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Tax talk.

Interest Revisited

The IRS has reconsidered its long-standing rules that limited deductions for mortgage loan fees. Under new IRS rules, points are deductible in full in the year paid if they satisfy the following five-part test:

1. They must be paid in connection with buying a primary residence. This restates the current rule that points are not fully deductible for second-homes or investment properties.

2. The standard settlement sheet must identify amounts as points. This may be done with any acceptable label such as origination fees, discount points, et al.

3. All amounts must be calculated as a percentage of the loan.

4. The points must be in line with standard financing practices. Fees must be competitive. No excessive points will be allowed as current deductions.

5. The actual payment of the points need not be paid separately by the buyer - the amount of any deduction will be limited to the amount of the buyer's total cash investment.

Note: This test is retroactive to points paid after 1990. Thus, deductions can be taken on tax returns that borrowers file 1991.

(Rev. Proc. 92-11)

New IRS Form

The new Form 8275-R must be attached to any return that takes a position contrary to IRS regulations. Any return that contains such a position and does not have this new Form 8275-R attached is subject to a 20% penalty. Use of his form does not guarantee protection from the penalty, as the Internal Revenue Service states that any position taken without merit will have the penalty applied.

Current Form 8275 may be used until the new Form 8275-R becomes available. Until that time, the taxpayer must write the word "Regulations" in the top right-hand of Form 8275.

New Estimated Tax For

Corporate Taxpayers

As a result of legislation enacted late last year to extend unemployment benefits, corporations must base their 1992 estimated tax payments on 93% (rather than the old 90%) of 1992 tax liability. This percentage was to be increased over five years, reaching 95% by 1996. However, the increase in percentage has been accelerated by additional recent legislation. The maximum percentage, still at 95%, now will be reached in 1993. Small corporations may continue to take advantage of the safe harbor requiring payment of 100% of the previous year's tax liability. Corporations which have not had taxable income in excess of $1 million in any of the three preceding years can use this alternative as the basis for their 1992 estimated tax payments.

Form 1120-W contains a worksheet that may be used by corporations to compute the amount of estimated tax due. The 1992 Form 1120-W that was included in the forms package sent to corporate taxpayers does not reflect this change in estimated tax. A revised Form 1220-W taking the higher percentage into account has been prepared. The IRS states this new revised form must be used instead of the one included in the 1120-W package. (Announcement 92-5, 1992-2 IRB 23)

Single Taxpayers and EIC

The Service has issued corrections in two publications regarding qualification for the Earned Income Credit (EIC). Publication 501: Exemptions, Standard Deductions and Filing Information (page 4) and Publication 17: Your Federal Income Tax (page 16) both state that a single taxpayer does not qualify for the EIC. This statement is incorrect and will be deleted from future publications. (Announcement 91-185, 1991-52)

Tips For Form 941

To avoid delays in processing Form 941, Employer's Quarterly Federal Tax Return, the IRS has made several suggestions:

* Use Line 4 only for adjustments from a prior quarter of the present tax year, never for overpayments or underpayments of prior year income taxes.

* Use Line 9 to make adjustments for underpaid and overpaid Medicare and Social Security taxes from previous quarters, even if the adjustment is for a prior calendar year quarter.

* Apply the payroll tax adjustment reported on lines 4 and 9 to a payroll deposit during the quarter. The "Record of Tax Liability" section is only for reporting current quarter liabilities.

* For line 4 or 9 adjustments, include a Form 941C or a written statement listing:

- the error's nature;

- the last date of the quarter when the error was made;

- the error amount;

- the quarter when the error was discovered;

- the quarter when the employee was refunded the overpayment;

- a sworn statement indicating that the employee gave the employer a statement that he or she will not claim a refund or credit for the unpaid amount, if the adjustment corrects previous year's Medicare or Social Security tax overpayment.

* Attach Form 941C to the Form 941 that has the Line 4 or 9 adjustments. Do not file them separately.

* Leave a good audit trail to reduce the amount of IRS inquiries.

Informal No Change Report

To Be Issued

An IRS revenue officer or field examiner will issue to a taxpayer or his/her representative an informal no-change-in-tax-status report immediately following an audit where such a determination has been made, according to a recent Internal Revenue Manual Transmittal.

