The Government Accountability Office (GAO) has issued its report on how the government handled requests for waivers from the Patient Protection and Affordable Care Act (PPACA) requirement that generally prohibits health insurance issuers and group health sponsors from imposing annual limits on the dollar value of essential covered health benefits beginning on Jan. 1, 2014. The GAO report, which was Congressionally mandated, found that waivers were granted in virtually all cases.
Background. For plan years beginning on or after Sept. 23, 2010 (e.g., Jan. 1, 2011, for calendar year plans), Public Health Service Act (PHSA) Sec. 2711, which has been incorporated into the Code, generally prohibits group health plans and health insurance issuers offering group or individual health insurance coverage from imposing lifetime or annual limits on the dollar value of health benefits. IRS, Dept. of Labor (DOL), and the Dept. of Health and Human Services (HHS) have jointly issued interim regs (temporary and final regs, in IRS's case) implementing these rules. (Preamble to TD 9491)
Although annual limits on the dollar value of benefits generally are prohibited, so-called “restricted annual limits” are allowed for “essential health benefits” for plan years (in the individual market, policy years) beginning before Jan. 1, 2014, so long as the annual limit is no less than:
(i) $750,000, for a plan year beginning on or after Sept. 23, 2010, but before Sept. 23, 2011;
(ii) $1,250,000, for a plan year beginning on or after Sept. 23, 2011, but before Sept. 23, 2012; and
(iii) $2,000,000, for plan years beginning on or after Sept. 23, 2012, but before Jan. 1, 2014. (Reg. §54.9815-2711T(c), T.D. 9491, 6/22/2010)
Certain grandfathered individual market policies are exempted from this provision.
PHSA Sec. 2711 authorizes HHS to establish a program under which the rules regarding restricted annual limits in Reg. §54.9815-2711T(d)(1) can be waived for a group health plan or health insurance coverage that has an annual dollar limit on benefits that's below the restricted annual limits. The waiver can apply if complying with the restricted annual limit rules would significantly decrease access to benefits under the plan or health insurance coverage, or would significantly increase premiums for the plan or health insurance coverage. The waiver can apply for a period to be determined by HHS. (Reg. §54.9815-2711T(d)(3))
In response to this authorization, HHS's Office of Consumer Information and Insurance Oversight (OCIIO)—subsequently renamed as the Center for Consumer Information and Insurance Oversight (CCIIO)—has issued guidance that provides that a group health plan or health insurance issuer may apply for a waiver from the restricted annual limits set out above. The waiver may be requested if the plan or the coverage offered by the issuer was offered before Sept. 23, 2010 for the plan or policy year beginning between Sept. 23, 2010 and Sept. 23, 2011 by submitting an application not less than 30 days before the beginning of the plan or policy year, or—for a plan or policy year that begins before Nov. 2, 2010—not less than 10 days before the beginning of the plan or policy year.
The application must include:
(1) the terms of the plan or policy forms for which a waiver is being sought;
(2) the number of individuals covered by the plan or policy forms submitted;
(3) the annual limits and rates that apply to the plan or policy forms submitted;
(4) a brief description of why compliance with the restricted annual limit rules would result in a significant decrease in access to benefits for those currently covered by the plans or policies, or a significant increase in premiums paid by those covered by the plans or policies, along with any supporting documentation; and
(5) an attestation, signed by the plan administrator or chief executive officer of the issuer of the health insurance coverage, certifying (a) that the plan was in force before Sept. 23, 2010, and (b) that applying the restricted annual limits to the plans or policies would result in (i) a significant decrease in access to benefits for those currently covered by the plans or policies, or (ii) a significant increase in premiums paid by those covered by the plans or policies.
A waiver approval granted under this process applies only for the plan or policy year that begins between Sept. 23, 2010 and Sept. 23, 2011. A group health plan or health insurance issuer must reapply for any subsequent plan or policy year before Jan. 1, 2014 when this waiver expires in accordance with future guidance from HHS.
HHS says that the waiver is primarily addressed to “limited benefit” or “mini-med” plans, which often have annual limits below the restricted annual limits, and which offer low-cost coverage to part-time workers, seasonal workers, and volunteers who otherwise may not be able to afford coverage at all. HHS cautions that the waiver does not affect any state law requirements addressing annual benefit limits in group health plans, or group and individual health insurance coverage.
The Department of Defense and Full-Year Continuing Appropriations Act for Fiscal Year 2011 (P.L. 112-10) directed GAO to report on annual limit waiver requests.
New “report card” on granting of waivers. The GAO report found that as of Apr. 25, 2011, CCIIO received a total of 1,415 applications for a waiver of restrictions related to annual limits on health benefits, and approved most of these applications. For 1,347 of the applications, or over 95%, CCIIO approved waivers covering all plans in the applications. For another 25 applications, CCIIO approved waivers for some plans and denied waivers for others within the same application. It denied waivers covering all plans in 40 applications. Three applications were pending at the time of GAO's review. GAO says approximately 3 million people were covered in approved plans and approximately 153,000 people were covered in denied plans.
The bulk of the approved applications were granted to self-insured employers (i.e., those funding health coverage for employees and assuming the financial risk rather than buying covering from a health insurance issuer (38.48%), health reimbursement accounts, or HRAs (33.33%), and multi-employer plans (23%).
GAO's report concludes that CCIIO granted waivers on the basis of an application's projected significant increase in premiums or significant reduction in access to health care benefits. Applications with a projected premium increase of 10% or more tended to be approved while applications with a projected premium increase of 6% or less tended to be denied. Applications with a premium increase between 7% and 9% required additional staff reviews to determine if the application met the agency's criteria.
References: For prohibition on lifetime or annual limits on health care coverage—plan years beginning on or after Sept. 23, 2010, see FTC 2d/FIN ¶H-1325.63; United States Tax Reporter ¶98,154.03.
Wednesday, June 22, 2011
Fincen Gives Certain Employees And Officers Of An Investment Advisor Extra Time To File FBARs
FinCEN Notice 2011-2
Treasury's Financial Crimes Enforcement Network (FinCEN) has announced in a Notice that certain employees and officers of an investment advisor with only signature authority over certain foreign financial accounts, who are required to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) with respect to those accounts, will have a one-year extension beyond the upcoming filing date of June 30, 2011. Thus, FinCEN Notice 2011-2 extends the deadline until June 30, 2012.
Background. Each U.S. person who has a financial interest in or signature or other authority over any foreign financial accounts, including bank, securities, or other types of financial accounts in a foreign country, if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year, must report that relationship each calendar year by filing TD F 90-22.1 with the Department of the Treasury on or before June 30th of the succeeding year.
In Notice 2009-62, 2009-35 IRB 260, IRS extended the deadline to June 30, 2010, to file a FBAR for years 2008 and earlier, for (i) persons with no financial interest in a foreign financial account but with signature or other authority over that account; and (ii) persons with a financial interest in or signature authority over a foreign financial account in which the assets are held in a commingled fund.
In Notice 2010-23, 2010-11 IRB 441, which modified and supplemented Notice 2009-62, IRS deferred the deadline for persons with signature authority over, but no financial interest in, a foreign financial account for which a FBAR would otherwise have been due on June 30, 2010, until June 30, 2011. This deadline applied to FBARs reporting foreign financial accounts for the 2010 and prior calendar years. Both of these extensions were provided to give Treasury more the time to develop comprehensive FBAR guidance.
On Feb. 24, 2011, the Treasury Department's Financial Crimes Enforcement Network (FinCEN) issued a final rule to amend the Bank Secrecy Act (BSA) regs regarding FBAR reporting requirements. The rule was made effective as of Mar. 28, 2011 and applies to 2010 reports required to be filed by June 30, 2011, and those for subsequent years. It largely adopted the proposed regs issued on Feb. 26, 2010, which provided additional guidance and clarification regarding who must file FBARs.
Deadline deferred. In FinCEN's Notice 2011-2, the deadline for filing FBAR forms is extended to June 30, 2012 for an employee or officer of an investment advisor registered with the Securities and Exchange Commission who has signature or other authority over, and no financial interest in, a foreign financial account of persons that are not investment companies registered under the Investment Company Act of 1940. Notice 2011-2 supplements FinCEN Notice 2011-1, which gave certain individuals with only signature authority until June 30, 2012, to file FBARs.
The extension is applicable to FBARs for calendar year 2010 and FBARs for calendar year 2009 or earlier calendar years for which the deadline was properly deferred under Notice 2009-62 or Notice 2010-23.
Observation: In Notice 2011-54, 2011-29 IRB (see ¶14), in response to comments that individuals with signature authority over, but no financial interest in, foreign financial accounts were having difficulty gathering the necessary information to file complete and accurate FBARs for 2009 and earlier calendar years by the June 30, 2011, deadline, IRS pushed the deadline back to Nov. 1, 2011. However, the June 30, 2011, deadline for reporting either signature authority over, or financial interest in, foreign financial accounts for the 2010 year remained unchanged. IRS specified that the relief provided in Notice 2011-54, didn't limit the relief provided in FinCEN's Notice 2011-1.
References: For foreign financial accounts reporting requirements, see FTC 2d/FIN ¶S-3650; United States Tax Reporter ¶60,114.06; TaxDesk ¶815,516; TG ¶60611.
Treasury's Financial Crimes Enforcement Network (FinCEN) has announced in a Notice that certain employees and officers of an investment advisor with only signature authority over certain foreign financial accounts, who are required to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) with respect to those accounts, will have a one-year extension beyond the upcoming filing date of June 30, 2011. Thus, FinCEN Notice 2011-2 extends the deadline until June 30, 2012.
Background. Each U.S. person who has a financial interest in or signature or other authority over any foreign financial accounts, including bank, securities, or other types of financial accounts in a foreign country, if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year, must report that relationship each calendar year by filing TD F 90-22.1 with the Department of the Treasury on or before June 30th of the succeeding year.
In Notice 2009-62, 2009-35 IRB 260, IRS extended the deadline to June 30, 2010, to file a FBAR for years 2008 and earlier, for (i) persons with no financial interest in a foreign financial account but with signature or other authority over that account; and (ii) persons with a financial interest in or signature authority over a foreign financial account in which the assets are held in a commingled fund.
In Notice 2010-23, 2010-11 IRB 441, which modified and supplemented Notice 2009-62, IRS deferred the deadline for persons with signature authority over, but no financial interest in, a foreign financial account for which a FBAR would otherwise have been due on June 30, 2010, until June 30, 2011. This deadline applied to FBARs reporting foreign financial accounts for the 2010 and prior calendar years. Both of these extensions were provided to give Treasury more the time to develop comprehensive FBAR guidance.
On Feb. 24, 2011, the Treasury Department's Financial Crimes Enforcement Network (FinCEN) issued a final rule to amend the Bank Secrecy Act (BSA) regs regarding FBAR reporting requirements. The rule was made effective as of Mar. 28, 2011 and applies to 2010 reports required to be filed by June 30, 2011, and those for subsequent years. It largely adopted the proposed regs issued on Feb. 26, 2010, which provided additional guidance and clarification regarding who must file FBARs.
Deadline deferred. In FinCEN's Notice 2011-2, the deadline for filing FBAR forms is extended to June 30, 2012 for an employee or officer of an investment advisor registered with the Securities and Exchange Commission who has signature or other authority over, and no financial interest in, a foreign financial account of persons that are not investment companies registered under the Investment Company Act of 1940. Notice 2011-2 supplements FinCEN Notice 2011-1, which gave certain individuals with only signature authority until June 30, 2012, to file FBARs.
The extension is applicable to FBARs for calendar year 2010 and FBARs for calendar year 2009 or earlier calendar years for which the deadline was properly deferred under Notice 2009-62 or Notice 2010-23.
Observation: In Notice 2011-54, 2011-29 IRB (see ¶14), in response to comments that individuals with signature authority over, but no financial interest in, foreign financial accounts were having difficulty gathering the necessary information to file complete and accurate FBARs for 2009 and earlier calendar years by the June 30, 2011, deadline, IRS pushed the deadline back to Nov. 1, 2011. However, the June 30, 2011, deadline for reporting either signature authority over, or financial interest in, foreign financial accounts for the 2010 year remained unchanged. IRS specified that the relief provided in Notice 2011-54, didn't limit the relief provided in FinCEN's Notice 2011-1.
References: For foreign financial accounts reporting requirements, see FTC 2d/FIN ¶S-3650; United States Tax Reporter ¶60,114.06; TaxDesk ¶815,516; TG ¶60611.
Practitioners Explain How “Blocker” Entities Can Solve A Variety Of Tax Problems
Practitioners discussed the use of “blockers” for tax planning purposes at a recent meeting of the International Tax Institute in New York. Blockers are entities that are placed in a structure in order to change the character of the underlying income or assets to obtain tax results that may otherwise be unavailable. This article describes a number of strategies highlighted at the meeting and explains the types of entities and structures used.
Background on blockers. The use of blockers is quite widespread. For example, many hedge funds use foreign corporations as blockers for their investors to invest in the fund or so that the fund may invest in portfolio companies. Blockers have also been used to prevent U.S. tax-exempt organizations from recognizing unrelated business taxable income (UBTI) and to prevent foreign investors from recognizing income that it effectively connected to a U.S. trade or business.
