tax notes
IRS Has Always Required Warrants
To Track Phones, Koskinen Says
How Much Trouble Can Cash Management Be?
Should We Promote or Punish Excess Profits?
Nina Olson Stands Up for Taxpayers
Private Equity Funds and the Unrelated Business Income Tax
FATCA and the Road to Expatriation
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Volume 149, Number 5 November 2, 2015
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Friday Morning Live
tax notes™
Volume 149
600
ON THE COVER
583
IRS Has Always Required Warrants
To Track Phones, Koskinen Says
How Much Trouble Can
Cash Management Be?
by Lee A. Sheppard
591
602
Should We Promote or
Punish Excess Profits?
Identity Theft Data Sharing
Could Expand After 2016
by Luca Gattoni-Celli
603
Final Exempt Bond Regs
Allow Aggregate Treatment
by Fred Stokeld
604
by Martin A. Sullivan
650
Koskinen Says He Testified
Truthfully Every Time
by William Hoffman
by Luca Gattoni-Celli
585
Number 5
Bond Reps Offer Recommendations
On Proposed Issue Price Guidance
by Fred Stokeld
606
Treasury Regs Abandon
Benefits and Burdens Test
by Andrew Velarde
Nina Olson Stands
Up for Taxpayers
607
by William Hoffman
Fee Waiver Regs May Change
Guaranteed Payment Example
by Amy S. Elliott
669
Private Equity Funds and the
Unrelated Business Income Tax
608
by Mark Berkowitz and Jessica Duran
691
by Amy S. Elliott
610
FATCA and the
Road to Expatriation
West Opposed to Tax Regimes
Primarily Defined by Ruling Policy
IRS May Replace Elective
Safe Harbors for Built-In Items
by Amy S. Elliott
by Matthew A. Morris
Cover graphic: Paul Paladin and Scanrail@bigstock.com/
Illustration by Derek Squires
611
PTPs Urge Reworking of Proposed
Natural Resource Regs
by Amy S. Elliott
615
Treasury Undecided on Creditability
Of U.K. Diverted Profits Tax
by Ryan Finley
581
FROM THE EDITOR
616
Officials Explain Rationale for
Partnership Subpart F Regs
by Andrew Velarde
617
NEWS
594
The Impact of BEPS Implementation
For U.S. Tax Planning
by Marie Sapirie
596
Lois Lerner Will Not
Face Criminal Charges
by Fred Stokeld
598
New 501(c)(4) Regs Could Come
Early Next Year, Koskinen Says
by Fred Stokeld
FATCA Prominent in Information
Reporting Committee Report
by Luca Gattoni-Celli
618
Confusion Over Offshore Accounts
Prompts IRS Response
by Amanda Athanasiou
620
Lawsuit Challenges IRS Transition
Rules for Offshore Disclosures
by William Hoke
624
Expatriations Ramp Up to
Even Higher Annual Record Pace
by Andrew Velarde
TAX NOTES, November 2, 2015
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CONTENTS
626
SPECIAL REPORTS
by William Hoke
628
Focus Shifting Away From
Switzerland, Investigators Say
669
by Mark Berkowitz and Jessica Duran
by William Hoke
631
Possible Pfizer-Allergan Merger —
Biggest Inversion Yet?
679
Tax Directors Share ‘War Stories’
On Transfer Pricing Audits
by William Hoke
635
Transfer Pricing Roundup
636
Court Holds for Taxpayer
In 40-Year-Old Gift Tax Case
by Ryan M. Finley and Kristen Langsdorf
by William R. Davis
638
VIEWPOINTS
691
FATCA and the Road to Expatriation
703
Kinder Morgan’s Choice of Entity
707
Investment Assets in
Corporate Separations
Obama Signs Short-Term
Highway Funding Bill
by Stephen K. Cooper and Kaustuv Basu
Ryan Elected Speaker
642
Congress Passes 2-Year
Federal Budget
POLICY PERSPECTIVE
713
Increasing Student Loans and Rising
Tuition: The Latest Research
by Kaustuv Basu
by Kat Lucero and Stephen K. Cooper
ON THE MARGIN
717
How Would Cardin’s VAT Affect
Social Security Recipients?
by Alan D. Viard
Koskinen Says IRS Will Try New
Budget Strategy in Fiscal 2017
by William Hoffman
644
by W. Eugene Seago
by Mark J. Warshawsky
640
643
by Matthew A. Morris
by Stanley Barsky
House Approves Reconciliation
Bill to Repeal ACA Taxes
by Kat Lucero
639
Inflation Adjustments Affecting
Individual Taxpayers in 2016
by James C. Young
by Amy S. Elliott and Andrew Velarde
633
Private Equity Funds and the
Unrelated Business Income Tax
BOOK REVIEWS
Potential Partnership Audit
Changes in the Budget Act
723
by Marie Sapirie
Effectively Updating
Effectively Representing
Reviewed by Bryan T. Camp
645
Pending Treaties Adopt
U.S., International Standards
by Ryan Finley
646
Analysts Say Cruz Tax
Proposal Is a VAT
by Paul C. Barton
648
727
Candidates Grilled on Tax
Plans in Third GOP Debate
TAX CALENDAR
IN THE WORKS
705
A look ahead to planned commentary
and analysis
by Paul C. Barton
650
Nina Olson Stands
Up for Taxpayers
Interviewed by William Hoffman
WEEKLY UPDATE
657
Guidance
661
Courts
665
Correspondence
by Joseph DiSciullo
by Joseph DiSciullo
by Joseph DiSciullo
580
TAX NOTES, November 2, 2015
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Film Decrying International Tax
Avoidance Premieres in U.S.
tax notes™
The Iron Triangle
Of Project Management
By Paige A. Foster — paige.foster@taxanalysts.org
Quality, time, and cost: Pick two. That project
management principle, sometimes called the Iron
Triangle, is familiar to software developers. And it
makes one ponder how the House Oversight Committee thought its request for Lois Lerner’s e-mails
could go off without a hitch. The committee essentially said: We want all the e-mails, we want them
now, and we don’t care whether you don’t have the
budget for it.
With technology and software playing an increasing role in society and within the IRS, the Iron
Triangle is a good reminder that if you want something done well and quickly, it is gonna cost ya.
And, if you don’t have the financial resources,
either you won’t get everything you want, or it will
take a lot longer to get it.
Technology is a common thread woven into this
week’s news stories. Data sharing, identity fraud
prevention, records retention, and cellphone tracking all depend on tech. And yes, the familiar IRS
budget lamentations echo throughout.
Information Sharing . . .
An advisory committee recommended more
technology funding to ‘‘bring IRS systems into the
21st century,’’ especially for FATCA reporting (p.
617).
. . . And Identity Theft
Preventing stolen identity refund fraud is the
goal of a data-sharing initiative among the IRS,
states, and private stakeholders (p. 602).
Records Retention
The Justice Department closed its investigation
into the tax-exempt organization application scandal, announcing that it won’t pursue criminal
charges against Lois Lerner (p. 596). Four days later,
Rep. Jason Chaffetz introduced a resolution calling
for the removal of John Koskinen as IRS commissioner (p. 600). It’s hard to take the articles of
impeachment too seriously. However, the resolution’s focus on missing records, computers, and
backup tapes is another example of how tech tools
come into play for the IRS.
The destruction of data on IRS backup tapes,
believed to contain Lerner’s e-mails, raised the issue
of records retention. During a recent hearing, Koskinen said that IRS employees are being trained on
records retention and that the IRS is upgrading its
e-mail systems (p. 598). It is unlikely that most
government agencies comply perfectly with the
National Archives and Records Administration’s
records retention rules. That’s not surprising; even
private companies dedicated to records management cannot comply with their self-imposed standards. Iron Mountain Inc., a respected S&P 500
company that provides data backup and storage as
well as document destruction services, has suffered
data losses. And that’s what its business is all about.
Cellphone Tracking
The Guardian recently reported that the IRS has
access to cell-site simulator technology that fools all
cell phones in its vicinity to send information to the
simulator, and thus to government investigators (p.
583). However, the IRS follows Justice Department
rules regarding the technology, which typically
requires that a warrant be obtained before use,
according to Koskinen.
Despite the Fourth Amendment, the government
doesn’t always need a warrant. One exception to
obtaining a warrant is if the search is necessary to
‘‘prevent imminent destruction of evidence.’’ Cue
amusing thoughts on how the cell-site simulator
technology could have been used to prevent destruction of Lerner’s e-mails.
The Justice Department rules also require data
collected by the simulators to be erased at least once
a day. So how exactly do the requirements for the
stealth simulator technology and records retention
overlap? If an agency has dropped the ball on
records retention, should it be using those cell-site
simulators? Would it know what to do if a simulator
picked up official government communications that
must be retained under other law?
Given enough time and money, those questions
likely can be adequately answered and even communicated to all government employees. Adequate
implementation also requires time and money.
Whether the IRS has the resources to lawfully
implement simulator technology remains to be
seen.
TAX NOTES, November 2, 2015
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FROM THE EDITOR
tax notes
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Copyright 2015, Tax Analysts ISSN 1048-3306
tax notes™
IRS Has Always Required Warrants
To Track Phones, Koskinen Says
phones using the simulator device’s signal type,
even if the device operator specifies the target
phone number or the electronic serial number of the
target phone or SIM card.
By Luca Gattoni-Celli —
luca.gattoni-celli@taxanalysts.org
Senators Question Koskinen
During the hearing, Koskinen told Wyden that
only IRS employees in the Criminal Investigation
division use cell-site simulators, and solely based
on probable cause of criminal activity. Koskinen
said the IRS uses them ‘‘primarily in cases of money
laundering, terrorism, and organized crime,’’ adding that he would provide information about the
frequency of their deployment within 30 days.
Koskinen emphasized that IRS practices follow
Justice Department rules governing the technology.
Those rules, announced September 3, include requiring a warrant to use a Stingray in most cases
and requiring that data be cleared from the device
after each mission and at least daily.
Koskinen repeated this assurance to Grassley
when asked if the IRS would issue its own policy,
saying it would continue to abide by the Justice
Department’s standards, as well as any updates to
them.
Grassley and Judiciary Committee ranking minority member Patrick J. Leahy, D-Vt., asked Treasury Secretary Jacob Lew to describe Treasury’s
cell-site simulator capability, including how many
devices it has, when it has used them, and whether
it always requires a warrant or permits exceptions,
in a letter dated October 29. The senators also asked
whether Treasury supports state or local deployment of the technology, requesting responses from
Lew by November 30.
‘‘Senator Grassley has raised questions with
other federal agencies regarding these devices and
whether the appropriate safeguards and protocols
are in place to protect the 4th Amendment rights of
innocent Americans,’’ his office said October 26 in a
written statement. ‘‘Given the nature of the IRS’
work and the general lack of trust the American
people have in the agency, its potential use of this
technology warrants added scrutiny.’’
The devices are widely known as Stingrays, after
a model sold by Harris Corp., which Wessler said is
the main vendor of such surveillance technology to
U.S. government entities. The Guardian reported
that the IRS in 2012 upgraded a Stingray II model to
a Hailstorm, also purchasing training from Harris
Corp. on how to use the latter.
IRS policy has always required that it obtain a
warrant to use cellphone-tracking surveillance devices known as Stingrays and that they be used only
in criminal cases, IRS Commissioner John Koskinen
said October 27.
‘‘Our policy has always been that you have to
demonstrate it is a criminal case. You have to get a
warrant for it,’’ Koskinen told reporters after a
Senate Finance Committee hearing on the IRS’s
response to the exempt organizations screening
controversy. (Related coverage: p. 598.)
‘‘You have to make sure’’ only to use the capability in criminal cases, Koskinen said. ‘‘We have
never used it in civil issues.’’
‘You have to make sure’ only to use
the capability in criminal cases,
Koskinen said. ‘We have never used it
in civil issues.’
Finance Committee ranking minority member
Ron Wyden, D-Ore., and committee member Chuck
Grassley, R-Iowa, asked Koskinen about the IRS’s
use of the technology. Wyden is on the Senate Select
Intelligence Committee, and Grassley chairs the
Judiciary Committee. Both have advocated greater
oversight and disclosure of government surveillance, including the use of Stingrays.
Their questions followed a report by The Guardian that the IRS acquired the so-called cell-site
simulator devices in 2009 and 2012, according to
invoices obtained under the Freedom of Information Act.
A cell-site simulator uses so-called IMSI catcher
technology: A broadcasted signal fools cellphones
into connecting with the fake cell tower, which then
extracts metadata — including location data — and
in some cases communications content, from those
phones, explained Nathan Freed Wessler, a staff
attorney with the American Civil Liberties Union’s
Speech, Privacy, and Technology Project.
Wessler told Tax Analysts the technology collects
this information indiscriminately, ensnaring all
TAX NOTES, November 2, 2015
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NEWS AND ANALYSIS
NEWS AND ANALYSIS
‘I would anticipate that it would take
one rogue member [of CI to] take an
issue like this and expand it far
beyond what the scope of it was
initially intended,’ Heller said.
disclosure of the technology, and its use against
him, after poring over legal documents in his prison
cell.
Despite previous speculation that the IRS had
used a Stingray, The Guardian report is the first clear
evidence that the agency actually possessed it.
Which government agencies used a cell-site simulator against Rigmaiden remains unclear.
Data collected on the strength and direction of a
phone’s connection to the Stingray can be used to
gradually work toward the phone’s location. However, this is only one facet of the information the
device collects about all the phones that connect to
it.
Wessler noted that a cell-site simulator can also
be used without specifying a target, to indiscriminately collect data from all phones that connect to it.
By comparing metadata collected in multiple locations where a suspect is thought to be, law enforcement may identify the suspect’s phone number by a
process of elimination.
These techniques could theoretically help the IRS
locate or identify the phone of someone suspected
of impersonating an IRS agent over the phone, for
example.
Fred Stokeld contributed to this article.
Finance Committee member Dean Heller, R-Nev.,
urged his colleagues not to take Koskinen’s responses as an answer. ‘‘I would anticipate that it
would take one rogue member [of CI to] take an
issue like this and expand it far beyond what the
scope of it was initially intended,’’ Heller said.
Legal and Technical Questions
The Department of Homeland Security recently
announced Stingray policies similar to the Justice
Department guidelines. Wessler explained that before those policies were announced, government
agencies, including local law enforcement, had typically relied on so-called pen register court orders to
authorize Stingray use. These orders require only
relevance to an ongoing criminal investigation,
which is less strict than a search warrant’s standards such as probable cause, Wessler said.
Wessler also noted the ACLU’s stance that surveillance techniques such as Stingrays may conflict
with the Fourth Amendment’s protection against
unreasonable searches and seizures, even if they are
authorized under statutory law by a warrant.
The criminal case in which this technology first
came to light was a tax case, United States v.
Rigmaiden, 844 F. Supp.2d 982 (D. Ariz. 2012), in
which Daniel Rigmaiden discovered and forced the
584
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Wessler told Tax Analysts that based on publicly
available information, the Hailstorm is thought to
be the most current iteration of the technology, but
he also noted that governments have treated their
surveillance capabilities and practices with extreme
secrecy.
A major concern about cell-site simulator technology, particularly advanced devices such as the
Hailstorm, is that it can be used to surveil communications themselves, including phone calls, and
that government authorities could do so with virtual impunity.
‘‘What it does is primarily allow you to see
point-to-point where communications are taking
place,’’ Koskinen said of the technique used by the
IRS, also assuring Wyden that it does not allow the
IRS to overhear voice calls. However, he added,
‘‘You may pick up texting.’’
Wessler said a Hailstorm can likely collect the
content of communications but added that he
would be surprised if the IRS or any government
agency was doing so without the proper warrant.
NEWS AND ANALYSIS
NEWS ANALYSIS
By Lee A. Sheppard — lees@taxanalysts.org
It’s hard to talk about football when the FIFA
scandal is becoming gorier by the day. No soap
opera in the Chelsea or Liverpool dressing rooms
can match the daily drip feed of corruption from the
sport’s governing body.
UEFA President Michel Platini’s hopes of distancing himself from his mentor Sepp Blatter and
succeeding him have been dented by an undocumented $2 million payment he received from FIFA.
Blatter said it was for accrued salary under a
gentlemen’s agreement. Both men have been suspended from FIFA for 90 days while Swiss authorities investigate. The election of a FIFA president will
still be February 26, 2016, and Platini may be
disqualified.
Despite the objections of FIFA’s sponsors, Blatter
refuses to resign from his post (he merely said that
he will not stand for reelection). Sponsors CocaCola, McDonald’s, Visa, and Anheuser-Busch InBev
have publicly asked Blatter to get out, with the beer
company calling him an obstacle to FIFA reform.
Two sponsors, Sony and Emirates Airlines, ended
their deals last year and were replaced by Gazprom.
Blatter — who is being investigated by the Swiss
attorney general for criminal mismanagement and
misappropriation of funds — insists that he will
clear his name. He is 78.
But we’re also getting closer to the answer to the
question why the Europeans didn’t get rid of Blatter
years ago and had to wait for the U.S. Department
of Justice to start indicting his underlings. To put it
succinctly, Blatter ain’t going down without taking
everyone else down with him — perhaps even
including the Kaiser.
That’d be German national hero Franz Beckenbauer. Germany might have bought the 2006 World
Cup — the bidding for which it won by a single
vote. FIFA and the German football federation are
investigating a €7 million payment by the latter to
FIFA’s cultural program that may not have been
used for its stated purpose (Der Spiegel, Oct. 16,
2015). The accusation is that the funds, lent by the
head of Adidas, were used as a schwarze kasse with
the full knowledge of the German bidding committee, headed by Beckenbauer.
‘‘Without dirty tricks, Germany wouldn’t have
had a chance of winning the bid to host the World
Physical Cash Pooling
Multinationals like to have all their excess cash in
one place, and their outside lenders like it that way
too. The old-fashioned way to pool cash is physical
— that is, a daily cash sweep from operating
companies to a group treasury that creates interestbearing intragroup loans booked as payables and
receivables for tax purposes. Physical pooling has to
be done currency-by-currency. The group treasury
faces the outside for foreign exchange exposure.
If the group parent is a U.S. resident, it cannot be
involved in cross-border physical pooling because a
loan to it would be a subpart F inclusion (section
956). The U.S. inbound loan rule is unique; no other
country’s subpart F analogue has such a rule. So if
the parent is Canadian, an inbound loan for an
operating company is treated as active income for
foreign accrual property income rules (section 95.2).
But physical pooling within the United States
was widely practiced because of long-gone restrictions on interstate banking. Other tax questions
involve back-to-back loans, transfer pricing, and
thin capitalization. Some countries have withholding taxes on related-party payments or capital controls. Practitioners believe that BEPS will kill off
physical pooling.
TAX NOTES, November 2, 2015
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How Much Trouble Can
Cash Management Be?
Cup. But that’s no excuse. . . . Decency must remain
a core German value,’’ Der Spiegel intoned (Oct 20,
2015).
FIFA has nothing on multinational companies
when it comes to moving large sums of cash around
the world. Around here, we’re used to a model of
multinational behavior that says that all intragroup
loans are phony, undertaken for the purpose of
stripping income out of operating companies in
countries with real tax systems. But multinationals
really do need to get a lot of their cash into one
place for business reasons and to satisfy outside
lenders.
Obviously the one place that cash representing
previously untaxed earnings cannot go is the
United States, whose CFC rules are unique in
treating inbound loans as repatriations. But for
U.S.-parented multinationals, cash management
outside the United States usually features a daily
cash sweep and a tax haven group treasury company, in which some U.S. affiliates (but not parents
or subparents) may participate.
Leaving U.S. law aside, what would base erosion
and profit-shifting changes in Europe mean for
group cash management? Even though some governments made some effort to excuse group cash
management operations from information reporting, they are not excused from other proposed rules
for the simple reason that they are often amenable
to income stripping.
NEWS AND ANALYSIS
But a recent German federal fiscal court case
permitted a write-down under old law because the
question raised by intragroup loans was the pricing
of the interest charge, not the validity of the loan
(Tax Notes Int’l, Aug. 1, 2011, p. 373). That same
court questioned the constitutionality of the interest
barrier rule (Tax Notes Int’l, Apr. 28, 2014, p. 329).
Bödefeld explained that legislation in Germany
proposed a year ago would extend the hybrid
mismatch rule currently applicable to dividends to
interest payments, so that no deduction would be
permitted for interest payments that are not taxed at
the receiving end or paid under an instrument that
is not treated as debt (Tax Notes Int’l, Sept. 28, 2015,
p. 1111). If an operating subsidiary sends cash to a
group finance company, it must be compensated for
the loan at an arm’s-length rate, a German court has
held.
Bernd Weissbrod/picture-alliance/
dpa/dpaweb/Newscom
Franz Beckenbauer, the Kaiser, with the Germany 2006
World Cup logo. How will history remember him?
German companies use cash pooling around the
world, according to Axel Bödefeld of Oppenhoff &
Partner, who co-chaired a panel with Jack Bernstein
of Aird & Berlis at the Vienna International Bar
Association (IBA) meeting. The EU interest and
royalties directive (2003/49/EC) generally prevents
withholding on interest payments. But this practice
is becoming more difficult, because directors have
to be given real power over the liquidity of subsidiaries, which cannot make deposits so large they
would become insolvent. Tax authorities suspect
that intragroup lending is just cover for income
stripping, Bödefeld noted.
Interest deductions are subject to German interest barrier rules limiting deductions to 30 percent of
EBITDA (section 4h of the Income Tax Act). Receivables on intragroup loans cannot be written down
(section 8b-3 of the Corporate Income Tax Act).
Moreover, a write-down of a receivable may be
treated as a distribution of hidden profits (built-in
gain) under some circumstances, such as when an
Austria has a plethora of rules, as Michaela
Petritz-Klar of Schoenherr explained. Austrian subsidiaries of foreign parents often participate in cash
pools. Their participation is scrutinized for proper
transfer pricing, thin capitalization, and low levels
of taxation for the group finance company. Interest
deductions are denied if the payee is low-taxed, the
borrower is too thinly capitalized, or the debt is
used in the acquisition of the shares of a related
party (debt push-down rule).
The disadvantages of physical
pooling are numerous. Tax authorities
suspect that intragroup lending is just
cover for income stripping, Bödefeld
said.
The Austrian rule denying deduction of payments to low-taxed payees was introduced as a
BEPS response in 2014. Petritz-Klar noted that the
concept of low taxation includes not just low nominal rates, but also dividend exemption for payments on hybrids and low effective tax liability
resulting from special rules like fictitious expense
deductions.
Austrian rules demonstrate the mismatch between cash management and transfer pricing.
Petritz-Klar explained that Austrian tax authorities
want documentation and arm’s-length pricing, usually at the parent’s rate rather than the affiliate’s
higher stand-alone rate. Deposit interest should be
at a market rate, and the resulting spread produced
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operating company is not compensated for a guarantee. Payments on intergroup guarantees are also
nondeductible.
NEWS AND ANALYSIS
Meanwhile, Hong Kong and Singapore compete
with each other with tax benefits for regional treasury centers. Neither withholds on outbound interest. Both have lots of treaties and low rates. But
Singapore has a big edge in this competition on
lifestyle considerations, Hong Kong-based Nelson
noted.
Canadian rules are very complex. The Canadian
affiliate is usually a lender, in the experience of
Alain Ranger of Fasken Martineau DuMoulin, who
spoke at an IBA conference in London earlier this
year. If a Canadian company makes a loan to a sister
foreign group finance company, it is treated as a
constructive dividend to the group parent, includable in its income, if the loan is left outstanding for
a year after the tax year when it was made.
The deemed dividend is subject to 15 percent
withholding, which is refundable when the loan is
repaid. The Canadian lender will be deemed to
receive interest at a prescribed rate. But this rule can
be avoided if the parties elect to include interest
income at a penalty rate, Ranger explained.
What if the Canadian company was not making
its own decisions — as is likely to be the case in a
cash pool? Canada’s foreign affiliate dumping rules
could treat that loan as a dividend to the parent
followed by on-loan to the finance company. These
hurdles explain why much Canadian cash pooling
is notional.
Notional Cash Pooling
Notional pooling involves an outside bank. All
members of the cash pool make deposits and withdrawals at the bank’s branches. One affiliate functions as cash pool leader. Cash movements across
borders are minimized because each bank branch
participates. No intragroup loans are created for tax
purposes because all the borrowing and lending are
by the bank (although some tax administrators may
take a different view).
Each member has an individual bank account.
The funds in each account are virtually, but not
legally, consolidated to form a group balance for
purposes of cash management. No cash pool member’s contractual relationship with the bank is affected by the virtual consolidation (a bank deposit
is a contract, not a bailment).
Another way of looking at the virtual system is
that the bank creates a shadow account for the
group. At the behest of the cash pool leader, the
bank debits and credits the shadow account for
each member. Interest is debited and credited to
and from the bank, and is respected for tax purposes. The cash pool leader gives instructions to the
bank about where to deploy money that both it and
the operating companies have on deposit or borrow.
Any member of the pool may be in the posture of
borrower or lender depending on its net position
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by Austrian transfer pricing rules has to be allocated around the group away from the finance
company, which the tax authorities see as a service
provider.
Analysis whether cash pooling is businessdriven or tax-driven is required, especially when
there is no net positive leverage. If tax authorities
do not respect the formal arrangements, payments
could be recharacterized as dividends or contributions of capital. Petritz-Klar admitted that the rules
were more complicated than necessary.
China is a tough country for pooling because it
has capital controls. The renminbi is generally convertible only for trade in goods and services. Steven
Nelson of VNS Tax & Legal explained that lending
requires a banking license, so loans have to be run
through licensed banks that charge fees for entrusted loans.
So companies could only do cash pooling within
China until recently, when some multinationals
were given permission for cross-border cash pooling. Regulations were issued. The Shanghai Free
Trade Zone has a separate cash pooling scheme (Tax
Notes Int’l, Oct. 7, 2013, p. 27).
Regulations issued in 2014 permit cash pooling
between an operating company in the Shanghai
Foreign Trade Zone and domestic affiliates (for
renminbi) and foreign affiliates (for foreign currency). The operating company would have to be
the cash pool leader, using a foreign trade account,
according to Nelson. But there is no limit on the
amount of borrowing or lending. The chief limitation is that the cash cannot come from outside
lending; it must be generated from operation and
investment by pool members. Nelson expressed
skepticism that this limit could be enforced, given
that pool members could be outside the zone.
More regulations issued in 2014 permit foreign
exchange pooling with a Chinese pool leader, Nelson noted. Approval is required. There are limits on
foreign exchange entering and leaving China. Foreign exchange can be converted into renminbi for
genuine business purposes and invested in financial assets. Unrelated suppliers and customers can
join the pool. Cross-border renminbi pooling requires approval from the People’s Bank of China.
But there are quotas, and pool funds cannot be
invested in financial assets (Circular 234).
China has a slug of withholding taxes on interest
and guarantee fees, and there has been no word
about any special treatment of cash pooling, according to Nelson. Interest deductions would not be a
problem as long as transfer pricing rules were
obeyed. Some rates have been challenged. Net
interest income is subject to business tax, which is
being converted to VAT.
NEWS AND ANALYSIS
Notional cash pooling avoids a lot of
problems raised by physical pooling.
But in the minds of some tax
authorities, it may not be notional at
all.
Some multinationals are not in the habit of
charging for intragroup guarantees, Kaywood
noted. Ranger responded that there could be a
deemed dividend if no guarantee fee was charged
on a parent guarantee.
Notional cash pooling avoids a lot of problems
raised by physical pooling. But in the minds of
some tax authorities, it may not be notional at all.
When it adopted German-style interest barrier
rules, Italy restricted deduction of net interest arising in notional cash pooling (Tax Notes Int’l, May 11,
2009, p. 481).
Austrian tax authorities see notional pooling as
mere service provision, for which cash management
fees are appropriate, according to Petritz-Klar. That
is, a nice, fat banklike spread cannot be attributed to
a group finance company doing notional pooling.
According to a recent ruling by the Canada
Revenue Agency, the Canadian general antiabuse
rule may apply to notional pooling because it may
be an avoidance transaction, Ranger explained. The
CRA’s theory appears to be that notional pooling is
the equivalent of physical pooling. According to
proposed legislation for back-to-back loan rules,
deposits to the bank would be intermediary debt or
a tainted right to use property. (Prior analysis: Tax
Notes Int’l, Nov. 10, 2014, p. 529.)
A recent Portuguese transfer pricing case provided a window on notional cash pooling through
the Netherlands. The subsidiary was always a net
creditor and its parent was always a net debtor in
their notional cash pool. Using the bank’s regular
interest rates, the difference between the pool’s debt
and credit rates was 121 basis points. The parent
had outside borrowing. The tax authority argued
that the subsidiary’s constant credit position effectively guaranteed the parent’s outside loans, so it
should be better compensated at 159 basis points
(Tax Notes Int’l, June 3, 2013, p. 999).
The arbitrators went for a profit split instead,
rejecting the tax authority’s argument for a comparable uncontrolled price. Two aspects of this case
are notable. First, the tax administrator argued that
a virtual lending relationship created a real lending
relationship because of the parties’ constant postures. Second, the European Commission appears to
be arguing for a comparable uncontrolled price in
the Fiat state aid case.
There could be a VAT issue for a group treasury.
A group treasury that sits above operating companies, as is usually the case, would be combined with
them for VAT purposes (VAT filing group). Physical
cash pooling is an exempt activity akin to banking.
But the operating companies’ combination with the
group treasury could result in the denial of recovery
of input VAT for the former. Petritz-Klar noted that
notional cash pooling, by contrast, is a service
subject to VAT.
‘‘It’s not clear how a notional shadow bank
account in a foreign country works under U.S. law,’’
said Michael Jacoby of EY at the Vienna IBA.
Notional pooling is not free from questions about
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with the pool. The bank typically limits the group’s
total borrowings to the sum of the group’s outside
lending limit plus total group members’ deposits.
So deposits effectively serve as collateral for payment of bank loans to the group’s net borrowers.
There may be negative balances if the group borrows a lot, on which all pool members would be
jointly liable.
No intragroup debt is created because all the
borrowing and lending are by the bank, according
to Ranger. Because a cash pool arrangement is
usually set up for business reasons, tax advisers
may not be present at creation or monitoring.
If specific entities should not be net borrowers,
this constant fluctuation can cause tax advisers to
tear their hair out. Notional pooling requires a lot of
daily, weekly, monthly, and annual monitoring for
tax purposes, even though it was set up for business
purposes, according to Ranger. If, at the end of a
day, there is more debit than credit, the parent may
be required to inject cash into the pool.
The bank treats individual virtual loans and
deposits as netted, so that the bank may be acting as
an agent, Sam Kaywood of Alston & Bird suggested
at the London IBA. Ranger responded that the
agency problem may be exacerbated because the
bank is often merely charging a fee for services of
managing the virtual pool, rather than the normal
spread between deposits and loans. If the bank is an
agent, then some or all of the pool members would
have a PE in the bank’s country of residence.
Canadian companies often use notional pooling
because physical pooling is difficult, according to
Ranger. The multinational guarantees its outside
debt with the bank deposits. Usually the group
members on the credit side give guarantees to the
group members on the debit side. Effectively the
parent guarantees all borrowing. Ranger explained
that the guarantees need to be priced reasonably so
that losses on the loans can be tax deductible
(General Electric Capital Canada Inc. v. The Queen,
TCC 563 (Dec. 4, 2009)). There may be corporate law
restrictions on guarantees.
NEWS AND ANALYSIS
Substance Requirements
At the London IBA, Pano Pliotis of GE explained
that notional cash pooling nonetheless requires a
Netherlands or Luxembourg entity that is a cash
pool leader and has a customer relationship with an
unrelated bank.
A group finance company need not involve any
personnel. It can be on autopilot. Often companies
want it that way because they don’t want to have to
get a banking license. The Netherlands and Luxembourg are favored jurisdictions for group treasuries,
but disfavored for sending personnel.
Cash pooling using the Netherlands is usually
notional, according to Ewout van Asbeck of Van
Doorne NV, who spoke at the London IBA. Cash
pooling is usually done with a single currency for
simplicity, but multiple currencies can be used. Van
Asbeck explained that Dutch tax authorities are not
pursuing compensation for guarantees, but are
thinking about whether to require charges for guarantees. His view was that fees should be charged for
guarantees.
A lot of EU cash pooling is run through Luxembourg and the Netherlands, where the work is
done, because of advantageous treaty networks,
according to van Asbeck. Banks in both countries
have good systems for cash pooling. A Dutch ruling
frees the recipient from many burdens. No operating company participating in pooling would be
deemed to have a permanent establishment in the
Netherlands, which has no thin capitalization rules,
withholding tax on intragroup interest, or stamp
duties.
A group finance company need not
involve any personnel. It can be on
autopilot. Often companies want it
that way because they don’t want to
have to get a banking license.
Dutch law requires a group treasury to have
sufficient capital to carry out its functions in order
to be considered the beneficial owner of the interest
paid to it. Otherwise it would be considered a
service provider, according to van Asbeck. It must
have equity at risk equal to 1 percent of its loan
book up to a maximum of €2 million equity. Profitparticipating loans are used to remove profits from
the Netherlands.
A Dutch group treasury is allowed to operate on
a cost-plus basis. The Dutch tax rate is 20 to 25
percent, but being allowed to run an intragroup
financial intermediary on a cost-plus basis reduces
the tax base greatly. The Dutch practice permits the
small spread to be split evenly between the group
finance subsidiary and the headquarters treasury
department (Decree IFZ2004/126M and Decree
IFZ2004/127M of Aug. 11, 2004).
Both countries will continue to issue rulings
because they believe that they have done nothing
wrong, according to van Asbeck. The commission
ruled that Fiat received prohibited state aid in the
form of a selective advantage that reduced its
Luxembourg tax liability by €20 million to €30
million (IP/15/5880). Luxembourg griped that the
criteria used were unprecedented.
The commission ruled that because Fiat Finance
and Trade Ltd. (FTT) was comparable to a bank, it
should have earned comparable profits. The commission accused the Luxembourgian authorities of
using a complex transfer pricing method to artificially lower FTT’s tax liabilities. Specifically, the
chosen method used a capital base that was too low,
so that the rate of return on this capital was below
market. FTT should have had adequate capital, and
should have earned a market return on it.
That is, Luxembourg ruling policy required too
small a spread in group finance companies. When
the standard 25-basis-point cost-plus margin was
subjected to Luxembourg’s regular 29 percent rate,
the result was a tax base lower than actual financial
income. Moreover, the tax base did not vary with
FTT’s actual performance.
Luxembourg group finance company rules are
substantially similar to Dutch finance company
rules. So every multinational that has a Dutch or
Luxembourg group finance company has to worry
about the commission ruling. (Prior analysis: Tax
Notes, Oct. 13, 2014, p. 156.)
FTT is not unique. Every Luxembourg group
finance company got the same ruling — to the point
that Luxembourg practitioners argue that there was
no selectivity. (Multinationals are a select group,
according to Commission v. Gibraltar, C-106/09 and
C-107/09.)
So what happens when one of these hollow
entities runs up against substance requirements?
Dutch law does have some minimal substance
requirements (Decrees DGB 2014/3098, DGB 2014/
3099, DGB 2014/3101, DGB 2014/3102, and DGB
2014/296M of June 3, 2014). Qualified personnel are
required for substance, but they do not have to be
employees of the company. But its board meetings,
bank accounts, and books must be in the Netherlands. Practitioners advise putting warm bodies in
group finance companies. (Prior analysis: Tax Notes
Int’l, May 19, 2014, p. 645.)
German CFC rules claw back interest income
earned in a low-tax jurisdiction unless the group
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interest deductibility, intragroup guarantees, thin
capitalization, and repatriation of operating company earnings.
NEWS AND ANALYSIS
Hybrids
At the London IBA, Kaywood explained that
preferred equity certificates (PECs) and convertible
preferred equity certificates (CPECs) are used to
shelter income earned by a Luxembourg group
treasury, which is usually opaque. PECs and CPECs
are loaded with a lot of equity features so that the
United States will consider them equity. Luxembourg treats them as debt, and interest is deductible. Usually the group treasury issues PECs or
CPECs to its U.S. parent, with subordination and
very long terms like 30 years.
According to Pliotis, the design issue is that the
PECs or CPECs should not be considered preferred
equity, which would remove deferral. The design
should ensure that these hybrid instruments are
treated as common equity. Interest payments to the
U.S. parent are deferred indefinitely.
Kaywood noted that BEPS action 2 would hit the
use of hybrid instruments. The action 2 secondary
rule and the amended parent-subsidiary directive
require EU member countries to change their laws
to deny a dividend exemption (Directive 2015/121).
The European parent would have to treat deductible payments from a cash pool leader as income
after those changes are made.
Luxembourg recently issued a draft law that
would comply with the amended directive. A Luxembourg holding company would not enjoy a participation exemption if dividends paid to it were
deductible by an EU-resident payer (article 166 of
the Luxembourg Income Tax Act). Ireland responded by requiring a business purpose for dividend relief.
HM Revenue & Customs recently issued a consultation document on BEPS and hybrid mismatches, which proposed new rules based on the
BEPS action 2 report. Jacoby noted that the U.K.
government may be looking at CPECs. That and
other factors may mean that some EU cash pooling
may have to be unwound.
Section 956
‘‘It would be very unwise to have the U.S. parent
as part of a cash pool unless there is a compelling
business reason and you could always be sure that
it will have a net positive position as a lender,’’ said
Pliotis, noting that each operating company’s balance and its legal significance has to be evaluated
separately if the taxpayer is relying on netting.
Section 956 treats a CFC’s investment of earnings
in U.S. property as gross income that should be
included by U.S. shareholders. Investment in U.S.
property is measured at the end of each quarter of
the CFC’s tax year. The amount included by U.S.
shareholders is the lesser of the excess of the
shareholder’s pro rata share of the U.S. property
held by the CFC over the shareholder’s share of
previously taxed earnings and profits, or the shareholder’s pro rata share of the CFC’s undistributed
earnings and profits.
Section 956(c)(1)(C) defines U.S. property to include an obligation of a U.S. person, which would
include a loan to the CFC’s U.S. parent. Reg. section
1.956-2T(d)(2)(i) defines the term ‘‘obligation’’ to
include ‘‘any bond, note, debenture, certificate, bill
receivable, account receivable, note receivable, open
account, or other indebtedness, whether or not
issued at a discount and whether or not bearing
interest.’’