Previously, the representative and the taxpayer would have to wait a minimum of three months, sometimes, longer before a no-change letter could be sent. This informal procedure will not change any of the formal process associated with an audit and no-change letters.

Recordkeeping For Day Care

Providers Eased

Day care providers who operate businesses in their homes will find it easier to file their federal income tax return because of simplified recordkeeping rules.

Under a ruling issued early this year by the IRS, if a room is available throughout the business day and is regularly used for day care, the square footage of that room will be considered as used for day care for the entire day. This new rule eliminates the need for a day care provider to keep records of the specific hours of business use of that room.

For example, a day care provider uses a bedroom available for child care throughout the business day for the children's morning and afternoon naps every business day. Even though the bedroom is not used during every hour of the business day, the total square footage of that room is considered as day care usage for the entire day.

According to the IRS, day care providers should figure this deduction on Form 8829, Expenses for Business Use of Your Home. This new form allows someone who operates a business in the home to list all the expenses from that business on one form, making it easier to determine the business owner's allowable deductions. This form along with Schedule C, Profit or Loss From Business, is attached to the day care provider's income tax return. (Revenue Ruling 92-3)

No Limitation Period For

Section 6701 Penalty

According to the US Court of Appeals for the Sixth Circuit, it was never Congress' intent to impose a limitations period on the assessment of the penalty for aiding the abetting in the understatement of a tax liability. Rather, assessment of the penalty could be made at anytime.

The appellate court ruled that a Federal district court erred in earlier applying the general five-year limitations period on commencement of actions, suits or proceedings for the enforcement of any civil fine, penalty or forfeiture to bar the IRS' assessment of the penalty. However, assessment of the penalty does trigger the time clock for the statute of limitations on collection of the penalty.

In addition, the Sixth Circuit also held that the lower court erred in finding the IRS could assess only one Code Section 6701 penalty per individual per calendar year. The Sixth Circuit holds the IRS can assess one penalty per taxable period or event - e.g., one for each false quarterly tax return. (Mullikin v. US, [underscore] F.2nd (6th Cir., December 30, 1991))

Carryback Provisions Regular

and AMT Losses

Taxpayers may not elect to carryback an alternative minimum tax NOL while electing to waive the carryback period for the regular tax NOL for the same year.

After an analysis of the pertinent IRC sections, the Tax Court concluded that although there are two types of taxes and NOLs, there is only one carryback period, to which a single waiver may apply. The court noted that Code Section 172(b)(3) relates to relinquishment of entire carryback period with respect to NOLs. It does not distinguish between a regular NOL or an AMT NOL and does not provide for two elections. Thus, an effective election under Code Section 172(b)(3) must relate to one carryback period. There being but one carryback period, the taxpayer's election must relate to both the regular and AMT NOLs. Without a valid 172 election, the NOLs must be carried back.

Note: An invalid election - one that elects to carryforward one NOL while carrying back the other - is considered to be no election. Therefore, both NOLs would be carried back during an audit. (Plumb v. Commissioner, 97 TC 44 (1991))

Partnership Allocation of

Nonrecourse Deductions

The Internal Revenue Service has issued final regulations that determine when a partnership has nonrecourse deductions. Under the regulations, the amount of a partnership's nonrecourse deductions for any tax year equals the net increase in the partnership's minimum gain minus the amount of any distributions of nonrecourse debt proceeds allocable to the increased minimum gain. This amount must be allocated among the partners in accordance with their interest in the partnership under Code Section 704(b). Minimum gain is the amount by which the nonrecourse liability exceeds the encumbered property's adjusted tax basis. In short, minimum gain is the amount the partnership would realize if the property securing the nonrecourse debt were transferred as full satisfaction for the loan. The net increase or decrease in a partnership's minimum gain is computed by comparing the current year's amount with the prior year's.

The regulation's only safe harbor is a complex three part test under which an allocation of nonrecourse deductions is automatically treated as being in accordance with the partner's interest. The allocation must pass each of the requirements below:

1. Economic effect test - the allocation must be consistent with the underlying economic arrangement of the partners. This means that in the event there is an economic benefit or economic burden that corresponds to an allocation, the partner to whom the allocation is made must receive such economic benefit or burden.

2. Reasonable consistency test - requires the ratio in which partners are permitted to share in the nonrecourse deductions must correspond to other allocations that are related to the nonrecourse deduction and have a substantial economic effect.

