Line Items


The IRS released final regulations defining an omission from gross income for purposes of the extended six-year limitations period for assessment of tax (TD 9511). The regulations finalize without change temporary regulations (TD 9466) that the Tax Court held to be invalid last May (Intermountain Ins. Serv. of Vail LLC, 134 TC no. 11 (2010); see previous Tax Matters coverage, Aug. 2010, page 67, and Nov. 2009, page 70). In its decision, the Tax Court followed the Ninth and Federal circuits (Bakersfield Energy Partners, 568 F.3d 767 (9th Cir. 2009), and Salman Ranch Ltd., 573 F.3d 1362 (Fed. Cir. 2009)) in applying the Supreme Court’s holding in Colony v. U.S., 357 U.S. 28 (1958), that an overstatement of basis and resulting understatement of gain does not constitute an omission from gross income for purposes of IRC §§ 6229 and 6501.


However, the Seventh Circuit Court of Appeals on Jan. 26 reversed the Tax Court, holding the six-year period applied to a basis overstatement in a Son-of-BOSS case, Kenneth and Susan Beard v. Commissioner (docket no. 09-3741). For the Tax Court proceedings see TC Memo 2009-184, discussed (with Intermountain) in Tax Matters, Nov. 2009, page 70. Without analyzing deference to the regulations, the Seventh Circuit said Colony did not control outside a trade or business setting and interpreted the statutes as including overstated basis.


Section 6501(e)(1)(A) provides that if a taxpayer omits from gross income an amount that should be included and that exceeds 25% of the amount of gross income stated in the return, the period of time for assessment is extended to six years. Section 6229(c)(2) applies a similar rule to partnerships. Under Treas. Reg. § 1.61-6(a), gross income includes “gains derived from dealings in property,” and these gains are “the excess of the amount realized over the unrecovered cost or other basis for the property sold or exchanged.” The final regulations provide that, outside the trade or business context, “an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis constitutes an omission from gross income” for purposes of sections 6229(c)(2) and 6501(e)(1)(A) (Treas. Reg. §§ 301.6229(c)(2)-1(a)(1)(iii) and 301.6501(e)-1(a)(1)(iii)).


The IRS disagrees with the court decisions and asserted in the preamble to the temporary regulations that its position in the regulations was entitled to deference. (The Service also has appealed the Tax Court’s holding in Intermountain Ins. Serv. of Vail to the District of Columbia Circuit Court of Appeals; oral arguments have been scheduled for April.)


The final regulations were effective Dec. 14, 2010, and for income tax purposes (the regulations also apply to estate and gift and excise taxes) will apply to tax years for which the period for assessing tax was open on or after Sept. 24, 2009 (the date the temporary regulations were issued).




The IRS released a new form and guidance relating to the small business health care tax credit for the 2010 tax year. The guidance (Notice 2010-82) discusses issues relating to employers’ eligibility for the credit and other eligibility issues.


The notice supplements earlier guidance (Notice 2010-44; for prior Tax Matters coverage, see “Line Items: Health Care Business Credit Explained,” July 2010, page 53) on the credit under IRC § 45R, added by the Patient Protection and Affordable Care Act, PL 111-148.


Beginning in years after 2009, section 45R provides tax credits for small businesses designed to increase levels of health insurance coverage. For 2010–2013 calendar years, businesses with 25 or fewer employees and average annual wages of less than $50,000 are eligible for credits of up to 35% of nonelective contributions on behalf of employees for insurance premiums. Charitable tax-exempt organizations under section 501(c) get a 25% credit against payroll taxes. (For years after 2013, the amounts of the credit are 50%, and 35% for exempt organizations.) The amount of the credit is based on a percentage of the lesser of: (1) the amount of nonelective contributions paid by the eligible small employer on behalf of employees under the arrangement during the tax year and (2) the amount of nonelective contributions the employer would have paid under the arrangement if each such employee were enrolled in a plan that had a premium equal to the average premium for the small group market in the state (or in an area in the state) in which the employer is offering health insurance coverage. For taxable entities, the credit is part of the general business credit; for tax-exempt entities, it is allowed as a refundable credit limited by the sum of income tax withheld from all employees’ wages during the year, plus employer and employee amounts for Medicare tax.


The notice also states that eligible small employers outside the United States that have income effectively connected with the conduct of a trade or business in the U.S. may claim the credit only if the employer pays premiums for health insurance coverage issued in and regulated by one of the 50 states or the District of Columbia.


