Latest Tax Report

2011 lays groundwork For Tax Reform, Makes Important Changes Impacting 2012

2011 had been predicted to be a quiet year in federal tax news - as it landed between major tax legislation in 2010 and expected tax reform in 2012 - but the year brought many significant tax developments from the Obama Administration, Congress, the Treasury Department, the IRS, and the courts. President Obama signed bills enacting hiring incentives, repealing three percent government withholding, and more. Congress initiated a national conversation on the pros and cons of tax increases, tax reform, and deficit reduction, which will frame tax proposals for 2012 and beyond. The IRS issued a steady stream of much-needed guidance for businesses and individuals, ratcheted up its attention on tax compliance, particularly in the international area, and continued its multi-prong initiative on return preparer oversight. Meanwhile, the Tax Court and other federal courts handed down decisions of their own, impacting rules for many other taxpayers. This Tax Briefing provides a review of the key tax law developments of 2011 and more.

TAX LEGISLATION

Over the course of 2011, it became clear that blockbuster tax legislation would essentially remain in a holding pattern until the 2012 presidential elections. "Must-do" tax laws, such as the extension of the payroll tax cut and other temporary "tax extenders," would be considered, as would "single issue" legislation to cure unpopular provisions such as expanded business payment information reporting, three-percent withholding on government payments to contractors, or patents on tax strategies.

Payroll Tax Cut

At the time this briefing was prepared, Congress was expected to pass - and President Obama was expected to sign - an extension of the 2011 payroll tax cut. The 2010 Tax Relief Act reduced the employee-share of old age, survivors and disability (OASDI) taxes to 4.2 percent (10.4 percent for self-employed individuals) for calendar year 2011. The employer-share of OASDI taxes remained at 6.2 percent for calendar year 2011. Several competing extension bills have been introduced in Congress.

Joint Select Committee on Deficit Reduction

The Budget Control Act of 2011 created a Congressional Joint Select Committee on Deficit Reduction, charged with achieving significant reductions in the federal budget deficit. The Budget Control Act directed the Joint Select Committee to present its proposals, in legislative language, to Congress before November 23. On November 21, the co-chairs of the Joint Select Committee announced that committee members could not reach an agreement on deficit reduction proposals.

Business Information Reporting

President Obama signed the Comprehensive 1099 Taxpayer Protection and Replacement of Exchange Subsidy Overpayments Act of 2011, repealing the expansion of Form 1099 business information reporting scheduled under the Patient Protection and Affordable Care Act (PPACA) to start for payments made on or after January 1, 2012. The PPACA required all businesses, charities and state and local governments to file an information return for all payments aggregating $600 or more in a calendar year to a single provider of goods or services, other than a payee that is a tax-exempt organization. The PPACA also repealed the reporting exception for payments made to corporations. The Comprehensive 1099 Taxpayer Protection Act repealed the PPACA's expanded business information reporting requirement as if it had never been enacted.

Rental Property Expense Reporting

The Comprehensive 1099 Taxpayer Protection Act repealed rental property expense reporting enacted by the Small Business Jobs Act of 2010. The 2010 Small Business Jobs Act would have required qualified landlords to report certain rental property expense payments of $600 or more in conjunction with their rental properties for qualified payments made after December 31, 2010. The Comprehensive 1099 Taxpayer Protection Act repealed rental property expense reporting as if it had never been enacted.

Government Withholding

President Obama signed the 3% Withholding Repeal and Job Creation Act of 2011 to repeal three percent government withholding on payments to contractors. The new law also provides tax credits to employers that hire military veterans, expands the Code Sec. 6331(h)(3) 100-percent continuous levy to federal vendors relating to property, in addition to goods or services, and directs the Treasury Department to study the tax compliance of government contractors.

Veterans Employment Incentives

The 3% Withholding Repeal and Job Creation Act also provides for an expanded Work Opportunity Tax Credit (WOTC) of up to $5,600 for employers that hire veterans who have been looking for employment for more than six months. Employers that hire veterans who have been unemployed for more than four weeks but less than six months are eligible for a tax credit reaching $2,400. Additionally, a tax credit of up to $9,600 is available to employers that hire veterans with service-connected disabilities who have been looking for employment for more than six months. A tax credit of up to $4,800 is available to employers that hire veterans with service-connected disabilities who have been looking for employment for less than six months. These incentives are available to individuals who begin work for the employer after the date of enactment of the new law (November 21, 2011) and sunset after December 31, 2012.

Tax Strategy Patents

In 2011, President Obama signed a comprehensive patent reform bill including a ban on tax strategy patents. The America Invents Act denies a patent for any strategy for reducing, avoiding or deferring tax liability.

Health Care Tax Credit

The health coverage tax credit (HCTC) pays for a percentage of qualified health insurance purchased by an eligible individual. The Trade Adjustment Assistance Extension Act of 2011 (2011 TAA Act) increased the percentage for coverage months beginning after February 12, 2011. Under the 2011 TAA Act, the HCTC is scheduled to expire after 2013.