‘It would be very unwise to have the
U.S. parent as part of a cash pool
unless there is a compelling business
reason and you could always be sure
that it will have a net positive position
as a lender,’ said Pliotis.
Even though the cash pool lender may have a
low margin, there is a risk that debt finance from
the operating companies would be aggregated so
that it could be considered to be lending to the
United States. Cash pooling is considered commingling, so cash pooling has been deemed loans to
U.S. parents in some cases, Jacoby explained at the
Vienna IBA (Gulf Oil Corp. v. Commissioner, 87 T.C.
548 (1986), aff’d in part and rev’d in part on other issues,
914 F2d 396 (3d Cir. 1990)).
Moreover, credit support for U.S. parent borrowing could be treated as an inbound loan. Crossguarantees by the U.S. parent would be treated as
an outbound service. Cross-guarantees among
CFCs could be a problem, according to Jacoby, until
the ‘‘look-thru’’ rule has been reauthorized (section
954(c)(6)). Moreover, if all the entities below the U.S.
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finance company has substance (section 7 et seq. of
the Foreign Tax Act). EU CFC rules are required to
permit flight to low-tax jurisdictions when there is
substance (Cadbury Schweppes PLC and CSO Ltd. v.
Commissioners of Inland Revenue C-196/04).
Petritz-Klar explained that Austrian tax law has
substance requirements to respect the payee of
interest as the beneficial owner, so there may be
questions when interest is paid to a group finance
company. There must be bodies and office space
and real decision-making as to the disposition of
funds.
Conduits are ignored; the focus is on the ultimate
payee. Petritz-Klar said that this inquiry could be
perversely circular, with taxpayers arguing that a
payee has no substance to get a result. Back-to-back
loans are disfavored and guarantees are scrutinized.
NEWS AND ANALYSIS
ECONOMIC ANALYSIS
Should We Promote or
Punish Excess Profits?
By Martin A. Sullivan — martysullivan@comcast.net
In recent years there has been growing interest in
dividing profits between normal and excess profits
and taxing each differently. For non-economists, the
idea of artificially splitting profits into these two
categories is puzzling enough. Adding to the confusion are seemingly contrary views about whether
excess profits should be penalized or promoted.
Sometimes economists advocate that excess profits
should be taxed more heavily than normal profits.
And sometimes the opposite course is recommended. To help sort all this out, let’s walk through
the different reasons excess profits arise and the
policy implications of each.
Historically, taxation of excess profits was mostly
about redistributing the profits of corporations that
were perceived as unfairly and excessively prospering from a national crisis. The United States imposed excess profit taxes during the First and
Second World Wars and during the Korean War. In
1980 Congress imposed a windfall profit tax on
major oil companies. Taxes like these aren’t part of
the current policy debate.
To keep matters manageable, we assume that
normal profits are determined by applying some
low-risk or risk-free rate of return to net tangible
capital. Excess profits are simply the residual after
subtracting normal profits from total profits.
No Intellectual Property, No Profit Shifting
Sometimes excess profits indicate that a business
is making smart investments and is generating a
genuinely high rate of return on its capital spending. Here it could be argued that excess profits
should be fully taxed and that normal profits
should be exempt from tax.
That offbeat approach to taxing profits is derived
from basic economics. Suppose a business has the
opportunity to invest in three $100 investment
projects — the first with a 20 percent return, the
second with a 15 percent return, and the last with a
10 percent return. If the company’s cost of funds is
12 percent, it will invest in the first two projects and
skip the third. Assuming all equity financing of
those two projects, the company will have total
profits of $35 (20 percent of $100 plus 15 percent of
$100). Using 12 percent as our assumed normal rate
of return, normal profits will be $24 (12 percent of
$200) and excess profits will be $11.
What is the effect of taxing excess profits? In this
framework, fully taxing excess profits doesn’t affect
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parent are checked, the operating companies could
be deemed to have made a payment to the United
States. Wouldn’t it be better to avoid intragroup
guarantees? Sometimes outside creditors ask for
them, according to Jacoby.
At the London IBA, Kaywood noted that a U.S.
law firm is being sued by a bankruptcy trustee for
malpractice for planning to make a CFC jointly and
severally liable for parent borrowing, costing the
bankrupt client hundreds of millions of dollars in
taxes. He pointed out that even if the foreign tax
credit would shelter a section 956 inclusion, it is
unlikely that a multinational booked a reserve for
the U.S. tax, so there would be an immediate hit to
earnings.
Debt funding to the cash pool coming from
outside could be aggregated with a loan back to the
U.S. to enlarge the section 956 inclusion because of
the funding antiabuse rule for corporations, said
Pliotis at the London IBA (reg. section 1.9561T(b)(4)). Under that regulation, a CFC will be
treated as holding U.S. property held by an affiliate
if one of the principal purposes of funding that
affiliate is to avoid section 956. That is, the cash pool
leader would be treated as a conduit. (Prior analysis: Tax Notes, Oct. 26, 2015, p. 470.)
NEWS AND ANALYSIS
Each country’s taxation of all profits
— not just taxation of normal profits
— affects a company’s investment
decisions.
What about an exemption for normal profits?
That is simply another manifestation of the economic principle that taxes on capital income are not
neutral. They create a bias against saving and
investment. Thus, for efficiency’s sake, taxes on
capital income should be zero.
But, again, only taxes on normal profits change
behavior. So to promote economic growth, as much
tax relief as possible should be directed to normal
profits. Tax relief for excess profit is wasted because
it is a windfall that does not change behavior.
That line of reasoning motivated the allowance
for corporate equity that has been available in
Belgium since 2006. In 2010 the highly regarded
Mirrlees Commission recommended that the
United Kingdom consider adopting an allowance
for corporate equity.
One huge caveat: That approach is much less
attractive if businesses have the option of locating
some of their business activities outside the United
States. In this case a business is deciding not only
how much to invest but also where to invest. On
this decision margin, each country’s taxation of all
profits — not just taxation of normal profits —
affects a company’s investment decisions.
Profit Shifting
Sometimes excess profits arise in a foreign subsidiary because a multinational has successfully
shifted profits into a low-tax jurisdiction. For example, suppose a U.S. parent and its Irish subsidiary each have $100 of tangible capital, generating a
12 percent return. But because the Irish subsidiary
sells products at artificially high prices to its parent,
the U.S. parent books $4 of profit and the foreign
subsidiary books $20. In this case, the Irish subsidiary has excess profit of $8.
In those circumstances, if the United States determines its transfer pricing rules are inadequate, it
may want to impose tax on excess foreign profits as
a backstop. That is the motivation behind the
Obama administration’s proposed 19 percent minimum tax on foreign profits. Under the proposal,
excess profits would be targeted with an extra tax
that includes a deduction equal to a risk-free rate of
return equity invested in active assets. As the official explanation puts it, the intention is to provide
an exemption on ‘‘a return on the actual activities
undertaken in a foreign country.’’ This proposal
resembles the 15 percent U.S. tax on foreign base
company intangible income proposed by former
House Ways and Means Committee Chair Dave
Camp as part of his 2014 tax reform plan. Under the
Camp proposal, the computation of foreign base
company intangible income allows a deduction
equal to 10 percent of the foreign subsidiary’s
adjusted basis in depreciable property.
Although aggressive profit shifting often occurs
with the transfer of intangible property, and the
Camp provision is described as a tax on intangible
income, the targeted excess profits do not necessarily arise from intangible assets.
Intangible Assets
In many cases, however, it may be that excess
profits are entirely attributable to intangible assets.
For example, suppose a business has $100 of tangible assets and $50 of hard-to-identify intangible
assets, all generating a 12 percent return. If excess
profits are measured by reference only to tangible
assets, the company’s total profit will be measured
as consisting of $12 of normal profit (that is, 12
percent of $100) and $6 of excess profit. Note that in
this case, measured excess returns do not arise from
profit shifting. And in fact, there may not actually
be any excess return on any asset (if those assets
were properly accounted for). There appears to be
an excess return only because the returns on intangible assets are being attributed to tangible assets.
If excess profits are flagging the existence of an
intangible asset, the question then arises why we
might want to tax income from intellectual property
differently than other income. Here are three possible reasons:
First, if the excess income identified is attributable to a patent or some other new technology
generated by scientific research, it is likely that the
asset is providing knowledge spillovers (positive
externalities) that benefit the economy generally. In
this case, it is appropriate for the government to
subsidize research because business on its own will
invest in less than the socially optimal level of
research.
One way to subsidize research is to provide a
lower tax rate for income that comes from investment in research. This is one justification for proposed U.S. patent boxes. That line of reasoning only
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investment. Taxing excess profits at, for example, 50
percent reduces the after-tax profit of the first two
projects, but there is still enough profit to make
them worthwhile. The first project with $8 of excess
profit would yield $16 after tax, and the second
project with excess profit of $3 would yield $13.50
after tax. Both yields are still above the $12 cost of
funds. For economists, that is an ideal tax because it
does not change behavior.
NEWS AND ANALYSIS
The question then arises why we
might want to tax income from
intellectual property differently than
other income.
Second, if income from intangible assets is considered to be a category of income particularly
vulnerable to transfer pricing abuse (because intangible assets are highly mobile and difficult to value),
we may want to impose domestic tax automatically
(as foreign base sales income is targeted for immediate taxation under current subpart F rules).
Both carrot and stick can be used to reduce profit
shifting. The most straightforward alternative is to
lower domestic tax rates across the board. That can
be achieved by a general rate reduction. But given
the high revenue cost, it might only be feasible to
limit rate reduction to particularly mobile income
— in this case, income from intangibles. That is
another justification for a patent box. The goal in
this case is to prevent other jurisdictions — particularly those with patent boxes — from stealing our
tax base.
In the United Kingdom, the calculation of net
patent box profits includes a deduction for a routine
return equal to 10 percent of the costs associated
with generating patent box gross receipts. As a
companion to his extra tax on foreign base company
intangible income, Camp’s tax reform proposal
includes a patent-box-like benefit for specific domestic intangible profits. Those profits are calculated by subtracting 10 percent of the net basis of
domestic depreciable assets from qualified income.
Because this justification for a patent box does
not depend on the existence of positive externalities, patent box benefits in this case should apply to
a wide range of intangibles, including marketing
intangibles. Here we are not necessarily talking
about moving real business activity but about shifting the location of reported profits to increase U.S.
tax revenue. The goal, simply stated, is to get U.S.
corporations to pay tax to the United States instead
of to foreign governments. It is even conceivable
that there can be a salutary Laffer curve effect:
Revenue can be raised by lowering rates.
Third, the justification for providing targeted tax
relief for profits from intangible assets is rooted in
the economic principle that, in order to minimize
distortions, mobile capital should be taxed at a
lower rate than immobile capital. To distinguish
that from the case in which just the reported profit
(not the underlying capital) is mobile, let’s suppose
transfer pricing rules work perfectly (or for patent
boxes, countries are adhering to OECD guidelines
on modified nexus that require substantial activity
to be associated with patent box profits).
Of course, a critical question for U.S. economic
policy is whether research and development is
mobile across national borders. That particular justification for a patent box, however, depends on
demonstrating that investment in research is more
mobile than other forms of investment. Given that
U.S. multinationals are strongly inclined to spread
manufacturing investment throughout the world
while undertaking most research activity at home, it
seems more likely that investment in research is less
mobile.
Conclusion
If excess profits truly result from extraordinary
profit levels, they may be taxed without affecting a
company’s overall level of investment. However,
governments must still be concerned that taxation
of excess profits will affect the location of investment.
If excess foreign profits result from artificial
profit shifting, the United States may want to impose U.S. tax on those profits as a backstop to
inadequate transfer pricing rules. However, in practice this domestic tax can only be applied to U.S.headquartered businesses and therefore cannot
reduce profit shifting by foreign-headquartered
multinationals.
If excess profits indicate that there are intangible
assets, governments, for a variety of reasons, may
want to tax domestic excess profits more lightly or
tax foreign excess profits more heavily than other
profits. If the goal is to promote domestic research,
tax relief should be limited to excess profits from
new technology and similar innovations.
If the goal is to raise revenue by inducing the
legal relocation of mobile intangible assets (not
necessarily with any increase in real business activity) into the United States, the U.S. government
must keep its domestic rate on intangible income
low relative to the combined U.S. and foreign rates
on intangible income. A minimum tax or a tightening of subpart F rules can raise the tax rate on
foreign profits. Foreign patent boxes can lower it.
Also, to raise revenue without double taxation, the
United States must also be able to prevent foreign
governments from claiming tax jurisdiction over
those profits.
To justify preferential treatment of domestic intangible income as an efficient investment incentive, it must be demonstrated that intangiblecreating investment is more mobile than other types
of investment.
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justifies a preferential rate for income from intangibles that generate positive externalities and therefore would not apply to trademarks and other
marketing intangibles.
NEWS AND ANALYSIS
NEWS ANALYSIS
By Marie Sapirie — marie.sapirie@taxanalysts.org
U.S. multinationals are facing uncertainty regarding the OECD’s base erosion and profit-shifting
project because of its extensive geographical reach.
But the eventual effect of BEPS-related changes on
taxpayers remains highly dependent on the degree
of consistency achieved in implementation.
The OECD’s final BEPS reports, released October
5, likely will not directly affect U.S. tax treaty policy
or the interpretation of U.S. tax treaties. On the
contrary, Treasury suggested that it expected to
influence the BEPS project when it released model
treaty language in May. (Prior coverage: Tax Notes,
May 25, 2015, p. 868.)
However, the planning structures U.S. multinational corporations must implement to reduce their
effective tax rates to levels similar to those faced by
their foreign competitors are highly reliant on the
tax treatment of ‘‘foreign-to-foreign’’ cross-border
transactions, said Itai Grinberg of Georgetown University Law Center. ‘‘What matters is that other
treaties will change and they will change in part just
because of the ambulatory theory of tax treaty
interpretation, and future foreign-to-foreign treaties
will be based on the OECD model and the multilateral instrument, and those will change.’’
The multilateral instrument is
intended to help implement changes
quickly, but that could be jeopardized
by its design as an à la carte menu.
With the exception of the multilateral instrument,
the process of issuing recommendations from the
BEPS project was not all that different from how
past treaty updates were made. Every 10 years the
United States updates its model treaty to reflect new
events; the OECD does the same about every two
years. ‘‘In that sense, this is part of the historical
trend,’’ said John L. Harrington of Dentons. What is
different with BEPS is that participants were not
limited to OECD countries, and the effects are
intended to have a broader geographical scope than
past model treaty updates.
Although the OECD’s model is sometimes used
as a reference point by non-OECD countries, the
input of nonmember countries resulted in some
changes, such as the permanent establishment
changes in action 7, that might not have otherwise
The United States doesn’t need the multilateral
instrument to make changes across all its treaties. A
legislative override could be used in the same way
that amendments to the multilateral instrument are
expected to be used, although it is preferable to
change the treaty with the treaty partner’s consent.
In jurisdictions that give treaties a higher status
than domestic law, the multilateral instrument can
be a tool to speedily implement a change across all
treaties.
Implementation and Spillover Effects
Many parts of BEPS implementation can be
thought of as a two-stage game, in which the
reports are just the first part of the process. If
domestic legislative action is necessary, the process
has moved into the second stage following the final
reports. But in the treaty area, for some jurisdictions, implementation is a ‘‘one-stage game’’ because domestic courts will use the OECD’s
guidance in resolving disputes, Grinberg said. Because, unlike the United States, other countries do
not produce a technical explanation for their treaties, domestic courts often look to OECD commentary as its equivalent and then import that
commentary into their countries’ treaties — even
when the language of the treaties and the model
differs. ‘‘Contrary to one’s expectations about how
law works or should work,’’ courts in many jurisdictions use OECD commentaries, ‘‘even when the
commentary is later in time,’’ said Grinberg. As a
result, ‘‘even setting aside the likely impact of the
multilateral instrument, changes to the OECD
model are surprisingly self-enforcing for soft law in
ways that are often underappreciated in the United
States because the OECD model matters much less
for U.S. tax treaty law than it does abroad,’’he said.
Many of the BEPS-related changes that do not
expressly address treaties could affect them, which
makes tax planning incrementally more challenging. The treaty-related changes envisioned in the
BEPS reports include the obvious ones regarding
treaty abuse and artificial avoidance of a PE. But the
proposals regarding corporate residence and transfer pricing could also affect treaties. Those other
areas ‘‘could impact the income reported by companies and whether a particular approach makes
sense,’’ said Harrington.
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The Impact of BEPS Implementation
For U.S. Tax Planning
been made. ‘‘The biggest question is regarding the
effect of the multilateral instrument. If this was a
typical change where countries agreed to change
treaties going forward, it can take a long time before
all or most treaties reflect the new language,’’ said
Harrington. The multilateral instrument is intended
to help implement changes quickly, but that could
be jeopardized by its design as an à la carte menu.
NEWS AND ANALYSIS
The Multilateral Instrument and Arbitration
The multilateral instrument is intended to
modify the OECD model treaty to make it consistent with BEPS outcomes. It is reasonable to expect
that negotiating the multilateral instrument will be
a lawyering process rather than a policy one, said
Grinberg. Although some substantive issues could
be reopened while negotiating the multilateral instrument — particularly for arbitration — there
may not be an appetite for reopening debate on
substantive language for much of the model treaty.
A provision for a mandatory binding mutual agreement procedure will be developed, and the countries that have committed to adopting it will work
on reconciling their positions on the arbitration
provision’s scope, according to the report on action
14.
Baseball arbitration works very well
for two-country disputes, but a new
arbitration mechanism may be needed
for multi-country disputes.
But will countries agree to arbitration in the
multilateral agreement if they haven’t previously
entered into arbitration provisions? From the perspective of U.S. multinationals, the open questions
are when it would be desirable for a foreign-toforeign treaty to include binding arbitration and
what issues are subject to arbitration. The BEPS
report on action 14 didn’t acknowledge the practical
issue of whether baseball arbitration will work in
the new dispute resolution paradigm contemplated
in the multilateral instrument. ‘‘I am a huge fan of
baseball arbitration, but baseball arbitration is made
for two-country disputes. If we have multi-country
income-based disputes, of the kind country-bycountry reporting might engender, baseball arbitration doesn’t necessarily provide a workable answer.
A new arbitration mechanism may be needed,’’
Grinberg said.
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The multilateral instrument marks a sea change
for the treaty negotiation process generally, but it is
unclear whether it will be as encompassing or as
speedily implemented as the action 15 report suggests, even if it is ready for signature by December
31, 2016. Open questions are what provisions the
multilateral instrument will include and which
countries will participate and sign on to which
provisions. That will take time to resolve. Historical
precedent in treaty negotiations suggests that expedited treatment of the multilateral instrument provisions may not happen in some jurisdictions,
including the United States.
Open Questions for U.S. Multinationals
The anticipated update to the U.S. model treaty
leaves some BEPS-related changes in the treaty
context in limbo because action 6 on treaty abuse is
on hold until the revision is complete. Even so, the
report upsets the apple cart by setting out a subjective rule that if a principal purpose of a transaction
is to obtain treaty benefits, the benefits will be
denied unless granting them would accord with the
treaty provisions’ object and purpose. The principal
purpose test’s subjectivity contrasts with the more
objective approach of the limitation on benefits
provision in the U.S. model, and it probably undermines some of the recent focus on dispute resolution.
Multinational companies have been putting more
substantial operations in local jurisdictions generally and are looking to the LOB provision as a
guidepost for qualifying for treaty benefits, but the
final report makes planning far less certain by
injecting more subjective principles into treaties,
said J. Brian Davis of Ivins, Phillips & Barker Chtd.
Treasury’s proposed revisions to the LOB article did
not persuade the OECD to embrace the LOB approach. Instead, the report lays out the following
choices: a more detailed LOB provision, the principal purpose test, or a simplified LOB combined
with a principal purpose test.
Dispute resolution could become riskier as the
principal purpose test is rolled out. ‘‘There is
greater uncertainty in terms of how you’ll fare
when dealing with [two jurisdictions] that implement action 6 and include the principal purpose
test, particularly where they don’t have wellresourced competent authorities or are not interested in arbitration,’’ said Davis. Despite the United
States’ recent focus on resolving treaty disputes,
taxpayers face far less enthusiasm for rapid resolutions abroad.
Noting that antiabuse rules in treaties are insufficient, the report advocates changes to the OECD
model treaty to ensure that treaties do not inadvertently prevent application of domestic antiabuse
rules. Although general antiabuse rules are not new,
‘‘putting them into a treaty perhaps makes it contextually clear to jurisdictions that this could be a
viable path for preventing a HoldCo from obtaining
treaty benefits,’’ said Davis.
U.S. multinationals may also feel the indirect
effects of the changes resulting from the BEPS
project regarding foreign tax credits. Under the
foreign tax credit rules, payments must be compulsory, which requires taxpayers to take steps to
minimize the foreign tax in some circumstances. ‘‘If
countries are fighting over [a payment], the U.S.parented group has to challenge the assessment;
NEWS AND ANALYSIS
Dispute resolution could become
riskier as the principal purpose test
is rolled out.
The timing and consistency of BEPS-related
changes are decisive factors in the ultimate effect of
the final reports. Although some changes may be
implemented quickly and consistently, others will
not. And the effects on planning resulting from that
uncertainty are likely to create challenges for taxpayers.
Lois Lerner Will Not
Face Criminal Charges
By Fred Stokeld — fred.stokeld@taxanalysts.org
Lois Lerner, the former director of IRS exempt
organizations who has been at the center of the
uproar surrounding the agency’s treatment of conservative organizations, will not face federal
charges connected to the controversy, the Justice
Department said October 23.
In a letter to leaders of congressional committees
that have been investigating the matter, Assistant
Attorney General Peter J. Kadzik said a recently
completed Justice Department investigation had
focused on whether Lerner, who was director when
the IRS used inappropriate criteria to select the
exemption applications of Tea Party organizations
and other right-leaning groups for additional scrutiny, could be criminally culpable. He said the
Justice Department had found no evidence that
Lerner’s political views influenced her decisions,
leadership, actions, or failure to act regarding exemption applications or any other matter.
Kadzik listed several factors supporting that conclusion. None of the IRS employees interviewed —
including some who were critical of Lerner’s leadership style and some who identified themselves as
politically conservative — witnessed, alleged, or
suspected that Lerner had acted with a political,
discriminatory, corrupt, or other inappropriate purpose, he said.
No IRS employees interviewed
witnessed, alleged, or suspected that
Lerner had acted with a political,
discriminatory, corrupt, or other
inappropriate purpose, said Kadzik.
When Lerner found out that the IRS determinations unit in Cincinnati was using inappropriate
screening criteria, she put a stop to it, Kadzik said,
adding that she was ‘‘the first IRS official to recognize the magnitude of the problem and to take
concerted steps to fix it.’’ To the extent Lerner
mishandled the oversight of application processing,
it was because she failed to use available materials
that would have enabled her to identify the problem sooner and she did not adequately supervise
her subordinates to ensure her directions were
carried out sufficiently, he said.
Kadzik said that although Lerner exercised poor
judgment by using her IRS e-mail account to exchange personal messages reflecting her political
views, the Justice Department found no evidence
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otherwise it can wind up paying more foreign tax
but not have it be creditable,’’ said Harrington.
Taxpayers are trying to ascertain how the PE
changes might affect treaties. ‘‘It will be interesting
to see how various jurisdictions address [PE issues]
in a scenario where the multilateral instrument is
not fully-subscribed by countries,’’ said Davis. Multinationals were concerned about the action 7 report
drafts because they left open the possibility that a
company could have a PE for just about anything,
but the final report reduced the scope of those
proposals. ‘‘Obviously, that will be something that
continues to receive a lot of attention as people start
to digest the specific practical implications of
BEPS,’’ Davis said, adding that except for companies with an immediate need for action (e.g., an
acquisition to address), most taxpayers are still
deciding what to do when there is uncertainty
regarding a PE. ‘‘Action 7 is an area where people
will continue to think about their structures and
how their supply chains’’ will work in the future, he
said.
NEWS AND ANALYSIS
Poor management is not a crime, said
Kadzik.
The Justice Department didn’t let the IRS off the
hook completely; it said it had uncovered substantial evidence of mismanagement, poor judgment,
and institutional inertia that led many EO applicants to believe they were being targeted for their
political opinions. But Kadzik said there would be
no criminal charges, remarking that poor management is not a crime.
‘‘We found no evidence that any IRS official acted
based on political, discriminatory, corrupt, or other
inappropriate motives that would support a criminal prosecution,’’ Kadzik said. ‘‘We also found no
evidence that any official involved in the handling
of tax-exempt applications or IRS leadership attempted to obstruct justice.’’
A statement from Lerner’s attorneys at Zuckerman Spaeder LLP praised the Justice Department’s
decision. ‘‘We are gratified but not surprised by
today’s news,’’ the statement said. ‘‘Anyone who
takes a serious and impartial look at the facts would
reach the same conclusion as the Justice Department. Ms. Lerner fully cooperated with the Justice
Department’s investigation. She produced all documents requested from her and answered all questions asked of her during two interviews. Ms.
Lerner is pleased to have this matter finally resolved and looks forward to moving forward with
her life.’’
The Justice Department’s decision is not sitting
well with congressional Republicans and conservative critics of the IRS, who have long challenged the
independence and impartiality of the probe and
have called for the appointment of an independent
counsel instead.
The news was predictable but deeply disappointing, said House Ways and Means Committee Chair
Paul Ryan, R-Wis., whose committee referred civil
rights allegations about Lerner to the Justice Department last year. ‘‘Over the past several years,
Ways and Means along with other congressional
committees have conducted a thorough bipartisan
investigation into the IRS’s targeting of organizations based on their political beliefs,’’ Ryan said in a
statement. He said his committee will continue to
find answers and hold the IRS accountable.
Ways and Means Oversight Subcommittee Chair
Peter J. Roskam, R-Ill., accused the Obama administration of trying to whitewash the IRS’s ‘‘abuse’’ of
taxpayers. ‘‘Lois Lerner clearly acted on her political bias to target conservative groups,’’ he said in a
statement. ‘‘We will continue to investigate the IRS
for abuse of taxpayers to ensure government bureaucrats are held accountable for their actions.’’
In a statement, House Oversight and Government Reform Committee Chair Jason Chaffetz,
R-Utah, called the Justice Department announcement ‘‘a reminder that the Obama administration
continues to refuse to hold anyone accountable at
the IRS. While the Justice Department may have
closed its investigation, as a coequal branch of
government, Congress will continue to seek accountability for the American people. A clear message must be sent that using government agencies
to stifle citizens’ freedom of speech will not be
tolerated. If the administration won’t send that
message, Congress will.’’
Rep. Darrell E. Issa, R-Calif., who chaired the
House Oversight Committee when that panel began
its investigations of the mishandled applications,
also criticized the Justice Department, saying in a
statement that its ‘‘decision to close the IRS targeting investigation without a single charge or prosecution is a low point of accountability in an
Administration that is better known for punishing
whistleblowers than the abuse and misconduct they
expose.’’
Also criticizing the Justice Department’s decision
was Senate Finance Committee member Chuck
Grassley, R-Iowa, who has introduced legislation
that he said will force the IRS to provide answers if
it fails to act on a social welfare group’s exemption
application in a timely manner or reaches a negative
determination on the organization’s exempt status.
‘‘The lack of accountability for the targeting scandal
will hit a lot of Americans as plain wrong,’’ he said.
In a blog post, Jay Sekulow of the American
Center for Law and Justice, which is representing
groups that say they were targeted by the IRS,
called the Justice Department decision an outrage.
‘‘The fact remains that conservatives were targeted
by the IRS,’’ Sekulow said. ‘‘They were targeted
because of their political beliefs.’’
But congressional Democrats said the Justice
Department decision confirms their conclusions
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the messages pertained to her official duties and
actions regarding the handling of the applications.
‘‘In fact, we uncovered no email or other communication showing that Ms. Lerner exercised her
decision-making authority in a partisan manner
generally, or in the handling of tax-exempt applications specifically, and no witness we interviewed
interpreted any email or other communication they
exchanged with Ms. Lerner in such a manner,’’ he
wrote.
Also, the Justice Department found no evidence
that the former director intentionally crashed her
hard drive or otherwise tried to conceal documents
or information from investigators, according to
Kadzik.
NEWS AND ANALYSIS
Republicans ‘have squandered
literally tens of millions of dollars
going down all kinds of investigative
rabbit holes with absolutely no
evidence of illegal activity,’ said
Cummings.
Ways and Means ranking minority member
Sander M. Levin, D-Mich., who recalled that in 2013
he advocated for Lerner’s resignation because of
her ‘‘mismanagement and poor judgment,’’ said
the Justice Department decision shows there was no
political bias, no corrupt motives, and no criminal
activity by the IRS in processing exemption applications. He criticized Ryan’s statement for attacking
the Obama administration and ‘‘politicizing’’ issues.
Rep. John Conyers Jr., D-Mich., ranking minority
member of the House Judiciary Committee, said
that ‘‘it is time Republicans end this partisan witch
hunt and focus on matters that impact the lives of
the American people.’’
New 501(c)(4) Regs Could Come
Early Next Year, Koskinen Says
By Fred Stokeld — fred.stokeld@taxanalysts.org
The IRS hopes to release new proposed regulations regarding the political activities of section
501(c)(4) social welfare organizations in early 2016,
IRS Commissioner John Koskinen said October 27.
Asked about the guidance project at a Senate
Finance Committee hearing on the IRS’s response to
the committee’s report on the agency’s treatment of
organizations applying for tax-exempt status, Koskinen said the IRS hopes to have the new regs out
‘‘early enough next year’’ so that work on them can
be completed well in advance of the election, ‘‘so
that there wouldn’t be any confusion.’’ Previous
proposed regs (REG-134417-13) on the topic were
released in November 2013, but they were widely
panned, prompting the IRS to go back to the
drawing board. (Prior coverage: Tax Notes, May 26,
2014, p. 886.)
Justice Department Investigation
Koskinen’s remarks came as he clashed with
Finance Committee Republicans over the Justice
Department’s decision not to prosecute anyone at
the IRS for the agency’s mishandling of conservative organizations’ exemption applications, with
GOP senators faulting the Justice Department’s
findings and the commissioner countering that the
department found no criminal wrongdoing.
Koskinen repeatedly referred to a Justice Department letter sent to lawmakers October 23 that said
that of the 100 IRS employees interviewed by the
department, including some who said they were
conservative Republicans, none reported witnessing any actions based on political bias. (Related
coverage: p. 596.) ‘‘There is not a finding . . . that an
individual exercised political bias in selecting applications for review,’’ Koskinen said.
But Republicans were not buying it. Committee
member Tim Scott, R-S.C., decried ‘‘a culture of
discrimination’’ at the IRS that targeted conservative organizations and individuals who donated to
them. Committee member John Thune, R-S.D., said
that culture ‘‘allowed employees to believe that
they could let their personal political views guide
how they treated the taxpayers and that there
would be no repercussions whatsoever for doing
so.’’ Committee member Pat Roberts, R-Kan., said
there was a systematic suppression of conservative
groups’ free speech rights by the IRS that ‘‘I think is,
sadly, ongoing.’’ Committee Chair Orrin G. Hatch,
R-Utah, said, ‘‘We all know there was political
bias,’’ though he admitted that he did not know if it
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that the IRS did not target conservative groups for
political reasons. ‘‘Over the past five years, Republicans in the House of Representatives have squandered literally tens of millions of dollars going
down all kinds of investigative rabbit holes — IRS,
Planned Parenthood, Benghazi — with absolutely
no evidence of illegal activity,’’ said Rep. Elijah E.
Cummings, D-Md., ranking minority member on
the Oversight Committee. ‘‘I believe the American
people have higher expectations for their elected
officials, and they want Congress to start doing its
job and focusing on issues that matter instead of
these ridiculous, partisan, taxpayer-funded attacks.’’
NEWS AND ANALYSIS
Koskinen disagreed with the
Republicans’ characterization of the
IRS, saying that TIGTA and the GAO
investigated the matter and found no
cases of politically motivated
targeting.
Republicans also complained that few IRS employees involved in the mishandled applications
have been disciplined and that some have received
bonuses and promotions. When committee member
Dean Heller, R-Nev., asked if anyone had been
fired, Koskinen said he could not discuss that
publicly but would be happy to talk to senators
privately. He also said the entire chain of command
in place when the applications were mishandled —
five levels of supervisors from the commissioner on
down — is no longer at the IRS.
Implementing Recommendations
The IRS has accepted all the recommendations
made in the report the Finance Committee released
in August that are in the agency’s control, Koskinen
said. (Prior coverage: Tax Notes, Aug. 10, 2015, p.
597.)
Koskinen reported that the average time to process an exemption application has been cut to 112
days, that there are procedures to ensure that applications undergo a neutral review process, and that
the IRS is tightening the internal controls of its audit
selection process, among other steps.
Regarding record retention, which became an
issue when IRS backup tapes believed to contain
Lerner’s e-mails were improperly erased, Koskinen
said that individual retention requests will now go
through the chain of command and that the IRS is
training its employees on retaining all media within
a particular area. He also said the IRS is upgrading
its e-mail system.
‘‘We should not be depending on individual hard
drives and disaster recovery tapes as a backup
system,’’ Koskinen said. ‘‘We should have a standard e-mail system that retains the records automatically, that’s easily searchable. We shouldn’t
have to spend $20 million in a year responding to
legitimate congressional inquiries for information.’’
The most important change is to require the free
flow of information from the bottom of the IRS to
the top, Koskinen said. ‘‘What we’re trying to
ensure is that if there is a problem anywhere in the
organization about anything, that employees feel
empowered and in fact feel responsible to note that
problem, report it to their managers, and if they feel
that’s not appropriate or they’re concerned about
that, to report it up through the organization.’’
Koskinen also addressed an issue that has led
some House Republicans to call for his ouster from
the IRS: his delay in telling Congress about the
crash of Lerner’s computer hard drive and the
resultant loss of e-mails. He explained that when he
learned of the crash in April 2014, it seemed that the
right thing to do first was determine what e-mails
had been lost and which could be recovered, then
tell Congress. The new policy is to advise lawmakers of such problems while the IRS is investigating
them, he said.
The issue resurfaced later in the day when House
Oversight and Government Reform Committee
Chair Jason Chaffetz, R-Utah, introduced a resolution calling for Koskinen’s impeachment, alleging
the commissioner had, among other things, failed to
tell Congress about the lost e-mails. (Related coverage: p. 600.)
On another matter, Koskinen was asked about
reports that the IRS has obtained a ‘‘cell-site simulator,’’ a device that mimics a cell phone tower in
order to collect data from phones connected to it.
Koskinen said the device is used by the IRS Criminal Investigation division and that its use is restricted to criminal investigations. A court order is
needed before it can be used, and there must be a
probable cause of criminal activity, he said. (Related
coverage: p. 583.)
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was criminal, and he singled out Lois Lerner, the
former IRS exempt organizations director at the
center of the controversy.
Koskinen disagreed with the Republicans’ characterization of the IRS, saying that in addition to the
Justice Department, the Treasury Inspector General
for Tax Administration and the Government Accountability Office investigated the matter and
found no cases of politically motivated targeting.
‘‘Clearly, I don’t mean to minimize at all the
delays [in processing applications], the mismanagement that took place from the start,’’ Koskinen said.
‘‘We’ve apologized to people for those delays. It
shouldn’t happen, but continuing to characterize it
as if there’s a politicized atmosphere and that’s
causing a lack of public confidence — if we say that
enough, there will be a lack of public confidence.’’
Koskinen also said that although Lerner had a
right to her political views, she had no right to
express them during her working hours at the IRS.
The committee’s ranking minority member, Sen.
Ron Wyden, D-Ore., said that although the IRS’s
actions constituted ‘‘a massive bureaucratic dysfunction’’ and a ‘‘disaster,’’ no political bias has
been uncovered.
NEWS AND ANALYSIS
By William Hoffman —
william.hoffman@taxanalysts.org
IRS Commissioner John Koskinen said October
28 that he testified to Congress truthfully and ‘‘to
the best of [his] knowledge every time,’’ responding
to questions about a House Republican effort to
impeach him.
‘‘I think the IRS has done everything within its
power to appropriately make sure that the situation
never occurs that taxpayers are unduly delayed in
their dealings with the IRS,’’ Koskinen told Tax
Analysts at the IRS Information Reporting Program
Advisory Committee meeting in Washington, referring to lingering concerns about alleged agency
targeting of political groups seeking section
501(c)(4) tax-exempt status.
Rep. Jason Chaffetz, R-Utah, chair of the House
Oversight and Government Reform Committee,
filed articles of impeachment against Koskinen on
October 27. ‘‘Commissioner Koskinen violated the
public trust,’’ Chaffetz said in a statement, charging
that the IRS chief failed to comply with a congressional subpoena and allowed documents to be
destroyed on his watch.
Koskinen defended the agency’s response to congressional investigations while acknowledging the
failures that prompted them. ‘‘Taxpayers need to be
confident . . . that they’re going to get treated fairly
by the IRS, that if we contact them it’s for something
in their tax return, not who they voted for, or what
party they belong to, what meeting they went to
two or three weeks ago.’’
‘‘I think the record is pretty clear that we’ve done
everything we can to respond to the six — now I
guess maybe seven — investigations going on, and
we’re anxious to make sure that we do everything
we can to make sure the situation doesn’t occur
again,’’ Koskinen said.
Lew: ‘Full Confidence’
Both the IRS and Treasury October 27 issued
statements objecting to the House charges. ‘‘The IRS
vigorously disputes the allegations in the resolution. We have fully cooperated with all of the
investigations,’’ the IRS statement said.
‘‘This move to impeach Commissioner Koskinen
is completely meritless and a distraction from important work on behalf of the American people,’’
Treasury said in its statement. ‘‘Secretary [Jacob]
Lew continues to have full confidence in Commissioner Koskinen and believes that his decades of
experience turning around both public and private
HOUSE REPUBLICANS INTRODUCE RESOLUTION TO IMPEACH KOSKINEN
Republican members of the House Oversight and
Government Reform Committee on October 27 introduced a resolution that would allow the House to
hold proceedings on the impeachment of IRS Commissioner John Koskinen for ‘‘high crimes and misdemeanors.’’
