Current developments in taxation of individuals.

• Author: Brennan, Elizabeth

This semiannual update surveys recent federal tax developments involving individuals. It summarizes notable cases, rulings, and guidance on a variety of topics issued during the six months ending April 2023. The update was written by members of the AICPA Individual and Self-Employed Tax Technical Resource Panel. The items are arranged in Code section order.

As it does each year, the IRS issued updates to certain procedural matters, in Rev. Procs. 2023-1,2023-2, and 2023-3. Rev. Proc. 2023-1 is a revised procedure for issuing letter rulings. Its major changes from Rev. Proc. 2022-1 include clarification that a ruling will be issued on a completed transaction if the ruling request is submitted before a return containing a tax position on that transaction is filed, even if a return has been filed for the year in which the transaction took place. (1) Rev. Proc. 2023-1 clarifies that while generally, the user fee for all requests under the revenue procedure must be paid through pay.gov, foreign entities that wish to submit payment from a foreign bank may submit their payment by check instead of using pay.gov. (2)

In Rev. Proc. 2023-2, providing procedures for furnishing technical advice, the only significant change noted from Rev. Proc. 2022-2 is the incorporation of electronic signature and submission procedures into the general instructions for requesting letter rulings and determination letters. (3)

Rev. Proc. 2023-3 updates the domestic "no rule" listing. The 2023 version indicates that rulings will not be issued with respect to S corporations under Sec. 1362(f) as to whether various rights indicate that the one-class-of-stock requirement is violated, because it is a factual question. In addition, Sec. 1362(f) rulings will not be issued regarding certain inadvertently terminated or invalid S elections. (4) Certain worker classifications under Sees. 3121,3306, and 3401 have been added as no-ruling areas, and some previous items were modified. (5)

Sec. 36B: Refundable credit for coverage under a qualified health plan

Several cases before the Tax Court applied rules governing eligibility for and amounts of premium tax credits (PTCs) and advance premium tax credits (APTCs) that assist qualifying individuals in maintaining health insurance coverage.

Income over 400% of federal poverty line: In Henry, (6) the Tax Court found that the taxpayer was not entitled to a PTC and was required to repay APTC payments because her income exceeded 400% of the federal poverty line (FPL). The taxpayer had been unemployed and in a "terrible" financial, physical, and mental state, the court stated. As a result, she made early withdrawals from a retirement or pension plan to cover living expenses. The Health Insurance Marketplace determined that the taxpayer was eligible for the PTC and the APTC.

Accordingly, for the 11 months of coverage she had in 2016, she received monthly APTC payments totaling $7,205. Her monthly premiums totaled $7,788. She was unable to pay the entire difference, and her coverage was terminated for nonpayment of premiums in November 2016. She contended that she canceled her insurance in February 2016, but there was no record of her doing so.

The taxpayer received Form 1095-A, Health Insurance Marketplace Statement, and a corrected Form 1095-A reflecting her coverage information, along with letters directing her to file a tax return it the form showed she received an APTC and to complete and attach Form 8962, Premium Tax Credit, to her tax return. She did file a 2016 tax return to report her income, which consisted of taxable pensions and annuities and taxable Social Security benefits totaling about $91,000. But she did not complete Form 8962 or attach it to her 2016 tax return.

The court found that her income was 598% of the FPL during 2016 and held that she was required to repay the credit. Although the taxpayer testified that she had canceled her health insurance in February 2016 and therefore no APTC payments should have been made on her behalf, she provided no documentation to corroborate her claim.

In Sneed, (7) the Tax Court held that the taxpayer was ineligible for the PTC because her income exceeded 400% of the FPL for her family size, and she was required to repay the APTC payments made on her behalf. The taxpayer did not appear to dispute the determination but sought a collection alternative because of financial hardship. However, the court held that in a deficiency proceeding under Sec. 6213(a), the collectability of the tax liability was not an issue before the court and held she was required to repay the APTC payments she received.

Alternative calculation: Manzolillo (8) is another PTC case. The couple in the case married in 2015 (the audit year). They both had requested APTC payments for their health insurance. When they completed Form 8962, they reported the credit as $3,200 instead of the actual $7,950 applied to premiums. They elected the alternative calculation for the year of marriage but failed to complete Part V of Form 8962.

