Recent developments in individual taxation.

• Author: Baldwin, David

PREVIEW

* As discussed in this article, the courts issued opinions and the IRS issued guidance on various subjects that are of importance to tax practitioners.

* The IRS clarified its position on the effect of a grouping election on the determination of whether a taxpayer qualifies as a rental real estate professional.

* In a revenue procedure, the IRS simplified the reporting rules for U.S. citizens or residents that have interests in Canadian retirement plans.

This article covers recent developments affecting taxation of individuals, including regulations, cases, and IRS guidance. The items are arranged in Code section order.

Sec. 1: Tax Imposed

No major changes have been made to the tax brackets per se. Tax brackets are indexed for inflation, but self-employment tax, alternative minimum tax (Sec. 55), and net investment income tax (Sec. 1411) are not inflation-adjusted. The inflation-adjustment changes are coded into commercial software packages.

Those whose marital status has changed as a result of the Supreme Court's decision (1) striking down one section of the Defense of Marriage Act (2) may be subject to a different tax table (i.e., married filing jointly or separately), but that was true last year as well. Many same-sex couples who were already married when the Supreme Court issued its decision may still need to file amended tax returns or protective claims for amended tax returns before the statute of limitation expires. All of these amended returns could greatly increase the workload this tax season.

Sec. 31: Taxes Withheld on Wages

Taxes withheld on wages are treated as having been evenly withheld throughout the year, as opposed to withheld in the quarter in which they were actually deducted from a taxpayer's paycheck. Therefore, an underwithheld taxpayer can lessen or eliminate the penalty for underpayment/underestimation by withholding substantially more at the end of the year.

For households with self-employed taxpayers who make quarterly tax payments, underpayments of estimated quarterly taxes may be offset with overpayments of withholding, regardless of whether most of the withholding occurred at the end of the year. As an added tip, while some taxpayers are required to make quarterly estimated payments, many of those taxpayers may find it easier to break up those payments into smaller monthly estimated tax payments rather than have to come up with large amounts of cash every quarter. (3)

Sec. 32: Earned Income

In a Tax Court case, a noncustodial father was not entitled to claim a minor child for purposes of the earned income tax credit (EITC), even though a pre-July 2,2008, final divorce judgment awarded him the dependency exemption. (4) The EITC is awarded to the parent the child has spent more than one-half of the tax year with, if that abode is located in the United States. Thus, noncustodial parents generally have difficulty claiming their dependent as a qualifying child for EITC purposes. (5)

Sec. 36: First-Time Homebuyer Credit

In Oxford, (6) the taxpayer sold her residence in October 2004 when she lost her job and moved in with her daughter in Kansas. After finding employment in California, in 2007, she bought a recreational vehicle (RV) that she lived in when she was not traveling. The RV was not stationary and was parked in an RV village that required owners to move their vehicles every six months. In March 2009, she had a house built, which she moved into in November 2009. She claimed a first-time homebuyer credit on her 2009 tax return, which the IRS disallowed, claiming that the RV was a home and therefore she had owned a principal residence during the three-year period required to qualify for the credit.

The Tax Court noted that the term "principal residence" has the same meaning for the first-time homebuyer credit as it does for Sec. 121. Regs. Sec. 1.121-1(b)(2) provides that the taxpayer's principal residence is the property the taxpayer uses during most of the year. However, a principal residence does not include personal property that is not a fixture under local law. Applying California law, the Tax Court determined that the taxpayer's RV was personal property, not a principal residence. Therefore, the taxpayer qualified for the credit.

Sec. 36B: Refundable Credit for Coverage Under a Qualified Health Plan

In Oklahoma v. Burwell, (7) a federal district court judge agreed that tax credits for coverage under a qualified health plan are available only in states where the states have established insurance exchanges. Under the Patient Protection and Affordable Care Act (PPACA), (8) Sec. 36B provides a premium tax credit to low- and moderate-income individuals and families who obtain health coverage required under PPACA through insurance exchanges. The question in this case was whether the provision authorizing the Sec. 36B tax credit applies to individuals who are covered through an exchange the federal government established.

