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Monthly Archives: July 2012

Father’s Transfer of Business to Children Through Gifts of Stock Followed by Redemption of Father’s Shares is Approved by IRS.

PrivateLetter Ruling 201228012 - The IRS issued a private letter ruling allowing a father to transfer his corporate business to his two children through the use of gifts and stock redemption. This transaction results in favorable tax consequences to the father, his children and the corporation.

The facts of this ruling are: A father owns all of the outstanding stock of a C corporation which has earnings and profits. The father is a director and president of the corporation and his two children are also directors of the corporation.
The father wants to retire and cede management and control of the corporation to his two children. In order to accomplish this, he devises a plan to gift some of his shares of stock in the corporation to each of his two children and then immediately thereafter have the corporation redeem his remaining shares of stock for cash and a promissory note for the total redemption price, as determined by a third-party appraisal. The promissory note is payable by the corporation over a period of time in monthly installments of principal and interest at the applicable federal rate.

The father made the following representations to the IRS:
  • The promissory note will not be subordinated to the claims of general creditors of the corporation.
  • The stock redemption price is not contingent on future earnings of the corporation, nor is it contingent on working capital being maintained at a certain level.
  • In the event of a default on the promissory note, no shares of the corporation will revert to or be received by the father or any entity related to him, nor will the father or any entity related to him be permitted to purchase the stock at public or private sale.
  • No shareholder of the corporation has been or will be obligated to purchase any of father’s shares of stock to be redeemed.
  • The redemption is related to the gifts of shares to the children.
  • None of the shares to be redeemed was acquired by father within the 10-year period from a family member whose stock would be attributed to father under the family stock attribution rules.
  • After the redemption, father will not have any interest in the corporation (including an interest as officer, director or employee), other than an interest as a creditor.
  • Father will execute and file the agreement and information required to be filed with the IRS.
  • Father will not hold any obligation of the corporation except for the promissory note.
  • Father will not enter into any contract or agreement, or have any other business relationship with the corporation.
  • The stock redeemed from father is not Section 306 stock. 
Based on this information, the IRS issued the following rulings:
  • The proposed gifts of shares by the father to his children do not have as one of their principal purposes the avoidance of federal income tax.
  • Provided that father files the required agreement with the IRS, referenced above, in accordance with the Tax Regulations and assuming that the conditions stated in the Tax Code (which were included in the representations made by father to IRS) are satisfied, the stock redemption will qualify as a complete termination of father’s interest in the corporation and will be treated as a sale of father’s stock to the corporation. This would result in gain recognition by father measured by the difference between the stock redemption price and the father’s tax basis in the shares redeemed. Such gain will be capital gain provided that the stock is a capital asset to father.
  • Father may report the gain on the redemption of his stock using the installment method of accounting.
  • The corporation will not recognize gain or loss on the distribution of the promissory note in redemption of father’s stock.
  • Provided that the stock redemption is not performed in satisfaction of a primary and unconditional obligation of either of father’s two children to acquire the stock of the corporation held by father, the redemption will not cause any dividend income to be constructively received by the children.
  • The interest paid by the corporation on the promissory note is deductible, subject to any applicable restrictions.
  • There is no imputed interest with respect to the promissory note.
While the above-referenced ruling is not binding authority, it is encouraging to note that the IRS did not treat the father’s gifts of his shares to his children immediately prior to the stock redemption transaction as having tax avoidance as one of its principal purposes. Otherwise, the stock redemption would not have qualified as a sale of father’s stock in the corporation and, instead, would have been taxed as a dividend to father to the extent of the corporation’s earnings and profits, without reduction for his basis in the stock.
The IRS viewed the father’s gifts of his shares to his children as part of an integrated plan to facilitate the father’s retirement from the business and allow him to cede management and control of the corporation to his children which the IRS apparently agreed was undertaken for proper business purpose.

