kaiser corp tax update - 2012
DESCRIPTION
2012 Corporate Tax UpdateTRANSCRIPT
Minnesota State Bar Association
2012 Tax Institute
Hot Topics In Corporate Taxation
December 5, 2012
By: Kevin Kaiser
Agenda • Report of Organizational Action Affecting Basis of
Securities - IRS Form 8937
• Abandonment Loss and Worthless Assets
• Liquidation – Reincorporation (upstream C Reorgs)
• Purchase Price Allocations
• Reasonable compensation
• Earnings and Profits and Year-end dividends
Report of Organizational Actions IRS Form 8937
• In 2008, Congress enhanced the information reporting on Form 1099 to include tax basis information
• Congress also added Section 6045B requiring any issuer of a specified security to file an information return to describe any organizational action that affects the basis of the security
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Report of Organizational Actions IRS Form 8937
• Form 8937 – Report of Organizational Actions Affecting Basis of Securities
– Designed to allow corporations to comply with Section 6045B corporation action reporting requirements
– Issued January 6, 2012
– Form must be filed when a corporate action affects basis
• Stock distribution
• Stock split
• Merger
• Acquisition
– Form must be filed by the earlier of (1) the 45th day following the organizational action; or (2) January 15th of the year following the calendar year of the organizational action
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Abandonment Loss and Worthless Assets
• Section 165 permits taxable losses for assets, including securities, that become worthless or abandoned during the current year
• Asset must have no current value and potential future value
• Loss must be claimed in the year the asset became worthless
– Taxpayer must show that asset was not entirely worthless in the preceding year
• Claiming of the loss must be accompanied by an “identifiable event”
• CCA 201207009 – Taxpayer may claim an abandonment loss with actually disposing of the asset if it is held solely for salvage value (reference to PLR 7920002 – permitting abandonment loss)
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Upstream C Reorganization PLR 201127004
P
S
LLC1
Other Members
1. S converts from corp to LLC – treated as C Reorg
2. S assigns LLC1 interest to P
3. S converts from LLC to corp – treated as a section 351 exchange
Steps
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Upstream C Reorganization
PLR 201127004 • P, a publicly-traded state X corporation, is the common parent of an affiliated group of corporations
filing a consolidated U.S. federal income tax return. P owns all of the outstanding common and preferred stock of S. The preferred stock is nonvoting preferred. Through its direct and indirect subsidiaries, S conducts Business A Operations and Business B Operations. All of S's Business A Ops are conducted by LLC1, which is classified as a partnership.
• To achieve state income tax savings and to "enhance management focus within S," P has proposed the following transactions:
• S will convert to a single-member LLC (Sub LLC) that would be disregarded (Conversion)
• Sub LLC would assign and transfer the LLC1 interest to P
• P would assign and transfer the LLC1 interest to new LLC classified as a disregarded entity (LLC2) in exchange for all membership interests in LLC2.
• Sub LLC would distribute the intercompany debt to P
• Sub LLC would convert to a corporation (New S) , (the Reincorporation)
• The deemed transfers will qualify as a reorganization under section 368(a)(1)(C). The Conversion will not be disqualified or recharacterized by reason of the reincorporation. Section 368(a)(2)(C) and Treas. Reg. Sec. 1.368-2(k).
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Upstream C Reorganization
• Parent and subsidiary affiliated group (consolidated or nonconsolidated)
• Move appreciated asset from subsidiary ("Sub") to parent (P)
1. Sub should be a "checkable entity" i.e., limited liability company classified
as a corporation
2. Check-the-box to liquidate Sub
3. Transfer or assign appreciated asset to P (while Sub is DRE)
4. Check-the-box to reincorporate Sub
• See also 201232033 and 200952032 (similar rulings)
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Upstream C Reorganization
• Tax developments that support the tax treatment of the upstream C
reorganization
– Regulation 1.368-2(k) transaction first to qualify for recognition should be respected (issued in 2007) – no recharacterization
When the elements of the C reorganization are satisfied, the tax analysis should stop, then begin to evaluate next transaction (in the example, a valid section 351 capital contribution)
– Section 368(a)(2)(C) transfer of assets to controlled corporation is OK (no remote continuity or asset alienation problem)
– Repeal of Bausch & Lomb doctrine - pre-existing ownership of target (Sub) stock will not prevent tax-free reorganization treatment
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Asset Purchases
Purchase Price Allocation
• Section 1060 prescribes allocation rules for asset acquisition that constitute an applicable asset acquisition
• Allocation reported on IRS Form 8594 – seven asset classes "I - VII”
• Section 1060 applies the so-called residual allocation method
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Asset Purchases
Purchase Price Allocation
• Purchase Price Allocation Cannot Be Changed – Post Acquisition
• Peco Foods Inc. v. Comm., T.C. Memo 2012-18 (1/17/12)
– Taxpayer cannot change Section 1060 purchase price allocation describe in asset purchase agreement (“APA”)
– IRS and Tax Court rejected taxpayer’s attempt to reclassify assets based on post-acquisition cost-segregation project
– APA was clear and there was no mistake or unknown facts
– Taxpayer bound by the agreement
– Court applied the rule of Danielson to bar a unilateral change
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Asset Purchases
Purchase Price Allocation – Cost Segregation studies, cont.
