New Consent Language Deadline Extended
In Rev. Proc. 2013-19, the IRS postponed until 2014 a requirement that practitioners use language mandated by Rev. Proc. 2013-14 to obtain taxpayers’ consent to disclose or use tax return information. The earlier revenue procedure, which was issued Dec. 26, 2012 (see “Tax Matters: Mandatory Language for Consents to Disclose, Use Taxpayer Information Modified,” March 2013, page 69), required use of modified mandatory language for consents obtained on or after Jan. 14, 2013. Under the extension, practitioners may use either the modified language or language previously authorized by Rev. Proc. 2008-35 until Jan. 1, 2014, when they must begin using the new language.
Appeal Lays Con Ed LILO to Rest
In an opinion that appears to close the door on lease-in, lease out (LILO) tax shelters once and for all, the Federal Circuit Court of Appeals reversed and remanded a case to the Court of Federal Claims, which had upheld the transaction (Consolidated Edison Co. of New York, No. 2012-5040 (Fed. Cir. 1/9/13)). In a departure from most recent case law, the lower court had held that the LILO transaction had economic substance and allowed Consolidated Edison (Con Ed) the rental deductions and interest expense it had claimed (Consolidated Edison Co. of New York, 90 Fed. Cl. 228 (2009); see previous Tax Matters coverage, “LILO Stands Up to Court Scrutiny,” Jan. 2010, page 61). This issue should not arise in the future because Sec. 470, which was enacted in 2004, specifically prohibits LILO transactions.
Con Ed, through a trust, entered an agreement with a Dutch utility to lease a 47.47% interest in an electric generating plant in the Netherlands and then sublease it back to the Dutch utility. If the Dutch utility did not exercise an option at the end of its sublease to purchase Con Ed’s remaining lease, Con Ed could either renew the sublease or require the Dutch utility to return its ownership interest in the Con Ed trust.
The IRS disallowed a claimed loss on the transaction, claiming the transaction lacked economic substance because Con Ed entered into it without any valid business purpose or reasonable expectation of making a profit beyond any tax benefits achieved. The Claims Court disagreed with the IRS and granted Con Ed’s refund claim. The government appealed.
The appeals court did not address the economic substance issue on which the lower court had based its decision and, instead, stressed that its recent decision in Wells Fargo & Co., 641 F.3d 1319 (Fed. Cir. 2011), compelled it to apply a substance-over-form analysis to Con Ed’s case. The Federal Circuit held that because there was undisputed evidence that the Dutch utility was reasonably likely to exercise the purchase option, the LILO transaction did not constitute a true lease, and Con Ed's rent deductions from the transaction should be disallowed.
The court applied a similar analysis to Con Ed’s deductions for interest expense from “loans” used to finance the transaction. According to the court, for the interest to be deductible, the loans must be genuine indebtedness. Finding that it was clear that the loans were not genuine indebtedness, the court held that Con Ed’s interest deductions from the LILO transaction should also be disallowed.
IRS: Reasonable Cause Requires Legal Inquiry
Although the Tax Court agreed with the IRS in Patel, 138 T.C. No. 23 (2012), that taxpayers improperly deducted the value of a house they donated to a fire department to burn for training, the court overturned the IRS’s imposition of an accuracy-related penalty against the taxpayers in the case.
In Action on Decision 2012-005 issued Jan. 17, the IRS said it will not acquiesce to the Tax Court’s finding in Patel that, with regard to the accuracy-related penalty under Sec. 6662, the taxpayers acted with reasonable cause and in good faith (see Tax Matters, “No Deduction for Bringing Down the House,” Oct. 2012, page 63).
On the charitable deduction, the court found that under state law, the taxpayers’ land included the house and any other structures and fixtures on it. Because the taxpayers retained title to the land after the fire department destroyed the house, if the donation was a real property interest at all, it was a partial interest. Finding that none of the categories qualifying as deductible contributions of partial interests in property under Sec. 170(f)(3)(B) applied, the court upheld the disallowance of the deduction.
Regarding the penalty, the court said that when the Patels filed the return at issue, in 2006, the legal issues were unsettled. In Scharf, T.C. Memo. 1973-265, the Tax Court had allowed a similar deduction, but for a contribution made before 1969, when Congress enacted the above restrictions on contributions of partial interests in property. After the Patels filed their return, the Tax Court held against taxpayers on similar facts in Rolfs, 135 T.C. 471 (2010), aff’d 668 F.3d 888 (7th Cir. 2012). Given the Patels’ facts and circumstances, including the uncertain state of the law at the time, the court said, they acted with reasonable cause and in good faith and were not liable for the penalty.
In the action on decision, the IRS said the court should not have
concluded the uncertain state of the law was a factor supporting
reasonable cause and good faith without considering whether the Patels
investigated the current state of the law, including whether they
sought competent professional advice. According to the IRS, “A
taxpayer cannot act in good faith and have reasonable cause on the
basis of the unsettled state of the law if the taxpayer was unaware of
the state of the law and did not make reasonable attempts to become aware.”