The resolution, sponsored by committee Chair
Jason Chaffetz, R-Utah, and 18 other Republican
members of the committee, came as Koskinen faced
grilling by the Senate Finance Committee on the
IRS’s response to that committee’s report on the
agency’s treatment of organizations applying for
tax-exempt status. (Related coverage: p. 598.)
The resolution contains four articles of impeachment detailing behavior that the sponsors believe
warrants the removal of Koskinen from office. They
allege that Koskinen failed to comply with a congressional subpoena ordering him to locate and preserve
IRS records related to congressional investigations of
the IRS’s handling of conservative groups’ exemption applications; that Koskinen lied in his testimony
before Congress regarding the e-mails of Lois Lerner,
the former IRS exempt organizations director at the
center of the investigations; that he ‘‘failed to act with
competence and forthrightness in overseeing the
investigation’’ of the IRS’s handling of exemption
applications; and that Koskinen ‘‘has acted in a
manner inconsistent with the trust and confidence
placed in him as an Officer of the United States.’’
‘‘Impeachment is the appropriate tool to restore
public confidence in the IRS and to protect the
institutional interests of Congress,’’ Chaffetz said in a
release. ‘‘This action will demonstrate to the American people that the IRS is under repair, and signal
that Executive Branch officials who violate the public
trust will be held accountable.’’
Rep. Darrell E. Issa, R-Calif., former chair of the
Oversight Committee, noted in a separate statement
that the House Judiciary Committee, of which he is a
member, would receive the impeachment resolution
and ‘‘consider the facts.’’ He added, ‘‘There has to be
some consequence for misleading and obstructing a
congressional investigation.’’
Chaffetz and other Oversight Committee members first officially called for Koskinen’s removal in a
letter to President Obama in July, although the idea
was first floated about a month earlier. Observers at
the time told Tax Analysts that while Koskinen’s
impeachment would be possible, the process would
be long and politically fraught. (Prior coverage: Tax
Notes, July 13, 2015, p. 139.)
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— Wesley Elmore
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Koskinen Says He Testified
Truthfully Every Time
NEWS AND ANALYSIS
Frustration With Koskinen
House Republicans told Tax Analysts on October
28 that it was too early to predict how an impeachment would proceed.
‘‘My frustration with the commissioner is that he
has continued to stonewall the investigations,’’ said
Ways and Means Committee member Kevin Brady,
R-Texas. ‘‘I have long said that until we have a new
commissioner willing to open the books . . . the IRS
would continue to be scandal-ridden. So I don’t
know what the prospects of impeachment would
be.’’
Former IRS Commissioner Lawrence B. Gibbs
lamented what he called a 50-year turn in U.S. tax
administration from agreed bipartisan principles of
tax policy and legislation to a lack of respect for
rules driven by partisan politicians’ economic, political, and social preferences.
Of the impeachment resolution, Gibbs said, ‘‘It’s
just another indication of the irresponsibility of our
politicians and the way they are treating our tax
system and the Internal Revenue Service.’’ He
added, ‘‘It’s no surprise. It’s more and more of the
same over the last six years.’’
Luca Gattoni-Celli and Kat Lucero contributed to this
article.
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institutions continue to make him the right person
to lead the IRS during a critical time for the agency.’’
Koskinen told Tax Analysts October 28 that he
had not consulted Lew or President Obama about
the matter.
Impeachment is a rarely used tool in Congress,
and the process is only vaguely defined by the U.S.
Constitution, Article II, section 4. Congress has
never impeached an IRS commissioner.
Chaffetz’s resolution must first go to a vote in the
House Judiciary Committee. If passed by a simple
majority, it would then go for a vote of the full
House, requiring another simple majority. After
that, the matter would go to the Senate for a trial,
with a two-thirds majority required for conviction.
Upon conviction on any charge, the official would
be automatically removed. (Prior coverage: Tax
Notes, July 13, 2015, p. 139.)
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NEWS AND ANALYSIS
By Luca Gattoni-Celli —
luca.gattoni-celli@taxanalysts.org
The IRS, state tax authorities, and industry stakeholders could share an increased amount of data to
combat tax fraud after a new information sharing
initiative rolls out for the 2016 filing season, an IRS
official said October 23.
Ken Corbin, director (return integrity and compliance services), IRS Wage and Investment Division, discussed ongoing work on the initiative to
share more than 20 ‘‘data components’’ to help
identify and prevent stolen identity refund fraud
(SIRF) at the Council for Electronic Revenue Communication Advancement’s fall meeting in Arlington, Virginia.
Corbin told Tax Analysts the timing of the recent
security summit was a factor in limiting the number
of data points. ‘‘We have to be respectful of making
sure we don’t endanger the filing season by introducing a lot of new elements and change within a
filing season,’’ he said.
Thirty-four state tax authorities and 20 financial
and tax services companies have signed on to the
initiative, which will begin with the 2016 filing
season, the IRS announced after hosting the security
summit in Washington on October 20. (Prior coverage: Tax Notes, Oct. 26, 2015, p. 483.)
The aggregated analytical information about
electronic filings will go beyond what is typically
included on tax forms, encompassing, for example,
‘‘the improper and/or repetitive use of’’ an IP
address to file, according to Corbin.
Corbin told Tax Analysts that the aggregate data
are not personally identifiable and are more like
measurements of trends than metrics about individual filers. The data would be used to adjust, or
weight, various IT system filters the IRS uses to
detect potential SIRF, he said.
The IRS is doing an ‘‘end-to-end review’’ of its
programming and is evaluating how to integrate
the new data sharing as part of its regular prefilingseason testing, Corbin said, noting that development of the initiative would continue for future
filing seasons.
An authentication working group created as part
of the security summit process that began in March
‘‘identified well over 100 new potential data elements,’’ Corbin said. The 20-plus elements being
shared for the 2016 filing season were selected from
those, but more could be added in time, he said.
Corbin said tax administrators wanted to maximize the initiative’s benefits in the first year without causing problems: ‘‘We were very careful about
looking at those data elements, and then determining which ones we thought would produce the best
interaction with what we have in play.’’
Corbin said the IRS’s biggest challenge regarding
the data sharing initiative during the filing season
would be distributing information consistently and
quickly at peak return volume to allow tax administrators to adjust their filters, fine-tuning the tools
they use to detect and prevent SIRF.
OFF THE BEATEN TAX: WHO’S WATCHING THE WATCHMEN?
The Off the Beaten Tax column is an occasional
roundup of recent unusual tax news.
Two former members of the Tampa Police Department, a married couple, have been charged with
participating in a wide-ranging stolen identity tax
fraud scheme.
Eric Houston, a former police detective, and LaJoyce Houston, a former police sergeant, took advantage of their positions with the police department to
access a state database containing the personal information of Florida drivers, according to a Justice
Department indictment filed October 27 in Tampa
and an October 28 Justice Department release. They
allegedly sent stolen information to Rita Girven, a
family friend and mother of the Houstons’ adopted
daughter, and other conspirators, who then used the
information to e-file fraudulent tax returns.
The conspirators allegedly used fraudulent tax
refunds to make purchases from Amazon.com Inc.,
pay off store credit cards, and pay for work on the
Houstons’ home swimming pool. Among the identity theft victims were deceased individuals, a witness to an alleged murder attempt who was
cooperating with a police investigation, and LaJoyce
Houston’s father, according to the Justice Department.
An October 28 report in The Tampa Tribune said
that according to a May 2014 affidavit, 4,600 people
whose personal information Eric Houston ran
through police databases over the course of three
years later became victims of tax fraud. The affidavit
said 21 individuals whose names were used were
victims, witnesses, or defendants of homicide or
battery investigated by Eric Houston and his squad.
Girven was charged separately and pleaded
guilty on March 16.
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Identity Theft Data Sharing
Could Expand After 2016
NEWS AND ANALYSIS
By Fred Stokeld — fred.stokeld@taxanalysts.org
Final regulations on allocation and accounting
for tax-exempt bonds provide for aggregate treatment of all partnerships and include other simplifications sought by the tax-exempt financing
community, though not all commentators’ recommendations were accepted.
The final regulations (T.D. 9741), released on
October 26, address allocation and accounting, and
some remedial actions regarding the section 141
private activity bond restrictions that apply to exempt bonds issued by state and local governments.
Proposed regs (REG-140379-02, REG-142599-02)
were published in 2006. (Prior coverage: Tax Notes,
Jan. 15, 2007, p. 157.)
A significant provision of the final regulations
that had been sought by the exempt financing
industry is aggregate treatment for all partnerships.
According to the preamble, aggregate treatment
was included in light of the development of various
financing and management structures for governmental facilities or section 501(c)(3) organization
facilities that involve the participation of private
businesses to provide flexibility to accommodate
public-private partnerships and to eliminate barriers to exempt financing of a government’s or
501(c)(3) organization’s portion of the benefit of
property used in joint ventures.
Aggregate treatment is also applied to partnerships for purposes of the ownership test under
which the property financed with qualified
501(c)(3) bonds has to be owned by a 501(c)(3)
entity or a governmental unit, as commentators had
requested.
Vicky Tsilas of Ballard Spahr LLP, who worked
on bond-related guidance in the Treasury Office of
Tax Legislative Counsel from 2012 to 2014 and
worked on the new regs, said this change shows
that the IRS and Treasury acknowledge that the
landscape has changed as a result of the Affordable
Care Act, ‘‘the most recent piece of law that encourages private and public involvement to provide
[the] most efficiencies in delivering services to the
market.’’
The definition of project is simplified to cover all
facilities or capital projects financed wholly or
partly with proceeds of a single issue of bonds. The
rule allows issuers to identify specific properties or
portions of properties regardless of the locations of
the properties or placed-in-service dates, the preamble explains. Commentators had voiced various
concerns about the definition in the proposed regs.
In the area of special allocation rules for eligible
mixed-use projects, the final regulations adopt commentators’ recommendations and make the undivided portion allocation method available to all
measurable use. The regs make the undivided portion allocation method the exclusive allocation
method for eligible mixed-use projects.
Tsilas praised that provision. ‘‘This was a great
simplification and opens up the field for financing a
project both with private and public funds,’’ she
said. ‘‘In a sense, this is a great step forward toward
encouraging more public-private partnerships in
financing various governmental projects and
should be applauded.’’
Under the proposed regulations, an issuer was
not allowed to use the anticipatory redemption for
a project for which the issuer had elected the special
mixed-use allocation rules, but the final regs, reflecting comments, expand the remedial action
rules ‘‘to encourage early redemption of tax-exempt
bonds without imposing another set of rules for
projects with unanticipated private business use,’’
the preamble says.
‘This was a great simplification and
opens up the field for financing a
project both with private and public
funds,’ said Tsilas.
‘‘This is also another step toward recognizing
that issuers may want to enter into other types of
agreements with private parties and should have
the ability to get out and not keep their bonds
outstanding,’’ Tsilas said.
Commentators did not get everything they asked
for. The IRS and Treasury rejected a recommendation to extend the proposed regs’ separate facility
treatment for output facilities to other types of
facilities, explaining in the preamble that ‘‘the use of
output facilities is measured differently from the
use of other facilities.’’
Regarding allocations to uses of a project, commentators had asked that unused qualified equity
be carried over from one year to another or, instead
of a carryover provision, that the limit be revised
from an annual limit to one covering the entire
measurement period. The final regs said no, explaining that the recommendation would require
revising the measurement rules and adding rules to
prevent the possibility of abuse, which would add
complexity. However, they clarify that the annual
limit applies only to use measured under the general measurement rules, not to use derived from
output contracts.
For the definition of qualified equity, the final
regulations do not include contributions of existing
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Final Exempt Bond Regs
Allow Aggregate Treatment
NEWS AND ANALYSIS
Bond Reps Offer Recommendations
On Proposed Issue Price Guidance
By Fred Stokeld — fred.stokeld@taxanalysts.org
Witnesses at an October 28 IRS hearing on proposed regulations on the definition of issue price for
tax-exempt bonds generally agreed that the proposal is better than an earlier version but asked for
changes and clarifications.
Representatives of the tax-exempt bond community made specific recommendations for improving
the proposed regs (REG-138526-14), which were
published in June and announced that the IRS was
withdrawing its earlier proposed definition of issue
price for purposes of the arbitrage restrictions under section 148, included in proposed regs (REG148659-07) that came out in September 2013. The
latest proposed regs provide an alternative method
of determining issue price for bonds, a substantial
amount of which are not sold under orders received
from the public as of the sale date, according to the
preamble. Using this method, an issuer may treat
the initial offering price to the public as the issue
price as long as requirements are satisfied. (Prior
coverage: Tax Notes, June 29, 2015, p. 1507.)
Speaking on behalf of the National Association of
Bond Lawyers (NABL), Linda B. Schakel of Ballard
Spahr LLP asked the IRS and Treasury to confirm
that an issuer does not need to choose between the
general method and the alternative method before
the issue date, and she asked for specifics on the
appropriate documentation for substantiating actual sales.
On the alternative method, Schakel requested
clarification on the obligations of the issuer and the
lead or sole underwriter regarding the certifications
and due diligence required to use the initial offering
price as the issue price. Also under the alternative
method, Schakel asked that the final regs confirm
the ability of issuers to rely on covenants regarding
the sale of bonds between the sale date and the
issue date.
Schakel, noting that the third condition for using
the alternative method focuses on issuer due diligence, asked the IRS and Treasury to clarify that the
issuer’s due diligence obligation regarding issue
price is that of a prudent person. She said the
proposed regs’ current language of ‘‘does not know
or have reason to know’’ would impose a section
6700 tax shelter standard on the definition of issue
price, which NABL believes is inappropriate in this
circumstance.
When John J. Cross III, Treasury associate tax
legislative counsel, asked Schakel why she thought
there would be less certainty with the tax shelter
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property as qualified equity for a project, as commentators recommended. According to the regs’
preamble, doing so would create difficult issues of
valuation and administrability and would not be
consistent with the rules that govern allocations of
proceeds of reimbursement bonds.
The IRS and Treasury also turned down the
recommendation that amounts other than proceeds
used to redeem bonds be treated as qualified equity,
explaining that allowing increased private business
use for redeeming bonds in the ordinary course
would be inconsistent with the private activity
bond restrictions on the bond issue being redeemed.
The final regs also declined commentators’ request that the amount of nonqualified bonds be
arrived at using the average amount of private
business use over the entire measurement period
instead of the highest private business use in any
one-year period. The request, the preamble said, ‘‘is
inconsistent with the limitations on annual allocations of proceeds and qualified equity to the uses of
the project.’’
Tsilas said the final regs are a huge step in the
right direction because they considered many recommendations of the National Association of Bond
Lawyers and simplified the rules greatly.
NEWS AND ANALYSIS
‘If we’re asked to find other
arrangements, it’s going to be difficult
for us to know whether we have
fulfilled our due diligence obligation,’
said Schakel.
‘‘[That’s] because all we’re aware of is the contractual relationship we have with parties, and so if
we’re asked to find other arrangements, it’s going to
be difficult for us to know whether we have fulfilled
our due diligence obligation if we’re not sure who
exactly we should be looking for to give us the
information,’’ Schakel explained.
Michael Decker, representing the Securities Industry and Financial Markets Association (SIFMA),
said the proposed regs are a significant improvement over the earlier version, particularly with the
inclusion of the alternative method. But he said
SIFMA has concerns, in particular with a requirement under the alternative rule that the lead underwriter certify that no underwriter will fill an order
placed by the public and received after the sale date
and before the issue date at a price above the initial
offering price unless the higher price is because of a
market change.
It is impossible for the lead underwriter to make
a certification regarding the behavior or activities of
other parties that are not directly controlled by the
lead underwriter, Decker said. ‘‘I, as the lead underwriter, can’t promise that other members of the
syndicate will only sell bonds at the initial offering
price,’’ he explained. ‘‘And I also can’t certify on the
pricing date with regard to activities that haven’t
happened yet. I can’t certify that members of the
syndicate, myself included, will only offer bonds at
the initial offering price until the closing.’’
Decker said SIFMA would be willing to try to
amend its model agreement among underwriters to
conform to the final issue price rule by specifying
that underwriters, regarding maturities in which
less than 10 percent were sold on the pricing date,
would be restricted in their ability to sell bonds at
prices above the initial offering price until closing.
‘‘We believe that lead underwriters would be able to
certify to the terms of the amended agreement
among underwriters, but not definitively that syndicate members will only sell bonds at the initial
offering price until closing,’’ he said.
Michael Imhoff, speaking on behalf of the Bond
Dealers of America, said there are two significant
issues that would make it unlikely that market
participants would want to use the alternative rule
as a safe harbor. First, an underwriter who sells
bonds before the issue date at a price higher than
the initial offering price would have to document,
in a way that will satisfy IRS auditors, that the
higher price resulted from market movements. Second, the lead underwriter would have to certify to
the issuer that no member of the syndicate sold
bonds at higher prices than the initial offering price.
‘‘In light of the significant vagueness of the
current proposal, we believe the alternative rule
would be avoided,’’ Imhoff said. He said the IRS
and Treasury should think about amending the
proposed general rule to allow for an additional
alternative actual sales approach that would allow
issue price to be established by selling at least 50
percent of a total issuance to the public. He also
recommended more flexibility in the case of smaller
bond issuances and smaller bond maturities and
said the Bond Dealers of America could work with
the IRS and Treasury to establish those thresholds.
Imhoff recommended a safe harbor for some
competitive sales, saying the rules should be
drafted to reflect that competitive underwritings
reduce the concerns that Treasury and the IRS have
regarding the determination of issue price.
Cross asked why the proposed alternative rule
could not be the approach for competitive sales.
Imhoff replied that the Bond Dealers of America’s
members think the alternative rule might cause
underwriters, when they have to take risk, to do it
at a higher yield.
‘‘I think they’re certainly willing to take risk on
the competitive deals, but if there were a safe
harbor . . . that may save issuers on the yield basis,’’
Imhoff said.
Cross responded, ‘‘That’s what the alternative
rule is, essentially — a safe harbor for cases where
you haven’t yet sold bonds.’’
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standard than with a prudent person standard,
Schakel replied that the language of ‘‘does not
know or have reason to know’’ is not fleshed out
well and suggests that the information must be
independently verified.
‘‘I think it is the uncertainty [of] the ‘should have
known’ or ‘reason to know,’ and it is only applying
to one specific part of the arbitrage regs, and to me
all of them are important; this one shouldn’t necessarily have a heightened level of due diligence,’’
Schakel said.
Lewis Bell, branch 5 attorney, IRS Office of Associate Chief Counsel (Financial Institutions and
Products), asked Schakel to expand on an NABL
recommendation that the term ‘‘other arrangement’’ be deleted to remove uncertainty in the
proposed regs’ definition of underwriter. Schakel
responded that although NABL is happy with the
revised definition of underwriter, including ‘‘other
arrangements’’ will make it more difficult for an
issuer to exercise due diligence.
NEWS AND ANALYSIS
By Andrew Velarde — andrew.velarde@taxanalysts.org
A Treasury official on October 27 defended the
agency’s new proposed regs that call for the removal of the benefits and burdens test under the
section 199 domestic production activities deduction.
Issued in August, the proposed regs (REG136459-09) would replace the benefits and burdens
ownership rule of reg. section 1.199-3(f)(1) with one
providing that ‘‘if a qualifying activity is performed
under a contract, then the party that performs the
activity is the taxpayer for purposes of section
199(c)(4)(A)(i).’’ Under the old rules, if one taxpayer
performs a qualifying activity on a contract with
another party, only the taxpayer that has the benefits and burdens of ownership of the qualifying
production property, qualified film, or utilities during the period in which the qualifying activity takes
place is treated as engaging in the qualifying activity.
‘‘This has been a highly contentious area. There
has been a lot of litigation trying to flesh out this
benefits and burdens test in the context of [section]
199,’’ Christopher Call, attorney-adviser, Treasury
Office of Tax Legislative Counsel, said on a webcast
sponsored by PricewaterhouseCoopers LLP. Call
said that under the old rules, the section 199 standard was intended to be similar to other benefits
and burdens standards, but that there has since
been a divergence, which the case law reflects. He
said that the government is concerned that multiple
taxpayers are taking the deduction for the same
activity. ‘‘We think the new standard is simple and
administrable and hope that it arrives at the proper
result,’’ he said. (Prior coverage: Tax Notes, Aug. 31,
2015, p. 931.)
Under the old rules, the section 199
standard was intended to be similar
to other benefits and burdens
standards, but there has since been a
divergence, said Call.
In United States v. Dean, 945 F. Supp.2d 1110 (C.D.
Cal. 2013), the assembly of ‘‘gift towers’’ from
products purchased elsewhere was not excludable
from section 199 as minor assembly. The proposed
regs reiterate the government’s disagreement with
that decision.
Joe Maselli of PwC noted that even though the
legislation enacting the regs passed 11 years ago, it
was still an evolving area of law within a young
code section. ‘‘This is an attempt to try to put a
regulation in place . . . to pick up the deference you
get under Mayo,’’ Maselli said. He added that the
government’s potential claims for deference under
Chevron and Mayo would be problematic if Treasury
were to ignore comments about the regs, because
they would be subject to a potential challenge
under Altera Corp. v. Commissioner, 145 T.C. No. 3
(2015). ‘‘You have in place a standard — benefits
and burdens — that has been around since the
inception of this statute,’’ Maselli said.
In Altera the Tax Court invalidated the 2003 final
cost-sharing regs that required taxpayers to include
stock-based compensation when determining operating expenses under qualified cost-sharing arrangements, holding that the government showed
insufficient factual basis for the finalized rule. In
Mayo Foundation for Medical Education and Research v.
United States, 131 S. Ct. 704 (2011), the Supreme
Court unanimously held that Treasury regs excluding medical residents from the student exception to
FICA taxation is a reasonable interpretation of an
ambiguous statute. (Prior coverage: Tax Notes, Aug.
3, 2015, p. 506. Prior analysis: Tax Notes, Aug. 17,
2015, p. 710.)
Pure service arrangements are ‘one of
the wrinkles’ to the new approach,
Call said.
But removing the benefits and burdens standard
may not resolve disputes between contractors and
principals over who is entitled to take the deduction, George Manousos of PwC argued. ‘‘The benefits and burdens of ownership standard derives
from the fact that you have to have a qualifying
disposition. So if you were simply to award the
‘contractor’ as the one doing the qualifying activity,’’ there’s some question whether the contractor
has a qualifying disposition, Manousos said. ‘‘Do
you still need to have a benefits and burdens of
ownership standard so the contractor can determine that it owns the property and therefore is
selling the property back? You could end up with a
null set here — no one getting the section 199
deduction.’’
Call noted that the regs request feedback on pure
service arrangements, which he acknowledged to
be ‘‘one of the wrinkles’’ to the new approach. But
he added that the current benefits and burdens test
doesn’t resolve the complexities presented by the
statute, which provides for the issuance of regs to
prevent more than one taxpayer taking a deduction
for an activity. ‘‘The benefits and burdens test does
not accomplish that,’’ he added, noting that the new
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Treasury Regs Abandon
Benefits and Burdens Test
NEWS AND ANALYSIS
Timelines on Coming Guidance
Asked about the likelihood of finalization in 2016
of the proposed regs, Call was noncommittal. Although Treasury is actively working on the regs, it
is ‘‘clearly early in the process,’’ he said, adding that
it was administrative practice not to release final
regs too close to a presidential election.
Temporary regs (T.D. 9731) were issued concurrently with the proposed regs that provide rules for
calculating W-2 wages for the deduction limitation
under section 199(b)(2) in the case of a midyear
disposition of a trade or business. The government
anticipates finalizing both guidance pieces as one
package, Call said, adding that some components
could be separated from the package if they were
‘‘hung up’’ by technical issues.
Also early in the process are regs related to
computer software, Call said. Regs under section
199 regarding computer software are listed under
the IRS and Treasury 2015-2016 priority guidance
plan.
‘‘The software regs have taken on a life of their
own,’’ Call said. Among the issues under consideration is whether the third-party comparable rule
has any relevance in light of current means for
distributing and using software online, he said. The
regs, when issued, would be in proposed form, Call
said, adding, ‘‘We’re taking a fresh look.’’ (Prior
coverage: Tax Notes, May 18, 2015, p. 768.)
Fee Waiver Regs May Change
Guaranteed Payment Example
By Amy S. Elliott — amy.elliott@taxanalysts.org
Practitioners are encouraging government officials to clarify a ‘‘potentially problematic’’ and
‘‘perhaps unintended’’ provision in the proposed
disguised fee waiver regulations that changes an
example in the guaranteed payment rules in a way
that could threaten some common preferred returns
received by partners.
The section 707(a)(2)(A) regulations (REG115452-14) propose to modify Example 2 — the
so-called floor example — in reg. section 1.707-1(c)
because, according to the preamble, it ‘‘is inconsistent with the concept that an allocation must be
subject to significant entrepreneurial risk to be
treated as a distributive share under section 704(b).’’
(Prior coverage: Tax Notes, Oct. 26, 2015, p. 473.)
Currently, the example provides that no part of
the minimum amount that a partner will receive
from its preferred return — a floor of at least $10,000
— constitutes a guaranteed payment. The fee
waiver regs propose to treat the full floor amount of
$10,000 in the example as a guaranteed payment.
Speaking October 28 at the New York University
School of Continuing and Professional Studies Institute on Federal Taxation, Blake D. Rubin of
McDermott Will & Emery said the proposed change
seems to indicate that the government doesn’t think
a partnership’s section 704(b) allocation should be
respected unless there’s significant entrepreneurial
risk associated with it.
Rubin said that while the focus of the regulations
is on disguised payments for services, the proposed
change to Example 2 is broader than that because
the example doesn’t address whether the guaranteed payment is for services or for capital.
The government’s focus ‘was on
services, so we weren’t focusing on
return on capital,’ said Wilson.
Rubin said preferred returns on capital are prevalent and it’s not uncommon to draft them as gross
income allocations. ‘‘If you put these statements in
the regs together — that a gross income allocation is
presumed to cause the allocation to lack significant
economic risk and if these rules apply more broadly
than just with respect to services — a gross income
allocation that is really a payment on capital can get
recast as interest’’ under section 707(a), which
changes the character of the payment from the
payee’s perspective, he said.
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rules were not intended to prevent property from
qualifying or not qualifying. ‘‘You really look to
who’s turning the screws, so to speak,’’ Call said of
analysis under the new regs.
Manousos argued that it would be wrong to
always construe contractors as the winners under
the new regs and principals as the losers. To illustrate, he proposed a hypothetical in which a principal loses money on a product produced by a
contractor and the principal has the benefits and
burdens of ownership. Under the new rules, that
loss is excluded from, and thereby increases, the
principal’s qualified production activities income,
he noted. By contrast, if a contractor loses money on
a product produced for a principal and the principal has the benefits and burdens of ownership,
under the proposed regs, the loss is included in, and
thereby reduces, the contractor’s qualified production activities income, Manousos said. ‘‘You have to
analyze . . . not only the facts of the contract, but
also the economic facts,’’ he said.
NEWS AND ANALYSIS
West Opposed to Tax Regimes
Primarily Defined by Ruling Policy
By Amy S. Elliott — amy.elliott@taxanalysts.org
Treasury is working on guidance on publicly
traded partnerships (PTPs), real estate investment
trusts, and tax-free spinoffs because it does not
want ‘‘a regime that’s governed by ruling practice
to be a preferable way to operate,’’ according to
Thomas West, Treasury legislative tax counsel.
West emphasized that although there’s value in
the IRS’s letter ruling program, Treasury is tasked
with regulating an area in which private letter
rulings, while not precedential, can be ‘‘perceived
as moving the needle on what the law is.’’
For PTPs and REITs, ‘‘each time a new ruling was
perceived to push the line out, the potential scope of
qualification for these vehicles expanded farther
and farther from what the actual regulations provided,’’ West said. His comments at the October 25
New York University School of Continuing and
Professional Studies Institute on Federal Taxation
came just before the October 27 hearing on the
proposed PTP section 7704 qualifying income regulations (REG-132634-14).
Private letter rulings, while not
precedential, can be ‘perceived as
moving the needle on what the law
is,’ said West.
West acknowledged that some practitioners were
surprised by the line drawn in the proposed PTP
regs. ‘‘We know that a number of companies are
concerned that activities that they believe were
blessed by prior IRS rulings might be considered
out of scope under the proposed regulations,’’ he
said. ‘‘We’ll see where that goes.’’ (Prior coverage:
Tax Notes, Oct. 5, 2015, p. 22.)
West addressed recent developments involving
the IRS’s section 355 tax-free spinoff ruling policy
(Notice 2015-59, 2015-40 IRB 467, and Rev. Proc.
2015-43, 2015-40 IRB 459). (Prior coverage: Tax
Notes, Oct. 26, 2015, p. 476.)
While no individual transaction spurred these
developments, ‘‘in recent years, corporations have
been doing spinoffs and relying on businesses that
were a tiny fraction of their overall value in order to
qualify under [section] 355,’’ West said. He said
there have been several recent transactions involving corporations distributing primarily investment
assets — either marketable securities or large real
estate portfolios — in spinoffs.
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Curtis Wilson, IRS associate chief counsel
(passthroughs and special industries), said the government’s focus ‘‘was on services, so we weren’t
focusing on return on capital.’’ He said the IRS has
heard similar comments and is looking at the issue.
‘‘We don’t want to upset legitimate transactions,’’
he said.
Craig Gerson, former attorney-adviser (partnerships), Treasury Office of Tax Legislative Counsel,
said another question raised by the proposed regs
involves the use of targeted capital account agreements by partnerships.
According to the preamble, the government believes that under current law — specifically reg.
sections 1.704-1(b)(2)(ii) and 1.707-1(c) — partnerships that use targeted allocations are required to
ensure that partner capital accounts ‘‘reflect the
partner’s distribution rights as if the partnership
liquidated at the end of the taxable year’’ even in a
year in which the partnership hasn’t earned enough
items of income to fill up a partner’s preferred
return.
Gerson, now with PricewaterhouseCoopers LLP,
said this implies that the government thinks those
partnerships should essentially ‘‘have a guaranteed
payment to get the capital accounts in the right
place.’’ He warned that ‘‘the clear implication is that
it applies to capital and profits.’’
On a more general note, Gerson said several
taxpayers have decided to amend their partnership
agreements to be more clearly in line with the
guidance. He said, however, that there’s concern
that if they amend their agreements or take other
steps to make them look more like the arrangements described in the proposed regulations, that
action by itself will be viewed by the IRS as an
admission of guilt.
‘‘No one entered into these agreements thinking
that they were outside the law,’’ Gerson said.
Wilson said, ‘‘The fact that you changed because
you wanted to make 100 percent clear that you fit
within the current guidance is not a reflection on
whether or not you were in compliance before.’’ He
said that while he can’t speak for all IRS revenue
agents, it seems illogical to take the position that
‘‘just because you changed that, that means your
prior structure is bad.’’
NEWS AND ANALYSIS
EO Short Form Burdening States
The 2014 implementation of Form 1023-EZ, the
streamlined version of Form 1023, ‘‘Application for
Recognition of Exemption Under Section 501(c)(3)
of the Internal Revenue Code,’’ may have had some
‘‘collateral consequences,’’ West said. The form is
used by smaller organizations to secure recognition
of their tax-exempt status from the IRS.
The new form, which requires less review and
due diligence by the IRS, has been successful in
reducing the backlog of section 501(c)(3) applications, West said. ‘‘The number of entities that have
been able to quickly get through the system and be
approved’’ has increased dramatically, he said.
But West said the new streamlined form has
created a problem for state regulators, who are
faced with policing ‘‘all these new tax-exempt orgs
that have suddenly come into existence.’’ He added
that in the past, the IRS — at least early in the
exemption process — had been ‘‘a gatekeeper for a
lot of these organizations’’ because the old Form
1023 regime ensured the applications were well
vetted.
Critics argue that the streamlined form could
allow unqualified organizations to obtain exemptions because it does not ask applicants for enough
information about their activities. (Prior coverage:
Tax Notes, Oct. 5, 2015, p. 39.)
West said that while the form has reduced the
demand for IRS resources, there have been some
‘‘knock-on consequences that not everybody appreciated at the time’’ of the form’s implementation.
He said both the IRS and state regulators will have
to deal with that.
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For spinoffs, as with PTPs and REITs, ‘‘there’s a
concern when the transactions and the real-world
practice . . . outpace our regulatory framework,’’
West said.
‘‘There have been a number of statutory changes
over the years that have made spinoffs easier and
more viable for different kinds of corporations.
That’s certainly OK,’’ West said. But because the
primary guidance in the area has been through the
letter ruling process, ‘‘we thought it was appropriate to take a step back and very consciously decide
where we think the lines should be and what we
think the rules should be rather than let the process
continue to evolve through a non-precedential,
highly factual, resource-intensive private letter ruling process,’’ he said.
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NEWS AND ANALYSIS
By Amy S. Elliott — amy.elliott@taxanalysts.org
The most recent annual joint Treasury-IRS priority guidance plan contains a new project under
section 382(h)(6) regarding treatment of built-in
items that is making practitioners worry that a
highly valued notice could be on the chopping
block.
Stuart J. Goldring of Weil, Gotshal & Manges LLP
said October 22 that taxpayers have been pleased
with Notice 2003-65, 2003-2 C.B. 747, which provides two safe-harbor methods — the section 1374
approach and the section 338 approach — for
identifying net unrealized built-in gain and loss
items under section 382(h).
‘‘It’s been very useful,’’ said Goldring, speaking
in New York at a Practising Law Institute conference on corporate tax strategies. ‘‘It’s been probably
one of the better notices that the Service has provided,’’ he said, adding that from a taxpayer’s
standpoint the notice has ‘‘stood the test of time.’’
But Krishna Vallabhaneni, acting Treasury
deputy tax legislative counsel, said the notice
‘‘sounds a little too useful’’ and ‘‘is not perfect.’’
Linda Z. Swartz of Cadwalader, Wickersham &
Taft LLP said the government doesn’t like the notice
because by making two approaches available to
taxpayers, it means they can choose the more advantageous way to augment the use of their losses.
Goldring said that each approach comes with
‘‘baggage.’’ He told Tax Analysts that there may be
some aspects of an approach that aren’t as favorable
as other parts, so that using one or both of the safe
harbors may be undesirable.
‘The government has set itself up for
a whipsaw,’ said Vallabhaneni.
Vallabhaneni said that even though he knows
taxpayers aren’t clamoring for the IRS to issue new
guidance in the area, given that the safe harbors are
essentially elective, ‘‘the government has set itself
up for a whipsaw, depending on the facts.’’ He
emphasized that ‘‘there really ought to just be one
answer.’’
UP-C STRUCTURES IN INVERSIONS MAY RAISE POLICY CONCERNS
The use of some so-called Up-C structures in
transactions facilitating the movement of U.S. corporations offshore raises policy concerns for the government under section 367, said John Merrick,
special counsel to the IRS associate chief counsel
(international).
The Up-C structure gets its name from its sibling,
the UP-REIT, or umbrella partnership real estate
investment trust. To effect an Up-C, a partnership
essentially puts a corporation on top of its ownership
structure so that the partnership is now owned by a
C corporation.
Speaking in New York at a Practising Law Institute conference on corporate tax strategies, Paul W.
Oosterhuis of Skadden, Arps, Slate, Meagher & Flom
LLP said that when a U.S. company gets acquired by
a foreign entity or engages in a combination that
results in a foreign entity on top, the transaction is
commonly structured as a stock acquisition.
‘‘Over the years, we’ve found that most public
companies are not concerned with whether their
shareholders were taxable on gain in their shares on
the transaction,’’ Oosterhuis said. ‘‘The exception is
when you have a major shareholder or a major
shareholder group that has substantial built-in gain
inherent’’ in its shares, he added. In those cases, the
transaction has to be done differently to accommodate that shareholder’s needs.
According to Oosterhuis, the tax advisers in a few
recent deals — namely the completed merger of U.S.
company Burger King Worldwide Inc. with Cana-
dian company Tim Hortons Inc. and the planned
2016 acquisition of U.S. company Broadcom Corp. by
Singapore company Avago Technologies Ltd. — used
partnership structures such as the Up-C to achieve
deferral for large shareholders.
In August the IRS declined Broadcom’s request
for a letter ruling on the section 367(a)(1) implications of its proposed merger. (Prior coverage: Tax
Notes, Aug. 24, 2015, p. 814.) Section 367(a) is an area
in which rulings are available based on the taxpayer’s characterization of the reorganization (Rev. Proc.
2015-1, 2015-1 IRB 1).
Oosterhuis asked whether the Service has any
concerns about these structures. Merrick said the
government is ‘‘very aware’’ of Up-C structures in
the cross-border context. While not speaking to any
particular transactions, he said that perhaps the
policy argument supporting the use of the Up-C
structure in the domestic context is ‘‘different than in
the international context.’’
Merrick said that while the form of Up-C structures can vary, in some cases ‘‘the economic return of
the partnership interest is almost a mirror reflection
of the foreign acquiring stock.’’ He said in these cases
it’s hard to argue that there are no policy concerns
under section 367, which imposes a deferred toll
charge on outbound reorganizations.
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— Amy S. Elliott
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IRS May Replace Elective Safe
Harbors for Built-In Items
NEWS AND ANALYSIS
PTPs Urge Reworking of
Proposed Natural Resource Regs
By Amy S. Elliott — amy.elliott@taxanalysts.org
Seventeen people spoke out at an October 27
public hearing on Treasury’s rules that propose to
more narrowly define the types of incomegenerating activities in the mineral and natural
resources industries that would allow publicly
traded partnerships (PTPs) to avoid the imposition
of corporate tax.
The recurring complaints revolved around the
guidance’s use of an exclusive list of activities that
produce qualifying income under section
7704(d)(1)(E), its focus on fuel production, and its
line-drawing that treats similar businesses differently.
The regs (REG-132634-14), issued May 5, spell
out what income qualifies for an exception to the
general rule that PTPs — also referred to as master
limited partnerships — are treated as corporations
for federal tax purposes. If 90 percent or more of an
entity’s gross income during the tax year is qualifying income, it is treated as a partnership and
doesn’t incur an extra level of tax. (Prior coverage:
Tax Notes, Oct. 5, 2015, p. 22.)
