Dawn Connolly, Author at Barnard Vogler & Company

With April 15 behind us, most taxpayers have filed their income tax returns. If for some reason, people have yet to file their 2013 return, they may owe interest and penalties when the return is ultimately filed.

It is important to note that interest and penalties are charged only if taxes are owed. If the return shows a refund, no interest or penalties apply, even if the return is filed late.

Here are eight points you should know about interest and late penalties:

The IRS checks all returns for mathematical accuracy. If the IRS finds you owe more money,it will send you a bill.
Interest is generally charged on any unpaid tax from the due date of the return until the date of payment. The interest rate is determined quarterly and is the federal short-term rate plus 3 percent. Interest is compounded daily. Currently, the interest rate is 3 percent because the federal short-term interest rate is 0 percent.
In addition to interest, if you file a return but do not pay the entire amount due on time, you will generally have to pay a late payment penalty of one-half of one percent for each month, or part of a month, up to a maximum of 25 percent, on the amount of tax that remains unpaid.
If you owe tax and do not file your return on time, a separate failure-to-file penalty is usually 5 percent of the tax owed for each month, or part of a month, that your return is late, up to five months. If your return is over 60 days late, the minimum penalty for late filing is the lesser of $135 or 100 percent of the tax owed.
The failure-to-file penalty is usually much more than the failure-to-pay penalty. In most cases, it is 10 times more, so those who cannot pay what they owe by the due date should still file their tax return on time, or file for an extension, and pay as much as they can.
The maximum penalty for failure to file and for failure to pay is 25 percent of the amount of tax owed, so the combined maximum is 50 percent of the tax owed.
The penalties for filing and paying late may be abated if you have reasonable cause and the failure was not due to willful neglect. Generally, interest charges are not abated. They continue to accrue until all assessed tax, penalties and interest are paid in full.
If you requested an extension of time to file your income tax return by the tax due date and paid at least 90 percent of the taxes you owe, you may not face a failure-to-pay penalty. However, you must pay the remaining balance by the extended due date. You will owe interest on any taxes you pay after the April 15 due date.

The IRS has provided a safe harbor that applies to the treatment of indebtedness secured by 100 percent of the ownership interest in a disregarded entity that holds real property.

The safe harbor will treat such indebtedness as indebtedness secured by real property for purposes of the income exclusion available under the cancellation of indebtedness rules.

Generally, a solvent taxpayer – other than a C corporation – whose qualified real property business indebtedness is discharged outside of a bankruptcy proceeding can elect to exclude some or all of the discharged amount from income. The excluded amount must be applied to reduce the basis of the taxpayer’s depreciable real property.

Qualified real property business indebtedness (QRPBI) is indebtedness that:

➤ Is incurred or assumed in connection with real property used in a trade or business and secured by such real property;

➤ Is considered “qualified acquisition indebtedness” if incurred or assumed by the taxpayer after 1992; and

➤ The taxpayer elects to treat as QRPBI.

QRPBI also includes indebtedness incurred to refinance qualified real property business indebtedness – but only to the extent it does not exceed the amount of the indebtedness being refinanced.

Revenue Procedure 2014-20 provides a safe harbor under which the IRS will treat indebtedness secured by 100 percent of the ownership interest in a disregarded entity holding real property as indebtedness secured by real property. If the indebtedness meets the other requirements, it will be QRPBI. Accordingly, any income from the discharge of indebtedness is eligible for the exclusion and basis reduction rules.

To qualify for the safe harbor, all of the following must be met:

The taxpayer or a wholly owned disregarded entity of the taxpayer incurs indebtedness.
The borrower directly or indirectly owns 100 percent of a separate disregarded entity owning real property; i.e., the borrower is not the same entity as the property owner.
The borrower pledges to the lender a first-priority security interest in the borrower’s ownership interest in the property owner. Any further encumbrance on the pledged ownership interest must be subordinate to the lender’s security interest in the property owner.
At least 90 percent of the fair market value of the total assets directly owned by the property owner must be real property used in a trade or business, and any other assets must be incidental to the acquisition, ownership and operation of the real property.
Upon default and foreclosure on the indebtedness, the lender will replace the borrower as the sole owner of the property owner.