Use of partnership with controlled foreign corporations (CFCs). Willard B. Taylor of Sullivan Cromwell LLP, considered the use of a U.S. partnership to elect into the CFC foreign tax credit rules or out of the passive foreign investment company (PFIC) rules. As an example, he considered the acquisition of a foreign corporation that would be a PFIC to U.S. investors (mostly with less than 10% interests).
Under Code Sec. 957, a CFC is defined as a foreign corporation with regard to which more than 50% of the total combined voting power of all classes of stock entitled to vote or the total value of the stock of the corporation is owned (directly, indirectly, or constructively) by U.S. shareholders. A U.S. shareholder for CFC purposes is defined as a U.S. person who owns (directly, indirectly, or constructively) 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. (Code Sec. 951(b))
Under Code Sec. 1298(b)(1) a foreign corporation is treated as a PFIC with respect to a U.S. shareholder, and the U.S. shareholder is subject to the excess distribution regime, if the foreign corporation qualified as a PFIC, but not a Qualified Electing Fund (QEF), at any point during the U.S. shareholder's holding period. However, Code Sec. 1297(d)(1) provides that a corporation will not be treated with respect to a shareholder as a PFIC during the “qualified portion” of such shareholder's holding period with respect to the stock in such corporation. (the “overlap rule”). A qualified portion is defined as the portion of a shareholder's holding period which is after Dec. 31,’97, and during which the shareholder is a U.S. shareholder of the corporation and the corporation is a CFC. (Code Sec. 1297(d)(2))
Although the foreign corporation acquired by a partnership would normally be a PFIC, Taylor noted that some investors prefer the subpart F regime over the PFIC rules. By using a blocker, if the investors invest in the foreign corporation through a U.S. partnership, they may opt out of the PFIC rules under Code Sec. 1297(d)’s “overlap” rule (see, e.g., PLR 201107004).
“You could look at this and say if Congress in the time they enacted the overlap rule was presented with a statute that said that you could have been a PFIC or a CFC at your election, would they have passed it?” he asked. “I'm not so sure.”
Investment in commodities through regulated investment companies (RICs). Under Code Sec. 851(b)(2), to be a RIC for a tax year, a corporation must meet an income test (qualifying income requirement) under which at least 90% of its gross income is derived from certain enumerated sources, including dividends, interest, payments with respect to securities loans, and gains from the sale or other disposition of stock or securities or foreign currencies, or other income (including but not limited to gains from options, futures or forward contracts) derived with respect to the RIC's business of investing in the stock, securities, or currencies. Commodities such as precious metals, however, are not included in Code Sec. 851(b)(2).
To get around this, a RIC may organize a foreign subsidiary that invests in commodities. Income (including dividend and subpart F) from the RIC's investment in the foreign corporation complies with the requirements of Code Sec. 851(b)(2). In effect, by using the foreign subsidiary as a “blocker,” the underlying commodity assets have been converted to RIC qualifying income.
The subsidiary may invest in commodities without paying U.S. tax. Moreover, if the subsidiary is located in tax haven jurisdictions such as the Cayman Islands, investment in commodities may be tax-free.
Publicly-traded partnerships (PTPs). John Hart of Simpson, Thacher & Bartlett LLP outlined a similar strategy using PTPs.
A PTP is taxable as a corporation under Code Sec. 7704(a). A partnership is a PTP if interests in the partnership either: (1) are traded on an established securities market (including a national exchange, a regional or local exchange, certain foreign exchanges, and an interdealer quotation system), or (2) are readily tradable on a secondary market or its substantial equivalent. (Code Sec. 7704(b)) However, a PTP won't be treated as a corporation if at least 90% of its gross income for the tax year is specified passive-type income, and certain other requirements are met. (Code Sec. 7704(c))
To get around the 90% limitation, the PTP can set up a subsidiary corporation which would then engage in earning the non-qualifying income. The subsidiary could be a U.S. or foreign corporation.
In the hands of the partnership, the income may take the form of dividends, gain on sale of the subsidiary's stock, subpart F income (if a foreign subsidiary), or PFIC inclusion, etc. Thus, through the use of a taxable corporation, the underlying non-qualifying income is converted to qualifying income.
Hart said that some taxpayers had taken the strategy one step further and placed debt in the subsidiary corporation. The subsidiary then made interest payments to the PTP, which was then considered qualifying income in the hands of the PTP. The subsidiary, in turn, was entitled to a deduction, thereby reducing the group's tax burden.
Elimination of UBTI through the use of a foreign corporation. Hart also outlined a strategy for tax-exempt investors seeking to invest in a U.S. partnership that either makes leveraged investments or investments that generate income not excluded from UBTI.
UBTI generally includes an organization's gross income from any unrelated trade or business, defined in Code Sec. 513, regularly carried on by it, less allowable deductions that are directly connected with the activity. (Code Sec. 512(a); Reg. §1.512(a)-1)
If the tax-exempt investor engaged in the investment directly and the activity was an active business, it might be viewed as UBTI. However, if the activity were instead conducted in a blocker foreign corporation, the foreign corporation would not be subject to U.S. tax (because its not a U.S. activity) and the non-U.S. owner would get income from the foreign corporation in the form of dividends or gain on the sale of shares of the foreign corporation. Assuming that the tax-exempt entity does not borrow money to make an investment in the foreign corporation, that type of income would not be UBTI.
Use of foreign corporation to shield foreign investors from filing U.S. tax return. Hart also presented an option for foreign investors seeking to invest in a U.S. partnership with business income that was effectively connected with a U.S. business but who did not want to file a U.S. tax return.
Rather than engaging in the activity directly, the foreign investors could establish a foreign corporation, and the foreign corporation could engage in the activity and earn the income effectively connected with the U.S. business. However, the effectively connected income is still subject to tax in the foreign corporation's hands (and possibly the branch profits tax), and the foreign investors may not achieve any tax savings on the use of the structure. In some circumstances, the investors could actually pay more U.S. tax, because if they are natural persons, they would not be subject to the branch profits tax; and capital gains could also potentially be imposed at higher rates through the use of a foreign corporation vis-a-vis foreign individuals. However, the foreign investors would be shielded from having to file a U.S. tax return.
Use of a partnership to allow nonresident aliens (NRAs) to invest in an S corporation. Under Code Sec. 1361 1, in order for a corporation to elect to be an S Corporation: (1) it must be a domestic corporation (or an entity classified as an association taxable as a corporation) that isn't an ineligible corporation; (2) it must have no more than 100 shareholders; (3) each shareholder must be an individual, a decedent's estate, a bankrupt's estate, or a specified type of trust or exempt organization, and no shareholder may be a NRA; and (4) it can have only one class of stock.
To get around the limitation on NRAs, an S corporation can form a partnership where it and the NRAs are partners. This results in substantively the same economic and legal rights as though the NRAs were direct shareholders in the S corporation.
Foreign investment in real estate investment trusts (REITs) through a structure that avoids tax due under the Foreign Investment in Real Property Tax Act (FIRPTA). Taylor described a structure that would allow a foreign corporation with investments in U.S. real estate to effectively elect out of FIRPTA.
FIRPTA added Code Sec. 897, Code Sec. 1445, and Code Sec. 6039C to the Code, which respectively impose income tax, withholding tax, and information reporting requirements on NRAs and foreign corporations that dispose of U.S. real property interests (USRPIs).
A gain or loss of a NRA or foreign corporation from the disposition of a USRPI is treated as effectively connected with a U.S. trade or business. (Code Sec. 897(a)(1) Under Code Sec. 897(c), a USRPI includes: (1) an interest in real property located in the U.S. or the Virgin Islands, and (2) any interest (other than solely as a creditor) in any U.S. corporation unless it's shown not to have been a U.S. real property holding corporation during the five-year period ending on the date of disposition.
However, an interest in a REIT isn't treated as a USRPI if the REIT is a domestically controlled qualified investment entity (QIE) under Code Sec. 897(h)(2), which in turn must meet certain requirements with regard to its U.S. real property holdings. (Code Sec. 897(h)(4)) A QIE is domestically controlled if at all times during the relevant testing period less than 50% in value of the stock was held directly or indirectly by foreign persons. (Code Sec. 897(h)(4))
Under the strategy, a REIT could be established for each U.S. property held by the foreign corporation. The foreign corporation would technically own less than 50% of the value of each REIT, and the balance could be owned by a U.S. subsidiary of the foreign corporation or by a U.S. investor that agrees to hold its investment in the REIT for at least five years.
Taylor said that the foreign corporation could essentially elect out of FIRPTA on real estate gains under the “domestically controlled” REIT rule under Code Sec. 897(h)(2) (see PLR 200923001, which provided that where a domestic corporation is the actual owner of stock in a REIT, foreign ownership of the corporation is disregarded).
References: For passive foreign investment companies, see FTC 2d/FIN ¶O-2202; United States Tax Reporter ¶12974; TG ¶30305. For RICs, see FTC 2d/FIN ¶E-6001; United States Tax Reporter ¶12974; TG ¶20525.
Background on blockers. The use of blockers is quite widespread. For example, many hedge funds use foreign corporations as blockers for their investors to invest in the fund or so that the fund may invest in portfolio companies. Blockers have also been used to prevent U.S. tax-exempt organizations from recognizing unrelated business taxable income (UBTI) and to prevent foreign investors from recognizing income that it effectively connected to a U.S. trade or business.
Use of partnership with controlled foreign corporations (CFCs). Willard B. Taylor of Sullivan Cromwell LLP, considered the use of a U.S. partnership to elect into the CFC foreign tax credit rules or out of the passive foreign investment company (PFIC) rules. As an example, he considered the acquisition of a foreign corporation that would be a PFIC to U.S. investors (mostly with less than 10% interests).
Under Code Sec. 957, a CFC is defined as a foreign corporation with regard to which more than 50% of the total combined voting power of all classes of stock entitled to vote or the total value of the stock of the corporation is owned (directly, indirectly, or constructively) by U.S. shareholders. A U.S. shareholder for CFC purposes is defined as a U.S. person who owns (directly, indirectly, or constructively) 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. (Code Sec. 951(b))
Under Code Sec. 1298(b)(1) a foreign corporation is treated as a PFIC with respect to a U.S. shareholder, and the U.S. shareholder is subject to the excess distribution regime, if the foreign corporation qualified as a PFIC, but not a Qualified Electing Fund (QEF), at any point during the U.S. shareholder's holding period. However, Code Sec. 1297(d)(1) provides that a corporation will not be treated with respect to a shareholder as a PFIC during the “qualified portion” of such shareholder's holding period with respect to the stock in such corporation. (the “overlap rule”). A qualified portion is defined as the portion of a shareholder's holding period which is after Dec. 31,’97, and during which the shareholder is a U.S. shareholder of the corporation and the corporation is a CFC. (Code Sec. 1297(d)(2))
Although the foreign corporation acquired by a partnership would normally be a PFIC, Taylor noted that some investors prefer the subpart F regime over the PFIC rules. By using a blocker, if the investors invest in the foreign corporation through a U.S. partnership, they may opt out of the PFIC rules under Code Sec. 1297(d)’s “overlap” rule (see, e.g., PLR 201107004).
“You could look at this and say if Congress in the time they enacted the overlap rule was presented with a statute that said that you could have been a PFIC or a CFC at your election, would they have passed it?” he asked. “I'm not so sure.”
Investment in commodities through regulated investment companies (RICs). Under Code Sec. 851(b)(2), to be a RIC for a tax year, a corporation must meet an income test (qualifying income requirement) under which at least 90% of its gross income is derived from certain enumerated sources, including dividends, interest, payments with respect to securities loans, and gains from the sale or other disposition of stock or securities or foreign currencies, or other income (including but not limited to gains from options, futures or forward contracts) derived with respect to the RIC's business of investing in the stock, securities, or currencies. Commodities such as precious metals, however, are not included in Code Sec. 851(b)(2).
To get around this, a RIC may organize a foreign subsidiary that invests in commodities. Income (including dividend and subpart F) from the RIC's investment in the foreign corporation complies with the requirements of Code Sec. 851(b)(2). In effect, by using the foreign subsidiary as a “blocker,” the underlying commodity assets have been converted to RIC qualifying income.
The subsidiary may invest in commodities without paying U.S. tax. Moreover, if the subsidiary is located in tax haven jurisdictions such as the Cayman Islands, investment in commodities may be tax-free.
Publicly-traded partnerships (PTPs). John Hart of Simpson, Thacher & Bartlett LLP outlined a similar strategy using PTPs.
A PTP is taxable as a corporation under Code Sec. 7704(a). A partnership is a PTP if interests in the partnership either: (1) are traded on an established securities market (including a national exchange, a regional or local exchange, certain foreign exchanges, and an interdealer quotation system), or (2) are readily tradable on a secondary market or its substantial equivalent. (Code Sec. 7704(b)) However, a PTP won't be treated as a corporation if at least 90% of its gross income for the tax year is specified passive-type income, and certain other requirements are met. (Code Sec. 7704(c))
To get around the 90% limitation, the PTP can set up a subsidiary corporation which would then engage in earning the non-qualifying income. The subsidiary could be a U.S. or foreign corporation.