Under section 45R, sole proprietors, partners in a partnership, shareholders owning more than 2% of the stock in an S corporation, and any owners of more than 5% of other businesses—and their family members—are not taken into account as employees for purposes of the credit. However, the section 45R definition of “family member” does not specifically refer to spouses. The IRS says, however, that certain spouses are nevertheless excluded from the definition of employee:

  • The employee-spouse of a shareholder owning more than 2% of the stock of an S corporation;
  • The employee-spouse of an owner of more than 5% of a business;
  • The employee-spouse of a partner owning more than a 5% interest in a partnership; and
  • The employee-spouse of a sole proprietor.


The notice says that leased employees are counted in computing a small business’s full-time-equivalent employees for purposes of the credit; however, the business cannot take into account premiums paid by the leasing organization on behalf of a leased employee. The notice also clarifies that health savings accounts and self-insured plans, including health reimbursement arrangements and flexible spending arrangements, are not “qualifying arrangements” for purposes of the credit because they are not health insurance coverage. The notice also discusses multiemployer health and welfare plans and church welfare benefit plans, which can count as qualifying arrangements for the credit.




Although it will not challenge a position upheld by the Tax Court (Capital One Financial Corp. and Subsidiaries v. Commissioner, 133 TC 136) allowing deferral of income recognition from credit card interchange fees, the IRS will continue to address related issues, the Service said in a Large Business & Industry division directive (LB&I-4-1110-030). The directive, issued in November 2010, supplements a chief counsel notice (CC-2010-018), in which the IRS said it would no longer challenge or litigate whether interchange fee income from credit card transactions creates or increases original issue discount (OID) on a pool of credit card loans. But in the latest directive, the IRS said it would continue to develop remaining open issues, including:


  • Whether an issuing bank has properly calculated accrual of credit card fees treated as OID for purposes of IRC § 1272(a)(6) (daily accrual of OID where payment of principal is subject to acceleration by prepayment of other obligations securing the debt, or for other reasons); and
  • Whether an issuing bank has properly changed its accounting method with respect to the treatment of credit card fees as OID subject to deferral under section 1272(a)(6).


The directive reverses LMSB-04-0208-002, April 22, 2008, which stated that interchange and merchant discount fees (designated a Tier II issue) are not interest and cannot constitute OID subject to deferral. In the Capital One case, the Tax Court held that the fees, which are paid by merchants to a credit card’s issuer for customer transactions using the card, could be recognized as OID over the life of a credit card obligation. The court rejected the IRS’ position that the fees collected by Capital One were payment for services (see “Tax Matters: Credit Card Fees Are OID,” JofA, Jan. 2010, page 58).




The Third Circuit Court of Appeals joined the Seventh Circuit in upholding the IRS’ two-year limit for filing a claim for innocent spouse equitable relief under IRC § 6015(f). The Third Circuit reversed a holding by the Tax Court that taxpayer Denise Mannella timely petitioned the IRS for innocent spouse equitable relief from unpaid taxes, penalties and interest arising from returns filed jointly with her husband. She filed the petition more than 28 months after the IRS began collection procedures with a notice of intent to levy. In so holding, the Tax Court had ruled invalid regulations requiring petitions under section 6015(f) to be filed within two years after the IRS begins collection actions (see prior coverage in “Tax Matters,” July 2009, page 76, and Sept. 2010, page 68). Earlier, the Tax Court had reached a similar conclusion in Cathy Marie Lantz v. Commissioner, 132 TC 131, which the Seventh Circuit reversed and remanded last June (607 F.3d 479).


The Third Circuit applied the reasoning of Lantz and the Chevron standard of deference to the regulation (Chevron v. Natural Resources Defense Council Inc., 467 U.S. 837 (1984))—that is, that the statute is ambiguous, but the regulation does not clearly violate congressional intent. Although the court thus ruled Mannella’s innocent spouse request untimely, it remanded to the Tax Court for further consideration her claim for equitable tolling of the deadline period. Mannella contended that her husband signed her name to the postal return receipt for the notice of intent to levy and did not tell her about it until more than two years later.




The Streamlined Sales Tax Governing Board last fall approved a request that “food or food ingredient,” as used in the Streamlined Sales and Use Tax Agreement (SSUTA), be interpreted to include carbon dioxide used as part of a “tabletop seltzer-making kit.” The status of the beverage-grade CO2 for sales and use tax purposes had been unclear, since the SSUTA defines “food or food ingredients” as “[s]ubstances, whether in liquid, concentrated, solid, frozen, dried, or dehydrated form, that are sold for ingestion or chewing by humans and are consumed for their taste or nutritional value,” but does not specifically mention gases. A Chicago attorney requested the interpretation on behalf of a client company that distributes and refills the carbon dioxide canisters used in the units. The request argued that the resulting fizz met the part of the definition relating to consumption of a food item for its taste, since it “changes the taste (and texture) of the water and makes for a pleasant drinking experience.”


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