2004 Law Change Invalidated Treasury Regulation Setting Cap at $100,000 for Penalty to Willfully File FBAR, Over $800,000 in Penalties Imposed

In 2018 we discussed two U.S. District Court cases where the IRS’s attempt to impose a greater than $100,000 penalty for willful failure to file a Foreign Bank Account Report (FBAR) return was denied by the courts, finding that a Treasury regulation that had not been changed since Congress removed the $100,000 maximum on such willful failures still controlled.[1]  The issue has now been addressed for the first time by a U.S. Circuit Court of Appeals in the case of Norman v. United States[2] and the IRS is much happier with the result.

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Taxpayer Allowed to Use Both §121 and §1031 in Dispositions for Property Following Fire

The IRS issued a private letter ruling to a taxpayer dealing with both the exclusion of gain on the sale of a residence under IRC §121 and the like-kind exchange provisions of IRC §1031 in PLR 201944006.[1]

The ruling involves a piece of property.

  • One of the taxpayers had purchased the property to use as a principal residence, and when the taxpayers were married they continued to use it as their principal residence.  Eventually the taxpayers moved into a new residence.

  • The property was then offered to rent.  While there was a period of time when the property was rented to full-time tenants, they also rented it for short-term rentals during other portions of this period of time.  The rental use ended when the property was destroyed in a fire.

  • Following the fire the taxpayers received funds for the destroyed residence, sold the land without rebuilding the residence and acquired new property in a transaction they hoped would qualify for deferral of gain under IRC §1031.[2]

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Wisconsin Appeals Court Rules Microsoft's Payments from OEMs for Machines Eventually Sold for Use in Wisconsin Is Not Wisconsin Income

The state of Wisconsin lost in an attempt to look further down the line to find an ultimate consumer to source sales in the case of Wisconsin Department of Revenue v. Microsoft Corporation, Court of Appeals, District IV, Appeal No. 2018AP2024.[1]

The case involves the state of Wisconsin looking to include in the sales factor fees paid to Microsoft for licensing Windows that are included in machines eventually purchased for use in Wisconsin. The purchasers of the computers enter into a sublicense with the manufacturer to use Windows.  The Wisconsin Department of Revenue argues that the licensing fee paid by the manufacturer when they installed Windows on the machine should be sourced to Wisconsin when sold to a Wisconsin resident.[2]

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§280E Is Not An Excessive Fine Under the Eighth Amendment and Also is Not Limited Just to Barring Deductions Under §162

A majority of the Tax Court concluded in the case of Northern California Small Business Assistants Inc. v. Commissioner, 153 TC No. 4,[1] that the denial of deductions for those operating businesses trafficking in cannabis is not a fine.  Therefore, the provision could not be found to be an excessive fine.

The Eighth Amendment to the U.S. Constitution provides:

Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.

The taxpayer, a medical marijuana dispensary operating under California law that allows such operations, argued that IRC §280E served as an excessive fine under the Eighth Amendment and thus should be disregarded by the Court.

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Interim Guidance Issued to Appeals Employees on BBA Partnership Audit Cases

The IRS has issued guidance to Appeals Employees regarding procedures that will be used in cases involving the Bipartisan Budget Act of 2015’s (BBA) revision to the partnership audit rules.[1]

The memorandum consists of a summary of procedural changes, followed by interim guidance until IRM 18.9 is revised along with an appendix containing the interim procedures and a glossary of BBA terms..  The interim guidance has an expiration date of October 18, 2021.

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Chief Counsel Establishes Procedures to Use S/MIME and Encrypted ZIP to Communicate with Taxpayers With Matters Before Counsel's Office

In Chief Counsel Norice 2020-002 the IRS Chief Counsel provides for two methods to use secure email to communicate personally identifiable information (PII) and return information with taxpayers and representatives involved in Tax Court litigation or in regard to letter ruling and closing agreements.[1]

The notice provides the following changes in procedures to communicate with taxpayers for Chief Counsel employees:

Effectively immediately, Chief Counsel employees may exchange PII and return information with taxpayers or their representatives during Tax Court litigation and letter ruling or closing agreement processes, using one of two email encryption methods:

1. The LB&I Secure Email System (SEMS), which authorizes the exchange of encryption certificates under specific circumstances, allowing the exchange of fully-encrypted emails and attachments, and

2. SecureZIP encrypted email attachments, allowing the sending of password-protected encrypted email attachments to anyone with a compatible zip utility.[2]

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California Rules that Directors Fees Are Sourced to State Where Highest Ranking Officers Carry Out the Board's Directions

In Chief Counsel Ruling 2019-03[1], the Franchise Tax ruled on the application of California’s market based sourcing rules as applied to an outside director that attended a shareholder or board of directors meeting in California.

Market based sourcing is increasingly being used by states to determine whether the state has the right to impose an income tax on the amounts paid to an out of state organization or resident for services rendered.  Previously states had generally looked to the location of the sale being tied to where the services were primarily performed.