Health Premium Assistance Credit

To pay for the cost of the 1099 Taxpayer Protection Act, estimated at approximately $25 billion over 10 years, another health care credit was cut back...but not until 2014. Beginning in 2014, taxpayers who purchase qualified health care coverage through an American Health Benefit Exchange are entitled to a refundable income tax credit equal to the health insurance premium assistance credit. The 1099 Taxpayer Protection Act increases the amount of the excess credit that has to be repaid by the taxpayer by providing an increasing cap based on household income.

The 2011 3% Percent Repeal and Job Creation Act went back to the same well for an offset later in the year, revising the definition of modified adjusted gross income for purposes of qualifying for the credit to include a portion of an individual's Social Security benefits excluded from gross income.

Preparer EIC Penalty

Individuals who prepare federal tax returns for compensation must meet due diligence requirements when preparing returns that include a claim for the earned income credit (EIC). The U.S.-Korea Trade Agreement of 2011 increased the penalty for failing to meet the EIC due diligence requirements to $500 (per occurrence) for returns filed after December 31, 2011.

Tax Extenders

At the time this briefing was prepared, a number of temporary tax incentives (known as "tax extenders") were scheduled to expire after December 31, 2011, unless extended by Congress. The expiring extenders include:

• ▪ State and local sales tax deduction

• ▪ Transit benefit parity

• ▪ Higher education tuition deduction

• ▪ Charitable distributions from IRAs

• ▪ Teacher's classroom expense deduction

• ▪ Research tax credit

• ▪ Code Sec. 25C residential energy credit

• ▪ Code Sec. 45L energy efficient home construction credit

• ▪ Biodiesel and renewable diesel incentives

• ▪ Various tax incentives for the District of Columbia

AMT Patch. At the time this briefing was prepared, enhanced AMT exemption amounts (part of the so-called "AMT patch") were scheduled to expire after December 31, 2011. The AMT exemption amounts for 2011 are $48,450 for single individuals and $74,450 for married couples filing a joint return and surviving spouses.

IRS Budget

At the time this briefing was prepared, Congress was expected to approve an omnibus budget bill for the federal government's 2012 fiscal year. It was unclear if the omnibus budget bill would reduce the IRS's budget for FY 2012.

FUTA Surtax

The 0.20 percent Federal Unemployment Tax Act (FUTA) surtax expired after June 30, 2011. The surtax, originally enacted in 1976, had been renewed in subsequent years, most recently in 2009.

DOMESTIC COMPLIANCE MEASURES

Many in Congress view taking steps to increase taxpayer compliance as a relatively straightforward and noncontroversial way to increase tax revenues without raising taxes. Compounded by the economic downturn and the rising national debt, the closure of the tax gap - the difference between what taxpayers owe and what is collected - continued to be a focal point as Congress turns to the IRS for results.

IRS Audits

The IRS audit rate for individual returns filed in fiscal year (FY) 2010 was 1.1 percent, according to statistics released by the agency in 2011 (IR-2011-27). This represented approximately 1.6 million returns out of the approximately 143 million returns filed by individuals. The audit rate for individual returns with positive income of $1 million or more was 8.4 percent for FY 2010. The FY 2010 audit rate for small corporations (corporations with assets below $10 million) was 0.9 percent. The FY 2011 audit rate for large corporations was 16.6 percent.

Fast Track Settlement

The IRS made the Fast Track Settlement (FTS) program available to small businesses and self-employed taxpayers to expedite case resolution in the IRS Small Business and Self-Employed (SB/SE) Division. Under the FTS program, which has met with success in the large business sector, taxpayers can work with IRS Appeals while their cases are still under audit in the SB/SE Division. The IRS, however, limited the FTS SB/SE program to certain locations: Chicago, Houston, St. Paul, Philadelphia, Central New Jersey, and the San Diego/Riverside area of California.

Worker Classification

The IRS announced a new program to enable employers to voluntarily reclassify their workers for federal employment tax purposes (IR-2011-95; Ann. 2011-64). The Voluntary Classification Settlement Program (VCSP) is open to employers that currently treat their workers as independent contractors and want to prospectively reclassify the workers as employees. In exchange for prospective treatment of the workers as employees, the IRS is offering a reduced penalty framework. Employers will not be liable for any interest and penalties on the amount and will not be subject to an employment tax audit with respect to the workers being reclassified.

In other worker classification news, the Tax Court found that an adjunct professor who taught online courses was an employee and not an independent contractor (Schramm, TC Memo. 2011-112, CCH Dec. 58,746(M)). The court found that the university controlled the taxpayer's performance and treated the arrangement as an employer-employee relationship, despite the lack of brick-and-mortar surroundings.

Broker Information Reporting

Starting with securities purchased in 2011, brokers are required to file information returns that not only provide the IRS and customers with details on the sales proceeds from each trade executed during the year but also the customer's adjusted basis in the security and whether any gain or loss is long- or short-term.