3. Minimum gain chargeback provision -- a partnership clause requiring nonrecourse deductions to be replaced with nonrecourse income allocations at the appropriate time. (TD 8385)

New Withholding Tables to

Boost Take Home Pay

A majority of American workers will get an advanced payment on next year's federal income tax refund due to the new tax withholding tables the IRS is sending to their employers. These new tables compensate for the fact that millions of Americans are currently overwithheld and end up giving the government an interest-free loan each year.

This permanent change in withholding will benefit low and middle income wage earners, resulting in an aggregate increase of about $25 billion over the next twelve months. The increase will be up to $345 per job for workers withheld at the married rate and up to $172 per job for those withheld at the single rates. In addition to workers, taxpayers who are retired and have tax withheld from their pensions will benefit from this change.

The IRS estimates that taxpayers who file about 89 million returns fall into the low and middle income category and will benefit from the withholding table changes. At present about 71 million of those returns result in refunds.

The average income tax refund has grown substantially over the past years. For tax year 1990, the average refund was over $900 (up from $680 just 10 years ago). Workers have too much tax withheld because they do not claim all the withholding allowances to which they are entitled. Eventually they receive the money in the form of a refund check when they file their returns, however, they have lost the use of this money during the interim.

Since these low and middle income taxpayers will see their 1993 refunds moved into their 1992 paychecks, they will see a smaller refund next year. IRS estimates that only 88% of filers can expect to receive a refund. Some will find that they still owe part of their tax liability when they file for 1992.

As the changes in withholding will be automatic, the IRS will waive penalties for any underpayment of estimated taxes in 1992 to extent that the underpayment is caused only by these adjustments to the withholding tables. However, employees who want to keep their withholding at the current rate must give their employers a new Form W-4 claiming the same number of withholding allowances - but they must ask for extra tax to be withheld each paycheck. Estimates for additional tax payments should be based on $345 for married taxpayers ($172 for single taxpayers) divided by the number of pay period during the year.

Exempt Organization Donor

Recognition Is Not


Tax exempt organizations can publicly acknowledge donors for their contibutions, but if the organizations conduct advertising for donors the payments are taxable income, not tax exempt contributions.

The IRS has states in Announcement 92-15 that recent publicity about corporate sponsorship income of college football bowl games has prompted concerns from many exempt organizations that recognition of contributors will make donations taxable. Howeve, the IRS has not changed its position on the issue of recognizing donors.

Under current tax law, donations a charitable organization receives are considered tax exempt contribution income if the organization does not, in return, provide a valuable benefit or service to the donor. Mere recognition of a contributor as a benefactor normally is of little or no value to the donor and is incident to the contribution. Tax exempt organizations that go beyond recognition and extensively promote the donor are engaging in advertising, which is unrelated to the mission of tax exempt organizations. In these cases, exempt organizations must pay unrelated business income tax (UBIT) on the payment received in exchange for advertising services provided.

All the facts and circumstances of the relationship between the sponsor and the exempt organization must be considered, the Service noted. Items to consider include the value of the service provide in exchange for the payment and the terms under which payments and services are rendered. (Announcement 92-15)

New Developments for Title

VII Awards

Under Code Section 104(a)(2), damages received on account of personal injuries are tax-free. This rule applies whether the damages are received by way of judgment or an out-of-court settlement. However, back pay awarded in settlement of a racial discrimination claim filed under Title VII of the Civil Rights Act of 1964 may no longer be excludable from gross income as damages received on account of personal injury.

The Supreme Court recently agreed to review Burke, a case in which the Sixth Circuit held that the entire amount of a judgment for sex discrimination under Title VII of the 1964 Civil Rights Act, including back pay, was excludable as damages for a personal injury. As far back as 1989, the Fourth circuit in Thompson considered the propert tax treatment of an award for sex discrimination in an action brought under both Title VII and the Equal Pay Act. In that case, the court concluded that liquidated damages were tax-free but back pay awarded under the Equal Pay Act was taxable.

The government, in its petition for Supreme Court review in the Burke case, argued that there was a conflict between Burke and the holding of the Fourth Circuit in Thompson that a back pay award was taxable. The taxpayer contended that there was no conflict. The basis of the taxpayer's argument was that Thompson dealt primarily with a different statute, the Equal Pay Act.

