Casualty Losses Under Sections 162 or 165(c)(2)

By John G. Hodnette

The Internal Revenue Code (“IRC”) sometimes provides multiple avenues for a taxpayer to obtain a deduction depending on how the taxpayer characterizes the loss. One example is a casualty loss deducted under either Section 162 or Section 165. Although these two sections may both offer a deduction for the same loss, they are not treated exactly the same under IRC. However, due to changes made by the 2017 Tax Act, taking the deduction under either of these sections may produce the same result.

Section 162 provides the general deduction for trade or business expenses. It is perhaps the broadest section in the IRC—it provides a deduction for almost all expenses or losses incurred by an operating trade or business. That includes both normal expenses associated with running a business and certain losses incurred by the business.  Section 162 provides an above-the-line deduction pursuant to Section 62(a)(1). That means the deduction is applied when determining adjusted gross income. Above-the-line deductions are not subject to any limitations or special rules, unlike many below-the-line deductions.

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The NOL Carryback Rules Under the CARES Act

By John G. Hodnette

On March 27, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act introduced a number of new provisions to assist businesses and individuals during the COVID-19 pandemic. One such provision adjusts the rules of net operating loss (“NOL”) carrybacks.

Before 2018, NOLs of a business or individual could be carried back two years and carried forward twenty years. When carried forward, NOLs at that time were allowed to offset 100% of taxable income. The Tax Cuts and Jobs Act of 2017, however, disallowed NOL carrybacks for all post-2017 losses, extended the twenty-year carryforward to an unlimited carryforward, but limited the NOL offset to 80% of taxable income.

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The Tax Implications of Three Programs Created by the CARES Act

By John G. Hodnette

The landscape of the United States has changed in the past weeks as COVID-19 continues to sweep across our nation. The Federal government attempted to mitigate the economic damage of the virus on March 27 with the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. Although the programs created by the CARES Act are being explained by media outlets, there is some confusion in the general public about the tax implications of these programs.

Most have heard about the $1,200 per person payments being sent by the IRS to qualifying individuals. These payments are increased by $500 for each dependent under the age of 17 and subject to a phase out for taxpayers above a certain income level. However, some taxpayers are confused about how these payments will be treated for tax purposes. The Act explains the payments are advance refundable tax credits for taxpayers’ 2020 taxes. For tax purposes, a tax credit is a dollar for dollar reduction in tax due. Credits are more powerful than deductions, which are a reduction in taxable income, not in tax. Some credits, such as this one, are refundable, meaning that if the credit exceeds the tax due, the excess is paid to the taxpayer. However, in this case, the government treated the credit as fully refundable in advance so taxpayers are able to receive these needed funds quickly. That does not mean that the payments are loans that must be repaid. It also does not mean the payments will be taxable income in 2020 or any other year. Rather, the payments are truly free money the government has sent to Americans to help them get through the COVID-19 pandemic.

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IRS Response to COVID-19: Installment Agreements, Offers in Compromise, and IRS Collection Actions

By John G. Hodnette

The novel coronavirus known as COVID-19 has changed the world as a global pandemic disrupts the day-to-day business operations of almost every country. The IRS has responded to ease the strain on taxpayers during this difficult time by modifying its procedures for collecting assessed federal tax liabilities.

First, those with existing IRS installment agreements have been granted a temporary pause on all payments from April 1 to July 15. Additionally, the IRS has made it clear it will not treat as a default nonpayment or similar events under any installment agreements during this period for any reason. Interest will continue to accrue on these balances. Although this pause also applies to direct debit agreements, the IRS will not automatically stop direct debit withdrawals from taxpayers’ bank accounts. Therefore, any taxpayer who has a direct debit installment agreement will need to request its bank to halt payments during this period. If the taxpayer has a traditional agreement (i.e., the installment payments are sent in by check or manually paid online every month), the only thing the taxpayer needs to do is stop payment during this period.

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Alimony Modifications: Taxation of Alimony Payments Under the 2017 Tax Act

By John G. Hodnette

Prior to the 2017 Tax Act, Section 71 provided alimony payments entitled the payor to a deduction and required the payee to include them in taxable income.  The 2017 Tax Act repealed Section 71.  For alimony orders executed after December 31, 2018, a payor of alimony receives no deduction, and an alimony recipient is no longer taxable on it.

