Individual taxation report.

Author:Baldwin, David R.


* The IRS issued proposed regulations that update the definition of dependent in the regulations to reflect changes made to Sec. 152.

* The Tax Court held that donee reporting for charitable contributions does not apply as a substitute for the contemporaneous written acknowledgment requirement until the IRS issues regulations allowing for donee reporting.

* A number of court decisions turned on whether taxpayers qualified as real estate professionals for purposes of the passive activity loss rules.

This article is a semiannual review of recent developments in the area of individual taxation, including several cases involving taxpayers who claimed to be materially participating in their real estate activities, one case where a taxpayer with significant income from other sources was denied loss deductions for her horse-breeding business, several cases on education expense deductions, and many other topics. The items are arranged in Code section order.

Sec. 24: Child tax credit

In Polsky, (1) a federal court of appeals upheld a district court's dismissal of a taxpayer's claim for a child tax credit for a permanently disabled daughter over the age of 17, saying that the age limit applied to all children eligible to be claimed for the credit and does not make an exception for disability, unlike the dependency exemption, which excepts from the age limitation individuals who are permanently and totally disabled.

Sec. 32: Earned income

Definition of "childless": The IRS reversed its position on what is considered "childless" for earned income tax credit (EITC) purposes. In IRS Publication 596, Earned Income Credit (EIC), the IRS took the position that if an individual meets the definition of a qualifying child for Taxpayer A and Taxpayer B, and Taxpayer A was awarded the tax break under the tiebreaker rules found in Sec. 152(c)(4), then Taxpayer B was not considered "childless" for EITC purposes. Under the new interpretation in Prop. Regs. Sec. 1.32-2(c)(3)(ii), Taxpayer B could claim the childless EITC provided the taxpayer met the other requirements of that section. The proposed regulation will be effective with tax years beginning after it becomes final, but pending the issuance of the final regulation, it may be applied to any open tax year.

Inmate in a penal institution:

In Skaggs, (2) the Tax Court concluded that a prisoner who was transferred to a state mental health care institution while incarcerated remained an inmate in a penal institution for purposes of Sec. 32(c)(2)(B)(iv), which bars income earned while an inmate at a penal institution from earned income for EITC purposes. Therefore, income he earned while he was at the state mental health care institution was not earned income.

Sec. 61: Gross income defined

The IRS issued a notice of deficiency to an individual taxpayer who, it claimed, had unreported income on her individual income tax return. Because the taxpayer, most of whose income came from her tax preparation business, did not keep adequate records, the Tax Court held that the IRS was justified in using the bank deposits method to reconstruct her income. (3) This case is also discussed under Sees. 162, 170, 212, and 274.

Sec. 63: Taxable income defined

The IRS released proposed regulations (REG-137604-07) on Jan. 19,2017, that apply changes made by the Working Families Tax Relief Act of 20044 to the uniform definition of dependent and other recent changes to the definition of dependency exemption. In addition, the proposed regulations also provide for changes made to the Code regarding filing status, the tax tables for individuals, the child and dependent care credit, the EITC, the additional standard deduction for the aged and blind, and taxpayer identification numbers for adopted children.

Before Sec. 63 was amended by the Tax Reform Act of 1986,5 a taxpayer received an additional personal exemption under Sec. 151 if the taxpayer or the taxpayer's spouse was either age 65 or older or blind as of year end. The proposed regulations remove the additional exemptions for age and blindness and add an additional standard deduction for age or blindness. This proposed change to the regulations reflects the current law.

Sec. 71: Alimony and separate maintenance payments

IRS Letter Ruling 201648001 is in response to a taxpayer's request that certain payments the taxpayer's ex-spouse made to the taxpayer not be considered alimony payments under Sec. 71(b). The payments related to the ex-spouse's being ordered to maintain a life insurance policy in an amount sufficient to cover his maintenance and child support obligations. The letter ruling concluded that the court-ordered spousal maintenance payments met only three of the four requirements to be considered alimony payments under Sec. 71(b)(1). Since the payments did not terminate at the payee spouse's death, the payments were not considered alimony payments. In addition, the payments did not end within six months before or after the date on which the former spouses' child would turn 18 and therefore were assumed not to be child support.