In the hands of the partnership, the income may take the form of dividends, gain on sale of the subsidiary's stock, subpart F income (if a foreign subsidiary), or PFIC inclusion, etc. Thus, through the use of a taxable corporation, the underlying non-qualifying income is converted to qualifying income.
Hart said that some taxpayers had taken the strategy one step further and placed debt in the subsidiary corporation. The subsidiary then made interest payments to the PTP, which was then considered qualifying income in the hands of the PTP. The subsidiary, in turn, was entitled to a deduction, thereby reducing the group's tax burden.
Elimination of UBTI through the use of a foreign corporation. Hart also outlined a strategy for tax-exempt investors seeking to invest in a U.S. partnership that either makes leveraged investments or investments that generate income not excluded from UBTI.
UBTI generally includes an organization's gross income from any unrelated trade or business, defined in Code Sec. 513, regularly carried on by it, less allowable deductions that are directly connected with the activity. (Code Sec. 512(a); Reg. §1.512(a)-1)
If the tax-exempt investor engaged in the investment directly and the activity was an active business, it might be viewed as UBTI. However, if the activity were instead conducted in a blocker foreign corporation, the foreign corporation would not be subject to U.S. tax (because its not a U.S. activity) and the non-U.S. owner would get income from the foreign corporation in the form of dividends or gain on the sale of shares of the foreign corporation. Assuming that the tax-exempt entity does not borrow money to make an investment in the foreign corporation, that type of income would not be UBTI.
Use of foreign corporation to shield foreign investors from filing U.S. tax return. Hart also presented an option for foreign investors seeking to invest in a U.S. partnership with business income that was effectively connected with a U.S. business but who did not want to file a U.S. tax return.
Rather than engaging in the activity directly, the foreign investors could establish a foreign corporation, and the foreign corporation could engage in the activity and earn the income effectively connected with the U.S. business. However, the effectively connected income is still subject to tax in the foreign corporation's hands (and possibly the branch profits tax), and the foreign investors may not achieve any tax savings on the use of the structure. In some circumstances, the investors could actually pay more U.S. tax, because if they are natural persons, they would not be subject to the branch profits tax; and capital gains could also potentially be imposed at higher rates through the use of a foreign corporation vis-a-vis foreign individuals. However, the foreign investors would be shielded from having to file a U.S. tax return.
Use of a partnership to allow nonresident aliens (NRAs) to invest in an S corporation. Under Code Sec. 1361 1, in order for a corporation to elect to be an S Corporation: (1) it must be a domestic corporation (or an entity classified as an association taxable as a corporation) that isn't an ineligible corporation; (2) it must have no more than 100 shareholders; (3) each shareholder must be an individual, a decedent's estate, a bankrupt's estate, or a specified type of trust or exempt organization, and no shareholder may be a NRA; and (4) it can have only one class of stock.
To get around the limitation on NRAs, an S corporation can form a partnership where it and the NRAs are partners. This results in substantively the same economic and legal rights as though the NRAs were direct shareholders in the S corporation.
Foreign investment in real estate investment trusts (REITs) through a structure that avoids tax due under the Foreign Investment in Real Property Tax Act (FIRPTA). Taylor described a structure that would allow a foreign corporation with investments in U.S. real estate to effectively elect out of FIRPTA.
FIRPTA added Code Sec. 897, Code Sec. 1445, and Code Sec. 6039C to the Code, which respectively impose income tax, withholding tax, and information reporting requirements on NRAs and foreign corporations that dispose of U.S. real property interests (USRPIs).
A gain or loss of a NRA or foreign corporation from the disposition of a USRPI is treated as effectively connected with a U.S. trade or business. (Code Sec. 897(a)(1) Under Code Sec. 897(c), a USRPI includes: (1) an interest in real property located in the U.S. or the Virgin Islands, and (2) any interest (other than solely as a creditor) in any U.S. corporation unless it's shown not to have been a U.S. real property holding corporation during the five-year period ending on the date of disposition.
However, an interest in a REIT isn't treated as a USRPI if the REIT is a domestically controlled qualified investment entity (QIE) under Code Sec. 897(h)(2), which in turn must meet certain requirements with regard to its U.S. real property holdings. (Code Sec. 897(h)(4)) A QIE is domestically controlled if at all times during the relevant testing period less than 50% in value of the stock was held directly or indirectly by foreign persons. (Code Sec. 897(h)(4))
Under the strategy, a REIT could be established for each U.S. property held by the foreign corporation. The foreign corporation would technically own less than 50% of the value of each REIT, and the balance could be owned by a U.S. subsidiary of the foreign corporation or by a U.S. investor that agrees to hold its investment in the REIT for at least five years.
Taylor said that the foreign corporation could essentially elect out of FIRPTA on real estate gains under the “domestically controlled” REIT rule under Code Sec. 897(h)(2) (see PLR 200923001, which provided that where a domestic corporation is the actual owner of stock in a REIT, foreign ownership of the corporation is disregarded).
References: For passive foreign investment companies, see FTC 2d/FIN ¶O-2202; United States Tax Reporter ¶12974; TG ¶30305. For RICs, see FTC 2d/FIN ¶E-6001; United States Tax Reporter ¶12974; TG ¶20525.
Remittances Of Employment Taxes Were Tax Payments Subject To Time Limit On Refunds
Nicholas Acoustics & Specialty Company, Inc. v. U.S., (CA 5 6/15/2011) 107 AFTR 2d ¶2011-950
The Court of Appeals for the Fifth Circuit, affirming the district court, has held that a corporation's remittances of employment withholding taxes were tax payments under Code Sec. 6513(c), and not deposits. Since such payments were subject to the Code Sec. 6511 three-year statute of limitations, the Court denied the corporation's refund request as untimely.
Background. IRS classifies a remittance of taxes as either a payment or a deposit. If a tax remittance is determined to be a deposit, it is treated like a cash bond, which IRS simply holds, and a taxpayer may seek a refund of the deposit at any time. (Rosenman v. U.S., (S Ct 1945) 33 AFTR 314) But if a remittance is deemed a payment, the taxpayer may only recover the money by filing a timely claim for a refund. (Miller v. U.S., (Fed Cl 11/9/2000) 86 AFTR 2d 2000-7058)
A remittance that discharges or pays a deemed or assessed tax liability constitutes a payment. In addition, a remittance also constitutes a payment if it's made under a Code section for which the statute's plain language states that the remittance is to be “deemed paid.” (Deaton v. Comm., (CA 5 2006) 97 AFTR 2d 2006-984, Baral v. U.S., (S Ct 2000) 85 AFTR 2d 2000-941)
In Baral, the Supreme Court considered an individual's refund claim for income tax partially paid through his employer's wage withholding and partially paid through his own remittance of the estimated tax. While Baral's analysis specifically applied to Code Sec. 6513(b)(1) and Code Sec. 6513(b)(2), which govern employee withholding taxes, the Court noted that remittances which are governed by a “deemed paid” provision akin to Code Sec. 6513 are “payments” subject to Code Sec. 6511. Under Code Sec. 6511(a), a claim for credit or refund of an overpayment must be filed by the taxpayer within three years from the time the return was filed or two years from the time the tax was paid, whichever period expires later.
Under Code Sec. 6513(c)(1), if a return for any period ending with or within a calendar year is filed before April 15 of the succeeding calendar year, the return is considered filed on April 15 of the succeeding calendar year. Under Code Sec. 6513(c)(2), if a tax with respect to remuneration or other amount paid during any period ending with or within a calendar year is paid before April 15 of the succeeding calendar year, the tax is considered paid on April 15 of the succeeding calendar year. Further, Reg. §31.6302-1(h)(9) provides that any money remitted to IRS in connection with Code Sec. 6513(c)(2) will be considered to be a payment of tax on the last day prescribed for filing the applicable return for the return period.
Facts. Between’99 and 2003, the construction firm Nicholas Acoustics & Specialty Company, Inc., (Nicholas) paid employment payroll taxes, but failed to file any tax returns. It didn't remit funds for the exact amount owed, but instead estimated the amount due, occasionally overpaying taxes. Nicholas erroneously assumed that IRS could apply the overpayment to other quarters in which it had underpaid its tax liability.
In 2003, IRS audited Nicholas due to its failure to file its returns. After the audit, Nicholas filed returns for the missing quarters, which allowed IRS to refund overpayments or credit the overpayments to certain quarters in which a deficit had occurred. IRS said it could only refund or credit Nicholas's overpayments for returns due within the past three years because of the statute of limitations. Nicholas still owed taxes for the period in question, even after IRS made the adjustments. IRS filed a lien against Nicholas, which it paid before seeking a refund.
In seeking a refund, Nicholas contended that the shortfall wouldn't have occurred if IRS had applied all of its overpayments to future or past quarters rather than transferring the money into an excess collection account. IRS countered that when Nicholas actually filed the refund claims, certain overpayments couldn't be refunded due to the three-year statute of limitations under Code Sec. 6511. Nicholas sought relief in the district court.
District court decision. The district court rejected Nicholas's contention that IRS should have classified the tax remittances as deposits rather than tax payments. As a deposit, the amount could be refunded at any time; but as a payment, the amount was subject to the statute of limitations. Relying on Baral, the district court found that the plain language of Code Sec. 6513(c)(2) made it a “deemed paid” provision and, accordingly, it concluded that tax deposits remitted under Code Sec. 6513(c) were payments. Nicholas's payments were subject to Code Sec. 6511’s statute of limitations as a matter of law. IRS was correct in not refunding Nicholas's late refund claims.
Taxpayer's position. Nicholas argued that the district court was wrong in concluding that its employment tax remittances were payments that couldn't be refunded due to the three-year statute of limitations. It argued that the district court erroneously concluded that Code Sec. 6513(c)(2) was a “deemed paid” provision under Baral.
Deemed paid. The Fifth Circuit concluded that the employment tax remittances constitute payments and that refunds of these payments were subject to the three-year statute of limitations under Code Sec. 6511. The Court found that the district court correctly interpreted and applied Baral. The plain language of Code Sec. 6513(c)(2) indicates that it is a deemed paid provision, and so subject to Code Sec. 6511’s limitation period for refunds. Similarly, Reg. §31.6302-1(h)(9) deems a remittance of employment taxes to be a payment.
The Court also noted that the remittances at issue constituted payments under the then-applicable Rev Proc 84-58, 1984-2 CB 501 (this revenue procedure was superseded after Nicholas filed its tax returns). In Rev Proc 84-58, IRS had set up a mechanism by which taxpayers could remit money (i.e., a “deposit in the nature of a cash bond”) to it and stop the accrual of underpayment interest. Rev Proc 84-58 stated that IRS would treat remittances as deposits if they were made before the mailing of a notice of deficiency and designated by the taxpayer in writing as a deposit in the nature of a cash bond. Nicholas's payments weren't made in response to a deficiency notice or a proposed liability. Additionally, at the time of payment, Nicholas didn't protest these payments in writing or request that the payments be treated as deposits.
Observation: In 2005, IRS issued Rev Proc 2005-18, 2005-1 CB 798, which provides procedures for taxpayers to make, withdraw, or identify deposits to suspend the running of interest on potential underpayments under Code Sec. 6603, which was added by the American Jobs Creation Act of 2004. Under this provision, which liberalized prior rules, a cash deposit made in conformity with IRS rules may be used to pay income, gift, estate, or generation-skipping tax or certain excise taxes that have not yet been assessed at the time of the deposit. Rev Proc 2005-18 superseded Rev Proc 84-58, effective for remittances made after Mar. 27, 2005. (Rev Proc 2005-18, Sec. 9)
References: For cash deposits to pay taxes, see FTC 2d/FIN ¶S-5804; United States Tax Reporter ¶66,034; TaxDesk ¶853,009. For employment tax reporting, see FTC 2d/FIN ¶S-2603; United States Tax Reporter ¶35,014.002; TaxDesk ¶557,001; TG ¶9120.
The Court of Appeals for the Fifth Circuit, affirming the district court, has held that a corporation's remittances of employment withholding taxes were tax payments under Code Sec. 6513(c), and not deposits. Since such payments were subject to the Code Sec. 6511 three-year statute of limitations, the Court denied the corporation's refund request as untimely.
Background. IRS classifies a remittance of taxes as either a payment or a deposit. If a tax remittance is determined to be a deposit, it is treated like a cash bond, which IRS simply holds, and a taxpayer may seek a refund of the deposit at any time. (Rosenman v. U.S., (S Ct 1945) 33 AFTR 314) But if a remittance is deemed a payment, the taxpayer may only recover the money by filing a timely claim for a refund. (Miller v. U.S., (Fed Cl 11/9/2000) 86 AFTR 2d 2000-7058)
A remittance that discharges or pays a deemed or assessed tax liability constitutes a payment. In addition, a remittance also constitutes a payment if it's made under a Code section for which the statute's plain language states that the remittance is to be “deemed paid.” (Deaton v. Comm., (CA 5 2006) 97 AFTR 2d 2006-984, Baral v. U.S., (S Ct 2000) 85 AFTR 2d 2000-941)
In Baral, the Supreme Court considered an individual's refund claim for income tax partially paid through his employer's wage withholding and partially paid through his own remittance of the estimated tax. While Baral's analysis specifically applied to Code Sec. 6513(b)(1) and Code Sec. 6513(b)(2), which govern employee withholding taxes, the Court noted that remittances which are governed by a “deemed paid” provision akin to Code Sec. 6513 are “payments” subject to Code Sec. 6511. Under Code Sec. 6511(a), a claim for credit or refund of an overpayment must be filed by the taxpayer within three years from the time the return was filed or two years from the time the tax was paid, whichever period expires later.
