, 178 F.2d 115 is an excellent

case discussing the factors for determining whether compensation is “reasonable.” A very important note that students should understand is that “reasonableness” is based on facts and circumstances. There is no black and white rule that students can use to determine conclusively whether particular amounts are reasonable or unreasonable. However, the Mayson case sets forth the factors the student must consider. They include:



* the employee’s qualifications * the nature, extent and scope of the employee’s work * the size and complexities of the business * a comparison of salaries paid to the company’s gross income and net

income * the prevailing general economic conditions * comparison of salaries to dividend distributions to stockholders * the prevailing rates of compensation for comparable positions * the salary policy of the company as to all employees * the amount of compensation paid to the employee in previous years * whether there is a close relationship between the compensation of the

officers and the total payroll to the ratio of stock ownership.

In Mayson, the court held that the facts before it suggested the amounts paid were reasonable. In the facts in this research project, students do not have all the necessary factual information to draw any conclusion. They may need to go back to the client and the available documents to find out the facts necessary to address the factors listed above.

c. Questions requiring further research include:

* Factual questions indicated above * What must the company do to satisfy IRC §461 and accrue the bonuses to

the recipients other than Sue.

Chapter 5 a-b The key authority besides the Code and Regulations is Mayson Manufacturing

Company (See discussion for Chapter 4 above). From study of this case and other related cases, the student will only be able to better understand the additional facts needed to reach a conclusion regarding the “reasonableness” of the payments. The student should understand that unreasonable amounts are not deductible, even though they are income to the recipient.

There are several issues needing resolution regarding the company’s accrual of the bonus, should the amounts be determined to be reasonable. First, the liability for the bonus must be fixed by the end of the year if the company wishes to take a deduction in the year of accrual. (This applies of course only to the amounts going to recipients other than Sue.) Court cases have held that to fix the liability, there must be an actual legal liability to pay the bonuses. This can be created by a formal resolution by the Board of Directors identifying the intended recipients and the bonus amounts. (See for example, Hamilton Coal Mining Co., Petitioner, V. Commissioner of Internal Revenue, 17 B.T.A. 1339 which held that the payment of a bonus as well as the designation of the parties to share in it and the



extent to which they should share in cannot be left completely to the future action of the board of directors. See also The Powell Pressed Steel Company v. Commissioner 3824, 4 TCM 455, which held that the amount of the bonus must be fixed or the method for calculating the amount must be fixed prior to year end in order to establish a liability.)

Second, the corporation must pay the bonuses no later than March 15 of the year following the creation of the liability, in order to deduct the bonus in the year of accrual. (IRC §404 - see above discussion). The payment to Sue is not deductible until the year paid. [IRC §267(b)].

An additional point that some students may make is that because the taxpayer is planning a bonus, the taxpayer can create facts helpful to establish a deduction. In addition, the taxpayer may wish to consider a “hedge agreement” to protect the company from the danger of the income used to pay the bonus being taxed at two levels if the amounts are later determined to be unreasonable – at the corporate level (because a deduction is disallowed if unreasonable) and the recipient level. A hedge agreement is a statement, usually in the corporate bylaws, that requires the return to the company of any amounts determined by the IRS to be unreasonable compensation.

With a hedge agreement in place, the person returning the unreasonable amounts is entitled to a deduction for that amount, thus resulting in no net recognizable taxable income (when looking at the transaction over a period of years). Likewise, the company does not recognize the returned unreasonable compensation as income. Without a hedge agreement, the taxpayer returning any unreasonable compensation to the company is treated as making a contribution to capital (a non-deductible item). Rev. Rul. 69-115. However, hedge agreements also carry risks. Depending on the proximity between the signing of the agreement and the bonus declaration, the very existence of a hedge may be used as evidence that the taxpayer also questioned the “reasonableness” of the bonus. The student should inform the taxpayer of the hedge option and also inform her of its risks.

c. There were no additional questions requiring research beyond a reference service.


used - what they liked and did not like, challenges and how they might be overcome. Requesting students to record the time they spent allows you to report back to them with the range of time required. Students can then learn whether they are within the normal range or outside.





chapter. The issue statement should be more refined than the issues formulated in Chapter 1. In this situation, there are a number of issues. It is best if each is addressed clearly and separately.


the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because of the number of issues involved, the student needs to pay particular attention at separating them and clearly indicating both the significance of the issue and any conclusion reached. The hardest part of this letter is for the student to realize that it is a planning letter, thus the student needs to be extremely careful in making sure he/she recognizes that the goal in this situation is to educate the client so that the client can make the best decisions and take all necessary actions. The student cannot and should not attempt to determine whether the amounts are reasonable given the information available at this point. Instead, the approach regarding the reasonableness issue should be one of discussing the factors that appear to be relevant in this situation and identifying facts that may be useful to the client in reaching a conclusion about the appropriate “reasonable amount.”

c. This provides the student with a good experience writing as the advocate of the

taxpayer. The student’s personal opinion about the appropriateness of the taxpayer’s action is irrelevant. The student now needs to try to use case law addressing “reasonableness” and argue that in the taxpayer’s situation, such amounts were reasonable.

Case Study C (Move of company headquarters) Chapter 1: a. Students should identify this research situation as one involving planning. The facts have not all been fixed and the taxpayer is looking to the researcher for

information and advice as to the best way to structure a headquarter move. The researcher here acts as an educator and creative advisor. The student should be aware of the extreme importance in a planning situation such as this to be very thorough and careful in the research process because of the increased vulnerability due to the fact that the taxpayer will likely act on the researcher’s advice. The researcher needs to be responsive, accurate and communicate effectively to the taxpayer throughout the planning process. This will require



working with the taxpayer to ensure that the researcher has all necessary facts. b. Questions may include the following: What is the fair market value of the

currently owned property? What did the company pay for the current property? What would they do with the single-story building on the large attractive lot? (Convert it or demolish it?) What would their plans be regarding the retail and residential portions of the other building? Are any of the potential properties currently on the market? If so, for how much and by whom? What is the desired timing of a move?

c. Assuming there is gain tied up in the current property, the initial issue is how best

to structure the transaction so that the non-recognition rules can apply. At this juncture, without reading the Code, this is all that the student is likely to identify. Note the importance of identifying potential gain and an effort to avoid its recognition as only an assumption. Without the answers to the questions identified in #a, the student cannot yet determine whether there is a potential gain. A potential loss might entirely change the approach of the researcher, because the taxpayer would most likely want to recognize the loss and therefore not want to fall into the non-recognition provisions.

d. This information may trigger some of the questions listed above that students did

not think of initially. In addition, the student will want to discover (perhaps through review of prior tax returns rather than through questions) the amount of previous depreciation deductions taken on the current property.

e. This can be a useful exercise to illustrate to students some of the challenges and

techniques involved in interviewing a client. For example, depending on the student’s substantive tax knowledge, some students may ask questions in a way too technical for the taxpayer to understand, using terms that only tax practitioners understand. Having the students practice asking questions in simple English can be a challenging but important exercise to the student. It also helps them learn to listen to the responses and determine whether the response triggers the need to ask a question not originally on the “list” of questions. The meeting should result in a “conversation,” not simply a rigid interview devoid of any on-the-spot critical thinking.

Chapter 2: a. The following Code Sections are relevant:

* IRC §1031(a)(1) - No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind.



* IRC §1031(a)(3) - Property to be received in the exchange must be

identified by taxpayer on or before the 45th day after the date the taxpayer transfers the original property and the property must actually be received within 180 days after the date of the taxpayer’s transfer (or the due date for the taxpayer’s return for the year of transfer if this is earlier).

* IRC §280B(a)(1) – No deduction is allowed for demolition costs. The

expenses must be charged to the land.

b Several new issues arise from studying the Code. They are: * What is the meaning of the words “like-kind”? Does the different types of

real estate involved in this situation qualify as “like-kind”?

* What is “property held for productive use in a trade or business or for investment”? What is the impact of the taxpayer’s intent to demolish the building if it acquires the large property? Would that property still qualify as property to be held for productive use?

* In addition, the timing rules present more logistical challenges in the

planning process. How many potential replacement properties can be identified? How is this accomplished?

c. The only definite information the Code provides at this point is that any

demolition expenses incurred by the taxpayer will not be deductible but instead will be added to the basis of the land. (IRC §280B)

. d. All of the research questions remain unanswered.

Chapter 3: a. The following Treasury Regulations provide further guidance in this situation:

* §1.1031(a)-1(b) - The word “like-kind” refers to the nature or character of

the property and not to its grade or quality. One kind or class of property may not be exchanged for property of a different kind or class. The fact that any real estate involved is improved or unimproved is not material.

* §1.1031(d)-2 - The amount of any liabilities of the taxpayer assumed by

the other party to the exchange is to be treated as money received by the taxpayer upon the exchange.

* §1.1031(k)-1 - A sale of property followed by a purchase of replacement

property does not qualify as an exchange unless a “qualified intermediary”



is used who: acquires the initial seller’s property (the taxpayer’s), transfers such property to the buyer, acquires the replacement property and transfers that to the taxpayer.

* §1.1031(k)-1(c)(4) - If the exchange is to be deferred (part of a three or

four party exchange), the identification and timing rules must be satisfied. For identification, any three properties may be identified regardless of their fair market value. In the alternative, other rules allow more than three properties to be identified depending on their fair market value as it relates to the sale property’s fair market value. These regulations also provide detailed rules about the mechanics of identifying potential replacement property.

c. Because this is a planning situation, the researcher at this point is responsible for

educating the taxpayer so that he can best plan the transaction. The only possible remaining question is the impact on the possibility of a tax free exchange if the property acquired is planned to be demolished.

Chapter 4: No additional work

Chapter 5: a-c In addition to the Code and Regulation cites listed above, students should have

located a case directly on point to the facts before the student. The Tax Court, in Knight v. Commissioner, 75 TCM 1992 (1998), held that the Code is clear in its requirement that the transfer of the replacement property must occur within 180 days after the initial transfer. In Knight, the sellers of the identified replacement property backed out of the arrangement. The court stated that even though such an action was beyond the taxpayer’s control, and even though the taxpayer’s made a “good faith attempt to adhere to the statute,” the Code and Regulations state that if the timing requirements are not met, the provisions of IRC §1031 are not available. The taxpayers in Knight argued that the court should take a more “citizen-friendly” approach. However, the court stated that that is not the role of the Tax Court stating, “The Internal Revenue Code, not general equitable principles, is the mainspring of this Court’s jurisdiction.” The case is also interesting for its comments about the authority of IRS publications: “It is well settled that authoritative tax law is contained in statutes, regulations and judicial decisions and not in informal publications. IRS publications...are merely guides published by the IRS to aid taxpayers.” As of Feburary, 2008, the Knight case remains authoritative.



Therefore, students should conclude that in this situation, the taxpayer will be required to recognize the $8,000,000 of gain on the sale of the property. The students will also want to research the character of the gain – capital in this case. Had the researcher properly advised the taxpayer about the identification rules, a second or third property should also have been identified within the required 45 days. Then there might have been some possibility, even at this late date, to effect a transfer of the alternate property within the 180-day deadline. However, the facts do not indicate that any such property was identified - an apparent flaw in the planning. Therefore, the taxpayer appears to be out of luck.


used - what they liked and did not like, challenges and how they might be overcome. Students who did not discover the Knight case will want to hear from others who may have been assigned this question how other students discovered this case. Requesting students to record the time they spent allows you to report back to them with the range of time required. Students can then learn whether they are within the normal range or outside.



chapter. The Code and Regulations need to be carefully explained. However, sometimes it is the tendency of the student to verbatim quote the IRC and Regulations. The provisions involved are so complex that it is better for the student to paraphrase and/or carefully select only those portions of the authority relevant to the issue at hand. Given that the memo is being written after it is known that the transfer did not occur, the critical issue in this memo is the impact of the failure to transfer. Some of the provisions that were relevant at the initial stages of planning are no longer pertinent and should not be addressed in the memo. (For example, deductibility of demolition expenses.) Even seemingly relevant provisions such as the definition of “like-kind” property are no longer important because of the impact of the failure to effect a transfer of property. Thus, this assignment should provide an opportunity to discuss again the impact of facts on the issue before the researcher, and how this changes as facts develop through the natural progression of a transaction.

b. The student here needs to apply the general client-letter writing skills addressing

the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. The conclusion in this letter should be quite straightforward – unfortunately, the transaction is a taxable transaction resulting in the need to



recognize $8 million of income. The student can practice using language that tries to soften the blow...perhaps suggesting future planning to lessen the tax blow, etc.

Case Study D (Dentist and damages award)

Chapter 1: a. Potential additional questions students may identify include:

* What are the details of the jury verdict? Was there a breakdown of the damage award?

* What were his actual medical expenses, by year? Did he take a deduction

for those expenses on any tax return?

* When did taxpayer receive the damages?

b. Potential sources of helpful information include: * the initial complaint filed which should provide information about the

breakdown of the damage request.

* the formal judgment paperwork which may provide the breakdown of the award.

* prior tax returns to determine if medical expenses were taken that relate to

this award.

c. Relevant facts: *Dentist received an award for damages in the amount of $3,080,000.

* Such award was made on the basis of a complaint claiming defamation and intentional infliction of emotional distress due to an untruthful rumor which resulted in the taxpayer’s loss of his dentistry business. *Taxpayer lost his business and as a result suffered from stress-related severe headaches, facial twitches and loss of appetite.

Irrelevant facts: *Age of taxpayer *Information about the person spreading rumor *Why the rumor was spread

d. After review of the materials, additional questions may arise. In addition, once the

student reviews the law, it is quite likely that additional questions will arise. The first question the student may identify is whether the damages received are taxable income. It is unlikely they will identify any additional issues. The new information helps the student to be more specific in identifying the research



issues. For example, additional issues that the new facts may trigger include:

* Is the $1,000,000 for lost wages includible in taxable income? (This is always an interesting subject as the research progresses, because most students simply assume that the lost wages must be included and thus do not even identify it as an issue.)

* The information about the $50,000 reimbursement for medical expenses

confirms that the student must review prior tax returns to determine if medical expense deductions were previously taken. It also presents a possible question regarding the treatment of expenses for psychological help.

* The $25,000 reimbursement for attorneys fees paid triggers a question

about this treatment. If the reimbursement is income, can taxpayer take a deduction for these fees?

* The information about the $2,000,000 in punitive damages should help the

student refine the question, specifically calling into issue the treatment of punitive damages received.

* What is the treatment of the $100,000 for pain and suffering award

received?

* What is the treatment of the $30,000 to compensate Tooth for the emotional distress he suffered?

* The payment of the $300,000 to taxpayer’s attorney creates an additional

research questions as to whether this payment can be deducted.

e. It is most likely that the taxpayer’s desired result is that the entire award will be excluded from taxable income and that the $300,000 in attorney’s fees paid will be deductible. It is important for the student to identify this because this provides a starting point or context for defining the researcher’s role. Although the researcher most definitely must look at all relevant authority carefully, the researcher will be looking at it from the vantage point of attempting to see whether an exclusion of the income can be supported (as well as a deduction of the legal fees). If the student were an employee of the IRS, the vantage point might be somewhat different. The research tools and process is the same, but it is very useful to begin with an understanding of the taxpayer’s desired outcome, even if this ultimately is not a viable one.

f. This is not a planning research situation because all the facts are already set and



the taxpayer has no ability to alter them. Of course, planning can occur in helping the taxpayer determine the best strategy for using the award once the amount of taxes is known.

Chapter 2:

a. The relevant Code Sections are: * §61- Gross income includes all income from whatever source derived.

* §104(a)(2) - Gross income does not include the amount “of any damages

(other than punitive damages) received (whether by suit or agreement) on account of personal physical injuries or physical sickness.” No exclusion is allowed for any amount taken as a medical expense deduction under §213 for any prior taxable year. Note: P.L. 104-108 added the word ‘physical’ where underlined preceeding.

* §104(a) flush language: “Emotional distress shall not be treated as a

physical injury or physical sickness. The preceding sentence shall not apply to an amount of damages not in excess of the amount paid for medical care...attributable to emotional distress.”

* §162(a) - Expenditures are deductible where they are ordinary and

necessary expenses of the taxpayer’s trade or business.

* §212 - Legal expenses, including attorneys fees, court costs and similar expenditures, are deductible if incurred in the production or collection of income.

* §213 - Medical expenses are allowed as a deduction the expenses paid

during the taxable year, not compensated for by insurance, for medical care of the taxpayer, his spouse, or a dependent to the extent that such expenses exceed 7.5 percent of adjusted gross income.

b-d Through studying the Code Sections cited above, students should have refined

their questions quite a bit. * The students should have concluded that the punitive damages must be

included in taxable income since the exclusion provision specifically omits this type of damage from the exclusion and IRC §61 includes it income. (This is a good opportunity to review the historical amendments for this section. There have been several relatively recent amendments relating to this type of situation that the students may find interesting. In addition, this will help them when they perform research in case law because most of the cases interpret the Code before the changes and can



thus be quite misleading.)

* Students will want to return to the client to find out what the actual medical expenses were related to the client’s emotional distress. Although this portion of the Code provision is difficult to read with all its double negatives, the impact is that the award for emotional distress will be included in income unless it went to pay for medical expenses incurred for such distress.

* The remaining issues require further research, but the student is better

informed and should have an overall better understanding of the subject matter and the issues from studying the Code. The student also must determine whether the damages received were on account of “physical injuries.” What is “physical”? Is “pain and suffering” physical? What about the stress-related symptoms?

Chapter 3: At first glance, Treasury Regulations §1.104-1 appear to provide guidance in this situation. However, this is an excellent example of how important it is for the student to check the reliability of the Regulations. By using any of the steps detailed in this chapter for doing so, the student should discover that these Regulations are solely out of date and do not reflect any of the changes made to the Code Section in recent years. Therefore, the Regulations are not helpful overall. The only language that they may want to notice (because subsequent case law addresses it) is the statement in Treas. Reg. §1.104-1(c) stating that the term damages received means an amount received through “prosecution of a legal suit or action based upon tort or tort type rights...” At this junction in their research, however, the significance of this statement will not be particularly clear.

Chapter 4: a. The case of Threlkeld v. Commissioner, 840 F.2d 2, 88-1 USCT ¶9370 does

appear to address many of the research questions. The case also involved a situation where damages were received as a result of a defamation action. The court looked to prior case law, particularly Roemer v. Commissioner, 716 F.2d 693 (CA9, 1983), and held that compensatory damages received pursuant to a judgment in a suit for injury to a person’s reputation would be excluded from gross income. Both courts held that the critical factor in determining whether damages are on account of “personal injuries” is the original nature of the claim filed. If the original claim was considered to be a “tort” by the state in which it was filed, then the damages paid in accordance with that claim are “on account of personal injury” regardless of the actual nature of the damages themselves. Thus, the case and its progeny (students may end up reading many of these cases) would hold that the compensatory damages received by the taxpayer are excludible.



This is another excellent illustration of the importance of always centering the research on the Internal Revenue Code. Hopefully, some students will note that the case law discussed above was interpreting the Code as it was written prior to the amendments discussed in the Chapter 2 answer. Therefore, the cases do not discuss the current language “on account of physical personal injury.” Nor do the cases accurately address the issue of punitive damages or emotional distress. Students may wonder why they did not discover this by reviewing the citator. This is a good opportunity to review again with them what information the citator can provide them. It does not alert them to the inapplicability of a case due to a change in the IRC.

