IRS ISSUES REGS ON SIX-YEAR LIMITATIONS ON BASIS OVERSTATEMENT
The IRS issued proposed and temporary regulations (TD 9466, REG-108045-08) Sept. 24 to clarify that an overstatement of basis can create a substantial omission of gross income under IRC §§ 6229(c)(2) and 6501(e) for purposes of the six-year extended period for assessments and collections of tax attributable to partnership items. In so doing, the Service sought to strengthen its position, which has been rejected in the Tax Court and two circuit courts this year.
The regulations, which were effective upon their release, add new Treas. Reg. § 301.6229(c)(2)-1T, which clarifies that, outside the trade or business context, “gross income,” as used in section 6229, has the same meaning as in section 61(a), the general definition that includes under paragraph (3) “gains derived from dealings in property.” They also replace Treas. Reg. § 301.6501(e)-1 with a temporary regulation of the same designation to specify that gross income can include “the excess of the amount realized from the disposition of the property over the unrecovered cost or other basis of the property.” Accordingly, outside the context of a trade or business, any basis overstatement that leads to an understatement of gross income under section 61(a) constitutes an omission from gross income for purposes of sections 6501(e)(1)(A) and 6229(c)(2) under the temporary regulations.
Section 6229(c)(2) substitutes six years for the ordinary three-year period in which the IRS may make assessments where there is a substantial omission of gross income, defined as more than 25% of gross income properly includible on the return. Section 6501(e) provides an exception where the item is disclosed on the return with sufficient information to indicate its nature and amount.
In June 2009, the Ninth Circuit Court of Appeals, affirming the Tax Court, held that no understatement of gross income had occurred where an assessment arose from an overstatement of basis ( Bakersfield Energy Partners LP, 128 TC 207, aff’d, 568 F.3d 767 (9th Cir., June 2009)). The following month, the Federal Circuit held similarly in Salman Ranch Ltd. v. U.S. (docket no. 2008-5053). The Tax Court also ruled in favor of the taxpayers on the issue in Kenneth and Susan Beard v. Commissioner (TC Memo 2009- 184) and Intermountain Insurance Service of Vail v. Commissioner (TC Memo 2009-195). The courts held that the 1958 Supreme Court ruling in Colony Inc. v. Commissioner (357 U.S. 28) controlled, even though it was decided under a predecessor statute to section 6229 under the 1939 Internal Revenue Code. The IRS has maintained throughout these cases that Congress intended in section 6229, as part of its 1954 overhaul of the IRC, to limit the holding in Colony Inc. to cases arising under the earlier statute.
In its preamble to the temporary regulations, the IRS noted that the Ninth and Federal circuits acknowledged that the current statute is ambiguous, and that the Ninth Circuit suggested the Service could clarify the matter by regulation.
The temporary regulations also serve as the text of the proposed regulations, on which written or electronic comments and requests for a public hearing must be submitted by Dec. 28, 2009. Comments may be sent by mail to the IRS at P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044, or electronically via the Web portal at regulations.gov.
OHIO’S CAT UPHELD
The Supreme Court of Ohio ruled that the state’s Commercial Activity Tax (CAT) does not violate the Ohio Constitution’s prohibition of excise or sales taxes upon food sales and purchases. The decision issued on Sept. 17, 2009, ( Ohio Grocers Association v. Levin, slip opinion no. 2009-Ohio-4872) reverses that of a state appellate court, which had agreed with the plaintiffs, the Ohio Grocers Association.
Ohio enacted the CAT in 2005 “on each person with taxable gross receipts for the privilege of doing business in this state” as part of a major reform that included a reduction of personal income tax rates and gradual repeal of personal property taxes and a previous corporate franchise tax. It levies $150 on the first $1 million in taxable gross receipts (after exempting the first $150,000) and 0.26% on receipts above $1 million. Gross receipts include amounts received from sales of goods or services, with no exclusion for food. See the Web site of the Ohio Department of Taxation at tinyurl.com/ybo495q.
The Ohio Constitution has since the 1930s prohibited any excise tax on “the sale or purchase of food for human consumption off the premises where sold” (article XII, § 3(C)). It further prohibits any “sales or other excise taxes” on wholesale sales or purchases of food (including nonalcoholic beverages) for human consumption, its ingredients or packaging or “in any retail transaction, on any packaging that contains food for human consumption on or off the premises where sold” (article XII, § 13). The CAT’s enabling legislation declares that it does not violate the state constitution in this regard because it is not a sales or excise tax but a franchise tax, imposed for the privilege of doing business in Ohio.