The IRS issued proposed regulations in 2011 on information reporting by brokers for transactions related to debt instruments and options (NPRM REG-102988-11). The proposed regulations build on regulations issued in 2010. The types of securities covered by the reporting requirement ("covered securities") include stock in a corporation, notes, bonds, debentures and other evidence of indebtedness, commodities, commodity contracts or derivatives, and any other financial instrument for which the IRS determines reporting adjusted basis is appropriate.

Elaborating on other basis reporting rules, the IRS also clarified in Notice 2011-56 that a dividend reinvestment plan (DRP) does not fail the requirement that at least 10 percent of every dividend on any stock be reinvested in identical stock if it pays cash in lieu of fractional shares when the cost of a share is greater than the dividend amount. Further, in Notice 2011-18, the IRS provided a transition deadline of January 17, 2012 for corporations that must report any organizational action (such as a stock split, merger or acquisition) occurring in 2011 that affects the basis of stock.

Limitations Period/Basis Overstatement

The Supreme Court agreed in late 2011 to resolve a split among the Circuit Courts of Appeal whether an overstatement of basis is an omission of gross income for purposes of the Code Sec. 6501(e) sixyear limitations period (Home Concrete & Supply, LLC, 2011-1 ustc ¶50,207). In 2010, the IRS issued final regulations specifically applying the six-year limitations period, in contrast to the typical three years, to the assessment of tax attributable to partnership items.

Merchant Payment Card Reporting

Code Sec. 6050W imposes information reporting requirements on payments made in settlement of payment card and third-party network transactions. The reporting requirement applies to payments made after December 31, 2011. The IRS finalized Form 1099-K, Merchant Card and Third Party Payments, in 2011, revised the rules for certain payment settlement entities making payments outside the U.S., and modified the rules for certain insurance companies. The IRS also delayed backup withholding for payment card transactions.

Bank Interest Reporting

The IRS issued proposed regulations (NPRM REG-146097-09) to expand information reporting on bank deposit interest paid to nonresident alien individuals who are residents of any foreign country. At the same time, the IRS withdrew regulations proposed in 2002, which had generally required reporting only in limited cases.

Whistleblowers

Congress overhauled the IRS whistleblower rules in 2006. In 2011, the IRS announced several developments related to the reformed whistleblower rules. The IRS issued final regulations on disclosure of return information to whistleblowers (T.D. 9516), and described the sources and withholding of whistleblower awards (PMTA 2010-60, 62, 63; PMTA 2011-01, 02).

Collection Financial Standards

The IRS updated its collection financial standards in 2011. These are used in calculating repayment of delinquent taxes. National standards apply to food, clothing, health care, and certain other expenses. Local standards apply to housing, utilities and certain transportation costs.

Tax Liens

The IRS announced some taxpayer-friendly changes in its lien processes in 2011 (IR-2011-20). Liens will be withdrawn immediately upon a taxpayer's request once full payment of taxes is made. The IRS will also allow lien withdrawals for taxpayers entering into a direct debit installment agreement for payment of back taxes and will withdraw a lien if a taxpayer on a regular installment agreement converts to a direct debit agreement. Liens will be withdrawn after a probationary period demonstrating that direct debit payments will be made, the IRS explained.

FOREIGN COMPLIANCE MEASURES

In enforcing the U.S. system of taxing worldwide income, the IRS has faced the dual challenges of identifying offshore assets or accounts that may generate taxable income and preventing existing rules from being "gamed" to either shelter foreign earnings or repatriate them tax free back into the U.S. In 2011, the IRS aggressively worked both sides of this problem.

2011 Offshore Voluntary Disclosure Initiative

The IRS launched a second offshore voluntary disclosure initiative (OVDI) in 2011. The 2011 OVDI (like a similar program in 2009) rewarded taxpayers with a reduced penalty framework in exchange for full disclosure of unreported offshore accounts. The 2011 OVDI covered the period 2003-2010 and closed in September 2011.

The 2011 OVDI generally required taxpayers to pay a penalty of 25 percent of the amount in the foreign bank account in the year with the highest aggregate account balance covering the 2003 to 2010 time period. Certain taxpayers may have qualified for reduced penalties of 12.5 percent and five percent. The 2011 OVDI had a higher penalty rate than the 2009 program; the IRS did not want to reward taxpayers who delayed coming forward. Participants were also required to pay back-taxes and interest for up to eight years as well as accuracy-related and/or delinquency penalties.

FBAR

The Treasury Department's Financial Crimes Enforcement Network (FinCEN) issued final rules on Form TD-F 90-22.1, Report of Foreign Bank and Financial Accounts (known as the "FBAR") (RIN 1506-AB08). Generally, United States persons are required to file an FBAR if the United States person had a financial interest in or signature authority over at least one financial account located outside of the United States; and the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported. The final rules clarify which foreign accounts must be reported, revised the definition of signature authority and made other changes.