Olefins From Natural Gas
Steve Bender of Westlake Chemical Partners LP,
an ethylene production PTP that went public in
2014, said his business received a letter ruling from
the IRS that income from its production, transportation, storage, and marketing of ethylene and its
co-products will constitute qualifying income. But
he said that when the proposed regs came out
expressly stating that the steam cracking of natural
gas into ethylene does not give rise to qualifying
income, the price of Westlake’s public units took an
immediate hit.
‘The value of Westlake and its
corporate sponsor decreased by more
than $1 billion’ following the issuance
of the proposed regulations, said
Bender.
‘‘In the two days that followed the issuance of the
proposed regulations, the value of Westlake and its
corporate sponsor decreased by more than $1 billion,’’ Bender said. He urged the government to
modify the regulations to treat ethylene produced
from natural gas the same as ethylene produced
from crude oil, which does give rise to qualifying
income under the regs.
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Stuart M. Finkelstein of Skadden, Arps, Slate,
Meagher & Flom LLP asked whether the government has decided whether future guidance will
embrace either the section 1374 approach or the
section 338 approach or ‘‘a mix of the two.’’ Vallabhaneni said that while it’s still too early to know, ‘‘I
don’t think it’s as simple as just going with’’ one
method or the other.
But Swartz said the government theoretically
will get whipsawed even if it decides on one
approach ‘‘because if you pick the less favorable
treatment for net unrealized built-in losses, that will
benefit every company with net unrealized built-in
gains, and vice versa.’’ Goldring said the government should keep in mind section 384 — a counterpart to section 382 — as it develops new
guidance.
NEWS AND ANALYSIS
Focus on End Product
Porter asked whether Westlake’s business would
be safe if the government changed the regs to say
that income from the processing of a natural gas
liquid to a liquid fuel, wax, or oil was qualifying.
Bender said the statute is focused on the starting
point — a natural resource — and not the end
products. In its written comments, Westlake indicated that if the government wants to keep its focus
on the end product, it should change its test to
include the requirement that ‘‘the output of the
activity must be a product of a type that is produced
in a crude oil refinery.’’
Porter asked, if the government were to adopt
that recommendation, how ‘‘would we keep from
expanding more and more activities as people
would move their activities into a crude oil refinery?’’ Bender responded that ‘‘the product slate’’
stemming from steam cracking and catalytic cracking really doesn’t change and hasn’t ‘‘for ages and
ages.’’
W. Randall Fowler of Enterprise Products Partners LP, who agreed with Westlake that the standard should be pegged to fuel or to a product of a
type that is produced in a crude oil refinery, stressed
that the statute is focused on the processing and
refining of a natural resource and is blind to the end
product. ‘‘Our customers will determine what the
ultimate use of the propylene is,’’ he said.
Robert J. McNamara of Andrews Kurth LLP said
the regs seem to reflect a bias on the government’s
part toward fuel production. His firm’s written
comments suggest that the government exclude the
only enumerated ‘‘bad’’ end product — plastics —
by defining qualifying income to include income
derived from all oil and gas products except ‘‘products of oil or gas that are not plastics or similar
petroleum derivatives.’’
The statute is focused on the
processing and refining of a natural
resource and is blind to the end
product, said Fowler.
McNamara said that generally, the focus should
be on ‘‘what goes into the process, not necessarily
what comes out.’’
Angela T. Richards of Andrews Kurth said the
only relevant limitation provided by the legislative
history is that plastics or similar petroleum derivatives are not minerals or natural resources for
purposes of the section 7704 qualifying income
rules. ‘‘We understand the need to draw a line
somewhere,’’ she said, adding that the line should
be drawn at PVC resins.
Lack of Authority
Richards said that nothing in the statute or
legislative history supports some of the lines drawn
in the regulations. ‘‘We believe it is highly inappropriate to in effect rewrite the statute to introduce
new limitations,’’ she said. ‘‘The proposed regulations present an extreme and unwarranted departure from the Service’s long-standing interpretation
of processing and refining.’’
The debate turned to the government’s differing
interpretation of the statutory language. Section
7704(d)(1)(E) provides that qualifying income constitutes ‘‘income and gains derived from the
exploration, development, mining or production,
processing, refining, transportation (including
pipelines transporting gas, oil, or products thereof),
or the marketing of any mineral or natural resource
(including fertilizer, geothermal energy, and timber) industrial source carbon dioxide, or the
transportation or storage of any fuel described in
subsection (b), (c), (d), or (e) of section 6426, or any
alcohol fuel defined in section 6426(b)(4)(A) or any
biodiesel fuel as defined in section 40A(d)(1).’’
Porter said some think the statute doesn’t say
that income derived from the exploration of products thereof is qualifying. ‘‘There’s nothing in the
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‘‘Catalytic cracking and steam cracking of natural
resources are essentially the same methods of processing and refining’’ and should both give rise to
qualifying income, Bender said. ‘‘This is also consistent with the principle that taxpayers engaged in
the same activities should be taxed the same way.’’
Dave Witte of IHS Chemical, who also spoke on
behalf of Westlake, said the production of olefins
such as ethylene and propylene from natural gas
does not constitute the manufacturing of plastic
products like polyvinyl chloride (commonly known
as PVC) and polyethylene (a plastic widely used to
make such things as clear food wrap). He added
that olefin fabrics are considered plastics.
Witte said ethane and ethylene and propane and
propylene are simple gases. ‘‘Manufacturing plastics involves combining hundreds of thousands of
hydrocarbon and other molecules to produce a
wholly new product,’’ he said. ‘‘No one I know in
the industry would ever consider the cracking of
[natural gas liquids] as manufacturing plastics.’’
Holly Porter, branch 3 chief, IRS Office of Associate Chief Counsel (Passthroughs and Special Industries), asked what ethylene and propylene are
used for. Witte said that while they’re used in a
‘‘whole host of different products, including fuels,’’
often large amounts of the profits earned from the
processing of natural gas liquids ‘‘are being made in
non-fuel products.’’ Bender said Westlake can’t control what its customers do with the ethylene and
propylene it sells.
NEWS AND ANALYSIS
pane is clearly articulated to be qualifying income,
propylene requires additional processing.
Fowler said the legislative history, as he reads it,
provides that propane is a natural resource. ‘‘You
can process and refine a natural resource,’’ he said.
So taking propane to propylene ‘‘is right down the
middle of the fairway with what a qualifying activity is.’’
Taking propane to propylene ‘is right
down the middle of the fairway with
what a qualifying activity is,’ said
Fowler.
Dance asked whether Fowler could simply put a
blocker structure around his business’s propylene
facility. Fowler said investors like simple structures,
and that the use of a blocker could create problems
with transfer pricing and shared services.
Clifford Warren, special counsel to the IRS associate chief counsel (passthroughs and special industries), asked how much of Enterprise’s income
would fall outside the qualifying income rules if the
regulations are finalized as is. Fowler said as much
as 20 percent of his business’s gross income could
be deemed nonqualifying.
Linda E. Carlisle of Miller & Chevalier Chtd.,
speaking on behalf of the Master Limited Partnership Association, formerly the National Association
TECH GROUPS URGE EXTENSION OF ITFA WITHOUT ONLINE SALES TAX
Eighteen technology groups sent a letter to congressional leaders October 26 urging them not to pair
an extension of the Internet Tax Freedom Act (ITFA)
with legislation that would impose sales taxes on
online purchases.
The technology groups said in the letter that they
oppose ITFA being extended with such bills as the
Marketplace Fairness Act and the Remote Transactions Parity Act because the bills would ‘‘discriminate against the Internet and electronic commerce by
imposing more onerous state tax collection obligations on remote sellers than would apply to local
retailers.’’
ITFA is a moratorium on Internet access taxes that
has been extended six times since it was enacted in
1998. It was most recently extended until December
11 as part of a continuing resolution to keep the
federal government open. (Prior coverage: Tax Notes,
Oct. 5, 2015, p. 42.) ‘‘ITFA bans discrimination while
these other proposals authorize discrimination,’’ the
letter said. ‘‘For this reason, ITFA should not be
linked to these Internet sales tax bills.’’
Mark Nebergall of the Software Finance & Tax
Executives Council helped draft the letter along with
Steve DelBianco of NetChoice. He told Tax Analysts
that the technology groups sent the letter to congressional leaders now because they expect a legislative
vehicle that could include ITFA to move soon. ‘‘I
think an ITFA extension is a popular proposal,’’
Nebergall said. ‘‘I don’t see that there is any opposition, but it’s just finding an appropriate bill to get it
through with.’’
But not everyone is onboard with extending ITFA
on its own or without attaching it to an online sales
tax bill. The National Conference of State Legislatures has urged Congress not to extend or make
permanent ITFA without first passing legislation that
would allow states to collect sales taxes on remote
transactions. (Prior coverage: State Tax Notes, Sept.
21, 2015, p. 980.)
The NCSL wrote a letter to congressional leaders
September 16 arguing that extending or making
permanent ITFA ‘‘would exacerbate the federal government’s infringement of state budget sovereignty
and would annually cost states hundreds of millions
of dollars.’’
TAX NOTES, November 2, 2015
— Jennifer DePaul
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statute when you look at it that indicates that you
can mine products thereof or that you can refine
products thereof,’’ she said. ‘‘The products thereof
comes when we talk about transporting, because at
that point refining has happened or processing has
happened.’’
Glenn Dance, special counsel to the IRS associate
chief counsel (passthroughs and special industries),
agreed. ‘‘It appears as though the introduction of
products thereof doesn’t come until you’re ready to
ship and store,’’ he said. ‘‘To read the words to say
that you’re supposed to believe that you can take
products thereof and refine them and process them
is changing the sequencing of the statute.’’
McNamara said, ‘‘I think you guys are reading
that too narrowly.’’
Porter said she’s also heard that the word ‘‘refining’’ in the statute was meant for crude oil and the
word ‘‘processing’’ was meant for natural gas. McNamara said he doesn’t agree.
Porter said the government is focused on the end
product because it’s trying to interpret the statute
with Congress’s intent in mind. She questioned
whether Congress enacted the exception to protect
the oil and gas fuel industry exclusively or the
chemical industry as well.
Fowler said legislative history supports the interpretation that natural resources should include
methane, butane, and propane. Dance said his
reading of the legislative history is that while pro-
NEWS AND ANALYSIS
Scrap Exclusive List
Carlisle said the government’s efforts to keep a
rein on what constitutes qualifying income by issuing an exclusive list is problematic and inconsistent
with prior practice. The list contains more than two
dozen items such as conducting geological surveys,
drilling wells, and operating equipment to convert
raw mined products to substances that can be
readily transported.
Carlisle said even if PTP representatives work
closely with the government to add to the list before
finalization, the list will still be missing something.
She said the government should instead provide
guidance in the form of standards and examples ‘‘as
is done in all other regulations.’’
But Porter disagreed. ‘‘Why can’t we get that list
right?’’ she asked, adding that the list covers broad
activities like oil drilling that won’t become outdated with the development of new technologies.
‘‘If you’re doing it by fracking, if you’re doing it by
whatever, it’s going to fall in.’’ Warren said that
because Congress provided a specific list in section
7704(d)(1)(E), he doesn’t understand why it’s
wrong to carry that approach forward in regulations.
Market Uncertainty
Some of the speakers explained how the guidance created uncertainty that has depressed their
unit prices. Fay West of SunCoke Energy Partners
LP said that even though her business believes that
its purification of coal into coke satisfies the definition of refining under the proposed regulations, the
guidance failed to make clear that processing of
ores includes non-mining processes such as purification.
‘‘As a result, SunCoke and its investors have
suffered staggering losses,’’ effectively eliminating
the business’s ability to access the public markets,
West said.
Porter asked where the purification of coal ends
and the manufacture of coke begins. John F. Quanci
of SunCoke said coke is not an end product.
Carlisle said the guidance has hit particularly
hard those firms with letter rulings that may fall
outside the rules. She said that while the IRS clearly
has the authority to revoke previously issued letter
rulings, such a drastic action is in practice undertaken only if there’s been a change in the facts or if
the ruling’s interpretation of the law is obviously
wrong.
Carlisle said that even with a 10-year transition
rule, there’s a fairness issue raised by the revocation
of letter rulings. She indicated that revoking a
ruling that a PTP reasonably relied upon creates
more of a concern than permanently grandfathering
a letter ruling that will never be issued to another
business.
‘Congress did not intend restrictive
meanings for the activities that
generate’ qualifying income, said
Carney.
Ryan K. Carney of Vinson & Elkins LLP said that
although in general he agrees that exceptions in the
tax code should be construed narrowly, ‘‘Congress
did not intend restrictive meanings for the activities
that generate’’ qualifying income, providing as evidence the phrase ‘‘derived from’’ in the statute. He
added that the use of an exclusive list creates the
presumption that anything not on the list is not
qualifying.
L. Price Manford of Vinson & Elkins said tax
lawyers — both inside and outside the government
— shouldn’t be deciding on ‘‘what constitutes a
physical or a chemical change and if so whether that
change is substantial.’’
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of Publicly Traded Partnerships, said Congress
didn’t enact section 7704(d)(1)(E) because it wanted
to help oil refineries.
‘‘Congress determined that the types of natural
resource activities that had been commonly conducted in partnership form should continue, because — as Treasury stated in its testimony — such
partnerships generated income from wasting assets,’’ said Carlisle, who worked at Treasury at the
time of the provision’s enactment.
NEWS AND ANALYSIS
By Ryan Finley — ryan.finley@taxanalysts.org
Treasury and the IRS have yet to determine
whether the U.K. diverted profits tax or repayments
of amounts that the European Union has deemed
illegal state aid constitute foreign income taxes for
foreign tax credit purposes.
At an October 26 luncheon held in Washington
by Bloomberg BNA and Buchanan, Ingersoll, &
Rooney PC, Jason Yen, attorney-adviser, Treasury
Office of International Tax Counsel, and Barbara
Felker, branch 3 chief, IRS Office of Associate Chief
Counsel (International), spoke about coming FTC
regulations and the effects of the OECD’s base
erosion and profit-shifting project.
Yen and Felker said Treasury and the IRS haven’t
decided whether the diverted profits tax, which
imposes tax on income diverted through ‘‘contrived’’ arrangements, represents a creditable foreign income tax. Yen noted that Treasury and the
IRS were looking forward to receiving a comment
letter on the topic from the New York State Bar
Association. ‘‘Obviously, the foreign tax regulations
were not drafted with these types of taxes in mind,’’
so it is causing Treasury to consider revisiting
aspects of the foreign tax regulations, Yen said,
adding that no specific guidance is immediately
forthcoming and that ‘‘everything is on the table.’’
tional norms, it raises questions about double taxation and the need for relief.
Yen discussed the follow-up work of the OECD’s
Working Party 11 on BEPS actions 2 (neutralizing
the effects of hybrid mismatch arrangements) and 4
(limiting base erosion involving interest deductions
and other financial payments). He said one element
of this work involves implementation of the group
ratio rule, an optional feature of the action 4 report,
which the United States supports, that caps interest
expense at the groupwide ratio of interest to earnings before interest, taxes, depreciation, and amortization. Yen said the other area deals with interest
expense limitation rules applicable to financial institutions. Beyond these areas, Working Party 11 is
identifying other types of hybrid mismatches beyond those addressed in the action 2 report, he said,
adding that the goal is to complete the work by the
end of 2016.
Yen provided a general overview of the timeline
for new regulations provided in the first-quarter
update to the Treasury and IRS 2015-2016 priority
guidance plan. He said the first priority is new
regulations regarding the allocation by partnerships
of foreign income tax under section 704(b), which
will be coming ‘‘quite soon.’’ He also noted that
there will be a ‘‘cleanup’’ of the section 901 regulations and that ‘‘comprehensive’’ new regulations
will be issued under section 901(m). Yen added that
it’s a ‘‘very, very high priority’’ to release new
regulations under section 905(c). ‘‘They’re very difficult regulations, but they’re important ones,’’ he
said.
‘The foreign tax regulations were not
drafted with these types of taxes in
mind,’ said Yen.
Other creditability questions dealt with repayments of amounts deemed to be illegal state aid by
the EU, such as the payments required by Starbucks
Corp. and Fiat Finance and Trade. (Prior coverage:
Tax Notes Int’l, Oct. 26, 2015, p. 301.) Although the
illegal state aid in those cases was in the form of
reduced taxes, Felker observed that this type of
payment ‘‘doesn’t sound like a tax.’’
Asked whether income tax imposed by another
country adopting a formulary apportionment system would qualify for the FTC, Felker said that ‘‘the
point of the [section] 901 regulations is to identify
the essential features of the U.S. income tax.’’ She
asked, ‘‘Is this foreign levy sufficiently comparable
to the base that we’re taxing to make it appropriate
to give a dollar-for-dollar credit?’’ Felker said that
as countries impose new tax schemes that diverge
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Treasury Undecided on Creditability
Of U.K. Diverted Profits Tax
NEWS AND ANALYSIS
By Andrew Velarde — andrew.velarde@taxanalysts.org
Moving between the various portions of recently
issued regs that seek to address issues regarding
subpart F inclusion in the context of loans involving
foreign partnerships, officials from the IRS and
Treasury explained their rationale for the new rules
on October 29.
The IRS and Treasury on September 1 released
proposed regs (REG-155164-09) regarding the treatment of U.S. property held by controlled foreign
corporations in transactions involving partnerships.
The proposed regs would generally treat an obligation of a foreign partnership as an obligation of its
partners for purposes of section 956. The government also released temporary regs (T.D. 9733) that
provide that a CFC will be considered to indirectly
hold investments in U.S. property acquired by any
other foreign corporation or a partnership that is
controlled by the CFC if a principal purpose for
creating, organizing, or funding (through capital
contributions, debt, or otherwise) that other foreign
corporation or partnership is to avoid the application of section 956 to the CFC. (Prior coverage: Tax
Notes, Sept. 7, 2015, p. 1052.)
Under the proposed regs, a partner’s attributable
share of U.S. property held by the partnership is
based on the partner’s liquidation value percentage
(LVP). Liquidation value is the cash a partner
would receive if the partnership sold all assets for
cash, the partnership satisfied all liabilities, and the
partnership liquidated.
‘‘We thought liquidation value percentage would
be readily ascertainable,’’ Brian Jenn, attorneyadviser in the Treasury Office of International Tax
Counsel, said at an event in Washington sponsored
by the District of Columbia Bar. Jenn added that
Treasury could have used another measure, such as
partner’s interest in partnership profits, which was
used in the proposed regs for determining a partner’s share of a foreign partnership’s obligation, but
that LVP was a good measure of a partner’s economic interest in partnership property.
Barbara Rasch, branch 2 senior technical reviewer, IRS Office of Associate Chief Counsel (International), emphasized, however, that the IRS and
Treasury were interested in comments if practitioners believed that economic interests were not
properly reflected by LVP. Jenn added that LVP
could be applied more broadly in future international reg projects if it proves to be a good tool for
determining partners’ interests in partnership property.
Aggregate Approach
The proposed regs use an aggregate approach in
determining whether the obligations of foreign
partnerships constitute U.S. property, whereby the
obligation is generally treated as a separate obligation of each partner to the extent of the partner’s
share of the obligation.
In defending the regs’ use of an aggregate approach rather than an entity approach, Jenn said
that Treasury was viewing activities within the
partnership form as substantially similar to a
branch operation.
‘‘If you had a loan from deferred earnings from a
CFC to a branch, you could clearly see that there is
a benefit to a U.S. shareholder. You’re financing its
business, the results of which flow on to the U.S.
person’s tax return,’’ Jenn said. ‘‘Similarly, where
there is a loan from a CFC to a partnership, to the
extent of the U.S. person’s partnership interest, you
are financing their business. . . . Really those situations look similar to us.’’
In defending the regs’ use of an
aggregate approach rather than an
entity approach, Jenn said that
Treasury was viewing activities within
the partnership form as substantially
similar to a branch operation.
Amanda Pedvin Varma of Steptoe & Johnson
LLP argued that the regs could have taken an
approach that examines whether there is a distribution to a U.S. person with an actual economic
benefit, as opposed to a more indirect benefit.
‘‘We think there still is a benefit,’’ Jenn replied,
regardless of a cash distribution, given the general
availability of the funds.
‘But for’ Rule Targeted at Planning
Under a special partnership distribution rule in
the proposed and temporary regs, if a foreign
partnership makes a distribution to a partner that is
a U.S. person related to a CFC that funded the
partnership through an obligation, and it wouldn’t
have made the distribution ‘‘but for’’ the funding
by the CFC, then rules apply that could increase the
amount of the obligation treated as U.S. property
held by the CFC.
Varma noted that there is no indication of what
facts might be relevant to the ‘‘but for’’ determination within the regs.
‘‘The ‘but for’ test is a facts and circumstances
determination,’’ Rasch said. ‘‘Keep in mind that this
rule is aimed at planning transactions, where the
U.S. shareholder is trying to access cash from the
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Officials Explain Rationale for
Partnership Subpart F Regs
NEWS AND ANALYSIS
Varma noted that there is no
indication of what facts might be
relevant to the ‘but for’ determination
within the regs.
‘‘Nobody really knows how to trace with much
certainty when you are talking about something
fungible like debt proceeds,’’ Jenn said. He said that
he wasn’t sure whether a principal purpose test,
used under the regs’ antiabuse rule, was more or
less administrable than a ‘‘but for’’ standard, but
that Treasury was open to hearing comments on the
latter.
FATCA Prominent in Information
Reporting Committee Report
By Luca Gattoni-Celli —
luca.gattoni-celli@taxanalysts.org
The IRS has created the necessary systems for
registration and data exchange under the Foreign
Account Tax Compliance Act, but ‘‘much more
technology funding is needed to bring IRS systems
into the 21st century,’’ according to an October 28
report by the IRS Information Reporting Program
Advisory Committee.
Accompanying the report was a formal letter to
IRS Commissioner John Koskinen, in which 2015
IRPAC Chair Mary Kallewaard expressed the committee’s belief that IRS funding must be restored to
previous levels for the tax system to function adequately and for IRPAC recommendations and
other process improvements to be feasibly implemented.
Koskinen, who appeared at a public meeting
with IRPAC to discuss the report, acknowledged
some of filers’ and practitioners’ concerns about the
FATCA’s reporting requirements. But he said the
IRS’s focus for the next two years would be on
rolling out and validating those information sharing and reporting systems and processes, adding
that the idea is not to play ‘‘gotcha’’ with filers but
rather to educate them.
‘‘The things that are most important for us are to
provide more information and simplification wherever we can on forms, instructions, [and] requirements,’’ Koskinen told Tax Analysts. He emphasized
the value of cooperation with outside stakeholders
on information reporting for what he refers to as the
agency’s ‘‘unfunded mandates,’’ particularly the Affordable Care Act and FATCA.
Input from IRPAC members is vital to
the daily business of tax
administration, said Koskinen.
Koskinen said input from IRPAC members, representing stakeholders such as practitioners, is vital
to the daily business of tax administration.
‘‘Whether it’s the financial industry, or the healthcare industry, or universities,’’ we want members
not only to understand the information we’re requesting but also to provide feedback, he said.
Among IRPAC’s other recommendations for reducing the compliance burdens was waiving the
reporting requirement under section 6050W for
‘‘reportable payment transaction’’ wire transfers of
funds equal to 1 cent — typically used to verify or
TAX NOTES, November 2, 2015
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CFC, so it won’t apply to ordinary course transactions. Ordinary, reoccurring distributions won’t be
subject to this rule. But if there’s a distribution that
is unusual or not consistent with the taxpayer’s
general practice, or the general practice in their
industry, then that could be something that could
cause an agent to take a closer look.’’ (Prior coverage: Tax Notes, Sept. 28, 2015, p. 1480.)
Jenn explained that the ‘‘but for’’ standard was
adopted because it was administrable. He said that
it was a ‘‘reasonable alternative’’ to using a tracing
rule, which raised concerns over administrability
and difficulty in taxpayer compliance.
NEWS AND ANALYSIS
Confusion Over Offshore
Accounts Prompts IRS Response
By Amanda Athanasiou —
amanda.athanasiou@taxanalysts.org
Recent feedback from practitioners prompted
clarifications on offshore voluntary disclosure program transition and streamlined cases and willful
foreign bank account report violation penalties
from Daniel Price, an attorney in the IRS Office of
Chief Counsel.
Speaking at a panel on the IRS’s OVDP and
streamlined filing compliance program on October
23 at the University of San Diego School of LawProcopio International Tax Law Institute annual
conference, Price said some practitioners have
asked whether feedback from revenue agents handling OVDP transition cases — through which
taxpayers who entered the OVDP before July 1,
2014, can request the reduced penalty structure of
the streamlined program — indicates the IRS’s
position on how it views the statement of facts for
new streamlined cases.
‘‘The answer is no,’’ Price said, explaining that
perceived pushback in transition cases on nonwillful certifications should not be interpreted as a
signal of how the IRS is handling the analysis of
non-willful certifications in new streamlined cases.
In transition cases, the taxpayer has the burden of
persuading the IRS that he was non-willful, Price
said. But in new streamlined cases, that burden of
persuasion doesn’t exist. ‘‘The IRS is going to
presume the taxpayer was non-willful unless facts
indicate otherwise,’’ he said, adding that the number of OVDP opt-outs has plummeted since transition terms were introduced last summer.
In new streamlined cases, ‘the IRS is
going to presume the taxpayer was
non-willful unless facts indicate
otherwise,’ said Price.
Price said it has come to his attention that some
attorneys perceive the willful FBAR violation penalty cap under IRS interim FBAR penalty guidance
issued May 13 to be 50 percent of the account value.
(Prior coverage: Tax Notes, June 8, 2015, p. 1098.)
The guidance states that in most cases involving
willful violations over multiple years, the total
penalty amount for all years under examination
will be limited to 50 percent of the highest aggregate balance of all unreported foreign financial
accounts during the years under examination.
However, based on the facts and circumstances of
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open accounts — by issuing guidance to exclude
such cases or implementing a minimum threshold.
IRPAC also asked the IRS to provide special relief
from incorrect taxpayer identification number penalty assessments for filers of non-wage information
returns for which current rules do not permit validation under the TIN matching program.
The committee asked that a checkbox specifically
authorizing that validation be added to forms W-9,
‘‘Request for Taxpayer Identification Number and
Certification,’’ and W-4P, ‘‘Withholding Certificate
for Pension or Annuity Payments.’’
NEWS AND ANALYSIS
‘‘The cap for willful cases that merit it is 100
percent of the account balance, not 50,’’ Price emphasized, urging practitioners to use the 100 percent figure in their worst-case-scenario analyses.
Omitted Accounts
Price said that for early OVDP participants who
have realized that their original submissions omitted an asset or account, there are two options: either
provide the new disclosure directly to the IRS
Criminal Investigation division or go to the revenue
agent who certified the case originally.
‘‘If an omission is deemed to be benign or
accidental, the terms of the current OVDP program
will be extended for that omitted account,’’ Price
said.
Asked how a late-discovered account would
affect an existing closing agreement, Price said only
that he would encourage practitioners ‘‘to face the
situation, to come forward to the IRS. We understand that mistakes can be made. Nobody’s perfect;
just provide us the information and the reason.’’
Price told Tax Analysts that if the IRS determined
an omitted account needed to be examined, it
would be ‘‘subject to all potential maximum penalties in a normal examination context.’’ A previous
closing agreement would remain in effect unless
there was a determination of fraud, he said, adding
that there are specific Internal Revenue Manual
provisions for setting aside a closing agreement.
‘Snowbird’ Problem Not Just for Canadians
Regarding the well-documented dilemma of U.S.
citizens or green card holders living abroad who
find themselves ineligible for both the streamlined
foreign offshore program and the streamlined domestic offshore program, Price said only that the
OVDP OPT-OUTS SUBJECT TO SAME AUDIT AS OTHER OFFSHORE TAXPAYERS
Taxpayers who opt out of the IRS’s offshore
voluntary disclosure program’s penalty regime will
still be subject to the same examination as other
taxpayers subject to the IRS’s special enforcement
program (SEP), according to Stephen Lepore, SEP
manager, IRS Small Business/Self-Employed Division.
Speaking October 27 at the annual Tax Controversy Institute in Beverly Hills, California, Lepore
described the purview of SEP, which has grown from
information gleaned from the disclosure by UBS AG
to include taxpayers who have not come forward,
OVDP opt-outs, and cases in which a taxpayer has
been removed from the OVDP. However, SEP does
not work the OVDP exams but runs concurrent
income tax exams, foreign bank account report exams, and penalty exams, he said. (Prior coverage: Tax
Notes, Nov. 18, 2013, p. 694.)
Lepore described the standard information document request SEP uses, noting that it is being called
the ‘‘scary IDR.’’ The SEP IDR can be 12 pages long,
and it asks for individual and foreign tax returns;
flow-through and trust information; estate and gift
tax information; information returns; FBARs; foreign
and domestic bank account information; account
signatory information; account transfers and wires;
foreign and domestic credit card accounts; foreign
and domestic brokerage accounts; loans; and wills or
estate planning, Lepore said. ‘‘You might see that we
are going to ask for foreign travel records, a copy of
your passport, which is probably unusual in a regular revenue agent exam. So if you see that, you know
that we are hinting that we have some offshore
information.’’
When asked about the difficulty in responding to
such an extensive IDR when some of the information
may be difficult for the taxpayer to obtain, Lepore
said that SEP will extend the time and make a second
request. ‘‘If we don’t get it for a second time, then we
will issue a summons,’’ he said. If the foreign information holders, such as the banks, are not forthcoming, SEP may approach a foreign tax attaché, issue a
third-party summons, or issue a formal document
request under section 982.
Lepore said the next step after the IDR is to
interview the taxpayer, separately if it is a joint
return, and then the return preparer. ‘‘We talk to
business associates, any legal or professional assistance [the taxpayers] had, like bankers and stockbrokers,’’ he said in response to a question about further
third-party contacts during a SEP audit.
SEP consults with the IRS Office of Chief Counsel
and may seek input from international examiners
and fraud technical advisers when appropriate, Lepore said.
Victor Song, a former IRS Criminal Investigation
division chief, described the assistance that tax attachés posted in embassies around the world provide
to special agents in international cases. They can be
used ‘‘to get information, to do interviews, to serve
subpoenas, to serve summonses if needed,’’ he said.
‘‘Instead of having the agents get on a plane and fly
out all over the world, we had people situated within
the embassy confines.’’ He added that the tax attachés would share information with other law enforcement attachés as well.
TAX NOTES, November 2, 2015
— Nathan J. Richman
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the case, examiners can recommend a higher (or
lower) penalty, up to 100 percent of the highest
aggregate balance of unreported foreign financial
accounts during exam years.
NEWS AND ANALYSIS
The hypothetical Mexican resident
coming to Wal-Mart every week would
be disqualified under the foreign
presence test, said Kaplan.
Kaplan suggested that a circumstance with
OVDP with opt-out is still viable, albeit ‘‘costly and
time consuming.’’ She confirmed that the hypothetical Mexican resident coming to Wal-Mart every
week would be disqualified under the foreign presence test. ‘‘All you can do with them is try to defer
your filing for another year’’ and make sure that in
2016 they don’t fail that residency test, she said.
But Price responded that the IRS would ‘‘never
encourage noncompliance, especially knowing noncompliance.’’ He said submitting delinquent returns and possibly arguing reasonable cause could
be an option but that it ‘‘may prompt an examination.’’
The problem with submitting delinquent returns
is that nonfilers will automatically get assessment
notices for late-payment and late-filing penalties,
which would not accrue in the streamlined program, Kaplan said. ‘‘Sometimes you can avoid the
late-filing penalty, but the late-payment penalty and
the authorities on reasonable cause there make it
virtually impossible for most people to avoid those
penalties,’’ she said.
Lawsuit Challenges IRS Transition
Rules for Offshore Disclosures
By William Hoke — william.hoke@taxanalysts.org
The IRS is treating some taxpayers unfairly and
illegally denying them the right to withdraw from
the more onerous 2012 offshore voluntary disclosure program and directly access the streamlined
filing compliance procedures (SFCP) announced
last year, according to a lawsuit filed October 26.
By being forced to observe the IRS’s transition
rules for moving into the SFCP, the three women in
the suit are exposed to much higher financial burdens, including a requirement to pay tax and interest on up to five additional years of income. Under
the OVDP, they are also subject to the accuracyrelated penalty or the delinquency penalty, neither
of which they would have to pay under the SFCP.
Participants in the 2012 OVDP must pay a penalty of 27.5 percent of the highest balance in their
accounts during an eight-year period. The SFCP
introduced in 2014 allow an individual who inadvertently failed to report offshore income to make
the correct filings for the most recent three years. By
certifying that the reporting and filing failures were
not willful, the individual would be subject to a 5
percent penalty or, if nonresident, to no penalty at
all.
The transition rules do not satisfy any
exception to the APA’s notice and
comment rulemaking requirements,
said the plaintiffs’ lawyers.
The complaint filed with the U.S. District Court
for the District of Columbia (Maze v. IRS, 1:15-cv01806) says that when the IRS promulgated the
SFCP in 2014, it unilaterally and without explanation prohibited individuals who had entered the
2012 OVDP from receiving the benefits of the 2014
procedures unless they complied with transition
rules.
‘‘The application of these transition rules purportedly required plaintiffs who reported their foreign bank accounts and assets through participation
in the 2012 OVDP out of a sense of responsibility
and candor to satisfy monetary and compliance
burdens that similarly situated individuals, who
waited until the 2014 SFCP were announced, do not
face,’’ the complaint says.
The plaintiffs’ lawyers said the IRS never published a notice of proposed rulemaking for the
transition rules in the Federal Register and didn’t
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IRS acknowledges the ‘‘gap of taxpayers that don’t
fit these two buckets.’’ (Prior coverage: Tax Notes,
Oct. 26, 2015, p. 507.)
The paradigmatic example has thus far been that
of the Canadian ‘‘snowbird,’’ who spends winters
or vacations in the warmer states. (Prior coverage:
Tax Notes, Nov. 10, 2014, p. 641.) But one audience
member inquired about a Mexicali or Tijuana resident who crosses the border once a week to go to
Best Buy or Wal-Mart.
NEWS AND ANALYSIS
Unaware of U.S. Reporting Requirements
All three of the plaintiffs are U.S. citizens and
residents.
Eva Maze, who was born in 1922, moved to the
United States to escape the Nazi occupation of
Romania in World War II. She went back to Europe
in 1948 and remained there until 2012, when she
returned to the United States. While still in Europe,
Maze transferred funds that she inherited from her
husband upon his death in 1992 from Swiss bank
accounts to bank accounts in France, where she
resided at the time. According to her lawyers, she
mistakenly believed the accounts were not reportable in the United States.
Although Maze applied for the 2012 OVDP, her
attorney notified the IRS of her intention to withdraw from that program to take advantage of the
2014 SFCP. She was informed by the IRS in June that
if she withdrew from the OVDP, her application to
enter the streamlined program would be denied
and she would be subject to a full examination. She
was told that she could only request transitional
treatment under the transition rules.
Suzanne Batra was born in the United States in
1937 and married a native of India. Her lawyers
said the Batras decided to deposit their money in
foreign accounts after the 1985 savings and loan
crisis because of continued instability in the U.S.
banking system and the financial security available
abroad. They said she, too, assumed that the new
accounts were not reportable to U.S. authorities.
According to the court filing, Batra learned of the
requirement to report the accounts in March 2010
and made a voluntary disclosure four months later.
She subsequently made a request to use the transition rules to qualify under the SFCP.
Margot Lichtenstein was born in Germany in
1924 and came to the United States in 1951 with her
husband, who had earlier fled Russia to escape
anti-Jewish pogroms in his native Poland. Lichtenstein inherited bank accounts from her husband in
1997, and her lawyers said she mistakenly believed
she did not have to report them in the United States.
They said she learned of the requirement to report
the accounts in June 2012, at which time she took
immediate action to join the 2012 OVDP. Earlier this
year, Lichtenstein told the IRS she wanted to withdraw from the 2012 OVDP and take advantage of
the SFCP.
Willful or Not?
The question whether the failure to report income or file was willful has been of great interest
because of the penalties that hinge on that determination. When the streamlined procedures were
modified in 2014 to permit U.S. residents to make a
disclosure in order to be subject to the lower 5
percent penalty, taxpayers were required to certify
that any previous compliance failure was nonwillful. Individuals living outside the country are
subject to no penalty at all. Qualifying individuals
have to file amended or delinquent tax returns for
three years, pay any tax and interest due on those
returns, and file an amended or delinquent foreign
bank account report for each of the most recent six
tax years.
The OVDP was changed at the same time to
increase offshore penalties from 27.5 percent to 50
percent if it became publicly known before a taxpayer applied for the program that either his financial institution or the party facilitating his failure to
comply was under investigation. (Prior coverage:
Tax Notes, Oct. 5, 2015, p. 7.)
The number of OVDP opt-outs has
plummeted since transition terms
were introduced last summer, Price
said.
Daniel Price, a lawyer with the IRS Office of
Chief Counsel, said on October 27 that while the
taxpayer in a transition case has the burden of
persuading the IRS that his behavior was nonwillful, that burden doesn’t exist under the SFCP.
‘‘The IRS is going to presume the taxpayer was
non-willful unless facts indicate otherwise,’’ he
said. (Related coverage: p. 618.) The number of
OVDP opt-outs has plummeted since transition
terms were introduced last summer, Price said.
FAQ 35
The plaintiffs’ lawyers said FAQ 35 of the frequently asked questions on the IRS’s website for the
2009 OVDP said IRS examiners do not have discretion to settle cases for amounts less than what is
properly due and owed. The FAQ said the examiners would compare the 20 percent offshore penalty
to the total penalties that would otherwise apply to
a particular taxpayer, and under no circumstances
TAX NOTES, November 2, 2015
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allow interested persons an opportunity to participate in the process. Further, the transition rules do
not satisfy any exception to the Administrative
Procedure Act’s (APA) notice and comment rulemaking requirements, they said.
