This Memorandum highlights several important U.S. federal income tax developments in the summer of 2022, including: (i) the Supreme Court agreeing to hear an FBAR penalty case, (ii) the Internal Revenue Service (“IRS”) issuing proposed Treasury regulations that clarify the meaning and federal income tax treatment of certain foreign currency contracts, and (iii) the introduction of proposed legislation to curb syndicated conservation easements.
I. Supreme Court FBAR Case.
The Supreme Court granted certiorari in the case of Bittner v. United States, a case that presents an issue of calculating non-willful penalties on foreign bank and financial accounts (“FBAR”) filings. An FBAR filing is an annual report that must be filed with the IRS by any U.S. person with a financial interest in or signature authority over certain foreign financial accounts, such as bank accounts and brokerage accounts. Currently, the federal Circuit Courts disagree on whether the penalty for a non-willful failure to file an FBAR is imposed on a per-account basis or on a per-form basis.
Although the penalty for a non-willful FBAR filing violation is limited to $10,000, the IRS has attempted to impose this penalty on a per-account basis. In other words, the IRS seeks to impose multiple $10,000 penalties if there are multiple foreign bank accounts that are unreported, even though those accounts would be reported on a single FBAR filing.
The Ninth Circuit has rejected the IRS’s position and limited non-willful penalties to a per-form basis (i.e., the penalties are capped at $10,000 annually). The Fifth Circuit more recently disagreed, holding that the penalty can be applied on a per-account basis, which means that there is no annual cap on the penalties. In granting certiorari, the Supreme Court is expected to resolve the circuit split at the appellate level.
II. Foreign Currency Contract Treatment Under Section 1256.
On July 5, 2022, the IRS issued proposed regulations (the “Proposed Regulations”) to clarify the definition of a “foreign currency contract.” Based on the Proposed Regulations, OTC foreign currency options are not eligible for mark-to-market treatment as 1256 contracts. The Proposed Regulations overturn a Sixth Circuit ruling1 that allowed taxpayers to treat OTC foreign currency options as 1256 contracts.
Under the Proposed Regulations, a “foreign currency contract” for 1256 contraction purposes is limited to a forward contract that:
- Requires delivery of, or the settlement of which depends on the value of, a foreign currency that is traded through regulated futures contracts;
- Is traded in the interbank market; and
- Is entered into at arms’ length at a price determined by reference to the price in the interbank market.
Taxpayers may rely on the Proposed Regulations for tax years ending on or after July 6, 2022.
III. Conservation Easements.
Congress is expected to pass legislation that would, in part, curb syndicated conservation easement transactions. In a conservation easement transaction, a taxpayer takes a charitable deduction for a “qualified conservation contribution,” which consists of a contribution of a qualified real property interest to a charitable organization exclusively for conservation purposes. While there are many non-abusive forms of conservation easements, a number of promoters have developed transactions that effectively rely on a greatly inflated value of the contributed property, thereby producing tax deductions that significantly exceed the amount invested in the property. The IRS has challenged these deductions as being abusive and has designated syndicated easements as listed transactions (i.e., tax shelters) for federal income tax purposes.
Under the proposed legislation, the charitable deduction for contribution of a conservation easement would be limited to 250% of the purchase price of the property, unless the property has been held for at least three years. An earlier version of the draft legislation applied the change in law on a retroactive basis, with proposed effectiveness as of December 23, 2016. Legislators appear to have struck a compromise to apply this law on a prospective basis once it is enacted.