Current developments in individual taxation.

Author:Baldwin, David R.

This article is a semiannual review of recent developments in the area of individual federal taxation. It covers cases, rulings, and guidance on a variety of topics. The items are arranged in Code section order.

Sec. 61: Gross income defined

To value noncommercial flights on employer-provided aircrafts, the IRS has released the standard industry fare level cents per mile and terminal charges for use in calculating the taxation of fringe benefits under Sec. 61. (1)

Sec. 86: Social Security and Tier 1 Railroad Retirement Benefits

In Johnson, (2) the Tax Court determined that, when calculating modified adjusted gross income to determine eligibility for the Sec. 36B premium tax credit, all Social Security benefits must be included in the calculation based on the year received, regardless of the period they relate to.

In this instance, the taxpayer did not include all the Social Security benefits he received during the year, which included a nontaxable portion of a lump-sum payment related to a prior year for which he made a Sec. 86(e) election. The court held that the definition of "amount equal to the portion of the taxpayer's social security benefits (as defined in section 86(d)) which is not included in gross income under Sec. 86 for the taxable year" was unambiguous and the determining factor was the year of receipt, not the year the payment was attributed to.

The Tax Court, following Johnson, came to the same conclusion in Monroe. (3)

Sec. 104: Compensation for injuries or sickness

In Doyle (4) the Tax Court ruled that the taxpayers had incorrectly excluded income under Sec. 104(a)(2) related to emotional distress. The husband received a settlement from his former employer for wrongful discharge. For the settlement money to be considered nontaxable under Sec. 104, it must be for personal physical injuries or sickness. The taxpayers argued that the husband's former employer had intended to pay him to compensate him for the physical sickness that was caused by his wrongful termination. To qualify to exclude income under Sec. 104(a)(2), a taxpayer must show "a direct causal link between the damages and the personal injuries sustained."

The settlement agreement stated "$250, 000 as settlement for his alleged emotional distress damages (non-economic) alleged in his claim for wrongful discharge in violation of public policy." After concluding the settlement was in fact for emotional distress, the court determined that it was not in connection with a personal physical injury or physical sickness because

Sec 104(a) states "emotional distress shall not be treated as a physical injury or physical sickness."

Sec. 107: Rental value of parsonages

In Gay/or, (5) the Seventh Circuit reversed a district court decision that Sec. 107(2)'s income exclusion for housing allowances provided for a "minister of the gospel" violated the Establishment Clause of the U.S. Constitution. As the Gaylor court noted, since the Religion Clauses of the First Amendment were adopted, courts have struggled with the interplay between them, as was seen in Walz v. Tax Commission of the City of New York. (6)

Whether a statute violates the Establishment Clause is evaluated under the three-part test set out in Lemon v. Kurtzman, 403 U.S. 602 (1971). Under this test, (1) the statute must have a secular legislative purpose; (2) its principal or primary effect must be one that neither advances nor inhibits religion; and (3) the statute must not foster an excessive government entanglement with religion. The district court found that the Sec. 107(2) housing exemption did not meet the secular purpose prong of the Lemon test because its true purpose was to "provide aid to a group of religious persons, " and it therefore violated the Establishment Clause.

The Seventh Circuit, however, determined that the IRS had established three secular purposes for the statute, so it had a secular legislative purpose. The court also found that the statute met the other two requirements of the test. Therefore, it reversed the district court's decision and held that Sec. 107(2) is constitutional.

Sec. 108: Income from discharge of indebtedness

On Feb. 22, 2019, the IRS released an updated Real Estate Property Foreclosure and Cancellation of Debt Audit Technique Guide. (7) The updated audit technique guide discusses the tax consequences when real estate is disposed of through foreclosure, short sale, deed in lieu of foreclosure, and abandonments.

In Letter Ruling 201902024, the IRS granted extensions of time for a taxpayer to make a Sec. 108(c)(3)(C) election to exclude income from the discharge of qualified real property business indebtedness and to make an election under Regs. Sec. 1.108-5(b) to reduce the basis of depreciable real property. The taxpayer was a real estate development partnership (organized as a limited liability company) that was formed to develop residential condominiums. When the partnership failed to reach its development goals and converted the remaining condominiums into rental units, it had cancellation-of-debt income.

Sec. 111: Recovery of tax benefit items

Rev. Rul. 2019-11, released on March 29, 2019, provided four examples illustrating how the long-standing tax benefit rule interacts with the new $10, 000 state and local tax (SALT) limit enacted by the law known as the Tax Cuts and Jobs Act (TCJA) (8) to determine the portion of any state or local tax refund that must be included in the taxpayer's federal income tax return. The announcement does not affect the treatment of state tax refunds received in 2018. The TCJA limited the itemized deduction for state and local taxes to $5, 000 for a married person filing a separate return and $10, 000 for all other tax filers. The limit applies to tax years 2018 to 2025.

The ruling contains four examples of the application of the tax benefit rule. In Situation 2, the taxpayer paid $12, 000 in state and local taxes--state and local income taxes of $7, 000 and real property taxes of $5, 000. Under Sec. 164(b)(6), the taxpayer's SALT deduction is limited to $10, 000. The taxpayer claims total itemized deductions of $15, 000. In 2019, the taxpayer receives a $750 refund of state income taxes paid in 2018, meaning the taxpayer's actual 2018 state income tax liability was $6, 250 ($7, 000 paid minus the $750 refund). Accordingly, the taxpayer's 2018 SALT deduction would still have been $10, 000, even if it had been figured based on the actual $6, 250 state and local income tax liability for 2018. The taxpayer did not receive a tax benefit on the taxpayer's 2018 federal income tax return from the taxpayer's overpayment of state income tax in 2018. Thus, the taxpayer is not required to include income from the taxpayer's 2019 state income tax refund on the taxpayer's 2019 return.

Sec. 119: Meals or lodging furnished for the convenience of the employer

In Technical Advice Memorandum (TAM) 201903017, the IRS evaluated whether meals and snacks that the taxpayer provided to employees at its headquarters were includible in the employees' wages. The taxpayer provided (1) meals without charge to all employees, contractors, and visitors, without distinction as to the employee's position, specific job duties, ongoing responsibilities, or other external circumstances; and (2) unlimited snacks and drinks in designated snack areas that were available to employees, contractors, and escorted guests.

The IRS ruled that generally the value of meals the taxpayer provided to its employees was includible in the employees' wages because the taxpayer failed to show that the meals were provided for substantial noncompensatory business reasons or for the employer's convenience. However, it ruled that meals provided to employees on call to handle emergency outages were for a substantial noncompensatory business reason and were therefore excludable from income under Sec. 119. The IRS also concluded that...

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