COMPANY NEWS

From: Aaron Weinberger
Sent: Wednesday, August 19, 2009 11:39 AM
To: Accountants
Subject: deferral of COD income on repurchased debt COD= Cancellation Of Debt

Mileage between job locations deductible—partial deduction for tools & clothing despite poor records

De Chacing et vir., TC Summary Opinion 2009 – 127

In a Summary Opinion, the Tax Court has held that mileage between a taxpayer's first and second work locations leads to deductions even though the second work location is near his home. It also allowed a partial deduction for the taxpayer's tools and clothing, on the strength of some photos and corroborating testimony.

Business transportation vs. commuting. Generally, business transportation, which is deductible, is transportation between two business locations in and around the city, town, or area where the taxpayer is located, whether the locations are in the same or different businesses. (Rev Rul 90-23, 1990-1 CB 28) However, the trip from the taxpayer's home to his regular place of business or employment, and back, is commuting, which is nondeductible personal travel. (Reg. § 1.162-2(e), Reg. § 1.262-1(b)(5))

Deduction for tools and protective clothing. The cost (as well as maintenance) of clothing provided by an employee is deductible if the special apparel (a) is required as a condition of employment, and (b) isn't adaptable to general or continued usage so as to take the place of ordinary clothing. (Rev Rul 70-474, 1970-2 CB 34) For example, protective clothing, such as safety shoes, hard hats, work gloves, etc., is deductible if required for the job.

An employee's unreimbursed employment-connected business expenses are deductible on Schedule A to the extent they exceed 2% of adjusted gross income (AGI).

Substantiating business expenses. In general, all business expenses must be substantiated. Taxpayers who are eligible to and in fact deduct business auto expenses by way of the mileage rate meet the substantiation rules by keeping a record of the time, place and purpose of business trips. Records and receipts of actual expenses are not required.

Under the Cohan rule, where the taxpayer is unable to substantiate expense deductions through adequate records or other proof, the court may estimate the deductible amount, bearing heavily, if it chooses, upon the taxpayer whose inexactitude is of his own making. (Cohan, George v. Com., (1930, CA2) 8 AFTR 10552)

Facts. Jose Chacin worked on a daily basis for a building contractor. Each day he drove from his home to the building contractor's office and received his assignment for the day. He would then proceed to the jobsite and perform as instructed for the day. He drove approximately 121 miles each day. Approximately 2 days each week he would proceed from the first job to a second job where he also worked as a carpenter. The second job was near his home, but he drove there from his first job.

Chacin maintained a log of his daily mileage. He would list the odometer reading and allow that reading to stand until there were nonbusiness miles. Because he drove to the same work location each day, it was not necessary to make a posting each day. Mr. Chacin did not distinguish his mileage from his first job to his second because the second was in the vicinity of his residence. Additionally, he believed that all of his mileage was deductible.

On his 2005 return, which he filed jointly with his wife, Leslie De Chacing, Chacin claimed $13,813 for all of his mileage (computed at the business mileage rates then in effect). He also claimed $850 for tools and $1,630 for protective clothing he was required to provide for work. These were gross amounts before application of the 2% of AGI floor.

Tax Court. The Tax Court said Chacin could not deduct the entire cost of his transportation to and from his job, but said he could claim deductions for the mileage from his first job site to the second one. Approximately 2 days each week, Chacin drove from his first job to a second job location which was near his home. Accordingly, the Court ruled that one-half of his mileage on those days (between jobs) was not commuting and is deductible.

RIA observation: The Tax Court's holding illustrates that the distance from the taxpayer's second job location to his home doesn't matter. Even if it's just a few blocks away from his home, mileage between the first and second job locations will still be treated as business transportation.

On the basis of the record before it, the Court held that Chacin was entitled to transportation expenses of $5,525 for the 2005 tax year.

As for Chacin's tools and protective clothing, there was some testimony about these expenses, and he also provided bank statements, along with some written notations about the generic category of various expenditures (i.e., “Jose work clothes”). The Court said that Chacin's recordkeeping on these items fell short of showing specific purchases, but did provide some photographs of certain equipment and work clothing showing that the work clothing was not suitable for everyday wear. Applying the Cohan rule, the Tax Court found that Chacin was entitled to deductions of $200 for tools and $400 for work clothing for the 2005 tax year.

RIA observation: The taxpayer would have fared far better had he been able to provide receipts for his tools and clothing, along with the photos.