FATCA Reporting

The Foreign Account Tax Compliance Act (FATCA), enacted as part of the Hiring Incentives To Restore Employment Act of 2010, requires certain U.S. taxpayers holding foreign financial assets to report information about those assets on a new form that must be attached to the taxpayer's annual tax return. FATCA also requires foreign financial institutions (FFIs) to report directly to the IRS certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest.

The IRS issued guidance addressing individual reporting of foreign financial assets in late 2011 (TD 9567). The IRS also set forth requirements for certain domestic entities to report foreign financial assets in the same manner as individual taxpayers. Taxpayers will file new Form 8938, Statement of Foreign Financial Assets. The IRS also described the penalties for failing to file Form 8938. However, Form 8938 is not required of individuals who do not have a return filing requirement, the IRS advised.

Foreign Financial Institutions. The IRS announced that it intends to provide for a phased implementation of certain FATCA provisions for foreign financial institutions (FFIs) (IR-2011-76, Notice 2011-53). Generally, the IRS will begin accepting FFI applications no later than January 1, 2013.

Foreign Tax Credit

The IRS issued final regulations on the reduction of foreign tax credit limitations under Code Sec. 904(d) as amended by the American Jobs Creation Act of 2004 (2004 Jobs Act). These regulations continue a strict "baskets" approach, fine-tuning certain recapture and safe harbor rules. The IRS also issued final regulations targeting highly-structured cross-border transactions used by certain taxpayers to artificially generate higher foreign tax credits (T.D. 9535, T.D. 9536).

Triangular Reorganizations

The IRS issued final regulations to prevent use of triangular reorganizations to repatriate earnings (T.D. 9526). The so-called "Killer B" regulations target what the IRS views as an abusive practice by certain entities to repatriate the earnings of a foreign subsidiary tax-free.

HEALTH CARE REFORM

The tax law is an integral component of the new health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act), providing tax incentives to promote certain behavior or directions and tax penalties to discourage others. Developments in 2011 illustrated the key role that the IRS plays in the tax component of health reform.

W-2 Reporting

The IRS expanded interim relief from reporting the cost of employer-provided health insurance coverage on Forms W-2 as required by the Patient Protection and Affordable Care Act (PPACA) for small employers (Notice 2011-28). Small employers are excused from reporting until further guidance is issued.

Small Employer Tax Credit

The IRS reminded small employers about the Code Sec. 45R small employer health insurance tax credit. Small employers may be eligible to claim the credit to offset the costs of providing health insurance to employees. Through 2013, the Code Sec. 45R credit reaches 35 percent (25 percent for tax-exempt employers). For 2014-2015, the Code Sec. 45R credit reaches 50 percent (35 percent for tax-exempt employees).

Branded Prescription Drug Fees

The PPACA imposes an annual fee on manufacturers and importers of certain branded prescription drugs offered for sale in the United States (Code Sec. 9008). In 2011, the IRS created a dispute resolution process for covered entities that disagree with the agency's calculation of their preliminary Code Sec. 9008 fee (Rev. Proc. 2011-24).

Employer Shared Responsibility

The PPACA imposes assessable payments on certain large employers after 2013 that generally fail to offer full-time employees the opportunity to enroll in minimum essential coverage under an employer plan or that offer full-time employees the opportunity to enroll in minimum essential coverage but the coverage is deemed unaffordable (in addition to other requirements). In 2011, the IRS described how it may implement the employer shared responsibility provisions of the PPACA (IR-2011-50, Notice 2011-36). The IRS also requested comments on how an "employer" should be defined, the calculation of the number of full-time employees, and the calculation of an employer's assessable payment and more.

Premium Assistance Tax Credit

The IRS issued proposed regulations on the Code Sec. 36B refundable health insurance premium assistance tax credit under the PPACA (NPRM REG-131491-10). Eligibility for the credit, the IRS explained, would be based on a number of factors, including income and family size. An individual must be enrolled in a qualified plan through an American Health Benefit Exchange.

Plan Benefits Summary

The IRS, along with the U.S. Departments of Health and Human Services (HHS) and Labor (DOL), issued proposed regulations on the PPACA's requirement that summaries of plan benefits be in "plain English" (NPRM REG-140038-10). The agencies developed a template for plans to use.

BUSINESS ENTITIES

Many business tax strategies increasingly rely on advantageous "entity selection" to more effectively recognize income and distribute profits. In 2011, "pass-throughs" and "disregarded entities" continued to predominate choice of entity concerns.

Disregarded Entities

IRS regulations treat disregarded entities as corporations for employment tax purposes. As a result, they cannot qualify for the FICA and FUTA exceptions because the individual owner is no longer considered the employer. In response to concerns from business owners, new temporary, proposed and final regulations apply the family and religious member FICA and FUTA exceptions to disregarded entities (T.D. 9554).

Partnerships

The IRS proposed to remove an existing regulation that exempts de minimis interests in a partnership from being tested for their substantial economic effect (NPRM REG-109564-10). According to the IRS, the change is necessary to prevent improper use of the de minimis rule.

