Flickr image courtesy John Snape under Creative Commons license
Pay me now, tax me now. A real estate operator agreed to build and lease a building to a tenant, a plasma collection center. The 10-year lease had a provision allowing the tenant to buy down monthly payments by reimbursing the landlord development costs. In 2008, the tenant chose to pay $1 million to the landlord under this lease clause.
Getting a $1 million payment can complicate your tax planning. Tax Court Judge Ruwe explains the simple approach used by the landlord on the joint return he filed:
Petitioners jointly filed a Form 1040, U.S. Individual Income Tax Return, for 2008. On one of the Schedules E attached to the return petitioners reported rents received of $1,151,493 in connection with the plasma collection center rental. Among the deductions that petitioners claimed on this Schedule E was a $1 million “contribution to construct” expense.
The IRS disagreed, saying that the taxpayer should have reported the amount as rent without the “contribution to construct” deduction.
When it got to Tax Court, the taxpayer dropped the deduction argument and instead argued, first, that the $1 million payment wasn’t income in the first place, but an expense reimbursement. The Tax Court said that the use of the payment to buy down rent payments was fatal to that argument.
The taxpayer then argued that the rental income should be spread over 10 years under the “rent levelling” rules of Section 467. This often-overlooked section was enacted to prevent games like tenants front-loading rent deductions via prepayments to tax-indifferent landlords. Judge Ruwe provides some background (some citations omitted):
Congress enacted section 467 to prevent lessors and lessees from mismatching the reporting of rental income and expenses. Section 467 provides accrual methods for allocating rents pursuant to a “section 467 rental agreement”. In order to qualify as a section 467 rental agreement, an agreement must have: (1) increasing/decreasing rents or deferred/prepaid rents and (2) aggregate rental payments exceeding $250,000. Both parties agree that the lease in this case qualifies as a section 467 rental agreement.
The court held that the lease didn’t “allocate” the $1 million payment across the ten-year lease term:
Petitioners argue that they should be permitted to use the constant rental accrual method provided in section 467(b)(2) in order to spread their rental income to other years. However, this method is inapplicable because it was intended to allow the Commissioner to rectify tax avoidance situations, and the regulations provide that this method “may not be used in the absence of a determination by the Commissioner”.
That’s a tool for the IRS, not for you, silly taxpayer!
The court also held that the rent was not “prepaid rent” that could be deferred over the lease term:
In applying this regulation to the facts of this case we first find that the lease in question does not “specifically allocate” fixed rent to any rental period within the meaning of section 1.467-1(c)(2)(ii)(A), Income Tax Regs. However, the lease does provide for a fixed amount of rent payable during the rental period (i.e., rent payable pursuant to the terms of the lease). Accordingly, in the absence of a “specific” allocation in the rental agreement, the amount of rent payable in 2008 must be allocated to petitioners’ 2008 rental period pursuant to section 1.467-1(c)(2)(ii)(B), Income Tax Regs., which provides that “the amount of fixed rent allocated to a rental period is the amount of fixed rent payable during that rental period.” Therefore, petitioners are required to include as gross income the entire $1 million lump-sum payment made pursuant to the terms of the lease for the year of receipt, 2008.
The Moral? Heads they win, tails you lose, when you aren’t extremely careful drafting a funky lease. Section 467 is obscure and, I suspect, frequently overlooked. It usually doesn’t matter, as most leases don’t get fancy. When they do, though — especially when you see big payment variances — you need to pay attention. The tax results may surprise.
TaxProf, TIGTA: IRS Ignored Recommended Security Upgrades That Would Have Prevented Last Week’s Hack Of 100,000 Taxpayer Accounts. Prof. Caron quotes the Washington Post:
A government watchdog told lawmakers Tuesday that the Internal Revenue Service has failed to put in place dozens of security upgrades to fight cyberattacks, improvements he said would have made it “much more difficult” for hackers to gain access to the personal information of 104,000 taxpayers in the spring.