IRS provides exclusive procedures to elect deferral of COD income on repurchased debt

Rev Proc 2009-37, 2009-36 IRB

IRS has issued a Revenue Procedure that provides the exclusive procedures for electing to defer recognizing cancellation of debt (COD) income under Code Sec. 108(i), including the time and manner for making the election and specific procedures for partnerships, S corporations, and tiered pass-through and foreign entities. Under Code Sec. 108(i), which was added by the American Recovery and Reinvestment Tax Act of 2009 (ARRA, P.L. 111-5), COD income from the reacquisition of business debt at a discount in 2009 and 2010 can be deferred until 2014, and then included in income ratably over five years. The guidance, which is effective for reacquisitions of debt instruments in tax years ending after Dec. 31, 2008, also requires electing taxpayers to provide additional information on returns beginning with the tax year following the tax year for which the election is made.

Background. For debt discharges in tax years ending after Dec. 31, 2008, a taxpayer can elect to have debt discharge income from the reacquisition of an applicable debt instrument after Dec. 31, 2008, and before Jan. 1, 2011, included in gross income ratably over five tax years beginning with:

(1) for repurchases occurring in 2009, the fifth tax year following the tax year in which the repurchase occurs, and

(2) for repurchases occurring in 2010, the fourth tax year following the tax year in which the repurchase occurs. (Code Sec. 108(i))

RIA observation: Although all of the deferred debt discharge income will eventually be recognized, the taxpayer benefits from the deferral of tax to later years. And, none of the taxpayer's tax attributes have to be reduced.

Applicable debt instrument means any debt instrument that was issued by a C corporation, or any other person in connection with the conduct of a trade or business by such person. (Code Sec. 108(i)(3)(A)) Debt instrument is broadly defined to include a bond, debenture, note, certificate, or any other instrument or contractual arrangement constituting indebtedness under Code Sec. 1275(a). (Code Sec. 108(i)(3)(B))

A reacquisition means, for any applicable debt instrument, any acquisition of the debt instrument by the debtor that issued (or is otherwise the obligor under) the debt instrument, or a person related to that debtor. (Code Sec. 108(i)(4)(A)) It includes:

an acquisition of the debt instrument for cash,
the exchange of the debt instrument for another debt instrument (including an exchange resulting from a modification of the debt instrument),
the exchange of the debt instrument for corporate stock or a partnership interest,
the contribution of the debt instrument to capital, and
the complete forgiveness of the indebtedness by the holder of the debt instrument. (Code Sec. 108(i)(4)(B))

Code Sec. 108(i)(5)(B)(i) provides that the election is made by including with the income tax return for the tax year in which the debt instrument is reacquired a statement that clearly identifies the instrument and includes any other information required by IRS. The election, once made, is irrevocable. Code Sec. 108(i)(5)(B)(iii) provides that, for partnerships, S corporations, or other pass-through entities, the election is made by the partnership, corporation, or other entity involved. In addition, IRS may prescribe any regs that are necessary or appropriate for applying the Code Sec. 108(i) rules, including regs on how these rules apply to pass through entities. (Code Sec. 108(i)(7))

New guidance. Rev Proc 2009-37, Sec. 4, provides that a taxpayer makes the Code Sec. 108(i) election by attaching a statement meeting the requirements of Rev Proc 2009-37, Sec. 4.05, to its timely filed (including extensions) original federal income tax return for the tax year in which the reacquisition of the applicable debt instrument occurs. If applicable, a taxpayer must also satisfy the additional requirements for certain partnerships (Rev Proc 2009-37, Sec. 4.07; S corporations (Rev Proc 2009-37, Sec. 4.08); certain foreign corporations (Rev Proc 2009-37, Sec. 4.09); and certain foreign partnerships. (Rev Proc 2009-37, Sec. 4.10) IRS grants an automatic extension of 12 months from the due date (prescribed in Rev Proc 2009-37, Sec. 4.01(1)(a)) for making the Code Sec. 108(i) election. The rules for automatic extension under Reg. § 301.9100-2(a) apply.

The common parent of a consolidated group makes the Code Sec. 108(i) election on behalf of all members of the group. (Rev Proc 2009-37, Sec. 4.02)

A taxpayer may treat two or more applicable debt instruments that are part of the same issue and that are reacquired during the same tax year as one applicable debt instrument for purposes of Rev Proc 2009-37. However, a pass-through entity may not treat two or more applicable debt instruments as one applicable debt instrument if the owners and their ownership interests in the pass-through entity immediately before the reacquisition of each applicable debt instrument are not identical. (Rev Proc 2009-37, Sec. 4.03)

Partial elections. Rev Proc 2009-37, Sec. 4.04, provides that a taxpayer may make an election for any part of COD income realized from the reacquisition of any applicable debt instrument. For example, if a taxpayer realizes $100 of COD income from the reacquisition of an applicable debt instrument, it may elect under Code Sec. 108(i)(1) to defer only $40 of the $100 of COD income. It may exclude from income the portion of COD income that the taxpayer doesn't elect to defer under Code Sec. 108(i) ($60 in this example) under the other Code Sec. 108 exclusion provisions, if applicable. A taxpayer isn't required to make an election for the same portion of COD income arising from each applicable debt instrument that it reacquires, but may make an election for different portions of COD income arising from different applicable debt instruments (whether or not part of the same issue).

