Recent developments in individual taxation.

• Author: Baldwin, David R.

This article is a semiannual review of recent developments in the area of individual federal taxation. It covers cases, rulings, and guidance on a variety of topics from May through

October 2019. The items are arranged in Code section order.

Sec. 36B: Premium tax credit

Indexing adjustments: In Rev. Proc. 2019-29, the IRS announced the 2020 Affordable Care Act premium credit indexing adjustments. In years prior to 2020 the rate of premium growth was based on per-enrollee spending for employer-sponsored insurance as published by the National Health Expenditure Account.

Starting in 2020 the measure of indexing adjustments is provided by the Department of Health and Human Services (HHS) and is based on increases in individual market premiums in addition to increases in employer-sponsored insurance premiums.

Sec. 61: Gross income defined

Cryptocurrency: In July 2019, (1 ) the IRS announced that it had begun to send letters to taxpayers identified as potentially failing to report income from virtual currency transactions. The IRS estimated that more than 10,000 taxpayers would receive these educational letters (Letter 6173, Letter 6174, or Letter 6174-A). All three versions have the same purpose: to help taxpayers understand their filing obligations as well as how to correct any past errors.

In October 2019, the IRS issued Rev. Rul. 2019-24 to provide guidance on two specific issues:

1. Does a taxpayer have gross income under Sec. 61 as a result of a "hard fork" of a cryptocurrency if units of a new cryptocurrency are not received?

2. Does a taxpayer have gross income under Sec. 61 as a result of an "airdrop" of a new cryptocurrency following a hard fork if new cryptocurrency is received?

   The revenue ruling stresses the ability to exercise dominion and control. If the address to which the cryptocurrency is airdropped is contained within a wallet managed through an exchange that does not support the newly created cryptocurrency, that would not give the taxpayer the ability to exercise dominion and control over the currency and therefore would not result in income.

   The revenue ruling concludes that:

1. A taxpayer does not have gross income under Sec. 61 as a result of a hard fork if the taxpayer does not receive units of a new cryptocurrency.

2. A taxpayer has gross income, ordinary in character, under Sec. 61 as a result of an airdrop following a hard fork if the taxpayer receives units of new cryptocurrency.

   Income and frivolous returns penalties: The Tax Court in Wells (2) assessed married tax protesters a $10,000 frivolous claims penalty for omitting their W-2 wage income, as they were previously warned against making baseless arguments. Although both worked for large corporations, they indicated on their joint 2014 income tax return that they had no income and sought a full refund of all withholding. Along with Forms W-2 received from their employers, they submitted Forms 4852, Substitute for Form W-2, Wage and Tax Statement, indicating zero wages. They attached a statement that made tax protester arguments. The Tax Court granted summary judgment against them and also assessed each a penalty of $5,000.

   Sec. 104: Compensation for injuries or sickness

   In McMillan? the Tax Court held that a taxpayer was not entitied to exclude $70,000 in purported pain-and-suffering damages she received upon settling her lawsuit against her homeowner's association. Sec. 104(a)(2) excludes from gross income damages that are received by suit or agreement "on account of personal physical injuries or physical sickness." The settlement document did not indicate that the money was an award for pain and suffering. In addition, the taxpayer admitted that her sickness could have been the result of stress, which would make it a symptom of emotional distress and mean that the settlement proceeds would still be includible in her income.

   The taxpayer also argued that the $70,000 was not taxable because it was used to pay her attorneys, but when settlement proceeds are income, so too is the portion that goes to attorneys' fees, as held in Banks. (4)

   Sec. 108: Income from discharge of indebtedness Partner's deferred COD income:

   The IRS National Office stated in a Technical Advice Memorandum that deferred cancellation-of-debt (COD) income under Sec. 108(i) is not included in calculating a transferee partner's share of adjusted basis to the partnership of partnership property for purposes of Regs. Sec. 1.743-1(d)(1) because that amount is not "tax gain" within the meaning of Regs. Sec. 1.743-1(d)(1)(iii). (5 ) The IRS reasoned that this income is not taxable gain that would arise upon the disposition of partnership assets within the meaning of Regs. Sec. 1.743-1(d)(1)(iii) because it does not arise as a result of a disposition of partnership assets or property at fair market value (FMV) for cash. The hypothetical transaction described in Regs. Sec. 1.743-1(d)(2) is only concerned with determining the amount of partnership tax gain or loss that would result from the disposition of partnership assets at FMV for cash, for purposes of determining an inside basis adjustment to partnership property. Deferred COD income is not and does not relate to partnership assets or property for purposes of the hypothetical transaction described in Regs. Sec. 1.743-1(d)(2) but is simply an item of deferred income that does not have or attract basis, is not transferrable or marketable, and has no FMV.

   Qualified principal residence debt: The taxpayer in Bui (6) sought to exclude $355,488 of discharged indebtedness from her gross income as qualified principal residence indebtedness. The Tax Court held that she may properly exclude $48,151 but must include the remaining $307,337 in gross income. Although the loans giving rise to COD income were secured by the taxpayer's residence, she was unable to offer adequate proof that, with the limited exception of $5,299, the funds were used to acquire, construct, or substantially improve the property. As a result, the court was unable to conclude that the COD income was excludable from gross income as qualified principal residence indebtedness, except for $5,299. Of the remaining COD income, the IRS and the taxpayer agreed that she was eligible to exclude $42,852 due to insolvency.

   Sec. 115: Income of states, municipalities, etc.

   The IRS concluded in a private letter ruling that a qualified settlement fund trust, set up to resolve claims arising from violations of certain federal and state laws, was exercising an essential governmental function with income accruing to a state or U.S. possession government. Therefore, its income was excludable from gross income under Sec. 115. (7)

   Sec. 121: Exclusion of gain from sale of principal residence

   In a private letter ruling, the IRS found that Sec. 121 applied to the disposition of vacant land on which a fire-destroyed principal residence was once located and that Secs. 121 and 1031 may be applied to the same transfer of property. (8)

   A taxpayer purchased property as a principal residence and, after getting married, the couple used the property as their principal residence. Following their move to a new residence, the taxpayers rented the property to full-time tenants and/or as a short-term rental until the home was destroyed in a fire.

   As a result of the destruction of the dwelling unit, the taxpayers received insurance proceeds in the year of the fire. The taxpayers sold the land on which the dwelling unit was located and acquired a new property.

   Although the taxpayers'sale of land was not a sale of vacant land as described in Regs. Sec. 1.121-l(b)(3), the IRS found that it was reasonable to apply those same requirements to a sale of vacant land on which the dwelling unit was once located. While considering Regs. Sec. 1.121-l(b)(3)(ii)(A), which provides that gain on the sale of the land is then excluded only to the extent of the maximum limitation amount applicable to the taxpayer, minus the gain excluded on the sale of the dwelling unit, the IRS concluded that the gain excluded under Sec. 121 on the sale of the land is the difference between the maximum limitation amount applicable to taxpayers and the gain excluded under Sec. 121 from the sale of the dwelling unit. Finally, citing Rev. Proc. 2005-14, the IRS ruled...