THE ELITE QUARTERLY – Taxation Published by CPElite,T.M. Inc.

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We hope you have a Happy Holiday season and a happy, healthy, and productive 2017. Thank you for yourbusiness. This is our final newsletter for 2016. There were four quarterly newsletters and two hours of ethicsfor 2016. If you did not receive all of our 2016 newsletters, you may download them from our website. Weare taking subscriptions now for our 2017 newsletter options and course special offer. Under our “2017 EAPackage” option (Option 2 on the order form on page 22 of this newsletter), you ensure that you get the 24hours of CPE credit each year that you need to meet your 72-hour three-year requirement. And, the cost isonly $5.83 per hour if you order now. Our “Special Offer” for our courses saves you $65. See page 23 fordetails. You save on all of our packages by ordering by February 15, 2017.

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What’s Inside This IssueNew identity theft scam goes after tax professionals 2

LLC member is subject to self-employment tax on LLC income 3

SSA announces 2017 thresholds 3

IRS issues 2016-2017 per diem rates 3

IRS provides self-certification for certain failed IRA rollovers 4

Power of attorney not a reason to avoid late filing penalty 4

New installment payment fees proposed and PTIN fee reduced 5

IRS reports ITIN changes and procedures 5

Taxpayer gets hit with excess IRA contribution excise tax 6

Qualified plan loan balance is taxable distribution 7

IRS permits estate Ponzi Scheme theft loss deduction 8

Income not recognized until development substantially completed 8

Forfeited deposit on cancelled contract ruled ordinary income 9

Taxpayer fails extraordinary services exception: activity is passive 9

Shareholders not permitted to use corporation’s losses 10

Special estate tax liens have priority over administrative expenses 11

Tax Court clarifies whistleblower award calculation 12

IRS has audit shortcomings for Roth conversions 14

TIGTA reports IRS audit examination trends 15

An Elite Possibility – Qualifying a rental activity as nonpassive 16

Index 18

Quiz Questions 18

Answer Sheet 21

Order Blank and CPE Information 22

INSTRUCTIONS – Read the content on pages1-17, the quiz questions on pages 18-20, and thequiz instructions on page 21. Select the bestanswer for each quiz question and record theanswers either on the answer sheet on page 21 oron-line at www.cpelite.com.

COURSE COMPONENTS, CONTENT LEVEL,AND LEARNING OBJECTIVES – The componentsof this newsletter are divided among IRS andrelated rulings, court decisions, T reasury-related

items, and An Elite Possibility. Specifically, IRS andrelated rulings are followed by court decisions,Treasury-related items, and this issue’s ElitePossibility dealing with rental properties owned byreal estate professionals under the passive activityloss rules. The content level of the newsletter is anupdate of these items. For the IRS and Treasury-related items, the learning objectives are: (1)Identify the facts and circumstances involving arecent identity theft scam attacking taxprofessionals; (2) Determine if an LLP member’sincome from his LLP is subject to self-employmenttax; (3) Know various Social Security amounts for2017; (4) Know various rates for the high-lowmethod of substantiating expenses for travel awayfrom home for 2016-2017; (5) Identify whichreasons qualify for self-certification to the hardshipexception to IRA rollover rules; (6) Know whetherthe granting of a Power of Attorney to a person toprepare a taxpayer’s tax return allows the taxpayerto avoid late-filing penalties; (7) Know the new PTINfee and user fees for installment paymentagreements; (8) Know recent changes andprocedures for Individual Taxpayer IdentificationNumbers; (9) Know recent TIGTA audit results ofIRS review of returns of taxpayers who do Rothconversions; and, (10) Recognize the current IRSefforts in investigating taxpayer compliance. Foreach court ruling, the learning objectives are: (1)Differentiate the taxpayer’s argument from the IRS’sposition; (2) Identify the factors used in the court’sdecision; and, (3) Recognize the decision reachedby the court. The learning objective for the ElitePossibility is be able to determine whethertaxpayers qualify for the real estate professionalexception to the passive activity and can deducttheir current rental losses. There are noprerequisites or additional materials needed nor isadvance preparation required for our newsletters.

Key Terms in This Issue of THE ELITE QUARTERLY

[Item 5] Self-certification: An IRS procedure which allows taxpayers to

make a written certification to a plan administrator or an IRA trustee that

a contribution satisfies the conditions for the hardship exception for late

IRA rollovers.

[Item 5] Hardship exception: Certain reasons which allow late IRA

rollovers to be made, thereby avoiding the recognition of income and

possible premature distribution penalty from an IRA distribution.

[Item 6] Power of attorney (POA): A written authorization to represent or

act on another's behalf in private affairs, business, or other legal matter.

[Item 8] ITIN (Individual Taxpayer Identification Number): IRS-assigned

numbers used by people who have tax filing or payment obligations

under U.S. law but who are not eligible for a Social Security Number.

[Item 9] Excise tax: The tax amounts to a penalty for excess contributions

to IRAs, Archer MSAs, Coverdell education savings accounts, health

savings accounts; and, ABLE accounts.

[Item 9] Excess IRA contribution: The difference between the actual

contribution made to an IRA and the allowed contribution. The excess

is subject to a 6% excise tax.

[Item 10] Substantially Level Amortization: With respect to loans from

qualified retirement plans, a requirement that loan repayments of

principal and interest be made in substantially level amounts over the

term of the loan.

[Item 12] Completed contract method: A method of accounting for certain

construction contracts where income is not recognized from the contract

until the construction is substantially complete (generally 95% or greater

or acceptance by the buyer).

[Item 13] Section 1234A: An uncommonly used provision in the Code

which allows forfeited deposits on certain terminated sales contracts to

be treated as capital gain income.

[Item 14] Extraordinary personal services: One of six exceptions in the

passive activity loss rules where a rental activity is not per se treated as

a rental activity if the taxpayer provides extraordinary personal services

in connection with making the property available for use by customers.

[Item 14] Passive activity: A trade or business activity in which the

taxpayer does not materially participate, or a rental activity.

[Item 16] “The first in time is the first in right”: A common-law principle

that governs priority of liens on property.

[Item 16] Section 6324A property lien: A special estate tax lien on

property that does not exclude amounts related to the estate’s

administrative expenses from the lien.

[Item 17] Collected proceeds: The qualified amount for calculating

whistleblower awards under Section 7632.

[Item 18] Roth conversion: Under a 2010 tax law change, a provision

permitting taxpayers to convert assets maintained in a traditional IRA into

a Roth IRA by paying all taxes due on converted assets.

[Item 18] Automated Underreporter Program: An IRS program that

matches the amounts reported by IRA trustees on Forms 1099-R to

amounts that taxpayers report on Lines 15a and 15b (IRA distributions)

and Lines 16a and 16b (pensions and annuities) of Form 1040 to identify

retirement income discrepancies.

[Item 20] Real estate professional rule: An exception to the passive

activity loss provisions which allows certain taxpayers engaged in real

estate to treat their rental activities as nonrental.

[Item 20] Material participation: A level of participation required to treat

a nonrental activity as a nonpassive activity.

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[ITEM 1] IRS REPORTS ON NEW SCAMATTACKING TAX PROFESSIONALS

In News Release 2016-103 [8/11/16], the IRSwarned tax professionals of an emerging phishingscam that goes after the tax data of taxprofessionals. The email scheme requests therecipient to download and install an importantsoftware update via a link included in the email. Considering that over the next few months, taxsoftware providers will be sending tax professionalsupdated tax software for the upcoming 2017 filingseason, tax professionals need to be extra carefulto assure they are not falling for this scam. Oncerecipients click on the embedded link, they aredirected to a website prompting them to downloada file appearing to be an update of their softwarepackage. The file has a naming convention thatuses the actual name of their software followed byan ".exe extension." Upon completion, taxprofessionals believe they have downloaded asoftware update when in fact they have loaded aprogram designed to track the tax professional's keystrokes, which is a common tactic used by cyberthieves to steal login information, passwords andother sensitive data. At the date of the newsrelease, the IRS only knew of a few cases wheretax professionals were victimized by this scam. However, in News Release 2016-119 [9/2/16], theIRS reports that it is aware of another two dozencases where this scam was successful in gainingaccess to sensitive information. The IRS urges alltax preparers to take the following steps: (1) run asecurity "deep scan" to search for viruses andmalware; (2) strengthen passwords for bothcomputer access and software access; (3) makesure their password is a minimum of eight digitswith a mix of numbers, letters, and specialcharacters, and change them often; (4) be alert forphishing scams: do not click on links or openattachments from unknown senders; (5) educate allstaff members about the dangers of phishing scamsin the form of emails, texts and calls; and, (6) reviewany software that a tax professional's employees orIT support vendors use to remotely access theprofessional's network, and review IT supportvendor uses to remotely troubleshoot technicalproblems and support the tax professional'ssystems. The IRS notes that remote accesssoftware is a potential target for bad actors to gainentry and take control of a machine. The IRS also

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noted that tax professionals should reviewPublication 4557, "Safeguarding Taxpayer Data, aGuide for Your Business," which provides achecklist to help safeguard taxpayer informationand enhance office security. For taxpayers thatbecome victims of this or similar scams, the IRSprovides several recommendations at its website.

[ITEM 2] CHIEF COUNSEL RULES LLC MEMBERIS SUBJECT TO SELF-EMPLOYMENT TAX ONHIS LLC INCOME SHARE

In Chief Counsel Advice Memorandum 201640014,the issue is whether a franchisee, the operatingmanager, president, and CEO of a partnershipwhich operates restaurants is a “limited partner”exempt from the self-employment tax on hisdistributive share of the partnership’s income. Thetaxpayer / franchisee bought franchise restaurantsand contributed them to an LLC treated as apartnership for federal income tax purposes. TheLLC’s gross receipts and net ordinary businessincome are almost entirely attributable to foodsales. The taxpayer owns the majority of the LLC. He is the only owner involved with the LLC’sbusiness operations. The franchise agreementsrequire him to personally devote full time and bestefforts work on the operation of the restaurants. The LLC’s operating agreement provides that thetaxpayer is the LLC’s operating manager, president,and CEO, and conducts the franchise’s day-to-daybusiness affairs. He has authority to manage theLLC, make all decisions, direct its operations, andhold regular meetings. He also has numerous otherresponsibilities that make him intimately involvedwith the LLC’s operations and success or failure,including hiring, firing, and overseeing all of theLLC’s employees. The LLC makes guaranteedpayments to the taxpayer. The LLC treats thetaxpayer as a limited partner for purposes of theSection 1402(a)(13) self-employment tax provision,and includes only the guaranteed payments in hisnet earnings from self-employment, but not his fulldistributive share of the LLC’s income. The LLC’sposition is that the taxpayer’s LLC income should bedivided for self-employment purposes into twoparts: (1) income attributable to capital invested orthe efforts of others, not subject to self-employmenttax, and (2) compensation for services rendered,subject to self-employment tax. The LLC assertsthat the guaranteed payments represent reasonablecompensation for his services. It asserts thatamounts he earns beyond his guaranteed paymentsare earnings basically of an investment nature. TheLLC further asserts that the investment returnstems from his capital outlays to acquire andmaintain the restaurants, and the services of theLLC’s employees in preparing and selling therestaurant’s food products. Chief Counsel (CC)concludes the franchisee is not treated as a limited

partner in a partnership, and is subject to self-employment tax on his full distributive share of thepartnership’s income. CC relies heavily on twocourt decisions. CC notes the Tax Court’sdiscussion of the ordinary meaning of the term“limited partnership.” The court stated that a limitedpartnership has two fundamental classes ofpartners, general and limited. General partnerstypically have management power and unlimitedpersonal liability. On the other hand, limitedpartners lack management powers but enjoyimmunity from liability for partnership debts. Theinterest of a limited partner in a limited partnershipgenerally is akin to that of a passive investor. CCdetermined that the taxpayer was not a limitedpartner. CC states that income from a foodservices business is part of a partner’s distributiveshare, and thus is included in calculating netearnings from self-employment, unless an exclusionapplies. It noted that the exclusion provision ofSection 1402(a)(13) that excludes the distributiveshare of a limited partner’s partnership income, butnot guaranteed payments made to the partner, wasintended to apply to those who “merely invested,”rather than those who “actively participated” and”performed services for a partnership in theircapacity as partners,” that is acted in the manner ofself-employed persons. CC concluded that thefranchisee did not act as one who merely investedin the LLC. He was subject to self-employment taxon his full distributive share of the LLC’s food salesincome. Planning Pointer: Taxpayers who wish toavoid self-employment tax on their share of anLLC’s income should consider either treating theLLC as an S Corporation or incorporating thebusiness as an S Corporation. Assuming thetaxpayer is adequately compensated for hisservices, the taxpayer’s share of S Corporationincome is not subject to the self-employment tax.

