Annette Nellen
Top 10 tax developments of 2012

As tax season approaches, a look at important changes practitioners should know about.

January 17, 2013
by Annette Nellen, Esq., CPA

The year-end drama of the fate of 100-plus expired and expiring tax provisions that resulted in a tax act that veered the nation off the “fiscal cliff” to a pothole-laden road of fiscal challenges, earns an obvious No. 1 place on the 2012 Top 10 Tax Developments list. What else should complete the list? This article presents a discussion of the most important developments.

1. The fiscal cliff and year-end tax legislation

While it has been known for years that individual tax rates were set to go up on Jan. 1, 2013, and that many tax cuts would expire, the Senate, House, and Oval Office were unable to reach consensus until the beginning of 2013. This last-minute activity also extended more than 50 items that expired at the end of 2011.

The result is fewer temporary provisions, a higher debt, greater interest expense, and tax practitioners having to learn new rules and planning perspectives. See Joint Committee on Taxation, Estimated Revenue Effects of the Revenue Provisions Contained in an Amendment in the Nature of a Substitute to H.R. 8, The “American Taxpayer Relief Act of 2012,” as Passed by the Senate on January 1, 2013, JCX-1-13.

The American Taxpayer Relief Act of 2012 (P.L. 112-240) makes the lower tax rates permanent for individuals with taxable income under $400,000 ($450,000 for married filing jointly), makes the alternative minimum tax (AMT) patch permanent, and extends many of the continually expiring provisions through 2013 (see Nellen, “Expiring Provisions by the Numbers,” Tax Insider, Sept. 13, 2012). There are many changes, including some that require taxpayer action this January. See AICPA Fiscal Cliff Resources; “Congress Passes Fiscal Cliff Act.”

2. Calls for comprehensive tax reform

Comprehensive tax reform was a focal point for the congressional tax committees as well as for the presidential candidates in 2012. The 112th Congress held more than 40 hearings on various aspects of tax reform, including examining other countries’ tax regimes, determining whether to increase incentives for manufacturing and innovation, and addressing simplification (see Professor Nellen’s website on tax reform hearings of the 112th Congress). In addition, in August 2012, the House passed H.R. 6169, calling for comprehensive tax reform with such elements as a top 25% rate for individuals and corporations and a territorial system, instead of the current worldwide system. The bill, which was not enacted, called for a plan to be introduced by April 30, 2013. (Pathway to Job Creation Through a Simpler, Fairer Tax Code Act of 2012, H.R. 6169 (112th Congress)).

While the key players for tax legislation are all calling for tax reform, there is no consensus on why reform is needed, what it should look like, the desired budgetary effects, and what transitional rules (if any) should be provided. See Nellen, “Pathway to Tax Reform,” Tax Insider, Aug. 9, 2012, and the AICPA Tax Reform website for more information.

3. The Supreme Court weighs in favorably on part of health care act

During the presidential race, a key part of President Barack Obama’s 2010 health care legislation was before the U.S. Supreme Court on the constitutionality of the individual mandate under Sec. 5000A. In a 193-page decision, the Court held that the mandate was a permissible tax. The Court first had to hold though, that the mandate was a penalty. That permitted the case to be heard under the Anti-Injunction Act, which requires a person to pay a tax before challenging it (National Federation of Independent Business v. Sebelius, Sup. Ct. Dkt. No. 11-393 (U.S. 6/28/12)); see “Supreme Court Upholds Health Care Law”).

While the House continued voting to repeal the health care legislation following the Court’s opinion (Repeal of Obamacare Act, H.R. 6079 (112th Congress)), the November 2012 election results leave this act in place. The following resources provide additional guidance on the health care law:

  • IRS website on the Affordable Care Act and list of guidance.
  • AICPA Health Care Reform Resources website.
  • White House health care website.