The Ohio Grocers Association filed suit in 2006 challenging the CAT with respect to food sales. A trial court ruled against the grocers, and they appealed to the Ohio Court of Appeals, Tenth Appellate District, which reversed. The state appealed to the Ohio Supreme Court, which said the CAT is what it purports to be, a business privilege tax that uses gross receipts as a “measuring stick” rather than as a direct tax on sales.
According to the court, ways in which the CAT does not operate like a tax on food sales include that it is not necessarily triggered by a food sale, and it is not added to the price of food at sale. The CAT’s generous exemption amount and low rate make it unlikely to ever be reflected in the price of food, making any direct relationship with food sales “extremely attenuated.”
Justice Paul E. Pfeifer dissented, saying the six-justice majority’s holding “cobbled together incongruent cases with an implausible rationale to conclude that a straightforward provision of the Constitution is inapplicable to the situation before it.” One of those cases, Aluminum Co. of Am. v. Evatt, 140 Ohio St. 385 (1942), rebuffed a similar challenge to the state’s franchise tax now being phased out and was the source of the majority’s measuring stick analogy. Its distinction between use of a transaction or value to calculate a tax on a privilege—as opposed to a tax on that transaction or value—has been applied in subsequent cases and “remains good law,” Justice Maureen O’Connor wrote for the majority. But, Pfeifer wrote, the majority failed to reckon with the fact that none of the factors of the older Ohio franchise tax were constitutionally prohibited. Other cases cited by the majority have held that a franchise tax can be properly based on factors that include tax-exempt ones, such as the 1956 U.S. Supreme Court decision in Werner Machine Co. Inc. v. Director of Division of Taxation (350 U.S. 492). In it, the court upheld a New Jersey franchise tax that was based partly on corporate net worth that included the value of tax-exempt federal bonds. The high court accepted that state’s argument that its franchise tax was not a direct tax upon property.
Most states with sales taxes exempt food sales either fully or partially through a reduced rate, according to a 2008 comparison by the Federation of Tax Administrators (at tinyurl.com/pezxf), although none other than Ohio are known to do so by constitutional provision. A few of those states also have a broad-based franchise tax on gross receipts including those from items exempt from sales or use tax. Washington state, for example, (which has no personal or corporate income tax) exempts food, prescription drugs and certain medical supplies from sales tax but, in most instances, includes their sale in gross receipts subject to its Business and Occupation Tax.
SERVICE ISSUES RETIREMENT PLAN GUIDANCE
The IRS issued four notices and three revenue rulings addressing technical issues of automatic contributions to qualified employer-sponsored retirement plans and clarifying that contributions may be made from payments of the value of paid vacation or other leave. The guidance also provided approved sample notices to employees concerning qualified rollovers of lump-sum distributions. For Web links, see the IRS’ “Retirement & Savings Initiatives” page at tinyurl.com/lz9ree.
Automatic contribution arrangements. Revenue Ruling 2009-30 addressed automatic increases in default automatic contribution amounts to qualified plans under section 401. Default automatic contributions to a plan can still be considered elective contributions for purposes of permitting employees alternately to receive them as cash compensation, even if they increase because of increases in compensation, the Service ruled. In a second holding, the Service ruled that default automatic contributions that increase on a day other than the first day of a plan year do not thereby fail to meet uniformity requirements of Treas. Reg. §§ 1.401(k)-3 and 1.414(w)-1 or qualified percentage requirements of section 401(k)(13).
In Notice 2009-65, the IRS provided sample plan amendments for automatic contribution arrangements to section 401(k) plans or automatic contribution arrangements eligible for permissible employee withdrawals of elective contributions under section 414(w).
Paid time off. Revenue Ruling 2009-31 held that section 401 plans may require or permit contributions based on cash compensation for unused paid time off work, and that plan participants will include such contributions in gross income only when they receive them as distributions. Revenue Ruling 2009-32 further clarified that the same treatment is available for such compensation paid at termination of employment.
Employee notices regarding rollovers. The IRS also issued Notice 2009-68 updating safe-harbor sample employee explanations required under section 402(f) for distributions eligible to be rolled over into another qualified plan. One sample letter covers rollovers from designated Roth accounts, and another covers other employer plans.
IRS WEB TOOL FOR FORM 990
The Service provided more help for filers of the new Form 990, Return of Organization Exempt From Income Tax. The online case study at tinyurl.com/mr9uzd includes videos and a sample completed main form and schedules A and B.