PLR 1251009: IRS permits revocation of an investment-income election after a software error

Plain-English summary

The IRS granted taxpayers 60 days to revoke an election that treated qualified dividends and capital gains as investment income. The taxpayers had made the election on Form 4952, but computerized tax-preparation software did not account for the alternative minimum tax, causing the election to increase their total tax. The IRS concluded that the taxpayers reasonably relied on a qualified tax professional, that the government would not be prejudiced, and that the taxpayers had reasonable cause for relief. The ruling allowed revocation by filing an amended return for the specified year.

Ruling snapshot

• Question: May the taxpayers revoke the investment-income election after the filing deadline?
• Outcome: Approved
• Key authorities: IRC §§ 163(d)(1) and 163(d)(4)(B); Treas. Reg. §§ 1.163(d)-1 and 301.9100-1 through 301.9100-3

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201251009 Third Party Communication: None
Release Date: 12/21/2012 Date of Communication: Not Applicable
Index Number: 9100.00-00
Person To Contact:
--------------------- ---------------------- ------------------------------
----------------------------- ---------------------------------------------------
----------------------------- Telephone Number:
---------------------------------- -------------------
Refer Reply To:
--------------------- CC:ITA:B03
------------------------- PLR-131423-12
----------------------------- Date:
------------------------- September 17, 2012

              TY: -------

Legend

Taxpayers = ---------------------------------------------------------
Year 1 = -------
Month 1 = --------------------
Taxpayers’ Representative = ------------------------------

Dear -----------------------:

   This is in response to your letter dated June 6, 2012. You requested an

extension of time to elect to revoke an election to treat qualified dividends and capital
gains as investment income for Year 1 under sections 163(d)(1) and 163(d)(4)(B) of the
Internal Revenue Code and section 1.163(d)-(1)(c) of the Income Tax Regulations.

                                          FACTS

   Taxpayers’ main source of income is investment income and rental income

related to their real estate interests. Taxpayers timely filed Form 1040, Individual
Income Tax Return, for Year 1. Taxpayers’ Representative prepared the return using
computerized tax return preparation software. Taxpayers’ Year 1 return included Form
4952, Investment Interest Expense Deduction, on which they elected to treat all net
long-term capital gain and qualified dividends as investment income. The effect of
electing to treat qualified dividends and net capital gains as investment income is to tax
the qualified dividends and net capitals gains at ordinary income tax rates. Taxpayers
paid both regular income and alternative minimum tax in Year 1.

   The computerized tax return preparation software did not consider the effect of

the alternative minimum tax in analyzing whether or not Taxpayers should make the
election under sections 163(d)(1) and 163(d)(4)(B) in Year 1. The election increased
PLR-131423-12 2

the total tax due because the alternative minimum tax due increased by more than the
regular income tax due decreased.

   Year 1 was the first year that Taxpayers’ Representative prepared Taxpayers’

return due to their relocation from out-of-state. Taxpayers’ Representative utilized tax
preparation software different from the one that had been used to prepare Taxpayers’
returns prior to Year 1 by Taxpayers’ previous tax preparer. Taxpayers’ Representative
was unaware that the software’s calculation optimizes the amount of net long-term
capital gain and qualified dividends to include in investment income for regular tax
purposes but does not consider the effect of such an election on the alternative
minimum tax.

   Taxpayers represented that they relied on Taxpayers’ Representative to

accurately prepare Taxpayers’ return and made the election under section
163(d)(4)(B)(iii) based on Taxpayers’ Representative’s advice. Taxpayers represented
that they were unaware of the inadvertent error due to the complexity of the issue.

   Taxpayers’ Representative did not realize until Month 1 when Taxpayers’

Representative reviewed the return for Year 1 at the request of Taxpayers’ financial
advisors that the Taxpayers would have been subject to less total tax in Year 1 if the
election had not been made. Taxpayers’ Representative contacted the software
developer and was told that considering the election’s effect on the alternative minimum
tax was beyond the tax return preparation software’s built-in capabilities. As a result,
Taxpayers seek permission to revoke the election for Year 1.

                                LAW & ANALYSIS

   Section 163(d)(1) provides that, in the case of a taxpayer other than a

corporation, the amount allowed as a deduction for investment interest shall not exceed
the net investment income of the taxpayer for the taxable year. Investment interest
expense that is disallowed by section 163(d)(1) may be carried to the next taxable year.
Section 163(d)(2).

   Section 163(d)(4)(B) provides in part that investment income is the sum of –
          (i) gross income from property held for investment (other than gain taken

into account under clause (ii)(I)),
(ii) the excess (if any) of
(I) the net gain attributable to the disposition of property held for
investment, over
(II) the net capital gain determined by only taking into account gains
and losses from dispositions of property held for investment, plus
(iii) so much of the net capital gain referred to in clause (ii)(I) as the
taxpayer elects to take into account under such clause.
PLR-131423-12 3

   Section 163(d)(4)(B) also states that such term shall include qualified dividend

income (as defined in section (1)(h)(ii)(B)) only to the extent the taxpayer elects to treat
such income as investment income for purposes of this subsection.

