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Help for Terrorism Victims

The IRS released Publication 3920, Tax Relief for Victims of Terrorist Attacks. It explains how individuals can file claims under the Victims of Terrorism Tax Relief Act of 2001 (See JofA, Tax Matters, Apr.02, page 88). Taxpayers (and their survivors) eligible for significant income and estate tax relief include victims of the attacks on the World Trade Center, the Pentagon and United Airlines Flight 93; the anthrax attacks; and the Oklahoma City bombing.

Under the act, a victim’s federal income taxes are forgiven for the year of the terrorist attack and for the preceding year. The minimum refund is $10,000—even for victims who owed no taxes.

Publication 3920 contains worksheets CPAs can use to help victims and their families determine the amount of tax forgiven. It also covers required documentation and where taxpayers should send their returns (IR-2002-23 (2-25-02)).

No Tax on Frequent Flyer Miles

It’s official. The IRS finally formalized its hands-off approach to frequent flyer miles. In announcement 2002-18, the service said it will not assert that a taxpayer has understated his or her federal tax liability by personally receiving or using frequent flyer miles or other promotional benefits (such as incentives from hotels and car-rental agencies) related to the taxpayer’s business or official (government-related) travel.

In the past, business travelers whose employers allowed them to keep and use such miles for personal travel feared the IRS would try to tax the value of these perks. Those taxpayers now can put such fears aside. However, employees must include in income any promotional benefits converted to cash or compensation paid in the form of travel.

Enter and Sign In, Please

In the wake of the September 11 terrorist attacks, many corporations are requiring IRS agents to provide personal information (Social Security number, home address, home phone number and driver’s license) before allowing them access for on-site audits. However, according to internal legal memorandum 200206054, disclosure of this information contravenes IRS authority under IRC section 7602 to set the time and place of an audit; according to the government, taxpayers cannot determine the conditions under which the IRS conducts an investigation. Agents need give only their names and IRS-supplied identifying number to gain access for an on-site audit. However, a taxpayer can ask IRS employees to wear company-provided badges while on corporate premises.

The memo instructs agents not to leave their IRS credentials with the company’s security force or allow them to be copied. Agents are urged to move the examination to the local IRS office if taxpayers refuse to allow an agent on site without revealing personal information.

Meal Deduction Limits

Over a five-year period, a corporation deducted 50% of its annual meal and entertainment expenses, as provided in IRC section 274(n). The corporation discovered it could have deducted some of the expenses in full. It estimated it incurred costs for more than 50,000 meals and entertainment items for each of the five years in question. The corporation wanted to amend its affected returns and deduct the correct amount. It asked the IRS if it could use statistical sampling techniques to estimate what percentage of the total expenses was exempt from the 50% limitation. The corporation cited a litigation guideline memorandum (LGM TL 97 (9-9-92), Use of Statistical Sampling Techniques in Examination of Tax Returns ) which allows both the IRS and taxpayers to rely on sampling techniques.

The government said section 274(d) imposes strict substantiation requirements for meal and entertainment expenses (the amount, time, place and business purpose of the expenditure plus documentary evidence). According to field service advice 200209028, the IRS decided a statistical sampling approach to substantiate meals and entertainment expenditures did not satisfy the strict requirements of section 274(d).

Assignment of Partial Interest

A taxpayer wanted to purchase a single-premium whole life insurance policy on his life and name a charity as its irrevocable beneficiary. He intended to immediately transfer to the charity all privileges, rights and interests in the policy while retaining only bare legal title. State insurance regulations prevented the taxpayer—who had 30 days after purchase to cancel the policy—from transferring title to the charity. The taxpayer asked the IRS if he could deduct the premium as a charitable contribution.

In the past, the IRS has denied a deduction when a taxpayer assigned a partial interest in an insurance policy to a charity. IRC section 170(f)(3) requires the taxpayer transfer his or her entire interest. However, according to revenue ruling 75-66, 1975-1 CB 85, the partial interest rule applies only if the taxpayer retains a substantial interest in the property.

In letter ruling 200209020, the IRS ruled that retaining bare legal title is not retention of a substantial right. Therefore, the taxpayer is allowed a charitable deduction but only after the cancellation period expires.

Deductibility of “Impact” Fees

A real estate developer purchased some unimproved land on which he intended to construct multifamily homes. The local government imposed an “impact fee” on the project—a one-time charge to finance specific off-site capital improvements for general public use (schools, water, police and fire) necessitated by the new development. The amount of the fee depended on the buildings’ size and the number of rental units. The developer paid the fee when the construction permit was issued.

For tax purposes, the developer wanted to know whether he could deduct such fees currently or if he should add them to the basis of the nondepreciable land or capitalize and add them to the depreciable basis of the buildings.

In revenue ruling 2002-9, IR-2002-20, the IRS determined the impact fees would result in a permanent improvement or betterment to the development projects and thus should be capitalized as part of the cost of the building under IRC section 263(a). If the building qualified as low-income housing, the impact fee could also be included in the basis for purposes of the IRC section 42 low-income housing credit.

Shareholder’s Personal Legal Fees

A shareholder in a video corporation was indicted on federal criminal charges of conspiracy to obstruct the lawful functions of the IRS. The shareholder eventually pleaded guilty to the charge. The corporation was not a defendant in the criminal case. However, it paid the shareholder’s personal legal fees and deducted them as an ordinary and necessary business expense on the corporate return. The IRS disallowed the deduction and issued a deficiency notice to the shareholder, treating the payment as a constructive dividend.

The Tax Court agreed with the government. It said the corporation could not deduct the shareholder’s personal expenses unless they were paid to protect the business or the criminal activity sufficiently related to the business. The court ruled the payment of the legal fees conferred an economic benefit on the shareholder without an expectation of repayment, resulting in a constructive dividend to him.

The court also said the shareholder could not deduct the legal fee as a miscellaneous itemized deduction because he failed to show the deduction was business related (TC Memo 2002-40).

—Michael Lynch, CPA, JD, professor of tax accounting at Bryant College, Smithfield, Rhode Island.