Law360 - December 16, 2014

This article highlights a number of interesting federal tax developments that were brought to the table during the 2014 calendar year. Developments discussed in this article include the 18-month transitional period for the Foreign Account Tax Compliance Act, the federal tax treatment of legally married same-sex couples, the taxation of virtual currency and the status of legislative activity to extend certain “extender” provisions through 2014.

Foreign Account Tax Compliance Act  — Transition Period

On July 1, 2014, after numerous delays and multiple rounds of interim administrative guidance, FATCA went into effect. FATCA was enacted as a measure to remedy perceived deficiencies in the current methods used by the Internal Revenue Service and the U.S. Department of Justice to identify U.S. persons who utilize foreign financial accounts or foreign entities. FATCA aims to detect, deter and discourage offshore tax abuses by establishing increased transparency through enhanced reporting and aggressive sanctions.

FATCA requires foreign financial institutions (“FFIs”) to undertake certain identification and due diligence procedures with respect to their account holders and to report annually to the IRS on account holders who are U.S. persons or foreign entities that are substantially owned by U.S. persons. Under FATCA, a U.S. entity that remits U.S.-source income to an FFI or to certain other foreign entities that are not in compliance with FATCA may be required to withhold a 30 percent tax on those payments.

On May 1, 2014, the IRS issued Notice 2014-33 to announce that the 2014 and 2015 calendar years would operate as a transition period for purposes of the IRS’ enforcement of FATCA. Within the transition period, the IRS will take into account the extent to which withholding agents, FFIs and other entities are making a good faith effort to comply with FATCA. The notice states that the transition period and other guidance described in the notice are intended to facilitate a smooth and orderly transition for withholding agents and FFIs to comply with FATCA’s requirements.

Federal Tax Treatment of Married Same-Sex Couples

In August 2013, the IRS and the Treasury Department ruled that same-sex couples who are legally married under state law will be treated as married for all federal tax purposes, including income, gift and estate taxes. The ruling applies to all federal tax provisions where marriage is a factor, such as:

• filing status,
• claiming personal and dependency exemptions,
• taking the standard deduction,
• employee benefits,
• contributing to an IRA and
• claiming the earned income tax credit or child tax credit.

In February 2014, the IRS published guidance applicable to legally married same-sex couples who reside in community property states. The guidance clarifies that legally married same-sex couples are treated as legally married for purpose of reporting community property on their federal income tax returns. In March 2014, the IRS published a list of frequently asked questions and answers for legally married same sex couples. Among the answers provided, the IRS states that a same-sex couple who was legally married in a prior open tax year is permitted to amend its tax return for any such year. As a separate answer, the IRS provides that the jurisdiction in which the same-sex couple resides does not impact their federal tax treatment as legally, so long as the couple was legally married in a state that recognizes the marriage.

Taxation of Virtual Currency as Property, Not as Foreign Currency

In Notice 2014-21, published in March 2014, the IRS announced that virtual currency will be treated as property for federal tax purposes. As a result of that treatment, purchases made with bitcoins (an existing form of virtual currency) are treated as property transfers and will trigger gain/loss recognition on the sale. For example, purchasing a $2 cup of coffee with bitcoins bought for $1 would trigger $1 in capital gain for the coffee drinker and $2 of gross income for the coffee shop.

Commentators have emphasized that the IRS’ decision to treat virtual currency as property, as opposed to as a foreign currency, could reduce the volume of transactions conducted with virtual currency. While the market for virtual currency is not yet fully established, certain vendors of low-priced items (such as coffee shops and other quick service food establishments) currently accept virtual currency. The challenge in that circumstance is that taxpayers are not inclined to think about capital gains when they purchase a cup of coffee or a sandwich. Such a tracking and reporting burden, if not altered by future IRS guidance, could significantly curtail the use of virtual currencies.

Selected 2014 Rulings and Regulations — In Brief

• The U.S. Supreme Court held that severance pay is subject to the Federal Insurance Contribution Act (“FICA”) withholding tax. United States v. Quality Stores Inc.
• The Supreme Court ruled that taxpayers have a right to challenge an IRS summons in court when they can show the tax agency might have issued the summons in bad faith. The Supreme Court held that a taxpayer has a right to conduct an examination of IRS officials regarding their reasons for issuing a summons if the taxpayer points to specific facts and circumstances that raise a plausible inference of bad faith by the examiners. United States v. Clarke, et al.
• Two appellate courts (the D.C. Circuit and the Fourth Circuit) reached opposite conclusions regarding the ability of the federal government to provide tax credits to individuals purchasing coverage on a federally administered exchange. The D.C. Circuit held that the Affordable Care Act only permits premium tax credits to be offered to individuals who obtain coverage under a state-run exchange. The Fourth Circuit held that the IRS’ view that the ACA authorizes premium tax credits to be offered to individuals who obtain coverage on a federal exchange was a permissible interpretation of the law. The D.C. Circuit has agreed to rehear the matter. Halbig v. Burwell and King v. Burwell
• The Tax Court ruled that a taxpayer can make only one nontaxable rollover contribution/distribution per year, regardless of the number of IRAs the taxpayer has. Prior IRS published guidance previously indicated that additional rollovers were permitted, but the IRS announced in March that it would revise its rules and publications to reflect the Tax Court’s decision. TC Memo 2014-21
• The Tax Court held that the value of an airline ticket obtained through the redemption of “thank you points” issued by a bank to the taxpayer was gross income to the taxpayer. The “thank you points” were issued by the bank in connection with the taxpayer’s opening up an account at the bank. The Tax Court concluded that the value of the ticket was income, because the points represent a “premium for making a deposit into, or maintaining a balance in, a bank account … in other words, something given in exchange for the use (deposit) of Mr. Shankar’s money; i.e., something in the nature of interest.” 143 T.C. 5

Extenders Renewal?

As of the writing of this article, the fate of the existing “extender” provisions in the Internal Revenue Code is uncertain. The extender provisions are temporary provisions in the Internal Revenue Code that expired at the end of 2013. The extender provisions include a laundry list of tax incentives that taxpayers would not be able to claim in 2014 if the provisions are not extended through 2014. As of the date of this writing, the House and the Senate are considering a bill that would extend most of the extender provisions through 2014 and there seems to be a general expectation in the tax community that a form of the bill will be passed and signed into law.

"Spotlight On Federal Tax Developments In 2014," by Rachel L. Devenow was published in the December 16, 2014 edition of Law360. Reprinted with permission.