The IRS also issued proposed regulations updating the definition of an interest in a limited partnership as a limited partner for purposes of the Code Sec. 469 passive activity loss (PAL) rules (NPRM REG-109369-10). The proposed regulations would treat an interest in a limited liability company (LLC) as a limited partnership for purposes of the Code Sec. 469 PAL rules.

S Corporations

The Court of Federal Claims held in 2011 that a taxpayer who conducted his business as an individual and through several S corporations created a "unified business enterprise" engaged in a business for profit (Morton, 2011-1 ustc ¶50,346). As a result, one or more of the S corporations could deduct expenses and take depreciation deductions because the taxpayer could impute his business activities and the business activities of one entity to his other entities.

BUSINESS DEDUCTIONS/CREDITS

The economic downturn continued to play a role during 2011 in the area of business deductions and credits, generally—but not always—encouraging the IRS to interpret relevant tax law more liberally than it might otherwise. Inflation-adjusted vehicle caps and mileage rates also helped many businesses owe a little less tax in 2011.

Bonus Depreciation

The 2010 Small Business Jobs Act extended the placed-in-service date for the 50-percent additional first year depreciation deduction to property placed in service before 2011 (before 2012 in the case of certain longer-lived and transportation property). The 2010 Tax Relief Act boosts 50-percent bonus depreciation to 100-percent for qualified investments made after September 8, 2010, and before January 1, 2012. The 2010 Tax Relief Act also makes 50-percent bonus depreciation available for qualified property placed in service after December 31, 2011 and before January 1, 2013. Certain long-lived property and transportation property is eligible for 100-percent expensing if placed in service before January 1, 2013.

In 2011, the IRS issued much-anticipated guidance on bonus depreciation under the 2010 Small Business Jobs Act and the 2010 Tax Relief Act (Rev. Proc. 2011-26). The IRS explained how taxpayers can elect to take 50-percent, rather than 100-percent, bonus depreciation, retroactive application of 50 percent bonus depreciation and more.

Small Business Expensing

Enhanced Code Sec. 179 small business expensing is scheduled to continue through 2012 but at less generous amounts than in 2011. The Code Sec. 179 dollar limit for tax years beginning in 2012 is $139,000 (adjusted for inflation) and the investment limit for tax years beginning in 2012 is $560,000 (adjusted for inflation).

2011 Vehicle Depreciation Limits

The IRS issued limitations on depreciation deductions for owners of passenger automobiles and trucks and vans first placed in service by the taxpayer during calendar year 2011 (Rev. Proc. 2011-21). The maximum depreciation limits under Code Sec. 280F for passenger automobiles first placed in service during the 2011 calendar year are: $11,060 for the first tax year ($3,060 if bonus depreciation is not taken); $4,900 for the second tax year; $2,950 for the third tax year; and $1,775 for each tax year thereafter.

The maximum depreciation limits under Code Sec. 280F for trucks and vans first placed in service during the 2011 calendar year are: $11,260 for the first tax year ($3,260 if bonus depreciation is not taken); $5,200 for the second tax year; $3,150 for the third tax year; and $1,875 for each tax year thereafter.

Mileage Rates

Mid-year adjustment. In 2011, the IRS made a mid-year adjustment to the optional mileage rates to reflect an increase in gasoline prices (IR-2011-69; Ann. 2011-40). The business standard mileage rate increased from 51 cents-per-mile to 55.5 cents-per-mile for business miles driven on or after July 1, 2011 and on or before December 31, 2011. The medical/moving standard mileage rate increased from 19 cents-per-mile to 23.5 cents-per-mile for medical/moving miles driven on or after July 1, 2011 and on or before December 31, 2011.

Business Travel

The IRS issued the simplified per diem rates that taxpayers can use to reimburse employees for expenses incurred for business travel after September 30, 2011. The IRS also abandoned plans to discontinue the "high-low" method for substantiating travel expenses (Notice 2011-82; Rev. Proc. 2011-47).

Employer-Provided Cell Phones

The IRS issued guidance on the treatment of employer-provided cell phones as an excludible fringe benefit. Generally, when an employer provides an employee with a cell phone primarily for noncompensatory business reasons, the business and personal use of the cell phone is nontaxable to the employee. The IRS also announced in a memorandum to examiners a similar administrative approach that applies with respect to arrangements common to small businesses that provide cash allowances and reimbursements for work-related use of personally-owned cell phones.

Real Estate Activities

The IRS released procedures in 2011 to allow qualified real estate professionals to make a late election to aggregate rental real estate interests for applying the passive activity loss rules under Code Sec. 469 (Rev. Proc. 2011-34). The new procedure, the IRS explained, is in lieu of the letter ruling procedure that would otherwise be used to obtain relief for a late election.

Economic Substance Doctrine

The IRS issued updated instructions to examiners on the codified economic substance doctrine (LB&I-4-0711-015). The IRS instructions detailed the various steps examiners must take to determine if the codified economic substance doctrine is applicable to a particular taxpayer.