Failure to meet the requirements of this safe harbor does not preclude the taxpayer from arguing, based on facts and circumstances, that its debt nonetheless qualifies for exclusion/basis reduction.

The safe harbor is effective for elections made on or after Feb. 5, 2014. ■

The Tax Court concluded in a recent case that a developer of a planned residential community did not have to recognize income under the completed contract method of accounting until the common improvements were completed.

Shea Homes and its related entities developed large planned residential communities. Shea contended that final completion and acceptance under the completed contract method of accounting did not occur until the last road was paved and the final performance bond required by state and municipal law was released.

The IRS contended that the subject matter of Shea’s contracts consisted only of the houses and the lots upon which the houses were built. Under its interpretation, the contract for each home met the final completion and acceptance test upon the close of escrow for the sale of each home. The IRS also contended that contracts entered into and closed within the same tax year were not long-term contracts eligible for the completed contract method of accounting.

The court determined that Shea was permitted to use the completed contract method of accounting. Further, the court held that the subject matter of the contracts consisted of the home and the larger development, including amenities and other common improvements (Shea Homes, Inc. v. Commissioner, 142 TC No. 3, Feb. 12, 2014).

The court reasoned that the primary subject matter of the contracts included the house, the lot, improvements to the lot and common improvements to the development.

The amenities of the development were of great importance to, and a crucial aspect of, the taxpayers’ sales effort, the attainment of governmental approval of the development and the buyers’ purchase decision. Accordingly, the amenities were an essential element of the home purchase and sale contract.

The IRS has concluded that amounts that a manufacturer paid to retailers to offset the cost of constructing display areas for the manufacturer’s products did not have to be capitalized.

Under the facts presented in Chief Counsel Advice (CCA) 201405014, the manufacturer enters into an agreement to pay the retailers to maintain retail space that conforms to the manufacturer’s design requirements. The agreement provides that the retailers must repay the manufacturer if, within 15 years, the retailer no longer conforms to the requirements of the display area, no longer sells and maintains a full line of the manufacturer’s products or no longer provides servicing. The agreement does not obligate the retailers to purchase any specific quantity of products.

The CCA concluded that the manufacturer did not have to capitalize its payments to the retailer because the manufacturer did not own the retail space and the payments did not create or enhance a separate and distinct intangible asset.

The retailers were required to sell and maintain a full line of products and to provide servicing on site. However, the retailers were not required to purchase any specific amount of products during the term of the agreement, and the price of the product was not fixed. The manufacturer did not have the right to provide any specific quantity of products to the retailers.

Most of us would be happy if the IRS never knew who we are or where we live.

But sometimes it’s a good idea to keep the government informed.

If you or one of your dependents had a name change last year, you should notify the Social Security Administration (SSA) before you file your federal income tax return. Otherwise, the name on your tax return will not match SSA records, which will likely result in a letter from the IRS inquiring about the mismatch.

If you overpaid your taxes, your refund could be delayed until the discrepancy is resolved.

Be sure to contact SSA if:

You got married or divorced and changed your name.
A dependent you claim had a name change.
You adopted a child and that child’s last name changed.

Your return must list the Social Security number of every dependent. If you have not obtained a Social Security number for a newborn child, you should process the necessary paperwork before you file your 2013 return.

You can effect a name change by filing Form SS-5, Application for a Social Security Card, with the SSA. It is also a good idea to let the IRS know about a change in address by filing Form 8822, Change of Address.

For individual, gift, estate or generation-skipping transfer tax returns, file Form 8822 or Form 8822-B, Change of Address or Responsible Party – Business, for your business. Note that Form 8822-B should be filed no later than 60 days after a change or by March 1 if the change occurred in 2013 and was not previously reported to the IRS.

2014 CPAmerica International

The Tax Court agreed with the IRS in a recent case that the one-rollover-per-year rule applies to all of a person’s IRAs, not to each of his IRAs separately. What is curious is that the IRS’s position in this case and the court’s holding are contrary to an IRS publication and at least one private letter ruling.

