Individual taxation: digest of recent developments.

• Author: Baldwin, David R.
• Position: Part 1

This article is Part I of a two-part article covering recert developments affecting taxation of individuals, including regulations, cases, and IRS guidance. The items are arranged in Code section order. This part covers Sec. 1, Tax Imposed, through Sec. 170, Charitable, etc.. Contributions and Gifts. Part It, which will appear in the April issue, will cover developments from Sec. 183, Activities Not Engaged in for Profit, through Sec. 7703, Determination of Marital Status.

Sec. 1: Tax Imposed (Filing Status)

In a district court case, the taxpayer testified in a deposition that his daughter stayed with him a couple of months during the year, mostly over holidays, and that he did not have primary physical custody of his daughter.(1) The taxpayer could not prove he provided more than half of his daughter's support or other facts to support that she was his dependent. Therefore, the court denied the taxpayer head-of-household filing status and the dependency exemption for his daughter.

Sec. 24: Child Tax Credit

When a taxpayer filed a Chapter 7 bankruptcy petition on Oct. 30, 2012, the bankruptcy trustee asked to see her 2012 tax return when it was filed. The taxpayer was due a refund of $2,762, of which $2,000 was from a child rax credit she had claimed on her Form 1040, U.S. Individual Income Tax Return, The trustee told the taxpayer that the full amount of the refund was part of the bankruptcy estate, but the taxpayer claimed the $2,000 child tax credit was exempt because it was a public assistance benefit designed to assist families with dependent children in meeting their obligations, which was exempt from the bankruptcy estate under Maine law. The bankruptcy court distinguished the child tax credit, which is not a refundable credit, from the additional child tax credit, which is, and concluded that the child tax credit was not exempt for bankruptcy purposes.(2) The taxpayer was required to pay the 2012 tax refund to the bankruptcy estate.

In a district court case, the taxpayer was denied the child tax credit for a disabled daughter over the statutory age limit of 16.(3) The child tax credit makes no exceptions for disability.

Sec. 36: First-Time Homebuyer Tax Credit

Although the first-time homebuyer tax credit has expired, cases involving it continue to be litigated. In a case decided by the Court of Federal Claims, a divorced taxpayer was denied the first-time home-buyer tax credit because his new home was purchased before his divorce decree was final.(4) The taxpayer was considered to have a beneficial ownership interest in his ex-wife "s home because he was still considered married when his new home was purchased. Therefore, he was not considered a first-time homebuyer.

Sec. 61: Gross Income Defined

Guidance directed at virtual currency users was issued by the Treasury Department's Financial Crimes F.nforcement Network.(5) Individuals use these virtual currencies (the most well-known one is Bitcoin) to purchase real or virtual goods or services or as payment for goods and services, or they sell them for use as real currency. Bitcoin use has been unregulated and untraceable. There is the beginning of an attempt to regulate the use of this virtual currency by requiring money transmitter licensing. Some have speculated that the IRS might have to issue guidance on the use of this currency, but it appears that bitcoins would be included in income under Sec. 61, which defines gross income as "all income from whatever source derived."

Sec. 62: Adjusted Gross Income Defined

In an Office of Chief Counsel Internal Revenue Service Memorandum, the IRS discusses the tax treatment of attorneys' fees paid under a settlement of employee lawsuits.(6) In general, attorneys' fees recovered must be included in gross income when the underlying recovery is taxable. Sec. 62UH20) allows for an above-rhe-line deduction for attorneys* fees and court costs paid in connection with any action involving a claim of unlawful discrimination. Sec. 62(e) defines unlawful discrimination and lists various federal, state, and local laws that fall under this definition. Attorneys' fees and costs incurred in an action involving an employment relationship are deductible as an abovc-thc-line deduction under Sec. 62(e){18). If attorneys' fees are not deductible above the line because they are not received in connection with an action involving a claim of unlawful discrimination, they may still be deducted as miscellaneous itemized deductions sub)ect to the 2% fli>or. For taxpayers subject to the alternative minimum tax, this deduction is not permitted.

Sec. 63: Taxable Income Defined

After the Supreme Court struck down Section 3 of the Defense of Marriage Act (DOMA)(7) in Windsor,(8) the IRS ruled that same-sex couples who are legally married under state or foreign laws are considered married for federal rax purposes, regardless of where they live. However, according to an FAQ section on the IRS website, same-sex and opposite-sex individuals who are in registered domestic partnerships, civil unions, or other similar formal relationships that are not marriages under state law are not considered married for federal tax purposes.

The IRS position seems clear that registered domestic partners are not married for federal tax purposes and thus are not able (or required) to file federal tax returns with a filing status of married filing lointly or separately. One example ot a tax provision that applies to married individuals but not domestic partners is Sec. 63(c)(6)(A), which generally prohibits I taxpayer from itemizing deductions if the taxpayer's spouse claims the standard deduction. This rule does not apply to registered domestic partners since they are nor considered spouses for federal tax purposes. A registered domestic partner can itemize deductions or claim the standard deduction regardless of whether his or her partner itemizes or claims the standard deduction.

Sec. 66: Treatment of Community Income

Another provision that does not apply to registered domestic partners is Sec. 66, which deals with treatment of community-income. Sec. 66 applies only to married taxpayers and does not apply to registered domestic partners since they are not married for federal tax purposes, according to the IRS's FAQs for registered domestic partners and individuals in civil unions.(9)

The IRS has issued temporary regulations that incorporate changes made in Notice 2011-70(10) in the deadline for requesting equitable innocent spouse relief, which also applies to relict from joint liability for community property income under Sec. 66(c).(11) Instead of a two-year deadline, a request for relief must be filed with the IRS within the period of limitation for collection of tax.

Under Sec. 66(c), married taxpayers who do not file a joint federal income tax return but are nonetheless liable for community income because they live in a community property state can request relief from loint liability in two ways. In a community property state, each spouse is responsible for the tax on one-half ot all the community property income for the year. Traditional relief from joint liability has been allowed under Sec. 66(c) to a requesting spouse on income that the requesting spouse did not know existed and had no reason to know existed. If a requesting spouse fails to satisfy those requirements, the IRS has discretion to grant equitable relief. The eligibility requirements used for granting equitable relief are the same for Sec. 66(c) and for Sec. 6015(f). As a result, the IRS has applied the same two-year deadline for spouses to file for equitable relief in community property states and will now apply the new longer deadline to Sec. 66(c) equitable relief cases.

Sec. 67: 2% Floor on Miscellaneous Itemized Deductions

The Tax Court allowed a taxpayer to deduct her tax preparation fees, based on her verbal testimony of the amount paid, even though there were many inconsistencies at trial.(12) The amount deductible, however, was subject to the 2%-of-adjusted-gross-income floor limitation under Sec. 67(a).

Sec. 71: Alimony and Separate Maintenance Payments

An above-the-line deduction may be claimed for alimony or separate maintenance payments during the tax year if those payments meet the following requirements:

* The payments must be made under a divorce or separation agreement (Sec. 71(b)(1)(A));

* The agreement must not specifically-designate the payment as not includible in the...