Chapter 5:

a-c Treatment of lost wages, medical expenses not previously deducted, pain and suffering are all compensatory damages that will be excluded from gross income under IRC §104(a)(2) if the student concludes that the damages were received on account of personal physical injuries. After review of the case law noted in Chapter 3, the necessary analysis appears to be examining the actual type of damages received: were they to compensate for physical injury? This is quite different from the analysis found in case law which looks at the actual type of the claim, and determines that if the claim is a “personal injury claim,” then the damages are all personal injury. Defamation is a personal injury claim. So at least the initial threshold test is satisfied. But now, the student must also look to see if the “physical” injury element is satisfied. Some of the damages will clearly fall into this category. These are: reimbursements for medical expenses not previously deducted. (However, even here, one needs to ask whether the psychologist’s expenses fit.) With respect to the “pain and suffering,” there is little helpful authority on this subject. The reimbursement for lost wages has traditionally been accepted as compensatory damages that are excluded if the claim was for a personal injury. In this situation, such exclusion is now unclear.

Obviously, this is a question with few black and white answers. The lack of clarity should lead to a good discussion and recognition by students that tax law is continually moving and provides spectrums of possibilities rather than always definite answers. This being said, the student must also realize that the taxpayer must ultimately make a decision based on the student’s advice – report the amounts in income or exclude them.

One of the issues identified cannot be answered until the student reaches some conclusion on the treatment of the damages. The deductibility of the legal costs incurred in the damage award is only possible if the award is determined to be included in income. [See Church v. Commissioner, 80 TC 1104 (1983).] Then the student should conclude that the legal costs involved in producing tax income are



deductible under IRC §212(1). Another interesting approach students might take is based upon an 11th Circuit Court decision rendered in 2001 that held that the interest earned prior to payout of a taxable award, if paid directly to attorneys under a legal contact to do so, will not be taxable. [Foster v. U.S., 87 AFTR2d 2001-2011.]

Regarding the medical expenses, if the student discovers that the taxpayer previously deducted the medical expenses, and the student determines that the reimbursement of these expenses would otherwise be excludable, the student should think of the possibility of amending the previous returns to remove the deduction so that the exclusion can be allowed. This may lead to a very important discussion about the significant difference between the value of an exclusion and a deduction.




Chapter 7: a. The student here needs to apply the general memo-writing skills addressed

in the chapter. In this situation, there are a number of issues. It is best if each is addressed clearly and separately.


the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because of the number of issues involved, the student needs to pay particular attention to separating them and clearly indicating any conclusions. Because the student may believe there is support for the taxpayer to exclude some of the amounts but with risk, it is important that the student clearly indicate that there is quite a bit of question about how such an exclusion would be viewed by the Service and the courts. Of course, the student may also conclude that the amounts must be included and that the student would not be comfortable signing a return without such inclusion. This presents a good opportunity to discuss the ethical rules and considerations discussed in Chapter 6.

c. This presents the student with a good opportunity for practicing advocacy skills.



The student will want to be careful to clearly explain the issues so that the lack of clear authority disallowing the exclusion is clear.

Case Study E (London assignment)

Chapter 1: a. Possible additional questions include:

* When did Ellie acquire the home? * What was the fair market value of the home when it was passed to Ellie? * What improvements has Ellie made to the home since acquisition? * Is she married? For how long? * Does she plan on returning to the United States? Will she return to her

home? For how long? * What is the rental value of the home?

b. The student might wish to see the following additional documents:

* Taxpayer’s prior tax returns * Her last deceased parent’s Form 706 * The document bequeathing Ellie that house

c. At this juncture, the student is probably unsure what facts are relevant. However,

those that appear relevant at the time include: * Home was bequeathed to Ellie * She has been assigned by her employer for a minimum of four years to a

position in Europe * Ellie would like to keep her house and rent it * Ellie will receive a housing allowance to cover her London housing costs * Ellie believes the house has a fair market value of at least $500,000 * Ellie wants to avoid taxable income should she have to sell the home

d. Once the student performs additional research, it is quite likely that he will need

to ask more questions at a later point. Until the pertinent authority is examined, the student will not be able to anticipate all the facts needed to address the question.

e. The first question the students may try to answer is whether Ellie will be able to

avoid recognizing taxable income should she sell her home given the facts stated above. Another question students may identify is whether Ellie is entitled to depreciate the home while it is being rented and deduct other expenses incurred in the house’s upkeep. In addition, what is the treatment of the housing allowance? Will the rental income be taxable to Ellie?

f. Ellie would like to rent out the house, take any allowed deductions and avoid

paying tax if she should end up selling the house. Knowledge of Ellie’s wishes



helps the student understand the context in which he is researching and provides a starting point for the research.

g. This is a planning research situation because not all the facts are currently fixed.

Depending on the research results, Ellie can control many of the facts by acting in accordance with the student’s advice.

Chapter 2: a. The relevant Code Sections include:

* §61- Gross income includes all income, from whatever source derived. (a)(5) specifically lists rental income

* §1014(a)(1) - Basis of property acquired from a decedent is the fair market

value at the date of the decedent=s death. * §1012 - General basis rules which would include in basis capital

improvements made that were not deductible.

* §121(a) - Gross income does not include gain from the sale or exchange of property if, during the 5-year period ending on the date of sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.

* §121(b)(2) - The amount of gain excluded from gross income shall not

exceed $500,000 for taxpayers filing a joint return.

* §121(d)(6) - The gain will be recognized to the extent of any depreciation allowed.

* §162 - Provides a deduction for expenses incurred in carrying on a trade or

business.

* §167(a) - A depreciation deduction is allowed for the exhaustion, wear and tear of property used in a trade or business.

* §168(b)(3)(B) - The straight-line method is used for residential rental

property.

* §168(c)(1) - The accelerated recovery period of residential property is 27.5 years.

* §263 - No deduction is allowed for capital expenditures.



* §469 - Passive loss rules will prohibit the deduction of a net passive loss. Real estate rental is a passive activity. If the adjusted gross income of the taxpayer is less than $100,000, up to $25,000 in rental real estate losses will be allowed each year. [§469(i)]

b. The Code Sections identified as relevant creates the need to discover many

additional facts, including those provided following the initial interview. Study of the Code only presents a few additional research issues: how is the two-year rule in IRC §121 applied? Can the taxpayer choose not to depreciate the home? Is rental of the home a “trade or business” so that IRC §162 and §167 apply? Additional information is needed to understand whether the passive loss rules will prevent the deduction of any net rental real estate loss. However, such information can easily be gained from review of the tax returns. In addition, students do not have any information about property taxes on the house nor on the husband’s ownership interest in the house. Since students were not given this information, they will need to make certain assumptions, clearly state those assumptions, and then understand the rules depending on which way the facts really fall.

c. The Code thoroughly addresses the research question. Probable conclusions are:

* The basis in the home is $380,000. This is calculated as follows: Fair market value at time of parent’s death: $300,000 [§1014] Plus: renovation costs 65,000 [§§1012, 263]

fence and landscaping 15,000 [§§1012, 263]

* If Ellie goes to London for four years as planned and then returns, she will need to live in the home for at least two years before she sells it if she is to exclude any gain from its sale. The current potential gain is $120,000: $500,000 fair market value less the $380,000 basis. [§1001]

* If Ellie returns and lives in the home with her husband for two years, she

will be able to exclude up to $500,000 of gain generated by the sale of the home, assuming Ellie and her husband file a joint return. This is true even if only Ellie holds an ownership interest in the home, as long as both Ellie and her husband used the home for the two years as their principal residence. [§121(b)(2)(A)]

* If Ellie does not return to her home but instead takes another international

assignment following the London assignment, she will not be able to avoid recognizing any gain from selling her home unless she returns and lives in it with her husband for at least two years before the sale. Otherwise, it would be better for her to sell the home within 3 years of their move to



London. Anytime during this period will entitle Ellie to apply the IRC §121 exclusion since they will have met the two year rule. After that time period, they will fail to meet the two year rule.

* If Ellie rents the property while in London, the rental income of $2500

will clearly be taxable. [§61] However, she will also be entitled to take as a trade or business deduction the monthly expenses of $1100 required for upkeep. In addition, she will be entitled to take an annual depreciation deduction of $13,818. [§168] Therefore, her net taxable income from the rental of the home is: $30,000 rental income - 13,200 expenses - 13,818 depreciation = $2982. Ellie most probably is also paying property taxes for the home which are deductible and would go to reduce this gain and perhaps turn it into a loss which is then subject to the passive loss rules. Because the students do not have this information, they will need to fork their analysis.

* If Ellie decides to rent the property, upon sale, she is required to recognize

at least the depreciation she was entitled to take (even if she did not take it). [§121 (d)(6) - depreciation “allowable.”] Therefore, if she stays in London for 4 years and then returns and stays long enough to qualify for the exclusion, if she rents the property, she will nonetheless be required to recognize $55,272 (the four years of depreciation) upon the sale, assuming there is a gain.

d. The only additional question students may have concerns the requirement

imposed by IRC §121 that the taxpayer use the home for at least two years out of five. What types of absences are allowed? What if the husband occasionally returned? Are there any planning ideas that more information about the Code Section might produce? IRC §121 requires that both spouses must meet the use requirements to be entitled to the $500,000 exclusion. This is important because one possible idea might be for Ellie’s husband to return after the third year away, thus establishing the two years of residential use for the five year period. This action will not entitle them to exclude $500,000 (less depreciation taken), but it may enable them to exclude up to $250,000. This is because Ellie’s husband may qualify under IRC §121 if he also owns the home.

Chapter 3: a-c Treas. Reg. §1.121-1(c) indicates that for purposes of determining whether a

property is used as a principal residence, short temporary absences such as vacations and seasonable absences can still be counted as residency. However, the Regulations also state that a one-year sabbatical absence cannot be included as a period during which the home was used as a residence (example 4). This



language suggests that the absences anticipated by Ellie and her husband will not be counted as time the home was used as a residence.

Regulation Section 1.121-1(b)(4) addresses the definition of principal residence and states that whether or not property is used by the taxpayer as the taxpayer's principal residence depends upon all the facts and circumstances. Example 1 addresses a situation where the taxpayer alternates between two properties, determining that the property where the taxpayer resides the longest will be eligible for the exclusion without facts indicating this is not the taxpayers principal residence.

d. There are really no additional questions left unanswered.


Chapter 5: No additional information was produced as a result of more research. The

Code provision is still too new to find any case law on the subject.

Chapter 6: No additional questions


chapter.

b. The student here needs to apply the general client-letter writing skills addressed in the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. This is particularly important since this is a planning letter, and Ellie is likely to rely upon the advice given. This may be a difficult letter for some to write because of all the possible actions available to Ellie and because of the calculations. A good challenge to the student!

Case Study F (Investment in 401(k) plan)

a. Potential additional questions might include: * Does Tom participate in any of the company’s other pension or retirement

plans?

b. Additional potential sources of information might include: * The 401(k) plan document * Employer-provided information about the plan * Prior years’ tax returns

c. All of the above facts appear relevant.



d. The student may need to ask additional questions after further study of the

relevant authority.

e. The first question the student will try to answer is whether a taxpayer can accelerate contributions made to a 401(k) plan or whether such contributions must be evenly distributed throughout the year.

f. The taxpayer would like the researcher to tell him that he can accelerate the

contributions.

g. This is a quasi-planning situation. Tom will be relying upon the research results and may make early contributions if the research indicates this is possible. Otherwise, all the remaining facts appear fixed.

Chapter 2:

a. Additional research questions now exist due to the new facts. The relevant Code Section for both the original question and the new ones include: • §401(a)(16) - A plan must limit the contributions that can be made on behalf

of the employee.

• §402(g)(1) - An employee may elect to defer under a 401(k) plan no more than $7,000 (adjusted for inflation each year - 2006 and after = $15,000.

• §402(g)(2)(A)(ii) - Excess deferrals must be either corrected by April 15 of

the following year and included in the employee’s gross income.

• §401(k)(3)(A) - The plan is required to meet one of two actual deferral percentage tests to prevent the highly compensated employees from electing to defer a disproportionately higher amount of their salary.

• §415(c)(1) – Annual contributions are limited to the lesser of $40,000 or

100% of participant’s compensation.

• §501(a) - The income earned by funds while held under the qualified plan is tax exempt.

• §79(a) - There shall be included in the gross income of an employee for the

taxable year an amount equal to the cost of group term life insurance on his life only to the extent that the face value of the insurance exceeds of $50,000. Such cost is determined in accordance with the Regulations.



• §106 - Gross income of an employee does not include employer-provided

premiums for accident or health insurance covereage.

• §127 - Up to $5,250 in educational reimbursements can be excluded if such amounts were provided by an employer under an educational assistance program. The education may now be graduate or undergraduate.

b. The Code answers some of the research questions, but not all. Thus far, students

can conclude the following: • The medical insurance premiums paid by the employer are excluded under

IRC §106.

• The $100,000 in life insurance provided by the employer will result in some amount of taxable income to Tom. How much is not yet known and will likely be answered by the Regulations.

• If Tom takes either level of the “Organizational Behavior” class under the

company’s educational assistance program, the tuition paid for this class will be excluded from Tom’s income. Also excluded will be reimbursements for books and class equipment as long as the total for the year does not exceed $5,250. [IRC §127] Students should note that this Code provision for many years contained a sunset provision resulting in its frequent termination, followed by renewal. In one of the most recent tax acts, Congress finally decided to make this Code Section more permanent, removing the sunset provision.

• Because company’s 401(k) plan must have a definite written program, Tom

will probably only be able to make contributions in a manner outlined in that plan.

• The deferred employee contribution amounts under 401(k) are not subject to

income tax. Also, income earned under the plan is tax-exempt until its distribution, and amounts distributed are not subject to social security taxes.

• If Tom accelerates the payments and then leaves the company too early in the

year, his contributions might exceed the limitation. The company would have to return the excess contributions and Tom would have to take the excess into income.

c. Some remaining questions include:



• How is the company match made on the 401(k)? For instance, if the company only matches up to 3% a pay check, Tom may not receive the $3,000 maximum employer contribution that he would otherwise have received because the company will have no employee contributions to match later in the year.

• Does the company plan or the case law allow Tom to contribute in the manner

he desires?

Chapter 3: a-c: The following Regulations are relevant to the research questions:

• §1.79-3(d) provides information regarding the appropriate calculation for determining the amount that must be included for excess life insurance. Because Tom is 50 years old, the includible amount is 48 cents per month per each $1000 in excess of the $50,000. Therefore, $5.76 (.48 x 12) times 50 (the number of 1,000s in excess of the allowed $50,000) = $288 that must be included in Tom’s income. This should be reflected in his W-2.

• §§1.401-1&-2 describe the requirements for a plan to be qualified.

• §1.415-6(b)(6)(iv) describes the treatment of earnings of excess plan

contributions.

b. The question regarding accelerated contributions still remains.


Chapter 5: a-c Most of the answers were addressed in previous chapters through study of the

Internal Revenue Code. Students will not find any additional information regarding the question about accelerated payments of the 401(k) contributions. Therefore, students will most likely also have attempted to research the question in the letter rulings. Unfortunately, no letter rulings appear to shed light on this question. As a result, students will have to draw a conclusion based upon the limited information they have. Because there does not appear to be a requirement that such contributions be evenly distributed throughout the year, it seems reasonable to assume that contributions may be made on an accelerated basis, with the one caveat that it cannot exceed 25% of the compensation earned to that point. Of course, the plan itself may control the timing and matching of the contributions. So to make a final recommendation, students would need to study this document carefully.




chapter. c. The student here needs to apply the general client-letter writing skills

addressing the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because the student may not have found conclusive authority for allowing the accelerated payments, the wording regarding this will need to be very carefully crafted and alert Tom to potential risk of disallowance.

d. This will provide the student with the opportunity to write a fairly straight

forward protest letter advocating for the client’s return position. This may require further research into IRC §162 and its Regulations if the student concluded that Tom could have excluded the reimbursements under IRC §127.

Case Study G (Toby and tax-free formation of corporation) Chapter 1:

a. Possible additional questions include: • What was her original cost in the office building? • Did she make any improvements on the office building since ownership? • What depreciation did she take on the building since transfer? (This will most

likely be gathered from review of tax returns. • What are the terms of the $100,000 promissory note? • Has she made any payments on the note?

b. Possible additional potential sources of information include:

• Toby’s prior years’ tax returns • Promissory note • Incorporation documents

c. Relevant facts: * Ten people formed a corporation to sell golf balls.

* Eight contributed equipment and cash for an equally divided 80% interest in the company. * Taxpayer contributed an office building with a fair market value of $1 million and a $100,000 promissory note to the company in exchange for a 20% interest in the company. * The transferred office building had liabilities of several hundred thousand.



* Taxpayer resides in Illinois. Irrelevant facts: * All other facts provided

e. Once the student reviews the relevant authority, it is most likely that she

will need to ask more questions.

e. At this stage, students will probably be unable to identify any specific issue and will simply state that the question is whether the transaction was structured to minimize any potential tax impact.

e. This is a not a planning type of research situation because it appears that

all the facts are already fixed. The client wants comfort that the transaction was structured properly.

Chapter 2: a. Relevant Code Sections include:

• §351(a) provides that no gain or loss shall be recognized if property is

transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control of the corporation.

• §362(a)(1) provides that the basis of property received by a controlled

corporation in a tax-free transfer is equal to the basis of the property in the transferor’s hands increased by any gain recognized by the transferor.

• §357(a) provides that the assumption of liability by a transferee corporation in

a transfer to a controlled corporation under §351 is not “money or other property” received by the transferor and will not prevent the transaction from being tax free.

• §357(b) prohibits the tax avoidance purpose. If the principal purpose of the

taxpayer with respect to the assumption of liability was a purpose to avoid income tax on the exchange, or was not a bona fide business purpose, the assumption of liability is to be considered as money received by the taxpayer on the exchange.

• §357(c) provides that if the liabilities assumed to which the property is subject

exceeds the total basis of all the properties transferred in a Code §351 exchange, the excess is treated as gain from a sale or exchange of a capital asset or a non capital asset.



• §358(a) sets the basis of the interest received in the hands of the transferee taxpayer in a §351 exchange

b. Analysis of the relevant Code Sections should help the students more clearly

identify the research questions. Now students should be asking: With the new facts, must Toby recognize any income as a result of the transfer of the building and the note to the corporation? What is her new basis in her corporate interest? What is the impact to the transaction of the note transferred?

c-d The Code addresses most, but not all, of the questions. When applied to the facts,

the Code provides us with the following: • The transaction appears to qualify as a Section 351 exchange in that the

transferring group received the required control.

• The amount of liabilities on Toby’s office building at the time of transfer totals $410,000 (Note A = $310,000 + Note B = 100,000). The basis in the building at the time of transfer was Toby’s purchase price of $500,000 less the $100,000 depreciation taken, or $400,000. Therefore, the amount of liabilities assumed by the corporation on Toby’s property exceeds her basis by $10,000. The question that remains is how does the note impact this transaction? Does the note have basis exceeding $10,000 so that Toby does not have liabilities in excess of her basis? If the personal note transferred to the corporation for exchange of corporation’s stock has a basis of its full face value, it would increase the aggregate basis of property transferred so that liabilities no longer exceed the aggregate basis. Thus, IRC §357(c) would not apply and there would be no gain triggered. However, if there is no basis in the note, then Toby must recognize the $10,000 excess liabilities assumed.