[ITEM 3] SOCIAL SECURITY ADMINISTRATIONANNOUNCES 2017 THRESHOLDS

The Social Security Administration announces at itswebsite (ssa.gov) three threshold amounts for 2017. It announces that the maximum taxable earnings forSocial Security purposes for 2017 will increase by$8,700 from $118,500 in 2016 to $127,200 in 2017. On the other hand, the SSA announces that thedomestic employee coverage threshold will remainfor 2017 at the same $2,000 amount it was for2016. The coverage threshold for election officialsand election workers increases by $100 from$1,700 in 2016 to $1,800 in 2017.

[ITEM 4] IRS ISSUES CURRENT RATES FORHIGH-LOW METHOD

In Notice 2016-58 [9/27/16], the IRS provides the2016 - 2017 per diem rates for taxpayers to use in

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substantiating the amount of ordinary andnecessary business expenses incurred whiletraveling away from home. These rates apply totravel on or after October 1, 2016. Under the high-low method, the per diem rates are $282 (up $7from 2015 - 2016) for travel to any "high-cost"locality, and $189 (up $4) for travel to any otherlocality within the continental United States (perdiem substantiation method). The amount of the$282 ($189) per diem that is treated as paid formeals for purposes of Section 274(n) is $68(unchanged) for travel to any high-cost locality, and$57 (unchanged) for travel to any other localitywithin the continental United States (CONUS). A"high-cost" locality is one with a federal per diemrate of $236 (up $6) or more. The specialtransportation industry M&IE rate is $63 per day forany locality within the CONUS. The rate for anylocality of travel outside the continental UnitedStates (OCONUS) is $68 (unchanged). The rate forany CONUS or OCONUS locality of travel for theincidental expenses only deduction is $5(unchanged) per day. Incidental expenses includeonly fees and tips given to porters, baggagecarriers, hotel staff, and staff on ships. Transportation between places of lodging orbusiness and places where meals are taken, andthe mailing costs of filing travel vouchers andpaying employer-sponsored charge card billings,are not included in incidental expenses. Compliance Pointer: As transportation and mailingexpenses are not included in incidental expenses,taxpayers who use per diem rates may separatelydeduct or be reimbursed for those expenses. IRS:For more on per diem and car allowances, see IRSPublication 463.

[ITEM 5] IRS PROVIDES SELF-CERTIFICATIONTO THE HARDSHIP EXCEPTION APPLICABLETO THE 60-DAY ROLLOVER RULES

Any amount distributed from a qualified retirementplan or IRA will be excluded from income if it istransferred to an eligible retirement plan no laterthan the 60th day following the day of receipt. Afterthat time, the distribution generally must be includedin the taxpayer’s gross income unless it meets theso-called hardship exception. A taxpayer meets ahardship exception in cases where the failure towaive the 60-day requirement would be againstequity or good conscience, including casualty,disaster, or other events beyond the reasonablecontrol of the individual subject to the requirement. In Revenue Procedure 2016-37 [8/24/16], the IRSprovides for a self-certification procedure wheretaxpayers may make a written certification to a planadministrator or an IRA trustee that a contributionsatisfies the conditions for self-certification providedin the procedure. Several reasons for missing the60-day deadline are provided in the procedure,

including the following: (1) an error committed bythe financial institution receiving the contribution ormaking the distribution to which the contributionrelates; (2) the distribution, having been made in theform of a check, was misplaced and never cashed;(3) the distribution was deposited into and remainedin an account that the taxpayer mistakenly thoughtwas an eligible retirement plan; (4) the taxpayer'sprincipal residence was severely damaged; (5) amember of the taxpayer's family died; (6) thetaxpayer or a member of the taxpayer's family wasseriously ill; (7) the taxpayer was incarcerated; and,(8) a postal error occurred. In order to qualify forself-certification, the IRS must not have previouslydenied a waiver request with respect to a rollover ofall or part of the distribution to which the contributionrelates. The procedure also requires that thecontribution must be made to the retirement plan orIRA within 30 days after the reason or reasonslisted in the self-certification no longer prevent thetaxpayer from making the contribution. Note: Aword of caution – the IRS may determine that therequirements for a waiver were not met because ofa material misstatement in the self-certification, thereason or reasons claimed by the taxpayer formissing the 60-day deadline did not prevent thetaxpayer from completing the rollover within 60 daysfollowing receipt, or the taxpayer failed to make thecontribution within 30 days after the reason orreasons no longer prevented the taxpayer frommaking the contribution.

[ITEM 6] LATE FILING PENALTY APPLIES EVENTHOUGH TAXPAYER GRANTED A POWER OFATTORNEY TO AN INDIVIDUAL TO PREPARETAXPAYER’S RETURN

In Chief Counsel Advice 201637012, the IRSconsidered the tax implications of filing a late returnwhere the taxpayer had granted a power of attorney(POA) to an individual to prepare, file and signincome tax returns, make estimated tax payments,and file gift tax returns for any gifts made by thetaxpayer for any year. At the time the POA wasgranted, the taxpayer was of sound mind. The POAincluded a paragraph that stated the POA shall beeffective even if the taxpayer later became disabled,incapacitated, or incompetent. The taxpayer’s taxreturn was not filed in a timely manner so the IRSassessed an addition to tax under Section 6651(a). The individual who was granted the POA petitioneda state court for the appointment of an EmergencyGuardian and Conservator for the taxpayer. Thecourt’s order characterized the taxpayer as an“incapacitated person.” Chief Counsel (CC) notedthat if the taxpayer is able to demonstrate to the IRSthat she was suffering from dementia and wastherefore unable to handle her own financial affairs,this could support a finding of reasonable cause forfailure to timely file her return. The current ruling

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focuses solely on whether the late filing penaltycould be waived due to the taxpayer’s reliance onthe individual granted the POA to file her tax returnin a timely manner. CC cited a 1985 SupremeCourt case (Boyle), which held that Congressplaced the burden of proof for filing tax returns onthe taxpayer, not on some agent or employee of thetaxpayer. In the case, the Supreme Court rejectedthe argument of an estate's executor that the estateshould be excused from the addition to tax for latefiling because it relied in good faith on an attorneyto timely file the return. Consequently, CCconcluded that the fact that the taxpayer had adurable power of attorney for the year at issueneither establishes nor results in a finding of areasonable cause for the late filing because thetaxpayer, not the individual granted the POA, had aduty to timely file and pay her taxes.

[ITEM 7] NEW USER FEES FOR INSTALLMENTPAYMENT AGREEMENTS PROPOSED AND PTINFEE REDUCED

In News Release 2016-108 [8/19/16], the IRSproposed a revised schedule of user fees effective1/1/17 and applicable to any taxpayer who entersinto an installment agreement to pay their taxliability. The revised installment agreement fees forregular installment agreements is set to increasefrom $120 to $225. However, under the revisedschedule any affected taxpayer could qualify for areduced fee by making their request online usingthe Online Payment Agreement application atirs.gov. A taxpayer who chooses to set up aninstallment agreement using the agency's OnlinePayment Agreement application will pay a fee of$149. The top rate of $225 applies to taxpayers whoenter into an installment agreement in person, overthe phone, by mail or by filing Form 9465 with theIRS. But a taxpayer who establishes an agreementin this manner can substantially cut the fee to just$107 (an increase of $55) by choosing to make theirmonthly payments by direct debit from their bankaccount. Similarly, they can cut this amount to just$31 by also choosing direct debit and setting up theinstallment agreement online. The proposed fee forlow-income taxpayers is $43 (no change). Alow-income taxpayer is a taxpayer who has incomeat or below 250% of the dollar criteria establishedby the poverty guidelines updated annually in theFederal Register by the U.S. Department of Healthand Human Services. The IRS estimates that afamily of four with total income of around $60,000 orless would qualify for the lower fee. The user feefor restructuring or reinstating an installmentagreement is $89 (up $39). Note: In TreasuryDecision 9781 [8/12/16], final regulations wereissued which reduce the PTIN fee for renewing yourPTIN for the 2017 filing season from $50 to $33.

[ITEM 8] IRS REMINDS TAXPAYERS OF RECENTITIN PROGRAM CHANGES AND PROCEDURES

In IR-2016-129 [10/7/16], the IRS remindstaxpayers affected by recent changes involving theIndividual Taxpayer Identification Number (ITIN)program about submitting their ITIN renewalapplications to the IRS. Under the PATH Act of2015, any ITIN not used on a federal tax return atleast once in the last three years will no longer bevalid for use on a tax return as of January 1, 2017. ITINs are used by people who have tax filing orpayment obligations under U.S. law but who are noteligible for a Social Security Number. Only ITINholders who need to file a federal tax return in 2017need to renew their ITINs. Taxpayers will need tohave a current ITIN in order to file a 2017 return. Taxpayers with ITINs that have not been used on afederal income tax return in the last three years willnot be able to file a return unless their ITINs arerenewed. ITINs with the middle digits 78 or 79 needto be renewed even if the taxpayer has used it inthe last three years. Those taxpayers have theoption to renew ITINs for their entire family at thesame time. Those who have received a renewalletter from the IRS can choose to renew the family'sITINs together even if family members have an ITINwith middle digits other than 78 or 79. Familymembers include the tax filer, spouse and anydependents claimed on the tax return. A taxpayermust fill out a Form W-7 and submit all requireddocumentation to renew an ITIN.

**REVIEW QUESTIONS AND SOLUTIONS**

1. In a recent identity theft scam attacking taxprofessionals, which one of the followingstatements is false?

a. The attacker gained access to sensitiveinformation held by tax professionals.

b. The IRS urges all tax preparers to reviewany tax software used by the taxprofessionals or their employees.

c. Scam artists are not likely to gain access toremote access software.

2. For a recent ruling dealing with an LLCmember’s earnings from his LLC, which one ofthe following statements is true?

a. The LLC treated both the member’sguaranteed payment and his distributiveshare as self-employment income.

b. The member was the only LLC memberinvolved with the LLC’s businessoperations.

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c. The Chief Counsel concluded that themember’s distributive share was self-employment income because he wasresponsible for the LLC’s debt.

3. For the 2016 - 2017 per diem rates under thehigh-low method for taxpayers to use insubstantiating business expenses incurredwhile traveling away from home, which one ofthe following statements is false?

a. The rate for incidental expenses is differentdepending on whether travel is within oroutside the continental United States.

b. The per diem rate for travel to a non-“high-cost” locality is $189.

c. A “high-cost” locality is one with a federalper diem rate of at least $236.