Compensation

Code Sec. 162(m) generally provides that compensation paid to certain highly-compensated employees by publicly-held corporations is not deductible if it exceeds $1 million; however, there is an exception for certain performance-based compensation. The IRS issued proposed regulations addressing the treatment of performance-based compensation attributable to stock options and stock appreciation rights (NPRM REG-137125-08).

Goodwill

The Ninth Circuit Court of Appeals found that goodwill proceeds from the sale of a dental practice belonged to the personal service corporation (PSC) and were not personal assets, subject to taxation as long-term capital gain (Howard, 2011-2 ustc ¶50,602). The taxpayer had entered into an employment agreement with the PSC that included a non-competition provision. The economic value of the personal relationships he established belonged to the PSC because of the employment agreement and the non-competition provision.

Advance Pricing Agreements

The IRS announced that the agency's Advance Pricing Agreement (APA) program and its Mutual Agreement Program (MAP) will move to the Large Business and International (LB&I) Division to form a new Advance Pricing and Mutual Agreement Program. The IRS predicted that the merged program will reduce the time needed to complete advance pricing agreements and to resolve transfer pricing disputes with treaty partners.

Notional Principal Contracts

The IRS issued final, temporary and proposed regulations intended to broaden the rules allowing nontaxable transfers of notional principal contracts and other derivative contracts (T.D. 9538; NPRM REG-109006-11). The regulations describe when the transfer or assignment of a derivative contract is not a taxable exchange to the nonassigning counterparty.

TAX ACCOUNTING DEVELOPMENTS

Timing considerations and the method under which business income and expenses are recognized can become complicated, often adding costs and uncertainties to what should be otherwise routine tax accounting matters. 2011 saw the IRS develop "safe harbors" and other pro-business timing and reporting rules to help.

Accounting Methods

The IRS updated the procedures to obtain automatic consent for a change in accounting method in Rev. Proc. 2011-14. The IRS added to the list of automatic consent changes in accounting method relating to the deduction of amounts paid or incurred for energy efficient property under Code Sec. 179D. The IRS also provided for automatic consent for changes in accounting method related to California franchise taxes, modified the procedures relating to certain employee compensation bonuses, and clarified certain LIFO provisions.

Employee Bonuses

The IRS revisited employee bonuses in Rev. Rul. 2011-29. The agency determined that an employer, using an accrual method of accounting, can establish "fact of liability" under the first prong of Code Sec. 461's all events test for bonuses payable to a group of employees. The IRS will allow this treatment even though the employer would not know the identity of any specific recipient and the exact amount payable to that recipient until after the end of the tax year.

Gift Cards

In Rev. Proc. 2011-17, the IRS provided a safe harbor method of accounting for accrual method merchants that issue gift cards to customers in exchange for returned merchandise. In Rev. Proc. 2011-18, the IRS allowed merchants to defer recognizing in gross income advance payments received from the sale of gift cards redeemable for goods or services of the taxpayer or a third party.

OID Accruals

The IRS issued a proposed revenue procedure to allow taxpayers to use a simplified method of accounting to allocate original issue discount (OID) on a pool of credit card receivables to an accrual period (Notice 2011-99). The method generally allocates to an accrual period an amount of unaccrued OID that is proportional to the amount of the stated redemption price at maturity of the pool that is paid by card-holders during the period.

Electric Utilities

The IRS issued guidance providing a safe harbor method of accounting for determining whether to deduct or capitalize certain electric transmission and distribution property expenses (Rev. Proc. 2011-43). The guidance also identifies certain expenses that are per se capital expenditures.

Advance Payments

IRS Chief Counsel explained how a taxpayer under examination, wanting to change its method of accounting for advance payments under Rev. Proc. 2011-14 may satisfy the requirement to file a copy of the application with the IRS during certain window periods (CCA 201145013).

INDIVIDUALS/PERSONAL TAX

Given the varied profiles of the 175 million individuals projected to file 2011 tax returns, the potential impact of significant developments for 2011 cover a wide range of issues. However, the most controversial issue raised during 2011 for individual taxpayers - whether to extend all or a part of the Bush-era income tax rates beyond 2012—remained unresolved.

Innocent Spouse Relief

The IRS abandoned its two-year limitations period for requesting Code Sec. 6015(f) equitable innocent spouse relief (IR-2011-80; Notice 2011-70). The IRS successfully defended the two year limitations period in several court cases (Mannella, CA-3, 2011-1 ustc ¶50,159; Lantz, CA-7, 2010-1 ustc ¶50,446). However, the Tax Court found the two-year limitations period was contrary to Congress' intent (Lantz, CCH Dec. 57,784).

Domestic Partners

The IRS described the tax treatment of registered domestic partners in community property states on its website (www.irs.gov). The IRS reviewed the filing status of registered domestic couples, Schedule C filed by registered domestic couples and various tax credits and registered domestic couples.

Disaster Relief

The IRS issued numerous guidance items in response to natural disasters in 2011 The guidance detailed filing and payment relief for victims of devastating storms across the southern United States, victims of Hurricane Irene and Tropical Storm Lee, and many other disasters.