Chapter 3: a-d The Regulations for IRC Sections 351-358 do not address the issue of the

personal note and how to determine its basis in this situation. They simply explain and restate the rules set forth in the Code as outlined above. Nor do the Regulations for Section 1012 address how to determine the basis of a note. The questions remain unanswered at this point.

Chapter 4:

a-c The case of Peracchi v. Commission, 143 F3d 487, 98-1 USTC ¶50,374 CA 9, 1998) (authoritative as of February 2008) does directly address the research question. The relevant facts in this case are that the taxpayer transferred two parcels of real estate to a wholly owned corporation in a Section 351 transaction. The liabilities on the real estate exceeded the taxpayer’s basis by $500,000. In an effort to avoid having to recognize the gain triggered by the excess liabilities, the taxpayer wrote a promissory note for over $1 million for a ten year term at 11%



interest. The taxpayer claimed the basis in the note is equal to its face value, and therefore he has no recognizable income at the time of the Section 351 transfer. The Service’s position is that the note is not a genuine debt and therefore is unenforceable. It also states that even if the note is genuine, it does not increase the taxpayer’s basis in the contributed property.

The court in Peracchi starts with an analysis of IRC §1012 which states that the basis of property is the cost of such property. However, the Code does not define “cost.” Although the IRS states that as a result, there is no basis in the note, the court points out that the note is worth something to the corporation should it become bankrupt. Corporate creditors will be able to go after the taxpayer’s personal assets. The court considered whether bankruptcy is a significant enough contingency to provide basis to the note and concluded that it is. The court concluded that the taxpayer incurred a “cost” of $1 million when he promised to pay the note. The court held that the note’s basis was its face value, and thus the taxpayer did not have recognizable gain on the transfer. In providing support for its conclusion, the Court quoted a secondary source, Bittker and Eustice’s treatise Taxation of Corporations and Shareholders, which said: “Section 357(c) can be avoided by a transfer of enough cash to eliminate any excess of liabilities over basis; and since a note given by a solvent obligor in purchasing property is routinely treated as the equivalent of cash in determining the basis of the property, it seems reasonable to give it the same treatment in determining the basis of the property transferred in a §351 exchange.”

Students should note that the facts in this case are somewhat different from those they are researching in that Perachhi was the sole owner of the new corporation, where Toby will only own 20%. It is unclear if this difference would alter the decision of the court. It is also interesting to note two observations about the Peracchi case: Judge Kozinski has a humorous flare to his writing (an atypical style!) and there was a dissenting opinion.

d. Students will probably feel comfortable at this juncture that they have the correct

answer to the research question. However, they will definitely need to citate the Peracchi case to ensure that it is the most current case (it is as of August 2005). In addition, Toby is an Illinois resident, and the Peracchi case is a 9th Circuit case which does not have jurisdiction over Toby.

Chapter 5: a-c In addition to the Code Sections cited above and the Peracchi case discussed in

Chapter 4, the students should have discovered a 2nd Circuit case, Lessinger v. Commissioner, 872 F.2d 519, 89-1 USTC ¶9254 (CA 2, 1989). This case also looked at the issue of a tax-free exchange under IRC §351 and the impact of the



transfer of a note to the newly established and wholly owned corporation. The IRS argued and the Tax Court held that the note had a zero basis, citing Alderman v. Commissioner, 55 TC 662 (1971). The 2nd Circuit reversed the Tax Court’s decision and held that the Lessinger facts are different from those in Alderman because Lessinger’s note does have a value to the corporation. In Lessginer, the court held that although the taxpayer has no basis in his own promise to pay, the corporation does have basis equal to its face value. The court took an unusual approach in interpreting IRC §357, stating that the reference to “basis” includes basis of the transferee as well as the transferor. Therefore, the court held that the taxpayer had no Section 351 gain since the transferred liabilities did not exceed the basis in the transferred property.

Students should note that the 9th Circuit chose not to follow the reasoning applied in Lessinger, stating that such an approach was “untenable.” The court disagreed with two conclusions in Lessinger: that the note had a basis of zero in the hands of the transferor, and that “basis” can include the transferor’s basis. However, the court agreed with the conclusion of Lessinger stating that the two erroneous positions “...was enough to dispel any section 357(c) gain to the taxpayer, proving that two wrongs sometimes do add up to a right.”

The students should be aware that this is an area of some controversy, with the IRS and Tax Court taking the position that a note in a Section 351 transfer will not help the taxpayer avoid the impact of IRC §357(c). Treasury in Rev. Rul. 68-629, 1968-2 C.B. 154 held that there is taxable gain when a promissory note is issued for the excess of liabilities over the basis of assets transferred to the controlled corporation. The IRS concluded in that ruling that the promissory note has a zero basis since the taxpayer incurred no cost in the creation of the note. However two circuits, applying different reasoning, disagree with the IRS and the Tax Court.


used - what they liked and did not like, challenges and how they might be overcome. Students who did not discover the Lessinger case will want to hear from others who may have been assigned this question how other student’s discovered this case. Requesting students to record the time they spent allows you to report back to them with the range of time required. Students can then learn whether they are within the normal range or outside.





chapter.

b. The student here needs to apply the general client-letter writing skills addressed in chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because there is a split between the IRS and the appellate courts on the treatment of this issue, it is important that the student clearly indicate that there is quite a bit of question about the appropriate tax treatment of this situation. Thus, while there is ample support to treat the transaction as tax free to Toby, doing so also runs the risk of the IRS challenging such treatment.

c. This is an excellent opportunity for the student to practice advocacy skills. The

student should discuss the issue in a logical manner, first discussing the relevant Code Sections. This will set up the discussion regarding the issue and the basis for the IRS’s challenge. The students will then want to use both the Lessinger and Peracchi cases as support for the tax return position taken.

Case Study H (Private school for troubled child)

a. Potential additional questions include those intended to gather more detail on the

potential schools the Worrieds have selected. What type of services does each school provide? What are the selection requirements of each school? What specific medical or psychiatric services does each school provide? What is the stated mission of the school?

b. Sources of potentially useful information might include the schools’ literature.

c. All of the above facts appear to be relevant at this point. There are no obvious

irrelevant facts provided.

d. There always is a chance that the researcher will need to ask more questions once the relevant authority is examined.

e. The initial question is simply whether such expenses will qualify as deductible

medical expenses. As the student researches, additional issues may arise.

f. The Worrieds want the student to conclude that the expenses will be deductible expenses. This should affect the student by providing the student with some direction as to the focus of the research - is there some way the expenses can be deductible?

g. This is a planning research situation because not all of the facts are currently



fixed. There is still some opportunity for the Worrieds to structure the facts in accordance with the research results.

h. This question provides the students with an opportunity to examine their

predispositions regarding the research results. This may lead to a discussion about the danger of being strongly predisposed to a certain result prior to performing research.

Chapter 2:

a. The following Code Sections are relevant: • §213(a) provides that expenses paid for “medical care” during the taxable year

that are not compensated for by insurance are allowed as a deduction to the extent that such expenses (when combined) exceed 7.5 percent of adjusted gross income.

• §213(d) provides that “medical care” includes amounts paid for the

“diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.” Deductible medical expenses may include lodging “while away from home primarily for and essential to medical care, if...the medical care is provided by a physician in a licensed hospital (or a medical care facility which is related to, or the equivalent of, a licensed hospital)...”

• §262(a) states that there shall be no deduction for personal, living, or family

expenses.

b. Studying the relevant Code Sections should help the student refocus the research towards the definition of “medical care” and whether the facts as provided are sufficient for one of the schools to be considered a “medical care facility.”

c-d The Code does not answer the research question, but provides a beginning point

for the student’s research. At this juncture, students may not be feeling very optimistic about the possibility of locating positive authority. However, it is definitely too soon in the research process to draw a negative conclusion.

Chapter 3: a. The following Treasury Regulations provide relevant guidance:

* §1.213-1(e)(1)(ii) - Amounts paid for psychoanalysis which is primarily for the purpose of alleviating a mental illness or defect qualify as medical expense.



* §1.213-1(e)(1)(v)(a) - “Where an individual is in an institution because his condition is such that the availability of medical care ... in such institution is a principal reason for his presence there, and meals and lodging are furnished while the individual requires continual medical care,” such care will constitute a medical expense. “For example, medical care includes the entire cost of institutional care for a person who is mentally ill and unsafe when left alone. While ordinary education is not medical care, the cost of medical care includes the cost of attending a special school for a mentally or physically handicapped individual, if his condition is such that the resources of the institution for alleviating such mental or physical handicap are a principal reason for his presence there. In such a case, the cost of attending such a special school will include the cost of meals and lodging, if supplied, and the cost of ordinary education furnished which is incidental to the special services furnished by the school. Thus, the cost of medical care includes the cost of attending a special school designed to compensate for or overcome a physical handicap, in order to qualify the individual for future normal education or for normal living...”

* §1.213-1(e)(1)(v)(b) - “Where an individual is in an institution, and his

condition is such that the availability of medical care in such institution is not a principal reason for his presence there, only that part of the cost of care in the institution as is attributable to medical care...shall be considered as a cost of medical care; meals and lodging at the institution in such a case are not considered a cost of medical care...For example, an individual is in a home for the aged for personal or family considerations and not because he requires medical or nursing attention,” only the cost attributable to medical care or nursing will be deductible.

* §1.213-1(e)(1)(v)(c) - It does not matter whether the institution is a

government sponsored institution or privately owned.

b. The Treasury Regulations listed above help further refine the research question so that the student now needs to determine whether the schools the Worrieds are considering might qualify as “special schools” in accordance with the Regulations. This appears to be primarily a factual determination. The student must also consider whether the principal reason for the son’s attendance at the school is for the benefit of the family members or because the resources of the institution may alleviating the son’s mental disabilities.

c-d The Regulations certainly help address the research question. However, it is still premature for the student to cease researching. Further guidance might very well be present in case law.



Chapter 4: No additional work required

Chapter 5: a-c In addition to the Code and Regulation Sections cited above, there are several

relevant cases that the students should find. Overall, they indicate that the following factors need to be considered in determining whether a medical expense for schooling costs will be allowed: These factors are: • The primary reason for sending the student must be medical, not educational.

(Intent of the taxpayer)

• The school’s primary mission should be to service students with a certain type of mental or physical challenge.

• The school admissions policies should reflect this mission and focus on

admitting primarily students with similar medical problems.

• The curriculum of the school must reflect the mission. Therefore, the educational services the school provides must in fact be incidental to the medical care provided by the school. If the educational services provided are greater than those necessary to treat the medical condition, the school most likely will not be a “special school.”

• The qualifications of the staff must reflect the school’s mission to serve

students with medical challenges.

Favorable Decisions:

• A mental disorder can be considered a disease within the meaning of IRC §213. Hendrick v. Commissioner, 35 TC 1223 (1961); Licterman v. commissioner, 37 TC 586 (1961); Fisher v. Commissioner, 50 TC 164 (1968); Rev. Rul. 63-91, 1963-1 CB 54.

• Greisdorf v. Commissioner, 54 TC 1684 (1970) concluded that a school was

special and the costs could be taken as a medical expense. Here the child had emotional problems and was recommended by her psychiatrist to a school established for students with special learning disabilities, particularly psychological ones. All of the staff were specially trained in psychology, and psychiatrists were on the staff. The school only accepted children with learning disabilities. The educational program was individually tailored for each student and was directed towards the student’s psychological needs to



improve her emotional well-being. Classes were ungraded, allowing students to progress at their own pace. The court held that the principal reason for the child attending the school was to improve her mental state, commenting that “this is precisely the type of situation covered by the provisions of section 1.213-1 of the regulations.”

• Rev. Rul. 78-340, 1978-2 CB 124 held that a school designed to educate

children with severe learning disabilities was a special school. Unfortunately, the ruling does not provide any factual details to make it very useful.

• Letter Ruling 8401024 dealt with a dyslexic student’s expenses to attend a

state school that only accepted students with a specific type of learning disability. The school provided different types of specialists unavailable in the public schools (neuropsychologists, language therapists, etc.). The curriculum was tailored for students with the specific type of disability. Some students may not have researched into Letter Rulings. However, given the factual basis for making a determination in the Worrieds’ situation, it is useful to have as much analogous information as possible. Therefore, it is useful for the students to research into the letter rulings. This provides the instructor with the opportunity to review researching into Letter Rulings and their authority.

Unfavorable Decisions:

• Atkinson v. Commission, 44 TC 39 (1965). This case denied a medical

expense deduction for expenses incurred in enrolling a child in a military academy. A medical doctor recommended the child be sent to a disciplinary boarding school because he was performing poorly in public school and was exhibiting behavioral problems. (The happy ending to the story was that the child became a good student, made friends and improved his relationship with his parents!) The Tax Court found that the principal reason for sending the child to the school was educational rather than medical, even though the child’s behavioral problems improved because of his attendance. The court also held that having a doctor’s recommendation is not sufficient evidence to support the deduction, saying: “Congress did not see fit as a condition for a medical expense deduction the mere prescription by a doctor of some course of procedure regardless of the condition of the individual, the nature of the expense, and the primary and direct objectives thereof.”

• Glaze v. Commissioner, 20 TCM 1276 (1961). The Tax Court held that

military school expenses were not deductible medical expenses. The school did not provide psychiatric or medical treatment for students beyond the norm for a public school.



• Pfeifer v. Commissioner, 79-2 USTC ¶9518 (CA 10) also disallowed a

medical expense deduction for educational costs incurred in order to provide smaller class sizes and personalized help to a child with learning and organizational disabilities. The court stated that: “the distinguishing characteristic of a special school is the substantive content of its curriculum. The curriculum of a special school may include some ordinary education, but this must be incidental to the primary purpose of the school to enable the student to compensate for or overcome a handicap....Consequently, a private school that does not have a special program, aside from its general...curriculum..., to alleviate a particular disability is not a special school.” [See also VanKirk v. Commissioner, 41 TCM 615 (1980) and Walton v. Commissioner, 45 TCM 65 (1982).]

• Fisher v. Commissioner, 50 TC 164 (1968) allowed a partial medical expense

deduction for educational expenses incurred on behalf of a child with emotional and psychological problems. The school specialized and only accepted students with normal intellect but with psychological problems. The school’s curriculum was completely structured to deal on an individual basis with this type of student. The child met with a psychologist on a daily basis. The court held that the school was not a “special school” and thus disallowed a complete medical expense deduction, holding that the cost of the ordinary education was “not incidental” to the psychological services provided. However, the court found that to the extent the child received medical services, a portion of the total tuition could be allocated to these services and taken as a medical deduction. This was accomplished by comparing the school’s fees to other private schools. The court assumed that the excess fees could be attributed to the special medical services provided.

• Fay v. Commissioner, 76 TC 408 (1981) is similar in that the court concluded

that a school designed to teach students with learning disabilities was not a special school since its primary purpose was to provide education. However, the court allowed a medical expense allocation to the portion of costs attributable to the learning disability program.

• Sims v. Commissioner, 39 TCM 700 (1979) disallowed “special school”

treatment to a school that consisted primarily of regular students, but had on its staff a psychologist who provided counseling for an extra charge. The court allowed a medical expense deduction for the specific medical service charges. The court stated: “...Although (the school) serves a student population composed largely of “normal” students and offers traditional education programs, this does not preclude a finding that it is a ‘special school.’...There



is no requirement in the regulations that a special school admit only students that are suffering from a mental or physical disease or defect....However,...(the court) has rarely allowed a medical expense deduction for the full cost of a private school education.”

• Similar cases disallowing a full deduction include: Grunwald v.

Commissioner, 51 TC 108 (1968) [Blind student in school with no medical doctors or teachers specialized in teaching the blind]; Barnes v. Commissioner, 37 TCM 1408 (1978) [Military school not deductible for child with dyslexia].




chapter.

b. The student here needs to apply the general client-letter writing skills addressed in the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because this is a planning situation, it is critical that the student clearly indicate the uphill battle towards having a school considered a “special school.” This should be clearly communicated to the Worrieds as well as the risks if they choose to take a deduction. It would be best if the student structures the letter to focus on the key factors the courts and service seem to look at in determining a school’s status, followed by examples for each factor based on the case law.

Case Study I (Fire caused by taxpayer)

Chapter 1: a. Additional questions the student may ask include:

• What are the details regarding dates? When did the fire occur, when did the taxpayer file an insurance claim?

• Was the home totally destroyed by the fire?

185

• What is the value of the land on which the house sits? How much of the $900,000 purchase price should be allocable to the land?

• What personal property was destroyed in addition to the home?

• How was the $900,000 purchase price paid? In cash or using a mortgage?

• What does taxpayer anticipate will be his total gross income this year? The

student will need to discover through some means the key income and deduction items taxpayer will have for the year.

b. Useful documents include prior years’ tax returns, homeowners insurance policy, and

evidence of insurance company’s refusal to pay on the claim, property tax bills (for possible allocation between home and land).

c. The details regarding the fire are not specifically relevant except that they go to the

question regarding whether the taxpayer was negligent in his actions. At this time, students will not know whether this is or is not relevant.

d. It is always the case that after research has been performed, additional questions may be

necessary. e. The first question the students will likely identify is a basic one: Does taxpayer have a

deductible casualty loss? If so, how much is the deductible loss? Does the fact that the loss possibly occurred as a result of the taxpayer’s negligence impact its deductibility?

f. Taxpayer clearly would like to take a deduction for the loss incurred. g. This is not a planning research project because all of the facts are already fixed. h. It will be interesting in this situation to hear whether students have a feeling about the

deductibility before they research. Some may believe that because the taxpayer’s apparent negligence cause the loss, the loss will not be deductibile. Others may not have formed any impression.

Chapter 2: a. The relevant Code Sections include:

• §165(a) allows a deduction for “any loss sustained during the taxable year and not compensated for by insurance or otherwise.”

• §165(b) limits the amount of the deductible loss to the adjusted basis of the property.


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• §165(c)(3) provides that an individual can deduct losses incurred with respect to property not connected with a trade or business if the loss arises from fire, storm, shipwreck or other casualty, or from theft.

• §165(h)(1) provides that an individual can deduct a loss arising from each

casualty to the extent that the amount exceeds $100.

• §165(h)(2) provides an additional limitation on the amount that taxpayer can be deducted. Only that amount of the loss that exceeds 10% of his adjusted gross income will be deductible.

• §165(h)(4)(E) requires that an individual taxpayer file a timely insurance

claim if he has insurance coverage for the loss in order to qualify for a deduction for any amount not compensated for by insurance.

b-d The Code provides initial guidance supporting a deduction for the home.

Taxpayer did suffer a loss caused by fire to property not held for carrying on a trade or business. However, most of the initially identified issues remain unanswered: What is the impact of taxpayer’s alleged negligence on the deductibility? Also, if a loss is to be allowed, only a deduction for the loss to the home and its contents will qualify. It is unclear how much of the initial purchase price will need to be allocated to the land. This is relevant because taxpayer did not suffer a loss to the value of the land, only to the structure on the land. Given the limitation of the loss to the amount of basis in the property lost, the maximum amount of the loss will be taxpayer’s $900,000 basis (plus any basis in personal property damaged), adjusted downward to take into consideration the value of the land.