4. Concerning the self-certification of the hardshipexception to the 60-day rollover rules, whichone of the following statements is true?

a. Once the reasons listed in the selfcertification no longer prevent the taxpayerfrom making the rollover contribution, thetaxpayer must make the contribution within60 days.

b. In order to qualify for self-certification, theIRS must not have previously been denieda waiver request with respect to a rollover.

c. The death of a member of the taxpayer'sfamily is not one of the reasons providedby the IRS that satisfies the conditions forself-certification.

Solutions

1. "C" is the correct response. The IRS notesthat remote access software is a potential targetfor bad actors to gain entry and take control ofa machine.

“A" is an incorrect response. Access wasgained to sensitive information held by taxprofessionals through a scam which instructsthe tax professional to install an importantsoftware update via a link included in the e-mail.

"B" is an incorrect response. The IRS urgestax professionals to take six steps, including the review of any tax software used by the taxprofessionals or their employees. NewsRelease 2016-103 and News Release2016-119.

2. "B" is the correct response. The memberwas the only owner involved with the LLC’sbusiness operations.

“A" is an incorrect response. The LLC didnot treat the member’s distributive share asself-employment income.

"C" is an incorrect response. The member’sdebt responsibility was not included in the ChiefCounsel’s analysis. Chief Counsel concludedthe member’s share was self-employmentincome because he actively participated in theLLC’s business. Chief Counsel AdviceMemorandum 201640014.

3. "A" is the correct response. The rate is $5for any locality.

“B" is an incorrect response. The per diemrate for travel to a non-“high-cost” locality is$189.

"C" is an incorrect response. A “high-cost”locality is one with a federal per diem rate of$236 or more. Notice 2016-58.

4. "B" is the correct response. One of the major

requirements for qualifying for the self-certification of the hardship exception to the IRArollover rules is that the IRS had not previouslydenied a waiver request with respect to arollover.

“A" is an incorrect response. The taxpayermust make the rollover contribution within 30days, not 60 days, from the date the reasonslisted in the self-certification no longer preventthe taxpayer from making the contribution.

"C" is an incorrect response. The IRSprovides several reasons that satisfy theconditions for self-certification including eightwe list in our newsletter. The death of a familymember is the 5th item in the list. RevenueProcedure 2016-37.

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[ITEM 9] TAXPAYERS GET HAMMERED WITHEXCISE TAX ON EXCESSIVE IRACONTRIBUTIONS

It is hard to sympathize when taxpayers get hit withsignificant tax penalties when they are clearlycommitting fraud or acting in a grossly negligentmanner. However, in the Wu case [8/29/16], it isdifficult to digest when an innocent couple isassessed substantial penalties for actions theybelieved were admirable – investing for the future.

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After selling their home in 2007, the taxpayers eachdeposited $200,000 into a traditional IRA. Each$200,000 contribution constituted an “excesscontribution.” In 2007 the maximum IRAcontribution was $4,000 so the excess contributionfor 2007 was $196,000. The excise tax on excesscontributions (plus earnings on the contributions) is6% and the excise tax continues to be imposed untilthe excess contribution is withdrawn. Thesecontributions, along with accrued earnings on thecontributions, remained in their accounts untilMarch 23, 2010. On that date, each withdrew theexcess contributions and earnings by transferringthe money to a different bank account. They alsonotified the IRS about the excess contributions andasked that the excise taxes on excessivecontributions be waived. The IRS assessed theexcise taxes and the taxpayers promptly paid thetaxes plus penalties. Since they did not discovertheir mistakes until March 2010, they realizednothing could be done to eliminate the excesscontributions for 2007 and 2008. However, theyargued that their withdrawals of their excesscontributions before the due date of their 2009 taxreturn resulted in no excise tax for the 2009 taxableyear. Section 4973(b) provides that anycontribution which is distributed from the individualretirement account before the due date of the returnis treated as an amount not contributed. The courtnoted that this provision covers only thosedistributions made before the return deadline of thetax year when the excess contribution was made,not withdrawals of contributions made in earlier taxyears. That is, for the 2007 tax year the taxpayercould have avoided incurring the annual tax onexcess contributions by withdrawing the excesscontributions by April 15, 2008. For any later yearthey could avoid the annual tax only by making thedistribution before the taxable year ended. As aresult, the 7th Circuit affirmed the District Court inruling that the excise taxes were imposed on allthree years, including 2009. We realize thatignorance is not a defense for violating the law butthere are many hardship exceptions throughout theCode. Maybe there should be one here. Note: Theexcise tax also applies to excess contributions tothe following accounts: (1) Archer MSAs, (2)Coverdell education savings accounts; (3) healthsavings accounts; and, (4) ABLE accounts.

[ITEM 10] QUALIFIED PLAN LOAN BALANCE ISTAXABLE DISTRIBUTION

In Martinez and Garcia [9/28/16], the principal issuewas whether the taxpayer’s unpaid balances of loanamounts she borrowed from her Section 403(b)qualified employer retirement plan (QP) weretaxable distributions. The taxpayer was a teacher inthe Los Angeles Unified School District. Sheborrowed from her school district QP to avoid

foreclosure on her spouse’s and her residence. OnJuly 29, 2010, she requested two loans from her QP(each had a separate plan administrator). Eachloan agreement indicated that the loans were to berepaid in quarterly payments over a five-year period. By a checked box in the agreement, it was indicatedthat the new loans were not to be used asresidential loans. She signed both loanagreements, representing that she understood theirterms, acknowledging that any loan that did notcomply with Section 72(p)’s requirements would betreated as a deemed distribution and thus taxableincome. She made initial payments on the twoloans, but stopped in May 2012. She continued toreceive loan repayment notices. The QP’sadministrators determined that as of November2012 she had defaulted on the loans. Theydeemed the loan balances of $20,581.85 and$2,906.92 to be 2012 taxable distributions. Theyissued her Forms 1099-R that showed therespective amounts as fully taxable. Section 402(a)provides generally that, per Section 72, QPdistributions are taxable to the plan distributee forthe taxable year of the distribution. But, there is anexception in Section 72(p)(2). Under the exception,the loan is not treated as a taxable distributionwhere the principal amount of the loan (whenapplied to the outstanding balance of all other loansfrom the same QP) does not exceed a specifiedlimit, and meets certain other requirements. Theloan is required to be repaid within five years. But,the five-year requirement does not apply for anyloan that is used to acquire any dwelling unit whichwithin a reasonable time is to be used as the QP’sparticipant’s principal residence. The loan is subjectto substantially level amortization over the loanterm. “Substantially level amortization” means“requiring that payment of principal and interest bemade in substantially level amounts over the termof the loan.” Loan payments are required to be paideither on the date due or within the allowed graceperiod. Plan administrators may allow a cure(grace) period, which cannot continue beyond thelast day of the calendar quarter following thecalendar quarter in which the required installmentpayment was due. Where there is a failure to pay,the amount of the deemed distribution equals theentire outstanding loan balance (including accruedinterest) at the time of the failure. The taxpayer didnot make loan payments after May 2012, and shedid not make the missed payments within thepermitted cure period. The taxpayer argued thatthe Code waives the requirement that a loan berepaid with level amortization in five years if the loanis made in connection with acquiring a principalresidence. The court stated that the taxpayer hadmisrepresented the Code. It stated that levelamortization still is required for QP loans used foracquiring a principal residence, though the codeallows for a loan period longer that five years when

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the loan proceeds are used in that manner. Further, the court stated that the taxpayerspecifically affirmed in both loan agreements thatthe loans were not to be used as residential loans –hence, both loans were made under a five-yearrepayment period. Thus, the court ruled that theloan balances were deemed taxable distributions.

[ITEM 11] ESTATE IS ENTITLED TO THEFTLOSS DEDUCTION FROM PONZI SCHEME

Mr. Heller died January 31, 2008. At death, heowned a 99% interest in a family LLC. The onlyasset held by the LLC was an account with BernardL. Madoff Investment Securities. Between theappointment of Mr. Heller’s estate’s co-executors onMarch 5, 2008, and November 28, 2008, a co-executor withdrew $11.5 million from the Madoffaccount, and distributed it per the LLC’s ownershipinterests. The $11.385 million estate share wasused to pay the estate’s taxes and administrativeexpenses. As a result of the Ponzi schemeperpetrated by Mr. Madoff, the LLC’s interest in theMadoff account and the estate’s interest in the LLCbecame worthless. The estate timely filed theestate tax return on April 1, 2009, claiming a$5,175,990 theft loss deduction relating to the Ponzischeme (the difference between the value of theestate’s interest in the LLC reported on the estatetax return and the estate’s share of the amountswithdrawn from the Madoff account). On February9, 2012, the IRS issued the estate a notice ofdeficiency in which it determined that the estate wasnot entitled to the theft loss deduction because theestate did not incur a theft loss during itssettlement. The estate petitioned the Tax Court tohear the dispute between the estate’s and IRS’spositions on the deductibility of the theft loss. InEstate of James Heller [9/26/16], the court notedthat under Section 2054 an estate is entitled to adeduction relating to “losses incurred during thesettlement of ... [the estate] arising ... from theft.” The court noted that whether an estate is entitled toa Section 2054 theft loss deduction relating toproperty held by an LLC was an issue of firstimpression, because neither legislative history northe Treasury regulations relating to Section 2054address the issue. The court’s holding, thus, wasbased solely on its analysis of Section 2054. Itstated that the estate tax is imposed on the value ofproperty transferred to beneficiaries. A loss refersto a reduction of the value of property that is held bythe estate. It noted that in addition to losing its soleasset as a result of the Ponzi scheme, the estate,during its settlement, also incurred a loss becausethe value of its interest in the LLC, not the estate,was the theft victim. The IRS conceded that MadoffSecurities defrauded the LLC, but asserted that theestate was not entitled to a Section 2054 deductionbecause the LLC, not the estate, was the theft

victim. The court stated that Section 2054 allowsfor a broader nexus between the theft and theincurred loss than does the IRS’s narrowinterpretation. The court relied on the language“arising from” in Section 2054 to say that the estateis entitled to a deduction if there is a sufficientnexus between the theft and the estate’s loss. Itheld the nexus was sufficient. Further, the courtdiscussed the purpose of the estate tax. While theestate tax is imposed on the value of property thatis transferred to beneficiaries, estate tax deductionsare designed to ensure “that the tax is imposed onthe net estate, which is really what of value passesfrom the dead to the living.” It stated that the theftextinguished the value of the estate’s interest in theLLC, thus diminishing the value of propertyavailable to Mr. Heller’s heirs. The court ruled thatthe estate was entitled to a deduction under Section2054. [ITEM 12] NINTH CIRCUIT APPROVES TAXCOURT’S INCOME RECOGNITION EVENTUNDER THE COMPLETED CONTRACT METHOD