Ponzi Schemes

The IRS modified previously-released guidance on claiming a theft loss from a Ponzi scheme (Rev. Proc. 2009-20). The modified guidance expands the optional safe harbor for claiming a theft loss to include situations in which the lead figure in a Ponzi scheme has died (Rev. Proc. 2011-58).

Tax Scams

The IRS warned taxpayers about various tax scams around the country (IR-2011-73). The IRS advised taxpayers to be alert for offers of "refunds" of Social Security taxes; inflated claims for the earned income credit (EIC), and claims for expired tax credits, among other false claims.

Medical Costs

The Tax Court found that amounts paid for long-term care of an individual with dementia were deductible under Code Sec. 7702B(c) (Estate of Baral, CCH Dec. 58,685). The individual's physician had determined that she needed 24-hour care; therefore the costs of employing two caregivers were qualified long-term care services and deductible.

Conservation easements

The Tax Court ruled in 2011 on a series of cases about charitable contributions of conservation easements (Kaufman, CCH Dec. 58,588; Boltar, CCH Dec. 58,593; Tempel, CCH Dec. 58,594). In Kaufman, the Tax Court found that the façade easement contribution failed to comply with IRS regulations. In Boltar, the Tax Court found that it was within its discretion to reject a valuation prepared by the taxpayer's experts. In Tempel, the Tax Court found that the sale of a state conservation easement generated short term capital gain as opposed to ordinary income.

Contribution Substantiation

IRS Chief Counsel determined that a charitable organization's Form 990 could not substitute as an acknowledgment of a taxpayer' donation (CCA 201120022). The Tax Code imposes various substantiation requirements on donations of money, property and other items to charitable organizations. In this case, the taxpayer failed to obtain a contemporaneous written acknowledgment from the charity for his contribution. Chief Counsel determined that the taxpayer could not satisfy the contemporaneous written acknowledgment requirement by reference to Form 990.

RETIREMENT DEVELOPMENTS

Replenishing depleted retirement savings was a common theme in the retirement planning community in 2011 In 2011, the IRS issued guidance on a variety of retirement savings plans and announced the 2012 cost-of-living limits for qualified plans.

2012 COLA Limits for Qualified Plans

Cost-of-living adjustments (COLAs) for qualified plans for 2012 reflect an uptick in inflation, the IRS announced (IR-2011-103). Among the highlights are (not an exhaustive list):

• ▪ The limits on elective deferrals for employees who participate in 401(k), 403(b), 457 plans and the federal government's Thrift Savings Plan increase from $16,500 for 2011 to $17,000 for 2012.

• ▪ The limitation for Code Sec. 415(c)(1) (1) defined contribution plans increases from $49,000 for 2011 to $50,000 for 2012.

Social Security Wage Base

The Social Security wage base increases from $106,800 for 2011 to $110,100 for 2012, the Social Security Administration (SSA) announced (www.socialsecurity.gov). The SSA also announced that the domestic employee coverage threshold is $1,800 for 2012; earnings below the threshold are not subject to Social Security tax.

Contributions

The Tax Court in 2011 rejected the IRS's attempts to recast a payment of dividends to an IRA as an excess contribution (Ohsman, CCH Dec. 58,617(M)). According to the Tax Court, the IRS failed to challenge the income tax treatment of the dividend distributions and could not rely on the substance over form doctrine to recharacterize the dividend payments.

Actuarial Tables

The IRS finalized regulations on the use of actuarial tables in valuing annuities, interests for life or terms of years, and remainder or reversionary interests. The final regulations reflected the most recent-available census data.

Church Plans

The IRS announced that church organizations applying for a letter ruling regarding the status of the church's retirement plan under Code Sec. 414(e) must give notice to plan participants and other interested persons (Rev. Proc. 2011-44)

Plan Amendments

The IRS issued a sample plan amendment that plan sponsors may adopt to satisfy Code Sec. 436 regarding limitations on the accrual and payment of benefits under certain underfunded single employer defined benefit plans (Notice 2011-96). The IRS also extended the deadline to amend a plan to satisfy Code Sec. 436 and the period during which such an amendment is eligible for relief from the anti-cutback requirements of Code Sec. 411(d)(6).

ESTATE PLANNING

After passing estate tax provisions in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, Congress did not act on any other estate tax proposals in 2011. The IRS issued guidance on the estate tax provisions in the 2010 Tax Relief Act in 2011.

Decedents Dying in 2010

The 2010 Tax Relief Act revived the federal estate tax for 2010 with an exclusion of $5 million and a maximum rate of 35 percent. The 2010 Tax Relief Act also gave estates of decedents dying in calendar year 2010 an election to opt out of the federal estate tax (known as the "Code Sec. 1022 election") and apply a modified carryover basis regime. The IRS developed Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent,” for estates of decedents dying in 2010 to make the Code Sec. 1022 election.