Chapter 3:

a. The relevant Treasury Regulations include: • §1.165-1(c)(1) clarifies the provision in the Code regarding basis and states

that the amount of loss allowable as a deduction “shall not exceed the amount prescribed by §1.1011-1 as the adjusted basis ...”

• §1.165-1(c)(4) states that in determining the amount of the loss, “proper

adjustment shall be made for any salvage value and for any insurance or other compensation received.”

• §1.165(d)(1) provides that a loss shall be allowed as a deduction only for the

taxable year in which the loss is sustained.

• §1.165-7(a)(3)(i) provides that a casualty loss occurs when an automobile is damaged and the “damage results from the faulty driving of the taxpayer...but is not due to the willful act or willful negligence of the taxpayer...”


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• §1.165-7(b)(1) confirms the initial determination that the loss cannot exceed the basis ($900,000 + basis in personal property) even though the fair market value of the land was higher. This provision states that the amount of loss to be taken shall be lesser of either the amount which is equal to the fair market value of the property immediately before the casualty reduced by the fair market value of the property immediately after the casualty, or the amount of the adjusted basis.

b-d The Treasury Regulations do not address the key remaining issue involving the

impact of taxpayer’s apparent negligence.


Chapter 5: a. In addition to the cited portions of the Code and Regulations, students may locate several potentially relevant cases. One such case is Heyn v. Commissioner, 46 TC 302. That case dealt with a deduction for a loss caused by a landslide that was entirely foreseeable because the taxpayer did not take heed of substantial warnings that the method of excavation used would result in a landslide. The court stated the following: “That it might have been foreseen or that it might have been prevented by the exercise of due care by the contractor are factors which in our opinion do not require that the landslide be denied classification as a casualty.” The court went on to state: “Of course, foreseeability may be a circumstance to be taken into account in determining whether a particular event is a casualty. But foreseeability alone is not conclusive. Meteorological forecasts may well forewarn a cautious property owner to take protective measures against an oncoming hurricane, but any ensuing losses may nevertheless be storm or casualty losses within the meaning of the law. Nor is negligence a decisive factor (emphasis added). Automobile accidents are perhaps the most familiar casualties today. Yet the owner of the damaged vehicle is not deprived of a casualty loss deduction merely because his negligence may have contributed to the mishap. This is made abundantly clear in the Treasury Regulations, Section 1.165-7(a)(3).”

“We are unable to perceive any distinction between a casualty loss arising from an automobile collision and one resulting from a landslide. Certainly, in the absence of gross negligence, the mere fact that the automobile owner negligently failed to have faulty brake linings replaced or that he negligently took a calculated risk in driving with smooth tires would not deprive him of a casualty loss if his vehicle were damaged in an accident occurring as a result of either of those conditions. The accident would nonetheless qualify as a casualty, notwithstanding the owner's negligence or that the accident was the consequence of his having taken a calculated risk in respect of known hazards.”


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Another potentially relevant case is Anderson v. Commissioner, 81 F.2d 457 (C.A. 10, 1936), in which a negligent driving cased damages in an automobile accident. The court described negligence as “an unintended breach of duty, resulting in injury to the property or person of another” and therefore very different from “willful.”

Carelessness alone is usually not considered a sufficient cause of a casualty. (See Keenan v. Bowers, 91 F.Supp. 771 (1950) in which a taxpayer was denied a casualty loss when she accidently flushed her diamond ring down the toilet.) However, carelessness combined with a sudden and unexpected event has triggered an allowed deduction. (See White v. Commissioner, 48 TC 430 (1967) in which a deduction was allowed when taxpayer lost her diamond ring when her husband accidently slammed the car door on her hand. [See also William Carpenter, 25 TCCM 1186 (1966) in which the court allowed a deduction when a diamond ring was destroyed by taxpayer unknowingly putting the ring in the garbage disposal.]

In Jack Farber, 57 TC 714 (1972), the taxpayer was allowed a deduction for the loss of lawn caused by his applying a chemical unintended for lawns which specifically stated so on the product label. The taxpayer had not read the label. Because the taxpayer acted on the recommendation of a salesman, the court held that the loss was not caused by the taxpayer’s gross negligence and was therefore a casualty.

Another case involving a fire is Blackman v. Commissioner, 88 TC 677 (1987). In that case, the court disallowed a casualty loss when the taxpayer set some clothing on fire on the stove during an argument. The fire spread and destroyed the house and its contents. Although the taxpayer did not intend to cause the house to burn down, the court held that the loss should not be allowed “when national or state policies would be frustrated.” Because taxpayer’s act was against state law (arson), the loss was not allowed.

b-c The Heyn case is very helpful in providing support that the loss is a deductible

casualty loss even if it was caused by the taxpayer’s negligence. However, the case, along with Treas. Reg. §1.165-7(a)(3)(i) appears to provide authority that if the loss is caused by “gross negligence” or by a “willful act or willful negligence” of the taxpayer, then the loss will not be deductible. Until the court issues a decision with respect to taxpayer’s responsibility and level of negligence, the resolution of the research question is unclear. The timing is such that this court decision may not be rendered prior to the date the return must be filed. This provides an opportunity for the students to discuss the taxpayer’s options: take the deduction for the current year and risk an audit should the court hold gross negligence or defer taking the deduction until the court decision and then amend the return (which most likely will send up a red flag re: the loss).


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d-e This is a good opportunity to discuss with the class the reference services they used - what they liked and did not like, challenges and how they might be overcome. Requesting students to record the time they spent allows you to report back to them with the range of time required. Students can then learn whether they are within the normal range or outside.

Chapter 6: No additional work required Chapter 7:

a. The student here needs to apply the general memo-writing skills addressed in the chapter.

b. The student here needs to apply the general client-letter writing skills addressed in the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because there is a great deal of uncertainty about the ultimate disposition of the facts (level of negligence) and the certainty of the law as a result, the risks of audit should a deduction be taken must be discussed. Students will need to clearly explain the taxpayer’s options.

c. This is an excellent opportunity for the student to practice advocacy skills. The student should discuss the issue in a logical manner, first discussing the relevant Code Sections and Regulation sections. This will set up the discussion regarding the issue and the basis for the IRS’s challenge. (Students should also realize that very likely, by the time the taxpayer received the audit, the results of the court case may also be known. The instructor may wish to insert a court decision on the negligence as an additional fact.)

Case Study J (Airline and safety devices)

a. Most of the relevant facts are already present. The student may wish to ask more details about the safety devices such as their individual cost and value they add to the plane. In addition, it would be helpful to have a breakdown of the anticipated costs between the actual cost of the device and the labor costs estimated to install the devices.

b. Perhaps the students might wish to see any documentation regarding the

requirement to install the additional safety devices.

c. All of the provided facts appear to be relevant.

d. There always is a chance that as a result of performing research, the researcher will need to ask more questions at a later point.

e. This problem presents two research questions: Will the cost of the safety devices

be deductible? Are the legal expenses deductible? f. The taxpayer clearly wishes to have both the cost of the safety devices and the


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legal expenses deductible.

g. Because this case deals with fixed facts, this is not a planning project.

h. This provides the students the opportunity to examine their “gut” feeling about the results of the research about to be performed. With this knowledge, the student can perhaps be better equipped to research objectively without being as greatly influenced by his predisposition.

Chapter 2: a. The following Code Sections provide useful information:

• §162(a) states that a deduction is allowed for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

• §263(a)(1) provides that no deduction is allowed for capital expenditures

which are generally defined as any amount paid for new buildings or for permanent improvement or betterments made to increase the value of any property or estate.

b-d The Code Sections represent a starting point and help to refine the questions.

With respect to the safety device costs, the refined issue becomes whether the devices are “expenses” deductible under IRC §162 or capital expenditures under IRC §263. The labor costs incurred in installing the devices appear to be deductible under IRC §162(a)(1). But another remaining question is: are the legal expenses deductible as IRC §162 expenses? The Code does not conclusively answer these research questions.

Chapter 3: a. The following Treasury Regulations are relevant:

• §1.162-4 provides that expenditures that keep property in an ordinarily efficient operating condition and do not add to its value or appreciable prolong its useful life are generally deductible as repairs.

• §1.263(a)1-2 provides that an expenditure is treated as capital and thus not

deductible if it adds to the value (or substantially prolongs the useful life) of the taxpayer’s property. However, amounts paid for “incidental repairs and maintenance” are not capital expenditures. Capital expenses include “the cost of acquisition, construction, or erection of buildings, machinery and equipment...” In addition, legal and other costs incurred in defending or perfecting title to property are capital expenditures.

. b-d The Treasury Regulations help to define the critical terms: expenses and capital

expenditures. Although the student may now be beginning to form the opinion that the devices are capital and thus not deductible, additional research is necessary to increase the student’s level of comfort that this is the correct


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conclusion. The student has also probably concluded that the labor costs associated with the installation are deduction as well as the legal fees.

Chapter 4: No additional work required Chapter 5: a-c In addition to the Code and Regulations, there are numerous cases students may

have found that shed some light on the research question. All are support for the conclusion that the safety devices are capital expenditures and are thus not deductible to the taxpayer. The cases suggest that the fact that such expenditures are “forced” in response to a legal requirement does not change their capital nature. The fact that the individual item has no value without being attached to the plane does not impact the capital character of the item. Therefore, students should conclude that the cost of the safety devices must be capitalized rather than deducted. The labor costs involved and the legal fees should be deducted. Some of these cases are:

• The Swig Investment Company v. United States, 96-2 USTC ¶50,540. This

Federal Circuit Court of Appeals case affirmed an unreported Court of Federal Claims decision prohibiting a hotel from deducting the cost of replacing concrete aspects of the hotel’s roof. The court held that even though the replacement was required by city ordinance, this did not change the fact that the changes increased the hotel’s value and prolonged its life and was thus not an incidental repair. Important to the facts in the student’s research case, the court stated the following: “We also find untenable Swig’s argument that the parapets and cornices have no independent useful life and will be worthless when the hotel becomes structurally unsound. Adopting this logic, work on an aging structure would seldom be classified as a capital investment unless the entire structure is similarly improved.” The court also stated that “the fact that a payment is imposed compulsorily upon a taxpayer does not in and of itself make that payment an ordinary and necessary business expense.”

• Other similar cases include: Teitelbaum v. Commissioner, 294 F.2d 541; 61-2

USTC ¶9632 (CA 7, 1961) [Electrical conversion costs required by a Chicago ordinance held to be capital]; Woolrich Woolen Mills v. United States, 289 F.2d 444, 61-1 USTC ¶9397 [Cost of filtration plan held to be capital even though it was built in response to a state anti-pollution law.]; International Building Co. v. Commissioner, 21 BTA 617 (1930) [Installation of safety devices in elevators as required by public law held capital].





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Chapter 7: a. The student here needs to apply the general memo-writing skills addressed in the chapter.

b. The student here needs to apply the general client-letter writing skills addressed in the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because this letter involves several different issues, they should each be separately stated and explained.

Case Study K (Palm Springs home and exchange)

a. The student has all of the relevant facts necessary to begin research. Certainly, details such as fair market values of the homes and intended replacements will ultimately be important. But at this juncture, there is no additional information needed to begin the research.

b. Their tax returns would be useful to see how they have treated the vacation homes

in previous years - deduction for upkeep, depreciation, etc.

c. At this point, it appears that all of the facts are relevant except for how he heard about the possibility of an exchange!

d. There is always the likelihood that after further research, the researcher will need

to ask additional questions.

e. The initial question is simply whether the facts as stated will enable the structure of a tax-free exchange so that the taxpayers can avoid paying tax on the appreciation of their Palm Springs home.

f. The taxpayers would like to replace their current Palm Springs home with another

Palm Springs home without needing to recognize any income.

g. This a definitely a planning situation since the taxpayers are looking to the researcher to help them structure a transaction. The facts are not yet fixed and can be created as a result of the advice the researcher provides.

h. This is an opportunity for the student to reflect upon whether he is entering the

research process with a preconceived notion as to the likelihood of being able to apply the tax-free rules. This is a useful exercise to help students see the potential impact early and unsupported opinions have on the research process and the researcher’s analysis. By recognizing he may have formed an unsupported opinion prior to research, the student will hopefully be careful not to let this negatively affect the research process he follows. It is also fun to see how different people view the same set of facts.


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Chapter 2:

a-c Several possibly relevant Code Sections are available for analysis:

• §121(a) states that gross income does not include gain from the sale or exchange of property held as a taxpayer’s principal residence for at least 2 out of the past 5 years. Because the facts do not support taking a position that the Palm Springs home served as the taxpayer’s principal residence at any time, this Code Section does not appear to be helpful to the taxpayer.

• §1031(a) allows for the nonrecognition of any gain on the exchange of

property held for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. This is the key Code Section for this research assignment. The issue that arises after studying this section is the meaning of the word “investment” as used in the section. Is the home in Palm Springs “held for investment”? Would the replacement property be considered to be “held for investment”? Does the personal use of the property preclude categorizing this property as investment property?

• Some students may believe that IRC §280A is relevant because it addresses

issues dealing with a person’s “residence” and deductions allowed for such residences. The section defines a residence as a dwelling unit used for personal purposes for a number of days which exceeds the greater of 14 days or 10 percent of the number of days during such year for which such unit is rented at a fair rent. Clearly, the Palm Springs home is a residence under this Code Section. However, how does this conclusion impact the research question? It really doesn’t. This section operates as a limitation to deductions generated by a person’s residence when it is also used for business purposes (rental, office, etc.). Therefore, there may be limitations on the ability to depreciate or take other related business deductions. The taxpayer has not asked the researcher any questions related to business deductions and given the fact that the home will not be rented, this Code Section appears to be irrelevant.

• In searching for other Code authority to help address the definition of the term

“investment” as used in IRC §1031, students may locate IRC §163(d) which addresses the deductibility of “investment interest.” IRC §163(d)(5) states that “for purposes of this subsection...property held for investment shall include” any property which produces income (as defined in IRC §469) and any interest in an activity involving the conduct of a trade or business. When reviewing IRC §469, this definition does not appear to provide much additional guidance and is limited only for purposes of that subsection. However, if students believe that such a definition may be useful, they may then turn to IRC §212 which allows a deduction for expenses incurred in connection with “property held for the production of income.” Notice that


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this Code Section does not use the term “investment.”

The Code does not adequately address the research question, but instead only triggers a quandary as to the meaning of the term “investment” as used in IRC §1031. If property is held for dual purposes – personal and investment – will the section still apply? If property is held for its potential appreciation in value, can that property be considered as “held for investment?”

Chapter 3:

a-d The Treasury Regulations provide some guidance in this situation, although it does not definitively resolve the research issue. The relevant provisions include:

• §1.1031(a)-1(b) provides interesting language when it defines “like-kind” (not

an issue in this situation). It states that “unproductive real estate held by one other than a dealer for future use or future realization of the increment in value is held for investment and not primarily for sale.” Although there is no issue regarding like-kind in the taxpayer’s situation, this Regulation suggests that the mere holding of real property to realize future appreciation qualifies as property “held for investment.” There is no other useful language in the Section 1031 Regulations. Nor are there any helpful Regulations interpreting the term investment as used in IRC §163(d).

• §1.212-1(b) states that “held for the production of income” (which IRC

§163(d) uses as the definition of “held for investment” for purposes of that subsection) includes holding property “not merely (for) income of the taxable year but also (for) income which the taxpayer...may realize in subsequent taxable years...Expenses paid or incurred in managing...property held for investment may be deductible under section 212 even though the property is not currently productive and there is no likelihood that the property will be sold at a profit or will otherwise be productive...”

There are no additional helpful Regulations. The initial issue remains unanswered: can property held for both personal and investment purposes be considered “held for investment” so that IRC §1031 applies?


Chapter 5: a-c The authority cited above is the only existing authority. Students will have

researched in the reference services and will have read many cases, but none dealing with the issue of dual holding purposes and tax-free exchanges. They will find cases addressing the inapplicability of IRC §1031 when a residence is sold instead of exchanged. They will also find cases indicating the section does not apply when the motive of the exchange is to immediately sell the property received. They may also find cases dealing with purely personal property. However, students need to remember that the issue here is how dual use property is treated. This research problem provides a real challenge to the students to


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focus on the issue before them as they read each case. The cases at first blush appear to be relevant. However, if the student continues to keep in mind the specific issue involved in this set of facts, the student should recognize that there is no helpful case law.

Students, leaving the reference services empty-handed, will want to research in the Letter Rulings. There are a few letter rulings that also appear relevant, and one issued in the early 80's whose facts seem quite similar in which the service allowed tax-free treatment. However, students also need to recall the limited authority of Letter Rulings, particularly very old rulings.

In the end, the student is left with simply the language of the Code and some potentially helpful language from the Regulations. The language of the Code, without any other special definitions applied, may be interpreted using the everyday dictionary meaning of the words. Thus, the student may conclude that taxpayers did hold the home for “investment.” The expectation of potential growth in the value of the property may suffice. Students may note that the Code does not require that the property be “held primarily for investment.” The absence of the word “primarily” may be used as support for the argument that as long as investment was one of the motives, the fact it was not the sole motive does not preclude application of Section 1031.



Chapter 6: No additional work required Chapter 7: a. The student here needs to apply the general memo-writing skills addressed in the

chapter. Stating the issue may present the biggest challenge to the student in this exercise.


the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because this is a planning situation, it is critical that the student clearly indicate the lack of any clear authority controlling this situation, and therefore the inherent risks treating the transaction as tax-free.

c. This is an excellent opportunity for the student to practice advocacy skills. The

student should discuss the issue in a logical manner, first discussing the relevant Code Sections and Regulation sections. This will set up the discussion regarding the issue and the basis for the IRS’s challenge. The IRS may very well have


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lacked focus and thus attempted to apply inapplicable case law. The student is left primarily to his skills of advocacy and reason since there is so little authority for either position (tax free treatment or taxable treatment).

Case Study L (Developer and contribution of easement) Chapter 1:

a. Most of the pertinent facts are already presented to the student. The student may want to discover whether the city asked Developer for the easement or whether the Developer approached the city.

b. The researcher might wish to review any correspondence between the city and the

Developer regarding both the development and the potential easement.

c. All of the above facts appear relevant at this time.

d. As the student begins researching, there may be additional information needed to make a conclusion.

e. The initial question most students will identify is the general question of whether

the contribution of the easement will generate a tax deduction to Developer.

f. The taxpayer wishes to have the contribution of the easement qualify as a charitable deduction.

g. This is a quasi-planning project. Most of the facts are fixed. However, the

taxpayer has not yet made the contribution and its future actions are dependent upon the results of the research.

h. This is an interesting subject to discuss to enable the students to understand the

impact of drawing too strong of an initial conclusion before performing any research. Many students may have no predisposition about the research outcomes of this particular project.

Chapter 2:

a. What Code Section(s) addresses the research question? • §170(a)(1) allows a deduction for any charitable contribution made within the

taxable year. §170(c)(1) defines the term “charitable contribution” as a contribution or gift to or for the use of a State, a possession of the United States, or any political subdivision of any of the foregoing, but only if the contribution or gift is made exclusively for public purposes. §170(C)(2)(C) provides that no part of the net earnings of which inures to the benefit of any private shareholder or individual.