Sec. 83: Property transferred in connection with performance of services

A corporation was denied a deduction for stock given to an employee that it claimed was given as compensation for services rendered. (6) The court of appeals concluded that the stock that the individual subscribed to in an earlier year was an investment and was not issued in connection with his employment. It further concluded that the only circumstances under which the individual would be required to return the stock to the company for less than fair market value (FMV) either did not constitute a substantial risk of forfeiture under Regs. Sec. 1.83-3(c)(2) or were so unlikely as to not constitute a substantial risk. A petition for writ of certiorari for this case was filed with the U.S. Supreme Court on April 4, 2017. (7)

Sec. 104: Compensation for injuries or sickness

IRS Letter Ruling 201643003 was issued in response to a taxpayer's request for guidance on the treatment of disability benefits paid to a police officer after the officer was injured and permanendy disabled while performing official duties. The ruling states that certain benefits paid to the police officer by the locally administered plan were excludable from gross income under Sec. 104(a)(1) as compensation for personal injuries or sickness.

The city for which the police officer worked had a statute that provided for pension and disability benefits to be paid to police and firefighters from the state defined benefit plan. Localities could withdraw from the state pension fund if they maintained a locally financed and administered alternative pension plan. The city for which the police officer worked provided this benefit from a locally administered and financed alternative pension plan.

In Letter Ruling 201706006, the IRS denied a taxpayer an alimony deduction for the amount of lump-sum payments the taxpayer was required to make to a former spouse under a court order.

The letter ruling concluded that the statute, which provides that if a participant of a statewide defined benefit plan becomes totally disabled as a result of injuries incurred while performing official work duties, is in fact a statute in the nature of a workers' compensation act. As such, benefits paid to the taxpayer are excluded from the taxpayer's income under Sec. 104(a)(1).

Sec. 152: Dependent defined

Custodial parent: In Lowe, (8) the Tax Court denied a dependency exemption for the primary custodial parent whose child did not live with her for more than half of the year at issue. The court order awarding primary custody was silent as to the tax treatment for the child. Further, the custodial parent did not have the proper written declaration required under Sec. 152(e), Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent.

Children placed for adoption:

Proposed regulations update the definition of a "dependent" to be consistent with the Fostering Connections to Success and Increasing Adoptions Act of 2008 and the Working Families Tax Relief Act of 2004, which amended Sec. 152 to provide that a child lawfully placed with a taxpayer for adoption can qualify as a dependent. (9) The definition of a dependent now includes an "adopted child" and an "eligible foster child." This proposed regulation also defines an authorized placement agency as an organization authorized by a state, the District of Columbia, a U.S. possession, a foreign country, or an Indian Tribal Government, or by a subdivision of any of those bodies.


* The IRS issued proposed regulations that update the definition of dependent to be consistent with Sec. 152 and reverse the IRS's previous position regarding when a taxpayer is considered childless for earned income tax credit purposes.

* The Tax Court held that the IRS was not required to provide regulations allowing donee reporting as a substitute for the Sec. 170(f)(8) contemporaneous written acknowledgment requirement for charitable contributions, and, because the Service had not issued those regulations, a taxpayer could not take a charitable deduction without a contemporaneous written acknowledgment even though the donee had reported the information for the taxpayer's contribution on a Form 990.

* As in prior years, the Tax Court decided in a number of cases whether taxpayers qualified as real estate professionals for purposes of the passive activity loss rules.

* In two cases, the Tax Court addressed whether, based on the types of activities they performed for an LLC, the LLCs' members should be considered limited partners in the LLCs and their income from them should be excluded from the members' self-employment income.

* The IRS identified a new hardship exemption from the individual shared-responsibility payment under Sec. 5000A.

Definition of AGS: Prop. Regs. Sec. 1.152-2 changes the interpretation in IRS...

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