“It would have been much more difficult if they had implemented all of the recommendations we made,” J. Russell George, the Treasury Inspector General for Tax Administration, told the Senate Finance Committee at a hearing on the data breach, which the IRS says was part of an elaborate scheme to claim fraudulent tax refunds.
Identity theft has been a neglected problem at the IRS for years. Billions of dollars have been lost both to petty Florida grifters and to “a worldwide criminal syndicate” taking advantage of IRS laxity. Yet the last two commissioners (and, sadly, the Taxpayer Advocate) have spent more effort trying to set up a preparer regulation scheme that would do nothing to stop fraud — but would increase IRS power and the market share of the big franchise preparers. Priorities.
And it’s not a matter of a pinched budget. Ask Commissioner Koskinen (via Tax Analysts, $link): “Koskinen acknowledged before the Finance Committee that the Get Transcript security breach was not a matter of resources, and thus budget, but of management.”
Russ Fox, The BEA Responds, or Making IRS Customer Service Look Normal (Bad). Russ reports that BEA has extended the deadline for its mandatory “survey” of foreign business ownership to June 30 for most filers.
Peter Reilly, Failure To File Texas Franchise Tax Form Voids Lawsuit. Sometimes ignoring a state tax filing can bite you in a surprising place.
TaxGrrrl, IRS Changes Position On Identity Theft, Will Provide Copies Of Returns To Victims. “Thanks to an inquiry from Sen. Kelly Ayotte (R-NH), IRS will now provide victims of identity theft with copies of the fraudulent tax returns filed using their personal and financial information.”
Robert Wood, If You Handle Cash, IRS Can Seize First, Ask Questions Later. “Even if your bank/cash efforts come from 100% legal money, the IRS says it still [c]an seize it.”
IJim Maule, Where’s the Promised Trickle-Over? Another example of the illusory nature of the benefits of publicly-funded pro sports venues.
Keith Fogg, Tax Court Continues to Take the Same “Angle” on Attorney’s Fees When IRS Concedes the Case. “I continue to find this line of cases to contradict the purpose of the statute. Particularly for those of us representing low-income taxpayers where the amount of tax at issue is low but the amount of time spent to prepare a case for trial not inconsequential, this loophole is swallowing the rule.”
Jack Townsend, Third Circuit Reverses Variance to One Day from Guidelines Range of 63 to 78 Months. Apparently one day isn’t close enough to 63 months.
Tony Nitti, Will Caitlyn Jenner’s Gender Reassignment Costs Be Tax Deductible?
David Brunori, Amazon Does the Right Thing (Tax Analysts Blog):
Shakopee was prepared to provide direct incentives to Amazon. But Amazon told Shakopee it didn’t want them. That’s right — Amazon said no to the tax incentives being offered.
I would like to think Amazon is being a good corporate citizen, but I really like the idea that it may have backed off because of potential political opposition to the incentives. Only politicians can stop the scourge of incentives. So if political hassles lead to fewer tax incentives, let’s have more political hassles.
Megan Scarboro, New Hampshire Considering Cuts to Corporate Tax Rate (Tax Policy Blog):
While New Hampshire generally has a good tax code, a tax cut for businesses could improve the state’s economic climate.
Because the state has no tax on wage income or general sales, New Hampshire is ranks 7th overall in our State Business Tax Climate Index, but a notable weakness is that high corporate rates drive a ranking of 48th in the corporate tax rate component.
In case you are wondering, Iowa is #50.
Jeremy Scott, Republican Support for Brownback’s Tax Plan Begins to Erode (Tax Analysts Blog).
Howard Gleckman, What’s Up With the No Climate Tax Pledge?
TaxProf, The IRS Scandal, Day 755
Career Corner. Study: Faking Long Hours Is Just As Good As Working Long Hours (Greg Kyte, Going Concern).