• §170(f)(3)(A) provides that a deduction under §170 is generally not allowed

for a charitable contribution of any interest in property that consists of less


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than the donor’s entire interest in the property other than certain transfers in trust. A contribution by a taxpayer of the right to use property shall be treated as a contribution of less than the taxpayer’s entire interest in the property. Certain exemptions exist, including one for qualified conservation contributions. It is not clear whether this applies to Developer at this stage in the research.

b-c From reading the Code, the students will likely begin to conclude that a deduction

does not appear promising. Students will now be focused on the language found in IRC §170(f)(3)(A) and be looking to determine how this provision applies to a contribution of an easement. Without further research, the student will not be able to make much more progress. Additional information is available in the historical amendments to the Code Section if students think to look there. The historical notes indicate that both P.L. 96-541 and P.L.95-30 amended this provision. Prior to the amendment, easements for conservation purposes were specifically listed as exceptions to the rule prohibiting a Section 170 deduction.

Chapter 3: a-c Several Treasury Regulations provide helpful guidance, including:

• §1-170A-14(a) states that a deduction may be allowed under §170(f)(3)(B)(ii) for the value of a qualified conservation contribution it meets certain requirements. The Regulation defines a “qualified conservation contribution” as a contribution of a “qualified real property interest to a qualified organization exclusively for conservation purposes.” The Regulation goes on to define a “qualified real property interest” as an “entire interest of the donor....” “Conservation purposes” is defined to include the preservation of land areas for outdoor recreation of the public. §1-170A-14(d)(1). The Regulations give the example that a hiking trail for the use of the public would meet this standard. Thus, an easement for the purpose of placing bike paths for the public would appear to fulfill the requirement that the donation be for “conservation purposes.”

• §1.170A-14(e) states that the donation must be “exclusively for conservation

purposes.” However, “a deduction will not be denied under this section when incidental benefit inures to the donor merely as a result of conservation restrictions limiting the uses to which the donor’s property may be put.”

• §1-170A-14(h)(3) provides that if the contribution does qualify, the deduction

is equal to the fair market value of the donated easement at the time of the contribution. This may be determined by comparable sales. If there are no such comparable numbers, the value is equal to the difference between the fair market value of the property it encumbers before granting the easement and the fair market value of the property after granting the easement. “If the granting of a perpetual conservation restriction ...has the effect of increasing the value of any other property owned by the donor...the amount of the deduction for the conservation contribution shall be reduced by the amount of


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the increase in the value of the other property, whether or not such property is contiguous. If, as a result of the donation...the donor...can reasonably expect to receive financial or economic benefits that are greater than those that will inure to the general public from the transfer, no deduction is allowable under this section. However, if the donor....can reasonably expect to receive a financial or economic benefit that is substantial, but it is clearly shown that the benefit is less than the amount of the transfer, then a deduction...is allowable for the excess of the amount transferred over the amount of the financial or economic benefit received....”

d. The question remaining is whether the facts are such that the contribution will be

considered a “qualified conservation contribution.” From the Regulations, this appears to depend entirely upon the relative value of the benefit of the contribution to the donor (enabling her to develop the land in the manner she would like) and the benefit to the donee (allowing it to develop the bike paths).

Chapter 4:

The case of Harold DeJong, 36 TC 896, somewhat addresses the research question, although it was written long before the Regulations were amended to their current state. In the DeJong case, the taxpayers made a contribution to a church. The contribution was in the form of tuition payments for the taxpayers’ children. The court held that “if a payment proceeds primarily from the incentive of anticipated benefit to the payor beyond the satisfaction which flows from the performance of a generous act, it is not a gift.” Applying this case’s reasoning to the research question, the taxpayer’s primary reason for making the contribution is so that the city will widen the streets and enable the developer to structure the development so that it will be more attractive with a landscaped public entrance and lighting. Just reading this case in conjunction with the Code and Regulations may lead the students to conclude at this point in the research that no deduction will be allowed.

Chapter 5:

a-c Based on the language of the Code and the Regulations, the deduction does not appear to be allowed. This is supported by Sutton v. Commissioner, 57 TC 239 (1971) which involved very similar facts and disallowed the deduction. Although this case preceded the changes made to the Regulations, the reasoning does not appear to be in conflict with the current language of either the Code or the Regulations. In Sutton, the taxpayer conveyed an easement over a strip of land for use in widening the street next to the taxpayer’s property. There was an ordinance that no buildings could be built until the street was widened. After the easement was contributed to widen the street, the taxpayer was able to build a service station. The court held that there was no charitable deduction because “the gift was made in expectation of certain specific direct economic benefits...” Although this case’s facts are less favorable than Developers (since Developer can develop the property without the widening, but simply prefers the widening), it appears to be representative of the case law on this issue. (See US v. Transamerica Corporation, 392 F.2d 522; Perlmutter v. Commisioner, 45 TC 311


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(1965); Rev. Rul. 57-488, 1957-2 CB 157; Rev. Rul. 76-257, 1976-2 CB 52).

On the other hand, there is some authority (again pre-dating the Regulations) that may be read to support a deduction. These cases include Scheffres v. Commissioner, 28 TCM 234 (1960) where the facts were such that the court found that there was no economic benefit to the taxpayer from the contribution since the donee would have acquired the land by purchase or condemnation in any event. Another favorable case is Toole v. Tomlinson, 63-1 USTC ¶9267 which held that the benefit to the donors was coincidental and irrelevant. The city had requested the easement and at the time of the donation, the taxpayer had no intent to develop the property. The same was held in G.A. Collman, 75-1 USTC ¶9303, which held that a deduction was allowed because the benefits from street widening did not inure to the owners. The court saw as important that the county was the group who initiated the conveyance, where in Sutton, the taxpayer approached the city. (See also, Citizens and Southern National Bank of South Carolina, 65-2 USTC ¶9618; C.W. Myers, 81-1 USTC ¶9179.)





b. This is the first assignment requesting a Letter Ruling. Students will need to

review the first Revenue Procedure of the year for guidance on some of the specific requirements. This is a different form of advocacy in writing. The student should find this easier than a protest letter in that the ruling request is not in response to a denial of the deduction by the Service, so there is no need to argue that another position is incorrect. Rather the student needs to use the facts before him (embellished by the instructor or student as determined to be appropriate by the instructor) as well as all the relevant authority and make a case for the correctness of taking a charitable deduction.

Case Study M (Interest on a loan)

a. At this point, the students will probably only ask questions requiring a repetition of the facts already provided. The factual situation is a bit complex, so this may be necessary. Additional clarifying facts are provided in Chapter 2. The instructor should study these to help with any possible role playing. However, after some research, addition relevant questions include:

• Did Bank 2 know why taxpayer was borrowing the money? Were they aware


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it was going to be used to pay interest on a loan from Bank 1?

• Was there any possibility that in January of Yr. 2, the taxpayer might have changed his mind and decided to use some funds other than those borrowed from Bank 2 to pay off the interest due?

• Was the check actually cashed by the bank? (The answer is yes).

• How much income did taxpayer have from investments (dividend and interest

income)?

b. Potential sources of information include loan documents, prior tax returns and a personal balance sheet of the taxpayer and any communication from the IRS.

c. It is too early in the process for the student to determine if any of the facts are

irrelevant. It is best for the student to begin with the assumption that they are all relevant.

d. Yes, as stated in #a.

e. The first question is simply whether the interest was deductible.

f. The taxpayer definitely wants the researcher to conclude that the interest was

appropriately taken as a deduction.

g. This is not a planning situation because all of the facts are fixed.

h. At this stage, the students probably do not understand enough to have developed an initial conclusion. They are probably quite confused as to why there might even be an issue!

Chapter 2:

a. The relevant Code Sections include: • §163(a) sets forth the general rule that there shall be allowed as a deduction all

interest paid or accrued within the taxable year on indebtedness.

• §163(d)(3)(A) provides a limitation on the deductibility of investment interest. This may seem relevant to the student since the interest in question is investment interest. However, the IRS is not challenging the deduction on these grounds, so the provision is irrelevant to this research question.

• §461 provides that a deduction that is otherwise allowed shall be taken for the

taxable year which is proper under the method of accounting used by the taxpayer. Students will probably not recognize that this is a relevant Code Section at this point. However, because the question relates to whether the taxpayer “paid” the interest, this Code Section is relevant, although not


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particularly helpful.

b. Analysis of the relevant Code Sections does not really help the student to refine the initial research question, other than to spot the key word the Service appears to be having trouble with: “paid” as used in IRC Section 163(a).

c. The Code does not at all adequately address the research question.

d. The initial research question remains. In addition, students now need to

investigate the meaning of “paid” in relation to the taxpayer’s facts.

Chapter 3: a-d The Treasury Regulations provide limited guidance as follows:

• §1.461-4(g)(1)(ii)(A) states that “payment” by a cash method taxpayer (which

students will assume the taxpayer is) includes the furnishing of cash or cash equivalence. “Payment does not include the furnishing of a note or other evidence of indebtedness of the taxpayer...As a further example, payment does not include a promise of the taxpayer to provide ... property in the future (whether or not the promise is evidenced by a contract or other written agreement. In addition, payment does not include an amount transferred as a loan...” This is the most helpful Regulation because it should begin to create some understanding by the student as to the issue. Did taxpayer pay with “cash or cash equivalent” or did he pay simply with a promise to pay in the future? Students will not be able to answer this at this point, and probably will not have found this Regulation either.

• §1.163-8T(c)(1) provides information about the tracing rules for the payment

of interest, stating that interest is treated as having been paid from the actual funds used for payment after applying the detailed and complex tracing rules of the Regulations.

Chapter 4: Newton A. Burgess, 8 TC 47 addresses the research question. In Burgess, the taxpayer borrowed money from Archer and Company. Prior to the due date of the note, the taxpayer borrowed additional money from Archer. He deposited the check in his regular checking account, then paid the interest on both loans from that bank account. The Service challenged the deduction claiming that Mr. Burgess did nothing more than pay with an extension of the original debt since he paid with funds borrowed from the original creditor. Therefore, the Service claimed he had not paid with cash or its equivalence and was not entitled to a deduction.

The court held that the deduction was allowed because the taxpayer had unrestricted control over the funds at the time of the payment. The fact that the debt was paid with borrowed funds did not automatically preclude the deduction. Payment of a debt with funds borrowed from a third party is not payment with a note. If the funds are borrowed


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from the same creditor, as long as the funds essentially lost their identify through “commingling” with the taxpayer’s other funds and the taxpayer had control of the funds, the amount is considered to have been “paid.”

This case should help the students better understand the issue. In addition, students will now be believing that taxpayer is entitled to the deduction using the Burgess decision as authority. This is particularly true because the Burgess facts are not as positive as those of the taxpayer. In Burgess, the second loan was taken from the same bank as the original loan. In taxpayer’s situation, the second loan was taken from a bank partially owned by the original bank. Thus, students now have a new issue to research: What is the impact of ownership by one bank on another in the context of paying with borrowed funds? Are the banks really the “same” so that the taxpayer even needs to worry about the Burgess factors at all? If the banks are considered different banks so that the taxpayer is viewed as borrowing from a third party, then there should be no question regarding the deductibility of the interest.

Chapter 5:

a-c There is much case law on the issue of payment of interest with borrowed funds. However, students will find no authority to help with the issue of whether the ownership relationship between the two banks creates a “same bank” borrowing problem at all. The students will need to use simple common sense and argument for this issue. Students may be tempted to use certain provisions of the Code such as the related party rules in IRC §267 or the consolidated return rules. However, these sections are not relevant to this question. The students need to understand that the courts created the fact that it may be different to pay a debt with funds borrowed from the same bank as opposed to funds borrowed from a third party bank. Therefore, the Code will provide no further clarification on this judicially recognized difference. Have the students think hard about the relevance of the Code Sections they may find on this point. For example, what is the impact of §267? It is to disallow a deduction from one related party to another. This is not the situation before the student. Relevant facts for the student may be: the taxpayer was unaware of the ownership (is it reasonable to expect the public to follow the ownership relationships of banks prior to borrowing?); the fact that different paperwork was completed for each loan, etc.

An additional argument the student will need to explore is, if the banks are treated as the “same,” are the facts such that the deduction will still be allowed? Here, there is lots of case law to guide the student. Most disallow the deduction. However, the factors applied in each are primarily the same: Did the taxpayer have unrestricted control over the borrowed funds such that payment with these funds can be considered to be “payment” as opposed to simply a continuation of the prior debt or a promise to pay. Critical factors include: did the taxpayer commingle the funds with his personal funds? If so, how long? Did the taxpayer have the right, or ability, to use the borrowed funds for something other than the payment of the debt? If so, this is a key factor in establishing unrestricted control. If, instead, the funds were “earmarked” by the bank to be used only for payment


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of the debt, the deduction is in question. Did the taxpayer have a business purpose for paying with borrowed funds? In taxpayer’s case, he did. The reason was that from an investment standpoint, he felt that it would be better to borrow than to liquidate his assets. Connected to this factor is the question, did the taxpayer have sufficient assets to cover the payment with other funds had he chosen to do so? The answer appears to be yes in the taxpayer’s situation. Therefore, the student should arrive at the answer that the interest is deductible. This is a good example of how the end result of a court decision is not as important as the reasoning used. The court’s reasoning then should be applied to the taxpayer’s situation. In this situation, when applying all of the court’s reasoning, the taxpayer has a very good case, even though almost all the court’s have disallowed the deduction. Taxpayer’s facts are simply better facts. Some of the relevant cases include:

• John C. Cleaver, 6 TC 452; affd., 158 Fed (2d) 342, where the court

disallowed the interest expense deduction in a situation where the borrowed funds never went through the hands of the borrower and never passed through his bank account. The court held that the interest was an addition to the principal sum and did not become deductible until the notes were paid.

• McAdams v. Commissioner, 15 TC 231 (1950) restated that interest paid with

funds borrowed from a third party are considered paid and thus deductible.

• Battlestein v. Commissioner, 80-2 USTC ¶9840 (CA 5) disallowed the deduction after applying the Burgess factors. The taxpayer in this case never commingled the borrowed funds with his own.

• Wilkerson v. Commissioner, 81-2 USTC ¶9657 (CA9) disallowed the

deduction applying the Burgess factors. The banks had specifically earmarked the loan proceeds for the purpose of paying the interest due. In addition, the taxpayer was not able to show that any additional funds were available to pay the interest.


used - what they liked and did not like, challenges and how they might be overcome. In this particular problem, students may have been frustrated by the fact that they could not locate a notice published by the IRS on the issue and referred to in the reference services. Neither service has this notice on their database. However, its reasoning is subsumed by the IRS’s position in the court cases.

Requesting students to record the time they spent allows you to report back to them with the range of time required. Students can then learn whether they are within the normal range or outside.



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chapter. Clarifying the issue is the greatest challenge in this particular research project. Students tend to want to leap right to the case law without first explaining what the problem is.


the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts.

c. This is a challenging protest letter because of the complexity of the issue

involved. The key here to writing a successful letter is to first set up the issue clearly. If students move straight to the relevant case law, the protest will most likely be ineffective. In addition to this challenge, the students have two separate and potentially conflicting arguments to present: the banks were two separate banks and not the “same” bank for purposes of the issue here, and, even if the two banks are viewed as one, the deduction is allowed based on the reasoning applied in case law. This will provide students with a good opportunity to see the importance of providing a clear transition between two potentially conflicting arguments so that neither argument is weakened by the presence of the other.

Case Study N (Accountant and auto racing) Chapter 1:

a. Some possible additional questions include: • How much time does he spend (or plan to spend) racing and working on the

car? • Does he maintain books for this activity? • What are the specific costs for maintenance, storage, etc.

b. Potential additional sources of information include his prior years’ tax returns and

any paperwork he may have (records, etc.) related to the racing activity.

c. All of the above facts appear relevant at this point. d. It is always the case that more questions may be necessary as the research

progresses.

e. The first question is broadly defined: What must the taxpayer do to maximize the possibility that the car and other related expenses will be deductible?

f. The taxpayer wants to be able to deduct the cost of his racing activities.

g. This is a planning situation. Not all the facts are established so that the taxpayer

can create or alter some facts in response to the research results.


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h. This provides the student with the opportunity to explore her assumptions regarding the research question prior to beginning the research process. The student can then be aware of this predisposition and attempt to ensure that it does not interfere with performing the research in the most thorough and objective manner possible.

Chapter 2:

a. The relevant Code Sections include: • §183(a) which provides that, except as otherwise provided, there is no

deduction for expenses attributable to an activity “not engaged in for profit.”

• §183(b) states that if an activity is not engaged in for profit, the only deductions allowed are for interest, state and local property taxes, and any other deductions allowable for the tax year without regard to whether the activity is for profit. In addition, amounts that would be allowable if the activity were engaged in for profit are deductible, but only to the extent gross income from the activity exceeds the allowed deductions. Therefore, no net loss is allowed for an activity “not engaged in for profit.”

• §183(c) defines the term “activity not engaged in for profit” to include any

activity other than one with respect to which deductions are allowable for the taxable year under §162 or §212.

• §183(d) provides a presumption that an activity is engaged in for profit if the

activity produced net income for 3 or more of the taxable years in the period of 5 consecutive taxable years.

• §183(b)(2) - Even if the activity is not considered to be an activity engaged for

profit, deductions attributable to the activity are allowed to the extent they do not exceed the gross income from the activity for the tax year.

• §183(e)(3) provides for a taxpayer election whereby the taxpayer requests a

deferral of any audit on this issue for three years from the first year of the activity.

• §167(a) provides for a depreciation deduction a reasonable allowance for the

exhaustion, wear and tear of property used in the trade or business, or of property held for the production of income.

• §280F(a)(1)(A) provides a limitation on the amount of depreciation that can

be taken for automobiles.

b. The Code Section helps refine the issue to a question of whether the racing will be considered a “not for profit” activity therefore subject to the limitations under IRC §183.


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c-d The Code does not provide sufficient information to make a determination as to whether the activity is “not for profit.” Further research is necessary. IRC §167 does provide clarity with respect to the amount of any depreciation deduction taxpayer may be entitled to.

Chapter 3:

a. The following Treasury Regulations provide further guidance: • §1.183-2(a) describes in detail some of the factors to consider in determining

whether an activity is engaged in for profit. All the facts and circumstances must be considered. Many factors must be considered, no one which is controlling. Some of the factors include: the expectation of the taxpayer to make a profit, the manner in which the taxpayer carries on the activity (businesslike with books?), the expertise of the taxpayer, the time and effort expended in carrying on the activity, the success of the taxpayer in carrying on other similar activities, the taxpayer’s history of income or losses with respect to the activity, the amount of occasional profits earned, the financial status of the taxpayer, and the existence of an element of personal pleasure or recreation.

b-d The Treasury Regulations provide the student with the factors to consider in

helping the taxpayer maximize his chances of taking deductions related to the racing activity without the limitations imposed by IRC §183. Because this is a planning situation, the facts are not fixed such that the student can come to a conclusion as to whether the activity is a for-profit activity outside the reach of IRC §183. However, the student does have enough information to advise the taxpayer regarding the important steps the taxpayer should take to help remove the risk that the activity will be treated as “not for profit.” The student will probably still wish to see if there are any cases dealing with race car driving.


a-c The key authority is found in the Regulations discussed above. In addition, students may have found some cases addressing race-car driving and IRC §183. There are many such cases, and as students are researching, they should keep in mind the reason for reading the cases. At some point, they should conclude that there is no value to be gained by reading more cases. Some (but not all) of the cases on point include:

• P. Dwyer, 61 TCM 2187 (1991) - the court disallowed treatment of auto

racing by an attorney as a for-profit venture. The attorney was not able to spend much time on the activity, did not need to make any profit since he earned significant income as an attorney and he suffered losses from the activity. However, the court did hold that the attorney’s son’s activities in the sport rose to the level of a for-profit venture.