Milan Patel of Anaford AG, one of the firms
representing the plaintiffs, said his client and the
other women are asking to be treated no differently
from taxpayers who are able to directly access the
SFCP. ‘‘The national taxpayer advocate has identified the issues raised in the complaint as among the
most serious problems within the IRS in its annual
report to Congress,’’ Patel said. ‘‘Unfortunately, the
IRS has repeatedly refused to address these problems.″
NEWS AND ANALYSIS
Transition Rules
The transition rules under the IRS’s FAQs for the
2014 OVDP stipulate that specified applicants in the
OVDP are provided ‘‘an opportunity to remain in
the OVDP while taking advantage of the favorable
penalty structure of the expanded streamlined procedures.’’ They also said applicants who directly
enter the 2014 SFCP must file and pay tax and
interest for amended or delinquent tax returns and
related information returns for only the previous
three years, while similarly situated applicants
seeking to transition from the OVDP into the SFCP
must file and pay tax and interest for amended or
delinquent tax returns for the eight previous years.
Applicants who directly take advantage of the
2014 SFCP are able to participate by certifying
non-willfulness. The IRS then determines whether
willfulness is present and selects applicants for
audit in accordance with the normal IRS audit
procedures. In contrast, applicants who already
participated in the OVDP before July 1, 2014, and
can access the SFCP only by way of the transition
rules have to affirmatively prove non-willfulness
before being allowed to take advantage of those
procedures. The plaintiffs’ lawyers said the IRS
does not publish, nor do its examiners follow, any
uniform set of standards under which nonwillfulness may be consistently and appropriately
determined.
The plaintiffs’ lawyers said that under the transition rules, an applicant has no opportunity to
administratively appeal or otherwise dispute a determination that the applicant could not establish
non-willfulness. If an applicant disagrees, the only
option is to opt out of the OVDP, which they said
will likely expose the applicant to an audit, higher
penalties because of a different standard of review,
and possible criminal prosecution. If the applicant
is removed from or opts out of the OVDP, he is
deemed ineligible for the SFCP.
‘The applicants who were more
responsible and came forward earlier
under the OVDP’ are being treated
worse than those who waited, says
the complaint.
The plaintiffs said the IRS contends that applicants who want to use the SFCP via the transition
rules are treated differently than similarly situated
applicants because the IRS must ‘‘concur on the
non-willful statement before agreeing to give the 5
percent penalty.’’ (Prior coverage: Tax Notes, Sept.
29, 2014, p. 1528.) ‘‘But the IRS also determines
whether applicants who directly enter the 2014
SFCP have willfully violated foreign account reporting requirements,’’ the plaintiffs’ lawyers said
in the complaint. ‘‘The need to determine nonwillfulness is the same in both programs and does
not justify the additional filing burdens, a heightened standard of review, and the additional tax,
interest, and penalty payments required by the
transition rules. The transition rules treat similarly
situated applicants differently depending solely on
whether they came forward before July 1, 2014, or
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would a taxpayer be required to pay a penalty
greater than what he would otherwise be liable for
under existing statutes, the lawyers said.
The lawyers also said the ‘‘existing statutes’’
referred to in FAQ 35 provide for a reasonable cause
exception to foreign account reporting violations,
apply a lower maximum penalty to non-willful
violations, and place the burden of proving willfulness on the IRS.
‘‘IRS examiners initially followed the guidance in
FAQ No. 35, analyzed reasonable-cause arguments,
made determinations of non-willfulness, and,
where appropriate, proposed a smaller penalty (or
no penalty at all),’’ the complaint says. ‘‘Yet despite
the plain language of FAQ No. 35, the IRS reversed
course in March 2011 and directed examiners not to
accept less than the 20 percent offshore penalty
regardless of whether ‘a particular taxpayer’ would
pay less under ‘existing statutes.’’’
The plaintiffs’ lawyers said FAQ 35 shows that
the IRS provided a mechanism under the 2009
OVDP by which an applicant’s facts and circumstances could be evaluated to determine willfulness, reasonable cause, and other pertinent issues
that allowed for a determination of decreased penalties under ‘‘existing statutes,’’ which the lawyers
said mean the laws of the United States. ‘‘But the
IRS abandoned that approach and adopted a rigid
position that the miscellaneous ‘offshore penalty’
applied in all but a few narrow circumstances,’’ the
complaint says.
Individuals qualifying for the SFCP are not subject to accuracy-related penalties, information return penalties, or foreign account reporting
penalties unless the returns filed are subsequently
selected for audit under existing audit selection
processes and the examination results in a determination that the original return was fraudulent or
that the foreign account reporting violation was
willful.
According to the plaintiffs’ lawyers, the 2014
SFCP essentially ‘‘gave back to non-willful participants what the IRS had taken away when it refused
to apply FAQ No. 35 as it was written, i.e., a
mechanism to ensure that such participants only
pay a penalty under the program that is roughly
calibrated to the one they actually owe under the
law.’’
NEWS AND ANALYSIS
Doctrine of Equality
One lawyer who is not involved in the case said
he isn’t inclined to predict how a judge might rule
under the APA, especially because of recent decisions related to the act. ‘‘But I do think there’s a
certain unfairness in some situations that this case
illustrates,’’ said the lawyer, who asked not to be
identified. ‘‘Under the doctrine of equality, which is
really getting deep into [administrative] law, the
plaintiffs may have a point.’’
In a 2011 memorandum, the national taxpayer
advocate told the IRS that a court might cite the
so-called Accardi doctrine, which is based on the
equality of treatment doctrine, to require the IRS to
follow its guidance in a FAQ for the 2009 OVDP if a
taxpayer reasonably relied on the FAQ to his detriment.
Brian C. McManus of Latham & Watkins LLP
said the 2014 SFCP is a much-needed improvement
over earlier versions of the offshore programs,
which did not properly account for what he said
was a wide range of taxpayer conduct ‘‘from willful
tax evasion to innocent mistakes, to everything in
between.’’
McManus said some individual taxpayers are
being treated unfairly compared with others. ‘‘In
particular, the IRS needs to take a close look at how
the streamlined transition cases are being handled,’’
he said. ‘‘But for the vast majority of taxpayers with
undisclosed foreign accounts, the IRS struck the
right balance and the offshore program was and
remains an excellent alternative to substantial penalties or indictment.’’ (Related coverage: p. 628.)
(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
after June 30, 2014, with the applicants who were
more responsible and came forward earlier under
the OVDP being treated worse under the transition
rules than those who waited to disclose until the
2014 SFCP were promulgated.’’
It takes a lot of hard work
to become an expert.
Fortunately, it’s much
easier to remain one.
To update their expertise each day, tax
professionals simply look to Worldwide Tax
Daily. It’s the only daily service for timely
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from more than 180 countries – with news
stories and analyses by more than 200
correspondents and practitioners.
To learn more, please visit us at
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®
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NEWS AND ANALYSIS
Practitioners have speculated over the cause of
the fluctuation in the numbers, though because the
Treasury notice reports only names of the individuals without any further detail, looking for a pattern
(or lack thereof) can be difficult. However, the most
recent spike may lend some credence to the theory
that the second-quarter drop was an anomaly and
that the rigors of reporting under the Foreign Account Tax Compliance Act are leading to the general
upward trend in expatriations. The number of renunciations for the most recent quarter is more than
50 percent greater than the total number of expatriations for the entirety of 2012, the year before the
January 2013 release of the FATCA regulations.
(Prior coverage: Tax Notes, Sept. 14, 2015, p. 1186.)
By Andrew Velarde — andrew.velarde@taxanalysts.org
After falling precipitously in the second quarter
of 2015, the number of U.S. expatriates climbed
again in the third quarter, reaching a record 1,426
individuals, nearly 7 percent higher than the previous quarterly record.
Treasury on October 26 released the notice listing the names of the expatriates for the quarter
ending September 30, as required under section
6039G. The most recent quarter’s number is up by
nearly 1,000 individuals from the previous quarter
and is higher than the previous record of 1,336
individuals, set in the first quarter of 2015. If that
pace were to continue for the full year, it would
mean more than 4,300 individuals will have expatriated in 2015. That number would be significantly
higher than the previous annual high of expatriated
Relinquishing citizenship is not without tax consequences. Under section 877A, governing the tax
responsibilities of expatriation, covered expatriates
who give up citizenship must pay a mark-to-market
FATCA or Fiction:
Is Foreign Asset Tax Compliance Causing People to Renounce U.S. Citizenship?
Expatriations Per Quarter
Reported Expatriations
1,400
1,200
1,000
Aug. 19, 2009: U.S., Swiss
governments reach
settlement on UBS
800
600
July 1, 2008: Justice
Department makes
John Doe summonses
against UBS AG public
400
Jan. 28, 2013: FATCA
regs released
July 1, 2014: FATCA
withholding begins
September 30, 2015
June 30, 2015
March 31, 2015
December 31, 2014
June 30, 2014
September 30, 2014
March 31, 2014
December 31, 2013
June 30, 2013
September 30, 2013
March 31, 2013
December 31, 2012
September 30, 2012
June 30, 2012
March 31, 2012
December 31, 2011
September 30, 2011
June 30, 2011
March 31, 2011
December 31, 2010
June 30, 2010
September 30, 2010
March 31, 2010
December 31, 2009
June 30, 2009
September 30, 2009
March 31, 2009
December 31, 2008
September 30, 2008
June 30, 2008
March 31, 2008
December 31, 2007
0
September 30, 2007
200
Source: Quarterly Federal Register reports made by the IRS, required under section 6039G.
With expatriation numbers showing dramatic spikes since the last quarter of 2012, some tax professionals are blaming the
compliance burdens imposed by FATCA, as well as prior high-profile U.S. anti-evasion efforts. Signed into law in March
2010, FATCA increased reporting requirements for taxpayers with assets offshore. For more information, see
http://www.irs.gov/Businesses/Corporations/Summary-of-FATCA-Timelines.
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individuals, set last year, when 3,417 individuals
chose to relinquish their U.S. citizenship.
Expatriations Ramp Up to Even
Higher Annual Record Pace
NEWS AND ANALYSIS
The most recent spike may lend some
credence to the theory that the
second-quarter drop was an anomaly.
Also, in September, the IRS published proposed
regulations (REG-112997-10) addressing a tax on
U.S. citizens and residents who receive gifts or
bequests from individuals who relinquished U.S.
citizenship. The tax applies to any property transferred to a U.S. citizen or resident that qualifies as a
covered gift or covered bequest under section 2801,
regardless of whether the property transferred was
acquired by the donor or decedent before or after
expatriation. (Prior coverage: Tax Notes, Sept. 21,
2015, p. 1304.)
Tom Kasprzak contributed to this article.
NOTICE PROPOSES EXCISE TAX EXCLUSION FOR NON-TRAVEL MILES
Treasury and the IRS are considering introducing
rules to exclude from excise tax some amounts
attributable to frequent-flier miles that are redeemed
for purchases other than taxable passenger air transportation, according to Notice 2015-76, 2015-46 IRB 1,
released October 29.
Under section 4261(e)(3)(A), any amount paid to
an air carrier for the right to provide mileage awards
for passenger travel is treated as an amount paid for
taxable transportation upon which excise tax must be
paid. Section 4261(e)(3)(C) permits Treasury to issue
rules that exclude from the excise tax amounts attributable to mileage awards that are used other than for
passenger air transportation.
The notice proposes a method for determining
how taxpayers such as credit card companies and
collectors such as airline mileage awards programs
could reduce a taxpayer’s tax base on purchased
frequent-flier miles. The method starts with the tax
base for frequent-flier miles purchased from a particular airline mileage awards program for each
election year, which runs from April 1 to March 31,
and reduces the tax base based on redemption data
from that program for the calendar year immediately
preceding the calendar year in which the election
year begins.
The reduction is calculated by multiplying the
amount paid for the right to provide frequent-flier
miles by an exclusion ratio and reducing the section
4261(a) tax base on the purchased frequent-flier miles
by this amount. The exclusion ratio is the number of
frequent-flier miles in that program redeemed during the calendar year in which the election year
begins for things other than taxable air transportation, over the total frequent-flier miles under that
program redeemed during the same period. The
method is proposed as a safe harbor provision that
collectors elect by reporting the exclusion ratio to the
IRS. The notice explains that Form 720, ‘‘Quarterly
Federal Excise Tax Return,’’ would be amended to
allow the collector to report the exclusion ratio to the
IRS.
The proposed change to the excise tax rules ‘‘is a
great benefit for small taxpayers who might purchase airline miles, not necessarily intending to fly,’’
said David A. Taylor of Anton Collins Mitchell LLP.
While corporate purchasers of airline miles know to
request refunds of excise tax for redemptions for
non-airline-travel uses, smaller taxpayers may not,
he said, adding that ‘‘the methodology looks reasonably workable,’’ assuming that credit card companies
and airlines have the data necessary to do the
calculation.
The notice requests comments on a number of
issues, including whether the method is workable for
taxpayers, whether it should be adopted as a rule of
general applicability instead of as a safe harbor,
whether the period of historical data used is appropriate, and whether airlines or mileage awards programs are willing to share historical data with
taxpayers so that they can verify the tax base upon
which the section 4261(a) tax is applied when a
taxpayer purchases frequent-flier miles. Treasury
and the IRS also requested comments on whether
instead of having airlines or mileage awards programs calculate the exclusion ratio, it might be
preferable to have an allocation percentage for the
entire airline industry.
TAX NOTES, November 2, 2015
— Marie Sapirie
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exit tax on the deemed disposition of their worldwide assets immediately before expatriation.
NEWS AND ANALYSIS
By William Hoke — william.hoke@taxanalysts.org
The U.S. premiere in New York on October 28 of
the film The Price We Pay, which documents what
the director says is widespread tax avoidance by
multinational enterprises, was followed by a panel
discussion in which participants said serious steps
must be taken to allow shortchanged governments
to meet vital social needs.
The film, which debuted at the Toronto International Film Festival and has already played in Paris,
was directed by Canadian filmmaker Harold
Crooks. It is based on the book The Coming Fiscal
Crisis by Canada’s Brigitte Alepin.
Early on, the film shows a U.S. Senate hearing at
which an executive of Apple Inc. was asked about
the tax domicile of one of its subsidiaries incorporated in Ireland. ‘‘It does not have a tax residency’’
was the halting reply of Phillip Bullock, who is
identified as the head of the multinational’s tax
operations.
That scene was effectively repeated various times
throughout the film, with parliamentary committees in the United Kingdom grilling executives of
various U.S. MNEs about their corporate structures
and why they paid so little tax in the United
Kingdom. The executives invariably stammered in
response to uncomfortable questions, citing ‘‘tax
efficiency’’ or claiming that ‘‘we pay all the tax you
require us to pay.’’ Those softball replies, while
presumably legally accurate, were hit out of the
park by legislators who snapped back by saying
either ‘‘Your tax efficiency is our tax avoidance’’ or
‘‘We’re not accusing you of being illegal; we’re
accusing you of being immoral.’’
Differing Historical Perspectives
The film tries to show that modern-day tax
avoidance has deep historical roots. William Taylor,
a vicar and Labour councilor in the City of London,
said that to understand the relationship between
the City of London and the rest of the metropolitan
area, it is necessary to look to the distant past.
‘‘When William the First came to Britain from
Normandy — a French king — to conquer the rest
of the country, he stopped at the gate of the City of
London,’’ Taylor said. ‘‘He didn’t finish the job. The
French never finished the job. And the City maintained the rights and privileges that existed in King
Edward’s day.’’
The film then turns to Stuart Fraser, who is
identified as a stockbroker and former chair of the
policy and resources committee of the City of
London. Fraser talked about the City’s develop-
ment over the centuries and how it has ‘‘built up
quite a substantial amount of money which we use
for the benefit of the nation.’’ Fraser said one of the
City’s primary goals has been ‘‘to promote London’s financial services on a global basis.’’ He
added, ‘‘What’s good for the City is good for the
country, providing that that money is earned fairly
and squarely and doesn’t jeopardize the health of
the nation, which it has not.’’
Fraser talked about the City’s
development over the centuries and
how it has ‘built up quite a substantial
amount of money which we use for
the benefit of the nation.’
Taylor clearly didn’t agree with Fraser’s view of
the City’s beneficent impact beyond its immediate
area. ‘‘The Square Mile of the City of London retains
all of the ancient rights and privileges and resources
of the ancient City of London, and the people who
live outside of the City of London — those 8 million
of which I’m one — don’t share those resources,
although we are citizens of London,’’ Taylor said.
‘‘What you have today . . . you have this institution
that promotes the single interest of finance capital
and is using this huge network of resources to
promote the single issue of finance capital. It’s a
travesty of its history.’’
The comments about France’s William the Conqueror ‘‘never finish[ing] the job’’ in 1066 were,
perhaps, a clever setup for the introduction later in
the film of Pascal Saint-Amans, the point man of the
OECD’s action plan to counteract base erosion and
profit shifting by MNEs. The film’s U.S. release
came just three weeks after the G-20 finance ministers endorsed the OECD’s final reports on the 15
items in the BEPS action plan.
The French connection in righting the alleged
wrongs of the City and MNEs was brought up later
in the movie with a clip of Timothy Ridley, who is
described as the former chair of the Cayman Islands
Monetary Authority, speaking at an OffshoreAlert
conference in Miami in 2013. ‘‘If we are now talking
about tax avoidance being bad, that is a significant
shift in the nature of the playing field,’’ Ridley said.
‘‘The particularly active players are, of course, the
OECD in terms of the tax field. And the current
head of the tax division, who’s a Frenchman, needless to say, [is] called Pascal Saint-Amans, who, by
the way, doesn’t pay any tax on his OECD salary.’’
Civilized Society
The film’s title is possibly a play on a quote that
is generally attributed to U.S. Supreme Court Justice Oliver Wendell Holmes Jr. that taxes are the
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Film Decrying International Tax
Avoidance Premieres in U.S.
NEWS AND ANALYSIS
Financial Transaction Tax
Income redistribution, by way of an FTT, is also
brought up near the film’s end. ‘‘To tax every
financial transaction, that has a nice simple
aim . . . a bit of redistribution,’’ said Saskia Sassen, a
sociologist at Columbia University. ‘‘It doesn’t kill
the monster. But every time you do one of your
monstrous activities, no matter how tiny, you redistribute a bit.’’
Several people appearing in the film said that an
FTT would make it less likely that the financial
sector’s problems of 2007 and 2008 would occur
again and that even if they did, the government
would have more funds to deal with the consequences.
FTTs have been discussed for a number of jurisdictions over the years ever since they were first
proposed in 1972 by Nobel Prize-winning economist James Tobin. Some European Union member
states have been pushing for an FTT, but the efforts
have stalled in recent months, largely out of concern
that it would drive financial trading away from any
countries that embrace the tax. (Prior coverage: Tax
Notes Int’l, July 6, 2015, p. 33.)
‘To tax every financial transaction,
that has a nice simple aim . . . a bit of
redistribution,’ said Sassen.
Alepin likened the threats of banks fleeing an
FTT to an apparently unsuccessful proposal in the
province of Quebec to increase taxes on the wealthy.
‘‘Unless we have real tax cooperation, a jurisdiction
like Quebec cannot act alone without being threatened with exile,’’ Alepin said.
Robin Hood and Chekhov’s Gun
Both the film and the panel discussion afterward
promoted the movement to implement an FTT,
which is often referred to as a ‘‘Robin Hood tax,’’
with two of the panelists sporting elfinlike green
hats. The women wearing the Robin Hood hats said
they have been heavily involved in pushing for an
FTT, with one of them estimating that the tax would
provide $300 billion a year to address U.S. social
needs.
Asked why the film didn’t focus on specific taxes
beyond the FTT and why it didn’t go more deeply
into the impact of tax avoidance on social problems
such as racial inequality and wealth redistribution,
Crooks said that he was trying to achieve a coherent
narrative. The core issue for the story he wanted to
tell was how the offshoring of the world’s wealth is
shifting the balance of power between the nation
state and the multinational corporations, Crooks
said.
‘‘The story begins with the creation of the offshore world, and [I was] thinking about [Russian
playwright Anton] Chekhov’s laws of storytelling
where he says that . . . if you put a gun or a revolver
over on the wall in the first act, you have to use it in
the third act,’’ Crooks said.
Impact of BEPS
Asked about the impact that BEPS is likely to
have on reducing the level of tax avoidance by
MNEs, James S. Henry, an economist and investigative journalist, said the OECD had made a good
start after tackling a difficult subject. Henry reminded the audience, however, that the BEPS reports are merely recommendations. ‘‘At the end of
the day, the actual revenue generated by these tax
reforms that they still have to get through Congress
and other places around the world is still a mystery
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price we pay for a civilized society. (Holmes actually said, ‘‘Taxes are what we pay for a civilized
society,’’ the words that appear over the entrance to
the IRS building in Washington.)
The nexus between taxes and a civilized society
is apparent throughout the film, with people talking
about the role that tax avoidance has on the government’s ability to finance a variety of features
found in many more developed countries.
A Chicago firefighter mocked the city’s mayor,
who was visiting the firehouse after a firefighter
had died in a fire, for scoffing at his suggestion that
a financial transaction tax (FTT) be implemented to
fund public sector pensions. The mayor told the
firefighter that there is no political support for an
FTT and that if he was serious about one, he should
run for public office.
Chicago’s police and firefighter pension funds
had a combined deficit of $12.1 billion as of December 31, 2014. Neither was more than 26 percent
funded at that time. On October 28 the City Council
approved a $7.8 billion budget package with sweeping tax changes, including the largest property tax
increase in the city’s history. There was heavy
criticism of the plan that the brunt of the higher
property taxes fell on the city’s business sector. An
FTT was not among the revenue measures passed
by the council.
The film also focused on the impact of the
corporate world’s alleged avoidance of tax on the
government’s ability to build roads, fund education, and provide housing for the needy. The role of
globalization and offshore finance on the ‘‘dismantling of the welfare state’’ is a recurring theme. ‘‘The
welfare system helps cushion the impact of an
industrial revolution,’’ said Alain Deneault, who is
described as a philosopher and political science
instructor at the University of Montreal. ‘‘It also
helps the economy find a new balance and invest
capital in job creation.’’
NEWS AND ANALYSIS
Henry also faulted the BEPS process
by saying that it left developing
countries ‘in the background.’
Panelist David Cay Johnston, a winner of the
Pulitzer Prize for exposing loopholes and inequities
in the federal tax code, said that while the OECD’s
work was an ‘‘earnest, serious effort to address the
problem,’’ it was based on the faulty assumption
that the existing system can be fixed.
‘‘I think that what we need to do is change the
rules and look at a new way to do things,’’ Johnston
said. He added that what needs to be done is to tax
gains and not necessarily profits. ‘‘That’s a subtle
distinction,’’ he said. ‘‘We need to address this,
without question.’’
Johnston said that progress was being made in
that direction until the administration of President
George W. Bush objected to the harmonization of
tax systems and international tax cooperation. ‘‘Tax
competition should be in the thesaurus next to ‘how
to rip you off’ and ‘how rich people get richer off of
the tax system,’’’ Johnston said.
Focus Shifting Away From
Switzerland, Investigators Say
By William Hoke — william.hoke@taxanalysts.org
The United States is likely to soon move beyond
Switzerland in its attempts to pursue and prosecute
Americans with undisclosed foreign assets, former
officials said October 22 when discussing the U.S.
strategy.
Victor Song, a former chief of the IRS Criminal
Investigation division, and Mark Matthews, one of
Song’s predecessors at CI, appeared at the University of San Diego School of Law-Procopio International Tax Law Institute annual conference as part
of a panel discussion on IRS criminal investigations.
Song, now executive vice president of compliance with Samsung Electronics America Inc., said
CI was called before Congress in 2008 to explain
what it was doing to combat international tax
evasion. ‘‘We really took the hit for that,’’ Song said.
‘‘The other side of the coin is, after you do take a
beating on [Capitol] Hill, a lot of times you do get
extra funding to start doing something.’’
Song said CI used to be fairly insular within the
IRS because of confidentiality restrictions. He said
that as a result of the hearings, CI was given more
latitude to work with other IRS divisions, as well as
with other countries and global organizations such
as the OECD. In addition to trying to encourage
taxpayers to comply, CI started pursuing banks,
wealth managers, and preparers who had been
facilitating noncompliance, Song said.
Matthews, now with Caplin & Drysdale Chtd.,
said earlier efforts to combat offshore evasion
proved largely ineffective. He said he would send
agents into tax havens to attend what he called
‘‘festivals of tax evasion.’’ There were ‘‘literally long
tables with people hawking their wares of ‘try this,
try this,’’’ he said, adding that it was ‘‘very open
and very notorious.’’ Matthews said he didn’t make
a dent in the problem. ‘‘The treaties were there, but
no one basically responded, or [they] slow-walked
your request,’’ he explained.
CI ‘finally got a good chief — Victor —
or a scary chief, I don’t know which
one it was,’ said Matthews.
Matthews said two things happened to turn the
situation around: ‘‘The CID finally got a good chief
— Victor — or a scary chief, I don’t know which one
it was, and [then] a guy named Brad Birkenfeld
walked in the door from UBS and told the story that
all of us believed was there.’’
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to me,’’ Henry said. ‘‘I don’t think we have any
good metrics for estimating how large that will be.’’
Henry also faulted the BEPS process by saying
that it left developing countries ‘‘in the background.’’ He referred to the U.N. tax committee as a
basic nonentity with four employees and an annual
budget of only $400,000. ‘‘We have had a difficult
time getting big players like India and China and
Brazil that basically can take care of themselves in
international tax to really stand up and demand a
more equitable system,’’ Henry said.
NEWS AND ANALYSIS
IRS Cozies Up to Historic Enemies
Matthews said 106 of the over 300 banks in
Switzerland indicated their willingness to work
with the IRS by entering the program. The IRS
‘‘turned their historical enemies . . . the Swiss
banks, into those pushing people in,’’ he said. ‘‘So
suddenly, the banks had a motive because every
client that you get to go into the program was a free
pass.’’
Of course, the clients and former clients of the
Swiss banks weren’t happy that the institutions
they had relied on to protect their secrecy were
cooperating with the IRS. ‘‘The banks were asked,
‘If I’m going to go in the program, I want a lot more
than a toaster from you,’’’ Matthews said. ‘‘‘I’m
going to want you to pay . . . half my penalty.’ That
generally didn’t work out.’’
Matthews said many banks instead paid their
clients’ legal and accounting fees. He said the banks
were telling their clients, ‘‘the U.S. government is
going to shoot me in the head, [and] I’ve got to give
up your information anyway. Why don’t you scurry
on in and save us all the trouble?’’
Although a significant section of Swiss bank
secrecy law remains intact, banks cooperating with
the U.S. government turn over specific data, including details about the dates, amounts, and destinations of wire transfers that close out U.S. persons’
accounts. While the account holders’ names are not
revealed, it is widely expected that the Justice
Department will use the detailed information on
these so-called leaver lists to file group requests
with the Swiss competent authority to obtain the
identities of U.S. taxpayers who have not disclosed
their account details.
Matthews said a team will be looking to see if the
United States has a tax treaty with the country
where the funds transferred out of a Swiss account
were sent. ‘‘They will now have the beginnings of
the evidence to create a valid treaty request . . . and
go after that same information in that other bank,’’
he said, ‘‘so [the IRS has] put together a pretty neat
little vice here.’’ The message for individuals who
think they’re safe because they got their money out
of Switzerland and into countries such as Panama is
that ‘‘there’s a very high chance they’re going to
find you,’’ Matthews said.
‘There’s sort of a special place in hell
in the Justice Department’s mind for
people who run and hide,’ Matthews
said.
Banks that actively market themselves as discreet
destinations for undeclared cash have cause for
concern as well. ‘‘There’s sort of a special place in
hell in the Justice Department’s mind for people
who run and hide,’’ Matthews said. ‘‘And the banks
who took on people . . . who were running from
Switzerland, the Department of Justice really finds
that behavior offensive, both on the part of the
banks and people who are running. That is a very
dangerous thing to be doing these days.’’
Steven Toscher, a criminal tax lawyer at Hochman, Salkin, Rettig, Toscher & Perez PC, said the
government’s strategy with the voluntary disclosure and Swiss bank programs is brilliant because
of the magnitude of the problem and the scarcity of
resources available to address it. ‘‘It’s based on the
presumption they can’t prosecute everybody,’’ Toscher said. ‘‘They just don’t have the resources.’’
Nowhere to Hide
Toscher said that when the Swiss bank program
first started, it targeted only banks, not trust companies and other financial institutions that had also
been facilitating tax evasion. ‘‘Now other types of
financial organizations have gone in or had discussions with the [Justice] Department,’’ he said. ‘‘The
framework has been set by the Swiss bank program,
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Swiss Bank Secrecy
Birkenfeld was a private banking manager with
UBS AG in Switzerland before leaving the bank in
2005 and later giving the IRS information about
UBS’s complicity with U.S. tax evaders. Birkenfeld’s
cooperation ultimately forced UBS to enter into a
deferred prosecution agreement with the U.S. Justice Department in which the bank admitted to
helping its U.S. clients evade taxes and agreed to
pay a fine of $780 million.
In the first serious breach in the long-standing,
rock-solid wall of Swiss banking secrecy, UBS
agreed to turn over the names of approximately 250
U.S. account holders as part of its deal with the
Justice Department. Swiss bank regulators said the
disclosures did not violate bank secrecy rules because the accounts were opened under false pretenses and therefore weren’t entitled to protection.
(Prior coverage: Tax Notes, Apr. 19, 2010, p. 257.)
Emboldened by the UBS disclosures, the U.S.
government resuscitated an anemic voluntary disclosure program and created the Swiss bank program. The goals of both programs were to go after
tax cheats and their enablers and to encourage as
many taxpayers as possible to comply by charging
penalties but removing the possibility of prison
terms. Under the Swiss bank program, qualifying
financial institutions enter into deferred prosecution agreements and are able to lower their penalties by convincing their U.S. clients to come into
compliance with the IRS. (Prior coverage: Tax Notes,
June 8, 2015, p. 1122.)
NEWS AND ANALYSIS
secrecy,’’ he said. Many people who ended up
paying penalties equal to 20 percent of their highest
undisclosed balances were not guilty of ‘‘active
meat-and-potatoes criminal tax behavior,’’ Toscher
said, but had instead inherited money or were
immigrants coming from countries that did not
protect them.
He commended the government for streamlining
the offshore voluntary disclosure program last year,
easing the penalties on account holders whose
failure to disclose and pay tax was non-willful.
Most taxpayers who do not have a history of willful
noncompliance will qualify for a 5 percent penalty
under the streamlined procedures. (Prior coverage:
Tax Notes, June 23, 2014, p. 1357.)
Courts Frown on Unequal Punishment
The panelists said the courts have not always
been pleased that many wealthy individuals who
had undisclosed accounts in Switzerland are getting off relatively lightly compared with more
garden-variety tax evaders, such as restaurant owners or roofing contractors who underreport income
on their domestic activities.
Matthews compared the earlier penalties for
people who had money squirreled away offshore
with those given to small business owners in the
United States who underreported income, implying
that the latter group is often punished more harshly.
‘‘You would think that, dollar for dollar, [those
involved in hiding assets in Switzerland] would get
more jail time than the . . . regular tax cheat,’’ Matthews said. ‘‘As [of] a few months ago, over 60
percent of the defendants got probation on an
average account size of $7 million. You gotta be
kidding me! How can that be? And I don’t think
anybody’s done more than two years [in prison].’’
‘Over 60 percent of the defendants
got probation on an average account
size of $7 million,’ said Matthews.
The government started off with bad case selection, Matthews said. One of the early prosecutions
involved a 79-year-old woman with a high school
education who wanted to enter the voluntary disclosure program but whose lawyer missed the
deadline. Matthews said the government rejected
her application (apparently because UBS had already turned over her name as part of its deferred
prosecution agreement). The woman was fined $22
million on a $44 million account. Despite facing a
six-year prison term, the woman was sentenced to a
single year of probation. According to Matthews,
the judge told the defendant after announcing the
probation, ‘‘Oh, by the way, looking at my watch, I
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[so] if you get to them before they get to you, you’re
going to be in much better shape.’’
Information derived from the leaver lists and
other sources is likely to shift the government’s
focus away from Switzerland, Song said. There are
still many people with their heads in the sand
because their undisclosed offshore assets are not
held in Switzerland, he said. ‘‘I wouldn’t be surprised if you see things in Central and South
America and Asia,’’ Song added.
Matthews said banks in other countries may
soon be knocking on the Justice Department’s door,
looking to cut a deal. ‘‘So beware Singapore, Hong
Kong, Dubai, Israel, Panama,’’ he said. ‘‘Your day
may come.’’
The panel moderator asked whether the statute
of limitations provides shelter for assets that were
in an undisclosed account in 2008 or earlier. Matthews said the Justice Department can still resort to
conspiracy charges, which he said go back six years
from the date of the last act of the conspiracy.
While the Justice Department generally doesn’t
like to base a prosecution solely on a conspiracy
charge, there is a new substantive count for the year
in which a leaver opens an undisclosed account in
another country, Matthews said. ‘‘That’s why they
will ultimately be able to have . . . fresh, substantive
counts for those waiver years,’’ he said.
Matthews said one possibility for individuals
with undisclosed accounts is to try filing an accurate tax return for the most recent year, along with
a foreign bank account report. ‘‘But you have left a
whale of penalties and exposure back there if you
don’t use one of these formal programs,’’ Matthews
said. ‘‘If you have a small enough account . . . that
might work for some people, but the government is
pretty smart, and they’re going to see new FBARs
coming in with new accounts on them. They’re not
idiots.’’
Toscher said individuals with undisclosed accounts derive no satisfaction from the fact that the
foreign jurisdiction where their money is stashed
has intact bank secrecy laws and does not have a tax
treaty with the United States because so many
foreign financial institutions have correspondent
banking accounts with U.S. banks. ‘‘They need to
deal with dollars,’’ he said. ‘‘The government believes that those correspondent accounts maintained in the U.S., [and] not in the name of
individual taxpayers, have a wealth of information
regarding individual taxpayers.’’
Toscher said that in most early voluntary disclosure cases, tax avoidance wasn’t necessarily the
motive for opening an offshore account, and the
account holders often weren’t earning significant
amounts of income on the undisclosed assets.
‘‘People weren’t buying yield; they were buying
NEWS AND ANALYSIS
The Strangest Sentence of All
Toscher said he would never argue with a judge
that his client should be treated more leniently in an
overseas tax case because of all the others who were
getting off more easily. ‘‘Those types of argument
don’t work, but [the disparity in sentencing] is the
proverbial elephant in the room,’’ he said, adding
that he thinks the sentences ‘‘are not reflective of
routine tax cases’’ and will not be ‘‘reflective of
what the next rounds of foreign criminal tax cases
are going to be.’’
Toscher said the system for determining punishments in foreign tax cases is imperfect. ‘‘The person
who . . . got the most jail time in a foreign case
was . . . somebody who [pleaded] guilty and cooperated with the government and gave the government all this information: Mr. Birkenfeld,’’ he said.
Birkenfeld was sentenced to 40 months in prison.
After being released on parole after 31 months, he
received a whistleblower award of $104 million
from the U.S. government for his ‘‘exceptional cooperation’’ with the Justice Department.
Possible Pfizer-Allergan Merger —
Biggest Inversion Yet?
By Amy S. Elliott — amy.elliott@taxanalysts.org and
Andrew Velarde — andrew.velarde@taxanalysts.org
One of the United States’ largest pharmaceutical
companies, New York-based Pfizer Inc., may have
finally found a merger partner that would enable it
to move its domicile to Ireland and reduce its U.S.
tax bill, even though the deal would likely trigger
the surrogate foreign corporation rules and be subject to limitations in a 2014 anti-inversion notice.
In a deal that observers assume would likely fall
between the 60 and 80 percent ownership fraction
thresholds in Notice 2014-52, 2014-42 IRB 712, Pfizer
(with a market cap of $214 billion) and Dublinbased Allergan PLC (with a market cap of $120
billion) announced October 29 that they are in
preliminary friendly discussions concerning a potential combination transaction.
The announcements stressed that ‘‘no agreement
has been reached and there can be no certainty that
these discussions will lead to a transaction, or as to
the terms on which a transaction, if any, might be
agreed.’’
Based on market cap alone, it appears that the
combination could result in Pfizer retaining a 64
percent stake in the combined entity, meaning that
while its new foreign status would be respected, it
wouldn’t be able to engage in some planning strategies — including the use of hopscotch loans — to
reduce its U.S. tax bill. However, details of the
proposed merger are sparse — including whether
there could be a premium paid for Allergan or
whether shareholders might be cashed out in the
transaction by Allergan, subject to the restrictions in
the notice on fattening up the foreign entity and
skinnying down the U.S. entity — and the ownership fraction would be tested on the closing date.
In 2013 Pfizer spun off its animal health business
unit (now Zoetis) in a $2.2 billion initial public
offering, which could trigger Notice 2014-52’s nonordinary course distribution test (the anti-skinnydown rule with a 36-month lookback), possibly
making it harder for Pfizer to fall below the 60
percent threshold.
The immediate value in the deal is that it would
enable the resulting foreign multinational to engage
in a debt push-down strategy that would generate
interest deductions in the high-tax United States
while the corresponding interest income is earned
in low-tax Ireland, said Bret Wells of the University
of Houston Law Center. The rate arbitrage ‘‘will be
a big benefit for the inversion on day one,’’ he said.
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see five seconds have passed. I now end your
sentence of probation.’’ Matthews said the judge
terminated the probation because he was mad
about the Justice Department’s case selection. (Prior
coverage: Tax Notes, Apr. 29, 2013, p. 486.)
Matthews said the Justice Department failed to
understand the weight that judges were giving to
the fact that up to 60,000 people who were later
entering into the disclosure program did not suffer
a similar fate.
Matthews represented H. Ty Warner, creator of
Beanie Babies, who pleaded guilty in 2014 to evading taxes on income derived from an undisclosed
account at UBS that he moved to another bank in
2002. Warner was fined $53.6 million and sentenced
to two years of probation and 500 hours of community service. (Prior coverage: Tax Notes, July 20,
2015, p. 267.)
‘‘The government stood up and said that wasn’t
a material punishment,’’ Matthews said. ‘‘I’m sorry,
[but] most people think a $53 million penalty is a
punishment. I think those kinds of factors are
causing the judges to say, ‘OK, these people have
been punished enough, especially when I look at
these other guys.’’’
Although the Justice Department appealed Warner’s sentence, it was upheld by the Seventh Circuit
in July.
NEWS AND ANALYSIS
Congressional Reaction
Upon receiving word of the possible deal, House
Ways and Means Committee ranking minority
member Sander M. Levin, D-Mich., issued the following statement: ‘‘Congress must realize that
while the Administration’s actions to curb tax inversions have had some impact, as companies continue to contemplate possible tax inversions, it is
our responsibility to act to address this loophole
once and for all.’’