While this change may seem straightforward, an interesting question arises when an alimony order is executed on or prior to December 31, 2018 but is later modified.  Although Treasury has not yet issued guidance, the 2017 Tax Act provides guidance at Pub. L. 115-97 § 11051(c).  That section states “any divorce or separation agreement (as so defined) executed on or before [December 31, 2018] and modified after such date [shall be bound by the amendments to this section] if the modification expressly provides that the amendments made by this section apply to such modification” (emphasis added).  Thus, one must expressly adopt the new law in the modification of the old alimony for the new law to apply.

By providing that one may essentially contract his or her way into the new law, Congress has passed the responsibility to the taxpayer.  Family law attorneys should be deeply familiar with these aspects of the tax code.

John G. Hodnette, JD, LLM is an attorney with Culp, Elliott, & Carpenter in Charlotte.


By Herman Spence III

On November 7, 2019, John Hodnette posted an article on the Tax Section’s blog regarding employee educational fringe benefits.  As noted in the article, Section 132(a)(3) provides an exclusion from gross income for working condition fringes.  A working condition fringe is any property or service provided to an employee to the extent, if the employee paid for such property or service, the payment would be allowed as a deduction under Section 162 or 167.  The 2017 tax act, however, eliminates individuals’ miscellaneous itemized deductions through 2025, including an employee’s expenses related to his or her job.  That raises the issue of whether working condition fringe benefits remain nontaxable given an employee cannot deduct employment related expenses.

It seems clear Congress did not intend to make working condition fringe benefits taxable.  In other cases in which Congress eliminated a nontaxable benefit, it did so directly, including moving expenses in Section 132(g)(2) and bicycle commuting benefits in Section 132(f).  Also, Section 132 only requires a payment be allowable as a deduction under Section 162 without mentioning Section 67.  Reg. § 1.132-5(a)(1)(vi) states the limitation of Section 67 is disregarded in determining the amount of a working condition fringe.  IRS publications, including Publication 15-B, continue to describe working condition fringe benefits as nontaxable.  Therefore, notwithstanding the suspension of employees’ ability to deduct employee expenses, working condition fringe benefits should continue to be nontaxable.

Herman Spence III is an attorney with Robinson Bradshaw in Charlotte.


By Keith A. Wood

This is the first of two installments of this article.  The second installment will soon be posted on the Tax Section blog.

I.     Damages for Emotional Distress Not Excludable from Taxable Income Unless Directly Associated with Physical Injury.

A.     Background.
Section 104(a)(2) provides an exclusion from gross income for damages received by a taxpayer for personal injury or physical sickness.  Generally, emotional distress is not physical injury or physical sickness.  Taxpayers, therefore, must report as gross income damages they receive for emotional distress unless they are reimbursements for medical care to treat the emotional distress.  IRC § 104(a).  Damages for emotional distress are excluded from gross income only when the emotional distress is attributable to a physical injury or a physical sickness.

B.     Doyle, TC Memo 2019-8.
Doyle was terminated from his employment after he raised concern with his employer’s president that the company was involved in illegal anti-competition schemes.  After he was terminated, Mr. Doyle began experiencing physical ailments such as nausea, vomiting, headaches, and backaches.  Ultimately, after a confidential settlement with his employer, Mr. Doyle was paid $350,000 “as settlement for unpaid wages” and $200,000 “as settlement for alleged emotional distress and damages”.  The Tax Court held the damages for the emotional distress were not excludable from gross income under Section 104(c)(2).  The underlying wrong committed by Mr. Doyle’s former employer was based on employment or contact matters and had nothing to do with physical injury.


II.     Custom Home Builder Not Entitled to Ordinary Loss on Deemed Sale of Lots. Ferguson vs. Commissioner, TC Memo 2019-40.

