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TAX MATTERS
FATCA deadlines postponed for six months  
By Sally P. Schreiber, J.D.
October 2013

In Notice 2013-43, the IRS delayed for six months until July 1, 2014, the start of withholding and certain other provisions of the Foreign Account Tax Compliance Act (FATCA).

The notice affects the effective dates of final regulations issued in April (T.D. 9610) providing rules on information reporting under FATCA by foreign financial institutions (FFIs) and withholding on certain payments to FFIs and other foreign entities.

Under FATCA, enacted as part of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147, U.S. withholding agents are required to withhold tax on certain payments to FFIs that do not agree to report certain information to the IRS regarding their U.S. accounts and on certain payments to certain nonfinancial foreign entities (NFFEs) that do not provide information on their substantial U.S. owners to withholding agents.

Under the notice, withholding agents will be required to begin withholding on withholdable payments made after June 30, 2014, to payees that are FFIs or NFFEs, for obligations that are not grandfathered under the rules, unless the payments can be reliably associated with documentation on which the withholding agent can rely to treat the payments as exempt from withholding. The notice also makes corresponding adjustments to various other time frames in the final regulations.

The notice also provides additional guidance concerning the treatment of financial institutions in jurisdictions that have signed intergovernmental agreements to implement FATCA but have not yet brought those agreements into force.

  Notice 2013-43

By Sally P. Schreiber, J.D., a JofA senior editor.


TAX MATTERS
D.C. Circuit rejects per-bet approach for nonresident alien  
By Charles J. Reichert, CPA
October 2013

The D.C. Circuit reversed a Tax Court decision by allowing a nonresident alien to use the same approach (per-session) to compute his gambling gains as used by U.S. citizens. The court found no reason nonresident aliens should have to use a different approach and remanded the case to the Tax Court to determine the proper tax liability.

Generally, nonresident aliens who gamble in the United States must pay U.S. tax on their gambling income won in the United States; however, the United States has tax treaties with 27 countries (see IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities) that exempt their citizens from tax on U.S. gambling winnings. U.S. citizens may deduct their gambling losses to the extent of their gambling gains; however, recreational nonresident alien gamblers may not deduct any gambling losses. IRS Advice Memorandum 2008-011 permits U.S. citizens to compute their gambling gains for each gambling session (per-session approach) rather than for each bet placed (per-bet approach). Nonresident aliens engaged in the trade or business of gambling in the United States may deduct their gambling losses.

Sang J. Park, a South Korean  national and citizen, played slot machines recreationally in the United States in 2006 and 2007, winning $431,658 and $103,874, respectively (but also losing more than that each year). Park did not report those winnings on his 2006 and 2007 federal income tax returns. After the IRS issued deficiency notices for both years, the taxpayer petitioned the Tax Court for relief. The Tax Court held the income was taxable to the United States because an existing treaty between the United States and South Korea did not exempt the gambling winnings of South Korean citizens from U.S. tax and the income was not effectively connected with a U.S. trade or business. The taxpayer appealed the decision to the D.C. Circuit.

Park did not appeal whether the gambling winnings were taxable but rather the approach used to compute the amount of income. The IRS argued that the per-session approach applies only to U.S. citizens and that gambling gains for nonresident aliens should be calculated on a per-bet basis, since recreational nonresident alien gamblers are not allowed to deduct gambling losses from their winnings. The appellate court rejected this argument, stating, “The fact that non-resident aliens may not deduct gambling losses from gambling winnings does not tell us how to measure those losses and winnings in the first place.” Also, according to the court, the per-session approach used by U.S. citizens is the best way to measure gambling gains, and there is no reason nonresident aliens should be prevented from using it. Because there was no court record of the taxpayer’s tax liability using the per-session approach, the court remanded the case to the Tax Court to properly compute the taxpayer’s tax liability under that approach.

  Park, No. 12-1058 (D.C. Cir. 7/9/13)

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.


TAX MATTERS
Final regs. clarify who is subject to 50% limit on meal and entertainment expenses  
By Sally P. Schreiber, J.D.
October 2013

The IRS issued final regulations clarifying which party is subject to the 50% limit on deductible meal and entertainment expenses under Sec. 274(n) (T.D. 9625). The final rules adopt proposed regulations (REG-101812-07) issued in July 2012 without substantive change.

As the IRS emphasized in the preamble to the earlier proposed regulations, only one party is intended to be subject to the limitation, and there has been controversy over who is subject to it when multiple parties are involved. Also, in the preamble, the IRS explained that the proposed regulations were intended to settle issues raised in Transport Labor Contract/Leasing, Inc., 461 F.3d 1030 (8th Cir. 2006), rev’g 123 T.C. 154 (2004); acq. in result, Rev. Rul. 2008-23.

Sec. 274(a) limits the amount of entertainment expenses that are deductible, and deductions for meals and entertainment are generally limited to 50% of the expenses incurred (Sec. 274(n)). Under Sec. 274(e)(2)(A), employers are not subject to the limitation to the extent they treat the expenses as compensation to employees.

