In three actions on decisions (AODs), the IRS stated it will hew to its position in any future litigation regarding certain issues on which courts ruled against it in 2015 and 2016.
Stine, LLC: In AOD 2017-02, the IRS said it would maintain its stance regarding when a retail store is placed in service for depreciation purposes. The District Court for the Western District of Louisiana erred, the IRS said, when it held for the taxpayer on the issue in Stine LLC, No. 2:13-03224 (W.D. La. 1/27/15). In that case, the taxpayer, a retailer of building materials and supplies, faced a statutory sunset of Dec. 31, 2008, to qualify for additional first-year depreciation under the Gulf Opportunity (GO) Zone Act (Sec. 1400N(d)) for two buildings used in its retail business. As of that date, the buildings had a 30-day occupancy permit for installing equipment, shelving, and racks but were not yet open for business, and customers were not allowed inside.
In holding that Stine was entitled to the GO Zone bonus depreciation, the district court found that the buildings were in a state of readiness and availability to perform their function of housing shelves, racks, merchandise, and equipment, and thus were placed in service on or before Dec. 31, 2008 (see "Tax Matters: Retail Buildings Placed in Service Before Being Open for Business," JofA, June 2015).
In its AOD, the IRS stated that the district court wrongly held, first, that the intended use of the building was to house and secure racks, shelving, and merchandise. Rather, the IRS said, the court should have determined the buildings' specifically assigned function in the context of the taxpayer's trade or business, i.e., as a retail store. Second, the court should have held that the property was placed in service when it was ready and available for regular operation and income-producing use pursuant to that specifically assigned function.
Accordingly, the IRS will continue in other cases to take the position that a retail store is placed in service for depreciation purposes when it is ready and available to operate as a retail store. It will further assert that a retail store's ability to begin operations is determined under the applicable factors of Rev. Ruls. 76-256 and 76-428 (which pertain to electric power generating facilities but focus on when a plant is ready and available for regular operation).
Shea Homes, Inc.: In AOD 2017-03, the IRS said it will not follow the Ninth Circuit's opinion in Shea Homes, Inc., 834 F.3d 1061 (9th Cir. 2016), in cases outside that circuit. In that case, the taxpayer, a homebuilder/developer, and subsidiaries applied the completed-contract method of accounting under Regs. Sec. 1.460-4(d) to entire housing developments rather than the individual homes within them that the taxpayers sold to customers.
Under the completed-contract method, a contract is considered complete, and income and allocable contract costs are taken into account, upon the earlier of (1) the customer's use of the subject matter of the contract and the taxpayer's having incurred at least 95% of the estimated allocable contract costs attributable to the subject matter, or (2) final completion and acceptance of the subject matter. The IRS argued that each house and lot was the subject matter of the contract, while Shea Homes argued it included common improvements and amenities.
The Tax Court held for the taxpayers (Shea Homes, Inc., 142 T.C. 60 (2014); see "Tax Matters: Home Builder Properly Reported Income Under Completed-Contract Method," JofA, June 2014). The Service appealed to the Ninth Circuit, which affirmed the Tax Court's holding because it concluded that the court's factual finding that the subject matter of each home construction contract consisted of the entire development or phase in which a house was situated was not clearly erroneous.
The IRS stated in the AOD that the 95% completion test is properly applied on a contract-by-contract basis to the "total allocable contract costs attributable to the subject matter of the contract" (Regs. Sec. 1.460-1(c)(3)(i)(A)). If the total costs of an entire development or phase were allocable to each individual home contract, "this same set of costs becomes deductible multiple times," the IRS objected. Also, contract completion is measured by a customer's use and acceptance of the subject matter, i.e., a home and lot, which does not extend to other homes in a development, the IRS stated.
Scott Singer Installations, Inc.: AOD 2017-04 involved the IRS's assertion of an S corporation's liability for employment taxes on its payments of the company's president and sole shareholder's personal expenses. The shareholder, Richard Scott Singer, claimed that payments by his company, Scott Singer Installations Inc., of his home mortgage and other personal expenses were repayments of loans he had made the company.
The Tax Court found that amounts advanced to the company of which Singer had a reasonable expectation of repayment were bona fide loans. Despite the lack of any promissory notes, maturity dates, or interest charged, the court found the business's records supported Singer's claimed intent to create a debtor-creditor relationship and held for the taxpayer (Scott Singer Installations, Inc., T.C. Memo. 2016-161; see "Tax Matters: S Corporation's Payments on its Owner's Behalf Are Held Not to Be Wages," JofA, Dec. 2016).
Although the IRS in the AOD acquiesced to the case's result, it disagreed with the court's reasoning. The IRS cited several cases in which courts have held that taxpayers' characterization of payments as other than compensation are not controlling. Acknowledging that those cases involved purported dividends rather than loan repayments, the IRS said that payments may still be compensation despite a debtor-creditor relationship. It stated that it will continue to assert that payments of personal expenses by an S corporation on behalf of its corporate officer/employee are wages unless the taxpayer objectively substantiates both the existence of a loan and payments that were made in repayment of that loan.
- AODs 2017-02, 2017-03, and 2017-04
—By Paul Bonner, a JofA senior editor.