During 2008, Alvan Bobrow requested and received a distribution from his traditional IRA. Later, he received a distribution from his rollover IRA. Within 60 days of each distribution, Alvan replaced the funds in the IRA accounts.

The Tax Court ruled in favor of the IRS, saying that the distribution from the rollover IRA was taxable because Alvan failed the one-rollover-per-year rule. The court said that the plain language of the tax code limits the frequency of nontaxable rollovers a taxpayer may elect. By its terms, the one-year limitation is not specific to any single IRA maintained by an individual but instead applies to all IRAs maintained by a taxpayer. The court also upheld the IRS’s assessment of the accuracy-related penalty (Alvan J. and Elisa Bobrow v. Commissioner, TC Memo 2014-21, Jan. 28, 2014).

The IRS position and the court’s holding are at odds with the IRS position in IRS Publication 590, Individual Retirement Arrangements, and in Private Letter Ruling 8731041.

“Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover,” according to Publication 590.

Publication 590 contains the following example:

Illustration: A taxpayer we’ll call Chris has two traditional IRAs (IRA-1 and IRA-2). On Date 1, Chris makes a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). Chris cannot, within one year of Date 1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA. However, Chris can make a tax-free rollover from IRA-2 into any other traditional IRA because Chris has not, within the last year, rolled over, tax free, any distribution from or made a tax-free rollover to IRA-2.

Neither the courts nor the IRS are bound by positions stated in IRS publications or tax form instructions. And only the taxpayer who receives a private letter ruling may rely on the conclusions expressed in it. The court in Bobrow did not address IRS Publication 590 or the private letter ruling.

The IRS must follow a corporation’s designation of voluntary payments toward the income tax liabilities of its owner/employees, according to a recent Tax Court ruling.

However, because the payments did not represent taxes withheld at the source, the IRS was allowed to levy on the assets of the owner/employees to collect applicable interest and penalties. Likewise, the corporation remained liable for interest and penalties attributable to its failure to remit taxes on a timely basis (James R. Dixon, et. ux. v. Commissioner, 141 TC No. 3, Sept. 3, 2013 and James R. Dixon, et. ux. v. Commissioner, TC Memo 2013-207, Sept. 3, 2013).

James and Sharon Dixon served as officers and employees of Tryco. After a number of successful years, Tryco stopped filing and remitting employment taxes, and the Dixons stopped filing individual income tax returns.

Later, the Dixons were criminally prosecuted for failure to file individual income tax returns. As part of a settlement, they agreed to make restitution to the IRS for taxes in the amount of $61,021.

The Dixons contributed this amount to Tryco, and Tryco submitted it to the IRS, accompanied by a letter stating that the payment represented Tryco’s withholding taxes to be applied to the withheld income taxes of the Dixons.

When accountants prepared the individual income tax returns for the Dixons’ missing years, they determined that the couple owed an additional $30,202 in taxes. The Dixons contributed this additional amount to Tryco, and the corporation in turn submitted it to the IRS with a letter similar to the earlier one.

On the advice of legal counsel, the Dixons chose not to pay their individual income tax liabilities directly, believing that the indirect payments through Tryco would reduce both the portion of the company’s withholding tax liability attributable to themselves and their own income tax liabilities. They also hoped to avoid interest and penalties because the tax law treats withholding at the source as paid in the year of the withholding irrespective of the employer’s date of remittance.

The IRS initially credited Tryco’s payments to the Dixons’ income tax liabilities, which settled their tax obligations but not the related interest and penalties. Later, the IRS reversed itself and applied the payments to Tryco’s general unpaid employment tax liabilities.

The IRS then issued a notice to the Dixons of intent to levy on their assets in satisfaction of their now unpaid income tax liabilities. The Dixons petitioned the Tax Court.

The Dixons contended first that they were entitled to a withholding credit for the amounts submitted by Tryco on their behalf. Second, they asserted that the IRS was obligated to honor Tryco’s designation of the payments as withheld income taxes and to credit the amounts toward the Dixons’ income tax liabilities.