Sec. 274(e)(3) provides two exceptions from the Sec. 274(a) limits for reimbursed expenses. Sec. 274(e)(3)(A) excepts expenses a taxpayer pays or incurs in performing services for another person under a reimbursement or other expense allowance arrangement where the employer does not treat the reimbursement as compensation to the employee. In that case, the employee does not have additional compensation or a deduction for the expense, but the employer deducts the expense and is subject to the deduction limit. If the employer treats the reimbursement as compensation, the employee may be able to deduct the expense as an employee business expense. In that case, the employee bears the expense and is subject to the deduction limit. The employer deducts the expense as compensation, which is not subject to the deduction limit under Sec. 274.

Sec. 274(e)(3)(B) applies if the taxpayer performs services for a person other than an employer and the taxpayer accounts (substantiates, as required by Sec. 274(d)) to that person. The Eighth Circuit applied this subsection in the Transport Labor case. In that case, the taxpayer, a leasing company that provided truck drivers to its clients, charged the clients for the wages and the per diem allowance it paid the truckers. Because the taxpayer provided services to its clients under a reimbursement or other expense allowance arrangement and accounted to the clients, it qualified under Sec. 274(e)(3)(B) for the exception from the Sec. 274(n) limit with respect to the per diem expense, and instead the clients were subject to the limit.

The final regulations contain a new definition of reimbursement or other expense allowance arrangement for purposes of Sec. 274(e)(3), independent of the definition for accountable plan purposes in Sec. 62(c). The regulations also clarify that the rules for applying the exceptions to the Secs. 274(a) and (n) deduction limits apply to reimbursement or other expense allowance arrangements with employees, whether or not a payer is an employer. Any party that reimburses an employee is a payer and bears the expense if the payment is not treated as compensation and wages to the employee.

The regulations also permit parties in arrangements involving nonemployees (i.e., independent contractors) to provide by agreement who is subject to the 50% limit. Absent an agreement, the limit applies to an independent contractor if he or she does not account for the expense under Sec. 274(d), and to the client or customer if the independent contractor meets the substantiation requirements. The regulations also include an example illustrating how the rules apply to multiparty reimbursement arrangements. Multiparty reimbursement arrangements are separately analyzed as a series of two-party reimbursement arrangements.

The final regulations apply to expenses paid or incurred in tax years beginning after Aug. 1, 2013.

  T.D. 9625

By Sally P. Schreiber, J.D., a JofA senior editor.


TAX MATTERS
New method for determining who gets Sec. 199 deduction under contract manufacturing arrangements  
By Alistair M. Nevius, J.D.
October 2013

The IRS issued new guidance to examiners in its Large Business & International (LB&I) Division regarding how to determine which taxpayer is entitled to claim the Sec. 199 domestic production activities deduction in a contract manufacturing arrangement (LB&I-04-0713-006). The directive replaces earlier guidance (LB&I-4-0112-001) issued last year, which had used a nine-question test to determine whether a taxpayer conducting production activities under a contract manufacturing arrangement with an unrelated third party meets the benefits-and-burdens-of-ownership requirement outlined in Sec. 199. The new guidance allows the parties to the arrangement to certify which has the benefits and burdens of ownership.

Sec. 199 allows taxpayers to deduct a specified percentage of the lesser of (1) qualified production activities income resulting from specified domestic production activities; or (2) taxable income determined without regard to the Sec. 199 deduction. For 2010 and later tax years the specified percentage is generally 9% (Sec. 199(a)(1)).

When taxpayers enter into a contractual arrangement with an unrelated party to perform some or all of the production activities potentially qualifying for the deduction, it can be unclear which party is entitled to the deduction. (The rules governing the tax treatment of these arrangements under Sec. 199 stipulate that only one taxpayer may claim the Sec. 199 deduction for a particular activity.)

Under Regs. Sec. 1.199-3(f)(1), only the taxpayer that has the benefits and burdens of owning the property during the period the qualifying activity occurs is entitled to claim a Sec. 199 deduction for that property. However, determining which party has the “benefits and burdens” of ownership can be complex.

To simplify the determination, the IRS in 2012 issued a directive telling its examiners to use a three-step process, each step containing three “yes” or “no” questions. The steps looked at contract terms, production activities, and economic risks. The new directive simplifies the examiner’s job even further, by replacing the nine-question test with three taxpayer statements:

  1. An explanation of the basis for the taxpayer’s determination that it had the benefits and burdens of ownership in the year or years under examination;
  2. A certification (using a form included in the directive) signed by the taxpayer; and
  3. A certification (using another form included in the directive) signed by the counterparty.

In general, taxpayers will be required to supply the benefits-and-burdens and certification statements within 30 days of when an information document request is issued regarding the Sec. 199 deduction.

  LB&I Directive LB&I-04-0713-006

By Alistair M. Nevius, J.D., the JofA’s editor-in-chief, tax.


TAX MATTERS
Rules for deferral of income from gift card sales clarified  
By Sally P. Schreiber, J.D.
October 2013

The IRS issued guidance clarifying that taxpayers that sell gift cards can defer recognizing income from the sale of gift cards redeemable by an unrelated third party until the year after the payment is received (Rev. Proc. 2013-29, clarifying and modifying Rev. Proc. 2011-18).