Under Code Sec. 6513(c)(1), if a return for any period ending with or within a calendar year is filed before April 15 of the succeeding calendar year, the return is considered filed on April 15 of the succeeding calendar year. Under Code Sec. 6513(c)(2), if a tax with respect to remuneration or other amount paid during any period ending with or within a calendar year is paid before April 15 of the succeeding calendar year, the tax is considered paid on April 15 of the succeeding calendar year. Further, Reg. §31.6302-1(h)(9) provides that any money remitted to IRS in connection with Code Sec. 6513(c)(2) will be considered to be a payment of tax on the last day prescribed for filing the applicable return for the return period.
Facts. Between’99 and 2003, the construction firm Nicholas Acoustics & Specialty Company, Inc., (Nicholas) paid employment payroll taxes, but failed to file any tax returns. It didn't remit funds for the exact amount owed, but instead estimated the amount due, occasionally overpaying taxes. Nicholas erroneously assumed that IRS could apply the overpayment to other quarters in which it had underpaid its tax liability.
In 2003, IRS audited Nicholas due to its failure to file its returns. After the audit, Nicholas filed returns for the missing quarters, which allowed IRS to refund overpayments or credit the overpayments to certain quarters in which a deficit had occurred. IRS said it could only refund or credit Nicholas's overpayments for returns due within the past three years because of the statute of limitations. Nicholas still owed taxes for the period in question, even after IRS made the adjustments. IRS filed a lien against Nicholas, which it paid before seeking a refund.
In seeking a refund, Nicholas contended that the shortfall wouldn't have occurred if IRS had applied all of its overpayments to future or past quarters rather than transferring the money into an excess collection account. IRS countered that when Nicholas actually filed the refund claims, certain overpayments couldn't be refunded due to the three-year statute of limitations under Code Sec. 6511. Nicholas sought relief in the district court.
District court decision. The district court rejected Nicholas's contention that IRS should have classified the tax remittances as deposits rather than tax payments. As a deposit, the amount could be refunded at any time; but as a payment, the amount was subject to the statute of limitations. Relying on Baral, the district court found that the plain language of Code Sec. 6513(c)(2) made it a “deemed paid” provision and, accordingly, it concluded that tax deposits remitted under Code Sec. 6513(c) were payments. Nicholas's payments were subject to Code Sec. 6511’s statute of limitations as a matter of law. IRS was correct in not refunding Nicholas's late refund claims.
Taxpayer's position. Nicholas argued that the district court was wrong in concluding that its employment tax remittances were payments that couldn't be refunded due to the three-year statute of limitations. It argued that the district court erroneously concluded that Code Sec. 6513(c)(2) was a “deemed paid” provision under Baral.
Deemed paid. The Fifth Circuit concluded that the employment tax remittances constitute payments and that refunds of these payments were subject to the three-year statute of limitations under Code Sec. 6511. The Court found that the district court correctly interpreted and applied Baral. The plain language of Code Sec. 6513(c)(2) indicates that it is a deemed paid provision, and so subject to Code Sec. 6511’s limitation period for refunds. Similarly, Reg. §31.6302-1(h)(9) deems a remittance of employment taxes to be a payment.
The Court also noted that the remittances at issue constituted payments under the then-applicable Rev Proc 84-58, 1984-2 CB 501 (this revenue procedure was superseded after Nicholas filed its tax returns). In Rev Proc 84-58, IRS had set up a mechanism by which taxpayers could remit money (i.e., a “deposit in the nature of a cash bond”) to it and stop the accrual of underpayment interest. Rev Proc 84-58 stated that IRS would treat remittances as deposits if they were made before the mailing of a notice of deficiency and designated by the taxpayer in writing as a deposit in the nature of a cash bond. Nicholas's payments weren't made in response to a deficiency notice or a proposed liability. Additionally, at the time of payment, Nicholas didn't protest these payments in writing or request that the payments be treated as deposits.
Observation: In 2005, IRS issued Rev Proc 2005-18, 2005-1 CB 798, which provides procedures for taxpayers to make, withdraw, or identify deposits to suspend the running of interest on potential underpayments under Code Sec. 6603, which was added by the American Jobs Creation Act of 2004. Under this provision, which liberalized prior rules, a cash deposit made in conformity with IRS rules may be used to pay income, gift, estate, or generation-skipping tax or certain excise taxes that have not yet been assessed at the time of the deposit. Rev Proc 2005-18 superseded Rev Proc 84-58, effective for remittances made after Mar. 27, 2005. (Rev Proc 2005-18, Sec. 9)
References: For cash deposits to pay taxes, see FTC 2d/FIN ¶S-5804; United States Tax Reporter ¶66,034; TaxDesk ¶853,009. For employment tax reporting, see FTC 2d/FIN ¶S-2603; United States Tax Reporter ¶35,014.002; TaxDesk ¶557,001; TG ¶9120.
Tax Court Dismisses Whistleblower Claim Because IRS Declined To Go After Taxpayer
William Prentice Cooper, III, (2011) 136 TC No. 30
The Tax Court has dismissed an attorney's claim for a whistleblower award based on an allegation that certain parties failed to pay millions of dollars of estate and generation-skipping transfer (GST) tax because IRS examined the allegation and decided not to go after the taxpayers. The Court said that, in a whistleblower case, its jurisdiction is limited to reviewing IRS's award determination and does not include any authority to redetermine the taxpayer's tax liability.
Background. The 2006 Tax Relief and Health Care Act (TRHCA, P.L. 109-432) amended Code Sec. 7623(b) to increase the amount of the award a whistleblower may receive and allow the whistleblower to appeal award determinations in the Tax Court. TRCA also established a Whistleblower Office within IRS to administer the whistleblower reward program.
A whistleblower claim qualifies under Code Sec. 7623(b), if it:
relates to a tax noncompliance matter in which the tax, penalties, interest, additions to tax and additional amounts in dispute exceed $2 million;
relates to any taxpayer, but in the case of an individual, one whose gross income exceeds $200,000 for at least one of the tax years in question; and
substantially contributes to a decision to take administrative or judicial action that results in the collection of tax, penalties, interest, additions to tax and additional amounts.
Under Code Sec. 7623(b)(1), if IRS proceeds with any administrative or judicial action, then an individual whistleblower will (unless his contribution is less than substantial) receive as an award at least 15%, but not more than 30%, of the collected proceeds (including penalties, interest, additions to tax, and additional amounts) resulting from the action (including any related actions), or from any settlement of the action. Under Code Sec. 7623(b)(2), an award is limited to 10% of collected proceeds if the whistleblower's contribution was less than substantial.
Facts. William Prentice Cooper, III, an attorney, filed two claims for a whistleblower award with IRS under Code Sec. 7623(b). In one claim, he alleged that a trust having over $102 million in assets was improperly omitted from the gross estate of Dorothy Dillon Eweson (Ms. Eweson), resulting in a possible $75 million underpayment in Federal estate tax. In the other claim, he alleged that Ms. Eweson impermissibly modified two trusts as part of a scheme to avoid the GST tax. The trusts at issue had a combined value of over $200 million at the time of Ms. Eweson's death in 2005. Cooper learned of the alleged violations through his representation of the widow of Ms. Eweson's grandson. He also verified the information by examining the public records and the records of his client. In addition, he submitted information to support the second allegation (filings in a New York Surrogate Court proceeding challenging the trust modifications as designed primarily to evade tax), and he provided a legal memorandum and draft legal documents from Ms. Eweson's attorneys that indicated the trusts were modified as part of a scheme to avoid the GST tax.
Some nine months after he filed the claims, the Whistleblower Office sent Cooper a letter denying the claims. The letter stated that an award determination couldn't be made under Code Sec. 7623(b) because he did not identify federal tax issues on which IRS would take action. The letter further explained that an award wasn't warranted for either claim because his information didn't “result in the detection of the underpayment of taxes.” Cooper filed petitions in the Tax Court seeking a review of IRS's denial of the whistleblower claims.
In response, IRS filed motions to dismiss these cases for lack of jurisdiction on the ground that no determination notice under Code Sec. 7623(b) had been made. In an earlier action, the Tax Court determined that the IRS letters denying the whistleblower's claims were “determinations” that gave the Tax Court jurisdiction to review the matter under Code Sec. 7623(b)(4).
In the current case, IRS filed answers to the two whistleblower award petitions. Attached to them was a memorandum from an IRS estate tax attorney. It summarized the facts, legal analysis and legal conclusion for IRS's denials of Cooper's claims.
Parties' arguments. IRS asked the Tax Court to dismiss the case on summary judgment because IRS said there were no genuine issues of material fact for trial. Cooper asserted that there were genuine issues of material fact because IRS failed to properly investigate facts relevant to the whistleblower claims. He further argued that IRS failed to apply the correct law in determining the merits of his claims. Cooper asked the Court to direct IRS to undertake a complete reevaluation of the facts in the matter, begin an investigation, open a case file, and take whatever other steps are necessary to detect an underpayment of tax.
Tax Court dismisses case. The Tax Court observed that generally, an individual who provides information to IRS that leads it to proceed with an administrative or judicial action is entitled to receive an award equal to a percentage of the collected proceeds under Code Sec. 7623(b)(1). Thus, stressed the Court, a whistleblower award is dependent upon both the initiation of an administrative or judicial action and the collection of tax proceeds.
Cooper wanted to litigate whether any transfer tax was due from the taxpayer. The Court said its jurisdiction in a whistleblower action is different from its jurisdiction to review a deficiency determination. In a deficiency action, the Tax Court can redetermine whether there is any income, estate or gift tax due under Code Sec. 6214(a). In a whistleblower action, however, the Court said its jurisdiction is limited under Code Sec. 7623(b) to IRS's award determination.
Congress did not authorize the Tax Court to direct IRS to proceed with an administrative or judicial action. IRS explained why it determined that there was no transfer tax due on the facts Cooper presented. He may disagree with IRS's legal conclusions for why there was no tax due. Nevertheless, whistleblower awards are preconditioned on IRS's proceeding with an administrative or judicial action. If IRS does not proceed, there can be no whistleblower award.
Since no tax was collected, there can be no award. Accordingly, the Tax Court dismissed the case.
References: For IRS's payment for information on tax violations, see FTC 2d/FIN ¶T-1030 et seq.; United States Tax Reporter ¶76,234 et seq.; TaxDesk ¶821,500 et seq.
The Tax Court has dismissed an attorney's claim for a whistleblower award based on an allegation that certain parties failed to pay millions of dollars of estate and generation-skipping transfer (GST) tax because IRS examined the allegation and decided not to go after the taxpayers. The Court said that, in a whistleblower case, its jurisdiction is limited to reviewing IRS's award determination and does not include any authority to redetermine the taxpayer's tax liability.
Background. The 2006 Tax Relief and Health Care Act (TRHCA, P.L. 109-432) amended Code Sec. 7623(b) to increase the amount of the award a whistleblower may receive and allow the whistleblower to appeal award determinations in the Tax Court. TRCA also established a Whistleblower Office within IRS to administer the whistleblower reward program.
A whistleblower claim qualifies under Code Sec. 7623(b), if it:
relates to a tax noncompliance matter in which the tax, penalties, interest, additions to tax and additional amounts in dispute exceed $2 million;
relates to any taxpayer, but in the case of an individual, one whose gross income exceeds $200,000 for at least one of the tax years in question; and
substantially contributes to a decision to take administrative or judicial action that results in the collection of tax, penalties, interest, additions to tax and additional amounts.
Under Code Sec. 7623(b)(1), if IRS proceeds with any administrative or judicial action, then an individual whistleblower will (unless his contribution is less than substantial) receive as an award at least 15%, but not more than 30%, of the collected proceeds (including penalties, interest, additions to tax, and additional amounts) resulting from the action (including any related actions), or from any settlement of the action. Under Code Sec. 7623(b)(2), an award is limited to 10% of collected proceeds if the whistleblower's contribution was less than substantial.
Facts. William Prentice Cooper, III, an attorney, filed two claims for a whistleblower award with IRS under Code Sec. 7623(b). In one claim, he alleged that a trust having over $102 million in assets was improperly omitted from the gross estate of Dorothy Dillon Eweson (Ms. Eweson), resulting in a possible $75 million underpayment in Federal estate tax. In the other claim, he alleged that Ms. Eweson impermissibly modified two trusts as part of a scheme to avoid the GST tax. The trusts at issue had a combined value of over $200 million at the time of Ms. Eweson's death in 2005. Cooper learned of the alleged violations through his representation of the widow of Ms. Eweson's grandson. He also verified the information by examining the public records and the records of his client. In addition, he submitted information to support the second allegation (filings in a New York Surrogate Court proceeding challenging the trust modifications as designed primarily to evade tax), and he provided a legal memorandum and draft legal documents from Ms. Eweson's attorneys that indicated the trusts were modified as part of a scheme to avoid the GST tax.