Generally if you are a builder and use thecompleted contract method (CCM), income is notrecognized until the contract is completed. So if abuilder develops a subdivision and builds singlefamily homes, normally income will be recognizedunder the CCM after the construction of each homeis completed. In Shea Homes [8/24/16], there is aninteresting twist on the timing of income recognition. The taxpayer’s business involved the analysis andacquisition of land for development, and theconstruction and marketing of homes and thedesign and/or construction of developments andhomes on the land it acquired. Its primary source ofrevenue was from the sale of houses. The partiesagree that the contracts at issue are long-termhome construction contracts and that the CCM is apermissible method to report income for homeconstruction contracts. Under the Treasuryregulations, a taxpayer's contract is completed uponthe earlier of (1) use of the subject matter of thecontract by the customer for its intended purpose(other than for testing) and at least 95% of the totalallocable contract costs attributable to the subjectmatter have been incurred by the taxpayer; or, (2)final completion and acceptance of the subjectmatter of the contract. The taxpayers applied the95% test to determine the year of contractcompletion, and took the position that the subjectmatter of their home construction contracts includedthe development in which the home was situated. For each tax year, the taxpayer calculated thepercentage completion on a development bydevelopment basis rather than on the basis of eachhome’s completion. If the incurred costs were equalto or greater than 95% of the budgeted costs, thenthe taxpayer reported income for that tax year fromhomes that had closed in escrow up to that date. Ifnot, the income was deferred until the percentage

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completion reached 95%. The IRS questioned thismethod and argued that the income from acompleted home should be recognized once ahome sale closed in escrow. The taxpayerdisagreed and pointed out that the subject matter ofits contracts with their buyers went beyond a merehouse and lot sale, but included the commonimprovements and the other requirements neededto create a house within the particular plannedcommunity development that the buyer hadbargained for. Therefore, it said, it had properlyapplied the 95% test to determine the date ofcontract completion, and its method of accountingreflected the subject matter of its home constructioncontracts and clearly reflected income. The TaxCourt sided with the taxpayer noting that the buyersof their homes understood and believed that theparties had contracted for the entire lifestyle of thedevelopment and its amenities. On appeal, the IRSargued that the 95% test should be met when thetaxpayer incurs 95% of the budgeted costs of thecontracted-for house, lot and common amenities,but not the costs of the other houses. The IRSindicated that a buyer of a house cannot himselfuse other homes and, therefore, the developmentas a whole could not be part of the subject matter ofthe buyer's contract. The Ninth Circuit counteredthat each person in the planned community would,indeed, have an interest in the use of other propertyin the development, and that would include not onlythe common amenities but also the use that othersin the development made of their own properties.The creation of the homeowners' associations inwhich each buyer had rights, and in the covenants,conditions and restrictions that ran with the landaffected not only the buyer but also otherprospective buyers and the properties they werepurchasing. The Ninth Circuit ruled in favor of thetaxpayers and affirmed the Tax Court’s decision. Note: Both the Tax Court and the Ninth Circuit musthave felt some discomfort with their decision asevidenced by the Ninth Circuit’s closing of itsdecision with the Tax Court’s admonition whichstates: "We are cognizant that our Opinion todaycould lead taxpayers to believe that largedevelopments may qualify for extremely long,almost unlimited deferral periods. We would cautionthose taxpayers a determination of the subjectmatter of the contract is based on all the facts andcircumstances." In other words, both courts believethat this case is not the typical situation but ratherthe exception. Other taxpayers who rely on thiscase will have to show that the focal point of thehome sales in their subdivision was on the plannedcommunity aspect of the subdivision with fairlyextensive amenities and common areas.

[ITEM 13] TAX COURT RULES ON CHARACTEROF FORFEITED DEPOSIT RECEIVED BY THESELLER

Trade or business assets have the best of bothworlds when it comes to the tax treatment of gains

and losses. If the gains and losses (not includingdepreciation recapture) from the disposition of tradeor business assets net to a gain, the net gain istaxed at the favorable capital gain rates. If the netgains and losses is a loss, the net loss is deductibleas an ordinary loss, so the tax savings are basedon the taxpayer’s marginal tax rate and there is no$3,000 limitation as in the case of capital losses. Suppose a taxpayer owns land that is a trade orbusiness asset and the taxpayer has an agreementto sell the property at a gain. The buyer provides asizable nonrefundable deposit to lock in the sale butlater the buyer does not follow through on the saleso the seller keeps the deposit. What is the taxseller’s treatment of the forfeited deposit? This wasthe issue in CRI-Leslie, LLC [9/7/16]. The forfeitedamount received by the seller was $9.7 million andthe IRS argued that the character of the incomewas ordinary income. The taxpayer argued that thegain was capital gain under Section 1234A. Section1234A provides in part that gain attributable to thecancellation, lapse, expiration, or other terminationof a right or obligation with respect to property whichis a capital asset in the hands of the taxpayer shallbe treated as gain or loss from the sale of a capitalasset. The taxpayer reasoned that since net gainsfrom the dispositions of trade or business assetsare treated as capital gains for calculating the taxon the gains, the term “capital asset” in Section1234A extends to property described in Section1231 (trade or business assets). In a regular TaxCourt decision, the Tax Court looked to the Code todetermine the outcome of the case. Specifically,Section 1221 defines capital assets as all assetsother than eight specific categories of assets. Some of the more common assets that are nottreated as capital assets are inventory, accountsreceivable, and copyrights, artistic compositions orsimilar property created by the taxpayer. Unfortunately for the taxpayer, Section 1221(a)(2)specifically excludes from the definition of capitalassets, “property, used in his trade or business, ofa character which is subject to the allowance fordepreciation provided in section 167, or realproperty used in his trade or business.” SinceSection 1234A expressly refers to property that is "acapital asset in the hands of the taxpayer" and noother type of property, and since property describedin Section 1231 is excluded explicitly from thedefinition of "capital asset" in Section 1221, the TaxCourt concluded that the plain meaning of "capitalasset" as used in section 1234A does not extend toSection 1231 property. Therefore, the forfeiteddeposit was taxed as ordinary income.

[ITEM 14] FOURTH CIRCUIT DECIDEST A X P A Y E R D O E S N O T M E E T“EXTRAORDINARY PERSONAL SERVICES”EXCEPTION FOR RENTAL ACTIVITY

In Johnson, Wijayaningsih [3/8/16], the only issuebefore the 4th Circuit Court of Appeals was whetherthe taxpayers met the extraordinary personal

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services exception to have a rental-like activity notbe classified as a rental activity. The IRS, with aNorth Carolina district court agreeing, determinedthat the taxpayers did not meet the exception, andthe losses that three rental properties they ownedincurred were passive and were not deductibleunder the passive activity loss rules. A passiveactivity is a trade or business activity in which thetaxpayer does not materially participate, or a rentalactivity (expressly defined as per se passiveactivities). The Treasury Regulations provides sixexceptions to the rule that rental activities are per sepassive activities, one of which is where thetaxpayer provides extraordinary personal servicesin connection with making the property available foruse by customers. An example of this exception inthe regulations is a hospital: the use by customersof the hospital property, including overnight lodgingand provision of meals, is incidental to the servicesthey receive from the doctors and nurses. Theexception means that an activity involving the use oftangible property is not per se passive ifextraordinary personal services are provided. Evenif the extraordinary personal services exceptionapplies, the taxpayer still must show that hematerially participated in the activity to escape thepassive activity loss rules. Amenities and services,which were provided at their three rental properties,included recreational activities such as fire andhorseshoe pits, satellite TV service, kitchen dishesand appliances, furniture, cleaning supplies andperiodic household services, landscaping, bathroomtoiletries, laundry facilities, and continentalbreakfast items. The court noted such servicescommonly are provided by landlords and do notsupport application of the extraordinary personalservices exception. Note: We wonder whether theservices listed are routine or commonly provided forrental real estate. The taxpayers alleged that oneof the taxpayers provided counseling services totheir residents upon request. These servicesinclude legal, tax, financial, and psychologicalcounseling. They argued that a resident’soccupancy of a room in one of the taxpayers’properties was incidental to his or her receipt ofsignificant personal services. The taxpayers offeredtheir own verified statements and the verifiedstatement of a resident, who stated that he decidedto move into one of the rental homes not for thenon-exclusive right to reside in a room, but insteadto receive the promised services, which includedcounseling services. The resident stated that heobserved other occupants who received theservices. The court noted that the rentals were notadvertised as homes where counseling serviceswould be provided, “but rather that these serviceswere explained ‘to the people coming.’ “ The 4th

Circuit found the evidence offered by the taxpayers did not support a finding that the rental homes were“akin to those services offered by a hospital orschool, where the prime concern of the tenants is

the receipt of services, whether medical, teaching,or, [this[ case, legal [financial, and psychological].” It ruled that the occupants’ use of their property wasnot incidental to the occupants’ receipt of thecounseling services, and the taxpayers failed tomeet the extraordinary personal services exception.

[ITEM 15] CORPORATION’S CATTLE RANCHINGLOSSES ARE NOT ATTRIBUTABLE TOCORPORATION’S OWNERS

A corporation was created and owned equally bytwo brothers to run a cattle operation. Thecorporation had a manger who managed the cattleoperation, and had 17 employees. The corporationfiled payroll tax returns and W-2's for employees. It held a workers’ compensation and employer’sliability insurance policy in its name with respect tothe cattle operation employees. The corporationbought and sold cattle under its name. The cattleoperation paid expenses, and booked them to thecorporation as receivables from the brothers (50%each). The brothers each were billed for 50% of theexpenses. Sales from cattle receipts weredeposited into the corporation’s bank account. Fiftypercent of the sales revenue was booked directlyinto the general ledger for each of the brothers, anda payable to the brothers was created on thecorporation’s books. All income from cattle saleswas split equally between the two brothers. Thecorporation filed Forms 1120, and reported no grossreceipts or sales. The brothers on their Forms 1040reported the gross receipts and expenses from thecattle operation, offsetting other income with thecattle operation’s net losses. In Barnhart Ranch,Co., et al [9/14/16], an issue was whether thecorporation (BRC) that ran the cattle operation, orits two brothers who equally owned it, were entitledto use the losses that BRC sustained. The brothersargued that they, not BRC, owned all the cattle, andthus they properly reported the income andexpenses of the cattle operation on their ownreturns. The IRS argued that the cattle bought andsold by BRC was that purchased by BRC in its ownname. The Tax Court stated that, absentextraordinary circumstances, a corporation’sbusiness is not attributable to its shareholders fortax purposes. Generally, when taxpayers choose toconduct business through a corporation, they willnot be permitted later to deny the existence of thecorporation if it suits them for tax purposes. Thecourt noted that exceptions do exist where thecreation of the corporation is not followed by anybusiness activity, the purpose for creating thecorporation was not a business purposes, or thecorporation was the agent of its owners. Both thetaxpayers and the IRS agreed that BRC had agenuine business purpose and actually carried onbusiness activity and is therefore a separate taxableentity. What they disagreed on was the purpose. The IRS asserted that BRC managed the cattle

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operation. The taxpayers asserted that BRC wasnothing more than a “joint interest accountingagent” of the two brothers. The court stated thatBRC did not actually provide accounting services. It noted that BRC’s federal tax returns for the taxyears in question identified its business activity andservice as “Management of Cattle Ranch.” Thecourt first decided that BRC’s business purpose andactivity was the management of the cattle operation,finding the following facts important: (1) BRCbought and sold cattle under its own name; and, (2)in its own name and carrying out the cattleoperation business, it held a bank account,purchased and held titles to vehicles, leased ranchproperty, and held ranch and workers’compensation and employer’s liability insurancepolicies. The court then considered who owned thecattle, and whether the corporation functioned onlyas the brothers’ agent. As to ownership, the courtnoted that BRC had command over the cattle in thatit was the recognized seller and buyer of the cattle. It deposited all cattle sales income into its BRCaccount, and directly paid cattle operationexpenses. The brothers caused BRC to hold itselfout to the public as the legal entity that owned thecattle. The brothers chose to do business using aseparate corporate entity, and benefitted from thatchoice, having limited liability. The court held thebrothers, then, could not disregard the corporationwhenever it is beneficial for them to do so. Thecourt deemed BRC the owner of the cattle and, asa separate taxable entity, was the taxpayer to whomthe net losses that stemmed from those assets areattributable. As to agency, the brothers argued thatthe losses were attributable to them as individualsbecause the corporation functioned as their agent. The court did note that an exception to the separatetaxable entity principle exists where a corporationserves as the agent of the taxpayers. The courtnoted that gross receipts generated by the cattleoperation were, for the most part, not transmittedfrom BRC to the petitioners. They were depositedinto the BRC account, and BRC then used thosefunds to pay monthly expenses. Ultimately, thebrothers received only the excess of receipts overexpenditures, and then only because of theircorporation ownership. The court stated that therecord showed that BRC acted for its own account,incurred its own debts, entered into its owncontracts with third parties to purchase goods andservices, and bought and sold cattle in its ownname, not as an agent. The court observed thatBRC performed the nitty-gritty of the cattleoperation, and it acted as the controlling entity withrespect to the cattle. The court concluded that BRCdid not serve as an agent, and nothing showed thatBRC was identified to any third parties as an agent,nor that the brothers were identified as principals. The court upheld the IRS’s position that BRC’sincome and expenses, and the resulting net losses,belonged to BRC, not the brothers.