Mr. Ferguson was a custom home builder operating through an S corporation.  Mr. Ferguson had a dispute with some of his customers regarding a new development project.  In settlement of the lawsuit, Mr. Ferguson’s S corporation transferred lots to the homeowners.  The S corporation claimed an ordinary loss deduction on the deemed sale of three of the lots by the S corporation.  The court disallowed the ordinary losses on the grounds that Mr. Ferguson was unable to prove the lots were not capital assets as defined in Section 1221(a).  The main factor that worked against Mr. Ferguson was he claimed capital gain treatment on six other lots that were transferred to other plaintiffs.


III.     Golf Course Operations Were “For Profit” Notwithstanding Long History of Significant Losses. WP Realty LP vs. Commissioner, TC Memo 2019–120.

Corbin Robertson was a 99% limited partner of WP Realty Limited Partnership and the sole owner of Olympia Enterprises, Inc., the general partner of WP Realty.  WP Realty operated a golf course that had years of significant losses totaling millions of dollars.  During the years at issue, Mr. Robertson was CEO and chairman of the board of the directors of two publicly traded companies.  His adjusted gross income for 2011 through 2014 was close to $175 million.  Mr. Robertson also was a very active real estate investor and developer.  The IRS took the position the primary purpose of the golf course was not to earn a profit.  Based on the following factors, the court determined the golf course activities were conducted for-profit:

  1. The partnership kept accurate books and records.
  2. The partnership had a business plan outlining capital improvements to contribute to the golf club’s growth.
  3. The partnership took steps to make the club more marketable.
  4. The golf course was operated in a businesslike manner. Over time the partnership took significant steps to increase its club membership, such as making major capital improvements.
  5. The partnership relied on experts and hired and consulted with experienced professionals in the golf industry.
  6. The partnership hired professionals to manage the golf course. The golf course club hired executive chefs to prepare meals.
  7. Mr. Robertson had been exceedingly successful in many other similar ventures.

The court stated the only factors that weighed against Mr. Robertson were the long history of losses, and anticipated appreciation of club assets were not expected to overcome those losses.  However, considering the other factors, the court concluded the golf course activities were operated with a for-profit motive.  The court noted, however, if the losses continued now that the partnership had initiated a new membership goal and finished major improvements, the partnership “may again find its profit motive before this court.”


IV.      Horse Breeding Activity Determined Not For Profit. Donoghue, TC Memo 2019–71.

A married couple incurred significant losses from their horse breeding activity.  The Donoghues owned horses but boarded them at farms and stables owned by others.  Mr. Donoghue was employed full-time, and Mrs. Donoghue was disabled.  From 1985 to 2012, the horse breeding activity incurred over $1 million of expenses but realized only about $34,000 of income.  The activity never turned a profit in any of those 27 years.

The Tax Court agreed with the IRS that the Donoghues did not operate their horse breeding activity for profit during 2010 – 2012.  The court viewed the following factors against Mr. and Mrs. Donoghue:

  1. Manner of conducting business.   The Donoghues did not breed, race or sell any of the horses.
  2. Expertise of advisors.   The Donoghues never hired experts nor sought the advice of experts on how to run a profitable horse breeding activity.
  3. Time and effort devoted to the activity.   Mr. and Mrs. Donoghue did not create any contemporaneous documentary evidence to corroborate the hours they spent on the activity.
  4. Expectation that assets used in the activity may appreciate.    The only assets owned as to the activity were the horses themselves.  and Mrs. Donoghue were unable to provide any evidence the value of the horses would ever exceed the losses of the activity.
  5. History of income and losses.   The activity never earned a profit in any year.
  6. Financial status of the taxpayer.   Mr. and Mrs. Donoghue received more than $100,000 in each of relevant years, but that income was completely wiped out by the losses of the horse farm.
  7. Personal pleasure and recreation. Mrs. Donahue loved her horse operations.  The Donoghues relied on employees to perform the more grueling aspects of the horse breeding business.