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• W.M. Bryson, Jr., 44 TCM 606 - the court treated auto racing as a for-profit activity.

• L.E. Likes, 61 TCM 3012 - the court held an investment advisor who also

participated in auto racing did not do so for profit. Among other things, the advisor did not keep adequate books and records.

• W. Canale, 58 TCM 694 - the court treated motorcycle racing as an activity

for profit in this particular situation.

• L.A. Bolt, 50 TC 1007 - the court held that an electrical engineer’s race car activities was a business rather than a not for profit activity.






the chapter. The first sentence or two should have the introductory sentence stating the scope of the request, followed by a brief but complete restatement of the relevant facts. Because this is a planning situation, it is important that the student focus on the factors the IRS and courts will look at in determining whether the deductions are appropriate. Discussing specific facts of cases should not be the focus!

Case Study O (Retainer fee) Chapter 1:

a. The student has most of the relevant facts. Two additional questions are: is this the first year that Big Company paid this type of retainer fee, or have they made such payments in the past? What method of accounting does Big employ - cash or accrual? (Given that Big is a long-time client, in “real life” the researcher would already know the answer to these questions.)

b. The student would want to review prior tax returns of Big as well as the retainer

agreement between Big and the law firm.

c. At this juncture, it appears that all the facts are relevant.


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d. There is always a chance that following further research, more questions will be

necessary.

e. The initial question is simply: is the retainer fee deductible?

f. The taxpayer would like the researcher to produce support that the retainer fee is deductible.

g. This is primarily not a planning research situation because the facts for the current

year are fixed. However, because the client is interested in how to proceed in future years, there is the opportunity to restructure the facts in the future if necessary. Therefore, there is a planning element to the question.

Chapter 2:

a. The potentially relevant Code Sections include: • §61(a)(4) - Gross income includes interest income.

• §162(a) which provides a deduction for all ordinary and necessary expenses

paid or incurred during the taxable year in carrying on any trade or business.

• §263 provides that there shall be no deduction for capital expenditures.

• §461(a) provides the amount of any deduction or credit shall be taken for the taxable year which is the proper taxable year under the method of accounting used in computing taxable income and on what are they based?

b-d The more refined research question becomes: is the retainer fee paid an ordinary

and necessary expense of Big? From just reviewing the relevant Code Sections in light of the facts of the case, students should be troubled with the fact that any unused portion of the retainer is returned to Big. If this is the case, at first glance, students will probably conclude that only the used portion of the retainer fee will possibly qualify for a deduction. Because the retainer fee earned interest, upon its return, Big will have to recognize the interest in income, and may probably treat the retainer as simply returned capital. Thus, Big is entitled to no deduction upon payment of the retainer since there is the possibility it will be returned, and no income other than interest upon return. The Code does not provide any particularly useful information regarding how a retainer might be structured in the future to be deductible.

Chapter 3:

a-d At this point, the student should feel fairly comfortable that the Code already provides the answer to the question regarding the treatment for the current year. The Regulations do not provide additional help for the question of how a retainer agreement might be structured to enable a deduction.


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Chapter 4: No additional work is required Chapter 5: a-c Through use of the reference services, students may find several cases addressing

the issue of the tax treatment of a retainer fee. Ultimately, they suggest that the retainer arrangement Big used is probably the most economical one, even though it does not trigger a deduction for the entire retainer amount. This is because at the end of the day, Big is able to deduct the amount of the retainer used for legal fees (under §162), and receive back the unused retainer (no taxable income) in addition to interest (taxable under §61).

One case allowed a deduction for the entire retainer fee even though it was not

used for legal fees. However, the retainer was not returned to the taxpayer but rather was used to purchase a capital acquisition, see Dana Corpration v. United States, 80 AFTR2d 97-5412. The court in that case held that even though the funds went to pay for a capital expenditure rather than an expense, the original purpose for the retainer was to guarantee the law firm’s representation. Because the retainer agreement clearly stated that none of the unused amount was to revert back to the company, the court held the full amount was deductible when paid because it was a business expense. The ultimate use of the funds was held not to impact the deductibility under the “origin of claim” doctrine.

The decision in Dana is definitely not applicable to the research facts before the student. One critical difference in the material facts render Dana ultimately irrelevant to Big’s situation. Big has the right for any unused portion of the retainer fee to be returned. The taxpayer in Dana had no right to any unused portion. Economically, the return of the unused portion of the retain seems far preferable to forfeiting it for the purpose of potentially qualifying for a tax deduction!






the chapter.


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Case Study P (Gobble and inability to develop land) Chapter 1: a. Possible additional questions include:

• What is the current status of the litigation?

• What are your current plans regarding the land?

• Have you attempted to sell the land?

b. The researcher would want to review prior years’ tax returns, and recent correspondence and documentation regarding the use of the land.

c. All of the facts appear relevant.

d. There is always a chance that more questions will need to be asked after research.

e. The central question before the researcher is whether the $1 million land

acquisition cost is deductible. A smaller issue is the deductibility of the legal expenses.

f. The taxpayer wants to be able to deduct both expenses.

g. This is not a planning research situation because most of the facts are fixed.

However there may be a planning element involved because it appears that not all the events are closed. Therefore, it may be possible for the taxpayer to take certain steps in order to create a deductible situation.

h. This is a fun opportunity for students to express their “gut feeling” about the

research results before performing any research. It is also a helpful exercise to enable them to be careful that such predispositions do not have a negative impact on their research.

Chapter 2:

a. The potentially relevant Code Sections include: • §162(a) provides that ordinary and necessary expenses paid during the year in

carrying on any trade or business are deductible.

• §165(a) allows a deduction for any loss sustained during the taxable year and not compensated for by insurance. The deduction is limited to losses incurred in a trade or business.

• §263(a) provides that no deduction shall be allowed for any amount paid for

new buildings or for permanent improvements made to increase the value of any property.

• §263A requires capitalization of all costs of property produced by the


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taxpayer.

• §1231 governs the characterization of gains and losses from sales, exchanges and involuntary conversions of property used in a trade or business and in some circumstances allows a loss to be considered ordinary rather than capital.

b-d The relevant Code Sections do not at this point help the student refine nor answer

the original research question, although they provide a starting point for further research.

Chapter 3: a-d The following Treasury Regulations provide further guidance:

• §1.165-1(c) provides that the amount of loss allowable as a deduction under §165(a) should not exceed the adjusted basis for determining the loss.

• §1.165-1(d)(1) provides that a loss must be evidenced by a closed and

completed transaction and fixed by an identifiable event.

• §1.165-2(a) allows the deduction of obsolescence of non-depreciable property, in the case where such business or transaction is discontinued or where such property is permanently discarded from use.

• §1.263A-2 defines produce to include development.

• §1.263A(a)-1(e)(3)(ii) considers engineering and design costs as indirect costs

requiring capitalization.

• §1.446-1(a)(4)(ii) provides that expenditures made during the year must be properly classified as between capital and expense items.

Chapter 4:

a-d The case of Willis, Gordon, TC Memo 1983-180. 45 TCM 1168 is only very slightly helpful to the situation at hand. The facts in Willis are quite different from the facts before the student. In Willis, the taxpayer owned a ship that was partially destroyed when it hit a submerged object in the water. Although taxpayer received a partial settlement from the insurer, he chose not to repair the ship and instead to sell it in its damaged condition. Taxpayer then took the insurance proceeds and sale proceeds and purchased a barge. The taxpayer attempted to claim that he did not have to recognize the gain he realized on the sale of the ship because IRC §1033 applied. The court held that there was no “involuntary conversion” as is required to apply §1033, stating: “The wording of the statute makes it plain that it does not include conversions or sales of property where the owner had a choice of keeping the property or converting or selling it.” Citing another case, the court stated: “[the] basic purpose of [the section] ... is to allow the taxpayer to replace his property or continue his investment without realizing


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gain where he is compelled to give up such property because of circumstances beyond his control.” The court concluded that the taxpayer’s sale of the ship was not a result of its partial destruction, but a business decision.

The only possible application of the Willis case to Gobble’s situation is to help the student conclude that IRC §1033 does not appear to be a Code Section that will help the taxpayer avoid gain recognition should the property be sold. The case does suggest that an important unknown fact is the value of the property Gobble is holding after considering the inability to develop the property under the original plans. However, it does not appear to be true that the property lacks value, just that Gobble’s original intent has been frustrated. It is likely that he has other options available with respect to the land’s development, just not any that are as economically lucrative perhaps.

Chapter 5: a-c The largest issue is the treatment of the $1 million land purchase price and

whether this can be deducted because Gobble’s plans have been frustrated. The only possible support for a deduction would be under Code Section 165. There is a dearth of helpful case law in this area. The closest case on point that students may have found is Lakewood Associates v. Commissioner, 109 TC No. 12 (1997). This case involved property on which the partnership owner (Lakewood) intended to build homes. At the time of the property purchase, the land was not zoned for residential use. Lakewood’s application for rezoning was denied. The City Council initially approved the rezoning, but subsequently, the rezoning was defeated in a voter referendum. In the year the rezoning was denied, although Lakewood did not sell or abandon the property, it took a loss under IRC §165 for the decrease in the value of the land due to the inability to create a residential development. To make matters worse, new Federal regulations were subsequently issued resulting in the majority of the land being classified as protected wetlands.

In Lakewood Associates, the Tax Court denied the deduction, stating: “To deduct a decrease in value of property, there must be some event that fixes the fact of the loss and the amount thereof...” Citing the Supreme Court case of United States v. White Dental Manufacturing Co. , 274 US 398 (1927), the court stated that “the mere diminution in value of property is not sufficient to establish a loss for purposes of section 165(a).” The court first looked at the impact of the federal wetland classification which the taxpayer claimed had diminished the land’s value significantly. The taxpayer determined the amount of the loss from this classification by considering what the value the land would have had if it had been developed as planned compared to the land’s undeveloped value. The court rejected this effort, indicating that “the realistic, objective potential uses” of the property control the determination of its value. The fair market value should not be the value of the property based on “the highest and best use for the property...regardless of whether the property is actually being used for that purpose.” To consider the value as if the property were developed as Lakewood planned, the court stated that Lakewood must prove that it was reasonable and


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probable that the...property could be rezoned for residential development within reasonable proximity to the year (of the deduction). The court considered the facts and concluded that because of the clear public objection to residential zoning, a change in zoning was not probable.

The court went on to examine whether the reduction in value of property caused by the inability to rezone created a deductible loss. The court stated that there must be a permanent closing of a transaction to create a loss - “some affirmative step that fixed the amount of the loss, such as an abandonment, sale or exchange.” The court stated that because there was a rezoning problem at the time of the property’s purchase, the denial of the rezoning application did not result in a denial of a right Lakewood previously possessed. “Lakewood paid an amount for the...property in excess of the $million agricultural use value under the belief that the property could be rezoned for residential development. Such an assumption, whether reasonable or not, is not grounds for a loss deduction under section 165 when the assumption is proved to be in error. Land use regulations are akin to market conditions that are constantly subject to change. If we treated an adverse zoning decision ...as a loss realization event, it would be necessary to treat increases from these sources as a taxable gain...Rather, we hold that until the...property is sold, abandoned, or otherwise disposed of in a completed transaction, Lakewood is not entitled to a loss deduction...Because Lakewood continued to own the property, there was not a closed and completed transaction.”

The decision in Lakewood was upheld by the 4th Circuit Court of Appeals in an unpublished decision. [99-1 USTC ¶50,127]. Although there are factual differences between that case and Gobbles, the holdings appear to be quite applicable. This should lead to a good discussion with the students about the factual differences and their impact, and also about the court’s reasoning and how it applies to Gobbles.

Regarding the deductibility of any development costs, the taxpayer is probably not going to find any support for a deduction. In Von Lusk v. Commissioner, 104 TC 207 (1995), the court required capitalization of a developer’s project development costs such as securing approvals. The court stated that in enacting Section 263A, Congress intended to require capitalization of costs beginning at the time of property acquisition until disposition. In Gobble’s case, the fact that development never occurred does not appear to be a helpful fact. In Reichel v. Commissioner, 112 TC 14 (1999), the court held that the mere intention to develop property requires capitalization of the indirect costs.

Gobble may be more successful in deducting its litigation costs under the authority of Rev. Rul. 78-389, 1978-2 CB 126. (See contra authority in Woodward v. Commissioner, 397 US 572 (1970) disallowing litigation costs related to acquiring an asset. However this should not apply since the reason for the lawsuit did not involve prevention from doing business.) There is no one right answer regarding the treatment of the legal fees. Students will be able to locate


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many cases addressing the deductibility of such fees and will need to examine the reasoning and the factual situations in each and conclude how they apply to Gobble.






the chapter.


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TEST PROBLEM BANK Note to instructors: The following potential test questions are in a variety of forms: short answer, multiple choice and true-false. Test questions are organized by chapter to make selection easier. Each chapter’s problems questioning key concept understanding are the source of all the short answer questions, although the wording is slightly changed. Therefore, you can find the answer to each short answer question in this instructor’s guide in the first section of the guide. Overview of Tax Research Questions: Short Answers 1. Define and give an example of the meaning of tax planning. 2. Define a fact. 3. Define and discuss the significance of a conclusion. 4. Define and discuss the significance of a relevant fact. 5. Define and give an example of a primary source. 6. Define and give an example of a secondary source. 7. Define and discuss the significance of a time budget. 8. What is the purpose of tax research? 9. Describe the four basic steps in the tax research process. 10. Why is it so important to determine the research question and, while being flexible to

refining the question, remain focused on it throughout your research process? 11. Why is it important to determine whether you have been asked to act in a planning role

when gathering facts and determining the research question? 12. What is the difference between a fact and a conclusion? Why is it important to recognize

the difference? 13. Does the research question stay the same throughout the research process? Why or why

not? 14. What is the danger of framing the research question too narrowly? 15. Describe the role of the tax researcher. When does tax research need to be performed?

What does the taxpayer usually expect you to do as their tax advisor? 16. What methods are available to gather relevant facts? Why is it important to be aware of

all the facts? What are some of the challenges presented in gathering facts? 17. What are the two sources of primary authority that provide interpretations of the Internal

Revenue Code? 18. How are reference services useful? 19. What is the difference between primary and secondary sources? How can you

distinguish between the two? 20. During which steps must you use skills of critical thinking? For each step where critical

thinking is essential, discuss why. 21. Discuss the variety of forms you may use in communicating the results of your research.


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22. Is it accurate to say that there is only one correct answer to every tax research question? Discuss the reasoning for your response. In what ways does your answer affect how the tax research process is conducted?

23. When might the tax researcher take on the role of tax advocate? 24. How can you determine when you are involved in tax planning? What is your role as a

tax planner? How does this differ from tax research in which no planning is requested? Why is it important to recognize the difference?

25. What standards must you abide by when signing a return or recommending a tax return position to a taxpayer? What must you do to satisfy this standard?

26. What practical considerations does the tax researcher need to be aware of when performing tax research?

27. What purpose do client files serve? What information should be included in a client file? True /False 28. Researching for a planning situation always requires more time and effort than

researching a situation where all the facts are already established. 29. The research process is always the same regardless of the research question. 30. Research conclusions may only be based upon primary authority. 31. If there is not primary authority on a research question, the researcher can feel

comfortable relying on supporting narrative found in a treatise. 32. Reference services should always be consulted before making a research conclusion. 33. A knowledgeable and well-trained researcher should always be able to locate a specific

answer to a tax question. 34. Circular 230 provides a comfortable litmus test to help practitioners determine what type

of research conclusions and client recommendations are proper. 35. The researcher should never sign a return when there is not substantial authority

supporting a return position. Multiple Choice 36. The most important step in the research process is:

a. Gathering the facts b. Locating relevant authority c. Drawing a conclusion d. All of the above

37. A research project involves tax planning when: a. All the facts are fixed and cannot be changed b. Only some of the facts are fixed c. None of the facts are fixed d. Both b and c

38. Which one of the following is a primary source of authority?

a. Treasury Regulation b. United States Tax Reporter c. BNA Tax Portfolio d. An expert’s opinion expressed in a prestigious text


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INTERNAL REVENUE CODE QUESTIONS Short Answers 1. Define and discuss legislative Committee Reports. 2. Define and discuss the Joint Committee on Taxation. 3. Define and discuss the Blue Book. 4. What is the USC? 5. What is Title 26? 6. What is flush language? 7. Define and discuss sunset provisions. 8. Define and discuss terms of art. 9. What is the significance of IRC §7701? 10. Define and discuss limiting language. 11. What is a transition provision in the IRC? 12. Explain the role of the following committees in the tax legislative process: House Ways

and Means, Senate Finance, Conference Committee. 13. What resources are generated by the legislative process? In what way are resources

useful? 14. How can you become informed regarding current Congressional activity in tax

legislation? 15. Where can you find Committee Reports of new legislation? How do you find Committee

Reports reflective of prior older legislation? 16. Discuss how the Internal Revenue Code is organized. Why is it important to understand

its organization? 17. Give examples of three methods of citing the Internal Revenue Code. 18. Name three ways to identify which part of the Internal Revenue Code is relevant in a

research project. 19. When can historical notes to a Code Section be helpful? 20. Name all the different sources for reading the Internal Revenue Code. What are the

major advantages and challenges for each different type of source? 21. Locate IRC Section 165 and answer the following. IRC Section 165 is part of which: a. Title b. Subtitle c. Chapter d. Subchapter 22. Locate IRC Section 162 and answer the following: a. What Subsections does it include? b. What Paragraphs are included in subsection (m)? c. What Subparagraphs are included in IRC Section 162(m)(4)? 23. Correctly cite the highlighted sentence in the following excerpt of the IRC.