Under the Stop Corporate Earnings Stripping Act
of 2014, Levin proposed strengthening sections
163(j) and 956 to limit earnings stripping. The bill
included the repeal of the section 163(j) debt-toequity safe harbor provision and a reduction —
from 50 percent to 25 percent — of the maximum
amount by which a U.S. entity’s net interest paid to
a related party can exceed its adjusted taxable
income before it is considered nondeductible.
Levin previously proposed the Stop Corporate
Inversions Act of 2014 (H.R. 4679), which would
have lowered from 80 percent to 50 percent the
maximum amount of stock that can be continuously
held by owners of the former domestic company
before an inverted company is treated as domestic
for tax purposes. (Prior coverage: Tax Notes, Aug. 11,
2014, p. 660.)
Will Pfizer Boldly Go?
Pfizer CEO Ian Read has not shied away from
proclaiming that there would still be benefits from
inversions even if Pfizer were to run afoul of the
Treasury notice. On a conference call in October
2014, he acknowledged that although Treasury
guidance made inversions more difficult and
changed the timing in realizing value in an inversion that fell between the 60 and 80 percent ownership thresholds, there was ‘‘still meaningful value
to be had’’ — the most significant of which was the
‘‘liberation of a substantial proportion’’ of future
cash flows outside the United States and into a
territorial system. (Prior coverage: Tax Notes, Nov. 3,
2014, p. 485.)
Speaking October 29 at an event sponsored by
The Wall Street Journal, Read said Pfizer is also
considering whether to split up its business lines —
possibly spinning off its slow-moving established
products business to increase the value of its innovative products business — if it’s determined that
the parts are worth more than the whole and the
company can find a way to ‘‘tax efficiently’’ realize
that value. He said that while no decision has been
made on such a possible division, he expects one
will be made by the end of 2016.
Pfizer had an effective tax rate on adjusted income of approximately 25 percent in 2014, according to its financial report. Also according to the
report, as of December 31, 2014, Pfizer had not
made a U.S. tax provision on approximately $74
billion of unremitted earnings from international
subsidiaries, claiming that they were intended to be
indefinitely reinvested overseas.
The Treasury notice seeks to make inversions
more difficult to accomplish by tightening rules
under section 7874 as well as limiting inverting
companies’ tax-free access to offshore earnings.
However, no action was taken against potential
earnings stripping of the U.S. tax base. Treasury
stated in the notice that it was considering guidance
to address strategies that avoid U.S. tax through
earnings stripping, including through the use of
intercompany debt. Treasury officials have repeatedly said regs following up on the notice could be
forthcoming this year. (Prior analysis: Tax Notes,
Aug. 10, 2015, p. 611. Prior coverage: Tax Notes, Sept.
14, 2015, p. 1194.)
Pfizer’s Prior Failed Inversion
Pfizer previously attempted to invert following a
proposed merger with AstraZeneca PLC, but the
proposal unraveled when the U.K.-based company
rejected Pfizer’s buyout offer. The package was
reportedly worth $119 billion. The size of the deal
and the profile of the players helped initially draw
attention to inversions last spring, fueling lawmaker ire. (Prior coverage: Tax Notes, May 26, 2014,
p. 878.)
Allergan itself was recently involved in a merger,
whereby the previously California-based Botox
maker was acquired by Dublin-based Actavis PLC
in a transaction valued at $66 billion. Actavis, which
used to be headquartered in New Jersey, completed
its 2013 inversion into Ireland by acquiring Dublinbased Warner Chilcott PLC. (Prior coverage: Tax
Notes, May 26, 2014, p. 878.)
A spokesperson for Pfizer declined to comment
on the possible terms of any deal beyond the
company’s public statement.
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Earnings stripping is ‘‘the elephant in the room
that the notice did not attack,’’ Wells told Tax
Analysts. ‘‘The basic reason companies do inversions is for the . . . ability to reduce U.S. tax on U.S.
income,’’ he said, although over time, inversions
also allow firms to move their intellectual property
to offshore holding companies.
‘‘Inversions are simply telling us that foreignbased multinational entities can achieve a lower tax
rate on U.S. business activities than can U.S. multinational entities,’’ Wells said. (Prior coverage: Tax
Notes, June 23, 2014, p. 1429.)
NEWS AND ANALYSIS
By William Hoke — william.hoke@taxanalysts.org
The United States and some other countries are
becoming more aggressive in pursuing and litigating transfer pricing cases, and companies’ responses range from the logical to the almost
ludicrous, tax directors of multinationals said October 22.
Speaking during a roundtable discussion at the
University of San Diego School of Law-Procopio
International Tax Law Institute annual conference,
panel co-moderator Nate Giesselman of Skadden,
Arps, Slate, Meagher & Flom LLP said tax directors
should remember that the settlement of a transfer
pricing issue is different from most other types of
agreements with tax authorities. ‘‘If you, as a tax
director, are making a reorganization, or an acquisition, or a spinoff, and the IRS comes and says, ‘We
think one of your intercompany notes should have
been a dividend,’ you can fight that point. And if, at
the end of the day, you agree to take the tax hit on
that, it’s done and over with, and you can go on
with your life,’’ Giesselman said. But if the IRS says
a U.S. subsidiary should be reporting a higher
margin than it is, the resulting exposure potentially
continues forever, he noted.
A good part of the roundtable discussion was
dedicated to what co-moderator Hal Hicks of Skadden referred to as ‘‘war stories.’’
Paul Yong, international tax director at Sempra
Energy, said he previously worked at a company,
which he didn’t identify, that was consistently hit
with assessments by the same auditor in Canada.
According to Yong, the revenue agent wasn’t particularly interested in auditing his company but
was bucking for a promotion. ‘‘At the end of the
audit, he would just assess us, [but] there’d be no
support for his assessment,’’ Yong said. ‘‘Rather
than argue and fight it . . . we’d settle. We’d give
him a little bit.’’
‘Sometimes you use a little street
smarts and get to the same place, a
better place,’ said Yong.
Yong said he was in Canada during an audit one
year and was told by his local manager that the
auditor brought in some newspapers every day and
read them in the morning before getting down to
work after lunch. Yong said he told his manager to
put hunting, fishing, and automotive magazines on
a table in the reception area outside the room where
the auditor was working. ‘‘Now he picks up a
couple of issues of magazines,’’ the manager told
Yong. ‘‘He does no work . . . at all.’’
At the end of the audit, realizing that he hadn’t
done any work, the auditor asked for an extension,
Yong said. Yong refused, saying he wanted a meeting with the auditor’s manager, an explanation of
the work the auditor had done, and the reason why
an extension was needed. ‘‘Guess what? Two weeks
later, a no-change audit,’’ Yong said. ‘‘Sometimes
you can use all your technical knowledge and argue
and argue all day, or sometimes you use a little
street smarts and get to the same place, a better
place.’’
More Than Technical Knowledge
Beth Wapner of Qualcomm Inc. said transfer
pricing isn’t necessarily just technical knowledge.
‘‘You read the regs, and maybe they make sense,
and maybe they don’t, but it boils down to the
numbers that you can present to the auditors and
the methodology or the reasonableness of what
you’re doing,’’ she said. ‘‘It doesn’t seem to me that
the IRS really wins a lot.’’
Wapner cited as an example the recent U.S. Tax
Court decision in Altera Corp. v. Commissioner, 145
T.C. No. 3 (2015), which represented the IRS’s third
straight defeat in its long-running attempt to require a U.S. corporation to include stock-based
compensation in the costs to be shared with a
foreign affiliate for jointly developing intangible
assets. (Prior analysis: Tax Notes Int’l, Aug. 3, 2015,
p. 386.)
Wapner said her company is participating in the
IRS’s compliance assurance process program, exchanging information with the agency before filing
its tax returns to increase certainty and reduce the
administrative burden. (Prior coverage: Tax Notes,
June 16, 2014, p. 1256.)
‘‘The CAP program is basically a real-time audit
of your tax return,’’ Wapner said. ‘‘It’s a very
efficient process. Having worked on audits that
were 12 years old and 10 years old, it’s almost
impossible to get information. People leave the
company or, unfortunately, pass away . . . or you
get boxes of junk, and you can’t find any real
information.’’
Jose Huerta, the Latin America, Caribbean, and
Canada tax director for Visa Inc., said the U.S. side
of multinational audits has been managed quite
well ‘‘on the controversy side.’’ Huerta said Brazil
has given him ‘‘heartburn’’ because the country
prescribes a net profit for intercompany transactions, which raises the potential for double taxation.
Wapner agreed. ‘‘I always crunch my teeth when
I hear we’re doing something in Brazil,’’ she said.
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Tax Directors Share ‘War Stories’
On Transfer Pricing Audits
NEWS AND ANALYSIS
Huerta said that as countries move to implement
the OECD’s base erosion and profit-shifting action
recommendations the audit process will become
more complex. ‘‘The concern that I personally have
in a post-BEPS environment with a competent authority case is that [BEPS has] kind of emboldened
the tax authority to be more aggressive to pursue,
quite frankly, U.S. multinationals . . . to shore up a
shortage in their treasury,’’ he said. That will lead to
significant increases in the workloads of competent
authorities and a consequent increase in the amount
of time needed to resolve the cases, Huerta said.
Give In to Win
Yong said auditors frequently like to travel to San
Diego, where his company is headquartered, and to
Los Angeles, which was home to a previous employer. ‘‘Los Angeles, Disneyland, Knott’s Berry
Farm, all those things,’’ he said. ‘‘We always tried to
schedule audits next to long government holidays.
A lot of them bring their family, and they don’t get
the work done. If you do have auditors coming in,
schedule it right next to a long government holiday.’’
Yong said his company used to fight auditors.
‘‘Most companies stick them in the basement,’’ he
said. ‘‘I have found that when you treat them
poorly, they look for ways to get revenge.’’ When
once confronted with a tax auditor’s request to
produce what he considered to be an unreasonable
number of documents, Yong said he told his audit
manager, ‘‘Let’s hire some temporary workers that
are very good at making Xeroxes, and let’s Xerox
HAWKINS CALLS FOR MORE VISIBLE OPR ACTIVITY
Karen Hawkins, former director of the IRS Office
of Professional Responsibility, said October 27 that
she is concerned that OPR may be returning to the
‘‘black hole’’ and ‘‘star chamber’’ that it had been
before her tenure.
‘‘I am concerned that the Office of Professional
Responsibility, at the moment, has gone to sleep,’’
Hawkins said at the annual Tax Controversy Institute in Beverly Hills, California. She said it was
distressing that the OPR has not posted discipline
statistics on its website since she retired in June.
‘‘Part of what you all need to know is that they are at
it, that they are keeping an eye on everything,’’ she
said. (Prior coverage: Tax Notes, July 27, 2015, p. 386.)
Hawkins noted that the most recent batch of
announced disciplinary actions in September (Announcement 2015-20, 2015-38 IRB 355) showed a
decline in the number of actions from those announced at the end of her tenure. In September there
were just 19 entries, nearly all of which were expedited suspensions based on other punishments, such
as the loss of a license. The June announcement
(Announcement 2015-15, 2015-22 IRB 1014) had 26
entries, several of which were not expedited suspensions, while the March announcement (Announcement 2015-7, 2015-13 IRB 823) had 46 entries.
Hawkins said she is also concerned about the
continued unavailability of final decisions on the
OPR website. She said she had ordered all of the
decisions removed in December to address a concern
about section 6103, but that the intent had been to
restore them after the cases had been cleaned up.
‘‘That project was well in hand and moving along
when I left,’’ she said, adding that the Web page is
still unavailable today.
‘‘You need to start encouraging that office to get
visible again,’’ Hawkins told the room full of tax
practitioners. She said that practitioners should ask
for guidance on OPR’s guidelines for practice, including any differences that may exist with those
established under her tenure.
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— Nathan J. Richman
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Developing Countries Easier to Work With
Yong said his company has been applying for a
unilateral advance pricing agreement with the U.S.
Treasury Department in connection with its assets
in Mexico. ‘‘There’s only one country that we’re
talking to, and it’s taken over two years, and we still
don’t have it,’’ he said.
Yong said it can be easier to deal with the tax
authorities of developing countries on transfer pricing issues. ‘‘I try not to roll my eyes when they talk
about developed countries and developing countries,’’ he said. ‘‘Which one is developed, and which
is developing? The U.S. is really behind in terms of
trying to provide certainty to companies, while the
so-called developing companies are really
quicker. . . . Mexico, Chile, and Peru [are] much
easier to work with.’’
Hicks, who was previously associate chief counsel (international) in the IRS Office of Chief Counsel, said the agency is confronted with resource
constraints that some of its foreign counterparts
don’t share.
Wapner said her company frequently finds it
easier to deal with audits on its home soil than it
does abroad. ‘‘In Korea, they just basically bring in
a SWAT team,’’ she said. ‘‘They go away and make
their adjustment.’’
In India, audits can remain open for extended
periods, said Wapner. ‘‘They seem to start their
audit close to the end of the statute of limitations,’’
she said. ‘‘They somehow have the ability to reopen
closed years.’’ In contrast, she said, Singapore is
‘‘pretty quick.’’
NEWS AND ANALYSIS
‘We always tried to schedule audits
next to long government holidays. A
lot of them bring their family, and they
don’t get the work done,’ said Yong.
Yong said one of the keys to shorten the tax audit
process in the United States is to assemble in
advance the documents that auditors will typically
request. ‘‘They come in . . . and they’re amazed,’’ he
said. ‘‘That’s really helped in terms of moving
things along faster.’’
Foreign Tax Credit a Zero-Sum Game
Hicks said the U.S. foreign tax credit system,
which generally allows a taxpayer to take a credit
against its U.S. tax liability for taxes paid abroad,
makes the IRS ‘‘understandably’’ reluctant to allow
the credit. The taxpayer has to demonstrate to the
IRS that any tax paid to a foreign government was
compulsory and was not made voluntarily, Hicks
said, adding, ‘‘It’s very tricky in . . . non-U.S. audits
when you settle and how you settle.’’
Hicks said the rules about when an FTC can be
taken used to be very procedural but that the IRS is
now starting to wield them more rigorously. ‘‘The
idea is ‘Have you done enough to . . . fight this
non-U.S. audit?’’’ he said.
Transfer Pricing Roundup
By Ryan M. Finley — ryan.finley@taxanalysts.org and
Kristen Langsdorf — kristen.langsdorf@taxanalysts.org
Alimera Sciences Inc.
Jurisdiction(s): Undisclosed
Alimera Sciences Inc., a biopharmaceuticals company based in Alpharetta, Georgia, reported in an
October Form 8-K that it recorded prior-period
transfer pricing adjustments of approximately $3.5
million.
Altera Corp.
Jurisdiction(s): United States
Altera Corp., a programmable logic device
manufacturer headquartered in San Jose, California,
reported in an October Form 10-Q that it recorded a
$26.2 million increase in income taxes payable and
receivable, primarily because of higher tax liabilities
in the United States and foreign jurisdictions for tax
exposures related to cost sharing and transfer pricing.
Jabil Circuit Inc.
Jurisdiction(s): Undisclosed
Jabil Circuit Inc., a global manufacturing services
company headquartered in St. Petersburg, Florida,
reported in an October Form 10-K that it is reasonably possible that its unrecognized tax benefits
could decrease during the next 12 months by $1.3
million from cash payments and $11.6 million related to the settlement of audits or the expiration of
statutes of limitations. The amounts relate primarily
to a possible transfer pricing adjustment.
Bristol-Myers Squibb Co.
Jurisdiction(s): Undisclosed
Bristol-Myers Squibb Co., a global pharmaceutical company headquartered in New York, reported
in an October Form 10-Q that it is being audited by
a number of tax authorities and that significant
disputes may arise regarding transfer pricing.
Bristol-Myers said it estimates that it is reasonably
possible that the total amount of unrecognized tax
benefits at September 30, 2015, could decrease by
$280 million to $340 million in the next 12 months as
a result of settlement.
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everything.’’ After ‘‘trucking documents to them
into their offices,’’ Yong said, the auditors later
admitted that they couldn’t get through all of the
material they had requested. ‘‘Give them what they
want,’’ he said. ‘‘There’s no way they can get
through them.’’
NEWS AND ANALYSIS
By William R. Davis — william.davis@taxanalysts.org
A 40-year-old tax dispute involving the Redstone
family, known for their ownership in CBS Corp. and
Viacom Inc., has concluded with the Tax Court
holding October 26 that the children did not receive
a gift but rather a transfer of shares.
In Estate of Edward S. Redstone v. Commissioner,
145 T.C. No. 11 (2015), the court said that in
determining whether a transfer of property was
made in the ordinary course of business — causing
an exception from the gift tax — it only matters that
the transferor of stock receive consideration for the
transfer, not that the transferees gave up consideration.
‘That is a bona fide, arm’s-length
transaction free of any donative intent
if I’ve ever seen one,’ said Crawford.
Mitchell Gans of Hofstra University School of
Law said the court’s decision appears to be the
correct answer given the regulations in the area and
problems with the IRS’s argument that consideration must be received from the transferee in order
to apply the ordinary course of business exception.
‘‘Judge Lauber’s decision is right on the merits,’’
Bridget J. Crawford of Pace University Law School
said. Edward Redstone did not make a gift to his
children; he transferred shares to them to settle a
lawsuit with his father, and ‘‘that is a bona fide,
arm’s-length transaction free of any donative intent
if I’ve ever seen one,’’ she said.
Howard J. Castleman of Castleman Law LLC,
who represented Edward Redstone’s estate, said he
thought the Tax Court’s opinion was well reasoned
and that it supports — both legally and factually —
what Edward Redstone had maintained his whole
life: that his departure from the family business in
1972 and the transfer of his stock to trusts for his
children resulted from a compromised settlement.
‘‘In the end, the Tax Court’s opinion was a largely
straightforward application of established gift tax
law to a clear set of facts, no matter how extraordinary those facts were,’’ Castleman said.
Background
‘‘It’s unusual to see a 1972 gift tax case, and what
they were arguing about was something even older
than that, dating back to a supposed oral trust from
1959,’’ Ronald D. Aucutt of McGuireWoods LLP
said.
The petitioner is the estate of Edward Redstone,
who died in 2011. The dispute involved a settlement
in 1972 between Edward and his father, Mickey, and
brother, Sumner. Sumner Redstone is well known as
the majority owner of CBS and Viacom.
From the 1930s to the 1950s, Mickey built a real
estate and movie theater business, which was eventually consolidated into a single holding company,
National Amusements Inc. (NAI). Mickey, Edward,
and Sumner each received one-third of NAI’s only
class of stock. Upon NAI’s incorporation, Mickey,
Edward, and Sumner contributed $30,328, $17,845,
and $18,445, respectively.
Toward the end of the 1960s, disputes arose
between Edward and his father and brother, leading
Edward to feel marginalized within the business
and family. His role at NAI gradually decreased,
and in 1971 Edward quit the business and threatened to sell his shares of the company to an
outsider. Mickey, who wanted to keep control of the
business within the family, refused to hand over the
stock certificates, claiming that Edward’s shares
were in trust for Edward’s children.
Mickey claimed that in 1959, when he created
NAI, the shares had been held in an oral trust
created at the same time. After months of negotiations, the parties agreed to settle by giving one-third
of Edward’s shares to trusts in the benefit of his two
children. His remaining shares were sold back to
NAI for $5 million.
Legal Issues
Edward did not file a federal gift tax return in
1972. The IRS in 2013 issued a notice of deficiency
for $737,625 in federal gift tax for the 1972 tax year.
Under section 2501(a)(1), gift tax is imposed on the
transfer of property by gift.
Section 2512(b) says that when property is transferred for less than adequate and full consideration,
the amount by which the property’s value exceeded
the value of the consideration must be a gift. Reg.
section 25.2511-1(g)(1) says that the gift tax also
doesn’t apply to ordinary business transactions. A
transfer of property in the ordinary course of business is ‘‘a transaction which is bona fide, at arm’s
length, and free from any donative intent.’’ These
three conditions are based on objective facts of the
transfer rather than the subjective motives of the
donor.
The court found that all three elements of a
transfer of property in the ordinary course of business were met, therefore satisfying the exception
from gift taxes. ‘‘The focus of the parties’ dispute is
whether Edward’s transfer of stock in trust for his
children was made for ‘an adequate and full consideration in money or money’s worth,’’’ the court
said.
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Court Holds for Taxpayer in
40-Year-Old Gift Tax Case
NEWS AND ANALYSIS
‘Trying to go back and establish facts
from 1959 and 1972 transactions just
doesn’t seem like a wise application
of resources by the IRS,’ said Aucutt.
Gans said he thinks the IRS’s basic argument that
Edward must have received the consideration from
the third party, the children in this case, was inconsistent with the law. ‘‘I think what really happened
here is that the real gift was made by the grandfather, Mickey,’’ he said. ‘‘I think that at the end of the
day, the IRS went after the wrong taxpayer.’’
‘‘I think these third-party transactions are a little
treacherous for the IRS because it comes down to
the identity of the donor,’’ Gans said. Clearly there
was a gift, and by concluding it was not made by
Edward, the court implicitly concluded it was made
by Mickey, he said.
‘‘I see more family disputes than I’d like to see,
and a lot of times they are settled by moving assets
around the family,’’ Aucutt said. ‘‘I appreciate that
while the IRS sees the moving of assets and is
concerned with the avoidance of the gift tax, usually making gifts to one another is the last thing
these folks have in mind while settling these kinds
of disputes.’’
Aucutt speculated that if the assets that were
transferred to Edward’s children had lost their
value, the IRS would not have gone after the
transaction, and ‘‘from that perspective it is not as
easy to be sympathetic with the IRS.’’ He added,
‘‘Trying to go back and establish facts from 1959 and
1972 transactions just doesn’t seem like a wise
application of resources by the IRS.’’
received from the transferee in order to count for
purposes of the gift tax. Thus, ‘‘the amount of A’s
gift to the child of the income interest is the excess
of the value of the income interest transferred to the
child over the value of consideration received by A
for that transfer,’’ the revenue ruling says. That
sentence is directly contrary to the argument the
IRS made in the case, Gans said.
Gans suggested that the children did provide
consideration, which conflicts with the court’s conclusion. Gans argues that, under the oral trust, the
children had a claim to shares in the corporation. To
the extent that they received fewer shares under the
settlement than under the terms of the oral trust,
they did in fact suffer a diminution in their rights
that inured to the benefit of Edward.
Sumner Redstone Case
There is still an open Tax Court case for the same
tax year involving Sumner Redstone as the petitioner, Redstone v. Commissioner, T.C. Dkt. No.
8097-13 (filed Apr. 10, 2013). That case contemplates
whether stock placed in trust for Sumner’s children
in 1972 as part of the settlement is a gift. (Prior
coverage: Tax Notes, May 13, 2013, p. 712.)
Crawford noted that in footnote 4 of the October
26 decision, the Tax Court makes clear that when no
gift tax return is filed, the statute of limitations does
not begin to run. ‘‘I expect that the Tax Court will
reject any statute of limitations argument by Sumner Redstone,’’ she said.
In footnote 2, the court observed that Edward’s
and Sumner’s cases are different because Edward
transferred shares to his children to settle a lawsuit
that he brought. ‘‘Whether Sumner will be able to
claim that his transfer to his own children was in
settlement of that suit remains to be seen; I predict
a finding of a taxable gift in that case,’’ Crawford
said.
Conflicting Arguments
In Rev. Rul. 77-314, 1977-2 C.B. 349, the IRS
indicated that consideration does not need to be
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After a lengthy discussion, the court noted that
the IRS did not ‘‘seriously challenge’’ the estate over
whether Edward provided consideration in the
1972 transaction. It challenged whether Edward’s
children provided consideration in exchange for the
transfer of the shares.
‘‘Respondent’s argument derives no support
from the text of the governing regulations,’’ the
court said, adding that it does not matter whether
the transferees provided consideration because the
regulations ask whether the transferor received
consideration.
The court decided that Edward received full and
adequate consideration in the form of recognition
by Mickey and Sumner that he was the outright
owner of 662⁄3 shares and NAI’s agreement to pay
$5 million in exchange for those shares.
NEWS AND ANALYSIS
By Kat Lucero — kat.lucero@taxanalysts.org
A reconciliation bill that would repeal major tax
provisions of the Affordable Care Act cleared the
House on October 23, advancing the fast-track
measure to the Senate, where it could avoid a
filibuster and pass by a simple majority vote.
The House approved the Restoring Americans’
Healthcare Freedom Reconciliation Act of 2015
(H.R. 3762) on a party line, 240-189 vote.
The White House has repeatedly said the administration opposes any attempts to dismantle the
ACA, and issued a statement of administration
policy October 21 saying President Obama would
veto the bill if it reaches his desk.
The bill would repeal the individual and employer mandates, the 2.3 percent medical device tax,
and the 40 percent excise tax on high-value health
plans, also known as the Cadillac tax. The bill
includes proposals from the House Ways and
Means, Education and the Workforce, and Energy
and Commerce committees.
‘‘Major components of Obamacare that are repealed under this legislation represent the core of
the coercive nature of the president’s healthcare law
— policies that are forcing people into a healthcare
system that Washington is simultaneously making
more expensive, less accessible, and with fewer
choices,’’ House Budget Committee Chair Tom
Price, R-Ga., said in a floor statement.
According to the Congressional Budget Office,
the bill would reduce federal deficits by $37.1
billion over the 2016-2025 period, under static estimates. Repealing the individual and employer
mandates would increase revenue by $147.1 billion,
and repealing the Cadillac tax would cost $91.1
billion, it said, citing estimates by the Joint Committee on Taxation.
‘‘So instead, because the Republican conference is
essentially mostly fighting itself, this institution is
handcuffed on these issues,’’ Levin said.
In the Senate, a few Republican opponents of the
ACA criticized the reconciliation bill for not repealing the entire law.
‘‘This simply isn’t good enough,’’ Republican
Sens. Mike Lee of Utah, Ted Cruz of Texas, and
Marco Rubio of Florida said in a statement October
22. ‘‘If this bill cannot be amended so that it fully
repeals Obamacare pursuant to Senate rules, we
cannot support this bill.’’ (Prior coverage: Tax Notes,
Oct. 26, 2015, p. 494.)
Another conservative group has been making the
same argument against the legislation, saying that it
has divided Republicans in Congress.
‘‘We expect the Senate to do better, and every
member that voted in favor of this bill should
explain to their constituents how full repeal of
Obamacare will become a reality in 2017,’’ Heritage
Action for America CEO Michael A. Needham said
in a statement after the House passed the measure.
House taxwriter Charles W. Boustany Jr., R-La.,
told Tax Analysts that lawmakers’ positions on the
reconciliation package have changed, comparing
them to ‘‘a moving goal post — especially with
senators running for president.’’
Boustany said Price had several conversations
with key senators to negotiate the specific ACA
provisions in the legislation, knowing that lawmakers have limitations using the reconciliation process.
‘If this bill cannot be amended so that
it fully repeals Obamacare pursuant to
Senate rules, we cannot support this
bill,’ Lee, Cruz, and Rubio said.
Several House Democrats argued that the reconciliation process was unproductive — especially
with Congress facing looming fiscal deadlines.
Ways and Means Committee ranking minority
member Sander M. Levin, D-Mich., criticized Republicans for focusing on repealing the ACA instead of dealing with the debt ceiling, tax extenders,
and the Highway Trust Fund.
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House Approves Reconciliation
Bill to Repeal ACA Taxes
NEWS AND ANALYSIS
By Stephen K. Cooper —
stephen.cooper@taxanalysts.org and
Kaustuv Basu — kaustuv.basu@taxanalysts.org
President Obama signed a stopgap extension of
spending authority for the federal Highway Trust
Fund on October 29, as House and Senate lawmakers turned their attention to a long-term transportation bill.
The Senate on October 28 approved the Surface
Transportation Extension Act of 2015 (H.R. 3819), a
bill to extend the trust fund’s spending authorization through November 20. The measure, which
passed the House a day earlier, will give lawmakers
time to complete work on a six-year transportation
bill.
The Senate passed the Developing a Reliable and
Innovative Vision for the Economy (DRIVE) Act of
2015 (S. Amdt. No. 2266 to H.R. 22) in late July. The
House Transportation and Infrastructure Committee approved its version of the bill, the Surface
Transportation Reauthorization and Reform Act of
2015 (H.R. 3763), on October 22.
The House is expected to consider H.R. 3763
during the week of November 2, but the Ways and
Means Committee will not mark up a tax title to
that bill, House taxwriter Kenny Marchant, R-Texas,
said. The revenue offsets in the Senate’s long-term
highway bill will likely be used by the House, he
said.
Instead, the House Rules Committee will hold a
November 2 hearing to merge the revenue offsets in
the Senate’s DRIVE Act with the House transportation bill, said Marchant and Rep. Peter A. DeFazio,
D-Ore., ranking minority member of the House
Transportation and Infrastructure Committee.
of Transportation estimates that the trust fund balance is expected to dip below a safe level.
Although DeFazio said he supported the shortterm extension bill in the House, he faulted his GOP
colleagues for not considering all options for funding a six-year highway bill. ‘‘We’re told any increase
in user fees, gas tax, barrel tax, indexation of the gas
tax, vehicle miles traveled, it’s all off the table,’’ he
said during floor debate on the short-term extension.
Ways and Means Committee Chair Paul Ryan,
R-Wis., negotiated with Senate Finance Committee
member Charles E. Schumer, D-N.Y., on a plan to
fund federal highway spending through a combination of international tax reform proposals, but
that effort stalled in early October. (Prior coverage:
Tax Notes, Oct. 12, 2015, p. 226.)
Ryan replaced Rep. John A. Boehner, R-Ohio, as
House speaker on October 29. (Related coverage: p.
640.) ‘‘So we will have to see in his new position, if
[Ryan] is willing. We are still willing to talk,’’
Schumer told reporters October 27. Schumer said he
and Ryan are still far apart from an agreement that
would result in higher funding for highways.
‘We’re told any increase in user fees,
gas tax, barrel tax, indexation of the
gas tax, vehicle miles traveled, it’s all
off the table,’ DeFazio said.
The DRIVE Act’s tax title includes roughly $8
billion in miscellaneous tax provisions. According
to a Joint Committee on Taxation explanation of the
bill (JCX-106-15), it includes tax provisions affecting
passports, estate taxes, mortgage reporting, filing
dates for tax returns, pension assets, and tax collection contracts.
Lawmakers want to pass a multiyear transportation bill before November 20, when the Department
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Obama Signs Short-Term
Highway Funding Bill
NEWS AND ANALYSIS
Ryan Elected Speaker
Rep. Paul Ryan, R-Wis., was elected House
speaker on October 29, leaving behind what he had
called his dream job — chair of the House Ways and
Means Committee.
The 236-184 House floor vote for Ryan brought to
an end weeks of uncertainty about the future of
House Republican leadership after outgoing
Speaker John A. Boehner, R-Ohio, announced he
was resigning. The House Republican Conference
nominated Ryan in an election on October 28. He
received 200 votes out of a possible 247.
Ryan became chair of the Ways and Means
Committee in January after leading the House
Budget Committee during the 112th and 113th
Congresses.
During his inaugural speech, Ryan offered a
small glimpse of his legislative agenda as the
House’s 54th speaker, criticizing the current tax
system: ‘‘How reassuring it would be if we actually
fixed the tax code,’’ he said.
‘How reassuring it would be if we
actually fixed the tax code,’ Ryan
said.
Senate Finance Committee Chair Orrin G. Hatch,
R-Utah, commended Ryan for his brief tenure on
the Ways and Means Committee, saying that the
former taxwriter is a ‘‘policy wonk’’ who can articulate the conservative agenda.
Brady vs. Tiberi
Ryan’s new role opens up a contest for the Ways
and Means chair between committee members
Kevin Brady, R-Texas, and Patrick J. Tiberi, R-Ohio.
House taxwriter Devin Nunes, R-Calif., who was
reportedly interested in chairing the Ways and
Means Committee, issued a statement on October
29 saying that he will stay on as chair of the House
Permanent Select Committee on Intelligence.
Rep. Sam Johnson, R-Texas, will be the interim
chair of Ways and Means while continuing to serve
as the Social Security Subcommittee chair. The
House Republican Steering Committee, which delegates the committee assignments to party members, will decide on the new chair by the end of the
week of November 2, according to taxwriter Rep.
Kristi L. Noem, R-S.D.
Ryan’s departure also creates a vacancy on the
committee. Lawmakers who might try for committee membership include Reps. Carlos Curbelo,
‘I’m really energized by where we are
at in the campaign,’ Brady said.
‘‘Expired and expiring provisions are a distraction to achieving a comprehensive re-write of the
Tax Code. On day one we need to provide leadership to address tax extenders before year’s end,’’
Tiberi wrote.
‘‘I have a vision for a Ways and Means Committee that leads in moving pro-growth tax reform and
tax relief for individuals, families, and employers,
while also advancing Medicare, Social Security, and
welfare reforms,’’ Tiberi continued.
Brady said October 29 that his campaign is going
well. ‘‘I’ve been through this process before. [The]
Steering Committee knows who I am and how I’m
bringing a pro-growth agenda to the Ways and
Means Committee and deliver it for our conference,’’ he said.
‘‘I’m really energized by where we are at in the
campaign,’’ Brady added.
Who Has the Edge?
Tiberi said Brady’s Texas delegation is the largest
among House Republicans, at 25 members and six
full committee chairs. ‘‘Obviously, they have a lot of
clout around here, and they are a force to be
reckoned with,’’ Tiberi said.
Brady challenged the perception that he is not as
strong a fundraiser as Tiberi. He said he raised more
than $2 million for the National Republican Congressional Committee last year — ‘‘nearly double
[the amount of] my good friend Mr. Tiberi’’ — and
that he has accelerated his fundraising.
According to a blog post on OpenSecrets.org,
Tiberi has ‘‘shared an impressive amount of his
wealth, contributing over $3 million to other Republican candidates and party committees. In fact,
he ranks 24th overall among House members in
giving to colleagues and party.’’ Brady has given
more than $2.6 million to party committees and
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By Kaustuv Basu — kaustuv.basu@taxanalysts.org
R-Fla., and Bradley Byrne, R-Ala., according to one
Ways and Means taxwriter.
The canvassing for support for the next committee chair is in full swing. Minutes after the House
adjourned for the day on October 29, Tiberi could
be seen in animated conversation with House Budget Committee Chair Tom Price, R-Ga., while Brady
stood at the back of the chamber.
Earlier in the day, Tiberi sent a letter to House
Ways and Means Republicans sharing his objectives
for the committee.
Tiberi said the committee needs to immediately
address funding for transportation infrastructure, a
comprehensive rewrite of the tax code, and advancing free trade.
NEWS AND ANALYSIS
Tiberi also introduced the following legislation,
which passed out of the Ways and Means Committee but hasn’t been taken up by the full House:
• H.R. 2510, which would enable businesses to
immediately deduct 50 percent of qualified
purchased property; and
• H.R. 961, which would make permanent the
subpart F exemption for active financing income.
Tiberi’s office pointed out that he was instrumental in passing a repeal of the ACA’s Form 1099
reporting requirements for small businesses. He
also headed tax reform efforts as former chair of the
Ways and Means Select Revenue Measures Subcommittee by examining in a series of hearings how
reform could affect different sectors of the economy.
‘‘The ideas and feedback generated in these hearings were incorporated into the Camp tax reform
draft,’’ Tiberi’s office said in an e-mail. ‘‘Congressman Tiberi was a member of Chairman Camp’s
‘kitchen cabinet’ on tax reform, meeting regularly to
discuss tax reform, giving feedback and generating
ideas.’’
Tiberi’s spokesperson said the
lawmaker is committed to working
with the new speaker toward the
long-term goal of fundamental tax
reform, but that he will also focus on
cost recovery issues that promote
increased investment, economic
growth, and job creation.
Earlier this year, the House passed a bill (H.R.
636) introduced by Tiberi that would allow taxpayers to expense up to $500,000 of investments in new
equipment and property per year under section 179,
with the deduction phased out for investments
exceeding $2 million.
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other candidates, making him 36th among current
House members, the post says.
‘‘If getting the nod to helm the Ways and Means
panel is a question of seniority, Brady has the
advantage. But if it’s a question of money, Tiberi has
been more helpful to his party over the years,’’ the
blog concludes.
When reporters asked Brady about the high
number of committee chairs from Texas, he said
that number could change dramatically because of
term limits. ‘‘At the end of the day, the steering
committee is going to choose not on regional differences but on experience — those who have united
the conference, and those who have frankly done
the work for many years and can move a progrowth agenda for the new speaker, which is me,’’
Brady said.
Over the past year, Brady has been a vocal
proponent of legislative efforts to repeal the Affordable Care Act using the budget reconciliation process, and for using international tax reform to pay
for federal highway construction.
Several Brady-sponsored bills have won House
approval, including:
• the American Research and Competitiveness
Act of 2015 (H.R. 880), a bill to simplify and
make permanent the research credit;
• the Death Tax Repeal Act of 2015 (H.R. 1105), a
bill that would repeal both the estate and
generation-skipping transfer taxes; and
• the State and Local Sales Tax Deduction Fairness Act of 2015 (H.R. 622), which would make
permanent the deduction for state and local
sales taxes.
Tiberi’s spokesperson said the lawmaker is committed to working with the new speaker toward the
long-term goal of fundamental tax reform, but that
he will also focus on cost recovery issues that
promote increased investment, economic growth,
and job creation.
NEWS AND ANALYSIS
By Kat Lucero — kat.lucero@taxanalysts.org and
Stephen K. Cooper — stephen.cooper@taxanalysts.org
Lawmakers last week passed a two-year budget
plan that includes major rule changes in partnership audits, as well as revisions to the Affordable
Care Act, pension contributions, and payroll revenue distribution.
The Bipartisan Budget Act of 2015 (H.R 1314)
passed on a 266-167 vote in the House on October
28 and on a 64-35 vote in the Senate on October 30.
Lawmakers were facing a November 3 deadline set
by Treasury for when the debt ceiling will expire.
On October 30 a White House spokesperson said
that President Obama is planning to sign the bill
November 2.
