Taxpayers receive 60 days to revoke an excessive investment-income election

Plain-English summary

Two retired taxpayers self-prepared their return and elected to treat qualified dividends and net long-term capital gain as investment income so they could deduct investment interest expense. They inadvertently included all of that income—far more than needed for the deduction—which subjected it to ordinary rather than capital-gain tax rates. The IRS detected and corrected the inconsistent tax computation, producing additional tax and interest. Although the election ordinarily required IRS consent to revoke, the taxpayers showed they had exercised reasonable diligence, were not fully informed of the election's consequences, and would not obtain a lower aggregate liability than a correctly limited original election. The IRS granted 60 days to revoke the election by amended return.

Ruling snapshot

• Question: May the taxpayers revoke a section 163(d)(4)(B) election that inadvertently treated all qualified dividends and net capital gain as investment income?
• Outcome: approved (they received 60 days to file an amended return revoking the election)
• Key authorities: IRC § 163(d); Treas. Reg. §§ 1.163(d)-1 and 301.9100-1 through 301.9100-3; Rev. Rul. 83-74

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202021004                                              Third Party Communication: None
Release Date: 5/22/2020                                        Date of Communication: Not Applicable
Index Number: 9100.00-00                                       Person To Contact:
                                                               -------------------, ID No. -----------------
                                                               Telephone Number:
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--------------------------                                     Refer Reply To:
--------------------------------                               CC:ITA:B03
                                                               PLR-118934-19
                                                               Date:
                                                               January 08, 2020

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                                    TY: ------------ -------------------------------------

Legend:

Applicants                      =      -----------------------------------------------
Year at Issue                   =      -------------------------------------------------
$N                              =      -------------
$Q                              =      -------------
$E                              =      -----------


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

This letter responds to your July 23, 2019, letter ruling request. That request relates to
your taxable Year at Issue, and was made pursuant to sections 301.9100-1 and
301.9100-3, Proc. & Admin. Regs.1 Your request seeks the Commissioner’s permission
to revoke your election to treat net long-term capital gain and qualified dividends as
investment income under section 163(d)(1) and (4)(B), and section 1.163(d)-1, Income
Tax Regs. (section 163(d)(4)(B) election).

                                                      FACTS

Applicants represent the following:

Applicants are retired individuals. As relevant here, Applicants’ taxable income for the
year at issue included $Q in qualified dividends and $N in net capital gain.

During the year at issue, Applicants incurred investment interest expenses totaling $E.


1 All section references are to the Internal Revenue Code and regulations in effect for the year at issue.
PLR-118934-19                            2

Applicants self-prepared their Form 1040, U.S. Individual Income Tax Return (return) for
the year at issue, without the assistance of any computer software and without seeking
any professional advice. On that return, Applicants elected to itemize their deductions.
In doing so, Applicants understood that in order to claim a deduction for their investment
interest expenses, they would need to make a section 163(d)(4)(B) election, an election
to treat an amount of their qualified dividend and capital gain income as “investment
income”.

Accordingly, Applicants made their section 163(d)(4)(B) election by completing a Form
4952, Investment Interest Expense Deduction (Form 4952), and claimed an investment
interest deduction of $E on the Schedule A, Itemized Deductions, attached to their
return for the year at issue.

On their Form 4952, however, Applicants inadvertently elected to treat the entirety of
their qualified dividend and capital gain income as investment income, an amount far
exceeding the amount necessary to permit their $E deduction for investment interest
expense for the year at issue.

This error had the unintended effect of rendering of Applicants’ qualified dividend and
capital gain income ineligible for taxation at capital gains rates, and instead subjected
that income to taxation at ordinary income rates. See sec. 1.163(d)-1(a), Income Tax
Regs. In reporting their tax due for the year at issue, however, Applicants failed to
account for the excessive nature of their section 163(d)(4)(B) election, and erred by
failing to compute their tax in a manner consistent with that election.

Applicants timely filed their return for the year at issue. Subsequently, the Service
discovered the error in Applicants’ tax computation and corrected that error in a manner
consistent with the scope of the section 163(d)(4)(B) election reported on Applicants’
Form 4952. As a result, the Service notified Applicants that they owed additional tax,
additions to tax, and interest for the year at issue.