Although this transaction could have been structured as a stock sale and achieved capital gain treatment, structuring this transaction as a stock redemption allows the corporation’s earnings and profits to be used to fund the stock redemption payments to father without creating any taxable dividends to the father or to the children.

If you desire to Transfer Your Business to your Children, contact the Tax Lawyers at Marini & Associates, P.A. for a FREE Tax Consultation at www.TaxAid.us or www.TaxLaw.ms or Toll Free at 888-8TaxAid (888 882-9243).

Read more at: Tax Times blog

Tax Developments in the Second Quarter of 2012

This letter highlights some of the more important tax developments that have come out during the previous hitsecondnext hit three months of 2012. Most are documents from the Internal Revenue Service, but some are important cases and legislative changes you might want to be aware of for you or your business.

Individual Mandate to Buy Health Insurance: In National Federation of Independent Business v. Sebelius, , No. 11-393 (U.S. 6/28/12), the U.S. Supreme Court, in a 5-4 opinion, upholds the individual mandate under Affordable Care Act (ACA) as within Congress's taxing power, stating that the ACA's “requirement that certain individuals pay a financial penalty for not obtaining health insurance may reasonably be characterized as a tax.”

Pension Smoothing: As part of the highway funding bill (MAP-21), effective for plan years beginning after December 31, 2011, the Act amends §430(h) to revise rules for determining the segment rates under single-employer plan funding rules by adjusting a segment rate if the rate determined under the regular rules is outside a specified range of the average of the segment rates for the preceding 25-year period (“average” segment rates). The Act also requires additional information to be included in the annual funding notice that defined benefit plans must provide to participants and beneficiaries, labor organizations representing such participants or beneficiaries, and the Pension Benefit Guaranty Corporation.

S Corporation Shareholder Basis: In Maguire v. Comr., T.C. Memo 2012-160 (6/6/12), the U.S. Tax Court held that shareholders in two related S corporations are not prohibited from receiving a distribution of assets from one of their S corporations and then contributing those assets to another of their S corporations in order to increase their bases in the latter to absorb losses otherwise unavailable due to the basis limitation of §1366(d)(1). The fact that the two S corporations had a synergistic business relationship and were owned by the same shareholders did not preclude this result because the distributions and contributions actually occurred. Shortly thereafter, the IRS issued Prop. Regs. §1.1366-2, REG-134042-07, 77 Fed. Reg. 34884 (6/11/12), which would clarify the requirements for increasing basis of indebtedness and to assist S corporation shareholders in determining with greater certainty whether their particular arrangement creates basis of indebtedness. The IRS explained that the proposed regulations would require that loan transactions represent bona fide indebtedness of the S corporation to the shareholder in order to increase basis of indebtedness; therefore, an S corporation shareholder would need not otherwise satisfy the “actual economic outlay” doctrine for purposes of §1366(d)(1)(B). According to the IRS, the proposed regulations' key requirement would be that purported indebtedness of the S corporation to a shareholder must be bona fide indebtedness to the shareholder.

COD Income Under §108: In Rev. Rul. 2012-14, 2012-24 I.R.B. 1012, the IRS ruled that to measure a partner's insolvency under §108(d)(3), each partner treats as a liability the amount of the partnership's discharged excess nonrecourse debt based on allocation of cancellation of indebtedness income to the partner under §704(b).

Earnings and Profits: In REG-141268-11, 77 Fed. Reg. 22515 (4/16/12), the IRS issued proposed regulations under §312 regarding allocation of earnings and profits in tax-free transfers from one corporation to another. The proposed regulations would clarify that, except as provided in Regs. §1.312-10, if property is transferred from one corporation to another and no gain or loss is recognized, no allocation of the earnings and profits of the transferor is made to the transferee unless the transfer is described in §381(a).

Deferral of Losses on Sale or Exchange of Property Between Controlled Group: In T.D. 9583, 77 Fed. Reg. 22480 (4/16/12), the IRS issued final regulations that provide that to the extent a selling member's loss would be redetermined to be a noncapital, nondeductible amount under Regs. §1.1502-13, but is not redetermined under Regs. §1.267(f)-1(c)(2) (which generally renders the attribute redetermination rule inapplicable to sales between members of a controlled group), the selling member's loss continues to be deferred.