• AmeriSouth XXXII, Ltd. v. Comm., T.C. Memo 2012-67 (3/12/12)
– Cost segregation study successfully challenged by the IRS
– Court focused on the purpose of the building in order to determine the classification of the assets used in the building
– Court stated that the focus of the analysis should take into account the context in which the assets are used - the buildings in question in AmeriSouth were apartment buildings
– Court concluded that although certain assets “could be moved”, in the residential apartment context, assets such as shelves, mirrors and other fixtures were intended to be “permanent”
Reasonable Compensation
• C corporations
– IRS challenges excess compensation
• S corporations
– IRS challenges insufficient compensation
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Reasonable Compensation
• Reasonable Compensation Factors
– Multi-factor Test
• Qualifications and training of employees
• Nature and scope of employees duties
• Size and complexity of business operation
• Compensation rates for competitors
– Hypothetical Independent Investor Test
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Reasonable Compensation
• Hypothetical Independent Investor Test
– Would an independent investor pay the employee the compensation at issue, and how the employees services affect the investor's return
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Reasonable Compensation
Recent cases
• Menard v. Commr., 560 F3d 620 (CA-7, 2009)
– Taxpayer victory in C corporation compensation case
• Mulcahy, Pauritsch, Salvador v. Commr., 680 F.3d 867 (CA-7, 2012)
– Government victory in S corporation compensation case
• David Watson PC v. U.S., 668 F.3d 1008 (CA-8, 2012)
– Government victory in S corporation compensation case
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Reasonable Compensation
• C corporation Excess Compensation
Corporation losses the compensation deduction
Recharacterized as corporate distribution
Dividend to the extent of earnings and profits (E&P)
Note – Adequate disclosure for penalty protection
Complete Form 1120, Schedule E (Rev. Proc. 2012-15)
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Earnings and Profits and Year-end Dividends
I. Present overview of federal tax rules governing the tax treatment of earnings and profits (“E&P”) and Dividend Distributions
II. Describe the E&P Computation process
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Overview of E&P Concepts
• Tax planning for distributions has always started with a few basic facts of life:
– Corporate shareholders generally prefer dividends, because of the dividends received deduction, presently embodied in Section 243
– Noncorporate shareholders generally prefer capital gain treatment (or return of capital)
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Overview of E&P Concepts
• The principal Code provisions governing pro rata distributions are contained in:
– Section 301 Distributions of Property
– Section 311 Taxability of Corporation on Distribution
– Section 312 Effects on Earnings and Profits
– Section 316 Dividend Defined
• In addition, with respect to corporate distributees, Sections 243, 246 and 1059, which contain the principal rules dealing with the dividends received deduction, are of particular importance.
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Overview of E&P Concepts
• Earnings and profits ("E&P") are taxed at the corporate level when earned, and again when the corporation distributes them to the owners of the company, the shareholders.
• E&P forms the foundation of the double tax system and applies to non-corporate shareholders and, to a limited extent (depending on ownership), to corporate shareholders.
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Earnings and Profits
• Dividend distribution to extent of “earnings and profits”
• Current E&P
• Accumulated E&P
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Consolidated E&P
• Treat consolidated group as a single entity by reflecting the E&P of lower-tier members in E&P of higher-tier members
• Consolidate the group’s E&P in the common parent
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Consolidated E&P
• Parent’s E&P are adjusted for Sub’s E&P
• Unused losses reduce E&P currently
• Intercompany transactions affect E&P when taken into account
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Deconsolidation
• Sub’s E&P eliminated immediately before it becomes a nonmember to the extent taken into account by any member
• Exceptions
– Acquisition of group
– Certain corporate separations and reorganizations
• This is an important consideration when acquiring companies or selling a subsidiary
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E&P Calculation • START - Taxable income
• Plus additions
– Tax exempt income, excess LIFO, DRD excess accumulated depreciation, etc.
• Depreciation Adjustment
• Less subtractions
– E.g., federal income tax, penalties, 50% meals and entertainment, §267 deductions, etc.
• Less Distributions to the extent of E&P
• FINISH = E&P
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E&P Determination (process) • Taxable income reconciliation
– Each year since inception
Reconcile originally filed return to final taxable income (audit adjustments, amendments, etc.)
• Transaction Analysis - analyze E&P effects of every corporate transaction
• E&P Adjustments - analyze E&P adjustments for each year
• E&P Depreciation - apply E&P depreciation rules (usually separate project)
• Final E&P Determination
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Example of a Summary of Estimated Consolidated Earnings & Profits
December 31, 2004 to December 31, 2011
Year
Beginning
of Year
E&P
Total Adjusted
Consolidated
Taxable
Income
Adjusted
Federal
Income Tax
Merger
and
Liquidation
Adjustments
Tax Exempt
& N/D Expense
Adjustments Distributions
End of
Year
E&P
12/31/04 0 10,000 (3,000) (150) (1,300) 5,550
12/31/05 5,550 7,500 (2,250) (100) (1,400) 9,300
12/31/06 9,300 2,500 (750) 100 (80) (1,560) 9,510
12/31/07 9,510 (100) 0 (75) (100) 0 9,235
12/31/08 9,235 3,000 (1,000) (200) (1,200) 9,835
12/31/09 9,835 4,000 (1,200) 120 (150) (1,750) 10,855
12/31/10 10,855 5,000 (1,500) (100) (1,500) 12,755
12/31/11 12,755 7,500 (2,250) (300) (1,555) 16,150
Totals 0 39,400 (11,950) 145 (1,180) (10,265) 16,150
Subtotal Accumulated E&P Before E&P Depreciation 16,150
Estimated Section 312(k) E&P Depreciation (cumulative) 500
Estimated Accumulated E&P (with depreciation adjustment) 16,650
Thank You
Hot Topics in Corporate Taxation
Contact Information Kevin W. Kaiser Lindquist & Vennum PLLP 4200 IDS Center 80 South Seventh Street Minneapolis, MN 55402 Phone: (612) 371-2467 E-mail: [email protected]
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Hot Topics in Corporate Taxation