Some nine months after he filed the claims, the Whistleblower Office sent Cooper a letter denying the claims. The letter stated that an award determination couldn't be made under Code Sec. 7623(b) because he did not identify federal tax issues on which IRS would take action. The letter further explained that an award wasn't warranted for either claim because his information didn't “result in the detection of the underpayment of taxes.” Cooper filed petitions in the Tax Court seeking a review of IRS's denial of the whistleblower claims.
In response, IRS filed motions to dismiss these cases for lack of jurisdiction on the ground that no determination notice under Code Sec. 7623(b) had been made. In an earlier action, the Tax Court determined that the IRS letters denying the whistleblower's claims were “determinations” that gave the Tax Court jurisdiction to review the matter under Code Sec. 7623(b)(4).
In the current case, IRS filed answers to the two whistleblower award petitions. Attached to them was a memorandum from an IRS estate tax attorney. It summarized the facts, legal analysis and legal conclusion for IRS's denials of Cooper's claims.
Parties' arguments. IRS asked the Tax Court to dismiss the case on summary judgment because IRS said there were no genuine issues of material fact for trial. Cooper asserted that there were genuine issues of material fact because IRS failed to properly investigate facts relevant to the whistleblower claims. He further argued that IRS failed to apply the correct law in determining the merits of his claims. Cooper asked the Court to direct IRS to undertake a complete reevaluation of the facts in the matter, begin an investigation, open a case file, and take whatever other steps are necessary to detect an underpayment of tax.
Tax Court dismisses case. The Tax Court observed that generally, an individual who provides information to IRS that leads it to proceed with an administrative or judicial action is entitled to receive an award equal to a percentage of the collected proceeds under Code Sec. 7623(b)(1). Thus, stressed the Court, a whistleblower award is dependent upon both the initiation of an administrative or judicial action and the collection of tax proceeds.
Cooper wanted to litigate whether any transfer tax was due from the taxpayer. The Court said its jurisdiction in a whistleblower action is different from its jurisdiction to review a deficiency determination. In a deficiency action, the Tax Court can redetermine whether there is any income, estate or gift tax due under Code Sec. 6214(a). In a whistleblower action, however, the Court said its jurisdiction is limited under Code Sec. 7623(b) to IRS's award determination.
Congress did not authorize the Tax Court to direct IRS to proceed with an administrative or judicial action. IRS explained why it determined that there was no transfer tax due on the facts Cooper presented. He may disagree with IRS's legal conclusions for why there was no tax due. Nevertheless, whistleblower awards are preconditioned on IRS's proceeding with an administrative or judicial action. If IRS does not proceed, there can be no whistleblower award.
Since no tax was collected, there can be no award. Accordingly, the Tax Court dismissed the case.
References: For IRS's payment for information on tax violations, see FTC 2d/FIN ¶T-1030 et seq.; United States Tax Reporter ¶76,234 et seq.; TaxDesk ¶821,500 et seq.
IRS Releases Simplified Draft Work Opportunity Tax Credit Form
Form 5884, Work Opportunity Credit
IRS has released a simplified draft Form 5884, Work Opportunity Credit, for taxpayers to claim this tax credit, which is scheduled to expire for employees who begin work after 2011. For many taxpayers, information previously reported on the form would now be reported directly on Form 3800, General Business Credit.
Background. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act, P.L. 111-312, 12/17/2010) extended the Code Sec. 51 work opportunity tax credit four months to include individuals who began work before Jan. 1, 2012. Under pre-Act law, wages for purposes of the credit didn't include any amount paid or incurred for an individual who began work after Aug. 31, 2011.
The credit allows employers who hire members of certain targeted groups to get a credit against income tax of a percentage of first-year wages up to $6,000 per employee ($12,000 for qualified veterans; and $3,000 for qualified summer youth employees). Where the employee is a long-term family assistance (LTFA) recipient, the credit is a percentage of first and second year wages, up to $10,000 per employee. Generally, the percentage of qualifying wages is 40% of first-year wages; it's 25% for employees who have completed at least 120 hours, but less than 400 hours of service for the employer. For LTFA recipients, it includes an additional 50% of qualified second-year wages.
The targeted groups are: Qualified IV-A recipients (qualified recipients of aid to families with dependent children or successor program); qualified veterans; qualified ex-felons; designated community residents (i.e., the former “high-risk youths” targeted group but with the maximum age requirement raised and the residency requirement expanded to include rural renewal residents); vocational rehabilitation referrals; qualified summer youth employees; qualified food stamp recipients; qualified SSI (supplemental security income) recipients; long-term family assistance recipients, i.e., members of a family that receives or received assistance under a IV-A program for a minimum period of time; and unemployed veterans and disconnected youths who began work for an employer after 2008 and before 2011.
Taxpayers use Form 5884 to claim the work opportunity tax credit for qualified first- or second-year wages paid to or incurred for targeted group employees during the tax year. A taxpayer's business doesn't have to be located in an empowerment zone, renewal community, or rural renewal county to qualify for this credit. Taxpayers can claim or elect not to claim the work opportunity tax credit any time within three years from the due date of their return on either an original return or an amended return.
As noted above, the work opportunity tax credit is scheduled to expire for employees who begin work after 2011. In addition, the renewal community designations expired at the end of 2009. Wages paid or incurred for services performed after 2009 by a designated community resident or summer youth employee who lived in a renewal community may no longer qualify for the work opportunity tax credit unless the designation is extended.
Draft Form. The Instructions to the Draft Form 5884 direct taxpayers not to report wages paid or incurred to qualified employees on Form 5884 unless the credit is extended. Further, the Instructions to the Draft Form 5884 direct taxpayers that carryforwards, carrybacks, and passive activity limitations for the credit are no longer reported on Form 5884. Instead, they must be reported on Form 3800.
In addition, taxpayers, other than partnerships, S corporations, cooperatives, estates, or trusts, whose only source of this credit is from those pass-through entities, wouldn't be required to complete or file this form. Instead, they could report this credit directly on Form 3800.
References: For the work opportunity tax credit, see FTC 2d/FIN ¶L-17775; United States Tax Reporter ¶514; TaxDesk ¶380,700; TG ¶14976.
IRS has released a simplified draft Form 5884, Work Opportunity Credit, for taxpayers to claim this tax credit, which is scheduled to expire for employees who begin work after 2011. For many taxpayers, information previously reported on the form would now be reported directly on Form 3800, General Business Credit.
Background. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act, P.L. 111-312, 12/17/2010) extended the Code Sec. 51 work opportunity tax credit four months to include individuals who began work before Jan. 1, 2012. Under pre-Act law, wages for purposes of the credit didn't include any amount paid or incurred for an individual who began work after Aug. 31, 2011.
The credit allows employers who hire members of certain targeted groups to get a credit against income tax of a percentage of first-year wages up to $6,000 per employee ($12,000 for qualified veterans; and $3,000 for qualified summer youth employees). Where the employee is a long-term family assistance (LTFA) recipient, the credit is a percentage of first and second year wages, up to $10,000 per employee. Generally, the percentage of qualifying wages is 40% of first-year wages; it's 25% for employees who have completed at least 120 hours, but less than 400 hours of service for the employer. For LTFA recipients, it includes an additional 50% of qualified second-year wages.
The targeted groups are: Qualified IV-A recipients (qualified recipients of aid to families with dependent children or successor program); qualified veterans; qualified ex-felons; designated community residents (i.e., the former “high-risk youths” targeted group but with the maximum age requirement raised and the residency requirement expanded to include rural renewal residents); vocational rehabilitation referrals; qualified summer youth employees; qualified food stamp recipients; qualified SSI (supplemental security income) recipients; long-term family assistance recipients, i.e., members of a family that receives or received assistance under a IV-A program for a minimum period of time; and unemployed veterans and disconnected youths who began work for an employer after 2008 and before 2011.
Taxpayers use Form 5884 to claim the work opportunity tax credit for qualified first- or second-year wages paid to or incurred for targeted group employees during the tax year. A taxpayer's business doesn't have to be located in an empowerment zone, renewal community, or rural renewal county to qualify for this credit. Taxpayers can claim or elect not to claim the work opportunity tax credit any time within three years from the due date of their return on either an original return or an amended return.
As noted above, the work opportunity tax credit is scheduled to expire for employees who begin work after 2011. In addition, the renewal community designations expired at the end of 2009. Wages paid or incurred for services performed after 2009 by a designated community resident or summer youth employee who lived in a renewal community may no longer qualify for the work opportunity tax credit unless the designation is extended.
Draft Form. The Instructions to the Draft Form 5884 direct taxpayers not to report wages paid or incurred to qualified employees on Form 5884 unless the credit is extended. Further, the Instructions to the Draft Form 5884 direct taxpayers that carryforwards, carrybacks, and passive activity limitations for the credit are no longer reported on Form 5884. Instead, they must be reported on Form 3800.
In addition, taxpayers, other than partnerships, S corporations, cooperatives, estates, or trusts, whose only source of this credit is from those pass-through entities, wouldn't be required to complete or file this form. Instead, they could report this credit directly on Form 3800.
References: For the work opportunity tax credit, see FTC 2d/FIN ¶L-17775; United States Tax Reporter ¶514; TaxDesk ¶380,700; TG ¶14976.
Trust's Distribution Of Annuity Contracts To Beneficiaries Won't Be Gratuitous Transfer
PLR 201124008
IRS has privately ruled that flexible premium deferred annuity contracts purchased by a trust, of which each of the trust beneficiaries will be the named annuitant of a contract in proportion to his residuary share of the trust, will be considered owned by natural persons for Code Sec. 72(u) purposes. Additionally, the trust's distribution of the contracts to the beneficiaries won't be treated as an assignment of an annuity contract without full and adequate consideration under Code Sec. 72(e)(4)(C).
Background. An annuity is a contract providing for regular payments beginning on a fixed date and continuing for the life of one or more individuals or for a term of years. Generally, the contract is a life insurance, endowment, or annuity contract purchased from an insurance company, but an annuity may be issued by a party other than a commercial insurer. The special tax rules for annuities under Code Sec. 72 generally permit the annuitant to recover the cost of the contract tax-free over the term of the annuity.
However, under Code Sec. 72(u), an annuity contract won't be treated as an annuity contract if it is held by a person who isn't a “natural person.” Instead, the income on the contract for any tax year of the policyholder will be treated as ordinary income received or accrued by the owner during that tax year. Corporations and trusts aren't natural persons according to the’86 TRA Committee Reports, but Code Sec. 72(u)(1) provides that the holding by a trust or other entity as an agent for a natural person will generally be disregarded.
An individual who holds an annuity contract transfers it for less than full and adequate consideration, is treated under Code Sec. 72(e)(4)(C)(i) as receiving a nonannuity payment equal to the excess of: (i) the cash surrender value of the contract at the time of transfer, over (ii) his investment in the contract.
Facts. Husband (H) established a grantor trust (Trust) and named as beneficiaries Wife (W) and their six descendants. H and W were co-trustees during H's life.
Upon H's death, W became the sole trustee, and the trust was divided into subtrusts A, B, and C. Subtrust A was allocated an amount based on the allowed estate tax exemption and marital deduction. Subtrust C was allocated an amount based on the estate tax exemption, provided the amount was not used for the payment of taxes, debts, or administration expenses of H's estate. Once all taxes, debts, and expenses have been paid, the assets of subtrust C are to be distributed to subtrust B, which contains all remaining trust property.
During the life of W, in her capacity as trustee and subject to an ascertainable standard, W may pay or use the property of subtrust B for the benefit of herself and others partly or wholly dependent upon her. At her death, the property of subtrust B is to be divided and distributed among the descendant-beneficiaries in the proportions stated in Trust.
W, as trustee, intends to purchase flexible premium deferred annuity contracts naming each of the descendant-beneficiaries as the annuitant on one annuity contract, in proportion to each's residuary share of Trust. The material provisions of each contract will be substantially the same, except for the dates of annuitization. Trust will be the owner and beneficiary of the contracts during W's life. Trust anticipates that its other assets will be sufficient to fund its expenses and make nominal distributions to W, and that there should not be any need for Trust to take a distribution from the annuity contracts.
Upon Trust's final distribution, each beneficiary will be distributed the contract for which that beneficiary is the annuitant. This distribution is anticipated to occur before the contract's annuity starting date. Trust won't receive any consideration from any beneficiary in exchange for the contracts.
IRS rules favorably. In a taxpayer-friendly private letter ruling (PLR), IRS concluded that the annuity contracts are considered owned by natural persons for Code Sec. 72(u) purposes, and that the distribution of the contracts by Trust to the beneficiaries won't be treated as an assignment of an annuity contract for less than full and adequate consideration under Code Sec. 72(e)(4)(C).
With regard to the Code Sec. 72(u) ruling, IRS examined the legislative history and determined that provision was largely intended to target employers' use of annuity contracts to fund significant amounts of deferred compensation for employees on a tax-favored basis. In contrast, the annuity contracts at issue are owned by a trust under which all of the beneficial interests are owned by natural persons in a non-employment context. Accordingly, IRS determined that the contracts were properly treated as being owned by a natural person for Code Sec. 72(u)(1).