UNICAP Avoided Cost Rule: The Federal Circuit Court of Appeals, in Dominion Resources Inc. v. U.S., No. 2011-5087 (Fed. Cir. 5/31/12), held that the associated property rule laid out in Regs. §1.263A-11(e)(1)(ii)(B), as applied to property temporarily withdrawn from service, is not reasonable interpretation of the avoided cost rule in §263A. At issue in the case was the amount of interest Dominion Resources must capitalize, rather than deduct, from its taxable income as a result of burner improvements in its power plants.

Defense of Marriage Act Held Unconstitutional: The First Circuit Court of Appeals, in (Massachusetts v. HHS, No. 10-2204 (1st Cir. 5/31/12), held that the Defense of Marriage Act, 1 USC §7, is unconstitutional, that provisions in the Act, which deny numerous benefits, including tax benefits, to same-sex couples lawfully married in Massachusetts, impermissibly undercut choices made by same-sex couples and states in deciding who can be married to whom. However, the court stayed enforcement of the decision until the Supreme Court has the opportunity to issue its own ruling on the case, citing the likely appeal of the First Circuit's holding.

Deduction for Local Lodging Expenses: The IRS issued proposed regulations, REG-137589-07, 77 Fed. Reg. 24657 (4/25/12), that would allow taxpayers to deduct local lodging expenses as ordinary and necessary business expenses in appropriate circumstances. The proposed regulations would not apply Regs. §1.262-1(b)(5) to expenses for local lodging of an employee that an employer provides to the employee or requires the employee to obtain, if: (1) the lodging is provided on a temporary basis; (2) the lodging is necessary for the employee to participate in or be available for a bona fide business meeting or function of the employer; and (3) the expenses are otherwise deductible by the employee, or would be deductible if paid by the employee, under §162(a).

Overstatement of Basis for Extended Statute of Limitations: The U.S. Supreme Court ruled, in (U.S. v. Home Concrete & Supply LLC, No. 11-139 (U.S. 4/25/12), that the extended six-year statute of limitations period in §6501(e) does not apply to overstatement of basis as an overstatement of basis is not an omission from gross income. The Court's ruling decides a circuit split in favor of the Fourth and Fifth Circuits versus the Seventh, Federal, D.C., and Tenth Circuits, which all held that an overstatement of basis is an omission of gross income triggering the extended six-year statute of limitations.

Reporting of Interest Paid to Foreigners: While reporting of interest to foreigners is controversial enough in its own right, final regulations (T.D. 9584, 77 Fed. Reg. 23391 (4/19/12)) are particularly notable in that the regulations will provide the IRS with information that can be exchanged with foreign authorities under information exchange arrangements to help the IRS under FATCA. The final rules ostensibly have been “simplified,” by requiring reporting only when interest is paid to a resident of a country with which the United States has an information sharing agreement; this in effect requires financial institutions to parse their customer base to identify customers to get reports and customers who don't need reports.

Draft Forms W-8: The IRS released draft Forms W-8 to comply with new FATCA requirements. Separate versions of Form W-8BEN are proposed for individuals (draft W-8BEN) and entities (draft W-8BEN-E), the latter of which is now six pages long instead of one. The forms can be found in the lower right corner of this URL: http://www.irs.gov/businesses/corporations/article/0,,id=236667,00.html

Inversions: The IRS, in T.D. 9592, 77 Fed. Reg. 34785 (6/12/12), and REG-107889-12, 77 Fed. Reg. 34887 (6/12/12), finalized and proposed regulations governing inversions. The most controversial provision is one that defines a “substantial business” in a foreign country by objective tests looking at whether 25% of assets, payroll and income are earned in a country. Since passing this test excuses a foreign company from the inversion rules, this is an important test.