[ITEM 16] 11TH CIRCUIT RULES SPECIALESTATE TAX LIEN HAS PRIORITY OVEREXECUTOR’S ADMINISTRATIVE EXPENSES

On October 17, 1989, an individual created arevocable trust. When she died on July 5, 2004, thetrust contained 39,700 membership units in aprivately-held, family-owned newspaper publishingcompany. In Spoor [10/4/16], the taxpayer was thepersonal representative of the deceased’s estate. On September 30, 2005, the taxpayer filed theestate’s Form 706 federal estate tax return. Theestate was valued at $36,624,546, the membershipunits held in the trust comprising $34,936.000 ofthat value. The taxpayer claimed a $1,086,265deduction for his personal representative fee toadminister the estate (administrative expenses). On the estate tax return, the estate elected to deferand pay its estate tax liability in 10 equalinstallments under Section 6166. It made 2005 taxpayments totaling $2.007,364.83, a March 2006payment of $687.70 and additional payments in2006, 2007, and 2008, of between $1,700,000 and$1,800,000. In August 2010, the estate agreed tothe creation of a special deferred estate tax lien onthe membership units under Section 6324A. By2012, the value of the units had become less thanthe unpaid portion of the deferred tax and interest,and the IRS demanded additional collateral from theestate. When the estate was not able to provideadditional collateral, the IRS accelerated theremaining deferred tax obligations. At September10, 2013, the remaining estate tax, penalties, andinterest totaled $10,483.006.47. With the estate’sfailure to pay its reported income taxes, atSeptember 2013, it owed an additional $551,106.39in income tax, penalties, and interest. UnderSection 6321, the income tax liability paymentfailure resulted in federal tax liens attaching to theestate beginning September 10, 2010. OnSeptember 26, 2014, the district court granted theUnited States the right to foreclose its tax liens onthe membership units. The taxpayer asserted hisclaim that his administrative expenses took priorityover the government’s liens. According to thetaxpayer, the value of the units that the estateowned had fallen to approximately $2 million. Thekey issue in the case was whether estate taxes takepriority over the estate’s personal representative’sadministrative expenses, given that the estate’sassets were insufficient to cover both the estatetaxes and the expenses. A Florida district court hadheld that Section 6324A is silent as to the priority ofclaims that arise prior to a federal tax lien. So, thecourt relied on the common-law principle that “thefirst in time is the first in right.” Because thetaxpayer’s administrative expense claim, as filedwith the Form 706 tax return in 2005, arose beforethe tax liens that were recorded and assessed inSeptember 2010, the district court ruled that thetaxpayer’s claim had priority. The United States

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appealed the district court’s decision to the 11th

Circuit. The 11th Circuit stated that federal tax liensdo not automatically have priority over all other liensand, absent provision to the contrary, priority forpurposes of federal law is governed by thecommon-law principle that “the first in time is thefirst in right.” It stated that estate tax liens differslightly from federal tax lien statutes. Under Section6324, a general estate tax lien arises automaticallyfrom date of death, and attaches to the grossestate, except for the part of the gross estate that isused to pay charges against the estate and theexpenses of its administration. An alternative to thisgeneral estate tax lien is available if more than 35%of the value of the adjusted gross estate isattributable to an interest in a closely-held business. Under the alternative, the executor may elect to paythe tax in up to 10 equal installments, with the firstpayment due up to five years from the payment duedate that otherwise would apply. Under Section6324A, the deferred amount of estate tax, plus anyinterest, penalties, and costs, becomes a lien infavor of the United States. As collateral, theexecutor may identify Section 6166 lien property inlieu of the Section 6324 gross estate. Generally,the maximum value of the property which the UnitedStates may require as Section 6166 lien propertymay not be more than the deferred estate taxamount and required interest. Until, and even after,the special lien is recorded, it is not valid againstcertain other liens and interests. The taxpayerargued that his claim for administrative expensestakes priority over the United States’s special estatetax lien because they arose before the lien wasrecorded. The 11th Circuit held that the text andstructure of Section 6324A do not permit anexecutor’s administrative expenses to trump aSection 6324A estate tax lien. It observed that thegeneral gross estate lien under Section 6324excludes administrative expenses from the grossestate tax lien. However, the Section 6324A specialproperty lien does not exclude amounts related toadministrative expenses from the special estate taxlien. Further, the circuit court held that the estaterepresentative’s claim for administrative expensesis not a lien, and so it is not governed by thecommon law “first in time first in right principle.” The court ruled that the taxpayer’s claim foradministrative expenses did not take priority overthe United States’s special estate tax lien.

[ITEM 17] TAX COURT CLARIFIES AMOUNT OFWHISTLEBLOWER AWARD

Section 7623(a) provides that the IRS is authorizedto pay awards for (1) detecting underpayments oftax, or (2) detecting and bringing to trial andpunishment persons guilty of violating the internalrevenue laws. Section 7623(b), entitled “Awards towhistleblowers” provides that if the IRS proceedswith any administrative or judicial action describedin Subsection (a) based on information brought to

the IRS’s attention by an individual, the individualshall receive as an award at least 15% but not morethan 30% of the collected proceeds (includingpenalties, interest, additions to tax, and additionalamounts) resulting from the action (including anyrelated actions) or from any settlement in responseto such action. The determination of the amount ofthe award by the Whistleblower Office shall dependupon the extent to which the individual substantiallycontributed to the action. Section 7623(b)(5) furtherprovides that this Subsection applies only if the tax,penalties, interest, additions to tax, and additionalamounts in dispute exceed $2,000,000. InWhistleblower 21276-13W [8/3/16], the petitioners,husband and wife, sought whistleblower awardsauthorized by Section 7623(b). After originallyrejecting the petitioner’s claims, the parties agreedthat the petitioners were to be awarded 24% of thecollected proceeds. The major issue in this caseconcerns the meaning of “collected proceeds.” Thetargeted taxpayer pleaded guilty to conspiring todefraud the IRS, filing false federal income taxreturns and evading federal income tax. Thetaxpayer paid the Treasury a total of $74,131,694consisting of $20,000,001 in tax restitution,$22,050,000 in criminal fines, $15,821,000 in civilforfeitures, and $16,260,693 for the forfeiture offunds involved in a money laundering transaction. The petitioner argued that the award should bebased on the entire amounts collected by thegovernment ($74.1 million). In contrast, the IRSargued that the award should be based only onamounts collected under a tax provision of Title 26(Internal Revenue Code) since Section 7623 relatessolely to violations of federal tax laws. The IRS alsoclaimed that any portion of the award based oncriminal fines ($22,050,000 in this case) is at oddswith administrative guidance which notes thatcriminal fines must be deposited into the Victims ofCrime Fund and cannot be used for payment ofwhistleblower awards. After reviewing several casesrelevant to this case, the Tax Court made severalpoints. First, proceeds are not necessarily moneybut represent what is produced or derived fromsomething such as a sale, investment, or business. Second, Congress chose to use a sweeping term“collected proceeds” rather than a more narrowterm such as amounts assessed and collected bythe IRS under Title 26. Third, it noted that manyInternal Revenue Laws are found outside Title 26,such as Section 530 of the Revenue Act of 1978,which is a relief provision dealing with employee-independent contractor classification. Fourth, itrejected the IRS’s arguments that the parentheticaldescription (including penalties, interest, additionsto tax, and additional amounts) in Section 7623(b)provides evidence that the proceeds relate solely tofederal tax collections. The Tax Court counteredthat the IRS ignored the word “including” in theparentheses and noted that it is used throughoutthe Code to provide examples rather than toexclude other things otherwise within the meaning

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of the term defined. The Tax Court ruled that theterm “collected proceeds” is broadly defined andincludes the entire $74.1 million in this case.

**REVIEW QUESTIONS AND SOLUTIONS**

5. In a court case involving excess IRAcontributions, which one of the followingstatements is false?

a. Because the taxpayers notified the IRS thatthey had made excess IRA contributions,the court ruled that all penalties andinterest should be waived.

b. Excess contributions made in the currentyear must be distributed by the due date ofthe tax return in order to avoid the excisetax.

c. The excise taxes were paid soon after theywere assessed by the IRS.

6. For a recent case involving loans a taxpayerincurred with her qualified plan, which one ofthe following statements is true?

a. After the taxpayer missed her firstrepayment, the plan balance at that timewas deemed to be a taxable distribution.

b. The loan agreements specified that theloan proceeds were to be used to acquirea principal residence.

c. The taxpayer’s qualified plan was a Section403(b) plan.

7. For a recent Tax Court case dealing with a theftloss deduction claimed by an estate, whichone of the following statements best describesthe tax law under Section 2054 for the issuethat the Tax Court faced?

a. Legislative history had addressed the issueunder Section 2054 before.

b. The case involved an issue of firstimpression.

c. Treasury regulations had addressed theissue under Section 2054 before.

8. In a court case involving home constructioncontracts and the completed contract method(CCM), which one of the following factors wassignificant in decisions reached by both theTax Court and the Ninth Circuit?

a. The taxpayer’s promotion of thedevelopments, which emphasized theplanned community aspects and life style

of the developments, including extensiveamenities and common areas.

b. Prior law, which generally includes incomefor home construction contracts under theCCM at the time a home sale is closed.

c. The taxpayer’s consistent treatment ofincome recognition under the CCM.

9. Based on a recent case dealing with the taxtreatment of forfeited deposits received by theseller, which one of the following statements istrue?

a. If the property under the cancelled salescontract is a trade or business asset, thecharacter of the gain from the forfeiteddeposit is a trade or business gain.

b. The basis of the property that was for saleis reduced by the amount of the forfeiteddeposit.

c. Section 1234A deals exclusively withcapital assets.

10. Based on a recent 4th Circuit Court decision,which one of the following types of services likely will meet the “extraordinary personalservices” exception to not classify an activity asper se a passive activity?

a. Satellite TV service and laundry facilitiesprovided by a rental real estate propertyowner to tenants.

b. Unadvertised tax services unused by manytenants, when provided by a rental realestate property owner to tenants.

c. Physician and nurse services provided topatients in a hospital, who also receivelodging and meals when staying in thehospital overnight.

Solutions

5. "A" is the correct response. While it is truethat the taxpayers informed the IRS about theexcess IRA contributions, the court did notwaive the interest and penalties.

“B" is an incorrect response. The penalty forexcess contributions can be avoided in the yearmade as long as the excess contribution (plusits earnings) is distributed by the due date ofthe taxpayer’s tax return.