4. Due-diligence reminders for charitable contributions

Several court decisions affirmed IRS denials of taxpayers’ charitable contributions because they failed to satisfy all of the requirements of Sec. 170 and the regulations. These cases serve as reminders for practitioners to review their firms’ due-diligence standards for charitable contributions and consider reminding clients throughout the year on how to make contributions that will be safe from IRS challenge. Here is a summary of the cases:

  • Durden, T.C. Memo. 2012-140: Deduction for cash donations to church denied for lack of Sec. 170(f)(8) substantiation. First letter from church did not indicate whether the donor received anything of value in return for his donation and the second letter was not contemporaneous.
  • Patel, 138 T.C. No. 23 (2012): A taxpayer gave a fire department the right to conduct training exercises and burn down the house and claimed a deduction of $339,504. No deduction was allowed per Sec. 170(f)(3), which denies deduction for partial interest in land. A license to use is not a donation of property, and the taxpayer did not transfer title to fire department.
  • Mitchell, 138 T.C. No. 16 (2012): Qualified conservation contribution denied due to failure to comply with Regs. Sec 1.170A-14(g)(2) because the deed of trust on the easement was not subordinated to the easement deed. In a case of first impression, the court held that the taxpayer could not avoid meeting the strict requirement of the subordination regulation for the deed of trust by making a showing that the possibility of foreclosure on that deed of trust was so remote as to be negligible under Regs. Sec. 1.170A-14(g)(3).
  • Rothman, T.C. Memo. 2012-163: Deduction for a historic façade easement was disallowed because of an improper valuation method. Substantial compliance was also not available because the appraisal failed to meet a number of other requirements.
  • Dunlap, T.C. Memo. 2012-126: Deduction for façade easement denied because valuation submitted by experts was not credible.
  • Mohamed, T.C. Memo. 2012-152: Taxpayers donated more than $18 million of real estate to charities in 2003 and 2004, but the deductions were denied because the taxpayers did not obtain qualified appraisals as required by the regulations.
  • Cohan, T.C. Memo. 2012-8: Deduction was denied because of insufficient verification letter and appraisal.
  • Kaufman, Nos. 11-2017, 11-2022 (1st Cir. 7/19/12): The court vacated and remanded part of a Tax Court decision because the Tax Court’s interpretation of a regulation under Sec. 170(h) was unduly restrictive.
  • Whitehouse Hotel L.P., 139 T.C. No. 13 (2012): In a 109-page ruling on valuation of qualified conservation contribution and application of penalties for overstatement, the court found the deduction was overstated and upheld the accuracy-related penalty.
  • Minnick, T.C. Memo. 2012-345: Deduction for a conservation easement contribution was denied because the mortgage was not subordinated to the easement.

5. Lengthy and intricate Sec. 1411 proposed regulations

Sec. 1411, enacted in March 2010 as part of the Health Care and Education Reconciliation Act of 2010, P.L. 111-152, imposes a 3.8% Medicare tax on all or a portion of net investment income of upper-income individuals, starting in 2013. Since 2010, practitioners have speculated on exactly how net investment income would be measured as the statute and legislative history are not explicit. On Dec. 5, 2012, the IRS provided insights into this with 159-page proposed regulations (including the preamble) (REG-130507-11).

The regulations are fairly complex and will require new planning perspectives for both investments and passive activities of affected individuals (as well as estates and trusts). Affected taxpayers will be given an opportunity in 2013 or 2014 to regroup their passive activities if desired. Final regulations are expected in 2013. See FAQs from the IRS and “IRS Issues Proposed Regs. on 3.8% Net Investment Income Tax.”

6. Postponement of the lengthy and intricate repair regulations

On Dec. 27, 2011, the IRS released temporary regulations on repairs vs. capitalization that also addressed materials and supplies, depreciation, and more. The regulations were originally effective on Jan. 1, 2012 (T.D. 9564). These regulations, with over 100 examples, were viewed by many, including the AICPA, as complex. See AICPA resource website. Not only were there many new rules, but most businesses and owners of rental property also had to consider whether accounting method changes were needed. See Rev. Procs. 2012-19 and 2012-20 for the rules on accounting method changes.

Because the regulations were effective at the start of 2012, affected taxpayers would need to make any required accounting method changes on their 2012 returns and be sure the regulations were followed on those returns.

In December 2012, the IRS provided relief to this filing season challenge by changing the effective date of the regulations to tax years beginning on or after Jan. 1, 2014, with the option to apply them to tax years beginning on or after Jan. 1, 2012, if desired. See modification to T.D. 9564 and Notice 2012-73. Final regulations with simplifications are expected in 2013. For more discussion of the regulations, see Anderson, “Key Aspects of the New Tangible Property Regulations,” 44 The Tax Adviser 24 (January 2013).