Looking to the Code Sec. 72(e)(4)(C) issue, IRS found that the legislative history of this provision indicates that this rule is intended to prohibit taxpayers from avoiding Code Sec. 72(s)’s required distribution rules by continuing tax deferral beyond the life of an individual taxpayer. Here, since the transfer of the contracts from Trust to the beneficiaries doesn't have the effect of avoiding Code Sec. 72(s)’s required distribution rules, the distribution of the contracts won't be treated as an assignment for less than full consideration.
References: For the requirement that annuity benefits be available only to natural persons, see FTC 2d/FIN ¶J-5005; United States Tax Reporter ¶724.25; TaxDesk ¶146,506; TG ¶12656. For transfers of annuity contracts without adequate consideration, see FTC 2d/FIN ¶J-5061; United States Tax Reporter ¶724.13; TaxDesk ¶146,531.
IRS has privately ruled that flexible premium deferred annuity contracts purchased by a trust, of which each of the trust beneficiaries will be the named annuitant of a contract in proportion to his residuary share of the trust, will be considered owned by natural persons for Code Sec. 72(u) purposes. Additionally, the trust's distribution of the contracts to the beneficiaries won't be treated as an assignment of an annuity contract without full and adequate consideration under Code Sec. 72(e)(4)(C).
Background. An annuity is a contract providing for regular payments beginning on a fixed date and continuing for the life of one or more individuals or for a term of years. Generally, the contract is a life insurance, endowment, or annuity contract purchased from an insurance company, but an annuity may be issued by a party other than a commercial insurer. The special tax rules for annuities under Code Sec. 72 generally permit the annuitant to recover the cost of the contract tax-free over the term of the annuity.
However, under Code Sec. 72(u), an annuity contract won't be treated as an annuity contract if it is held by a person who isn't a “natural person.” Instead, the income on the contract for any tax year of the policyholder will be treated as ordinary income received or accrued by the owner during that tax year. Corporations and trusts aren't natural persons according to the’86 TRA Committee Reports, but Code Sec. 72(u)(1) provides that the holding by a trust or other entity as an agent for a natural person will generally be disregarded.
An individual who holds an annuity contract transfers it for less than full and adequate consideration, is treated under Code Sec. 72(e)(4)(C)(i) as receiving a nonannuity payment equal to the excess of: (i) the cash surrender value of the contract at the time of transfer, over (ii) his investment in the contract.
Facts. Husband (H) established a grantor trust (Trust) and named as beneficiaries Wife (W) and their six descendants. H and W were co-trustees during H's life.
Upon H's death, W became the sole trustee, and the trust was divided into subtrusts A, B, and C. Subtrust A was allocated an amount based on the allowed estate tax exemption and marital deduction. Subtrust C was allocated an amount based on the estate tax exemption, provided the amount was not used for the payment of taxes, debts, or administration expenses of H's estate. Once all taxes, debts, and expenses have been paid, the assets of subtrust C are to be distributed to subtrust B, which contains all remaining trust property.
During the life of W, in her capacity as trustee and subject to an ascertainable standard, W may pay or use the property of subtrust B for the benefit of herself and others partly or wholly dependent upon her. At her death, the property of subtrust B is to be divided and distributed among the descendant-beneficiaries in the proportions stated in Trust.
W, as trustee, intends to purchase flexible premium deferred annuity contracts naming each of the descendant-beneficiaries as the annuitant on one annuity contract, in proportion to each's residuary share of Trust. The material provisions of each contract will be substantially the same, except for the dates of annuitization. Trust will be the owner and beneficiary of the contracts during W's life. Trust anticipates that its other assets will be sufficient to fund its expenses and make nominal distributions to W, and that there should not be any need for Trust to take a distribution from the annuity contracts.
Upon Trust's final distribution, each beneficiary will be distributed the contract for which that beneficiary is the annuitant. This distribution is anticipated to occur before the contract's annuity starting date. Trust won't receive any consideration from any beneficiary in exchange for the contracts.
IRS rules favorably. In a taxpayer-friendly private letter ruling (PLR), IRS concluded that the annuity contracts are considered owned by natural persons for Code Sec. 72(u) purposes, and that the distribution of the contracts by Trust to the beneficiaries won't be treated as an assignment of an annuity contract for less than full and adequate consideration under Code Sec. 72(e)(4)(C).
With regard to the Code Sec. 72(u) ruling, IRS examined the legislative history and determined that provision was largely intended to target employers' use of annuity contracts to fund significant amounts of deferred compensation for employees on a tax-favored basis. In contrast, the annuity contracts at issue are owned by a trust under which all of the beneficial interests are owned by natural persons in a non-employment context. Accordingly, IRS determined that the contracts were properly treated as being owned by a natural person for Code Sec. 72(u)(1).
Looking to the Code Sec. 72(e)(4)(C) issue, IRS found that the legislative history of this provision indicates that this rule is intended to prohibit taxpayers from avoiding Code Sec. 72(s)’s required distribution rules by continuing tax deferral beyond the life of an individual taxpayer. Here, since the transfer of the contracts from Trust to the beneficiaries doesn't have the effect of avoiding Code Sec. 72(s)’s required distribution rules, the distribution of the contracts won't be treated as an assignment for less than full consideration.
References: For the requirement that annuity benefits be available only to natural persons, see FTC 2d/FIN ¶J-5005; United States Tax Reporter ¶724.25; TaxDesk ¶146,506; TG ¶12656. For transfers of annuity contracts without adequate consideration, see FTC 2d/FIN ¶J-5061; United States Tax Reporter ¶724.13; TaxDesk ¶146,531.
Federal Circuit Finds Interest Netting Not Allowed For Years Before Sub Was Acquired By Parent
Energy East Corporation v. U.S., (CA Fed Cir 6 3/20/2011) 107 AFTR 2d ¶2011-962
The U.S Court of Appeals for the Federal Circuit, affirming the Court of Federal Claims, has held that interest netting wasn't available for interest on a parent corporation's deficiency and interest on overpayments made by two of its subsidiaries. The Court reasoned that because the subsidiaries were separate and different taxpayers wholly unrelated to the parent corporation when the underpayment was due and when the overpayments were made, they weren't the “same taxpayer” as required under Code Sec. 6621(d), the provision allowing interest netting.
Background. Code Sec. 6621(a)(1) establishes the interest rate for overpayments, and Code Sec. 6621(a)(2) establishes the interest rate for underpayments. Under Code Sec. 6621(d), to the extent interest is payable for any period under Code Sec. 6601 (imposing interest on underpayments) and allowable under Code Sec. 6611 (paying interest on overpayments) on equivalent underpayments and overpayments by “the same taxpayer,” the net rate of interest under Code Sec. 6621 on the underpayment and overpayment amounts is zero for the overlapping period.
“Taxpayer” is defined as “any person subject to any internal revenue tax.” (Code Sec. 7701(a)(14)) “Person” includes a corporation. (Code Sec. 7701(a)(1))
Facts. Energy East Corporation (Energy East) and its subsidiaries, Central Maine Power Company (CMP), and the Rochester Gas & Electric Corporation (RG&E), were separate and unrelated taxpayers during the’95,’96,’97, and’99 tax years. Energy East acquired CMP in 2000 and RG&E in 2002. Before the acquisitions, CMP had overpaid its taxes for’95,’96, and’97; RG&E had overpaid its tax for’96 and’97; and Energy East had underpaid its taxes for’99. Energy East filed suit in the Court of Federal Claims to recoup $2,715,007 of interest in connection with the overpayments by CMP and RG&E and the underpayment by Energy East. Both Energy East and IRS moved for summary judgment on the issue of whether interest should be netted.
Court of Federal Claims decision. The Court of Federal Claims held that because Energy East and its subsidiaries weren't the same taxpayer when they made the overpayments and underpayments, they weren't entitled to interest rate netting under Code Sec. 6621(d). Under Code Sec. 6621(d), interest rates may be netted only on equivalent underpayments and overpayments “by the same taxpayer of tax.” The Energy East corporation that underpaid its taxes in’99 was not the “same” taxpayer as either the CMP corporation that overpaid its taxes in’95,’96, and’97, or as the RG&E corporation that overpaid its taxes in’96 and’97. These entities were neither “identical” nor “without addition or change.” Rather, the subsidiaries were changed when their parent corporations were acquired by Energy East in 2000, giving them the ability to form a consolidated group. Because Energy East later acquired RG&E and CMP and filed consolidated tax returns for all three corporations, the three corporations didn't lose their status as separate taxpayers or retroactively acquire a status as one and the same taxpayer for the tax years before their joining the group.
Court of Appeals affirms. The Federal Circuit concluded that Energy East couldn't net the interest from its underpayment with the interest from its subsidiaries' overpayments because it wasn't the same taxpayer as its subsidiaries at the time the payments were made. Code Sec. 6621(d) requires that taxpayers be the same when the overpayments and underpayments are made.
The Court rejected Energy East's claim that a “reasonable” interpretation of Code Sec. 6621(d) should allow interest netting if the parent and subsidiary file consolidated returns when the netting claim is made. The Court found that the language of Code Sec. 6621(d) clearly provides an identified point in time at which the taxpayer must be the same—i.e., when the overpayments and underpayments are made. Energy East chose to ignore the plain language of the statute, and instead proposed an erroneous interpretation that rested on a limited reading of the statute and unnecessary reliance on the legislative history. In analyzing Code Sec. 6621(d), the Court found nothing in the legislative history that supported Energy East's interpretation.
The Court also rejected Energy East's contention that Code Sec. 6621(d) allowed interest netting for the period when the corporations file consolidated returns and interest was accruing on their respective overpayments and underpayments—i.e., that because the period of its underpayment overlapped with the period of its subsidiaries' overpayment after consolidation, Code Sec. 6621(d) allows interest netting. CMP's and RG&E's overpayments were made in’95-97, and Energy East's underpayment was made in’99—all of which occurred before Energy East's acquisition of CMP and RG&E. These underpayments and overpayments weren't made by the “same taxpayer,” and so couldn't be attributed to Energy East.
References. For zero net interest rate in the case of overlapping underpayments and overpayments, see FTC 2d/FIN ¶V-1301.1; United States Tax Reporter ¶66,214; TaxDesk ¶851,008; TG ¶71563.
The U.S Court of Appeals for the Federal Circuit, affirming the Court of Federal Claims, has held that interest netting wasn't available for interest on a parent corporation's deficiency and interest on overpayments made by two of its subsidiaries. The Court reasoned that because the subsidiaries were separate and different taxpayers wholly unrelated to the parent corporation when the underpayment was due and when the overpayments were made, they weren't the “same taxpayer” as required under Code Sec. 6621(d), the provision allowing interest netting.
Background. Code Sec. 6621(a)(1) establishes the interest rate for overpayments, and Code Sec. 6621(a)(2) establishes the interest rate for underpayments. Under Code Sec. 6621(d), to the extent interest is payable for any period under Code Sec. 6601 (imposing interest on underpayments) and allowable under Code Sec. 6611 (paying interest on overpayments) on equivalent underpayments and overpayments by “the same taxpayer,” the net rate of interest under Code Sec. 6621 on the underpayment and overpayment amounts is zero for the overlapping period.
“Taxpayer” is defined as “any person subject to any internal revenue tax.” (Code Sec. 7701(a)(14)) “Person” includes a corporation. (Code Sec. 7701(a)(1))
Facts. Energy East Corporation (Energy East) and its subsidiaries, Central Maine Power Company (CMP), and the Rochester Gas & Electric Corporation (RG&E), were separate and unrelated taxpayers during the’95,’96,’97, and’99 tax years. Energy East acquired CMP in 2000 and RG&E in 2002. Before the acquisitions, CMP had overpaid its taxes for’95,’96, and’97; RG&E had overpaid its tax for’96 and’97; and Energy East had underpaid its taxes for’99. Energy East filed suit in the Court of Federal Claims to recoup $2,715,007 of interest in connection with the overpayments by CMP and RG&E and the underpayment by Energy East. Both Energy East and IRS moved for summary judgment on the issue of whether interest should be netted.
Court of Federal Claims decision. The Court of Federal Claims held that because Energy East and its subsidiaries weren't the same taxpayer when they made the overpayments and underpayments, they weren't entitled to interest rate netting under Code Sec. 6621(d). Under Code Sec. 6621(d), interest rates may be netted only on equivalent underpayments and overpayments “by the same taxpayer of tax.” The Energy East corporation that underpaid its taxes in’99 was not the “same” taxpayer as either the CMP corporation that overpaid its taxes in’95,’96, and’97, or as the RG&E corporation that overpaid its taxes in’96 and’97. These entities were neither “identical” nor “without addition or change.” Rather, the subsidiaries were changed when their parent corporations were acquired by Energy East in 2000, giving them the ability to form a consolidated group. Because Energy East later acquired RG&E and CMP and filed consolidated tax returns for all three corporations, the three corporations didn't lose their status as separate taxpayers or retroactively acquire a status as one and the same taxpayer for the tax years before their joining the group.
Court of Appeals affirms. The Federal Circuit concluded that Energy East couldn't net the interest from its underpayment with the interest from its subsidiaries' overpayments because it wasn't the same taxpayer as its subsidiaries at the time the payments were made. Code Sec. 6621(d) requires that taxpayers be the same when the overpayments and underpayments are made.