"C" is an incorrect response. Once the IRSassessed the excise taxes, the taxpayerspromptly paid the taxes plus penalties. Wu.

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6. "C" is the correct response. The plan wasthe taxpayer’s Section 403(b) qualifiedretirement plan with her employing schooldistrict.

“A" is an incorrect response. The taxpayerhad a grace (cure) period (by the end of thequarter following the quarter in which a loanpayment was due) in which to make up amissed payment.

"B" is an incorrect response. The taxpayerspecified in the loan agreements that the loanswere not to be used as residential loans. Martinez and Garcia.

7. "B" is the correct response. The Tax Courtnoted that whether an estate is entitled to aSection 2054 theft loss deduction relating toproperty held by an LLC was an issue of firstimpression, because neither legislative historynor the Treasury regulations relating to Section2054 had addressed the issue.

“A" is an incorrect response. Legislativehistory had not previously addressed the issue.

"C" is an incorrect response. Treasuryregulations had not previously addressed theissue. Estate of James Heller.

8. "A" is the correct response. Both courtsbased their decision on the special emphasisthe taxpayer made on selling a lifestyle andplanned community rather than a particularhouse.

“B" is an incorrect response. Although it istrue that under prior law home buildersgenerally recognize income under the CCMafter the construction of each home iscompleted, the courts sided with the taxpayerwho recognized the income when thedevelopment was substantially (95%)completed.

"C" is an incorrect response. While thetaxpayer was consistent with its treatment, thisfactor was not relevant in either court’sdecision. Shea Homes.

9. "C" is the correct response. Section 1234Aexpressly refers to property that is "a capitalasset in the hands of the taxpayer." The courttook a narrow interpretation of this provisionand denied capital gain treatment on the receiptof a forfeited deposit on a cancelled sale oftrade or business property.

“A" is an incorrect response. The gain wastreated as ordinary income even though the

forfeited deposit related to a cancelled sale oftrade or business property.

"B" is an incorrect response. While a basisreduction in the property where the sale wascancelled may have merit, it was nevermentioned in the case. CRI-Leslie, LLC.

10. "C" is the correct response. One example inthe treasury regulations notes that servicesrendered by doctors and nurses to patients in ahospital would be extraordinary. On the otherhand, the providing of overnight lodging andmeals to patients at the hospital are notextraordinary services as they are incidental tothe patient’s being there principally for medicalservices.

"A" is an incorrect response. These wereexamples of common, routine services, allegedby the taxpayers and agreed by the court, whichdid not rise to the level of extraordinaryservices.

"B" is an incorrect response. For the case,such services that the taxpayers provided, perthe court, did not rise to the extraordinaryservice level. Johnson, Wijayaningsih.

444444444444 TREASURY 4444444444444444

[ITEM 18] THE TIGTA REPORTS UNDERREPORTED INCOME FROM ROTHCONVERSIONS WAS NOT SUFFICIENTLYDETECTED BY THE IRS

In Report Number 2016-10-054 [8/30/16] issued bythe Treasury Inspector General for TaxAdministration (TIGTA), the TIGTA reports theresults of an audit to assess whether the IRS hassufficient processes in place to address taxpayerswho underreport taxes due when converting assetsto Roth IRAs. It made two recommendations to theIRS based on the audit. As background, it notedthe changes effective in 2010 which allowedtaxpayers with AGIs above $100,000 to convertassets maintained in a traditional IRA into a RothIRA by paying all taxes due on converted assets. In2011 approximately 400,000 taxpayers convertedmore than $10 billion in assets from traditional IRAsto Roth IRAs. Form 8606 is required to be attachedto Form 1040 when a conversion takes place, andis used to determine the taxable amount due toconversion. Third-party trustees report Rothconversions to taxpayers and the IRS on Forms5498 and 1099-R. The IRS AutomatedUnderreporter (AUR) Program matches theamounts reported by IRA trustees on Forms 1099-Rto amounts that taxpayers report on Lines 15a and15b (IRA distributions) and Lines 16a and 16b(pensions and annuities) of Form 1040 to identify

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retirement income discrepancies. The TIGTAconcluded that, while the IRS has processes inplace to address taxpayers who underreport taxesdue on Roth conversions, the AUR employees didnot always follow the processes. The TIGTAreviewed a random sample from 18,382 potentialRoth IRA conversion compliance cases, and foundthat the IRS did not follow its establishedprocedures in 48 of the 383 sampled cases. The13% error rate was higher than the IRS’s estimated7.4% error rate for all types of discrepancy casesworked by the AUR Program. The TIGTA foundthat in some instances the errors were due tounclear AUR Program guidance for processing RothIRA conversions, and in other cases the guidancewas not followed by AUR Program personnel. TheTIGTA recommended that the IRS should clarifyguidance and educate AUR Program personnel onRoth IRA conversion issues. The IRS agreed withthis recommendation. Also, the TIGTA found thatin 97 of the 383 sampled cases (25%), there wasinformation that could have been researched onIRS systems that would have enabled IRS AURProgram personnel to correctly conclude thatminimal or no taxes were due on discrepanciesresulting from Roth conversions. Even though ineach of the 97 discrepancies taxpayers received CP2000 Notices (“Request for Verification ofUnreported Income, Payments, or Credits”), little orno additional tax ended up being assessed. TheTIGTA also found that some taxpayers whorecharacterized Roth IRA conversions were sentunnecessary notices, and some taxpayers wereunnecessarily sent notices when a Form 8606showed their Roth IRA conversion was not a taxableevent. The TIGTA recommended that the IRSshould update processes and procedures toconsider all information that it has readily availableon IRS systems for Roth IRA conversions beforeissuing notices to taxpayers. The IRS disagreedwith this recommendation.

[ITEM 19] TIGTA REPORTS IRS TRENDS INCOMPLIANCE ACTIVITIES THROUGH FISCAL2015

In Report Number 2016-30-073 [9/8/16], the TIGTAprovides a compilation of statistical informationreported by the IRS in the area of complianceactivities over five years through Fiscal Year (FY)ending September 30, 2015. During FYs 2009 and2010, the IRS hired more than 1,500 revenueofficers. However, the number of revenue officershas decreased 30% over the past five years, from3,733 in FY 2011 to 2,612 at the end of FY 2015. Inaddition, the number of contact representativeswithin the Automated Collection System (ACS) hasdecreased 22%, from 2,622 in FY 2011 to 2,045 inFY 2015. Total tax revenue increased each yearfrom $2.4 trillion in 2011 to $3.3 trillion in 2015. However, revenue collected through enforcement

activities decreased to $54.2 billion in FY 2015 from$57.1 billion (a 5% decline) in FY 2014. Losses inthe number of examination employees continued toaffect the number of examinations of tax returns. InFY 2015, the number of examinations conducted bythe IRS decreased less than 1% from the numberconducted during FY 2014. However the number ofexaminations was more than 20% lower than thenumber conducted during FY 2011. IRSexaminations can range from the issuance of anIRS notice asking for clarification of a single taxreturn item that appears to be incorrect(correspondence examination) to a face-to-faceinterview and review of the taxpayer’s records. Thenumber of individual income tax returnexaminations decreased for the fifth straight year.The IRS examined 1,228,117 (one of every 120) taxreturns in FY 2015. This is 1% less than the numberof examinations performed in FY 2014 and 22%fewer examinations than the five-year high reportedin FY 2011. During FY 2015, 83% of theexaminations of individuals were performed bycorrespondence, which is less than 1% more thanduring FY 2014. One of every 714 individualincome tax returns filed received a face-to-faceexamination, which is a 10% decrease comparedwith FY 2014, when one of every 646 individualreturns received a face-to-face examination. Examinations of individual returns with income ofbetween $200,000 and $1 million decreased 13%from FY 2014 to FY 2015 (71,280). In contrast thepercent of individual returns with incomes over $1million that were audited increased from 7.7% in FY2014 to 10% in FY 2015.

**REVIEW QUESTIONS AND SOLUTIONS**

11. In a recent TIGTA report for its audit of IRSreview of returns with Roth conversions, whatwas the rate for the IRS’s not researchinginformation on its systems that would haveallowed it to conclude that minimal or no taxeswere due on discrepancies resulting from Rothconversions?

a. 25%.b. 13%.c. 7.4%

Solutions

11. "A" is the correct response. The TIGTAfound that in 97 of the 383 sampled cases(25%), there was information that could havebeen researched on IRS systems that wouldhave enabled IRS AUR Program personnel tocorrectly conclude that minimal or no taxeswere due on discrepancies resulting from Rothconversions.

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“B" is an incorrect response. 13% was therate the TIGTA found from its sampling that IRSpersonnel did not follow its establishedprocedures to detect underreported taxes dueon Roth conversions.

"C" is an incorrect response. 7.4% was theIRS’s estimated error rate for all types ofdiscrepancy cases worked by its AUR Program. TIGTA Report 2016-10-054.

44444 [ITEM 20] AN ELITE POSSIBILITY 444444

Assume a couple owns a rental home near theirresidence which they rent to tenants on a one-yearlease. The husband is a real estate agent and thewife is a physician. Because their combined AGI isin excess of $150,000, they do not qualify for the$25,000 rental deduction for taxpayers who meetthe active participation rules. The husband collectsthe rent, advertises and shows the property when itis vacant, and arranges for repairs of the rentalhome when needed. He also makes the mortgagepayment and pays any other bills associated withthe rental home. The number of hours devoted tohis real estate business averages out to about 40hours per week and the amount of time he devotesto the rental home is about 10 hours per month. For the current year, the rental home has a taxableloss of $10,000. May the couple deduct the$10,000 rental loss against gross income in thecurrent year assuming they have no other passiveincome or losses? The Ninth Circuit decision inGragg [8/4/16] sheds some light on this questionand offers a tax-planning and investmentopportunity. In this case, the wife was a real estateagent and she contended that the losses from theirrental property were deductible under the realestate professional rule, which is an exception tothe passive activity loss rules. Because more than750 hours and 50% of her personal services weredevoted to real estate activities, she argued thattheir losses were automatically nonpassive and theydid not need to prove material participation. TheDistrict Court granted summary judgment in favor ofthe IRS and the taxpayer appealed. The only issueaddressed by the Ninth Circuit is whether the realestate professional rule automatically renders a realestate professional's rental losses nonpassive anddeductible, or whether it merely removes Section469(c)(2)'s per se bar on treating rental losses aspassive. The Ninth Circuit indicated that this issuehas not yet been addressed in its circuit althoughthe Tax Court has squarely rejected it. The TaxCourt has ruled that the Code provides only twotypes of passive activities – (1) all rental activitiesexcept those where the taxpayer qualifies as a realestate professional, and (2) activities where thetaxpayer is not a material participant. Theprofessional rule simply moves the activity into thesecond category. To be exempted from the passiveactivity loss limitations, the taxpayer must

demonstrate that she is a material participant in theactivity, including rental activities where thetaxpayer satisfies the real estate professional rule. The Ninth Circuit agreed with the Tax Court’sreasoning and affirmed the District Court’s rulingthat the taxpayer must demonstrate that shematerially participated in the rental activities. Thetaxpayer then argued that she materiallyparticipated in the rental activities but the NinthCircuit declined to address her new argument as itwas not raised in the District Court hearing. On thebasis of court cases that we have read in this area,the focal point of material participation is the 500hour test, which is the first of seven safe harborsprovided in the Treasury regulations. In ourexample, and most likely in the Graggs’ situation,the 500 hour test is not satisfied. However, thereare at least two safe harbors which the taxpayers inour example satisfy. First, Regulation Section1.469-5T(a)(2) provides “the individual'sparticipation in the activity for the taxable yearconstitutes substantially all of the participation insuch activity of all individuals (including individualswho are not owners of interests in the activity) forsuch year.” In our example, the husband prettymuch takes care of everything that is needed to bedone to rent out the dwelling. When you have agood tenant who pays on time and stays for the fulllength of the lease, there is not much to do exceptto collect and deposit the rent, pay a few bills eachmonth, and make repairs from time to time. Thissafe harbor provides no minimum number of hourseach year so if the taxpayer-owner of a rental homemanages the property, the taxpayer should qualifyas a material participant under this safe harbor anddeduct the rental losses assuming they satisfy thereal estate professional rule. Second, RegulationSection 1.469-5T(a)(2) provides “the individualparticipates in the activity for more than 100 hoursduring the taxable year, and such individual'sparticipation in the activity for the taxable year is notless than the participation in the activity of any otherindividual (including individuals who are not ownersof interests in the activity) for such year.” So if thetaxpayer hires someone to provide some of theservices related to managing real property, thetaxpayer must satisfy two requirements in this safeharbor – his hours dedicated to this activity must begreater than (1) 100, and (2) more than anyoneelse’s hours. More dedicated recordkeeping isrequired under this safe harbor to substantiate thenumber of hours devoted to the rental activity but itshould not be too burdensome. Therefore, if ataxpayer is in the real estate business, owns arental property, and manages the property, thepassive activity loss rules should not apply therebygiving the taxpayer a nice tax deduction as well asa diversified investment from the traditional Section401(k) investment of mutual funds that most taxpayers choose as their major retirementinvestment.