Section 83 - Property Transferred in Connection with the Performance of Services (a)General rule If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of - (1)the fair market value of such property (determined without regard to any restriction


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other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over (2)the amount (if any) paid for such property, shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. The preceding sentence shall not apply if such person sells or otherwise disposes of such property in an arm's length transaction before his rights in such property become transferable or not subject to a substantial risk of forfeiture. (b)Election to include in gross income in year of transfer (1)In general Any person who performs services in connection with which property is transferred to any person may elect to include in his gross income for the taxable year in which such property is transferred, the excess of - (A)the fair market value of such property at the time of transfer (determined without regard to any restriction other than a restriction which by its terms will never lapse), over

True/False 24. Under the provisions of the United States Constitution, all major revenue bills must

originate in the United States House of Representatives. 25. The appropriate way to cite the current Internal Revenue Code is “Internal Revenue Code

of 1954 as amended.” 26. The appropriate way to cite the current Internal Revenue Code is “Internal Revenue Code

of 1986 as amended.” 27. The Internal Revenue Code is the primary source of authority in tax research. 28. The tax researcher must always ultimately base a research conclusion on the Internal

Revenue Code’s application. 29. The Internal Revenue Code is Title 25 of the United States Code. 30. The Internal Revenue Code is Title 26 of the United States Code. 31. The Blue Book may provide helpful information, but it is not primary authority that can

be used in making a research conclusion. 32. The explanation written by the Joint Committee on Taxation is not primary authority on

which the researcher can rely. 33. Only the Conference Committee reports are authoritative. 34. The Blue Book may provide helpful information, but it is not authority that can be relied

upon in making a research conclusion. Multiple Choice 35. The Internal Revenue Code is written by:

a. The President b. The House of Representatives c. Congress d. The Internal Revenue Service e. The Secretary of Treasury


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36. When researching legislative history, the first committee report to locate and read is: a. Conference Committee b. Ways and Means Committee c. Senate Finance Committee

37. Committee Reports can be found in the following source: a. Internal Revenue Bulletin b. Cumulative Bulletin c. Tax publisher releases of the reports d. All of the above

38. Which of the following types of information do the historical amendments to the Code never provide? a. Key transition rules b. Text of committee reports c. Text of prior law language d. Number of Public Law amending the section

39. “For purposes of...” represents what type of language? a. Term of art b. Flush language c. Limiting language d. Sunset provision

40. Which one of the following best describes a “sunset provision”? a. A provision that indicates that Congress will update the language periodically b. A provision indicating that the specified numbers will be adjusted for inflation c. A termination provision

TREASURY INTERPRETATIONS QUESTIONS Short Answer 1. Define and discuss the significance of Proposed Regulations. 2. Define and discuss the significance of Temporary Regulations. 3. Define and discuss the significance of Regulation Preambles. 4. What is 26 CFR? 5. What is the Internal Revenue Bulletin? 6. What is the Cumulative Bulletin? 7. Define and discuss the significance of Revenue Rulings. 8. Define and discuss the significance of Revenue Procedures. 9. What is a citator? 10. Define and discuss the significance of Letter Rulings. 11. Define and discuss the significance of Technical Advice Memoranda. 12. What are General Counsel Memoranda? 13. What are IRS Announcements? 14. What are IRS News Releases? 15. What are IRS Publications? 16. Define and discuss the significance of a nonacquiescence. 17. Discuss why the researcher must pay close attention to Treasury interpretations, even if

there is a court case which is helpful to the taxpayer.


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18. When should the researcher turn to the Treasury Regulations for guidance? Can the researcher always count on the Treasury Regulations to help answer the research question? Why or why not?

19. How is it possible to have a Regulation conflict with a Code Section? 20. What steps must the researcher take to ensure the reliability of a Regulation? 21. List four sources where you can access the full text of a Treasury Regulation. Compare

the sources. What are their advantages and disadvantages? 22. How are Treasury Regulations and Revenue Rulings different? 23. When does a Revenue Ruling provide the greatest amount of authority to the researcher? 24. What are the central components of a Revenue Ruling? 25. What do the elements of the following Revenue Ruling cites represent? Rev. Rul. 90-5, 1997-1 C.B. 5 Rev. Rul. 99-100, I.R.B. 1999-37, 15 26. Describe the process you must take to ensure the reliability of a Revenue Ruling. 27. Does the Citator inform you of all documents that are related to the research issue? Why

or why not? 28. What is the difference between a Letter Ruling and a Revenue Ruling? 29. Describe how to locate the Revenue Rulings that interpret a specific Code Section when

you do not wish to use a reference service. 30. What do the elements in the following Letter Ruling cite represent? PLR 99-03-050 31. When is it advisable to research Letter Rulings and Technical Advice Memoranda? How

do you find which Letter Rulings are relevant to your question? 32. Why is it usually more prudent to electronically search the Letter Ruling database for a

Code Section or Regulation Section cite rather than a key word? 33. What is the significance of an acquiescence? Nonacquiescence? When are they issued? 34. What are the differences between the Code and the Regulations? 35. What are the differences between a Revenue Ruling and a Revenue Procedure? 36. How does the Service indicate its opinion about a court decision? 37. How can you determine whether the Service has acquiesced to a court decision? 38. What is the correct cite for Revenue Ruling 98-12 which is found on page 70 of the first

Cumulative Bulletin volume for 1998? What is the correct cite for Revenue Procedure 99-5 which is found on page 10 of the fifth Internal Revenue Bulletin issued in 1999?

39. What is the correct cite for Revenue Ruling 99-10 which is found on the 25th page of the second Internal Revenue Bulletin for the year?

True/False 40. It is proper procedure to cite the Internal Revenue Bulletin for a 1976 Revenue Ruling. 41. Final Regulations have the force and effect of law and therefore must always be followed

by taxpayers. 42. Final Regulations are often out of date and are not authoritative. 43. Final Regulations have the force and effect of law as long as they are reasonable and

consistent with the Internal Revenue Code. 44. Temporary and Final Regulations have the same effect as long as they are reasonable and

consistent with the Internal Revenue Code.


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45. In the Internal Revenue Code, Congress authorizes the IRS to prescribe all rules and regulations necessary to administer the Code.

46. Letter Rulings and Revenue Rulings have the same level of authority. 47. IRS Publications represent primary authority. 48. The IRS is bound by the instructions even if they do not accurately reflect the IRC. 49. A Revenue Ruling is always as authoritative as a Regulation. 50. Revenue Rulings are binding on the Internal Revenue Service until they are revoked,

superceded, modified or declared invalid by a court. 51. A Revenue Ruling which has been “obsoleted” should not be used as authority. 52. Treasury Regulations central thrust is to provide interpretations of the IRC with respect to

a specific factual situation. 53. Proposed Regulations are not authoritative. 54. In certain circumstances, Proposed Regulations may be used as authority. 55. A Treasury Decision is another name for a Revenue Ruling. 56. You should always citate a Revenue Ruling before using it as authority. 57. Revenue Procedures cannot be citated. 58. You should always citate a Final Regulation before you rely upon it. 59. Citating a Revenue Ruling will provide information about whether the Code has been

amended to affect the impact of the ruling. Multiple choice 60. Which of the following cannot be citated?

a. Temporary Regulation b. Final Regulation c. Internal Revenue Code Provision d. Committee Report e. All of the above

61. Which of the following can be citated? a. Final Regulation b. Revenue Ruling c. Revenue Procedure d. All of the above e. Both b and c

62. Final Regulations are written by: a. The Senate Finance Committee

b. The Joint Committee on Taxation c. The Internal Revenue Service d. Congress

63. The Internal Revenue Bulletin is published: a. Weekly b. Monthly c. Semiannually d. Annually

64. The Cumulative Bulletin is published: a. Weekly b. Monthly


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c. Semiannually d. Annually

65. Which of the following is a correct citation? a. Rev. Rule. 82-57, 1982-2 CB 400 b. Rev. Rul. 82-57, 1982-2 CB 400 c. RR 82-57, 1982-2 CB 400 d. Rev. Rul. 82-57, CB 1982-2, 400

66. In the Letter Ruling citation LTR 200225050, the last three digits represents: a. The number of the ruling for the specific week in the year b. The page number in the reporter volume for the year c. The paragraph number in the reporter volume for the year d. The page number in the Cumulative Bulletin for the year

67. Which of the following cannot be found in the Cumulative Bulletin? a. Congressional committee reports b. Revenue Rulings c. Revenue Procedures d. Letter Rulings e. Both a and d

JUDICIAL INTERPRETATION QUESTIONS Short Answer 1. What is case law? 2. What is the Tax Court? Discuss why a taxpayer may wish to litigate in this court. 3. What is the District Court? Discuss why a taxpayer may wish to litigate in this court. 4. What are Circuit Courts? How do cases get to this court? 5. What is a Writ of Certiorari? 6. What is the Golsen rule? 7. What does USTC represent? 8. What does AFTR represent? 9. What is the significance of Rule 155? 10. Define the term en banc. 11. Define the term respondent. 12. Define the term Pro se. 13. What is the definition and significance of dicta? 14. What is parallel citation? 15. Discuss the impact of the Supreme Court denying “Cert” versus granting “Cert.” 16. Is it possible to find two cases, both involving nearly identical facts, where the courts

issue opposite conclusions? Why? How do you decide which case to use in your research? Assuming you decide which case to utilize, should you ignore the other case?

17. What factors do you use to determine which cases are important to your research? 18. What is the difference between an “official reporter” and an “unofficial reporter”? 19. What are the two Federal tax case services? What benefit do they provide to the tax

practitioner? Are all cases related to Federal tax matters always listed in the two Federal tax case services?

20. What steps must the researcher take to ensure the reliability of a court case?


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21. Where can the decisions of all Federal tax cases, other than the Tax Court, be found? 22. How do you determine whether a case is under appeal or if a Writ of Certiorari has been

filed? 23. If you locate an Appellate Court decision, are there circumstances in which you may need

to study the lower court’s opinion? 24. Discuss the structure of a court case. Briefly describe the steps you take to most

efficiently read a case. 25. What is a “headnote”? How is a headnote useful to a tax researcher? 26. What do “id” and “supra” mean? When is it appropriate to use each term? 27. What is the difference between dictum and a court’s holding? 28. What is the difference between overruling a case and reversing a decision? 29. What is “precedential authority”? 30. Discuss what information a Citator provides. Compare and contrast two of the Citator

resources available. Why is citating a case critical? 31. What are the types of decisions the Tax Court renders? How do they differ? 32. What do the elements of the following cite represent? Purple Plum, 105 TC 100 (2001) 33. What do the elements of the following cite represent? Purple Plum, 98 TCM 900 (2001) 34. What do the elements of the following cite represent? Purple Plum, RIA T.C. Memo

Dec. ¶99,976 35. What do the elements of the following cite represent? Purple Plum, 99-2 USTC ¶8953

(CA 5, 1999) 36. What do the elements of the following cite represent? Purple Plum, 30 AFTR2d 95-3567

(CA 1, 1995) True/False 37. Court cases are more important than Regulations. 38. Court cases are more important than Treasury Interpretations. 39. A Supreme Court case directly on point is controlling. 40. When a writ of cert for a case has been granted, the case’s authority is questionable. 41. Filing a writ of cert means that the Supreme Court will hear the case. 42. When the Supreme Court disagrees with a decision it earlier rendered, it can reverse the

earlier decision. 43. When the Supreme Court disagrees with a decision it earlier rendered, it can overrule the

earlier decision. 44. The District Court in the 7th Circuit must follow decisions rendered by the 7th Circuit

Court of Appeals. 45. The Tax Court is never bound by Circuit Court decisions. 46. The Tax Court is always bound by prior decisions rendered by the Circuit Court with

jurisdiction over the taxpayer petitioning in the Tax Court. 47. The Tax Court is always the best court for a taxpayer wishing to have a favorable

decision. 48. The taxpayer may have a jury trial in the Tax Court. 49. The taxpayer may have a jury trial in the District Court. 50. It is not necessary to citate a Supreme Court case. 51. It is always necessary to citate any case upon which the researcher intends to rely.


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52. Citating a case will provide the researcher with a list of all the cases addressing the issue of the cited case.

53. Citating a case in the CCH citator only provides a list of cases that have cited the case at issue.

54. RIA’s citator provides more information about the citing cases than the CCH citator. 55. Citating a case will alert the researcher to any relevant changes in the IRC that may affect

the authority of a case. 56. All tax cases can be found in the USTC service. 57. All tax cases can be found in the AFTR service. 58. Tax Court cases are located in the USTC service. 59. It is appropriate for a researcher to feel comfortable relying on dicta to support a

conclusion. 60. Once a case has been appealed, it is never appropriate to cite or rely upon the appealed

decision. 61. When you see the term Supra, it informs you that the reference is to the most

immediately preceding cite. Multiple Choice 62. Which of the following cases can be found in the USTC service?

a. Circuit Court of Appeals b. Tax Court c. District Court d. All of the above e. Only a and c

63. Which of the following cannot be found in the AFTR service? a. Supreme Court cases b. Appellate Court cases c. Claims Court cases d. Tax Court cases

64. Select the cite below that represents a proper citation. a. Peach v. Commissioner, 76 TC b. Peach v. Commissioner, 76 TC 45 (1998) c. Peach, 76 TC 45 d. Peach v. Commissioner, 76 TC 45 (1998)

SECONDARY SOURCE QUESTIONS Short Answer 1. What is a secondary source? Name two examples. 2. What is a reference service? Name two examples. 3. What is an annotation in a reference service? 4. What does CCH stand for? 5. What does RIA stand for? 6. What are BNA Portfolios? What information do they have to offer the researcher? How

are they different than other secondary sources? 7. Describe folio searching. 8. Describe boolean searching.


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9. What is hypertext and how is it useful to the researcher? 10. What are treatises? Name two publishers of tax treatises. 11. What is the Master Tax Guide? What information does it provide? Name the two

publishers of this source. 12. What types of information do reference services provide? 13. Why is it unwise to base your research conclusion solely on what you read in a reference

service? 14. What types of primary sources do the reference services refer to? 15. Should you feel comfortable that the reference service will refer you to every relevant

Treasury interpretation? Why or why not? 16. What are the factors to consider in selecting the type of reference service that’s best for

your research project? 17. What material is covered for each Code Section in the Code-oriented services? 18. List the steps you must take when using a Code-oriented service. 19. How is CCH’s Code-oriented service different from RIA’s? 20. Why is it important to skim through the entire table of annotations before reading the

annotations themselves? 21. What types of topically structured reference services are available to you? 22. Describe how to find the relevant volume of RIA’s Federal Tax Coordinator. 23. How do you find the relevant BNA portfolios? 24. What are the inherent risks in electronic searching? 25. What are the two types of electronic search technologies? Describe the major differences

between these two types. Provide examples of services using each type. 26. What is segment searching and when might it be useful? 27. Which reference services only enable you to use electronic searching as your main

research methodology? 28. Compare the databases of the Internet services of Lexis-Nexis, RIA (Checkpoint), CCH. 29. What are some of the tools available only through electronic research? Which services

offer these tools? 30. In addition to reference services, what other secondary services are available? 31. Describe how to identify possible tax articles relevant to your research. True/False 32. Some secondary sources are just as authoritative as primary sources. 33. A reference service can speed up your research time by providing you with the answer so

that you do not need to refer to the actual texts of primary source authority. 34. A reference service is intended to direct you to relevant primary authority. 35. Even if an explanation in a reference service appears to provide a conclusive answer to

the research question, it is usually important to examine the primary authority supporting the explanation.

36. It is unwise to base your research conclusion solely on what you read in a reference service.

37. Code-oriented services are more reliable than those topically structured. 38. The reference services contain the full-text of committee reports. 39. Reference services attempt to refer the researcher to all relevant Revenue Rulings,

Revenue Procedures, Letter Rulings and case law.


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40. Reference services attempt to refer the researcher to all relevant Revenue Rulings, Revenue Procedures and case law.

41. The code-oriented reference services published by CCH and RIA are similar in every substantive way.

42. BNA portfolios are comprehensive reference service tools, intended to provide the researcher with a reference to every relevant case and Revenue Ruling.

43. CCH’s Web-based Tax Research NetWork uses the boolean search methodology. Multiple Choice 44. Which one of the following is a secondary source?

a. Law journal article written by a judge b. Letter Ruling c. The Blue Book d. Treasury Regulation

45. Which one of the following is a secondary source? a. Claims Court decision b. Tax Court decision c. United States Tax Reporter annotation d. Senate Finance Committee Report

46. The unique feature of Boolean search engines is: a. Its use of connectors such as and and or b. The ability to segment search c. Its automatic searching for synonyms d. Its ability to search for plurals

47. Which is not a feature of RIA’s Federal Tax Coordinator? a. Narrative discussions of the tax law b. Footnotes to relevant case authority c. Discussion of current developments d. Annotations summarizing relevant authority

48. The primary difference between a Code-oriented reference service and a topically-structured service is: a. The method of discussing an authority b. The number of authorities referenced c. The Code sections covered d. The method of discussing current developments

49. A treatise is: a. A journal article b. An outdated reference service c. A brief summary of a particular topic of the law d. A detailed text on a particular topic of the law

50. A unique feature of the BNA Portfolios is: a. The detailed coverage of each topic b. The working papers c. References to primary authority d. The scope of topic coverage


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51. The Federal Tax Advisor is: a. Published by RIA b. Published by CCH c. Available only electronically d. Both a and c e. Both b and c

52. What is not true about The Master Tax Guide (published either by CCH or RIA) a. It is published every year. b. It is very easy to use. c. It can be used as the basis for a conclusion. d. It is extremely thorough on most topics. e. Both c and d

53. The Code-oriented reporters do not attempt to provide complete references to which of the following? a. Relevant case law b. Relevant Letter Rulings c. Relevant Revenue Rulings d. Relevant Revenue Procedures

COMPLETION OF RESEARCH QUESTIONS Short Answer 1. What is Treasury Circular 230? Who wrote it? What is its significance? 2. What does the term “practice before the IRS” mean? Why is it important? 3. What are the tax research standards a tax practitioner must be aware of? Who

promulgated these standards? 4. What is the “reasonable inquiry standard”? 5. What is the source of the “due diligence standard”? What does it require of the tax

practitioner? 6. What is the impact of failing to abide by the standards provided in Circular 230? 7. What is the impact of failing to abide by the standards provided by the AICPA? 8. What guidelines regarding appropriate research standards do the Treasury Regulations

offer? 9. Compare the research guidelines provided by Circular 230, the AICPA and Treasury

Regulations. How do they differ? 10. Who does Circular 230 bind? 11. Who does the AICPA’s Statements on Responsibilities in Tax Practice bind? 12. Why is it important for you to know when your research is complete? 13. Describe the step of “pondering” your research results. What must you consider? 14. Assume you complete all the research steps, but you still don’t feel comfortable with

your conclusion. What do you do? 15. In reviewing your research results, you find you have a Revenue Ruling that clearly states

your taxpayer cannot do what he wants to do. However, you also found a case (although with no jurisdiction over your taxpayer) that says he can. What do you do? What practical considerations are important?

16. Under what circumstances are you required as tax researcher to refrain from recommending a certain tax position to a taxpayer.


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17. What is the importance of primary authority? 18. Assume that Mr. X tells you about a court settlement which resulted in her receiving

$50,000 in breach of contract damages. You communicate to Mr. X that as a result of your research, it is clear that the $50,000 will have to be included in his taxable income. Mr. X later provides to you all of the material necessary for you to prepare his return but does not mention the $50,000. When questioned, he tells you that he doesn’t want to pay taxes on this amount and asks you just to pretend that the two of you never had the conversation and that you don’t know anything about the $50,000. What are your responsibilities in completing Mr. X’s tax return?

19. Your client is a resident of California. He has asked you to research whether he must recognize some of his receipts as income. How will you advise your client if your research resulted in locating the following authority: * Revenue Ruling that speaks directly to the issue and requires income recognition? * A Tax Court case concerning a California taxpayer that directly addresses the issue and concludes the income may be excluded from taxable income? * A 3rd Circuit Court of Appeals case that, although the facts are slightly different, concludes the income must be included?

