AICPA AND ABA REQUEST ECONOMIC SUBSTANCE GUIDANCE
The AICPA and the American Bar Association (ABA) Tax Section jointly issued a comprehensive set of recommendations to the IRS to encourage the Service to quickly establish guidance for applying the recently codified economic substance doctrine.
In the absence of specific guidance, the organizations warned in a 65-page report released Jan. 18, “revenue agents may see it as their responsibility to consider application [of the doctrine] in connection with every issue raised in an examination,” and that such broad assertions could have “a significant chilling effect on a wide range of business transactions.”
New IRC § 7701(o) stipulates that a transaction that is subject to the doctrine will be treated as having economic substance only if (1) it changes the taxpayer’s economic position in a meaningful way (apart from federal income tax effects) and (2) the taxpayer has a substantial purpose (apart from federal income tax effects) for entering the transaction. The provision was included in the health care reform law last year and applies to transactions entered into after March 30, 2010.
The AICPA and ABA Tax Section asked the Service to adopt a framework to help taxpayers determine whether the doctrine is relevant to a transaction, especially since taxpayers now face up to a 40% penalty for violations (reduced to 20% if the transaction is disclosed by the taxpayer) under a strict-liability standard, meaning no reasonable-cause exception is available.
The AICPA and the ABA Tax Section also urged the IRS to issue guidance on other undefined terms in the statute, such as “economic position,” “meaningful way” and “substantial purpose.” The organizations recommended that the Service issue binding regulations with full opportunity for comment, but barring that, it should at least develop and make public detailed directives for revenue agents and field counsel. To further protect taxpayers, the groups also recommended, the IRS should expand its expedited private letter ruling procedures to cover a broader range of transactions and issues, to help taxpayers know prospectively if a planned transaction will fall under the economic substance doctrine. And, given the rigid nature of the penalty, the AICPA and ABA Tax Section called on the IRS to add safeguards such as an expanded approval process and a conference of right before the penalty can be asserted.
In addition, they recommended creating a panel of public- and private-sector tax professionals to advise the IRS on applying the economic substance and strict-liability provisions.
HIGHER 990 FILING THRESHOLD WIDENS USE OF E-POSTCARD
In Revenue Procedure 2011-15, the IRS raised the gross receipts threshold requiring exempt organizations to file Form 990, Return of Organization Exempt From Income Tax, from $25,000 to $50,000, allowing more tax-exempt organizations to instead use Form 990-N (e-Postcard ).
Tax-exempt organizations are generally required to file either a Form 990 or the shorter Form 990-EZ annually. Under IRC § 6033, organizations with annual gross receipts of less than $5,000 are exempt from the filing requirement, and the IRS has discretion to excuse larger organizations from the filing requirement.
The IRS previously had set the Form 990 gross receipts threshold at $25,000 for section 501(c)(3) organizations other than private foundations, but has now raised the threshold to $50,000, effective for tax years beginning on or after Jan. 1, 2010.
E-FILING LIKELY TO FALL SHORT OF GOAL
The IRS is unlikely to meet its goal of having 80% of all major types of tax returns filed electronically by 2012, the IRS Oversight Board said. The prediction was in the Oversight Board’s Electronic Filing 2010 Annual Report to Congress released in January.
The e-file goal was originally set by Congress in 1998 for 80% of all individual returns to be e-filed by 2007. The goal has subsequently been expanded to include all major individual, business and exempt organization tax returns, and the target date has been delayed to 2012.
For individual returns, the e-filing rate was approximately 70% in 2010—and could reach 80% by 2012—but for all major types of tax returns in 2010 it was 59%, the Oversight Board said.
SERVICE PARRIES ROBINSON KNIFE
The IRS announced (Action on Decision 2011-01) it won’t acquiesce in the Second Circuit Court of Appeals’ holding last year in Robinson Knife Manufacturing Co. Inc. v. Commissioner (600 F.3d 121). The Second Circuit had reversed the Tax Court (TC Memo 2009-9), saying a manufacturer’s royalty payments for the use of trademarks could be currently deducted rather than capitalized where the payments were based on sales and not production of goods (for previous Tax Matters coverage, see “Royalty Payments Held Deductible,” July 2010, page 50). The Second Circuit held the payments were not subject to the “unicap” rules of Treas. Reg. § 1.263A-1(e)(3)(i) governing indirect costs because they were not properly allocable to inventory produced by the taxpayer. Even though the licensing agreements were necessary to producing the kitchen knives and other tools, their costs were not incurred until Robinson Knife sold the goods, the court said.
In saying it will not follow that holding, the IRS said the court had “confused the timing with the purpose of the payments.” The Service also noted that in December 2010 it issued proposed regulations (REG-149335-08) designating sales-based royalty payments as production costs allocable to inventory produced by the taxpayer and subject to capitalization.
WORDS, WORDS, WORDS
In her testimony (tinyurl.com/6hxata8) Jan. 20 to the House Ways & Means Committee on tax reform, National Taxpayer Advocate Nina Olson tackled anew an often-cited indicator of complexity of federal tax law—the sheer size of Title 26 of the U.S. Code. Her office downloaded a copy of the Tax Code from the House’s website (tinyurl.com/2zbctc), opened it in Microsoft Word and hit the “word count” feature, tallying 3.8 million words. That copy of the Code didn’t include 2010 changes, she noted. On the other hand, she acknowledged, her method may have included more material than in others’ earlier attempts, since it was unable to distinguish between legislative text proper, versus captions and page numbers. It also included tables of contents, legislative histories, effective dates and other supporting matter. Yet, “as a practical matter, a person seeking to determine the law will likely have to read and consider many of these additional words,” she added.
An estimate six years earlier by the Tax Foundation yielded a count of 2.1 million words, and in 2001 the Joint Committee on Taxation counted 1.4 million words. Even if one allows for variations in methodology, the trend seems clear, Olson said, noting that the Tax Foundation estimated the length in 2005 was nearly three times that of 30 years earlier. Now, she said, “the Tax Code has grown so long that it has become challenging even to figure out how long it is.”
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