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Tax Court Cannot Order the IRS to Reexamine Taxpayer When Whistleblower Believes IRS Assessment is "Woefully Inadequate"

A whistleblower found out that his award is limited to what the IRS decides to collect, even if the whistleblower believes the agency should have assessed substantially more tax in the case of Apruzzese v. Commissioner, TC Memo 2019-141.[1]

The plaintiff and his co-claimant had submitted a Form 211, Application for Award for Original Information, to the IRS Whistleblower Office (WO).  The plaintiff and the co-claimant had been involved in litigation against an estate and claimed the estate had omitted substantial assets from its Form 706 filed with the IRS, understating its estate tax by several million dollars.[2]

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Due to Delays in the Issuance of WOTC Certifications, Agents Directed to Not Challenge Taxpayers Who Claim Credit in Year Certification Received

The IRS Large Business and International (LB&I) and Small Business/Self-Employed (SBSE) Divisions have issued a memorandum to agents regarding issues with claims of the Work Opportunity Credit.[1]  Agents are directed not to question the timing of claiming the work opportunity credit when the employer claims the credit in the year a delayed certification is received rather than the year the employer paid or incurred qualified wages.

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2019 Form 1040 Schedule 1 Will Ask Taxpayers If They Have Had Virtual Currency Transactions

Just before the extended individual filing deadline for 2018 returns, the IRS released new instructions and a second revision to a Form 1040 Schedule 1 that adds a question related to IRS’s increased interest in virtual currencies.

The IRS has released the complete draft instructions for Form 1040 and Form 1040-SR for 2019[1] and the instructions for Form 8995-A, the form for computing the qualified business income deduction for taxpayers with taxable income in excess of the threshold amount.[2]

The Form 8995-A instructions are much like the previously released Form 8995 instructions, including containing the comment about reducing QBI by charitable contributions related to the business, a position that many found surprising in the “simple” form instructions.

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IRS Releases Long-Awaited Cryptocurrency Guidance

The IRS finally released its promised guidance on tax issues related to cryptocurrencies in the form of Revenue Procedure 2019-24[1] and a set of frequently asked questions on the IRS website.[2]

The Revenue Procedure looks to answer a question may have had about how to treat the hard fork of a cryptocurrency.  The best-known hard fork of a cryptocurrency was the fork that created Bitcoin Cash in August 2017.[3]  Investopedia’s article on Bitcoin Cash describes the fork and related issues as follows:

Amidst a war of words and staking out of positions by miners and other stakeholders within the cryptocurrency community, Bitcoin Cash was launched in July 2017. Each Bitcoin holder received an equivalent amount of Bitcoin Cash, thereby multiplying the number of coins in existence. Bitcoin Cash debuted on cryptocurrency exchanges at an impressive price of $900. Major cryptocurrency exchanges, such as Coinbase and Itbit, boycotted Bitcoin Cash and did not list it on their exchanges.[4]

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IRS Expands Voluntary IP PIN Program to Additional 10 States

The IRS has expanded the number of states by 10 for which residents can voluntarily apply for an Identity Protection Personal Identification Number (IP PIN).  This expansion was announced by the IRS in its e-News to Tax Professionals email subscription sent out on October 4, 2019.[1]

The IP PIN program was created to combat tax-related identity theft.  Originally the PINs were issued only at the IRS’s discretion to actual or suspected victims of tax-related theft.  As Kay Bell notes on her website, in 2010 the IRS created a pilot program in 2010 to allow for taxpayers to voluntarily request IP PINs, limited to only the three areas that had the highest level of tax related identity theft.[2]

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Pennsylvania Will Apply $500,000 Economic Nexus Rule for Corporate Income Tax Filings in 2020

In Pennsylvania Corporation Tax Bulletin 2019-04,[1] the state of Pennsylvania announced that it will begin treating any corporation with $500,000 of sales into the state as having nexus with the state.  The state bases this revised view of nexus based on the Supreme Court’s rejection of a physical presence requirement for sales tax nexus in the Wayfair  case.[2]

The Department provides the following analysis for why it has concluded physical presence should also no longer be a requirement for income tax nexus:

The Court went on to conclude “that the physical presence rule of Quill is unsound and incorrect.”

As a result, the Commerce Clause analysis set forth in Complete Auto Transit remains valid, but the physical presence rule, which was previously held in Quill to be a necessary part of the substantial nexus prong is incorrect. While taxpayers contested for years whether the physical presence nexus standard in Quill was limited to sales taxes or also applied to corporate net income taxes, the decision in Wayfair has made certain that, at least prospectively, no physical presence standard exists for purposes of limiting the ability of a state to impose a net income tax on an out of state taxpayer so long as the constitutional requirements under the Due Process and Commerce Clauses of the United States Constitution are satisfied.[3]

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Drafts of 2019 Forms 1065 and 1120S, As Well As K-1s, Issued by IRS

The IRS has released new and/or update draft Forms 1065, 1120S, and the related K-1s for 2019.  The new form contains certain changes for 2019 returns.

Some of the more significant revisions are:

  • Required use of tax basis capital for the capital account reconciliation on Schedule K-1 for partnerships;

  • Disclosure of additional information related to §704(c) transactions on the partnership Schedule K-1;

  • Guaranteed payments will have to be split on the partnership K-1 between those for capital and those for services;

  • Additional information on the existence of activities for at-risk and passive activity purposes on all forms; and

  • Switch to the descriptive text disclosures for §199A information that was first revealed on the July draft of the Form 1120S Schedule K-1.

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