On July 23, 2019, Applicants filed the present letter ruling request, seeking an extension
of time and permission to revoke their section 163(d)(4)(B) election for the year at issue,
pursuant to sections 301.9100-1 and 301.9100-3, Proc. & Admin. Regs.

The period of limitation on assessment under section 6501(a) for the year at issue has
not expired.

                                             LAW

Section 163(d) 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 that taxpayer for the taxable year.

Section 163(d)(4)(B) provides, in part, that investment income is the sum of:
PLR-118934-19                               3

       (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)(II) (or, if lesser, the
               net gain referred to in clause (ii)(I)) as the taxpayer elects to take into
               account under this clause

Further, a taxpayer may also elect to take all or a portion of qualified dividend income
into account as investment income. Sec. 163(d)(4)(B) (flush language).

A taxpayer electing to treat qualified dividend and certain net capital gain income as
investment income must make such an election on or before the due date (including
extensions) of that taxpayer’s Federal income tax return for the year in which net capital
gain is recognized or the qualified dividend income is received. Sec. 1.163(d)-1(b),
Income Tax Regs.

As a consequence of making such an election, the qualified dividend and net capital
gain income subject to that election will be rendered ineligible for taxation at the capital
gains rates. Sec. 1.163(d)-1(1), Income Tax Regs.

A taxpayer’s election, in this regard, may only be revoked with the consent of the
Commissioner. Sec. 1.163(d)-1(c), Income Tax Regs.

Applicants are requesting permission to revoke their section 163(d)(4)(B) election to
treat the entirety of their qualified dividend and net capital gain income as investment
income. This is analogous to those situations concerning taxpayers who fail to make a
particular regulatory election and subsequently seek an extension of time to do so
pursuant to sections 301.9100-1 and 301.9100-3, Proc. & Admin. Regs. See Rev. Rul.
83-74, 1983-1 C.B. 112.

As applicable here, sections 301.9100-1 and 301.9100-3, Proc. & Admin. Regs.,
provide the standards that the Commissioner uses when determining whether to grant a
taxpayer’s request for an extension of time for the making of a regulatory election.

A “regulatory election” is an election whose due date is prescribed by a regulation
published in the Federal Register, a revenue ruling or procedure, or notice or
announcement published in the Internal Revenue Bulletin. Sec. 301.9100-1(b), Proc. &
Admin. Regs.

A taxpayer’s request for an extension of time to make a regulatory election will be
granted when the taxpayer provides evidence (as described in the regulations) that
establishes to the satisfaction of the Commissioner that the taxpayer acted reasonably
PLR-118934-19                              4

and in good faith despite its failure to timely make that regulatory election, and granting
relief will not prejudice the interests of the Government. Sec. 301.9100-3(a), Proc. &
Admin. Regs.

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) 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, including a tax professional
       employed by the taxpayer, and the tax professional failed to make, or advise the
       taxpayer to make the election.

Section 301.9100-3(b)(1), Proc. & Admin. Regs. These benchmarks are disjunctive
and, as such, a taxpayer only need satisfy one in order to be deemed to have acted
reasonably and in good faith. Vines v. Commissioner, 126 T.C. 279, 291 (2006).

Conversely, 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 1.6664-2(c)(3)) and the new position requires or
       permits 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.


Sec. 301.9100-3(b)(3), Proc. & Admin. Regs.

Further, if specific facts have changed since the original due date for making the
election that would render the election more advantageous to a taxpayer, the
Commissioner may decline to grant relief. Sec. 301.9100-3(b)(3)(iii), Admin. & Proc.
Regs. In this sense, “the relevant inquiry is whether allowing a late election gives the
taxpayer some advantage that was not available on the date due.” Vines v.
PLR-118934-19                            5

Commissioner, 126 T.C. at 293.

Section 301.9100-3(c)(1), Proc. & Admin. Regs. provides that the Commissioner will not
grant an extension of time if the interests of the Government will be prejudiced by the
granting of that extension. For example, the Commissioner may find that the interests
of the Government are prejudiced when granting relief would result in the taxpayer
having a lower tax liability in the aggregate for all taxable years impacted by the election
when compared against the taxpayer’s liabilities that ought to have resulted had the
taxpayer made a timely election (taking into account the time value of money). Sec.
301.9100-3(c)(1)(i), Proc. & Admin. Regs.