With the rapid growth in the use of gift cards in recent years and the increasing variety of ways in which they are sold and redeemed, the IRS has been issuing guidance to address tax accounting issues regarding recognition of revenue and expenses related to gift cards and gift certificates.

Revenue from sales of gift cards is not recognized immediately for financial reporting purposes and may also be deferred for tax purposes. Under the new rule, if a gift card is redeemable by an entity whose financial results are not included in the taxpayer’s applicable financial statement (as defined in Rev. Proc. 2004-34, §4.06), the taxpayer recognizes in income payment for a gift card to the extent the gift card is redeemed during the tax year. For a taxpayer without an applicable financial statement, if a gift card is redeemable by an entity whose financial results are not included in the taxpayer’s financial statement, a payment for a gift card is treated as earned by the taxpayer to the extent the gift card is redeemed by the entity during the tax year. Any payment the taxpayer receives that is not recognized in income in the year of receipt must be recognized the next year.

Because the rule as it was originally drafted in Rev. Proc. 2011-18 appeared to apply only to gift cards that were redeemable by related parties, this clarification was necessary to permit deferral in cases where the cards were redeemable by an unrelated entity. The new rule applies to tax years ending on or after Dec. 31, 2010.

  Rev. Proc. 2013-29

By Sally P. Schreiber, J.D., a JofA senior editor.


TAX MATTERS
TIGTA: Identity theft protection needs improvements  
By Sally P. Schreiber, J.D.
October 2013

In an audit, the Treasury Inspector General for Tax Administration (TIGTA) found that the IRS has greatly improved its identity theft protection program since the 2012 filing season but that additional changes should be made (The Taxpayer Protection Program Improves Identity Theft Detection; However, Case Processing Controls Need to Be Improved, TIGTA Rep't No. 2013-40-062 (June 21, 2013)). The report looked at the program controls used to process suspected cases, not at the adequacy of IRS filters in identifying potential tax identity theft fraudulent refund claims, which will be the subject of a separate TIGTA review.

Improvements noted. TIGTA found that the Taxpayer Protection Program improves identity theft detection and that the improvements made since the 2012 filing season helped even more. In 2012, the program identified 324,670 tax returns involving identity theft and prevented the issuance of fraudulent tax refunds totaling $2.2 billion. During the 2012 filing season (for 2011 returns), only 10 employees were assigned to answer the toll-free telephone hotline, and as a result, only 24% of the calls to the number reached an employee. For the 2013 filing season, responsibility to answer the toll-free number was transferred to the Wage and Investment Division’s Accounts Management function, where more than 200 employees answered the phones.

Other improvements were the development of clear guidelines for employees in working potential identity theft cases. TIGTA interviewed a number of IRS employees, all of whom said the guidelines were helpful and that management listened to their suggestions for improvement.

Shortcomings. Under the program, the IRS mailed 375,742 letters to taxpayers during calendar 2012 asking the taxpayer to verify that he or she filed the return. If a letter in such cases is returned as undeliverable, there is no response, or the tax return is determined to involve identity theft, the IRS does not process the return and places an identity theft indicator on the return. However, TIGTA found that required identity theft indicators were not always placed on taxpayer accounts because Taxpayer Protection Program employees did not consistently follow procedures to input these indicators and because the format for entering information was not consistent, resulting in mismatched taxpayer identification numbers (TINs).

The second shortcoming was that employees in the Taxpayer Protection Program were not updating the central IRS Account Management Services (AMS) system with the actions they had taken on taxpayers’ identity theft accounts. TIGTA explained that it was crucial that employees accurately update the AMS system because managers use it to identify the inventory of open and closed cases and to review casework.

Third, TIGTA found that the IRS had not established procedures to track how long identity theft cases took to resolve. The IRS claimed that it took an average of 15 minutes from the time a taxpayer placed a telephone call to resolve cases, but TIGTA noted that this did not account for taxpayer attempts to contact the IRS by mail, pointing specifically to taxpayer letters that had not been assigned to an employee in the three months after they were received.

The final criticism was the lack of documentation of training that Taxpayer Protection Program employees had received. The IRS provided TIGTA with a list of the employees who had received the training, but it kept no other records and did not require training to be documented in the Enterprise Learning Management System, the IRS’s centralized storage location for employee training records.

Recommendations. TIGTA made four recommendations to address these shortcomings, all of which the IRS agreed to implement:

  • Develop a process to ensure that required identity theft indicators are placed on taxpayer accounts;
  • Develop a process to ensure that employees are properly updating the AMS system with the actions they have taken on identity theft cases;
  • Develop a system to measure how long it takes to resolve cases and ensure the measurement begins at the first taxpayer contact;
  • Ensure that employees receive the required training and that records are kept in the Enterprise Learning Management System.


  TIGTA Rep't No. 2013-40-062

By Sally P. Schreiber, J.D., a JofA senior editor.


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