16

**REVIEW QUESTIONS AND SOLUTIONS**

12. In a recent case dealing with the real estateprofessional exception to the passive activityloss rules, why did the Ninth Circuit deny thetaxpayers a current deduction for their lossesfrom their rental property?

a. It ruled that neither the husband nor thewife qualified for the real estateprofessional exception.

b. It ruled that satisfying the real estateprofessional exception does notautomatically treat rental losses asnonpassive.

c. It ruled that neither the husband nor thewife was a material participant in the rentalproperties.

Solutions

12. "B" is the correct response. The Ninth Circuitruled that satisfying the real estate professionalexception merely shifts the property from therental category of passive activities to thesecond category which requires materialparticipation in order to be excluded from thepassive activity loss limitation.

“A" is an incorrect response. The wife wasa real estate agent and qualified for the realestate professional exception.

"C" is an incorrect response. The NinthCircuit declined to address whether thetaxpayer was a material participant becausethis issue was not raised in the District Courthearing. Gragg and An Elite Possibility.

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All rights reserved. The reproduction or translation of these materials is prohibited without the written permission of CPElite.T.M. Thematerial contained in CPElite'sT.M. courses and newsletters qualifies for CPE credit designed to enhance the professional knowledge ofthe individual. The material is sold with the understanding that CPEliteT.M. is not engaged in rendering legal, accounting, tax, or otherprofessional services in a consulting capacity. Publication Date – September 15, 2016.44444444444444444444444444444444444444444444444444444444444444444444444444444444444444444444444444444444444444

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INDEX

Administrative expenses,1 2,8,11- 12,20 Agency, 5,11Automated Underreporter, 2,14,20Business purpose, 10-11Collected proceeds, 2,12-13,20Completed contract method, 2,8, 13,19Domestic employee, 3,18Estate tax, 1-2,8,11-12,20Estate tax lien, 1-2,11-12,20Excess IRA contribution, 1-2,13, 19Excise tax, 1-2,6-7,13,19

Extraordinary personal services, 2, 9-10,13,19First in time is the first in right, 2, 11-12,20Hardship exception, 1-2,4,6-7,18High-low method, 1,3-4,6Installment agreement, 5,19ITIN, 1-2,5,19LLC, 1,3,5-6,8-9,14,18-19Material participation, 2,16-17Passive activity, 1-2,10,13,16-17, 19-20Ponzi scheme, 1,8Power of attorney (POA), 1-2,4-5, 18

Qualified Plan, 1,7,13Real estate professional rule, 2,16Roth conversions, 1,14-16,20Section 1234A, 2,9,13-14Self-certification, 1,4,6Self-employment, 1-3,5-6,18Social Security, 1-3,5,18Substantially level amortization, 2,7Taxable distribution, 1,7-8,13Theft loss, 1,8,13-14,19User fee, 1,5Whistleblower, 2,12,20

4444444444444444444444444444444444444444444444444444444444444444444444444444444444444444***** QUIZ QUESTIONS *****

Place your answers to the following 20 Multiple Choice Questions on the enclosed answer sheet (page 21).

ON-LINE TESTERS GO TO CPELITE.COM

1. Concerning a new identity theft scam announcedby the IRS, which one of the followingstatements is false?

a. The scam focuses on tax returns that arefiled by mail.

b. The IRS is aware of around 25-30 caseswhere the scam was successful.

c. In the scam, tax professionals are instructedto download a file to update their taxsoftware.

2. For a recent ruling dealing with whether an LLCmember’s income from the LLC was subject toself-employment tax, which one of the followingstatements is false?

a. The LLC member was an inactive investor inthe LLC.

b. The member’s guaranteed payment fromthe LLC was subject to self-employment tax.

c. The IRS ruled that a member’s distributiveshare from the LLC was subject to self-employment tax.

3. Which one of the following Social Securityamounts does not change from 2016 to 2017?

a. The maximum taxable earnings for SocialSecurity purposes.

b. The domestic employee coverage threshold.

c. The coverage threshold for election officialsand election workers.

4. For 2016 - 2017, how much of the per diem ratefor travel to a “high-cost” locality is treated aspaid for meals?

a. $57. b. $68.

c. $63.

5. The IRS provides several reasons for missing the60-day rollover rules that qualify for a self-certification hardship exception. Which one ofthe following is not one of the reasons?

a. The taxpayer's principal residence wasseverely damaged.

b. The taxpayer was out of town on businessduring the last week of the 60-day period.

c. The taxpayer was incarcerated.

6. In an IRS ruling where the taxpayer granted apower of attorney (POA) to a person to preparethe taxpayer’s tax return, why didn’t the ChiefCounsel find a reasonable cause for the latefiling?

a. The POA was invalid.

b. There was no proof that the taxpayer wasincapacitated before the filing deadline.

c. The taxpayer, not the individual granted thePOA, had a duty to timely file her tax return.

18

7. Which one of the proposed or projected fees for2017 is incorrect?

a. $43 for regular installment agreements forlow-income taxpayers.

b. $50 for PTIN renewal.

c. $89 for restructuring or reinstating aninstallment agreement.

8. For a recent ruling on Individual TaxpayerIdentification Numbers (ITINs), which one of thefollowing statements is true?

a. If an ITIN has not been used on a federaltax return at least once in the last threeyears, it will no longer be valid effectiveJanuary 1, 2017 unless it is renewed.

b. Taxpayers who must renew their ITIN do nothave an option to renew ITINS for theirfamily at the same time.

c. A taxpayer files Form W-9 to renew an ITIN.

9. In a court case involving excess IRAcontributions, which one of the followingstatements is true?

a. The excise tax equals 10% of excess IRAcontributions each year until the excess isdistributed.

b. The IRS discovered the excess IRAcontributions after it audited the taxpayer’s2007 tax return.

c. For taxable years after the excesscontribution is made, the excise tax for asubsequent year is avoided by withdrawing(distributing) the excess contribution by theclose of the subsequent taxable year.

10. Based on a recent case dealing with a taxpayer’sloans from her qualified retirement plan, whichone of the following statements is false?

a. The loans were required to be repaid withsubstantially level payments.

b. The loans were to be repaid within fiveyears.

c. The taxpayer was permitted to use the loanproceeds as a residential loan.

11. For a recent case dealing with a theft lossclaimed by an estate, which one of the followingstatements is true?

a. The estate claimed a theft loss deductionequal to the value of the estate’s interest inthe LLC.

b. The Tax Court agreed with the IRS that the

law calls for a narrow interpretation of nexusbetween the theft and the incurred theft loss.

c. The IRS argued that the estate was notentitled to a theft loss deduction because theestate did not incur a theft loss during itssettlement.

12. In a court case involving home constructioncontracts and the completed contract method,what is the critical event that the Ninth Circuitruled that triggers whether 95% of the budgetedcosts were incurred?

a. When the taxpayer incurs 95% of thebudgeted costs of the development,including the number of planned homes,lots, and common amenities.

b. When the taxpayer incurs 95% of thebudgeted costs of the contracted-for house,lot, and common amenities, but not thecosts of the other houses.

c. When a home sale closes in escrow.

13. A taxpayer engages in a contract to sell an officebuilding for $1 million and receives a $50,000nonrefundable deposit. The buyer decides not toclose on the purchase and forfeits the $50,000deposit. Based on a recent court case, what isthe character of the gain resulting from thedeposit forfeiture?

a. Capital gain.

b. Trade or business gain.

c. Ordinary income.

14. For a recent 4th Circuit decision involving thepassive activity loss rules, which one of thefollowing statements is false?

a. The providing of numerous amenities andservices including fire and horseshoe pits,satellite TV service, kitchen dishes andappliances, furniture, cleaning supplies, andcontinental breakfast items met the“extraordinary personal services” exceptionto avoid rental properties being classified asa rental passive activity.

b. The IRS argued that the taxpayers’ rentalactivities were passive activities.

c. The 4th Circuit agreed with a North Carolinadistrict court that upheld the IRS position.

19

15. Which one of the following was not determinedto be an important factor by the Tax Court in arecent decision in which it attributed losses froma cattle operation to a corporation, not thecorporation’s owners?

a. The corporation bought and sold cattleunder its own name.

b. The corporation held a bank account, andheld workers’ compensation and employer’sliability insurance policies.

c. The corporation had a manager whomanaged the cattle operation.

16. For a recent case involving a special estate taxlien and the estate administrator’s administrativeexpenses, what principle or law did the 11th

Circuit use to decide if the expenses could bepaid before (excluded from) the estate tax lien?

a. The principle “the first in time is the first inright” applied to provide that administrativeexpenses may be paid before the special taxlien.

b. A special tax lien under Section 6324A doesnot exclude amounts related toadministrative expenses from the speciallien.

c. The estate representative’s claim foradministrative expenses is a lien on theestate.

17. After an individual provides evidence to the IRSthat a taxpayer is committing fraud, thefraudulent taxpayer pays $5,000,000 to the IRSconsisting of $4,000,000 in taxes, $600,000 ininterest and penalties as provided in the InternalRevenue Code (IRC), and $400,000 in criminalfines provided in laws outside the IRC. Thetaxpayer and IRS agree that the taxpayer willreceive a whistleblower award equal to 20% ofthe qualified collected proceeds. Based on arecent case, what is the amount of qualifiedcollected proceeds?

a. $5,000,000.b. $4,600,000.c. $4,000,000.

18. In accordance with a recent TIGTA report dealingwith IRS detection of noncompliance for Rothconversions, which one of the following was nota TIGTA finding?

a. The 13% error rate was lower than the IRS’sestimated error rate for all types ofdiscrepancy cases worked by the IRS’s“Automated Underreporter (AUR) Program.”

b. The errors committed by IRS personnelwere due in part to unclear AUR Programguidance for processing Roth IRAconversions.

c. The errors committed by IRS personnelwere due in part to guidance not beingfollowed by AUR Program personnel.