Program-Related Investments of Private Foundations: The IRS issues proposed rules (REG-144267-11, 77 Fed. Reg. 23429 (4/19/12)) providing guidance to private foundations on program-related investments. The proposed regulations provide a series of new examples illustrating investments that qualify as program-related investments and do not modify existing regulations. Instead, they provide additional examples that illustrate the application of the existing regulations, IRS said. The charitable activities illustrated in the new examples are based on published guidance and on financial structures described in private letter rulings, IRS said. Aside from private foundations, the proposed regulations affect foundation managers participating in the making of program-related investments.

Delay in Basis Reporting of Debt Instruments: The IRS, in Notice 2012-34, 2012-21 I.R.B. 937, in response to concerns about approaching deadlines, states that brokers will have until 2014 to begin basis reporting on debt instruments and options. The change is in response to worries voiced by brokers and other interested parties who complained to the IRS that the proposed effective date of Jan. 1, 2013, did not give them enough time to build and test the systems required to implement the reporting for debt instruments and options. The Energy Improvement and Extension Act of 2008 amended the broker reporting rules in §6045 for certain securities, including debt instruments and options.

Proving IRS Deficiency Notices: The Federal Circuit Court of Appeals, in Welch v. U.S., No. 2011-5090 (Fed. Cir. 5/18/12), lays out a test for determining whether evidence submitted by the IRS is sufficient to demonstrate the mailing of a deficiency notice. “Use of the form prescribed in the Internal Revenue Manual for establishing compliance with the notice of deficiency mailing requirement — PS Form 3877 — is not a prerequisite to the government demonstrating mailing of a notice of deficiency, but some corroborating evidence of both the existence and timely mailing of the notice of deficiency is required,” explained the Federal Circuit

First-Time Homebuyer Credit: The U.S. Tax Court, in a case of first impression (Trugman v. Comr., 138 T.C. No. 22 (5/21/12)), holds that an individual may not claim the First-Time Homebuyer Credit for a principal residence purchased through a Subchapter S corporation. The court examined the term “individual” within the context of §36, and “read the term ‘individual' in section 36 to exclude S corporations.” The court stated “S corporations are not individuals for purposes of section 36” and the corporations remain freestanding entities “independently recognizable” from their shareholders.

Substantial Risk of Forfeiture: The IRS, in REG-141075-09, 77 Fed. Reg. 31783 (5/30/12), addresses points of confusion surrounding the “substantial risk of forfeiture” provision under §83. The proposed rules would, among other clarifications, provide that a such a risk can be established only through a service condition, or a condition related to the purpose of the transfer. The general concept of the provision is that property (such as stock options) is not to be included in the gross income of a service provider (such as an employee) if there is a risk that the conditions on which the property transfer are based could fail to materialize and the property thus forfeited.

Health FSA Salary Reduction Limits: The IRS, in Notice 2012-40, 2012-26 I.R.B. 1046, stated that the $2,500 limit on salary reduction contributions to health flexible spending arrangements set by a provision of the 2010 federal health care law does not apply for plan years starting before 2013. Notice 2012-40 fleshes out the details of the $2,500 cap on salary reduction contributions to cafeteria plan health FSAs under §125(i). The notice defines the term “taxable year” under §125(i) as the plan year of a cafeteria plan, a clarification that employers sponsoring plans with fiscal years not lining up with the calendar year have been anxiously awaiting.

Fee for Renewing PTIN: The Eleventh Circuit Court of Appeals held, in Brannen v. U.S., No. 11-14138 (11th Cir. 6/7/12), that the Treasury Department has the statutory authority to charge fees for issuing and renewing preparer tax identification numbers.