A partnership that elects to defer less than all of the COD income realized from the reacquisition of an applicable debt instrument may determine, in any manner, the part, if any, of a partner's COD income amount that is the partner's deferred amount and the portion, if any, of a partner's COD income amount that is the partner's included amount. For example, one partner's deferred amount may be zero while another partner's deferred amount may equal that partner's COD income amount (or any portion thereof). A partner may exclude from income the partner's included amount under the other Code Sec. 108 exclusion provisions, if applicable.

RIA caution: Rev Proc 2009-37, Sec. 4.04, cautions that the above partnership rule applies for purposes of Code Sec. 108(i) only and isn't intended as an interpretation of or a change to existing partnership law under Code Sec. 704.

Required Information statement. Under Code Sec. 108(i)(7)(B), a taxpayer that makes a Code Sec. 108(i) election (except for a protective election under Rev Proc 2009-37, Sec. 4.11(1)) must attach a statement meeting the requirements in Rev Proc 2009-37, Sec. 5.02, to its return for each tax year beginning with the tax year following the tax year for which it makes the election and ending with the first tax year in which all items deferred under Code Sec. 108(i) have been recognized. (Rev Proc 2009-37, Sec. 5.01) Additional annual reporting requirements apply for certain partnerships (Rev Proc 2009-37, Sec. 5.0 ); S corporations (Rev Proc 2009-37, Sec. 5.04); certain foreign partnerships ( Rev Proc 2009-37, Sec. 5.05); and tiered pass-through entities. (Rev Proc 2009-37, Sec. 5.07) Additional information statements are required to be made on behalf of certain foreign corporations. (Rev Proc 2009-37, Sec. 5.06)

Transition rule. Except as provided below, IRS will treat a Code Sec. 108(i) election as effective if a taxpayer files an election with its federal income tax return filed on or before Sept. 16, 2009, using any reasonable procedure to make the election. However, an election that doesn't comply with Rev Proc 2009-37, Sec. 4, will not be effective unless the taxpayer on or before Nov. 16, 2009, files an amended return for the tax year of the election and complies with those requirements. (Rev Proc 2009-37, Sec. 7.01)

A taxpayer that files a Code Sec. 108(i) election on or before Sept. 16, 2009 may modify that election by filing an amended return on or before Nov. 16, 2009 (for example, to modify the amount of COD income the taxpayer elects to defer). To be effective, such a election modification must meet the requirements in Rev Proc 2009-37, Sec. 4. (Rev Proc 2009-37, Sec. 7.02)

A taxpayer filing an amended return on paper must write “ Section 108(i) Election ” on the top of the first page. A taxpayer that files the amended return electronically should indicate “ Section 108(i) Election ” on the return. (Rev Proc 2009-37, Sec. 7.03)

Tax Court holds basis overstatement isn't omission of income for 6-year limitations period

Beard, TC Memo 2009-184

The Tax Court has again held that an overstatement of basis is not an omission of gross income for purposes of the 6-year limitations period of Code Sec. 6501(e)(1)(A).

Background. Code Sec. 6501(a) generally provides that a valid assessment of income tax liability may not be made more than 3 years after the later of the date the tax return was filed or the due date of the tax return. However, under Code Sec. 6501(e)(1)(A), a 6-year period of limitations applies when a taxpayer omits from gross income an amount that's greater than 25% of the amount of gross income stated in the return.

In Bakersfield Energy Partners v. Comm. (CA9 6/17/2009), 103 AFTR 2d 2009-2712, the Ninth Circuit, affirming the Tax Court, held that an overstatement of basis was not an omission of gross income for purposes of the 6-year limitations period of Code Sec. 6501(e)(1)(A). The Court stressed that the taxpayer didn't omit any income receipt or accrual in its computation of gross income; it reported the full amount of the receipts from the purchaser of the oil and gas properties.