The IRS argued that its policy of honoring designations of voluntary payments does not extend to designations of delinquent employment tax by one party toward the income tax liability of another.

The Tax Court concluded that the funds submitted by Tryco to the IRS were not withheld at the source and, accordingly, the Dixons were not entitled to a credit against their individual income tax liabilities. Regarding the Dixons’ second argument, the majority determined that the IRS was obligated to follow its published administrative position regarding designations of voluntary payments.

The IRS was therefore directed to credit the $91,223 payments to the Dixons’ account, discharging their income tax obligations. The IRS was allowed, however, to levy on the Dixons’ assets to collect applicable interest and penalties. Tryco likewise remained liable for interest and penalties.

Qualified estates get automatic extension for portability election

“Most relatively simple estates … do not require the filing of an estate tax return,” according to the IRS. For decedents dying in 2013 or 2014, estates valued at less than $5,250,000 (2013) or $5,340,000 (2014) are excluded from estate tax.

When a person dies owning assets less than the applicable exclusion amount, the executor of the estate can elect to transfer the unused portion to the surviving spouse. This so-called “portability election” has been available since 2011.

However, the election must be made on a timely filed estate tax return. Therefore, the election would not be effective for an estate that did not file a return because the value of the assets in the estate was below the filing threshold.

Now, if estates of decedents who died before Jan. 1, 2014, and fall below the dollar threshold for having to file an estate tax return want to elect to take the portability exclusion, they can get an automatic extension to make that election, according to a recent IRS revenue procedure.

Under Revenue Procedure 2014-18, the estate of a decedent who is survived by a spouse is permitted to make a portability election, allowing the surviving spouse to apply the decedent’s unused exclusion amount to the surviving spouse’s own transfers during life and at death. The amount received by the surviving spouse is called the deceased spousal unused exclusion, or DSUE, amount.

The executor of the estate of the deceased spouse must elect portability of the DSUE amount on a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, which must include a computation of the unused exclusion amount. A portability election is effective only if made on a Form 706 filed no later than nine months after the decedent’s date of death or by the last day of the period covered by an extension – if an extension for filing has been obtained.

When an estate is filing an estate tax return only to make a portability election, the new revenue procedure provides an automatic extension of the Form 706 filing deadline.

To qualify for the automatic extension, the following requirements must be met:

1. The taxpayer must be the executor of the estate of a decedent who:

Has a surviving spouse
Died after Dec. 31, 2010, and on or before Dec. 31, 2013
Was a citizen or resident of the United States on the date of death

2. The taxpayer must not be required to file an estate tax return as determined based on the value of the gross estate and adjusted taxable gifts.

3. The taxpayer must not have timely filed an estate tax return.

4. A person permitted to make the election on behalf of a decedent must file a complete and properly prepared Form 706 on or before Dec. 31, 2014.

5. The person filing the Form 706 on behalf of the decedent’s estate must state at the top of the form that the return is “FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER Code Sec. 2010(c)(5)(A).

If you listened to the State of the Union address last month, you heard President Obama unveil a new type of retirement savings plan called “myRA.”

MyRA is a savings vehicle designed to serve people whose employers do not provide access to a retirement plan. The best estimate is that about half of all workers and

75 percent of all part-time workers are in this category.

Here are the details released to date:

➜ MyRAs will be backed by a security that looks and feels like a savings bond.

➜ The government will back them with the same variable-interest-rate return offered by the G Fund, the Government Securities Investment Fund in the federalemployees’ Thrift Savings Plan.

➜ Savers will be guaranteed that the value of their accounts will never go down.

➜ Savers will pay no fees on the accounts.

➜ Savers can open the accounts for as little as $25 and can make additionalcontributions in amounts as small as $5.

The myRA will use after-tax dollars, like a Roth IRA, and withdrawals under most circumstances will not be taxed. While it is funded by paycheck deductions, savers will be able to keep their accounts when they change jobs.

Although the program can begin without legislative approval, employers will not be required to participate. Congressional approval is required to force employers who do not have retirement accounts to set up payroll withholding procedures for myRA.

The myRA program has a $15,000 limit. After reaching that mark, savers will have to move their dollars to a Roth IRA.