Spousal Portability

The IRS provided guidance for estates electing to transfer the unused federal estate tax exclusion of a deceased spouse to a surviving spouse (a portability election) (IR-2011-97, Notice 2011-82). The 2010 Tax Relief Act provides for portability of the exclusion between spouses for decedents dying after December 31, 2010 and before January 1, 2013.

Protective Estate Tax Claims

The IRS explained how decedents' estates can file protective claims for a refund of estate taxes based on a potential deduction for an unpaid claim or expense (Rev. Proc. 2011-48). The protective claim must describe in detail the claim or expense, the ground on which the refund is claimed and more.

EXEMPT ORGANIZATIONS

In 2011, the IRS took a number of steps to help tax-exempt organizations that may have inadvertently lost their exempt status. The IRS also issued guidance impacting exempt organizations and generally recorded an uptick in audits of exempt organizations of all sizes, from hospitals and foundations to community-based charities.

Reinstatement of Exempt Status

The IRS announced a special program to help organizations whose tax-exempt status was automatically revoked to regain their status. Small tax-exempt organizations must apply for reinstatement of tax-exempt status and pay a reduced user-fee. Generally, the application for reinstatement of tax-exempt status must be made within 15 months of revocation of tax-exempt status.

Gift Tax Examinations

The IRS announced that it would not pursue gift tax examinations of contributions to Code Sec. 501(c)(4) organizations while the agency reviews the need for additional guidance or legislation in this area (IRS website announcement). The IRS also issued instructions to its examiners not to pursue gift tax examinations of contributions to Code Sec. 501(c)(4) organizations.

RETURNS AND RETURN PREPARATION

The IRS continued its concerted push to move more taxpayers to electronic filing. The IRS also implemented more phases of its return preparer oversight initiative in 2011.

Electronic Filing

Specified tax return preparers are subject to new electronic filing requirements (T.D. 9518). Beginning January 1, 2011, specified tax return preparers who reasonably expected to file 100 or more covered returns in calendar year 2011 generally had to file those returns electronically. The threshold for mandatory electronic filing by specified tax return preparers is 11 or more covered returns in calendar year 2012 and subsequent years.

Return Preparer Oversight

The IRS fine-tuned its return preparer oversight initiative in 2011. The IRS unveiled a registered tax return preparer examination (IR-2011-111) and provided more details about continuing education for registered tax return preparers (IR-2011-115). The IRS also began enforcing its new requirement that all return preparers who prepare returns for compensation use a preparer tax identification number (PTIN) (IR-2011-47; Ann. 2011-29). Additionally, the IRS issued final Circular 230 Rules of Practice (T.D. 9527).

Refunds

The Treasury Department launched a pilot program in 2011 to issue federal income tax refunds to individuals on prepaid debit cards. Individuals can make cash withdrawals from the prepaid debit cards at ATMs.

Documents

The IRS issued final regulations under Code Sec. 7502(c) on how to show evidence of delivery of documents to the agency in cases where there is no direct proof of actual delivery. The IRS described when registered or certified mail is prima facie evidence of delivery. The IRS also extended the prima facie evidence of delivery rule under Code Sec.7502(c) to services provided by a designated private delivery service.

Schedule UTP

In 2011, the IRS clarified its "policy of restraint" in connection with Schedule UTP, Uncertain Tax Positions. Under the IRS policy of restraint, if a document is otherwise privileged under the attorney-client privilege, the Code Sec. 7525 tax advice privilege, or the work product doctrine, and the document was provided to an independent auditor as part of an audit of the taxpayer's financial statements, the IRS will not assert during an examination that privilege has been waived by such disclosure. In 2011, the IRS indicated that the policy of restraint with respect to Schedule UTP would apply to documents requested by Appeals.

Schedule M-3

The IRS clarified the reporting of research and development expenditures on Schedule M-3, Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More. The IRS made the clarification in a frequently asked question (FAQ) on its website.

Filing Deadlines

The IRS finalized regulations providing an automatic five-month extension to file most partnership, estate and trust returns (T.D. 9531). The IRS explained that the five-month period, in contrast to alternative proposals, reduces the overall burden and strikes the most reasonable balance for taxpayers.

Code Sec. 6707A Penalties

The IRS issued final regulations on the Code Sec. 6707A reportable transaction penalty (T.D. 9550). The final regulations reflect modifications to the Code Sec. 6707A penalty made by the Small Business Jobs Act of 2010. The IRS also identified various factors it will take into account when considering whether to rescind a Code Sec. 6707A penalty.

Online Tools

The IRS launched a new app (IRS2Go) in 2011 for smartphones allowing users to check the status of their refunds. The IRS app also provides tax tips and access to IRS news. The IRS also posted on its website a new tool to enable taxpayers to obtain tax transcripts.

IRS Buyouts

The IRS announced in November 2011 that it offered buyouts and early outs to approximately 5,400 employees. The IRS reported that employees who accept the buyouts (Voluntary Separation Incentive Payments) and early outs (Voluntary Early Retirement) would go off the agency's payroll by December 31, 2011.

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