Further, the Commissioner may determine that the interests of the Government will be
prejudiced if the period of limitations on assessment under section 6501(a) for the
taxable year in which the election should have been made, or any taxable years that
would have been impacted by the election had it been timely made, has closed or will
be closed before the taxpayer’s receipt of a ruling ostensibly granting relief. Sec.
301.9100-3(c)(1)(ii), Proc. & Admin. Regs.

                                        ANALYSIS

Applicants’ request, here, pertains to a regulatory election as defined in section
301.9100-1(b), Proc. & Admin. Regs., because the due date for making a section
163(d)(4)(B) election is prescribed by section 1.163(d)-1(b), Income Tax Regs.
Accordingly, the Commissioner has the authority under sections 301.9100-1 and
301.9100-3, Proc. & Admin. Regs., to grant Applicants’ request for an extension of time
to revoke their section 163(d)(4)(B) election for the year at issue.

The information submitted, and representations made by Applicants establish that they
acted reasonably and in good faith under section 301.9100-3(b)(1) and (2) , Proc. &
Admin. Regs. Applicants made their section 163(d)(4)(B) election after exercising
reasonable diligence in the preparation of their Federal income tax return for the year at
issue. Despite exercising reasonable diligence, Applicants inadvertently elected to treat
their entire qualified dividend and net capital gain income as investment income, an
amount far greater than necessary to claim their associated investment interest
deduction. In this sense, the dollar value of Applicants’ election itself reveals that they
were not fully informed with regard to all material aspects of the section 163(d)(4)(B)
election and its related tax consequences, notwithstanding Applicants having
undertaken sufficient due diligence in researching that election and its relation to the
investment interest deduction.

Accordingly, Applicants will be considered to have acted reasonably and in good faith.
Sec. 301.9100-3(b)(1)(iii) and (3), Proc. & Admin. Regs.

Moreover, based on Applicants’ representation of the facts, granting an extension of
time to revoke their section 163(d)(4)(B) election will not prejudice the interests of the
government under section 301.9100-3(c)(1). Applicants have represented that granting
PLR-118934-19                             6

relief would not result in a lower tax liability in the aggregate for all taxable years
affected by the election than would have resulted had they timely made and correctly
applied that election (taking into account the time value of money). Further, Applicants
have represented that the period of limitations on assessment under section 6501(a)
has not closed for the taxable year at issue, or for any taxable years that would have
been affected had Applicants timely made and correctly applied that election.

                                      CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
Applicants acted reasonably and in good faith, and that granting their request will not
prejudice the interests of the government. Accordingly, the requirements of sections
301.9100-1 and 301.9100-3(b)(1) of the regulations have been satisfied.

The consent of the Commissioner is hereby granted to revoke Applicants’ election
under section 163(d)(4)(B) to treat net capital gains and qualified dividends as
investment income for the year at issue. The extension of time to revoke this election
shall be for a period of 60 days from the date of this ruling, and is to be made by filing
an amended return for the year at issue.

This ruling is limited to providing an extension of time to revoke the Applicants election
under section 163(d)(4)(B) for the year at issue. Except as expressly provided herein,
no opinion is expressed or implied concerning the tax consequences of any aspect of
any transaction or item discussed or referenced in this ruling under any other provision
of the Code. In particular, no opinion is expressed (1) as to whether any of Applicants’
interest expense qualifies as a deductible interest expense, or (2) as to the proper
characterization of, or the tax rates applicable to, any items of Applicants’ income.

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 appropriate parties. 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.

A copy of this ruling must be attached to Applicants’ Federal income tax returns for the
tax years affected. Alternatively, if Applicants file their returns electronically, they may
satisfy this requirement by attaching a statement to their return that provides the date
and control number of this letter ruling.

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 representatives. We are also sending a copy of this letter
to the appropriate operating division director. Enclosed is a copy of the letter ruling
PLR-118934-19                           7


showing the deletions proposed to be made in the letter when it is disclosed under
section 6110 of the Code.


                                        Sincerely,



                                        BRINTON WARREN
                                        Chief, Branch 3
                                        Office of the Associate Chief Counsel
                                        (Income Tax & Accounting)


Enclosure: Copy of the letter for section 6110 purposes




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