Federal tax update

Regulations

Final Regulations Under Sections 1, 741 and 1223 dealing with holding periods of interests in flowthrough entities require that a pro rata portion of gain be taxed at 28 percent when the entity holds collectibles and mandate a divided holding period in a partnership when there has been a net capital contribution in the preceding year.

Proposed Regulations Under Section 121 allow the principal residence exclusion to be claimed by a bankruptcy estate and allow $500,000 to be utilized by a surviving spouse in the year of sale.

Proposed Regulations Under Code Section 401 would prescribe significant restrictions on the use of comparability profit-sharing plans through years beginning after December 31, 2001.

Proposed Regulations Under Code Section 6075 would, if finalized, make automatic a six-month extension of time for filing an estate or generation-skipping tax return.

Cases

In Sidell v. Commissioner, 225 F.3d 103, the First Circuit Court of Appeals, agreeing with the Fifth Circuit, affirmed a Tax Court decision upholding the regulation recharacterizing income from self-rented property as non-passive.

In King v. Commissioner, 115 TC No. 8, the Tax Court elaborated on its early 2000 decision in Corson v. Commissioner, indicating that the Commissioner must serve notice of an innocent spouse claim docketed in Tax Court on the other individual who shall have the opportunity to intervene in the litigation.

In LabelGraphics, Inc. v. Commissioner, 221 F.3d 1091, the Ninth Circuit agreed with the Tax Court that only $406,000 of $879,000 deducted as "compensation" to a sole shareholder was reasonable; the Court looked at the five prongs of the employee's role, a comparison with similar companies, the condition of the company, potential conflicts of interest and evidence of a company's internal inconsistency.

In Folios v. Commissioner, 224 F.3d 16, the First Circuit Court of Appeals agreed with the Tax Court that an individual engaging in horse racing and breeding for 27 years, all unprofitable, and with a cumulative $6.65 million in net losses was engaged in a hobby; the Court rejected the taxpayer's contention that the cumulative losses were "isolated, nonrecurring" and "marginally relevant."

Revenue Rulings, Procedures and Notices

In Revenue Procedure 2000-37, the Internal Revenue Service approved reverse Starker exchanges under certain circumstances where: an accommodation party acquires legal title and holds other indicia of ownership to the intended replacement property; the property to be given up is identified within 45 days and the taxpayer receives the property within 180 days after the transfer to the accommodation title holder; and a qualifying written agreement is entered into within five days after transfer to the accommodation title holder.

Letter Rulings

In Letter Ruling 200033048, IRS determined that the owner of an IRA can restart taking substantially equal periodic payments without incurring the 10 percent early distribution penalty even though an earlier distribution was penalized because one of the payments was not substantially equal.

In Letter Ruling 200041022, IRS determined that "physical injuries" for purpose of the exclusion of damages requires observable bodily harm such as bruises or cuts; where a damage award was for sex discrimination, battery and intentional infliction of emotional distress, the portion of the settlement covering the time period from the commencement of physical injuries was determined to be excludable.

by

David S. De Jong

Stein Sperling Bennett De Jong et al

Rockville, MD

Copyright American Association of Attorney-Certified Public Accountants 2000
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