The IRS audited their return and issued a notice of deficiency, which the court upheld after adjusting the PTC for the alternative marriage-year computation. The taxpayers argued that the IRS was precluded from increasing their tax liability because they received a refund for 2015, but the court held that, under the case law, it is well settled that granting a refund does not preclude the IRS from making a subsequent adjustment to a taxpayer's liability.

Sec. 61: Gross income defined

In Fairbank, (9) the Tax Court ruled in the IRS's favor in a case involving multiple years of tax deficiencies and accuracy-related penalties. Spanning tax years 2003 to 2011, with the exception of 2010, the case addressed entity classification, undisclosed information, underreporting by way of a statute of limitation, unreported income from foreign accounts, and accuracy-related penalties due to negligence.

In the early 1960s, Barbara Fairbank (then Barbara Hagaman) was married to Earl Hagaman, and the couple had four children together. Earl Hagaman was a CPA working for large corporations throughout their marriage until the late 1970s, when he became an oil broker, working for his own companies. As a successful businessman and well-versed in financial matters, he had full responsibility over the couple's finances, including several financial accounts in New Zealand and Switzerland. Despite Earl Hagaman's personal financial success, he failed to file federal income tax returns for the years 1980 through 1982, during which he moved in excess of $16 million from banks in the United States to Switzerland and New Zealand.

In early 1981, the couple separated and in 1982 were divorced. In 1985, the IRS sent them a notice of jeopardy assessment for tax years 1980 through 1982, stating that Earl Hagaman had "engaged in sham operations... and derived large profits from these activities." According to the IRS's jeopardy assessment notice, the foreign operations generated significant income that Earl Hagaman failed to report on his U.S. federal income tax returns. The Service assessed more than $14.7 million in tax and interest.

In 1990, Barbara Fairbank received innocent-spouse relief for the tax years 1980 and 1981 (when still married to Hagaman). Hagaman settled his federal income tax liabilities with the IRS.

As part of the couple's divorce agreement, Earl Hagaman was ordered to pay monthly child support. Despite what the interim agreement stated, the couple modified the agreement verbally, and he began paying Fairbank substantially more than originally ordered and made several deposits into foreign bank accounts, stating that Fairbank "wanted the payments to be made to her Swiss establishment, Xavana Establishment."

In 2008, the IRS issued a John Doe summons requesting information relating to U.S. holders of undisclosed foreign accounts with Union Bank of Switzerland (UBS). This summons was instrumental in the U.S. Department of Justice securing a well-known settlement in which UBS admitted to engaging in a scheme of aiding U.S. clients in hiding income from the IRS.

During this process, the IRS discovered Fairbank had an unreported account with UBS and issued her a notice of deficiency for tax years 2003-2009 for all income generated from the account. Fairbank argued that the IRS could not assess the delinquent tax and penalties because the statute of limitation under Sec. 6501(a) had expired. The IRS contended that the notice of deficiency was timely. The limitation period remained open under Sec. 6501(c)(8) because Fairbank failed to notify the IRS of certain foreign transfers with respect to Xavana Establishment and the UBS account, the Service argued.

The Tax Court held that the statute of limitation had not run under Sec. 6501(c)(8) because Fairbank had not complied with the reporting requirements in Secs. 6048(b) and (c) and the notice of deficiency was timely issued. The court also held that Fairbank was not entitled to any reasonable-cause defense against accuracy-related penalties based on reliance on professional advice, as she had attempted to argue, because she had provided her CPA inaccurate information regarding her foreign bank accounts. Thus, the court held, she did not rely in good faith on the CPA's advice.

Sec. 72: Annuities; certain proceeds of endowment and life insurance contracts

Lack of proof withdrawn funds met an exception: The taxpayer in Ghaly (10) withdrew $71,147 from his retirement account in 2018 to provide for his family because he had been laid off from his job. Some of the funds were used for his son's surgery. He also defaulted on a retirement plan loan that year. To restore the withdrawn amounts, he opened two new retirement accounts in 2020 and contributed the maximum amount allowed. He was issued two Forms 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for 2018. One...