RIA observation: The Court of Appeals for the Federal Circuit, reversing the Court of Federal Claims, agrees with the Ninth Circuit and the Tax Court that an overstatement of basis isn't an omission of gross income for purposes of the extended limitations period. See Salman Ranch Ltd. et al. v. U.S. , (CA FC 7/30/2009) 104 AFTR 2d ¶ 2009-5190 discussed Newsstand e-mail 8/3/09 or Federal Taxes Weekly Alert 08/06/2009. But some other courts agree with IRS that the 6-year limitation period can be triggered by a basis overstatement. See Brandon Ridge Partners v. U.S. , (DC FL 7/30/2007) 100 AFTR 2d 2007-5347 discussed in Federal Taxes Weekly Alert 8/9/2007.

Facts. Kenneth Beard was a majority shareholder (76%) in two S corporations, MMCD, Inc. (MMCD), and MMSD, Inc. (MMSD). He entered into short sales in which he borrowed U.S. Treasury notes from a third party and sold them for cash to another third party, generating $12,160,000 in cash.

He used this cash to buy more Treasury notes for $5,700,000 and $6,460,000, and on the same day transferred them to MMCD and MMSD, respectively, together with the short positions (the obligation following the short sale to replace the borrowed securities). On the same day MMCD and MMSD sold their Treasury notes and closed the short positions on the Treasury notes for $7,500,000 and $8,500,000, respectively.

Beard sold his entire interest in MMCD and in MMSD to an unrelated third-party for $6,574,939 and $7,638,211, respectively. On his '99 tax return, on Schedule D, Capital Gains and Losses, he claimed a cost basis of $6,161,351 in MMCD and $7,638,463 in MMSD and net gains from the sales of the shares of $413,588 and $992,748, respectively. He also reported gross proceeds from the sale of Treasury notes of $12,125,340, a cost basis of $12,160,000, and a resulting net loss of $34,660. There was no indication that the S corporations had assumed the liability to cover the short position in Treasury notes on either MMCD's or MMSD's Schedule M-2, Analysis of Accumulated Adjustments Account, Other Adjustments Account, and Shareholders' Undistributed Taxable Income Previously Taxed, for their '99 return.

On Apr. 13, 2006, IRS issued a notice of deficiency reducing Beard's bases in the MMCD and MMSD stock by $5,700,000 and $6,460,000, respectively. As a result, there was a $12,160,000 increase in the capital gain from the sale. IRS maintained that the bases in the MMCD and MMSD stock were inflated because they weren't reduced by the liability to close the short position.

Beard timely filed a petition with the Tax Court. He claimed that the notice of deficiency was issued after the period of limitations had expired because an overstatement of basis isn't an omission from gross income that would trigger the extended period of limitations under Code Sec. 6501(e)(1)(A).

No extended limitations statute. The Tax Court concluded that basis overstatement is not an omission of gross income, and so the extended limitation statute didn't apply. In reaching its decision, the Court relied on the Supreme Court's decision in Colony, Inc. v. Com., (1958, S Ct) 1 AFTR 2d 1894, 357 US 28, interpreting the predecessor of Code Sec. 6501(e) in the '39 Code. In that case, the Supreme Court held that “omits” means something “left out” and not something put in and overstated.

The Tax Court rejected IRS's argument that Bakersfield was wrongly decided and that Colony should be limited to cases where the taxpayer (as in Colony ) was involved in the sale of goods and services. IRS argued that (1) Colony's interpretation of the predecessor of Code Sec. 6501(e) in the '39 Code wasn't binding because its successor, Code Sec. 6501(e)(1)(A) , was materially different; and (2) that Colony should apply only to taxpayers who realize gross receipts from sales or services in the course of a trade or business.

The Tax Court noted that these same arguments were rejected by the Ninth Circuit in Bakersfield , which found that: (a) Congress didn't change the language in the body of Code Sec. 6501(e)(1)(A) , which is identical to the language in the predecessor of Code Sec. 6501(e) in the '39 Code that the Supreme Court had construed in Colony ; and (b) the Supreme Court didn't even hint that its interpretation was limited to cases in which the taxpayer was engaged in a trade or business. The Tax Court, just as the Ninth Circuit had, concluded that it would be inappropriate to distinguish and diminish the Supreme Court's holding in Colony.

RIA observation: The Brandon Ridge Partners decision (referred to above) accepted IRS's argument limiting the application of Colony's gross receipts test to trades or businesses in which gross income results from the sale of goods or services.

Any tax advice contained in this written or electronic communication (including attachments) was not intended or written to be used to avoid any penalty imposed by a taxing authority, nor may the user/recipient of this communication use this written tax advice for that purpose. Please contact us with any questions regarding this notice.

Aaron Weinberger
Padell Nadell Fine Weinberger LLP
59 Maiden Lane
New York , NY 10038
Ph 212-424-9545
Fax 212-262-2769

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