The court also upheld assessment of the Section 6662 substantial understatement penalty.  The Donoghues contended they had reasonable cause and acted in good faith because they had a prior audit for 2007 in which the IRS ultimately conceded the hobby loss issue in Tax Court.  However, as stated in Transupport, Inc. v. Commissioner, T.C. Memo 2016-216 at 41:

“Petitioner again argues that the methodology was used consistently over years and was therefore correct.  Petitioner apparently believes that repeating a fallacy over and over again and ignoring contrary evidence will succeed.  It does not.  A well established principle is that what was condoned or agreed to for a previous year may be challenged for a subsequent year.  Auto Club of Mich. v. Commissioner, 353 U.S. 180 [50 AFTR 1967] (1957); Rose v. Commissioner, 55 T.C. 28 (19709).  Thus, the results of a prior audit do not constitute substantial authority.”


V.      Bankruptcy Court Refuses to Allow Partnership to Convert to C Corporation Status.

In In Re Schroeder Brothers Farms of Camp Douglas LLP, 123 A.F.T.R. 2d 2019-2080,  the U.S. Bankruptcy Court refused to allow the debtor, an entity taxed as a partnership for tax purposes, to convert to C corporation status by making a check the box election on Form 8832.  The bankruptcy court held that allowing the partnership to convert to a C corporation was not in the best interests of the debtor, the estate, or its creditors.


VI.     IRS Rules S Election was Inadvertently Terminated by Operating Agreement Amendment.

In PLR 201930023, the IRS concluded an LLC’s S election was inadvertently terminated after its members adopted an amendment to the distribution provisions in the LLC operating agreement.  The taxpayer was an LLC that elected to be taxed as an S corporation.  Thereafter, the LLC and its members amended the agreement to provide liquidating distributions would be made in accordance with positive capital account balances.  Later, the operating agreement was amended again to provide for distributions on a pro rata basis.

The IRS ruled the S election was terminated by virtue of the first amendment.  However, because all distributions were actually made to the members in proportion to their membership interests, the IRS ruled the termination was inadvertent, and therefore the LLC would continue to be taxed as an S corporation in all periods.

Keith A. Wood is an attorney with Carruthers & Roth, P.A. in Greensboro.

S Corporations: Dealing with Accumulated Earnings and Profits

Please send articles for the Tax Section blog to: Herman Spence at

By Kerri L.S. Mast

C corporation income is generally subject to two levels of taxation.  It is taxed at the corporate level when earned and at the shareholder level when distributed.  An S corporation, on the other hand, generally is not taxed at the corporate level; its items of income and deduction flow through to its shareholders when earned.  Subsequent distributions by the S corporation to the shareholders often can be made tax-free.  However, the taxation of distributions is more complicated if the S corporation has C corporation accumulated earnings and profits (E&P).

An S corporation does not generate E&P.  However, it can possess E&P as a result of either converting from C corporation to S corporation or acquiring a C corporation.  E&P generated in a C corporation are subject to two levels of taxation – corporate and shareholder – and retain this character even if subsequently owned by an S corporation.  Accumulated E&P was taxed at the C corporation level and will be taxed again as a dividend to recipient S corporation shareholders when distributed.

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Pro Bono Opportunity

By Helen Herbert

Are you looking for a pro bono opportunity where you can use your tax expertise?  The NCBA Tax Section is looking for tax attorneys to train selected military personnel to be tax return preparers through the Military Volunteer Income Tax Assistance (VITA) Program.

The Military VITA Program is designed to assist US military personnel with preparation of federal and state tax returns and thereby save US military families the cost of tax return preparation and, in many instances, receive tax refunds. Many US military families are unfamiliar with federal and state tax requirements and how to file a complete and accurate tax returns and, accordingly, need help in preparing their personal income tax returns.

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Employee Educational Fringe Benefits Under the 2017 Tax Act

By John G. Hodnette

One of the most appealing benefits of working for a university is an educational assistance program.  Free or discounted college education is extremely valuable given tuition continues to increase at an average of 8% per year.  Whether these benefits are taxed as compensation or excluded from income is vitally important to university employees.

Three code sections are especially important when an employer provides an employee or employee’s family with free or discounted college education.  The first is Section 117, which excludes from gross income qualified scholarships granted to an individual who is a candidate for a college degree.  Section 117(d)(1) additionally provides where an educational institution at the university level grants qualified tuition reduction to an employee for an undergraduate degree, that tuition reduction is not included in gross income.

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