The Court rejected Energy East's claim that a “reasonable” interpretation of Code Sec. 6621(d) should allow interest netting if the parent and subsidiary file consolidated returns when the netting claim is made. The Court found that the language of Code Sec. 6621(d) clearly provides an identified point in time at which the taxpayer must be the same—i.e., when the overpayments and underpayments are made. Energy East chose to ignore the plain language of the statute, and instead proposed an erroneous interpretation that rested on a limited reading of the statute and unnecessary reliance on the legislative history. In analyzing Code Sec. 6621(d), the Court found nothing in the legislative history that supported Energy East's interpretation.
The Court also rejected Energy East's contention that Code Sec. 6621(d) allowed interest netting for the period when the corporations file consolidated returns and interest was accruing on their respective overpayments and underpayments—i.e., that because the period of its underpayment overlapped with the period of its subsidiaries' overpayment after consolidation, Code Sec. 6621(d) allows interest netting. CMP's and RG&E's overpayments were made in’95-97, and Energy East's underpayment was made in’99—all of which occurred before Energy East's acquisition of CMP and RG&E. These underpayments and overpayments weren't made by the “same taxpayer,” and so couldn't be attributed to Energy East.
References. For zero net interest rate in the case of overlapping underpayments and overpayments, see FTC 2d/FIN ¶V-1301.1; United States Tax Reporter ¶66,214; TaxDesk ¶851,008; TG ¶71563.
Multinational's “Swap-And-Assign Transactions” Were Taxable Repatriations Of Earnings
Schering-Plough Corp. (Merck & Co., Inc.) v. U.S. (CA 3 6/20/2011) 107 AFTR 2d ¶2011-960
The Court of Appeals for the Third Circuit, affirming a district court, has held that a large pharmaceutical company's “swap-and-assign transactions” were loans and not sales of future income streams to its offshore subsidiaries. As loans, they triggered an immediate tax under the subpart F provisions.
Background. Subpart F of the Code mandates taxation of foreign earnings and profits (E&P) upon repatriation to the U.S. Mechanically, Subpart F assesses a tax on any “United States shareholder” (as defined in Code Sec. 951(b) and Code Sec. 951(b)) of a “controlled foreign corporation” (CFC) (as defined in Code Sec. 957 and Code Sec. 958) when the U.S. shareholder invests previously untaxed foreign E&P in “United States property.” An obligation by a United States shareholder acquired by a CFC is deemed to be such an “investment in United States property” under Code Sec. 956(c)(1)(C). When a CFC makes a loan to its domestic parent, the amount of the loan is presently taxable under Subpart F.
Observation: On May 11, 2011, Congressmen Kevin Brady (R-TX), Jim Matheson (D-UT), Robert Dold (R-IL), Jim Cooper (D-TN), Devin Nunes (R-CA) and Jared Polis (D-CO) filed H.R. 1834, the “Freedom to Invest Act of 2011.” It would allow U.S. companies to repatriate earnings from their foreign subsidiaries at a reduced tax rate for a limited period.
Facts. In’91 and’92, Schering-Plough, an international pharmaceutical conglomerate, wishing to repatriate its subsidiaries' foreign earnings back to the U.S., entered into two 20-year interest rate swap transactions with Algemene Bank Nederland, N.V. (ABN), a Dutch investment bank. Under the swaps, the two counterparties agreed to exchange periodic interest payments based on a hypothetical amount (the notional principal) and two different interest rate indices. The swap agreements obligated Schering-Plough and ABN to make periodic payments to each other reflecting the movement of the particular interest rate assigned to their respective sides of the transaction.
Under the swaps, Schering-Plough had the right to assign or otherwise transfer its right to receive interest payments from ABN (the receive legs). It assigned the majority of the receive legs to two of its foreign subsidiaries. In return, the subsidiaries made lump-sum payments to Schering-Plough totaling approximately $690 million. Schering-Plough did not report the lump sums as present income. Instead, it deferred reporting income until later years, relying on Notice 89-21, 1989-1 CB 651. Specifically, because Notice 89-21 required ratable taxation of payments received in exchange for the assignment of future income streams from notional principal contracts, Schering-Plough reported income for the lump sums by amortizing them over the period in which the future income streams had been assigned. Notice 89-21 states that “[n]o inference should be drawn as to the proper treatment of transactions that are not properly characterized as notional principal contracts, for instance, to the extent that such transactions are in substance properly characterized as loans.”
Observation: Notice 89-21 has since been repealed and parties are now required to recognize all such payments as loans under Reg. §1.446-3(g)(4) and Reg. §1.446-3(h)(4)(1).
In 2004, characterizing the transactions as loans, IRS assessed a tax deficiency upon Schering-Plough because it had not reported the lump-sum payments as present income in’91 and’92, the years in which they had been received. Schering-Plough paid the $473 million tax bill, filed for a refund, and ultimately sued in district court after IRS denied the refund.
The district court determined that the economic characteristics of the swap-and-assign transactions did not pass muster as sales under substance-over-form analysis. Rather, the evidence demonstrated that the transactions were, in true economic substance, loans. As loans, the transactions were outside the scope of Notice 89-21 and were taxable under Subpart F as repatriated earnings.
The district court also determined that the transactions lacked economic substance. In addition, it rejected Schering-Plough's argument that it suffered disparate treatment at IRS because IRS didn't go after a similarly-situated taxpayer.
Third Circuit's loan analysis. The Third Circuit said that determining whether a transaction qualifies as a loan requires an analysis of both the objective characteristics of the transaction and the parties' intentions. Under its prior precedent, for disbursements to constitute true loans there must have been, at the time the funds were transferred, an unconditional obligation on the part of the transferee to repay the money, and an unconditional intention on the part of the transferor to secure repayment. In the absence of direct evidence of intent, the nature of the transaction may be inferred from its objective characteristics.
With respect to the parties' intentions, the Third Circuit found no reason to disturb the well-supported finding by the district court that the parties believed that they were crafting a loan, rather than a sale. This was supported by both direct and meaningful indirect evidence.
The more difficult question was whether the transactions had the objective economic attributes of loans. As government experts established, the transactions had certain objective indicia of loans, such as a fixed maturity date, a fixed principal sum, periodic interest payments, and a payment schedule. However, the main dispute was whether the transactions created an unconditional obligation on the part of Schering-Plough to repay the money. In the face of the Code's general insistence on the controlling effect of economic reality rather than form, the Third Circuit refused to apply this test in the literal sense. Rather, the Court held that, in determining whether there was an “obligation” to repay, the test is whether the transferor's intention was to structure the transaction to ensure repayment of funds as a practical matter. Here, the evidence was sufficient to show the parties intended to secure a repayment that was effectively if not explicitly unconditional.
The Third Circuit rejected Schering-Plough's argument that the involvement of ABN meant that the transactions could not have been loans between Schering-Plough and its subsidiaries. The Court said that there is no reason that a loan cannot be arranged among three parties. It also concluded that ABN could be properly considered as a mere conduit for payments between Schering-Plough and its subsidiary.
Accordingly, the Third Circuit held that the district court correctly found that the transactions were in substance loans, not sales. As loans, they were outside the scope of Notice 89-21 and were taxable as repatriated earnings. Because it found the transactions to be loans, the Third Circuit didn't examine the district court's alternative finding that the transactions lacked economic substance.
Failed disparate treatment argument. Schering-Plough also argued that it suffered disparate treatment at the hands of IRS because another taxpayer (Taxpayer One) engaged in a substantially similar transaction and was not assessed a deficiency. When Taxpayer One was being audited in the mid’90s, IRS's National Office issued a Field Service Advice (FSA) to its personnel examining Taxpayer One indicating that transactions of this kind would not be taxable as loans. Schering-Plough asserted that IRS should be bound by its treatment of Taxpayer One's transaction under International Business Machine (IBM) Corp v. U.S., (1965, Ct Cl) 15 AFTR 2d 1526.
In the IBM case, one of IBM's competitors obtained a private letter ruling holding that certain of its products were not subject to a particular excise tax. IBM immediately requested a similar ruling holding that its effectively identical products were not subject to the same tax. After two years, IRS denied the request. At the same time, it informed the competitor that its products would be subject to the tax, but only prospectively. In effect, therefore, only IBM was obliged to pay the excise tax for goods sold during the two years before IRS's denial, though both IBM and its competitor were obliged to pay the excise tax for goods sold after IRS's denial. The Court of Claims ultimately concluded that this was an abuse of discretion.
The Third Circuit noted that the Court of Federal Claims subsequently limited the holding of IBM to its facts and other courts have applied it narrowly.
The Third Circuit said that IBM did not apply to the situation in this case. Taxpayer One did not receive a formal written ruling from IRS holding that its transaction was not taxable, as the competitor did in IBM and which other circuits have required to sustain a claim of disparate treatment. Although IRS did issue an FSA concerning Taxpayer One, FSAs are not binding documents, nor, at the time, were they even public; they are meant as guidance for the team conducting an audit, not as an assurance for the taxpayer being audited. Thus, the Third Circuit rejected the disparate treatment argument.
References: For subpart F income, see FTC 2d/FIN ¶O-2401; United States Tax Reporter ¶9524; TG ¶30429.
The Court of Appeals for the Third Circuit, affirming a district court, has held that a large pharmaceutical company's “swap-and-assign transactions” were loans and not sales of future income streams to its offshore subsidiaries. As loans, they triggered an immediate tax under the subpart F provisions.
Background. Subpart F of the Code mandates taxation of foreign earnings and profits (E&P) upon repatriation to the U.S. Mechanically, Subpart F assesses a tax on any “United States shareholder” (as defined in Code Sec. 951(b) and Code Sec. 951(b)) of a “controlled foreign corporation” (CFC) (as defined in Code Sec. 957 and Code Sec. 958) when the U.S. shareholder invests previously untaxed foreign E&P in “United States property.” An obligation by a United States shareholder acquired by a CFC is deemed to be such an “investment in United States property” under Code Sec. 956(c)(1)(C). When a CFC makes a loan to its domestic parent, the amount of the loan is presently taxable under Subpart F.
Observation: On May 11, 2011, Congressmen Kevin Brady (R-TX), Jim Matheson (D-UT), Robert Dold (R-IL), Jim Cooper (D-TN), Devin Nunes (R-CA) and Jared Polis (D-CO) filed H.R. 1834, the “Freedom to Invest Act of 2011.” It would allow U.S. companies to repatriate earnings from their foreign subsidiaries at a reduced tax rate for a limited period.
Facts. In’91 and’92, Schering-Plough, an international pharmaceutical conglomerate, wishing to repatriate its subsidiaries' foreign earnings back to the U.S., entered into two 20-year interest rate swap transactions with Algemene Bank Nederland, N.V. (ABN), a Dutch investment bank. Under the swaps, the two counterparties agreed to exchange periodic interest payments based on a hypothetical amount (the notional principal) and two different interest rate indices. The swap agreements obligated Schering-Plough and ABN to make periodic payments to each other reflecting the movement of the particular interest rate assigned to their respective sides of the transaction.
Under the swaps, Schering-Plough had the right to assign or otherwise transfer its right to receive interest payments from ABN (the receive legs). It assigned the majority of the receive legs to two of its foreign subsidiaries. In return, the subsidiaries made lump-sum payments to Schering-Plough totaling approximately $690 million. Schering-Plough did not report the lump sums as present income. Instead, it deferred reporting income until later years, relying on Notice 89-21, 1989-1 CB 651. Specifically, because Notice 89-21 required ratable taxation of payments received in exchange for the assignment of future income streams from notional principal contracts, Schering-Plough reported income for the lump sums by amortizing them over the period in which the future income streams had been assigned. Notice 89-21 states that “[n]o inference should be drawn as to the proper treatment of transactions that are not properly characterized as notional principal contracts, for instance, to the extent that such transactions are in substance properly characterized as loans.”
Observation: Notice 89-21 has since been repealed and parties are now required to recognize all such payments as loans under Reg. §1.446-3(g)(4) and Reg. §1.446-3(h)(4)(1).
In 2004, characterizing the transactions as loans, IRS assessed a tax deficiency upon Schering-Plough because it had not reported the lump-sum payments as present income in’91 and’92, the years in which they had been received. Schering-Plough paid the $473 million tax bill, filed for a refund, and ultimately sued in district court after IRS denied the refund.
The district court determined that the economic characteristics of the swap-and-assign transactions did not pass muster as sales under substance-over-form analysis. Rather, the evidence demonstrated that the transactions were, in true economic substance, loans. As loans, the transactions were outside the scope of Notice 89-21 and were taxable under Subpart F as repatriated earnings.
The district court also determined that the transactions lacked economic substance. In addition, it rejected Schering-Plough's argument that it suffered disparate treatment at IRS because IRS didn't go after a similarly-situated taxpayer.
Third Circuit's loan analysis. The Third Circuit said that determining whether a transaction qualifies as a loan requires an analysis of both the objective characteristics of the transaction and the parties' intentions. Under its prior precedent, for disbursements to constitute true loans there must have been, at the time the funds were transferred, an unconditional obligation on the part of the transferee to repay the money, and an unconditional intention on the part of the transferor to secure repayment. In the absence of direct evidence of intent, the nature of the transaction may be inferred from its objective characteristics.
With respect to the parties' intentions, the Third Circuit found no reason to disturb the well-supported finding by the district court that the parties believed that they were crafting a loan, rather than a sale. This was supported by both direct and meaningful indirect evidence.