19. Concerning a recent TIGTA study involving IRSefforts in investigating taxpayer compliance overthe last five years, which one of the followingstatements is false?

a. The number of revenue officers hasdeclined 30% over the last five years.

b. Examinations of individual returns withincome over $1 million during FY 2015decreased from FY 2014.

c. During FY 2015, 83% of the examinationsof individuals were performed bycorrespondence.

20. Assume a single taxpayer builds homes anddevotes an average of 45 hours per week to thisbusiness. He also owns a rental home to whichhe devotes an average of 15 hours per monthcollecting rent, advertising the property when it isvacant, and paying bills. No one else is involvedin managing the rental home. When repairs areneeded, the taxpayer makes the repairs himself. This year, he incurs a $10,000 loss on the rentalhome and has no passive activity income. Basedon a recent court case and An Elite Possibility,which one of the following statements is false?

a. Because the rental home is a rental activity,none of the $10,000 is deductible this year.

b. The taxpayer satisfies the real estateprofessional exception to the passive activityrules governing rental activities.

c. Because the taxpayer devotes more than100 hours annually to the rental home andhis participation is more than anyone else,he is considered a material participant in therental home.

20

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QUIZ INSTRUCTIONS AND ANSWER SHEET – WINTER 2016, VOLUME XXV, NUMBER 4, TAXATION(LATEST RECOMMENDED COMPLETION DATE: WITHIN ONE YEAR OF PURCHASE)

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Option 2 - 2017 EA Package - 24 hrs of CPE **select ONE course below: Enter $155 ($140 if paid by 2/15/17) ___________

Option 3 - 2017 Annual Subscription - 18 hours of CPE: Enter $135 ($120 if paid by 2/15/17) ___________

Option 4 - Quarterly Newsletter submitted as single issue (4 hrs of CPE): Enter $40 _________

Option 5 - Special Course Offer - 20 hrs of CPE **select 3 courses below: Enter $135 ($120 if paid by 2/15/17) _________

Option 6 - Individual 6-hour Course(s) **select below - $10 per CPE hour (# of courses checked times $60) _________ _Select Courses for Options 2, 5, and 6__

**Course # 1 2 3 4 5 6 7 8 Delivery - PDF Or Mail On-line Testing - Yes No

2. AMOUNT DUE: Total of all Options (Payable by Check to CPEliteT.M. Inc. or VISA, MC, Discover below) $

PLACE ORDER one of 4 ways – At our website www.cpelite.com (first-time online customers – Click ‘Order Now’ Tab, existing

online customers – log in to your account), phone or fax 1-800-950-0273, or by mail.

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For mail and fax orders, please complete the credit card information below for VISA [ ] Mastercard [ ] Discover [ ] (check one)

Credit Card # _________________________________________________Ex piration Date _________________________________

Name_________________________________________________ Signature____________________________________________

Phone________________________ Address______________________________________________________________________

To order by mail - CPElite, T.M. Inc.. Customers with Zip Codes below 56000 -- Address to P.O. Box 721, White Rock, SC 29177-0721. Customers with Zip Codes above 55999 -- Address to P.O. Box 1059, Clemson, SC 29633-1059. To order by phone orfax using your Discover, Mastercard, or VISA, call or fax: 1-800-9500-CPE. Please have your credit card information available. To order on the internet visit our web site at www.cpelite.com, then click the ‘Order Now’ Tab. We appreciate your business!

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CPE CREDIT INFORMATION

Contact us by E-mail (cpeliteinc@aol.com), phone or Fax (1-800-950-0273)

SIX CPE CREDIT OPTIONS - DETAILS BELOW

OPTION 1 - 2017 Unlimited CPE Online Package - up to 66 hrs

OPTION 2 - 2017 EA Package - 24 hrs

OPTION 3 - 2017 Annual Subscription Package -18 hrs

OPTION 4 - Single Newsletter - 4 hrs

OPTION 5 - Special Course Offer - 20 hrs

OPTION 6 - Individual Course(s) - 6 hrs per course

OPTION 1 – 2017 Unlimited CPE Online Package – upto 66 hours of CPE - $175 ($160 if paid by 2/15/17). Coursesavailable in PDF format in your online account or emailed byrequest. Quizzes online. Covers four quarterly 4-hour issues ofThe Elite Quarterly – Taxation (including Ethics issue for enrolledagents) and all eight courses. Refer to page 24 for coursedescriptions. The 2017 courses (available by March 31st) must becompleted by December 31, 2017, under this option.

OPTION 2 – 2017 EA Package - 24 hours of CPE – $155($140 if paid by 2/15/17). This satisfies the average annualcontinuing education requirement for Enrolled Agents. Includesfour quarterly 4-hour issues of The Elite Quarterly – Taxation issued 4 times per year (plus 2 hour Ethics issue for enrolledagents) and one 6-hour 2017 course (available by March 31st) bymail or PDF format. Make course selection for option 2 on theorder form on page 22.

OPTION 3 – 2017 Annual Subscription to The EliteQuarterly – 18 hours of CPE - $135 ($120 if paid by 2/15/17). For those wishing to complete only newsletters for CPE credit. Includes four quarterly 4-hour issues of The Elite Quarterly –Taxation issued 4 times per year (plus 2-hour Ethics issue forenrolled agents).

OPTION 4 – Single Quarterly Newsletter – Select Option4 on the order form, and enclose your check for $40 payable toCPElite,T.M. or provide your credit card authorization.

OPTION 5 – Special Course Offer – Choose 3 of ourcourses for a total of $135 ($120 if paid by 2/15/17). Plus youreceive the 2 hour Ethics issue for enrolled agents free – A totalsavings of $65 ($80 if paid by 2/15/17). Make course selection foroption 5 on the order form on page 22.

OPTION 6 – Individual Course(s) - We offer eight 6-hourCPE credit courses which are updated annually. Each coursecosts $60 under this option. Make course selection for option 6 onthe order form on page 22.

ENROLLED AGENTS – Our CPE newsletters and coursesqualify for EA’s. Our “ethics” newsletter satisfies the 2-hour ethicscomponent for EA’s.

CPAs AND LICENSED ACCOUNTANTS – Our newsletters and courses conform to the enhanced AICPA/NASBAStandards for providers of continuing professional education. Weare a NASBA-approved QAS Learning Provider.

CPE INFORMATION – Each newsletter and course contains 5quiz questions per CPE hour. You must score at least 70% toreceive CPE credit. Online testers see ONLINE TESTING below. Otherwise, place your answers to the quiz questions on theanswer sheet (page 21) and remit payment if you have notpurchased one of our packages. You specify the date youcomplete the quiz on your answer sheet. You must completethe material for CPE credit within one year from the purchasedate. Our materials are also available for download atwww.cpelite.com.

ONLINE TESTING – Current online testers – Go towww.cpelite.com, and log in to your account. New customersCLICK “Online Testing Available” at our website for instructions. Our online testing system is integrated into our website.

HOW TO ORDER – Order at our website at www.cpelite.com,by clicking the “Order Now” Tab, otherwise:

1. Complete the newsletter

2. Fill in the answer sheet

3. Complete order form/select payment option

4. Enclose payment

5. Mail, fax, or email the answer sheet and order form

Questions? E-mail us at cpeliteinc@aol.com. Or, call us at1-800-950-0273, or for more information regarding administrativepolicies such as complaint and refund, please contact our officesat 1-800-950-0273.

We are the leader in continuing professionaleducation newsletters!

44444444444444444444444444444444444444444444444444444444444444444444444444444444444A DESCRIPTION OF CPElite's T.M. CPE MATERIALS

The recommended CPE hours for our newsletters are based on length of written material, level of difficulty, and input from reviewers andpilot testers. Each hour of credit specified below is based on a 50-minute hour per CPE hour. The content level of materials is an update[U] for our newsletters and basic [B] for each course. Notes: There are no prerequisites nor is advanced preparation required for ourproducts. The learning objectives of each CPE product are provided below and on page 24. All our materials are available for downloadand on-line testing.

NEWSLETTERS

[1] THE ELITE QUARTERLY – Recommended CPE Credit – 4 Hours per issue [U]

To make practitioners aware of recent tax developments in legislation, the IRS, judicial decisions, and the Treasury. The four issuestypically are available on-line, by email, or mail by the following dates: May 1, July 15, September 15, and November 30. Each issuecosts $40. An annual subscription to all four issues costs $135 ($120 if paid by 2/15/17). The 2-hour ethics issue for enrolled agentsis included in the subscription.

[2] ETHICS FOR ENROLLED AGENTS – Recommended CPE Credit – 2 Hours per issue [U] To provide recent developments affecting tax professionals which satisfy the ethics and professional conduct component required for

enrolled agents only. The 2017 issue costs $20 and is free to annual subscribers to The Elite Quarterly and Option 5 orders.444444444444444444444444444444444444444444444444444444444444444444444444444444444444444

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THE ELITE QUARTERLY NEWSLETTERPublished by CPElite,T.M. Inc.

P.O. Box 721, White Rock, 29177-0721 or

P.O. Box 1059, Clemson, SC 29633-1059 Change Service Requested

** 4 HOURS OF SELF-STUDY CPE CREDIT INSIDE **

ON-LINE TESTING AT NO ADDITIONAL CHARGE

FREE ELECTRONIC REPORTING OF CPE TO THE IRS

The leader in “continuing professional education newsletters” for tax professionals

(Visit us at www.cpelite.com or Call us at 1-800-950-0273)

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COURSES – Field of Study: Federal Tax[1] INCOME ITEMS AND PROPERTY TRANSACTIONS. Recommended CPE Credit: 6 HRS [B]

To provide an explanation of (1) selected income items affecting individual income taxpayers, including social security income,alimony, and scholarships, and (2) common property transactions involving individual income taxpayers, such as capital gains,sale of personal residence, and like-kind exchanges.

[2] ABOVE-THE-LINE DEDUCTIONS. Recommended CPE Credit: 6 HRS [B]

To provide an explanation of (1) expenses commonly deducted by Schedule C taxpayers, including travel, transportation, andhome office deductions, and (2) and common above-the-line deductions.

[3] ITEMIZED DEDUCTIONS. Recommended CPE Credit: 6 HRS [B]

To provide an explanation of medical expenses, taxes, residence interest, charitable contributions, nonbusiness casualty andtheft losses, miscellaneous itemized deductions, and the standard deduction.

[4] RATES, CREDITS AGAINST TAX, AND SPECIAL ISSUES. Recommended CPE Credit: 6 HRS [B]

To provide an explanation of the tax rate structure, selected credits (including the earned income tax credit and the educationcredits), estimated tax payments, and selected special issues (including filing status and exemptions).

[5] PARTNERSHIP TAXATION – PART I. Recommended CPE Credit: 6 HRS [B]

To provide an explanation of (1) the tax implications of formation, including gain or loss, basis of partnership interest, and basisof partnership assets after formation and (2) general reporting procedures of partnership items.

[6] PARTNERSHIP TAXATION – PART II. Recommended CPE Credit: 6 HRS [B]

To provide an explanation of the special topics involving partnership operations and the tax implications of sales of partnershipinterests, partnership distributions, and redemptions of a partner’s interest.

[7] S CORPORATION TAXATION – PART I. Recommended CPE Credit: 6 HRS [B]

To provide an explanation of (1) considerations in being an S Corporation, (2) requirements and election to be an S Corporation,(3) elections and operations, (4) shareholder basis issues, and (5) reporting and compliance.

[8] S CORPORATION TAXATION – PART II. Recommended CPE Credit: 6 HRS [B]

To provide detailed coverage of S Corporation shareholder basis issues, and an explanation of loss limitation issues,distributions made by an S Corporation to its owners, and S Corporation shareholder changes and income taxes.

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