20. The only authority you find after an exhaustive research process is a ten-year-old Letter Ruling. Although the ruling provides few details regarding the transaction the Treasury was reviewing, what is available appears relevant and suggests a position favorable to your client’s preferred approach. What do you advise your client?

21. Your library only contains one of the reference services. It does not contain any case books, or the Cumulative Bulletins. You do not have access to an electronic library. However, there is a full law library in the city. Your client has requested that you advise her on the impact of a corporate liquidation resulting in a property distribution to the client of $25,000. From your review of the reference service, you believe that she is entitled to exclude the value of the item from income. The reference service provides summaries of several court cases taking this position. What do you do at this point? Why?

22. You are researching the deductibility of a certain expense. You take the following steps: Gather facts⎟Determine issue⎟Study the regulations⎟Examine annotated reference service⎟study the 2 cases which initially appeared to be on point⎟conclude the cases are irrelevant. You have performed no other research steps nor reviewed authority other than that indicated. What additional steps are advisable at this point? Why?

23. You are researching the deductibility of a certain expense. You take the following steps: Gather facts⎟Determine issue⎟ Examine IRC ⎟ Examine BNA portfolio that seems to adequately answer the research question. You have performed no other research steps nor reviewed authority other than that indicated. What additional steps may be advisable at this point? Why?

24. You are researching the deductibility of a certain expense. You take the following steps: Gather facts⎟Determine issue⎟Examine annotated reference service⎟ locate a Revenue Ruling that appears directly on point and allows the deduction. You located the Revenue Ruling as soon as you began using the reference service. You did not continue reviewing the reference service once you spotted the Revenue Ruling cite. You have performed no other research steps nor reviewed authority other than that


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indicated. What additional steps are advisable at this point? Why? 25. You are researching the deductibility of a certain expense. You take the following steps:

Gather facts⎟Determine issue⎟Study the IRC ⎟Review the related Treasury Regulations⎟Confirm that the helpful Regulation still reflects current statutory law⎟Examine Volume 4 of the annotated reference service⎟ Thoroughly review that volume and identify two cases which appear directly on point and which allow the deduction ⎟ Examine the cases and conclude they are applicable. Are there additional steps remaining in the research process before you advise your client? If so, what are they? Why?

26. You are researching the deductibility of a certain expense. You take the following steps: Gather facts⎟Determine issue⎟Study the IRC ⎟Review the related Treasury Regulations and determine that there is no Regulation for the relevant Code provision⎟ Examine the pertinent volumes of a topical reference service and find no helpful guidance. How do you proceed? Are there additional steps remaining in the research process before you advise your client? If so, what are they? Why?

27. You are researching the deductibility of a certain expense. You take the following steps: Gather facts⎟Determine issue⎟Examine a case recommended to you by your supervisor and determine the case is right on point and favors the taxpayer’s preferred position. What additional research steps are necessary before you advise your client?

True/False 28. Circular 230 provides a comfortable litmus test to help practitioners determine what type

of research conclusions and client recommendations are proper. 29. A case that is still good authority is more significant than a current Revenue Ruling. 30. The researcher can feel quite comfortable recommending to a client a position that is

supported by a current (and not superceded) Revenue Ruling. 31. The researcher should never sign a return when there is not substantial authority

supporting a return position. Multiple Choice 32. Circular 230 was written by:

a. The Treasury Department b. The Joint Committee on Taxation c. The Congress d. The AICPA e. The ABA

33. The sources of tax practice guidelines include: a. The ABA b. The AICPA c. The Treasury d. The Code e. All of the above

34. The AICPA’s standards bind: a. All those who practice before the IRS b. All Certified Public Accountants c. Only those CPAs who are members of the AICPA


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d. Members of the ABA and AICPA 35. The most important element contributing to excellent research is:

a. Critical thinking and analysis b. Completeness of the tax library c. Time spent on the research d. Staying within the alloted budget

36. In order to be able to rely upon a case decision, it is essential that: a. The facts are essentially identical to the clients b. The case was decided by a court with jurisdiction of the client c. You citate the case to ensure it has not been overruled or reversed d. The case was decided by the Supreme Court

COMMUNICATING RESEARCH RESULTS QUESTIONS Short Answer 1. What is the purpose of an office memo? List the main elements. 2. What are the main elements of a client opinion letter? 3. What is the purpose of a protest letter? How does the purpose impact the style you use in

writing one? 4. What type of writing is involved in a Letter Ruling request? 5. What does FIRAC stand for? 6. What are the various types of internal and external written communications? What

factors determine which type of communication is most appropriate? Why? 7. Why are client letters the riskiest form of communication for the tax practitioner? 8. What factors must you consider when making an oral presentation? 9. What is a white paper? 10. What is the difference between a long-form opinion letter and a short-form opinion

letter? 11. When would you advise a taxpayer to seek a Letter Ruling? 12. Describe two conditions or qualifications in an opinion letter. 13. You are reviewing a subordinate’s draft client opinion letter. The first sentence states the

following: “We have reviewed the tax implications of the transaction you described to us in our meeting held last week. We find that you will be able to proceed as planned.” The letter then begins to address the research findings. In what ways would you correct this?

14. You are reviewing a subordinate’s draft client opinion letter. Comment on the appropriateness of the following first sentence: “Our opinion is accurate beyond a reasonable doubt. You may be assured that the positions stated herein are correct.”

Multiple Choice 15. The most important element of an office memo is:

a. The statement of the facts b. The discussion of the relevant Code Section c. The researcher’s findings and conclusions d. All of the above

16. Which of the following is not an example of an external written communication?


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a. Protest letter b. Office memo c. Letter Ruling request d. Client opinion letter

17. The first sentence in a client opinion letter should be: a. A statement of the scope of the research performed b. A statement of the facts c. The researcher’s conclusion

18. When writing a client opinion letter, which is true about the statement of facts? a. It is proper for the researcher to refer to the facts as described over the telephone

on as specified date. b. It is proper for the researcher ro refer to the facts as discussed in a personal

meeting with the client on a specified date. c. It is proper for the researcher to restate each of the facts as understood by the

researcher. d. It is proper for the researcher to write the letter without restating the facts.

19. Which of the following elements is true about an opinion letter? a. The researcher must be very cautious to ensure a thorough and correct discussion

because legal vulnerabilities are higher than in other forms of writing b. The research can be relatively cavalier when writing an opinion letter because the

letter is only directed at a client rather than a formal court officer c. The opinion letter should not contain citations to authority relied upon d. The opinion letter should contain citations to authority relied upon. e. Both a and d

20. In which of the following is it appropriate for the tax researcher to take a position s/he does not personally agree is correct? a. Protest letter b. Client opinion letter c. Office memo d. Both a and b

OVERVIEW OF TAX PRACTICE AND PROCEDURE Short Answer 1. Define and discuss the significance of the Internal Revenue Service Restructuring and

Reform Act of 1998. 2. What is the role of the Secretary of the Treasury? 3. What is the role of the Internal Revenue Service Commissioner? 4. What is the role of the IRS Oversight Board? Who does it consist of? 5. Describe the role of the Chief Counsel of the IRS. 6. Describe the role of the Treasury Inspector General for Tax Administration. 7. Describe the role of the National Taxpayer Advocate. 8. Define and discuss the significance of the statute of limitations. 9. What does mitigation of statute of limitations refer to? 10. What types of audits might the IRS perform? 11. Define and discuss the significance of a Revenue Agent’s report. 12. Define and discuss the significance of an IRS summons.


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13. Define and discuss the significance of Form 870. 14. Define and discuss the significance of a closing agreement. 15. Define and discuss the significance of a Statutory Notice of Deficiency. 16. Define and discuss the significance of an IRS assessment. 17. Define and discuss the significance of a levy. 18. Define and discuss the significance of being an income tax return preparer. 19. Define and discuss the significance of privileged communications. 20. Is the tax system of the United States a self-assessment system? What does this mean?

How is this different from other countries’ systems? 21. What must a completed tax return contain in order to be considered as having been filed? 22. What incentives does the Code provide to the taxpayer to comply with the tax laws? 23. When must a calendar year individual taxpayer file the individual income tax return? 24. If a corporation’s fiscal year closes on July 30, when must it file its income tax return? 25. If the filing date occurs on a holiday, when must the return be filed? 26. An individual taxpayer anticipates that her unpaid tax liability will be approximately

$10,000. She does not have all the information necessary to file the tax return by the due date. What are her options?

27. What is the last date an individual calendar year taxpayer’s tax return can be filed if all extension requests are filed and granted?

28. When may the IRS reveal tax return information to someone other than the person filing the return or his authorized representative?

29. In general, what is the statute of limitations for an income tax return timely filed on April 15, XXX2? What if the return is not due until April 15, but the taxpayer files the return on February 1, XXX2?

30. When might the statute of limitations be longer than three years? 31. What is a “30-day letter”? 32. What options are available to the taxpayer upon receiving a “30-day letter”? 33. What are the potential methods the IRS can use to investigate whether the taxpayer has

complied with the tax laws? 34. When is the IRS entitled to institute a grand jury investigation regarding tax compliance? 35. What is a “90-day letter”? 36. What options are available to the taxpayer upon receiving a “90-day letter”? 37. When may a taxpayer petition the U.S. Tax Court? How is this done? 38. Who may represent a taxpayer in a U.S. Tax Court proceeding? 39. When may a taxpayer request to have the Tax Court decide a case under the “small tax”

case procedures? Why might the taxpayer choose to make this request? 40. What is a “jeopardy assessment”? When may this be appropriate? 41. What does a “jeopardy assessment” entitle the IRS to do? 42. If a taxpayer disagrees with the position of the IRS and is assessed a tax deficiency, what

options are available to the taxpayer? 43. In order to be considered filed, what must a claim for refund include? 44. When is the last day a claim for refund can be filed if the tax return was filed on April 15,

year XX02 and the tax (plus penalties) was paid on December 1, year XX06? 45. When is the last day a claim for refund can be filed when the return was filed and full

payment was made on February 15, year XX02? The return was not due until April 15 of that year.


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46. What are the taxpayer’s options when a refund claim is denied by the IRS? 47. If the taxpayer wishes to file suit in court, what factors might the taxpayer consider in

selecting which court to petition? 48. What does it mean to state that a particular party has the “burden of proof”? 49. What are some examples of the level of burden of proof a party may carry? 50. In tax cases, who carries the burden of proof, the IRS or the taxpayer? 51. Under what circumstances may attorneys fees be awarded to a taxpayer? 52. What are the various methods the IRS may use in attempting to collect taxes assessed? 53. According to the Treasury Regulations, what constitutes “return preparation” for

purposes of the penalty provisions? 54. List three obligations of a tax return preparer? 55. What are the penalties if the tax return preparer fails to sign a tax return he prepared? 56. What are the potential penalties for a tax return preparer who signs a return he knew

reported a position with no “realistic possibility of being sustained” and fails to disclose this fact on the return?

57. What are the potential penalties for a tax return preparer who intentionally ignores information reported to him by the taxpayer in an attempt to understate the tax liability shown on the return?

58. What are some of the criminal charges a tax return preparer may be subject to? What are the potential consequences if found guilty?

59. Discuss some of the penalties that can be imposed on the taxpayer for understating his tax liability.

60. What types of communication may be protected by the attorney-client or accountant-client privilege?

61. What is the philosophical basis for the attorney-client/accountant-client privilege? 62. Is there an accountant-client privilege? 63. When may a tax-related communication fall outside the protection of the accountant-

client privilege? True/False 64. The Commissioner of the IRS is the person charged with the responsibility of

implementing and enforcing the IRC. 65. The Commissioner of the IRS is appointed by the President of the United States for a

renewable 5-year term. 66. A return filed on the wrong form but reporting the information in an accurate and

complete manner is considered a return filed. 67. In most cases, joint returns only need to be signed by one of the parties. 68. In most circumstances, an individual return must include a Social Security number. 69. Individuals are entitled to a 4-month extension to file the tax return. This extension is

automatically granted without a request for extension required. 70. Individuals are entitled to an automatic 4-month extension request upon request. An

additional discretionary 2-month extension may be awarded upon request. 71. The tax return is considered filed on the date the return is received by the Service, unless

received after the due date of the return. 72. As long as the return is timely filed, the exact date of filing is irrelevant.


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73. Even if the filing date of a tax return is extended, any tax liability owning is due on the due date of the tax return.

74. Generally, tax returns are confidential documents between the taxpayer and the IRS. 75. The statute of limitations can never be more than 3 years. 76. Filing a fraudulent return triggers an unlimited statute of limitations. 77. Upon receipt of the “90 day letter,” the taxpayer has 90 days to respond to the Service

with a protest letter. 78. Upon receipt of the “90 day letter,” the taxpayer has 90 days to file a petition in Tax

Court. 79. Taxpayer may file a claim for refund in the Federal District Court immediately after

paying the amount of taxes assessed. 80. There is no specific time frame within which a taxpayer must file a claim for refund with

the IRS. 81. If a refund claim is filed within three years of the return filing date, the refund amount

cannot exceed the total tax paid within the three years prior to the date of the claim. 82. The IRC provides that the government must pay interst on a taxpayer overpayment. Multiple Choice 83. A return is considered filed:

a. When received by the Service if received prior to the due date of the return b. Only when postmarked c. On the date received by the Service unless received after the due date. If received

after the due date, then on the date postmarked 84. Which of the following is required for a return to be considered filed?

a. Taxpayer signature under penalty of perjury b. The correct form c. Computation of tax liability d. All of the above

85. The provisions governing the time in which permissible audits and assessments must occur are called: a. Extension provisions b. Closing agreements c. Statutes of limitations d. Filing requirements

86. The general statute of limitation for a non-fraudulent filed tax return is: a. Three years from the actual date of filing b. Three years from the due date for filing, even if filed after the due date c. Three years from the due date for filing, or if filed late, then the date of the filing d. None of the above

87. The statute increases to six years when: a. The taxpayer filed a fraudulent return b. The taxpayer failed to file a return c. The taxpayer omitted income exceeding 25% of the taxable income d. The taxpayer omitted income exceeding 25% of the gross income

88. A statutory notice of deficiency is mailed to the taxpayer with which of the following? a. The “30 day letter”


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b. The “90 day letter” c. The Revenue Agent’s Report d. None of the above

89. Upon receipt of a “90 day letter,” the taxpayer has 90 days in which to: a. File a petition in Tax Court b. File a petition in Federal District Court c. Protest to the IRS about the revenue agent’s findings d. Both a and c

90. A summons can be issued to allow the Secretary of Treasury to do which of the following? a. Examine any potentially relevant material b. Require the taxpayer to appear and produce records c. Enter without permission the taxpayer’s property d. All of the above e. Both a and b

91. Which of the following statements is true? a. Taxpayer may have a jury trial in the Tax Court. b. Taxpayer may have a jury trial in Claims Court. c. Taxpayer may have a jury trial in the Circuit Court of Appeals. d. Taxpayer may have a jury trial in the Federal District Court. e. Taxpayer may have a jury trial in both the Tax Court and the Federal District

Court. 92. Which court is the only court where the taxpayer can file before paying any taxes

assessed? a. Federal District Court b. Claims Court c. Tax Court d. All of the above

STATE RESEARCH QUESTIONS Short Answer a. Discuss why it is important to be aware of state tax issues. b. Describe how nontax state laws may affect Federal tax research. c. Describe the types of tax issues that can arise concerning state taxes. d. What is the name of your state’s general statutory income tax laws? e. What agency administers your state’s income tax laws? f. Identify your state courts, from the lowest court to the highest. g. Is there a body in your state between the taxing agency and the courts that can hear and

decide tax cases? If so, what is it called? h. Identify the secondary sources available to you regarding your state’s taxes. i. List three types of taxes that your state imposes. j. Name two states that do not have a personal income tax.


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Test Problem Answers

Overview of Tax Research Questions Short Answer- contained in the pertinent provisions in text answer guide True/False 1. F 2. F 3. T 4. F 5. F 6. F 7. F 8. F Multiple Choice9. D 10. D 11. A INTERNAL REVENUE CODE QUESTIONS Short Answer21. a. 26 b. A c. 1 d. B 22. a. a-p b. 1-4 c. A-F 23. IRC Section 83(b)(1) True/False24. T 25. F 26. T 27. T 28. T 29. F 30. T 31. F 32. F 33. F 34. F


Test Problem Answers 237

Test Bank Answers

Multiple Choice35. C 36. A 37. D 38. B 39. C 40. C TREASURY INTERPRETATIONS QUESTIONS Short Answer- contained in the pertinent provisions in text answer guide 38. Rev. Rul. 98-12, 1998-1 CB 70 Rev. Proc. 99-5, IRB 1999-5,10 39. Rev. Rul. 99-1, IRB 1999-2 , 25 or Rev. Rul. 99-1, 1999-2 IRB 25 True/False40. F 41. F 42. T 43. T 44. T 45. F 46. F 47. F 48. T 49. F 50. T 51. T 52. F 53. F 54. T 55. F 56. T 57. F 58. F 59. F Multiple Choice60. D 61. E 62. C 63. A 64. C

238 Test Problem Answers

Test Bank Answers

65. B 66. A 67. D JUDICIAL INTERPRETATION QUESTIONS Short Answer- contained in the pertinent provisions in text answer guide 37 . Case name, volume, Tax Court Reports, 1st page of case, date 38. Case name, volume, Tax Court Memo (CCH), 1st page of case, date 39. Case name, Tax Court Memo reporter from RIA, Decision number (paragraph) 40. Case name, year of decision -volume for that year, United States Tax Cases (CCH),

paragraph number of case, 5th Circuit Court of Appeals, date 41. Case name, volume, American Federal Tax Reports Second series, year-1st pg of case, 1st

Circuit Court of Appeals, date True/false42. F 43. F 44. T 45. T 46. F 47. F 48. T 49. T 50. F 51. T 52. F 53. F 54. T 55. F 56. T 57. F 58. T 59. T 60. F 61. F 62. F 63. F 64. F 65. T 66. F Multiple Choice 67. E


Test Bank Answers

68. D 69. D SECONDARY SOURCE QUESTIONS Short answer- contained in the pertinent provisions in text answer guide True/False32. F 33. F 34. T 35. T 36. T 37. F 38. F 39. F 40. T 41. T 42. F 43. T Multiple Choice44. A 45. C 46. A 47. D 48. A 49. D 50. B 51. E 52. E 53. B COMPLETION OF RESEARCH QUESTIONS Short Answer – contained in the pertinent provisions in text answer guide True/False28. F 29. F 30. T 31. F Multiple Choice

240 Test Problem Answers

Test Bank Answers

32. A 33. E 34. C 35. A 36. C COMMUNICATING RESEARCH RESULTS QUESTIONS Short Answer- contained in the pertinent provisions in text answer guide Multiple Choice15. D 16. B 17. A 18. C 19. E 20. A OVERVIEW OF TAX PRACTICE AND PROCEDURE Short Answer- contained in the pertinent provisions in text answer guide True/False 64. F

65. T 66. F 67. F 68. T 69. F 70. T 71. T 72. T 73. T 74. T 75. F 76. T 77. F 78. T 79. F 80. F 81. T 82. F

Multiple Choice

83. C 84. D


Test Bank Answers

85. C 86. C 87. D 88. A 89. A 90. D 91. D 92. C

STATE RESEARCH QUESTIONS- contained in the pertinent provisions in text answer guide

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Tax Research Instructor's Manual