Inequitable administration: documenting family for tax purposes.

• Author: Infanti, Anthony C.
• Position: III. Attribution Rules 5. Documentation Required through Conclusion, with footnotes, p. 401-429

5. Documentation Required

   Only a handful of provisions incorporate the [section] 267 or [section] 318 attribution rules by reference and actually include an identification or documentation requirement. For instance, to obtain the (now expired) first-time homebuyer credit in [section] 36, a taxpayer must file Form 5405, which requires the taxpayer to certify that her home was not purchased from a related person. (223) The taxpayer is also required by statute to attach to her return a copy of the executed settlement statement relating to the purchase as a prerequisite to obtaining the credit. (224) In addition, the installment sale rules of [section] 453 contain antiabuse rules targeted at potentially manipulative sales of property between related persons. (225) A taxpayer reporting gain on the installment method must file Form 6252, which contains a section that specifically addresses related party installment sales. The first line of this section requires the taxpayer to identify the name, address, and taxpayer identification number of the related purchaser of the property. (226) And [section] 1031(f) contains an antiabuse rule that is designed to prevent related persons from engaging in a like-kind exchange in order to shift the basis of properties prior to an anticipated sale. (227) The IRS requires taxpayers to make relatively detailed reports regarding such related party exchanges, including documenting the identity of the related party to the exchange. (228)

   2. Other Attribution Rules

   Though [section][section] 267 and 318 are the most commonly encountered attribution rules in the Code, there are a few provisions with their own unique attribution rules. In this section, I briefly describe these attribution rules and their attendant identification and documentation requirements (if any). I first describe generally applicable attribution rules and then address rules that apply only to married different-sex couples. The identification and documentation requirements in these attribution rules share the same haphazard quality as the family tax provisions discussed in Part II of this Article.

3. General Attribution Rules

   Section 541 imposes a personal holding company tax on the undistributed, generally passive income of corporations. As originally conceived, the personal holding company tax targeted corporations that functioned as incorporated pocketbooks, incorporated talents, or incorporated yachts or country estates to provide their shareholders a means of avoiding taxation at the (then higher) graduated rates that applied to individuals. (229) To be classified as a personal holding company, a corporation must meet both an income test and an ownership test. (230) The ownership test requires that more than 50% of the value of the corporation's stock must be held by five or fewer individuals. (231) For purposes of determining whether this ownership test has been satisfied, [section] 544 requires taxpayers to take into account its own special set of constructive ownership rules. (232) Given the central importance of the ownership requirement to classification as a personal holding company, it should not be surprising that there is a section of the personal holding company tax return that requires the corporation to identify the name and address of each of the shareholders who comprise the requisite five or fewer individuals who own more than 50% of the value of its stock. (233) Interestingly, this same stock ownership requirement is incorporated by reference in the at-risk rules of [section] 465 (including a modified version of the constructive ownership rules), and it there serves the important role of setting the outside parameters of the class of closely held corporations subject to those rules. (234) Yet, there is no requirement that corporate taxpayers document which shareholders cause them to be subject to the at-risk rules. (235) The same is true of the passive activity rules, which indirectly borrow the personal holding company stock ownership requirement by incorporating by reference the definition of closely held corporation from [section] 465. (236)

   Section 1256 contains mark-to-market rules that require taxpayers to annually recognize as gain or loss any unrealized appreciation or depreciation in regulated futures, foreign currency, and certain other contracts. (237) Hedging transactions are, however, excepted from this mark-to-market regime "to ensure that [section] 1256 does not impede valuable functions served by the commodity futures markets" to the agricultural and commercial sectors in reducing the risks associated with the sale of crops and the bulk purchase of items. (238) Nevertheless, to prevent manipulation of the hedging exception by tax shelters, "syndicates" are made ineligible for the exception. (239) For this purpose, a "syndicate" is defined as any entity other than a C corporation if "more than 35 percent of the losses of such entity during the taxable year are allocable to limited partners or limited entrepreneurs." (240) Individuals who actively participate in the business and certain relatives of individuals who actively participate in the business are not classified as limited partners or limited entrepreneurs for this purpose. (241) Though recordkeeping requirements do apply to hedging transactions, these recordkeeping requirements do not include information relating either to an entity's qualification as a "syndicate" or to the application of the rule attributing one person's active participation in the business to certain of her relatives. (242)

   To be eligible to elect treatment as a small business (i.e., "S") corporation, a domestic corporation is not permitted to have more than 100 shareholders. (243) For purposes of this requirement, all members of a family are now treated as a single shareholder. (244) Adding to the generosity of this provision, [section] 1361 has its own, rather broad definition of family. It includes (1) a husband and wife and (2) a common ancestor who is up to six generations removed from the youngest generation of shareholders who would be members of the family along with any lineal descendants (and spouses or former spouses of lineal descendants) of that common ancestor (without any generational limit). (245) When filing an S election, the name and address of each consenting shareholder must be included with the election. (246) If more than 100 shareholders are included on the list, a box must be checked to indicate that application of the family attribution rule of [section] 1361 brings the number of shareholders below the maximum of 100. (247) However, no details are required concerning which shareholders are related to each other, the exact number of shareholders after application of the attribution rules, or how the attribution rules were applied. (248)

   The so-called kiddie tax is essentially another form of attribution rule, as it is designed to prevent parents from assigning unearned income to their minor children in order to get a second (or third or fourth) bite at the lower brackets in the graduated rate schedule. (249) The kiddie tax combats this abuse by effectively attributing the income back to the parent; in other words, the minor child's unearned income is taxed at the parent's marginal tax rate. (250) In fact, in some circumstances, the parent can simply elect to report the minor child's unearned income on her own tax return. (251) If the kiddie tax applies to a minor child's unearned income, the child's parent is required to furnish to the child his/her taxpayer identification number, and the child is required to include that taxpayer identification number on his/ her own return. (252)

   Assignment of income concerns are also the impetus behind [section] 704(e), which deals with family partnerships. Under [section] 704(e)(1), a person will be recognized as a partner in a partnership in which capital is a material income-producing factor, no matter whether that person's partnership interest was acquired by purchase or by gift. If a partnership interest is created by gift, then [section] 704(e)(2) requires that an allocation be made to the donor in an amount equal to reasonable compensation for any services that the donor renders to the partnership. (253) Section 704(e)(2) further requires that the donee's distributive share of partnership income not be proportionately greater than the donor's distributive share with respect to the donor's own contributed capital. (254) For this purpose, a purchase of a partnership interest between family members is recharacterized as a gift, and the fair market value of the purchased interest is treated as donated capital. (255) Nevertheless, neither Form 1065 nor the accompanying instructions make any mention of family partnerships, let alone request any information regarding one family member's acquisition of a partnership interest from another. (256)

4. Spousal Attribution Rules

   There are several attribution rules that apply just to spouses. For example, the first-time homebuyer credit in [section] 36 (discussed above) is available only to taxpayers who are at least eighteen years of age at the time of purchase. (257) If two unmarried individuals purchase a home and only one meets the age requirement at the time of purchase, they may allocate the first-time homebuyer credit only to the individual who meets the age requirement and only she will be permitted to claim any part of the credit. (258) If, however, these same two individuals are married, then one spouse's satisfaction of the age requirement will be attributed to the other spouse, and they both will be permitted to claim the credit. (259)

   In addition, [section] 121 permits a taxpayer to exclude from gross income up to $250,000 of the gain on the sale of a principal residence, provided, however, that the taxpayer meets certain ownership and use requirements and does not claim the exclusion more than once every two years. In the...