The legislation establishes the top-line spending
levels for a separate omnibus funding measure and
would finance the federal government for fiscal
2016 and 2017, increase defense and non-defense
spending, and extend the debt ceiling deadline to
March 15, 2017.
Once the bill is enacted, appropriators will work
on detailed funding amounts for an omnibus measure. Lawmakers are hoping to finalize one before
December 11 — the expiration date of a temporary
measure that has been keeping government agencies open for the first few weeks of fiscal 2016.
Without a budget law passed by that deadline,
Congress will again have to churn out another
stopgap proposal, a continuing resolution, to fund
the government.
‘As always, we will go line by line
through agency budgets and make
decisions to ensure the best possible
use of every taxpayer dollar,’ Rogers
said.
‘‘My committee will now begin the hard work of
negotiating and crafting an omnibus Appropriations bill that will fund the entirety of the federal
government through fiscal year 2016,’’ House Appropriations Committee Chair Harold Rogers,
R-Ky., said in a statement. ‘‘As always, we will go
line by line through agency budgets and make
decisions to ensure the best possible use of every
taxpayer dollar.’’
Partnership Audit Compliance Proposal
To help offset the two-year budget, the bill includes an $11.22 billion tax compliance proposal
that would simplify the auditing process for part-
nerships, reducing down to one the three current
regimes they are subject to. The compliance proposal is broadly similar to the Partnership Audit
Simplification Act of 2015 (H.R. 2821), introduced in
June by House Ways and Means Committee member James B. Renacci, R-Ohio. (Related coverage: p.
644.)
Renacci told Tax Analysts that he was not part of
the budget negotiations. The taxwriter said he first
learned that his tax compliance proposal would be
in the budget agreement on the eve of the deal’s
unveiling. He criticized the process, saying that it
was a ‘‘prime example’’ in which ‘‘Congress circumvents regular order.’’
‘‘Unfortunately, the latest budget and debt ceiling package has once again hijacked the legislative
process,’’ Renacci said in an e-mail. ‘‘That said, due
to the engagement that I have had with stakeholders over the [last] four months, the partnership
audit proposal now in the budget package is a
significant improvement from any prior version
proposed by the administration or Congress.’’
ACA and Other Tax Provisions
Also included in the budget bill is a provision to
repeal the ACA’s requirement that employers with
more than 200 employees automatically enroll their
employees in qualifying healthcare plans.
‘Unfortunately, the latest budget and
debt ceiling package has once again
hijacked the legislative process,’
Renacci said.
Employer contributions to pension accounts
would also be affected by the budget bill’s proposed
increase in interest rates by 5 percentage points each
year for two more years, through 2023. The budget
summary said this provision would reduce required pension contributions by employers, giving
them more taxable income and thereby raising
revenue. (Prior coverage: Tax Notes, Oct. 6, 2014, p.
50.)
A payroll tax revenue provision in the budget
agreement aims to reallocate an additional 0.57
percentage points to the Disability Insurance Trust
Fund in 2016-2018, but the total payroll tax rate
would not change, according to the budget summary.
New House Speaker-elect Paul Ryan, R-Wis.,
supported the bill despite earlier criticizing the
funding process — ‘‘It stinks,’’ he told reporters
October 27.
Several Democrats expressed support for the
deal. In a statement, House Democratic leaders
said, ‘‘It’s a responsible agreement that is paid for in
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Congress Passes
2-Year Federal Budget
NEWS AND ANALYSIS
ACA Tax Provisions
Later this year, the Senate plans to consider a
separate budget reconciliation bill that includes
controversial provisions to repeal major tax provisions of the ACA and to defund Planned Parenthood. (Related coverage: p. 638.)
The reconciliation bill would go through a ‘‘votea-rama’’ session in the Senate, where lawmakers
can offer dozens of amendments to it, according to
Senate Republican Whip John Cornyn of Texas.
Cornyn told reporters the measure would likely
be considered before Thanksgiving. The House
passed it on October 9.
Koskinen Says IRS Will Try New
Budget Strategy in Fiscal 2017
By William Hoffman —
william.hoffman@taxanalysts.org
The IRS will try a new strategy for winning more
funding from Congress when the agency presents
its fiscal 2017 budget proposal, IRS Commissioner
John Koskinen said October 23.
In addition to requesting funds split between
four basic priorities — taxpayer services, enforcement, operations support, and business systems
modernization — the IRS will specify how much it
wants for individual initiatives and then ask Congress to hold the Service accountable for the results
the agency promises in return, Koskinen said at the
Council for Electronic Revenue Communication
Advancement (CERCA) fall meeting in Arlington,
Virginia.
‘‘When I say taxpayer service, what’s that
mean?’’ Koskinen asked the CERCA audience. ‘‘I
think it’s important for [Congress] to understand,
this is the initiative, the money you will spend,
whether it’s $10 million here or $50 million there,
that would in fact be the building block taking us
down the road.’’
The risk is that appropriators may be tempted to
target individual initiatives they or their constituents don’t like, Koskinen acknowledged.
‘It should be obvious to everybody by
now, we have no budget buffers or
contingency funds hidden anywhere,’
said Koskinen.
‘‘My sense is we’re much better off having that
discussion than having people try to figure out, in
that big [budget] bucket of IT or that big bucket of
enforcement [funding], exactly what’s going on and
where have you hid the other money that you’re not
telling us about,’’ the commissioner said. ‘‘It should
be obvious to everybody by now, we have no
budget buffers or contingency funds hidden anywhere.’’
‘Devastating Effects’
Koskinen said he doesn’t expect Congress to
appropriate the full $12.9 billion the Obama administration has requested for the IRS in fiscal 2016.
But Koskinen warned that proposed Senate and
House budgets that would cut IRS funding by $470
million or $838 million, respectively, in fiscal 2016
would have ‘‘devastating effects’’ on agency operations and employment, including the potential loss
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a balanced way by ensuring that hedge funds and
private equity firms pay the taxes they owe and by
cutting billions in wasteful spending.’’
However, outgoing Speaker John A. Boehner,
R-Ohio, told reporters on October 27 that the budget agreement would have detractors.
‘‘You’re going to see bricks flying from those who
don’t like the bipartisan agreement,’’ he said. Boehner said he never had a doubt the agreement would
be reached with the Obama administration, despite
the criticism from some lawmakers.
NEWS AND ANALYSIS
Potential Partnership Audit
Changes in the Budget Act
By Marie Sapirie — marie.sapirie@taxanalysts.org
A partnership proposal in the budget bill would
create a single, streamlined set of partnership audit
rules, repealing the rules from the 1982 Tax Equity
and Fiscal Responsibility Act and electing large
partnership (ELP) rules.
Streamlining partnership audits has been a focus
of legislative efforts and executive proposals over
the past few years. Most recently, House Ways and
Means Committee member James B. Renacci,
R-Ohio, offered his Partnership Audit Simplification Act of 2015 (H.R. 2821), which was nearly
identical to the proposal in former Ways and Means
Chair Dave Camp’s Tax Reform Act of 2014 (H.R. 1).
(Prior coverage: Tax Notes, July 13, 2015, p. 157.
Related coverage: p. 642.)
Former Sen. Carl Levin introduced legislation in
December 2014 designed to make it easier to audit
large partnerships by assessing tax liabilities at the
partnership level and eliminating the requirement
to notify all partners before an audit. (Prior coverage: Tax Notes, Dec. 22, 2014, p. 1324.)
The Obama administration included new simplified partnership procedures in its 2015 revenue
proposals. ‘‘The common theme among these proposals, and reflected in the Budget Act, is a shift in
the payment of tax from those persons who were
partners for the year under audit and received the
tax benefit from the tax item at issue, to the partnership and its current partners,’’ said Mary A.
McNulty of Thompson & Knight LLP.
Practitioners said that although the plan in the
budget agreement is imperfect, it reflects comments
about previous proposals. ‘‘Hopefully there will be
future opportunities to continue to iron out remaining aspects that are not needed to accomplish the
policy goal of greater tax compliance,’’ said Jeffrey
D. DeBoer of the Real Estate Roundtable in a
statement.
The proposals effectively apply the current ELP
rules to most partnerships, including partnerships
with a limited liability company, a trust, or another
partnership as a partner. McNulty noted that the
bill did not adopt a suggestion from practitioners
that would have expanded the application of the
ELP rules at the first-tier level for passthrough
partners, rather than at the partnership entity level.
‘‘That approach would have addressed the complex
computational problems present in multi-tiered
partnerships but been a less draconian approach
than the entity-level assessment approach in the
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of ‘‘several thousand’’ more employees eliminated
through continued hiring freezes and attrition.
Koskinen told Tax Analysts that he did not
anticipate or plan for reductions in force at the IRS
but couldn’t rule them out under direr budget
eventualities.
To the CERCA audience, the commissioner repeated his request that Congress decide the fate of
tax extenders legislation before filing season or risk
a delay to the start of filing season, especially if the
extenders that are passed require changes to forms
or to IRS information technology systems.
In the battle against stolen identity refund fraud
(SIRF), Koskinen said the IRS will be going on the
offensive in 2016. The IRS’s third security summit
meeting, convened October 20 at IRS headquarters,
announced that the agency, state tax authorities,
and major tax and financial companies had agreed
to share more than 20 data metrics designed to
prevent or catch SIRF. (Related coverage: p. 602.)
Koskinen said the IRS learned a lot from the Get
Transcript data thefts earlier this year, including
that the agency needs to make more and better use
of taxpayer identity authentication procedures and
income data matching to fight tax-related identity
theft. (Prior coverage: Tax Notes, June 1, 2015, p.
981.)
NEWS AND ANALYSIS
Partnerships Created by Gift
A second proposal in the bill would clarify that
Congress did not intend for the family partnership
rules to provide an alternative test for whether a
person is a partner in a partnership, and that the
generally applicable principles of law apply. Monte
Jackel of Jackel Tax Law said the issue stems from
the opinion in Castle Harbour (TIFD III-E Inc. v.
United States, 660 F. Supp.2d 367 (2009)). This provision is tangentially related to the partnership
audits provision in that it also addresses how to
collect tax more efficiently from large partnerships,
he said.
Steven R. Schneider of Goulston & Storrs PC
agreed that the change was prompted by Castle
Harbour. ‘‘They’re putting [section 704(e)] back
solely in the gift context, to where it was likely
originally intended,’’ he said.
Pending Treaties Adopt
U.S., International Standards
By Ryan Finley — ryan.finley@taxanalysts.org
Pending amendments to the Switzerland-U.S. tax
treaty would allow for information exchange between tax authorities under a broader range of
circumstances, according to testimony provided at a
Senate Foreign Relations Committee hearing October 29.
At the hearing, Sen. Johnny Isakson, R-Ga., and
Sen. Robert Menendez, D-N.J., heard testimony on
tax treaties from Robert Stack, Treasury deputy
assistant secretary (international tax affairs), and
Thomas Barthold, chief of staff, Joint Committee on
Taxation. The hearing addressed pending treaties or
amendments to treaties with Hungary, Chile, Poland, Switzerland, Luxembourg, Japan, and Spain,
as well as the Convention on Mutual Administrative Assistance in Tax Matters.
In his testimony, Stack stressed the importance of
timely approval of the pending treaties, complaining of the ‘‘prolonged and unprecedented delay’’
that may deny U.S. companies protection from
double taxation, leave law enforcement without the
tools needed to fight tax evasion, jeopardize U.S.
leadership on transparency issues, and cause other
countries to question the United States’ reliability as
a treaty partner. Stack added that the pending
treaties enjoy ‘‘tremendous support’’ from the business community.
Regarding the United States’ tax treaties with
Hungary and Poland, the most important additions
are the adoption of limitation on benefits provisions
to prevent treaty shopping, Stack said. He added
that corporate tax data indicates the existence of
extensive treaty shopping.
Stack rejected the argument that the information
exchange provisions of the pending treaties introduce a ‘‘new and unacceptably low standard’’ for
exchanging information between tax authorities,
and one that departs from a traditional standard
allowing information exchange only when there is
suspicion of tax fraud. Stack said the standard for
information exchange adopted in the pending treaties and amendments, that the information be ‘‘foreseeably relevant,’’ has been the U.S. standard since
1996 and has since become the international standard. Of the 57 U.S. tax treaties in force, Stack said,
only the treaty with Switzerland provides for information exchange only in cases of tax fraud. Stack
argued that the restrictiveness of this standard has
impeded the enforcement of U.S. tax law on U.S.
citizens and has allowed Switzerland to become a
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Budget Act,’’ she said. Partnerships with 100 or
fewer qualifying partners could opt out of the new
rules.
Under the bill, the tax matters partner rules
would be replaced with a simplified partnership
representative provision that allows a partnership
to designate either a partner or non-partner to be
the representative with the sole authority to act on
behalf of the partnership for purposes of partnership audit and judicial proceedings. McNulty said
this is a practical solution that gives partnerships
much more flexibility regarding who can be chosen.
The proposed statute of limitations for assessments would look only at when the partnership’s
return was filed and extensions between the IRS
and the partnership, rather than taking into account
partners’ individual statutes of limitation. The statute of limitations for filing partnership refund
claims would be based solely on when the partnership return was filed but could not be extended by
agreement.
‘‘Complexities remain in the streamlined provisions in the Budget Act, particularly regarding the
computation of the imputed underpayment and
determining who pays,’’ said McNulty. The bill
presents several alternatives for potential payers,
including the partnership, the partnership and the
partners who file amended returns for the reviewed
year, all partners in the reviewed year for which the
partnership files adjusted Form K-1s, and the former partners of a partnership that ceases to exist.
Unlike with prior proposals, partners would not
be subject to joint and several liability for any
liability determined at the partnership level. ‘‘While
the Budget Act is taxpayer favorable and much
welcomed, further proposals may be needed to
ensure payment of a partnership’s entire tax liability,’’ said McNulty.
NEWS AND ANALYSIS
Stack said that a country must
adequately demonstrate the link
between the information sought and
the investigation underway.
According to Barthold, the pending treaty with
Spain introduces a 0 percent withholding tax rate
on parent-subsidiary dividends, while the treaty
with Japan broadens the eligibility criteria for the 0
percent rate.
A unique addition to the treaty with Japan is the
provision for limited assistance between tax authorities in the collection of taxes, Stack said. According to Stack, it is not generally the policy of the
United States to include such provisions in its tax
treaties, but in this case, they are expected to
provide a net revenue gain to the United States.
This provision abrogates the common law ‘‘revenue
rule,’’ which prevents the United States from collecting revenue for other countries, Barthold said.
He added that the United States has expressly
reserved on including similar provisions in the
multilateral convention. ‘‘The committee may want
to explore the basis for agreeing to this departure
from general policy,’’ he said.
Analysts Say Cruz
Tax Proposal Is a VAT
By Paul C. Barton — paul.barton@taxanalysts.org
A low flat rate for individuals along with what
some are calling a 16 percent VAT for businesses
highlight the tax plan of Republican Sen. Ted Cruz
of Texas, a candidate for the 2016 GOP presidential
nomination.
Cruz unveiled his ‘‘Simple Flat Tax Plan’’ in an
October 28 op-ed in The Wall Street Journal and
during a debate among Republican White House
candidates the same day in Boulder, Colorado.
(Related coverage: p. 648.) Cruz became the ninth of
15 GOP candidates to commit a tax plan to paper.
(Prior coverage: Tax Notes, Oct. 19, 2015, p. 361.)
Key provisions include:
• replacing the corporate income tax with a 16
percent tax on net business sales — gross sales
minus expenses and capital investments —
which the Tax Foundation characterized as a
subtraction method VAT;
• eliminating payroll taxes;
• allowing repatriation of overseas profits at a
one-time rate of 10 percent;
• consolidating the seven tax brackets for individual and joint filers into one 10 percent
bracket on all wage, salary, and investment
income, with a family of four paying nothing
on the first $36,000;
• keeping the child tax credit and the earned
income tax credit, although the latter would
have ‘‘anti-fraud’’ and ‘‘pro-marriage’’ reforms;
• keeping deductions for charitable giving and
home mortgage interest, with the latter capped
at principal values of $500,000;
• eliminating estate taxes, taxes on overseas
profits, the alternative minimum tax, and all
taxes related to the Affordable Care Act; and
• establishing tax-free savings accounts worth
up to $25,000.
As he did when he launched his presidential
campaign in March, Cruz said his flat tax would
lead to the abolishment of the IRS ‘‘as we know it’’
and would end its use as ‘‘political weapon, with a
simple tax code that is transparent and resistant to
corruption.’’ He did not, however, specify how
taxes owed would be collected under his plan.
(Prior coverage: Tax Notes, Mar. 30, 2015, p. 1590.)
The Tax Foundation estimated the cost of Cruz’s
plan at $768 billion over 10 years on a dynamic
basis and at $3.6 trillion under static scoring. The
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‘‘haven for tax cheats.’’ These problems make it
necessary to amend the treaty with Switzerland, he
said.
According to Stack, the foreseeably relevant standard has adequate safeguards to prevent ‘‘fishing
expeditions’’ and to protect confidentiality of information. He said that a country must adequately
demonstrate the link between the information
sought and the investigation underway.
Regarding other amendments to the United
States’ existing treaties, Stack said that the pending
amendments to treaties with Japan, Spain, and Switzerland introduce mandatory binding ‘‘baseballstyle’’ arbitration, in which a neutral arbitrator must
choose between one of the positions submitted by
the parties to the dispute. On these provisions, Barthold suggested that ‘‘the committee may wish to
consider the extent to which inclusion of mandatory
arbitration rules’’ now represents U.S. policy.
NEWS AND ANALYSIS
A VAT for Americans?
Some, but not all, conservatives warmly greeted
Cruz’s plan.
‘‘Under the Cruz tax plan, everyone’s rate would
be lower than today, and everyone would pay taxes
at the same rate as their neighbor,’’ said Grover
Norquist, head of Americans for Tax Reform. ‘‘The
Cruz universal savings account is a fantastic idea.
In one fell swoop, it would revolutionize savings
for every family in America who can’t afford a team
of financial advisors.’’
‘Under the Cruz tax plan, everyone’s
rate would be lower than today, and
everyone would pay taxes at the same
rate as their neighbor,’ said Norquist.
Similarly, Club for Growth President David
McIntosh said: ‘‘Ted Cruz’s tax reform plan is
another example of his strong and steady record on
fighting for lower taxes. A flat tax for individuals
and for businesses, a generous opportunity for
tax-free savings, and the elimination of the death
tax and Obamacare taxes are all policies that would
clearly stimulate economic growth.’’
Economist Kyle E. Pomerleau of the Tax Foundation called the business tax proposal ‘‘a pure consumption tax. As such, the plan would be progrowth.’’
But Chris Edwards, fiscal policy analyst at the
Cato Institute, didn’t like what he saw. ‘‘While
Senator Cruz is a champion of small government,
his business value added tax would spur government growth,’’ Edwards said. ‘‘VATs have fueled
the growth of large welfare states in Europe, and a
VAT would have the same effect if introduced in the
United States.’’
Edwards said, ‘‘Senator Cruz’s plan would hide a
large share of the cost of government in a much
expanded business tax where average voters could
not see it. Individuals ultimately pay the burden of
business taxes, so for transparency in a democracy,
taxes ought to be collected from individuals, not
businesses.’’
Harry Stein, fiscal policy analyst at the leftleaning Center for American Progress Action Fund,
said Cruz’s VAT would amount to ‘‘a huge consumption tax,’’ hitting low- and middle-income
Americans the hardest — especially many retirees
and others without wage, salary, or investment
income. ‘‘They will pay much higher prices because
of the VAT,’’ Stein said.
As for the 10 percent rate for individuals, Stein
said it represents ‘‘huge tax cuts to wealthy people’’
by increasing the after-tax income of the top 1
percent by almost 30 percent, which would be
‘‘enormously expensive.’’ And he said it would be
hard for lower-income Americans to take full advantage of the tax-free savings accounts.
While Cruz says his plan will guarantee the
future of Social Security and Medicare, Stein said he
needs to explain how, since he is eliminating the
payroll taxes that fund them now.
Howard Gleckman of the Urban-Brookings Tax
Policy Center said: ‘‘High-income households
would get a big tax cut. Low-income households
might also. Hard to know what happens in the
middle.’’
Cruz is at least the second GOP presidential
candidate to propose what many regard as a VAT.
Similar comments were made about the proposal of
Sen. Rand Paul, R-Ky., who in June called for a 14.5
percent rate applied to business revenues minus
some allowable expenses. Paul also called for eliminating payroll taxes. (Prior coverage: Tax Notes, June
22, 2015, p. 1352.)
Some Democrats have also demonstrated support for a VAT-style tax, notably Senate Finance
Committee member Benjamin L. Cardin, D-Md.,
who proposed the Progressive Consumption Tax
Act of 2014 late last year. (Prior coverage: Tax Notes,
Jan. 19, 2015, p. 329.)
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foundation also said it would add 1.39 percent
annually to economic growth compared with current tax law.
On the revenue side, it said the VAT alone would
bring in at least $25 trillion over a decade, many
times more than the corporate income tax it would
replace. The latter brought in $321 billion in fiscal
2014, according to the Joint Committee on Taxation
(JCX-70-15).
NEWS AND ANALYSIS
By Paul C. Barton — paul.barton@taxanalysts.org
Republican presidential candidates faced questions about the cost and fairness of their various tax
plans — and some revealed new details about them
— during October 28 debates in Boulder, Colorado.
Broadcast by CNBC, the debates involved one in
prime time for the 10 leading GOP candidates in the
polls, and an earlier undercard debate for four
others. They marked the third set of debates for
those seeking the 2016 Republican nomination.
Taxes were a leading topic from the start as
billionaire real estate developer Donald Trump was
asked how his plan could cut taxes at least $10
trillion over a decade without increasing deficits
and the national debt. The Tax Foundation has
estimated the cost of his tax plan at about $10
trillion on a dynamic basis and at close to $12
trillion on a static basis. (Prior coverage: Tax Notes,
Oct. 5, 2015, p. 47.)
Trump did not answer the question directly,
referring instead to supply-side economist Larry
Kudlow, an economics commentator on CNBC who
he said ‘‘loves my tax plan,’’ especially its call for a
15 percent rate on all businesses.
‘‘We’re bringing corporate taxes down, bringing
money back in,’’ Trump said, referring to the more
than $2 trillion that U.S. corporations have stashed
overseas because of tax issues.
But a moderator continued to press Trump about
the cost, referring to economists who have said its
chances of being revenue neutral were about the
same as him ‘‘flying away from that podium by
flapping [his] arms.’’
Trump responded, ‘‘Then you have to get rid of
Larry Kudlow, who sits on your panel, who’s a
great guy, who came out the other day and said, ‘I
love Trump’s tax plan.’’’
Cruz said his flat tax applies to ‘the
billionaire and the working man; no
hedge fund manager pays less than
his secretary.’
During the debate, Sen. Ted Cruz of Texas, long
an advocate of the flat tax, announced a formal tax
plan, which was also released in an op-ed in The
Wall Street Journal. Cruz’s plan calls for the elimination of corporate income and payroll taxes, replacing them with a 16 percent ‘‘business flat tax’’ on all
business income, minus purchases from other businesses and capital investment. For individuals,
there would be a 10 percent flat tax on all income,
whether from wages or investments. But for a
family of four, the first $36,000 of income would be
tax free. (Related coverage: p. 646.)
Cruz said his flat tax applies to ‘‘the billionaire
and the working man; no hedge fund manager pays
less than his secretary.’’
The news analysis website Vox.com, however,
said Cruz’s plan was ‘‘the most irresponsible Republican tax cut yet.’’ And Maya MacGuineas, head
of the Committee for a Responsible Federal Budget,
commented on the debate by saying, ‘‘The continued race to the bottom on tax policy is really
discouraging.’’
Ben Carson, the retired neurosurgeon from
Florida, said that when he formally releases his
plan, it will probably call for a flat rate ‘‘much
closer’’ to 15 percent than the 10 percent rate he had
talked about earlier — and likened to biblical tithing.
When asked about 15 percent still leaving a $1.1
trillion shortfall in federal funding, Carson said:
‘‘You also have to get rid of all the deductions and
all the loopholes. You also have to [have] some
strategical cutting in several places. Remember, we
have 645 federal agencies and subagencies. Anybody who tells me that we need every penny and
every one of those is in a fantasy world.’’
If the 15 percent rate were applied to corporations and investment income like capital gains, any
shortfall would be eliminated ‘‘pretty quickly,’’ Carson said, adding, ‘‘So that is not by any stretch a pie
in the sky.’’
But Ohio Gov. John Kasich criticized his competitors’ plans, saying ‘‘they would put us trillions and
trillions in debt.’’
Kasich added: ‘‘I’m the only one on this stage
that has a plan that would create jobs, cut taxes,
balance the budget, and can get it done because I’m
realistic. You just don’t make promises like this.’’
Economists at the Tax Foundation, however, said
October 15 that Kasich’s tax plan was lacking in key
details, making it difficult to apply economic models to calculate its cost.
Former Hewlett-Packard CEO Carly Fiorina,
meanwhile, was asked about her goal of reducing
the tax code to just three pages.
‘‘You know why three?’’ she said. ‘‘Because only
if it’s about three pages are you leveling the playing
field between the big, the powerful, the wealthy,
and the well-connected who can hire the armies of
lawyers and accountants and, yes, lobbyists to help
them navigate their way through 73,000 pages.
Three pages is about the maximum that a single
business owner or a farmer or just a couple can
understand without hiring somebody. Almost 60
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Candidates Grilled on Tax
Plans in Third GOP Debate
NEWS AND ANALYSIS
‘If you just cut their income tax, there
isn’t much income tax to cut,’ Paul
said.
Sen. Rand Paul of Kentucky said his 14.5 percent
flat tax plan does the most for middle-income
earners because it comes with a proposal to eliminate payroll taxes.
‘‘If you just cut their income tax, there isn’t much
income tax to cut,’’ Paul said. ‘‘Mine actually cuts
the payroll tax, and I think it would spread the tax
cut across all socioeconomic levels, and would
allow it to be something that would be broadly
supported by the public in an election.’’
During the undercard debate, former Pennsylvania Sen. Rick Santorum was questioned about the
fairness of his 20 percent flat tax proposal. He
denied it was regressive.
‘‘We have a $2,750 per person tax credit — that’s
$2,750 off the taxes due, not a deduction, a credit,’’
Santorum said. He added that ‘‘if you run the
numbers, no American [is] going to be paying more
taxes under our proposal.’’
At the same time, Santorum insisted his tax
proposals were part of an overall plan to balance
the budget, unlike other plans that would cost at
least $10 trillion over a decade. But the Tax Foundation has said his plan would cost $1.1 trillion over
10 years when accounting for economic growth and
$3.2 trillion otherwise. (Prior coverage: Tax Notes,
Oct. 19, 2015, p. 367.)
Louisiana Gov. Bobby Jindal, who has proposed
eliminating corporate income taxes, was asked
what tax preferences he would eliminate so that
corporate rates could be lowered. Jindal at first
discussed only the individual tax aspects of his
plan, but finally said: ‘‘I’d get rid of all the corporate
welfare. Make the CEOs pay their same tax rates the
way the rest of us do.’’
Jindal was also asked about his proposal to make
even the poorest individuals pay a 2 percent income
tax rate when they already pay payroll taxes.
‘‘You’re talking about payroll taxes that fund programs,’’ he said. ‘‘People pay for their Medicare,
they pay for their Social Security. I want every
American to worry and care about how those folks
in D.C. are spending our money.’’
Former New York Gov. George Pataki said he
would get rid of all tax loopholes, saying they cost
$1.4 trillion a year. ‘‘I will enact tax cuts, get rid of
those loopholes, and make the system fairer for all
Americans,’’ he said.
When asked about corporations relocating overseas to avoid U.S. taxes, Sen. Lindsey Graham of
South Carolina said: ‘‘We owe to every businessperson and worker in America the best environment in
the world to create a job. We owe that to American
businesses. [A] 35 percent corporate tax rate is the
second highest in the world. We need to lower it so
they don’t leave.’’
Graham also said the secret to South Carolina
landing a Boeing plant was, ‘‘We had a low tax
structure.’’
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percent of American people now need to hire an
expert to understand their taxes.’’
Former Florida Gov. Jeb Bush was asked why his
tax plan would tax labor at 28 percent but capital
gains at only 20 percent, given issues of income
inequality. Bush responded: ‘‘Look, the simple fact
is that my plan actually gives the middle class the
greatest break: $2,000 per family. And if you make
$40,000 a year, a family of four, you don’t pay any
income tax at all. Simplifying the code and lowering
rates, both for corporations and personal rates, is
exactly what we need to do. You think about the
regulatory cost and the tax cost — that’s why small
businesses are closing, rather than being formed in
our country right now.’’
Later, Florida Sen. Marco Rubio disputed charges
that his tax plan gave more benefits — according to
Tax Foundation scoring — to the top 1 percent than
middle-income earners.
Rubio insisted: ‘‘But the greatest gains, percentagewise, for people, are going to be at the lower end
of our plan, and here’s why: Because in addition to
a general personal exemption, we are increasing the
per-child tax credit for working families. We are
lowering taxes on small business.’’
NEWS AND ANALYSIS
TAX ANALYSTS EXCLUSIVE
Interviewed by William Hoffman —
william.hoffman@taxanalysts.org
The Taxpayer Advocate Service will host its
first International Conference on Taxpayer
Rights on November 18
and 19 in Washington.
Cosponsored by Tax
Nina Olson
Analysts, the conference will bring together tax administrators, practitioners, and academics from around the world
to compare their approaches to taxpayer rights
and efficient, effective tax administration.
National Taxpayer Advocate Nina Olson has
promoted taxpayer rights during her nearly
15-year career at the IRS, culminating with IRS
Commissioner John Koskinen inaugurating the
Service’s own Taxpayer Bill of Rights in June of
2014.
Olson recently spoke with Tax Analysts’ William Hoffman about the differences between
taxpayer rights and remedies, embedding taxpayer rights in the Internal Revenue Manual,
and why Sweden’s idea of taxpayer rights
would never work in the United States.
Tax Analysts: Why are we talking about international taxpayer rights when we don’t even have
taxpayer rights here at home?
Nina Olson: That’s a loaded question, and I
disagree with the premise. We do have taxpayer
rights at home. That’s part of what we’ve been
saying all these years — that the United States
actually has a tremendous number of statutory
rights and a fair amount of administrative protections, but nobody knows about them. Our survey
showed 11 percent of U.S. taxpayers know what
their rights are. That’s a miserable percentage.
That’s why I wanted the TABOR, so that it could be
an organizing principle so people could understand
underlying principles and begin to learn about their
statutory protections.
My organization has created a website that contains a list of statutory rights under each of the 10
thematic rights that are contained in the TABOR. So
the taxpayer can go and look on our website and
say, ‘‘Well, OK, you say I have a right to appeal.
What does that mean?’’ You can see the statutory
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Conversations: Nina Olson
Stands Up for Taxpayer Rights
and the administrative provisions in plain English
and their source of authority — the actual part of
the code — so you know it’s a law.
There are remedies under our rights, although
there are certainly some rights that don’t have
remedies. That’s what we’ve been working on:
identifying those and thinking about what an appropriate remedy would be to give those particular
rights some teeth.
Some countries have a grand statement of rights
but no specific remedies. Some countries derive
their rights from a convention of human rights. The
question is, how much of those human rights apply
in the tax context? Is tax something different that
you don’t have these human rights protections? Do
you need something else? Or, what are the remedies
under these human rights conventions as applied to
the tax world?
At the conference, we’re going to try to learn
from what other countries are doing. At the same
time, they can come and see what we’re doing.
That’s what the first panel is about. It will set a
foundation from which people can understand the
theories of taxpayer rights and the conventions or
principles from which they derive. One speaker, Joe
Thorndike, will talk about the United States’ progression through all of our TABORs. That progression was statutory, and it used a reactive approach
to counter abuses or perceived abuses. The United
States didn’t have an overarching principle. That’s
was what was missing.
Another speaker will talk about Italy — it has a
charter of rights, but it doesn’t have a lot of statutory protections. What do you need to do to create
remedies?
TA: Which countries do a better job than the
United States of protecting taxpayer rights and
remedies?
Olson: That’s a hard one. I think the United
States does very well with their rights and remedies, but I think the problem is that it doesn’t have
remedies for certain rights, for example, for poor
taxpayer service. The number two right in our
TABOR is the right to quality service. My organization took the rights to focus groups and asked,
‘‘What do you think of them?’’ Everybody, whether
they were preparers or taxpayers, laughed us out of
the room about the right to quality service.
What’s the remedy if you don’t get quality service? The United Kingdom and Australia have
apology payments for putting the taxpayer through
a lot of burden. They’re symbolic; they’re not compensatory. You’re not going to be able to say, ‘‘I
spent this many hours on the phone.’’
For the tax administration to say, ‘‘I’m sorry.
Here’s some recognition of what we made you go
through,’’ is a remarkable trust-building thing for
NEWS AND ANALYSIS
We wanted to take a few areas where you were
weren’t necessarily working with mature countries
— the kind of country like the United States, where
as much as taxpayers grumble about taxes, they
truly comply with the laws — and then look at
some of the other countries and some of the challenges that they have.
TA: At what point do taxpayer rights conflict
with efficient tax administration, and how would
you propose resolving those conflicts, especially
when you’re dealing with it on an international
scale?
Olson: I don’t think that there’s a conflict, if you
think of efficiency as including effectiveness. As I’ve
said in everything I’ve written about the TABOR, it
is the roadmap to effective tax administration. If
you have effective tax administration, it will be as
efficient as it can be, as opposed to the most
efficient. The most efficient is not asking anybody
anything and just telling them, ‘‘you owe money
and I’m going to collect it.’’ There are no rights
involved.
The minute you start thinking about due process,
procedural justice, or human rights, you bring in an
element of inefficiency because you look at people’s
facts and circumstances. But if you don’t look at
their facts and circumstances, you have an ineffective tax system and, ultimately, an inefficient one,
because you are going to have to start using more
and more brute force to make people comply, and
that is expensive.
There’s a balance. In all the rights there’s always
a point of cutoff. There’s the right to finality. It
works for both the government and the taxpayer.
There’s a period in which you can ask for a refund.
There’s also a period in which the government can
collect. That finality brings some efficiency into the
system.
There’s a right to an appeal, but there are limits to
it. None of these rights prevent the government
from putting limitations like that on. But on the
other hand, they do protect the government from
cutting them off prematurely or just refusing to hear
from the taxpayer. That right to challenge the IRS’s
position and be heard is an incredibly important
right.
In every focus group the participants said they
didn’t know they had the right to challenge the IRS
or be heard by the IRS. That right includes an
obligation on the part of the IRS: that it has to listen
to the taxpayer, too. It doesn’t mean you have to
keep listening to them over and over. There’s some
point where you can say, ‘‘OK, we’ve had the
dialogue. Here’s where I am.’’
But that process — procedural justice — is important to people’s willingness to comply with
decisions of the government and to continue to
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that taxpayer. It might tip that taxpayer to continue
to be compliant, rather than having such a bad
experience that he says, ‘‘I’m not going to be
compliant. Come and find me.’’
I wasn’t able to get a representative from Chile at
this conference, but a few years ago, Chile had just
enacted a TABOR and a tax court. You can go to the
tax court if any of those rights were violated,
including the right to professional service.
TA: The fourth panel covers challenges in ‘‘operationalizing’’ taxpayer rights. Can you define
operationalizing? What are some of the specific
challenges to operationalizing taxpayer rights on an
international scale?
Olson: When you’ve got a great document and a
list of statutory rights, how do you embed those
things into the culture of the organization?
We’ve talked about how you let taxpayers know
about rights — that’s partly what the TABOR is. But
what do you do inside the organization? One of the
people on this panel is my attorney-adviser, who
has been working with me on the TABOR. She’s
going to talk about trying to embed the TABOR and
the principles into the IRM.
Can you say, in some section that’s discussing
issuing levies, for example, that you need to think
about whether issuing the levy is going to create an
economic hardship before you issue the levy? Because one of the protections of the law is that you
have to release it if it creates an economic hardship.
Why would you issue a levy if you’re going to
have to release it? Couldn’t you do a little thinking
in advance? We’re trying to tie the economic hardship issue to the right to a fair and just tax system.
That would mean that you have to think about the
taxpayer’s circumstances.
Put that language in the IRM and then think
about it when you’re considering issuing the levy.
Having that language in the IRM gets people thinking about the principles. Moreover, if the IRM is tied
back to a general principle, when you have a
taxpayer that doesn’t fit into the four corners of an
IRM provision, maybe you could deal with that.
We have a CEO from South Africa and he’s going
to talk about what it’s like to establish an office
there, his relationship with the tax authority, and
that authority’s role in a country that is facing a lot
of challenges and has a different taxpayer base than
the individual income tax that we have.
The third speaker on that panel is an attorney
and adjunct professor from Greece. She’s going to
talk about what taxpayers might do in a country
that’s well known for challenges to tax compliance
and a profound lack of trust among taxpayers, and
the role that taxpayer rights can play in trying to
move the dial a little bit on compliance.
NEWS AND ANALYSIS
would expect that I would get some recommendations from it. I always learn from other countries.
TA: How do you plan to get legislative recommendations through a Congress that revolts at the
idea that Denmark might do something better than
the United States?
Olson: I don’t know that if you phrase it in a way
that says, here’s a good idea and whether it came
from Denmark, Mexico, or Louisiana, why
wouldn’t I do that? I visit state tax administrators
and get very good ideas from them.
There’s a panel that involves two representatives
of governments, Steve Vesperman, the deputy commissioner for small business and individuals for the
Australian Tax Office, and Lennart Wittberg, who is
the strategist for the Swedish Tax Agency. Steve is
going to talk about something interesting that Australia is doing. They have a new commissioner, and
their new commissioner challenged them to design
a tax administration around the 5 percent of taxpayers who don’t comply. That’s it. In the process of
doing that, they should create rules and procedures
— and FATCA could come to mind there — that
will be imposed on the 95 percent of taxpayers who
are willing to comply.
They didn’t say whether they were in compliance, but that they were willing to comply. The
commissioner challenged them to design the tax
administration as if they were looking at the 95
percent, so that the same laws could be used to go
after the 5 percent. I thought that was brilliant. I
haven’t been able to think through what starting
from that point would mean for the United States,
but that’s in my mind as I look at programs now. Is
this the tail wagging the dog? And I will be interested to hear how they are dealing with it in their
tax administrations.