   Section 1.163(d)-1(b) of the regulations provides that the election under section

163(d)(4)(B) must be made on or before the due date (including extensions) of the
income tax return for the taxable year in which the qualified dividend income is received
or net capital gain is recognized.

  Section 1.163(d)-1(c) of the regulations provides that the election under section

163(d)(4)(B)(iii) is revocable with the consent of the Commissioner.

  Under section 301.9100-1(c), the Commissioner has discretion to grant a

reasonable extension of time to make a regulatory election under all subtitles of the
Code, except subtitles E, G, H and I, provided that the taxpayer acted reasonably and in
good faith and granting relief will not prejudice the interests of the government.

    Section 301.9100-3 provides extensions of time to make a regulatory election

under Code sections other than those for which section 301.9100-2 expressly permits
automatic extensions. Requests for extensions of time for regulatory elections will be
granted when the taxpayer provides evidence to establish to the satisfaction of the
Commissioner that the taxpayer acted reasonably and in good faith and granting relief
will not prejudice the interests of the government.

  Section 301.9100-3(b)(1) states that a taxpayer will be deemed to have acted

reasonably and in good faith if the taxpayer –
(i) requests relief before the failure to make the regulatory election is
discovered by the Service;
(ii) inadvertently failed to make the election because of intervening events
beyond the taxpayer’s control;
(iii) failed to make the election because, after exercising due diligence, the
taxpayer was unaware of the necessity for the election;
(iv) reasonably relied on the written advice of the Service; or
(v) reasonably relied on a qualified tax professional, and the tax
professional failed to make, or advise the taxpayer to make, the election.

    Taxpayers acted reasonably and in good faith because Taxpayers reasonably

relied on a qualified tax professional who used faulty computerized tax preparation
software and consequently advised Taxpayers to make the election. This software
failed to consider the effect of the alternative minimum tax in analyzing whether or not
Taxpayers should make the election under sections 163(d)(1) and 163(d)(4)(B) in Year
1.
PLR-131423-12 4

     Under section 301.9100-3(b)(3), a taxpayer will not be considered to have acted

reasonably and in good faith if the taxpayer –
(i) seeks to alter a return position for which an accuracy related penalty
has been or could be imposed under section 6662 at the time the taxpayer requests
relief (taking into account section 1.6664-02(c)(3)) and the new position requires a
regulatory election for which relief is requested;
(ii) was informed in all material respects of the required election and
related tax consequences, but chose not to file the election; or
(iii) uses hindsight in requesting relief. If specific facts have changed
since the original deadline that make the election advantageous to a taxpayer, the
Service will not ordinarily grant relief.

    Taxpayers are not seeking to alter a return position for which an accuracy-related

penalty has been or could be imposed under section 6662 at the time relief is
requested. Because of the failure of the computerized tax return preparation software
to consider the alternative minimum tax in analyzing whether or not Taxpayers should
elect to treat all net long-term capital gain and qualified dividends as investment income
in Year 1, Taxpayers had not been informed in all material respects of the election and
its tax consequences. Furthermore, Taxpayers are not using hindsight in requesting
relief. Taxpayers have represented that specific facts have not changed since the
original deadline that made the election appear advantageous.

    Section 301.9100-3(c)(1)(i) provides in part that the interests of the government

are prejudiced if granting relief would result in the taxpayer having a lower tax liability in
the aggregate for all taxable years affected by the election than the taxpayer would
have had if the election had been timely made (taking into account the time value of
money). Section 301.9100-3(c)(1)(ii) provides, in part, that the interests of the
government are ordinarily prejudiced if the taxable year in which the regulatory election
should have been made, or any taxable years that would have been affected by the
election had it been timely made, are closed by the period of limitations on assessment.
Under these criteria, the interests of the government are not prejudiced in this case.
Taxpayers have represented that granting relief would not result in a lower tax liability in
the aggregate for all taxable years affected by the election than Taxpayers would have
had if the election had been timely made (taking into account the time value of money).
Furthermore, the taxable years in which the regulatory election should have been made
and any taxable years that would have been affected had it been timely made, are not
closed by the period of assessment.

                                      RULING

   Accordingly, the consent of the Commissioner is hereby granted for an extension

of time pursuant to sections 301.9100-1 and -3 for Taxpayers to revoke the prior Year 1
election pursuant to section 163(d)(4)(B) and section 1.163(d)-1(c) of the regulations.
PLR-131423-12 5

Taxpayers have an extension of 60 days from the date of this ruling in which revoke the
election for Year 1 by filing an amended return for that year.

   This ruling is limited to providing an extension of time to elect to revoke the

election under section 163(d)(4)(B). It does not provide relief from any liability incurred
as a result of filing a late election; nor is it a ruling that the taxpayer is otherwise eligible
to make the election. No opinion is expressed as to the applicability of any other
provision of the Code or the regulations which may be applicable under these facts.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it may not be used or cited as precedent.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

   A copy of this letter must be attached to any income tax return to which it is

relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling.

  The rulings contained in this letter are based upon information and

representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

                                     Sincerely,



                                     Christopher F. Kane
                                     Chief, Branch 3
                                     (Income Tax & Accounting)