The district court considered two recent appeals court cases, Halhig v. Burwell (9) (D.C. Cir.) and King v. Burwell (10) (4th Cir.), that reached different conclusions on this issue. In Halbig, the court concluded that the premium tax credit is available only to taxpayers who buy insurance on state-established exchanges. In King, the court concluded that the premium tax credit is available to taxpayers who buy insurance on either state-established or federally facilitated exchanges. The district court in Oklahoma sided with Halbig and agreed tax credits apply for taxpayers only in states where states have established exchanges. (11) Also, on Nov. 7,2014, the Supreme Court agreed to hear King. (12)

Sec. 61: Gross Income Defined

The Tax Court found that salary a Junior Reserve Officer Training Corps instructor received was not excludable from gross income as a nontaxable military allowance since the taxpayer was not on active duty at the time he received the compensation and it was paid to him by a school district. (13) Therefore, the compensation was not considered a nontaxable military allowance for subsistence and housing because, to be a nontaxable military allowance, the taxpayer must be on active duty, or if not on active duty, be participating in full-time training, training duty with pay, or other full-time duty, and the payments must be paid to the taxpayer by the federal government.

The Tax Court concluded that a stipend a taxpayer received under a fellowship grant was taxable because he did not prove that he used the funds to pay his education expenses. (14) The Tax Court further found that other funds the taxpayer received for performing research were subject to self-employment tax because he received them for performing research and he was engaged in the trade or business of medical research.

Sec. 71: Alimony and Separate Maintenance Payments

The Tax Court disallowed an alimony deduction for spousal maintenance payments that were scheduled to end when the youngest child graduated from high school. (15) The court found that the payments were child support payments since they were linked to a "child-related contingency." The parties' intent that these payments were deductible alimony, written in their separation agreement, could not overrule Sec. 71(c)(2), which treats payments that are reduced upon a child-related contingency, including leaving school, as child support payments.

In another case, the Tax Court found that a lump-sum payment a divorced taxpayer made to his ex-wife constituted a nondeductible property settlement, not deductible alimony. (16) The taxpayer's argument that the payment was part of a spousal support obligation was contradicted by the separation agreement's requiring the taxpayer to make a lump-sum payment as a property settlement.

Sec. 72: Annuities; Certain Proceeds of Endowment and Life Insurance Contracts

In Robertson, (17) the Tax Court upheld the imposition of the Sec. 72(t) 10% additional tax on an early distribution from a retirement plan. Although the taxpayer claimed that he filed a tax return for the year and had paid the other tax due on his wage income at that time, he was unable to prove he filed the return and was unable to show that he did not receive the distribution or that he was exempt from the penalty.

In Matthews, (18) the taxpayer, who had lost his job, requested a distribution from his 401(k) plan. At the time, he had an outstanding loan from the plan. The distribution he requested was reduced to repay the outstanding loan, and the balance was transferred to the taxpayer. The Tax Court concluded that the loan offset and the plan distribution were both subject to the additional 10% tax on early distributions and that, unfortunately, there was no exception for hardship.

In another case, the taxpayer withdrew money from his IRA to purchase real property, arguing that the purchase was made on the IRA's behalf. (19) The Tax Court upheld the IRS's determination that this was a taxable distribution that was also subject to the 10% additional tax on early withdrawal. The Tax Court reasoned that the financial institution maintaining the IRA did not permit investments in real property and thus the taxpayer did not act as the IRA's agent and the IRA did not purchase the property.

In Letter Ruling 201424014, the IRS found periodic payments received under a new annuity option are amounts received as annuities under Sec. 72(b)(1) only to the extent they don't exceed an amount computed by dividing the investment in the contract, as adjusted for any refund feature, by the number of payments anticipated during the time they are to be made.

In Letter Ruling 201434030, the IRS found that a division of an IRA account in a divorce was not a taxable transfer. In addition, since the transfer was not a distribution and the interest transferred was treated as the former spouse's account, it did not modify the substantially equal periodic payments or trigger tax under Sec. 72(t)(4).

The IRS has issued final...