The more difficult question was whether the transactions had the objective economic attributes of loans. As government experts established, the transactions had certain objective indicia of loans, such as a fixed maturity date, a fixed principal sum, periodic interest payments, and a payment schedule. However, the main dispute was whether the transactions created an unconditional obligation on the part of Schering-Plough to repay the money. In the face of the Code's general insistence on the controlling effect of economic reality rather than form, the Third Circuit refused to apply this test in the literal sense. Rather, the Court held that, in determining whether there was an “obligation” to repay, the test is whether the transferor's intention was to structure the transaction to ensure repayment of funds as a practical matter. Here, the evidence was sufficient to show the parties intended to secure a repayment that was effectively if not explicitly unconditional.
The Third Circuit rejected Schering-Plough's argument that the involvement of ABN meant that the transactions could not have been loans between Schering-Plough and its subsidiaries. The Court said that there is no reason that a loan cannot be arranged among three parties. It also concluded that ABN could be properly considered as a mere conduit for payments between Schering-Plough and its subsidiary.
Accordingly, the Third Circuit held that the district court correctly found that the transactions were in substance loans, not sales. As loans, they were outside the scope of Notice 89-21 and were taxable as repatriated earnings. Because it found the transactions to be loans, the Third Circuit didn't examine the district court's alternative finding that the transactions lacked economic substance.
Failed disparate treatment argument. Schering-Plough also argued that it suffered disparate treatment at the hands of IRS because another taxpayer (Taxpayer One) engaged in a substantially similar transaction and was not assessed a deficiency. When Taxpayer One was being audited in the mid’90s, IRS's National Office issued a Field Service Advice (FSA) to its personnel examining Taxpayer One indicating that transactions of this kind would not be taxable as loans. Schering-Plough asserted that IRS should be bound by its treatment of Taxpayer One's transaction under International Business Machine (IBM) Corp v. U.S., (1965, Ct Cl) 15 AFTR 2d 1526.
In the IBM case, one of IBM's competitors obtained a private letter ruling holding that certain of its products were not subject to a particular excise tax. IBM immediately requested a similar ruling holding that its effectively identical products were not subject to the same tax. After two years, IRS denied the request. At the same time, it informed the competitor that its products would be subject to the tax, but only prospectively. In effect, therefore, only IBM was obliged to pay the excise tax for goods sold during the two years before IRS's denial, though both IBM and its competitor were obliged to pay the excise tax for goods sold after IRS's denial. The Court of Claims ultimately concluded that this was an abuse of discretion.
The Third Circuit noted that the Court of Federal Claims subsequently limited the holding of IBM to its facts and other courts have applied it narrowly.
The Third Circuit said that IBM did not apply to the situation in this case. Taxpayer One did not receive a formal written ruling from IRS holding that its transaction was not taxable, as the competitor did in IBM and which other circuits have required to sustain a claim of disparate treatment. Although IRS did issue an FSA concerning Taxpayer One, FSAs are not binding documents, nor, at the time, were they even public; they are meant as guidance for the team conducting an audit, not as an assurance for the taxpayer being audited. Thus, the Third Circuit rejected the disparate treatment argument.
References: For subpart F income, see FTC 2d/FIN ¶O-2401; United States Tax Reporter ¶9524; TG ¶30429.
Information Reporting Suspended For Foreign Financial Asset Holders & PFIC Shareholders
Notice 2011-55, 2011-29 IRB
A new Notice suspends information reporting required under the Hiring Incentives to Restore Employment Act (HIRE Act, P.L. 111-147), for certain individuals with an interest in a “specified foreign financial asset,” as well as for shareholders of a passive foreign investment company (PFIC). The information reporting is suspended until IRS issues the forms necessary to report the requisite information.
Observation: Once the requisite forms become available, affected taxpayers will have to disclose the information for the suspended period with their next income tax or information return.
Background. For tax years beginning after Mar. 18, 2010, the HIRE Act provides that individuals with an interest in a “specified foreign financial asset” during the tax year must attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000. (Code Sec. 6038D(a)) In addition, to the extent provided by IRS in regs or other guidance, Code Sec. 6038D will apply to any domestic entity formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if the entity were an individual. (Code Sec. 6038D(f))
“Specified foreign financial assets” are: (1) depository or custodial accounts at foreign financial institutions, and (2) to the extent not held in an account at a financial institution, (a) stocks or securities issued by foreign persons, (b) any other financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and (c) any interest in a foreign entity. (Code Sec. 6038D(b))
The HIRE Act also added new Code Sec. 1298(f) which, effective Mar. 18, 2010, requires U.S. persons who are shareholders of a PFIC to file an annual report containing such information as IRS may require. Before the enactment of Code Sec. 1298(f), PFIC shareholders had to file Form 8621 (Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) under certain circumstances.
In Notice 2010-34, 2010-17 IRB 612, IRS said that until it issued guidance on Code Sec. 1298(f), those required to file Form 8621 before the enactment of Code Sec. 1298(f) should continue to file it as provided in the instructions (e.g., upon disposition of stock of a PFIC, or with respect to a qualified electing fund under Code Sec. 1293). IRS also said PFIC shareholders not otherwise required to file Form 8621 annually before Mar. 18, 2010, won't have to file an annual report as a result of Code Sec. 1298(f) for tax years beginning before Mar. 18, 2010.
Regs on the way. Notice 2011-55 says that IRS will issue:
... new regs on Code Sec. 6038D and Code Sec. 1298(f);
... new Form 8938, “Statement of Specified Foreign Financial Assets,” to be used to report an interest in one or more specified foreign financial assets under Code Sec. 6038D. Individuals will have to attach this form to their income tax return for the tax year; and
... a revised Form 8621 modified to reflect Code Sec. 1298(f). Affected PFIC shareholders will be required to attach the revised Form 8621 to their income tax return or information return (e.g., Form 1065, “U.S. Return of Partnership Income”) for the tax year.
Filing suspended till forms become available. Notice 2011-55 suspends the Code Sec. 6038D reporting requirements until IRS releases Form 8938. Similarly, PFIC shareholders that would not be required to file Form 8621 under the current instructions to this form may, under Code Sec. 1298(f), have to file an income tax return or information return (e.g., Form 1065) for a tax year beginning on or after Mar. 18, 2010, but before the IRS releases revised Form 8621. Pending the release of the revised Form 8621, the Code Sec. 1298(f) reporting requirement is suspended for tax years beginning on or after Mar. 18, 2010, for PFIC shareholders not otherwise required to file Form 8621. PFIC shareholders with Form 8621 reporting obligations as provided in the current instructions to Form 8621 (e.g., upon disposition of stock of a PFIC or with respect to a qualified electing fund under Code Sec. 1293) must continue to file the current Form 8621 with an income tax or information return filed before the release of revised Form 8621.
After new Form 8938 or revised Form 8621 is released, individuals and PFIC shareholders for which the filing of Form 8938 or 8621 is suspended for a tax year will have to attach Form 8938, Form 8621, or both, as appropriate, for the suspended tax year to their next income tax or information return required to be filed with the IRS.
When assessment period begins to run. Under Code Sec. 6501(c)(8), the limitations period for tax assessments for periods for which reporting is required under sections Code Sec. 6038D or Code Sec. 1298(f) doesn't expire before three years after the date on which the IRS receives Forms 8938 or 8621, as appropriate, for the tax year. A Form 8938 or 8621 filed for a suspended tax year with a timely filed income tax or information return (taking into account extensions) as required by Notice 2011-55 will be treated as having been filed on the date that the income tax or information return for the suspended tax year was filed. Failure to furnish Forms 8938 and 8621 for the suspended tax year may result in the extension of the limitations period for the suspended taxable year under Code Sec. 6501(c)(8), and penalties may apply.
Notice 2011-55 reminds taxpayers that compliance with Code Sec. 6038D or Code Sec. 1298(f) doesn't relieve them of the responsibility to file Form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts,” (FBAR) if the FBAR is otherwise required to be filed.
References: For reporting requirement for individuals with foreign assets, see FTC 2d/FIN ¶S-3650.1; United States Tax Reporter ¶60,38D4; TaxDesk ¶815,516; TG ¶60613. For annual information reporting by PFIC shareholders, see FTC 2d/FIN ¶O-2201.1; United States Tax Reporter ¶12,984; TG ¶30301.
A new Notice suspends information reporting required under the Hiring Incentives to Restore Employment Act (HIRE Act, P.L. 111-147), for certain individuals with an interest in a “specified foreign financial asset,” as well as for shareholders of a passive foreign investment company (PFIC). The information reporting is suspended until IRS issues the forms necessary to report the requisite information.
Observation: Once the requisite forms become available, affected taxpayers will have to disclose the information for the suspended period with their next income tax or information return.
Background. For tax years beginning after Mar. 18, 2010, the HIRE Act provides that individuals with an interest in a “specified foreign financial asset” during the tax year must attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000. (Code Sec. 6038D(a)) In addition, to the extent provided by IRS in regs or other guidance, Code Sec. 6038D will apply to any domestic entity formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if the entity were an individual. (Code Sec. 6038D(f))
“Specified foreign financial assets” are: (1) depository or custodial accounts at foreign financial institutions, and (2) to the extent not held in an account at a financial institution, (a) stocks or securities issued by foreign persons, (b) any other financial instrument or contract held for investment that is issued by or has a counterparty that is not a U.S. person, and (c) any interest in a foreign entity. (Code Sec. 6038D(b))
The HIRE Act also added new Code Sec. 1298(f) which, effective Mar. 18, 2010, requires U.S. persons who are shareholders of a PFIC to file an annual report containing such information as IRS may require. Before the enactment of Code Sec. 1298(f), PFIC shareholders had to file Form 8621 (Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) under certain circumstances.
In Notice 2010-34, 2010-17 IRB 612, IRS said that until it issued guidance on Code Sec. 1298(f), those required to file Form 8621 before the enactment of Code Sec. 1298(f) should continue to file it as provided in the instructions (e.g., upon disposition of stock of a PFIC, or with respect to a qualified electing fund under Code Sec. 1293). IRS also said PFIC shareholders not otherwise required to file Form 8621 annually before Mar. 18, 2010, won't have to file an annual report as a result of Code Sec. 1298(f) for tax years beginning before Mar. 18, 2010.
Regs on the way. Notice 2011-55 says that IRS will issue:
... new regs on Code Sec. 6038D and Code Sec. 1298(f);
... new Form 8938, “Statement of Specified Foreign Financial Assets,” to be used to report an interest in one or more specified foreign financial assets under Code Sec. 6038D. Individuals will have to attach this form to their income tax return for the tax year; and
... a revised Form 8621 modified to reflect Code Sec. 1298(f). Affected PFIC shareholders will be required to attach the revised Form 8621 to their income tax return or information return (e.g., Form 1065, “U.S. Return of Partnership Income”) for the tax year.
Filing suspended till forms become available. Notice 2011-55 suspends the Code Sec. 6038D reporting requirements until IRS releases Form 8938. Similarly, PFIC shareholders that would not be required to file Form 8621 under the current instructions to this form may, under Code Sec. 1298(f), have to file an income tax return or information return (e.g., Form 1065) for a tax year beginning on or after Mar. 18, 2010, but before the IRS releases revised Form 8621. Pending the release of the revised Form 8621, the Code Sec. 1298(f) reporting requirement is suspended for tax years beginning on or after Mar. 18, 2010, for PFIC shareholders not otherwise required to file Form 8621. PFIC shareholders with Form 8621 reporting obligations as provided in the current instructions to Form 8621 (e.g., upon disposition of stock of a PFIC or with respect to a qualified electing fund under Code Sec. 1293) must continue to file the current Form 8621 with an income tax or information return filed before the release of revised Form 8621.
After new Form 8938 or revised Form 8621 is released, individuals and PFIC shareholders for which the filing of Form 8938 or 8621 is suspended for a tax year will have to attach Form 8938, Form 8621, or both, as appropriate, for the suspended tax year to their next income tax or information return required to be filed with the IRS.
When assessment period begins to run. Under Code Sec. 6501(c)(8), the limitations period for tax assessments for periods for which reporting is required under sections Code Sec. 6038D or Code Sec. 1298(f) doesn't expire before three years after the date on which the IRS receives Forms 8938 or 8621, as appropriate, for the tax year. A Form 8938 or 8621 filed for a suspended tax year with a timely filed income tax or information return (taking into account extensions) as required by Notice 2011-55 will be treated as having been filed on the date that the income tax or information return for the suspended tax year was filed. Failure to furnish Forms 8938 and 8621 for the suspended tax year may result in the extension of the limitations period for the suspended taxable year under Code Sec. 6501(c)(8), and penalties may apply.
Notice 2011-55 reminds taxpayers that compliance with Code Sec. 6038D or Code Sec. 1298(f) doesn't relieve them of the responsibility to file Form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts,” (FBAR) if the FBAR is otherwise required to be filed.
References: For reporting requirement for individuals with foreign assets, see FTC 2d/FIN ¶S-3650.1; United States Tax Reporter ¶60,38D4; TaxDesk ¶815,516; TG ¶60613. For annual information reporting by PFIC shareholders, see FTC 2d/FIN ¶O-2201.1; United States Tax Reporter ¶12,984; TG ¶30301.
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