Even if you qualify for myRA, you may wish to consider a Roth IRA as an alternative. Both Roth IRAs and myRAs are expected to have the same income limits on contributions.

If you decide to open a Roth IRA, you should shop for a custodian that charges no fees. You will not be subject to the savings limits, and you will not have to wait for your employer to agree to participate.

With a Roth IRA, you may not be able to set up an account with contributionthresholds as low as the $25/$5 amounts available with myRA. However, you can probably approximate the “safety of principal” aspect of myRA by investing exclusively in government bonds.

The Tax Court has concluded that three individuals incorrectly characterized ordinary partnership income from the sale of real estate as long-term capital gain.

In this case, Concinnity, LLC, which elected to be taxed as a partnership, was organized by Cordell Pool, Justin Buchanan and Thomas Kallenbach. These three individuals also incorporated Elk Grove Development Company (Cordell D. Pool, et. al. v. Commissioner, TC Memo, 2014-3, Jan. 8, 2014).

Concinnity purchased 300 acres of undeveloped land. At the time of purchase, the land was already divided into four sections (phases 1-4). This property later became the Elk Grove Planned Unit Development (PUD).

Concinnity entered into an agreement that gave Elk Grove Development Company the exclusive right to purchase phases 1-3, consisting of 300 lots. This agreement required Elk Grove to complete all infrastructure improvements necessary to obtain the final plat of each phase of the PUD. Concinnity also entered into an improvements agreement with the county agreeing that it, as subdivider, would pay for the improvements to the land in phase 1.

On its income tax returns, Concinnity consistently reported that it sold land resulting in long-term capital gain. The three partners reported their shares of the partnership’s gain from the sale of real property as long-term capital gain.

The IRS claimed that Concinnity’s land sales produced ordinary income. The three partners claimed that the sale produced capital gain because the land was held for investment.

The Tax Court agreed with the IRS that the proceeds of the land sale should be reported as ordinary income. In reaching its conclusion, the court reviewed several factors:

➤ Nature of acquisition. The Tax Court found that the record did not clearly show Concinnity’s purpose in acquiring the land. However, the evidence suggested that it acquired it for development and sale. While the court noted that the operative inquiry was the purpose for which the property was held – not the purpose of its acquisition – the court determined that there was no evidence showing that Concinnity’s intentions changed during the course of holding the property. The court concluded that the taxpayers failed to show that the property was held for investment purposes.

➤ Frequency and continuity of sales. The court observed that frequent and substantial sales of real property more likely indicate sales in the ordinary course of business, whereas infrequent sales for significant profits are more indicative of real property held as an investment. In this case, the record was not clear as to the frequency and substantiality of Concinnity’s sales. The court found that the record was insufficient to establish Concinnity’s role in the business or overall level of activity with regard to the property. In the end, the court concluded that the taxpayers failed to show that their sales were not frequent and substantial.

➤ Nature and extent of business. The IRS argued that the only documents in the record indicated that Concinnity brokered the deals, found additional investors for the development project, secured water and wastewater systems, and guaranteed performance on the improvements agreement. While it did not wholly accept the IRS contentions, the court found that there was evidence that Concinnity obligated itself to make certain water and wastewater improvements to the PUD and paid for those improvements. The court reasoned that this level of activity was more akin to a real estate developer’s involvement in a development project than to an investor’s increasing the value of his holdings.

➤ Activity of seller about the property. The record was unclear as to whether Concinnity sold lots only to Elk Grove or also sold lots to others. The court found that the taxpayers failed to show that Concinnity did not spend large portions of its time actively participating in the sales of the PUD lots. The court said that this factor weighed in favor of the IRS.

➤ Extent and substantiality of the transaction. While the IRS argued that Elk Grove should be ignored as an entity because the taxpayers incorporated it principally to evade or defeat tax, the court found that the “identical ownership” of Concinnity and Elk Grove did not necessarily mean that Elk Grove should be disregarded. However, the court concluded that the taxpayers failed to produce sufficient evidence demonstrating that they engaged in a bona fide, arm’s-length transaction. ■