7. Possible FICA tax refunds

In Quality Stores, No. 10-1563 (6th Cir. 9/7/12), the Sixth Circuit ruled that the taxpayer was entitled to a FICA refund of $1,000,125 on payments to “employees upon terminating their employment involuntarily due to business cessation.” The court found these payments to be “supplemental unemployment compensation benefits (SUB payments) that are not taxable as wages under FICA.” This ruling is contrary to CSX Corp., 518 F.3d 1328 (Fed. Cir. 2008) and Rev. Rul. 90-72. In October 2012, the Department of Justice asked the Sixth Circuit for an en banc rehearing, noting that the case was of “exceptional importance” (DOJ petition for en banc rehearing), but the Sixth Circuit denied that petition on Jan. 4, 2013.

Employers who made similar payments might want to consider filing protective claims for a FICA tax refund.

8. Likely elimination of the need for the overused practitioner’s email disclaimer

In September 2012, Treasury issued proposed regulations amending Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10) (REG-138367-06). One major change is to remove the lengthy Section 10.35, Requirements for Covered Opinions. Among many requirements, this section is the one that leads tax practitioners to place a caveat on letters and emails that the contents cannot be relied on to eliminate penalties. Section 10.37 would be modified to strengthen the written advice requirements. See the edited version of Circular 230 showing proposed changes.

When the regulations are finalized, practitioners may find that more appropriate and tailored disclaimers can be placed in letters and emails instead.

9. Apportionment of business income and the relevance of the multistate tax compact

For many years, several states have used apportionment formulas that place extra weight on the sales factor relative to the payroll and property factors. The Multistate Tax Compact calls for equal weighting of the factors. See Federation of Tax Administrators, “State Apportionment of Corporate Income.”

Out-of-state companies (those with payroll and property held mostly outside of a state where sales are sourced) get a better tax result when less weight is placed on the sales factor. Some of these companies filed amended returns in some states applying equal weighting of the factors and arguing that those states were members of the Multistate Tax Compact and were thus not allowed to change the weighting of their apportionment factors.

In 2012, a California court, in the Gillette case, held that California was bound by the compact so Gillette and the other parties to the litigation were allowed to use equal weighted factors (The Gillette Co. v. Franchise Tax Bd., A130803 (Cal. Ct. App. 10/2/12)).

Similar issues have arisen in Oregon, Texas, and Michigan. In a 2012 Michigan ruling, the court held that Michigan was not bound by the compact (International Business Machines Corp. v. Department of Treasury, No. 306618 (Mich. Ct. App. 11/20/12)).

This is a significant issue for states because they will lose revenue if companies successfully challenge use of the Multistate Tax Compact formula to pay a lower tax bill. Contrary results from California and Michigan point out that the issue is not clear. Further litigation is expected in 2013 as well as guidance from the states. Perhaps the U.S. Supreme Court or Congress will step in to clarify the matter.

10. Moving closer to federal action on state sales tax nexus

In 2012, the famous Quill decision reached its 20th anniversary (Quill Corp. v. North Dakota, 504 U.S. 298 (1992)). In that case, the U.S. Supreme Court held that a vendor must have a physical presence in a state to have sales tax nexus. The Court also noted that because this issue involved the Commerce Clause of the U.S. Constitution, and not the Due Process Clause, Congress could provide a different result if desired without raising due process issues.

While catalog sales caused the states concern over sales tax collection in 1992, today, it is e-commerce sales. States argue that they lose about $23 billion in use tax collections and would like to see Congress enact legislation that, in effect, overturns the Quill decision, at least for vendors with sales beyond a to-be-determined de minimis level. (Maciag, “Use Tax Revenues: How Much Are States Not Collecting?,” Governing (May, 1, 2012).)

While legislation has been introduced at least back to 1994 and a few hearings have been held over the years, Congress spent little time on this topic. See Nellen, “After Twenty Years Congress Still Has Not Acted on Sales Tax,” Forbes blog (June 3, 2012).

However, the 112th Congress held two hearings on the topic, and there were three proposals being considered. Nellen, “Affiliate Nexus and State Sales Tax” website (with links to Main Street Fairness legislative proposals).

Although nothing was enacted in 2012, the bills are likely to be reintroduced in 2013 and Congress may finally act to enable states that simplify their sales tax laws to collect from non–de minimis remote vendors.

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Annette Nellen, Esq., CPA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She chaired and is now a member of the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax policy and reform and a blog.