In another recent case, the Court of Appeals for the District of Columbia Circuit explicitly held that a back pay award under Title VII of the 1964 Civil Rights Act is taxable. The District of Columbia Circuit, affirming the Tax Court's decision, points to Thompson for support and states explicitly its disagreement with Burke.

According to the holding in yet another recent case, payment is excludible under Code Section 104(a)(2) only if: (1) the payment constitutes damages and (2) the damages are for a personal injury. According to the Sparrow court, Burke was wrong for its assumption that what the taxpayer received in that case were damages; they were not. The court reasoned that damages are awarded only in actions at law. The only relief provided under Title VII is an equitable remedy, not a legal one. Title VII specifies a court may enjoin unlawful employment practices, award back pay, and provide "any other equitable relief." Thus, the back pay awarded under Title VII is in the nature of an equitable remedy of restitution, and not the legal remedy of damages.

However, the 1991 Civil Rights Act complicates things further. This new law provides that compensatory and punitive damages, not formerly available under Title VII actions, may now be recovered. These damages, in addition to any equitable remedy, include, among other things, awards for future pecuniary losses and emotional pain. Such damages will continue to be awards excluded from gross income. (Sparrow v. Commissioner, [underscore] F. 2nd [underscore], 1991 US App LEXIS 27991, (DC Cir. 1991)).

1988 Profits Foreign-Controlled

U.S. Corporations

Set New High

Profits of foreign-controlled U.S. corporations reached $11.2 billion for 1988, twice the $5.6 billion reported for 1987. This is just one of the facts reported in the Fall 1991 issue of the Internal Revenue Service quarterly publication, the "Statistics of Income Bulletin."

These 42,000 companies also reported $5.8 billion in income tax for 1988, compared with $4.6 billion the year before. The receipts they reported amounted to $800 million. Companies controlled by Japanese businesses accounted for 25% of these receipts. Those controlled by United Kingdom companies accounted for anothr 18%.

Partnerships for 1989 continued to turn around their long-term trend of net losses, reporting $14.1 billion in profits, slightly less than the $14.5 billion reported for 1988.

Total revenue reported by nonprofit charitable organizations was $310.8 billion for 1987, up form $292.5 billion for 1986. Total expenses were $288.7 billion, 84% of which was for the cost of conducting programs.

University Concerts Create

Unrelated Business Income

An organization that is otherwise tax-exempt is nonetheless subject to tax on income form a trade or business which is not related to the organization's exempt purpose. In a recent technical advice memorandum, the IRS held that income received by a university from professional entertainment events sponsored by the university and held at a university owned facility constitute unrelated business income.

The taxpayer, a state university, owns and operates an on-campus multi-purpose facility which is used for a number of educational activities including class registration, intercollegiate athletic contests and commencement exercises. In addition, the facility was used during the year for 45 "ticket events" consisting of rock concerts, concerts by contemporary professional entertainers, and professional sporting events.

To support its claim that the activities at the facility meet the "substantially related" test, the university says that the events "contributed importantly to the accomplishment of the university's exept purpose by providing a forum for the exposition of contemporary or popular musicians." The university claims that promotion of the arts is an important component of a balanced program of social, cultural, recreational, and educational activities which supplement the academic programs of the university and enchance the quality of life in the university community. Yet, the university has a School of Fine Arts which has no involvement in the selection of events to be held at the facility and does not normally participate in presentations. Tickets to events at the facility are sold through a commercial ticket service. Ticket prices are generally the same for the general public as for students.

The IRS concluded that the substantially related test is not met here because of the manner in which the activity is conducted and not necessarily because of the nature of the entertainment itself. It is unnecessary to decide whether events performed by contemporary musical artists contribute importantly to the university's educational purposes. The Service focused on the manner in which the university decides to secure the performers and the business considerations that they university uses as a foundation for its decisions. The only apparent criterion utilized by the university is profitability. The emphasis on revenue maximization to the exclusion of other considerations indicates that the trade or business is not operated as an integral part of the university's educational program and that th activity fails the substantially related test. (PLR 9147008
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Title Annotation:new rules on business and individual taxation
Author:Berkery, Peter M., Jr.; Green, Gary L., Jr.
Publication:The National Public Accountant
Article Type:Column
Date:Mar 1, 1992
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