NewsNotes

Lesli S. Laffie, J.D., LL.M.

Interest Nettng • Unemployment Benefits Extended •  Gitlitz Redux • Teachers’ Expenses •  Nonfiler Initiative • Federal Government Spending 2003 (Chart)  

Court Decisions

Interest Netting

A common parent of an affiliated group that acquired and developed oil, gas and other energy properties could not net interest expense and income under Regs. Sec. 1.861-8(e)(2). In Sunoco, Inc., 118 TC No. 11 (2002), the Tax Court reversed its prior decision in Bowater, Inc., 101 TC 207 (1993), rev'd, 108 F3d 12 (2d Cir. 1997), and determined that Regs. Sec. 1.861-8(e)(2) does not permit interest income and expense netting.

The taxpayer claimed foreign tax credits (FTCs) under Sec. 901 in computing its affiliated group's consolidated tax liability for four tax years. In computing the overall Sec. 904 FTC limit, the taxpayer allocated and apportioned a portion of the interest expense of each group member to sources outside the U.S. in calculating the numerator of the limiting fraction under Sec. 904(a).

The taxpayer attempted to change the manner in which it allocated and apportioned the interest expenses. It contended that it could allocate and apportion net (rather than gross) interest expense in calculating taxable income under Regs. Sec. 1.861-8(e)(2) as in effect for the four tax years in issue, in computing taxable income from sources outside the U.S., which represents the numerator of the Sec. 904 limiting equation.

However, Regs. Sec. 1.861-8(e)(2) does not permit interest income and expense netting. The Tax Court determined that the regulation's language foreclosed the taxpayer's position; Sec. 861(a)(1), 862(a)(1) or the regulations promulgated thereunder contemplate that the portion of a taxpayer's gross income consisting of interest income for the year would be reduced or entirely offset by interest expense. Under Regs. Sec. 1.861-8(e)(2), the taxpayer has to allocate the gross amount of its interest deductions to all of its gross income.

Legislation

Unemployment Benefits Extended

The Job Creation and Worker Assistance Act of 2002, Section 201, provided up to 13 weeks of additional unemployment benefits to individuals in states suffering severe economic distress. The benefits are available to individuals who filed their initial claim after March 14, 2001, are still unemployed and have exhausted their regular unemployment benefits.

Gitlitz Redux

Last year, the Supreme Court held in David A. Gitlitz, 121 S.Ct. 701 (2001), that S corporation cancellation of debt (COD) income is a passthrough item that increases shareholder basis. (See NewsNotes, "S COD Income Passthrough," TTA, March 2001, p. 148.) Section 402 of the Job Creation and Worker Assistance Act of 2002 removed this valuable benefit.

Effective for debt discharges occurring after Oct. 11, 2001, if an S corporation is insolvent, a shareholder can no longer use the corporation's COD income to increase stock basis.

Teachers' Expenses

Section 406 of the Job Creation and Worker Assistance Act of 2002 allows teachers and professional educators a new tax break for 2002 and 2003—they can deduct up to $250 of unreimbursed classroom expenses above the line.

Covered expenses include:

• Books.
• Supplies (other than nonathletic supplies for health or physical education courses).
• Computer equipment (including related software and services).
• Other equipment and supplementary materials used in the classroom.

The expense has to be one that can otherwise be deducted under Sec. 162 (i.e., a trade or business expense). Educators who qualify to take the deduction include K12th grade:

• Teachers.
• Instructors.
• Counselors.
• Principals in a school for a minimum of 900 hours in the course of a school year (a "school" is defined as one that provides elementary or secondary education, as determined under state law).

A qualifying educator should maintain all receipts for deductible expenses under the new law. The new law does not specifically mention certain issues. For instance, although it defines categories of qualifying educators, it does not specifically mention substitute teachers or whether it covers summer-school expenses.

Miscellaneous

Nonfiler Initiative

A Treasury Inspector General for Tax Administration (TIGTA) report entitled, "Improvements Are Needed to Enable the National Non-Filer Strategy to Achieve Its Objectives," examined IRS efforts to bring potentially 2.3 million individual nonfilers and 2.1 million business nonfilers into the tax system. The report reviewed the National Nonfiler Program's effectiveness.

"Nonfilers" are individuals or businesses that do not comply with the return-filing requirements. The report notes that nonfilers may not submit timely tax returns due to lack of knowledge, confusion, poor recordkeeping, differing legal interpretations, unexpected personal emergencies and temporary cashflow problems.

Recognizing that some noncompliance is intentional, the report noted that certain nonfilers are referred to IRS Criminal Investigation for criminal tax evasion investigations.

The IRS estimated the number of nonfilers through historical information and limited third-party data, including information returns submitted by employers, financial institutions and other business entities. Individual nonfilers include taxpayers required to report their sole proprietorship activities with their individual returns; business nonfilers include taxpayers that must file returns to report employment, corporate income, excise and highway-use taxes.

TIGTA recommended that the IRS improve its coordination with states collecting sales tax and employment tax information, an effort already underway under the new IRS organizational structure. In addition, TIGTA recommended that the IRS fully establish accountability and measurable milestones, as well as a method to gauge cost-effectiveness of the various action items in the National Nonfiler Strategy.

The report can be found on the TIGTA Website, at http://www.treas.gov/tigta .