Individual taxation: digest of recent developments.

• Author: Cook, Ellen

This article covers recent developments affecting taxation of individuals, including last year's tax relief and small business legislation, regulations, cases, and IRS guidance. The items are arranged in Code section order.

Sec. 1: Tax Imposed

In mid-December 2010, Congress passed and President Barack Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and job Creation Act of 2010 (Tax Relief Act). (1) This act extended the 2001 and 2003 tax cuts for two more years through the end of 2012. Thus, the highest statutory tax rate for individuals continues to be 35%. The higher child credit and the lower tax rate for qualified dividends and capital gains continue through 2012. For 2011 and 2012, as in 2010, there is no phaseout of itemized deductions or personal exemptions. Various other changes were included in the act. For further information, see Tax Trends, "EGTRRA and JGTRRA Tax Rates Extended for Two Years in Lame Duck Session," 42 The Tax Adviser 133 (February 2011).

Sec. 25A: Hope and Lifetime Learning Credits

The American opportunity tax credit was extended through 2012 by the Tax Relief Act. A report titled "The American Opportunity Tax Credit," issued by the Treasury Department on October 12, 2010, explains how the American opportunity tax credit works, estimates what benefits typical families can expect to receive compared with prior law, and shows how families have already benefited from the new credit. Among the findings in the report:

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* The American opportunity tax credit increased tax incentives for higher education by over 90%, or $8.7 billion, in 2009.

* 12.5 million students and their families received a tax incentive for higher education in 2009, an increase of 400,000 from 2008.

* American opportunity tax credit recipients in 2009 received an average tax credit of over $1,700, about 75% more than the average Hope scholarship or the lifetime learning credit recipient in 2008.

* 4.5 million students and families received a tax refund from the American opportunity tax credit in 2009 with an average value of $800, which they would not have been eligible for in 2008.

Sec. 35: Overpayments of Tax

The Sixth Circuit held that the Tax Court properly upheld the IRS's application of an individual's tax overpayment to his tax liability for a discharged tax year, rather than the year requested by the individual. (2) Although the IRS generally will honor a taxpayer's request to apply voluntary payments, the individual's overpayment was not a voluntary payment; therefore, his desire to have the funds allocated to his tax liabilities for a particular tax year was inconsequential. The IRS possessed statutory discretion to credit the overpayment to any tax year.

Sec. 36: First-Time Homebuyer Credit

The first-time homebuyer credit expired in 2010 (eligible home purchases must have closed on or before September 30, 2010). The GAO issued a report, "Tax Administration: Usage and Selected Analyses of the First-Time Homebuyer Credit," to Congress in response to a request for updated information on the use of the first-time homebuyer credit. The report identifies the number of first-time homebuyer credits and dollar amounts claimed for each credit version by state and provides state rankings, using selected statistics, such as the total dollar amount of the credit claimed in each state.

A June 2010 report issued by the Treasury Inspector Genera! for Tax Administration (TIGTA) reported that 4,608 prisoners claimed the first-time homebuyer tax credit while incarcerated at the time they reported a home purchase. (3) TIGTA estimated that approximately 1,295 of the claims were processed, resulting in $9.1 million in tax credits.

Sec. 36C: Adoption Expenses

The IRS issued guidance (4) on the expanded adoption credit under Sec. 36C (5) and released Form 8839, Qualified Adoption Expenses, for claiming the refundable credit on 2010 tax returns.

The IRS provided safe harbors for determining the finality of foreign adoptions for purposes of the adoption credit under Sec. 36C and the exclusion for employer reimbursements under Sec. 137. (6) The safe harbors apply to adoptions governed by the Hague Convention on Protection of Children and Cooperation in Respect of Intercountry Adoption (convention) and subject to the Intercountry Adoption Act of 2000 (convention adoptions). Rev. Proc. 2005-31 (7) continues to apply to nonconvention adoptions. Finally, the revenue procedure provides guidance on filing amended returns to claim the credit or exclusion for convention adoptions that became final in 2008 or 2009. A taxpayer within the scope of this revenue procedure who meets the requirements of a safe harbor may rely on that safe harbor to determine when a foreign adoption of an eligible child is final.

Rev. Proc. 2010-35 modifies and supersedes portions of Rev. Proc. 2009-50.8 For tax years beginning in 2010, it provides:

Adoption credit under Sec. 36C: The maximum credit is increased to $13,170 from $12,170. The available adoption credit begins to phase out for taxpayers with modified adjusted gross income in excess of $182,520 and is completely phased out for taxpayers with modified adjusted gross income of $222,520 or more.

Exclusion from income under Sec. 137: The amount that an employee can exclude from gross income for the adoption of a child with special needs is increased to $13,170. The maximum amount that an employee can exclude from gross income for the amounts paid or expenses incurred by an employer for qualified adoption expenses furnished under an adoption assistance program for other adoptions by the employee is $13,170, and the amount excludable from an employee's gross income is phased out as under the adoption credit.

The IRS has provided interim guidance for computing and substantiating claims for the adoption credit beginning with the 2010 tax year, including but not limited to the following provisions: (9)

* An adoption credit amount claimed in an earlier tax year that an individual carries forward to a tax year beginning in 2010 is allowed as a refundable tax credit. Amounts carried forward to a tax year beginning in 2010 are not subject to an income limitation in that tax year.

* For both domestic and foreign adoptions, if an individual pays or incurs qualified adoption expenses (QAEs; these include reasonable and necessary adoption fees, court costs, attorneys' fees, and other expenses directly related to, and for the principal purpose of, adopting an eligible child) during or after the tax year in which the adoption becomes final, the credit is allowed in the tax year in which the individual pays or incurs the QAEs.

* For domestic adoptions, the credit is allowed for QAEs that an individual pays or incurs in a tax year before the adoption becomes final. However, an individual may not claim the credit for those QAEs until the next tax year.

* For foreign adoptions, the credit is allowed only in the tax year in which the adoption becomes final.

* Expenses for an unsuccessful domestic adoption are aggregated with the expenses of a successful adoption of another child for purposes of applying the dollar limitation.

Sec. 59: Alternative Minimum Tax Definitions and Special Rules

The IRS granted a taxpayer an extension of time to make an election under Sec. 59(e) as permitted by Regs. Sec. 301.9100-3 in a number of situations where the taxpayer acted reasonably and in good faith and where granting an extension of time to make an election would not prejudice the interests of the government. (10) Although some of these rulings involved corporations, the same principles would apply if the taxpayer were an individual.

Sec. 61: Gross Income Defined

Credit card rebates: Use of credit cards may entitle cardholders to rebates, which can be received in the form of cash or donations to charity. Two questions were involved in a recent letter ruling: (11) (1) Is the rebate considered income? The IRS says no. The rebate is really an adjustment to the purchase price of the goods or services purchased by the cardholder. This is not considered an "accession to wealth" and thus is not includible in income. (12) (2) Is the cardholder entitled to a charitable contribution deduction if it opts to have its rebate donated to a qualified charitable organization? The IRS says yes. Because the cardholder chooses whether to have the rebate go to charity, this is a voluntary contribution and qualifies as a Sec. 170 charitable contribution.

Whether the cardholder is allowed to deduct the donation depends on whether the recordkeeping requirements of Sees. 170(f)(8) and (f)(17) are satisfied. Under Sec. 170(f)(8), for contributions of $250 or more, the donor must receive written, contemporaneous acknowledgment from the charity noting the amount of the contribution and stating that no goods or services were provided in exchange for the...