Portability of Deceased Spousal Unused Exclusion Amount: The IRS issued temporary and proposed regulations (T.D. 9593, 77 Fed. Reg. 36150 (6/18/12); REG-141832-11, 77 Fed. Reg. 36229 (6/18/12)) providing guidance on the estate and gift tax applicable exclusion amount and the applicable requirements for electing portability of a deceased spousal unused exclusion (DSUE) amount to the surviving spouse. The temporary rules also provide guidance on the applicable rules for the surviving spouse's use of the DSUE amount. The portability rules affect married spouses where the death of the first spouse occurs on or after Jan. 1, 2011.

If you have any concerns about how any of these new development would affect you, contact the Tax Lawyers at Marini & Associates, P.A. for a FREE Tax Consultation at www.TaxAid.us or www.TaxLaw.ms or Toll Free at 888-8TaxAid (888 882-9243).
Source BNA

Read more at: Tax Times blog

Capital Gains Taxes Are Going Up

The top tax rate on long-term capital gains is currently 15%. That’s why Mitt Romney is spending so much time talking about his tax returns.

That revelation has set off a familiar debate about whether that low rate is appropriate. Often overlooked in these discussions, however, is the fact that the days of the 15% tax rate are numbered. As of this posting, it has only 342 left.

On January 1, 2013, capital gains taxes are scheduled to go up sharply:

First, the 2001 and 2003 tax cuts are scheduled to expire. If that happens, the regular top rate on capital gains will rise to 20%. In addition, an obscure provision of the tax code, the limitation on itemized deductions, will return in full force. That provision, known as Pease, increases effective tax rates on high-income taxpayers by reducing the value of their itemized deductions. On net, it will add another 1.2 percentage points to the effective capital gains tax rate for high-income taxpayers.
And that’s not all. The health reform legislation enacted in 2010 imposed a new tax on the net investment income of high-income taxpayers, including capital gains. That adds another 3.8 percentage points to the tax rate.

Put it all together, and the top tax rate on capital gains is scheduled to increase from 15% today to 25% on January 1. That’s a big jump. If taxpayers really believe this will happen, expect a torrent of asset selling in November and December as wealthy taxpayers take final advantage of the lower rate.
Of course, the tax cuts might get extended for all Americans, including high-income taxpayers. That’s what happened in 2010. In that case, the increase in the capital gains rate will be smaller. Because of the health reform tax, the top capital gains tax rate will increase from 15% to 18.8%. That’s still a notable increase, but would likely set off much less tax-oriented selling this year.

Source David Marron

Read more at: Tax Times blog

Treasury Releases Model Intergovernmental Agreement for Implementing the FATCA

WASHINGTON – The U.S. Department of the Treasury today published a model intergovernmental agreement (model agreement) to implement the information reporting and withholding tax provisions commonly known as the Foreign Account Tax Compliance Act (FATCA). Enacted by Congress in 2010, these provisions target non-compliance by U.S. taxpayers using foreign accounts

The agreement was developed in consultation with France, Germany, Italy, Spain and the United Kingdom and is based on a framework announced by those five countries and the United States in February.

Treasury said the agreement would be a basis for close cooperation between the United States, these five countries, the Organization for Economic Cooperation and Development, the European Union, and other partner governments.

The model agreement follows through on the commitment reflected in the joint statement issued with the same countries in February to collaborate on developing an intergovernmental approach to implementing FATCA. The model agreement is accompanied by another joint communique with France, Germany, Italy, Spain, and the United Kingdom, endorsing the agreement and calling for a speedy conclusion of bilateral agreements based on the model.

There are two versions of the model agreement - a reciprocal version and a nonreciprocal version. Both versions establish a framework for reporting by financial institutions of certain financial account information to their respective tax authorities, followed by automatic exchange of such information under existing bilateral tax treaties or tax information exchange agreements. Both versions of the model agreement also address the legal issues that had been raised in connection with FATCA, and simplify its implementation for financial institutions.
If you have any FATCA problems or questions, contact the Tax Lawyers at Marini & Associates, P.A. for a FREE Tax Consultation at www.TaxAid.us or www.TaxLaw.ms or Toll Free at 888-8TaxAid (888 882-9243).

Read more at: Tax Times blog