This memorandum highlights several significant U.S. federal income tax developments over the summer of 2022, including: (i) the Supreme Court has agreed to hear an FBAR sanction case, (ii) the Internal Revenue Service (“IRS”) issued proposed Treasury regulations that clarify the meaning and federal tax treatment of certain foreign currency contracts, and (iii) the introduction of a bill to limit easements of unionized conservation.
I. Supreme Court FBAR case.
The Supreme Court granted certiorari in the case of Bittner v. United States, a case that poses a problem of calculating unintended penalties on foreign bank and financial account reporting (“FBAR”). An FBAR filing is an annual report that must be filed with the IRS by any U.S. person with a financial interest or signing authority in certain foreign financial accounts, such as bank accounts and brokerage accounts. Currently, the federal circuit courts disagree on whether the penalty for an unintentional failure to file an FBAR is imposed on an account-by-account or per-form basis.
Although the penalty for an unintentional FBAR filing violation is limited to $10,000, the IRS has attempted to impose this penalty on an account-by-account basis. In other words, the IRS is looking to impose multiple $10,000 penalties if there are multiple unreported foreign bank accounts, even if those accounts would be reported in a single FBAR filing.
The Ninth Circuit rejected the IRS’ position and limited involuntary penalties to one form per form (i.e. penalties are capped at $10,000 per year). More recently, the Fifth Circuit disagreed, saying the penalty can be applied on an account-by-account basis, meaning there is no annual cap on penalties. By granting certiorari, the Supreme Court is supposed to resolve the circuit split at the appellate level.
II. Treatment of Foreign Currency Contracts under Section 1256.
On July 5, 2022, the IRS issued a proposed rule (the “Proposed Rule”) to clarify the definition of an “exchange contract”. Under the proposed rule, OTC currency options do not qualify for mark-to-market treatment as 1256 contracts.1 which allowed taxpayers to treat OTC currency options as 1256 contracts.
Under the Proposed Regulations, a “foreign currency contract” for contraction purposes is limited to a forward contract that:
- Requires delivery or whose settlement depends on the value of a foreign currency traded through regulated futures contracts;
- Is traded on the interbank market; and
- Is concluded under arm’s length conditions at a price determined by reference to the price on the interbank market.
Taxpayers can rely on the proposed regulations for tax years ending on or after July 6, 2022.
III. Conservation easements.
Congress should pass legislation that would partially restrict syndicated conservation easement transactions. In a conservation easement transaction, a taxpayer takes a charitable deduction for an “eligible conservation contribution”, which is a contribution of an eligible real estate interest to a charity exclusively for conservation purposes. Although there are many non-abusive forms of conservation easements, a number of developers have developed transactions which effectively rely on a greatly inflated value of the contributed property, thus producing tax deductions which greatly exceed the amount invested in the property. property. The IRS challenged these deductions as abusive and designated the syndicated easements as listed transactions (i.e., tax shelters) for federal income tax purposes.
Under the bill, the charitable deduction for contributing a conservation easement would be limited to 250% of the purchase price of the property, unless the property has been owned for at least three years. An earlier version of the bill applied the change to the law on a retroactive basis, with proposed coming into force as of December 23, 2016. Lawmakers appear to have struck a compromise to apply this law prospectively once it does. will be enacted.