TA: What would be the ideal outcome from this
conference for you?
Olson: There’d be two things. One is that I would
get good ideas about what I could recommend to
Congress or the IRS. There will be IRS officials
there. There will be Treasury people. There will be
people from the private sector. We have representatives from about 14 countries coming to talk. I hope
that people in the United States will feel more
comfortable that taxpayer rights are a universal part
of tax administration, and that they will not view
them as something you have to check the box on.
The other thing that I would like to see is the
beginning of a body of thoughtful work on taxpayer
rights in tax administrations, whether it’s research,
academic or practice articles, or discussions.
Every country is different. So the taxpayer rights
that have been created in the United States are
different from Sweden’s approach to taxpayer
rights. That’s where maybe I am in line with
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engage the government. There’s a lot of research in
areas other than tax that shows that where there are
processes in place that respect the rights of people,
people are more willing to live with an adverse
decision because they felt that they were listened to.
And they got the explanation because they had the
right to be informed. They understand, even if they
don’t like it, how the decision was arrived at.
That means they’ll continue to be engaged instead of us inefficiently having to go out and find
them and enforce the law against them. Over the
long term, a TABOR is the roadmap to both an
effective and an efficient tax administration.
TA: Some in the tax community object that the
Foreign Account Tax Compliance Act is a violation
of taxpayer rights on an international scale. Do you
agree?
Olson: I don’t know how it could be a violation
of rights on an international scale since every community has its own set of rights. That’s part of the
problem. To me, I think the jury is still out on what
it is like under various European conventions and
provisions. We just have to wait and see how it’s
thought about.
The problem with FATCA is that it imposes
burdens on taxpayers at all sorts of levels, and it’s
not clear what benefits we’re really going to get
from it or what we’ll be able to do.
My attention has been more on the foreign bank
and financial account report and on the offshore
voluntary disclosure arrangements. I could make a
strong case that those violate many of our rights.
For example, under that disclosure initiative,
there is a secret committee that reviews recommendations for what would be the settlement in a
particular case. Taxpayers are not allowed to talk to
anyone on that committee. They don’t receive a
detailed explanation of the decisions that the committee made. I can’t say it’s a violation because this
is not a law, but it impairs the taxpayer’s right to be
informed and, ultimately, the sense that he is part of
a fair and just tax system.
TA: Are there legislative proposals that you
would expect to come out of this conference? Something that needs to get through Congress to be
implemented?
Olson: We’ve made in our annual reports, and
particularly in the most recent one, the number one
legislative recommendation was taking all the legislative recommendations we’ve made in the past
and fitting them under the 10 rights, and saying,
‘‘Congress, here’s something that you could do that
would fill in gaps or update some of the past
protections for the current administrative environment.’’
Part of doing an international conference is to
hear what other people are working on, and I
NEWS AND ANALYSIS
wish Congress would look at and conduct oversight
on. That’s what I really want Congress to do.
Talking about impeaching the commissioner gets in
the way of that oversight, and it becomes personal
in a way that it should never be.
TA: You’ve spoken out about how Congress’s
budget cuts of the IRS are hurting its efforts during
filing season, but last filing season went well in
many respects. The Treasury Inspector General for
Tax Administration reported that Affordable Care
Act implementation went relatively smoothly. Backend systems seemed to work well. Do you run the
risk of being perceived as crying wolf when the IRS
still manages, despite all obstacles, to pull off a
successful filing season?
Olson: I’m not crying wolf. Yesterday I had a
conversation with a senior official in the New York
State tax administration, and they said, ‘‘The IRS
used to be viewed as the shining example for all of
us, and it’s not anymore.’’
You talk to the people and practitioners who are
trying to get through on the phone. That they can’t
get through for an hour. That on the phone line
people are getting notices for balance-due returns.
And the level of service on that phone line is 37
percent.
Almost two-thirds of the taxpayers calling to pay
us money and make payment arrangements cannot
get through. If they can’t get through, the next step
that’s going to happen to them, because the IRS
doesn’t know they’re trying to get to us, is that a
machine will reach out and garnish their paycheck,
or seize their bank account, or file a lien against
them. And the taxpayer is sitting out there saying,
‘‘But I’ve been calling you. I’ve been trying to get
through.’’
I think that’s abysmal. It’s the worst I’ve ever
seen. Yes, the IRS delivered the ACA, but at what
cost? Millions of taxpayers who had issues and
needed to talk to the IRS weren’t able to do that.
In our June report’s filing season write-up, we
said it was like A Tale of Two Cities: ‘‘It was the best
of times, it was the worst of times.’’
So for those of you who are lucky enough not to
have a problem with the IRS, things went well. But
if you had the slightest issue with the IRS, it was
disastrous. The reason why the ACA worked is
because the money that was traditionally put into
taxpayer service was moved to it and FATCA.
It’s a difficult choice. I understand why they did
it. But look at the taxpayers who are harmed. This is
not right, and it will undermine compliance in the
future.
I don’t think anyone would say that I’m crying
wolf. It’s not going to get better unless the IRS gets
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members of Congress. I’ve spent at least two weeks
meeting with Swedish tax officials over the years,
and I think that many of the things that they talk
about are great ideas, but they will never fly in the
United States, because I know U.S. taxpayers and
they look at things differently.
TA: Give me an example.
Olson: Sweden’s tax rate is unbelievably high,
but its tax agency is the most respected government
agency. Taxpayers see a direct connection between
the things that they get and the tax agency. The tax
agency is the entity that makes sure they get those
things.
Right there you have an extraordinary difference.
In the United States, people are talking about the
IRS commissioner being impeached and how the
tax agency is distrusted. Since our founding, we
have not so much distrusted taxes as the way the
tax laws are applied and who’s applying them,
who’s imposing them on us, and how are they
being collected.
So the U.S. environment is almost an adversary
environment. I showed Lennart Wittberg a video
that we had created to educate taxpayers on taxpayer rights. I’m very proud of that video. It’s on
our website. It ends with, ‘‘Your rights. Know them.
Use them.’’ Lennart’s reaction was, ‘‘Well, that’s
assuming that the agency wouldn’t respect your
rights. That’s very adversarial.’’ And I never would
have thought about that. From the Swedish perspective, of course the tax agency would try to
respect your rights.
What they’re going to need is something very
different from what we need. From what South
Africa needs. From what Italy or Greece needs, or
France or Germany. Or Asia. Or Mexico.
TA: We are coming up on the halfway point of
Commissioner Koskinen’s term. How do you grade
his performance?
Olson: I have a very good relationship with him.
He’s one of the few commissioners I’ve worked for
who really understands the role of the Taxpayer
Advocate Service, and he is very much a supporter
of my office and my work.
He listens to me, and I’ve never found his door
not open. I have engaged him in discussions about
tax administration and the future of tax administration. He has acted on not all my recommendations,
but some of them, and on particularly difficult
issues. I have a great deal of respect for him.
TA: What do you think of the talk in Congress
about impeaching him?
Olson: I think it’s inappropriate. I’m not sure
why they are focusing on him. It’s hard for me
about the 501(c)(4) issue because I think it was a
very serious issue. But at this point, there are more
serious issues that are going on with the IRS that I
NEWS AND ANALYSIS
because it’s either too complex or it’s asking for
information that they don’t have.
I don’t know where that balance is, but I’m
heartened to know that the IRS is thinking about it.
TA: Is there another balance, though, that should
be struck between the needs of the IRS on the one
hand, and the capabilities and the requirements of
their private sector counterparts helping them in
this work? Where is that balance struck to protect
taxpayer information and privacy?
Olson: In the past you had a choice. You could
either have the IRS imposing things on the private
sector and then they would scream and yell — some
of them — ‘‘We can’t do this!’’ Or you wouldn’t
have the IRS imposing something and you’d have
very great disparity between some entities doing
this and some entities doing that, and the states
were requiring some things, but those requirements
weren’t carried up to the federal government. And
that’s why it’s good in the summit to have the states
involved as well.
The point of the summit is to have all these
players at the table and to reach a consensus about
what we can do. What burden they can bear, what
they can deliver, and in what time frame. What are
the states saying and imposing, because maybe we
could pick up some of that. Can the IRS pick up
some of these things that the states have been
requiring? Can it be built into our system?
TA: TIGTA found in September that the IRS is not
adequately managing its mail correspondence with
U.S. taxpayers living abroad. In its response to
TIGTA, the IRS said, ‘‘There are too few foreign U.S.
taxpayers to justify fixing this given the agency’s
resource constraints. Congress should fund a secure
online portal for them instead.’’ Is this really an
appropriate response even given the budget
crunch? Doesn’t that say to U.S. taxpayers living
abroad, ‘‘You’re on your own when it comes to your
tax obligations’’? How might this situation affect
your hopes for implementing taxpayer rights for
U.S. taxpayers in foreign lands?
Olson: The first thing is that the IRS has done a
lot of surveys of international individual taxpayers,
and it’s clear that they want an online account. They
want to communicate with the IRS by e-mail.
I think that that is a long-term solution, but
communicating with the IRS by e-mail doesn’t
require an online account. You could do a demonstration project, and I think the IRS is looking at
that. A few years ago, we were able to convince
some at the IRS to have a toll-free line for individual
international taxpayers. But when it was floated up
they didn’t allow it because they said it was too
expensive.
I’m tired of hearing ‘‘too expensive.’’ The example that I gave of not picking up the phone to
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more funding for taxpayer service, or it gets funding for the ACA and FATCA and it can move money
back to taxpayer service.
You can only undermine taxpayer service for so
long and then you get distrust of the system and
alienation and you increase that confrontational
and adversarial component. Then that starts showing up in people’s actions, like, ‘‘Come and get me.’’
Dealing with someone in an enforcement environment is so much more expensive than dealing
with someone on the taxpayer service side. If the
taxpayer was calling to say, ‘‘I can’t afford to pay
this. I have economic hardship,’’ under the TABOR,
you’re not allowed to issue a levy. You have to
release the levy if the taxpayer proves the economic
hardship. When levies are automatic, we don’t hear
from the taxpayer. So then we issue the levy. Or
they get to the Taxpayer Advocate Service and now
you have two employees working the case, my
employee and the IRS employee, so it costs twice as
much. Plus, you have to undo the action you did.
And by the way, we’d make you return the levy
proceeds that you shouldn’t have taken in the first
place. If only you’d picked up the phone you would
have known that the levy wasn’t proper.
You can see how that costs the system more than
just funding the phone call in the first place.
TA: On October 20 the IRS conducted a press
conference about its Security Summit process. How
do you feel that summit process is going?
Olson: I’m watching it closely. I’m glad that
they’re holding it, that they’ve elevated it to a
summit level. I’m sorry that it took a breach to get
everybody together and go, ‘‘Oops.’’ I think we’ve
now got the other parts of the government paying
attention to the IRS. The IRS has an incredible asset
of the United States: the personal financial information of every taxpayer of the United States, and it
must be protected.
Getting the most creative minds on the security
side to put their minds to it will be better for
everyone. It turns out that there are things that
they’re doing in the private sector that would help
us. There are some things that we were thinking
about that the private sector could adopt. I think
having folks who are well informed about security
protocols of other government entities is also helpful because that would bring some shared knowledge there.
The difficult balance is, as you’re trying to protect
the filing of tax returns, and as you go into the
future of having an online account, how hard do
you make it for taxpayers to access their accounts?
There’s a point where your concern about security actually makes the system unusable, or at least
usable only by an elite group, and there’s a whole
group of people who can’t get through legitimately
NEWS AND ANALYSIS
challenges that they are facing so we can better
address their needs. We’ve cut off that dialogue
except for the dialogue that happens between international taxpayers and the Taxpayer Advocate Service.
I’m still trying to get my offices over there. If the
IRS is closing the attachés, is there a way for me to
get a local taxpayer advocate over four parts of the
world, so that we could at least be in that community and identify their needs?
We’d work the cases back home, but we’d have
somebody that was there, a skeletal staff with
someone to advocate for that group of taxpayers. I
think that would protect taxpayer rights.
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hear about economic hardship is just multiplied by
the international taxpayers.
The other thing is that at the same time that
you’re imposing FATCA and all these other things
on international taxpayers, you’re closing your four
attachés, the only places where there was help —
London, Beijing, I think it was Frankfurt, and Paris.
At least in those places you had a core group of
people from inside the IRS that knew the problems
of international taxpayers. Not only could they help
the international taxpayers navigate some of these
things, but they did outreach and education and
worked with embassies to help the U.S. taxpayers in
different countries. They could bring information
back to the United States and say that these are the
“The question is not whether states will
raise the necessary money. Rather, it’s
which groups they will tax.”
— David Brunori,
Deputy Publisher
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Where
state legislators
discover their
best tax ideas.
tax notes™
Final Regs Address Private
Activity Bond Restrictions
By Joseph DiSciullo — joseph.disciullo@taxanalysts.org
Final regulations (T.D. 9741) address the allocation and accounting rules, and some permitted
remedial actions, that apply to tax-exempt bonds
issued by state and local governments for purposes
of the private activity bond restrictions under section 141. (Related coverage: p. 603.)
In September 2006 the IRS issued proposed regulations (REG-140379-02 and REG-142599-02) on the
allocation and accounting rules for tax-exempt
bond proceeds, including special rules for mixeduse projects and rules on the treatment of partnerships for purposes of section 141. The 2006 regs also
amended the section 145 rules on related matters
that apply to qualified section 501(c)(3) bonds.
Effective October 27, the final regs adopt, with
changes, some provisions of the 2006 regs. Other
provisions are not being finalized and are withdrawn in a simultaneously released notice (REG140379-02, REG-142599-02).
In July 2003 the IRS issued proposed regulations
(REG-132483-03) on the amount and allocation of
nonqualified bonds for purposes of some remedial
actions under sections 141 and 142. Final regs (T.D.
9150) were published in August 2004 adopting
provisions regarding section 142. However, because
of the interrelationship between the remedial action
provisions under section 141 and the allocation and
accounting rules, the portions regarding section 141
were not finalized then. Thus, effective October 27,
the new final regs also adopt rules on the amount
and allocation of nonqualified bonds for purposes
of the remedial action provisions under section 141.
In response to commentators’ concerns about the
general allocation rules, the final regs provide several clarifications and simplify the definition of
project to cover all facilities or capital projects
financed in whole or in part with proceeds of a
single bond issue. That definition allows issuers to
identify specific properties or portions of properties
regardless of the properties’ locations or placed-inservice dates.
Commentators criticized the complexity of two
alternative special elective allocation methods under the proposed regulations for a mixed-use project — the discrete physical portion allocation
method and the undivided portion allocation
method. The commentators also criticized the administrative burdens associated with electing to use
one of these methods and the discrete portion
method’s overly rigid treatment of reallocations or
‘‘floating’’ allocations. As a result, the final regs
expand the availability of the undivided portion
allocation method to include all measureable use,
making it the exclusive allocation method for eligible mixed-use projects and thereby eliminating
the discrete portion method and the election requirement.
The final regulations adopt with some changes
the proposed definition of qualified equity and
clarify the meaning of the same plan of financing.
The final regs provide aggregate treatment for all
partnerships, including for purposes of the definition of qualified section 501(c)(3) bonds under section 145(a). The final regs also provide a rule for
measuring the private business use of financed
property resulting from the use of the property by a
partnership that includes a partner that is a nongovernmental person.
The final regulations adopt a suggestion to expand the remedial action rules to encourage early
redemption of tax-exempt bonds without imposing
another set of rules for projects with unanticipated
private business use. The 2003 regs proposed
changes to the amount and allocation of nonqualified bonds to be remediated as a result of a deliberate action causing the private business tests or the
private loan financing test to be met. The final regs
adopt those proposed changes, providing a transition rule for outstanding bonds and reducing the
amount of nonqualified bonds.
The final regulations generally apply to bonds
sold after January 24, 2016, but the rules regarding
remedial actions apply to deliberate actions that
occur after that date.
Air Transportation Tax
The IRS and Treasury have requested comments
(Notice 2015-76, 2015-46 IRB 1) on guidance they
are considering under section 4261(e)(3)(C) that
would exclude from the air transportation tax
amounts attributable to mileage awards (frequentflier miles) that are redeemed other than for the
taxable transportation of persons by air.
Section 4261(a) imposes a tax on the amount paid
for the taxable transportation of any person. Section
4261(e)(3)(A) provides that for purposes of the air
transportation tax, any amount paid (and the value
of any other benefit provided) to an air carrier (or
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GUIDANCE
GUIDANCE
PTIN User Fee
Temporary regulations (T.D. 9742) reduce from
$50 to $33 the user fee for individuals who apply for
or renew a preparer tax identification number. The
text of the temporary regs serves as the text of
concurrently issued proposed regs (REG-12149615).
Final regs (T.D. 9501) issued in September 2010
require a tax return preparer who prepares or
assists in preparing all or substantially all of a tax
return or refund claim after 2010 to have a PTIN.
The 2010 regs also stated that the IRS would set
forth in forms, instructions, or other appropriate
guidance PTIN application and renewal proce-
dures, including the payment of a user fee. Concurrently issued final regs (T.D. 9503) established a $50
user fee to apply for or renew a PTIN.
The IRS has determined that the full cost of
administering the PTIN program from now on has
been reduced from $50 to $33 per application or
renewal. According to the preamble of the regs, the
lower fee is a result of several factors, including the
reduced number of PTIN holders (about 700,000)
from the number originally projected (1.2 million)
in 2010; the absorption of some development costs
in the program’s early years; and the fact that some
activities that would have been required to regulate
registered tax return preparers will not be performed.
Individuals who apply for or renew a PTIN will
continue to pay a fee directly to a third-party
vendor that is separate from the user fee described
in the temporary regs. The vendor fee is increasing
from $14.25 to $17 for original applications and
from $13 to $17 for renewal applications.
The temporary regulations are effective October
30. The annual PTIN application and renewal period that usually begins on October 15 has been
postponed to November 1 for 2015.
Withholding
The IRS has reminded (IR-2015-120) taxpayers
that checking their withholding early in the year
will make it easier to get the right amount of tax
withheld.
Taxpayers are advised to try to match their
withholding with their actual tax liability. Besides
wages, income tax is often withheld from other
types of income, such as pensions, bonuses, commission, and gambling winnings, the IRS points
out.
If not enough tax is withheld, individuals will
owe tax at the end of the year and may have to pay
interest and a penalty. If too much tax is withheld,
they will lose the use of that money until they get
their refund.
Taxpayers should check their withholding if they
get a big refund or find that they have an unexpected balance due. Personal or financial changes
such as getting married, getting divorced, having a
child, or buying a home might affect an individual’s
tax liability.
A withholding calculator is available on the IRS
website, or taxpayers can use the worksheets and
tables in Publication 505, Tax Withholding and Estimated Tax, to see if they are having the right amount
of tax withheld. If an adjustment is necessary,
taxpayers may need to give their employer a new
Form W-4, ‘‘Employee’s Withholding Allowance
Certificate,’’ to change their withholding status or
the number of allowances.
658
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any related person) for the right to provide mileage
awards for (or other reductions in the cost of) any
transportation of persons by air is treated as an
amount paid for taxable transportation. However,
Treasury is authorized under section 4261(e)(3)(C)
to prescribe rules that exclude from the tax any
amounts attributable to mileage awards that are
used other than for the transportation of persons by
air.
The IRS and Treasury have not prescribed an
allocation method that taxpayers and collectors of
the tax can use to exclude amounts attributable to
mileage awards that are used other than for taxable
air transportation. As a result, taxpayers currently
must pay tax on all frequent-flier miles purchased
from an airline mileage awards program and then
file a claim for credit or refund for tax paid on those
frequent-flier miles that were ultimately redeemed
other than for taxable air transportation.
However, Treasury and the IRS are now considering a possible method that would allow a reduction in a taxpayer’s section 4261(a) tax base for
amounts paid for mileage awards based on historical redemption data. Under this approach, for each
12-month period beginning on April 1 and ending
on March 31 (the election year), the tax base for
frequent-flier miles purchased from a particular
airline mileage awards program would be reduced
based on redemption data from that airline mileage
awards program for the calendar year immediately
preceding the calendar year in which the election
year begins (the base period). The amount paid for
the right to provide frequent-flier miles under the
program would be multiplied by an exclusion ratio
determined as specified in Notice 2015-76, thereby
reducing the section 4261(a) tax base on the purchased frequent-flier miles accordingly.
Among the redemptions that would be excluded
from tax under the rules are those for international
air transportation, restaurant gift cards, magazine
and newspaper subscriptions, free hotel nights, and
items from an airline’s shopping catalog.
GUIDANCE
organizations described in section 170(c) are deductible as business expenses to the extent they are
not disallowed by other provisions of section 162
and to the extent they are not contributions under
section 170.
For similar reasons, the IRS determined that the
taxpayer’s donations to organizations not described
in section 170(c) are also deductible as business
expenses, subject to the same limitations. If the
taxpayer received any section 6033 notices from
donee organizations, the appropriate proportion of
those donations would not be deductible, the IRS
said.
Lastly, the IRS concluded that amounts paid to
certified B corporations (for-profit entities with a
social mission included in their corporate bylaws)
would be deductible as ordinary and necessary
business expenses under section 162, subject to
various provisions of the statute that may act to
disallow the deduction. For example, section 162(e)
denies a deduction for any amount paid or incurred
in connection with influencing legislation, participating in any political campaign, influencing the
general public regarding elections or legislative
matters, or any direct communication with a covered executive branch official in an attempt to
influence official actions.
Julie Brienza and Emily Vanderweide contributed to
this column.
TAX NOTES, November 2, 2015
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Business Deductions
In a legal memorandum (ILM 201543013), the IRS
determined that amounts remitted by a taxpayer to
various organizations as part of a charitable gift
program were paid with a reasonable expectation of
commensurate financial return and therefore were
deductible under section 162(a) as business expenses.
Section 162(a) provides that all ordinary and
necessary expenses paid or incurred during the tax
year in carrying on a trade or business are deductible. Section 170 allows a deduction for a contribution to an organization described in section 170(c).
Under section 162(b), no deduction is allowed under section 162(a) for any contribution or gift that
would be allowed as a deduction under section 170
were it not for the limitations provided in that
section. By regulation, no deduction is allowed
under section 162(a) for a contribution or gift if any
part of it is deductible under section 170. The regs
also state that transfers of property to an organization described in section 170(c) that bear a direct
relationship to the taxpayer’s trade or business and
are made with a reasonable expectation of commensurate financial return may constitute valid deductible expenses of a trade or business.
The IRS found that the taxpayer ‘‘appears to have
acted with the reasonable belief’’ that establishment
of the charitable gift program would enhance and
increase its business. Therefore, its donations to
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tax notes™
Tax Court Finds No Gift Tax Owed
On Shares Transferred to Trusts
By Joseph DiSciullo — joseph.disciullo@taxanalysts.org
The Tax Court held that a decedent’s transfer of
shares in a closely held corporation to trusts for his
children as part of a settlement agreement did not
trigger gift tax liability, finding that the transfer was
made in the ordinary course of business and was for
full and adequate consideration (Estate of Redstone v.
Commissioner, 145 T.C. No. 11 (2015)). (Related coverage: p. 636.)
The decedent owned one-third of the stock in a
family owned drive-in theater. When he, his father,
and his brother began to disagree regarding family
and business matters, the decedent left the business
and demanded his stock. When he was denied, he
took legal action. The decedent’s father claimed that
his son did not own all the shares in his name, but
that a portion of the shares were held for the benefit
of the decedent’s two children under an oral trust.
In 1972 the decedent and his family settled the
dispute. The decedent received $5 million for twothirds of the shares held in his name, and he was to
contribute the other third of the shares to trusts for
his children. Over 30 years later, the IRS became
aware of the transfer from subsequent litigation
regarding the company shares. On examination the
IRS determined a gift tax deficiency and imposed
penalties against the decedent for the shares contributed to the children’s trusts.
The Tax Court held that the transfer did not
result in gift tax liability for the decedent. The court
looked to the applicable gift tax regulations, which
provide that gift tax does not apply to ‘‘a transfer
for a full and adequate consideration in money or
money’s worth, or to ordinary business transactions.’’ Reg. section 25.2512-8 provides three elements for a property transfer to qualify as an
ordinary business transaction: It must have been
bona fide, transacted at arm’s length, and free of
donative intent.
The Tax Court concluded that the transfer was
bona fide because it occurred in settlement of an
actual dispute between the decedent and his family.
The decedent believed that he had a legitimate
claim to all the stock but agreed to transfer a portion
to the trusts to end litigation and receive payment
for the remaining shares. The court also found that
the transfer occurred at arm’s length. At the time of
the transfer, the decedent was estranged from his
brother and father, and both sides were represented
by counsel. The court determined that the decedent
had acted as someone would act in a dispute with a
stranger.
The Tax Court further held that the transfer was
free of donative intent. The court said the decedent
did not willingly transfer the shares to his children.
In fact, he believed that he was entitled to all the
stock and transferred a portion of it only because of
his father’s demand.
The Tax Court rejected the IRS’s argument that
the lack of consideration provided by the decedent’s children necessarily made the transfer a gift.
Instead, the court found that the decedent received
full and adequate consideration for his transfer in
the form of recognition by his father and brother
that he was the owner of two-thirds of the shares
and his receipt of the $5 million payment for the
shares.
Information Disclosure
The Tax Court held that an IRS adverse determination letter and examination report revoking a
nonprofit corporation’s tax-exempt status were
written determinations subject to public disclosure
and that the documents were properly issued to the
entity despite the IRS withdrawing the original
letter and issuing a second revocation letter to the
entity (Anonymous v. Commissioner, 145 T.C. No. 10
(2015)).
Following an examination, the IRS issued a letter
revoking the entity’s tax-exempt status and imposing a tax liability. An examination report accompanying the letter identified several reasons
supporting revocation, including that the entity had
allowed proceeds to inure to the benefit of private
individuals.
During litigation, the entity and the IRS reached
a settlement that resulted in the entity agreeing to
pay a lump sum to fulfill its tax obligation and to
not contest the revocation of its tax-exempt status.
The IRS withdrew its original revocation letter,
issued a new determination letter recognizing the
entity’s current tax-exempt status, and issued a new
letter revoking the entity’s tax-exempt status for a
defined period.
The second revocation letter included the same
justification for revoking the entity’s tax-exempt
status but did not include an examination report.
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COURTS
COURTS
Practice Before the IRS
A U.S. district court dismissed an individual’s
suit against former and current IRS employees
claiming they violated his constitutional rights by
taking action to suspend him from practice as an
enrolled agent, finding that Congress and Treasury
established a comprehensive remedial scheme that
precludes his action against the employees (Bowman
v. Iddon, No. 1:14-cv-00520 (D.D.C. 2015)).
In 2003 the plaintiff was indicted in a district
court for multiple felonies, including mail fraud,
wire fraud, and money laundering. As a result, he
was incarcerated for nearly five years. During this
time, the IRS Office of Professional Responsibility
sent a notice of proceeding to the individual’s
business address, but he never received it. The IRS
also sent to the same address a notice of the
suspension decision from the OPR director (who is
among the five defendants), stating that the individual was no longer eligible to practice before the
IRS. The plaintiff did not learn of the suspension
until he was released from prison.
The individual sought damages from the defendants in their individual capacities under the doctrine of Bivens v. Six Unknown Agents of Federal
Bureau of Narcotics, 403 U.S. 388 (1971), under which
federal courts have discretion in some circumstances to create a remedy against federal officials
for constitutional violations. The defendants moved
to dismiss, arguing that the plaintiff has no standing
to bring the action because he cannot show that the
defendants caused the injury that he allegedly
suffered. The defendants also contended that a
Bivens remedy is unavailable under the circumstances because a comprehensive remedial scheme
exists in the tax code and the accompanying regulations.
The district court disagreed with the contention
of the defendants that the individual’s felony convictions were grounds for suspending him from
practice before the IRS as a matter of law — and that
therefore any deficiency in notice was irrelevant.
On the contrary, the court found that Circular 230
does not mandate the plaintiff’s suspension from
practice but merely allows the use of expedited
procedures that still require sending notice to the
person who would be subject to a suspension.
According to the court, it was not a foregone
conclusion that the plaintiff would have been suspended even if he had received the notice. Therefore, the individual’s ‘‘status as a felon and the
availability of expedited procedures in these circumstances does not interrupt the chain of causation between the harm that Plaintiff allegedly
suffered and the actions that he claims are unconstitutional,’’ the court said. The court also rejected
the defendants’ argument that the individual’s enrolled agent status would have terminated after
three years because of his failure to comply with the
applicable renewal requirements.
However, the district court looked more favorably on the defendants’ Bivens argument. The court
noted that it must decline to exercise discretion to
create a remedy against federal officials for constitutional violations when ‘‘special factors counsel
hesitation in doing so.’’ Among those special factors, the court said, is the existence of a comprehensive remedial scheme. Citing the D.C. Circuit, the
court held that when ‘‘Congress has put in place a
comprehensive system to administer public rights,
has ‘not inadvertently’ omitted damages remedies
for certain claimants, and has not plainly expressed
an intention that the courts preserve Bivens remedies,’’ courts ‘‘must withhold their power to fashion damages remedies’’ under Bivens. Accordingly,
the court concluded that no Bivens remedy was
available to the plaintiff.
As a final matter, the court said the fact that the
individual may not actually have ever been an
enrolled agent (as alleged by the defendants) —
either at the time of the suspension or at any other
time — does not change its conclusion. In light of
662
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The entity objected to the IRS disclosing under
section 6110 the original revocation letter and examination report.
Section 6110(a) provides that ‘‘the text of any
written determination and any background file
document relating to such written determination
shall be open to public inspection’’ except as otherwise provided in section 6110. Under section
6110(c), the IRS must redact from any disclosed
written determination seven specified types of information, including the names, addresses, and
other identifying details of the person to whom the
written determination pertains and information the
disclosure of which would create a clearly unwarranted invasion of privacy.
The court held that the original revocation letter
and examination report were a ‘‘written determination’’ under section 6110(a). The letter represented a
final determination by the IRS to revoke the entity’s
tax-exempt status, and the examination report included relevant facts and applicable provisions of
law. The documents were also properly issued to
the entity, the court said.
According to the court, the entity’s arguments
against disclosure were unpersuasive. The court
explained that the decision to withdraw the original
letter and report were not made because they were
erroneous. The court concluded that no exception
existed in section 6110 to prevent disclosure of a
written determination that the IRS withdraws as
part of a settlement.
COURTS
Employment Taxes
A U.S. district court dismissed a doctor’s lawsuit
against a hospital claiming the hospital breached its
fiduciary duty to him by not seeking a refund of
FICA taxes paid on his behalf or by advising him to
do so (Reuss v. Orlando Health Inc., No. 6:15-cv-00805
(M.D. Fla. 2015)).
The doctor is now employed by the hospital as a
surgeon, but during the period relevant to his
action, he worked for the hospital as a medical
resident. During his residency, the hospital withheld FICA taxes from his wages and in accordance
with the requirements of IRS regulations, submitted
those taxes along with the hospital’s own contributions to the IRS.
Historically, the IRS interpreted the student exception from FICA taxes to exclude medical residents. However, in 2004 Treasury issued a
regulation providing that an employee who performs the services of a full-time employee (40 or
more hours per week) is not a student exempt from
FICA taxation. Because a medical resident’s normal
work schedule calls for more than 40 hours of work
per week, the rule effectively ended the applicability of the student exception to medical residents for
services performed after April 1, 2005. However, the
IRS decided to honor protective claims for FICA tax
refunds filed before that date on behalf of medical
residents under the student exception. The hospital
filed a protective FICA tax refund claim in 2004 on
behalf of itself and its medical residents for FICA
taxes paid in the year 2000, but it did not file
protective claims for itself or its residents for the
years 2001-2005.
The doctor claimed that the hospital breached its
fiduciary obligation by failing to disclose or otherwise act on the existence of the 2001-2005 refund
opportunity. By the time he found out about the
refund opportunity, the FICA tax refund statute of
limitations period had elapsed. The doctor sought
to recover from the hospital an amount equivalent
to that contributed on his behalf for FICA taxes for
the years 2001-2005.
The district court held, however, that no fiduciary duty existed between the doctor and the
hospital. The court found the cases relied on by the
doctor to be clearly distinguishable from his case. In
Childers v. N.Y. & Presbyterian Hospital, 36 F. Supp.3d
292 (S.D.N.Y. 2014), the court held that when an
employer files for a refund of FICA taxes, it has a
fiduciary duty to ensure its employees receive the
benefit of their fair share of any refund received.
The decision did not, however, support the proposition that the hospital had a fiduciary duty to
ensure that its employees received the benefit of
FICA tax refunds when the hospital chose not to file
for a refund on its own behalf or when the hospital
did not appropriate the money for itself, according
to the Reuss court.
In Mills v. United States, 890 F.2d 1133 (11th Cir.
1989), the court held that when an employer files its
own FICA tax refund claim, it has a duty to also file
a refund claim on behalf of its employees. The Reuss
court found, however, that ‘‘Mills in no way suggests that the hospital had a duty to notify its
employees of refund opportunities or to file on their
behalf for years where it elected not to seek a
refund.’’
The Reuss court also determined that the doctor’s
suit was actually a tax refund suit and therefore is
preempted by section 7422. The court pointed out
that claims for taxes erroneously collected must be
filed with the IRS. ‘‘Section 7422 exists to protect an
employer from liability when it is acting as a
collection agent for the Government,’’ the court
said, adding that the statute does not apply only
when there is ‘‘completely distinct allegedly unlawful conduct’’ on the part of the employer that does
‘‘not arise out of the [employer’s] collection of
taxes.’’ Because the hospital’s conduct was neither
separate nor distinct from its role as a collecting
agent on behalf of the IRS, the court construed the
doctor’s claim for breach of fiduciary duty as a tax
refund claim, which was therefore preempted by
section 7422.
Linda Friedman and Patrice Gay contributed to this
column.
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the comprehensive remedial scheme available to
the plaintiff, the court determined that he should
have sought redress for his grievances through the
system established by Congress and by Treasury
regulations. Therefore, the entire case was dismissed.
(Before the
rest of the world
quotes him.)
“There may be liberty and justice for all,
but there are tax breaks only for some.”
— Martin Sullivan, PhD
Contributing Editor
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Read him here first.
tax notes™
Commentators Offer Input on
U.S. Model Income Tax Treaty
By Joseph DiSciullo — joseph.disciullo@taxanalysts.org
The Association of Global Custodians (AGC) has
commented on the draft provisions for the next U.S.
model income tax treaty, explaining some of the
potential difficulties for U.S. institutional investors
and suggesting modifications to alleviate those
problems.
The association says it believes some of the draft
provisions may have the unintended effect of making it more difficult for U.S. institutional investors
that are validly entitled to treaty benefits to obtain
those benefits in practice from foreign treaty partners. This is because in recent years foreign treaty
partners of the United States have been imposing
burdensome procedural requirements on U.S. institutional investors, ostensibly to enforce limitation
on benefits requirements in the treaties. As a result,
treaty-based withholding tax relief to which U.S.
institutional investors (such as mutual funds and
pension funds) are legitimately entitled is being
effectively denied. The AGC estimates that the
foreign taxes inappropriately being withheld from
U.S. funds now total billions of dollars.
Therefore, the association recommends that any
LOB provision in a U.S. tax treaty should include an
outright safe harbor for U.S. regulated investment
companies. As a fallback, however, the AGC suggests that whenever a treaty is concluded that
subjects RICs to the potential need to qualify under
an ownership/base erosion safe harbor, the United
States should simultaneously enter into a memorandum of understanding with the treaty partner that
will confirm the ability of U.S. RICs to obtain relief
at source based on a self-certification of their qualification under that test, without the need to provide
detailed information or documentation about their
underlying investors. Similar provisions should apply to pension funds, the association says.
Tony Edwards of the National Association of
Real Estate Investment Trusts (NAREIT) has expressed support for Treasury’s provision of a specific real estate investment trust exception from the
new special tax regime concept that the department
is proposing to add to the model treaty. However,
the association is ‘‘concerned that the draft language for this exception could inadvertently raise
technical issues and create unintended ambiguity
regarding the application of this exception to U.S.
REITs upon the inclusion of the proposed special
tax regime provision in future U.S. bilateral tax
treaties.’’
NAREIT says it believes any potential ambiguity
could be avoided — and Treasury’s objective in
providing a REIT exception could be accomplished
— through modifications to the draft language that
would explicitly refer to U.S. REITs in the treaty
text. The association contends that this approach
would circumvent the need to describe a REIT
regime and eliminate any ambiguity regarding
whether the U.S. REIT regime meets all the elements of such a description as a technical matter.
However, if the REIT regime exception were
instead to be created using a description of a REIT
regime, NAREIT proposes two modifications to the
draft language to clarify the treatment of U.S. REITs.
First, the requirement that the entities be marketed
primarily to retail investors should be adjusted to
reference ‘‘direct or indirect’’ retail investors. Second, the investor-protection regulation requirement
should be eliminated.
Nancy McLernon of the Organization for International Investment (OFII) has asserted that the
proposed changes to the U.S. model income tax
treaty do not achieve the right policy balance and
will reduce foreign direct investment. The organization believes that the United States should ensure
that ‘‘U.S. international tax policy aligns with U.S.
economic interests to promote job creation and
economic growth [and] that changes to U.S. tax
treaty policy should not undercut the historical
purpose of treaties in providing a reliable tax environment for companies operating across borders.’’
OFII argues that the proposed antiabuse rules
attempt to dictate, set, and monitor U.S. domestic
tax policy, none of which should be within the
purview of tax treaties. The organization also contends that some provisions in the proposed model
treaty could restrain the ability of Congress to
reform or implement tax policy without creating
additional tax burdens on businesses. For those
reasons, OFII suggests that the special tax regimes
and partial termination provisions not be adopted.
Arbitrage Bonds
Public Financial Management Inc. (PFM) has
commented on proposed regulations (REG-13852614) on the definition of issue price for purposes of
the section 148 arbitrage investment restrictions
applicable to tax-exempt bonds.
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CORRESPONDENCE
CORRESPONDENCE
The table below lists the dates by which public comments on proposed regulations must be received by the
IRS. The text of each proposed regulation includes instructions for sending comments to the IRS.
Due
Date
Code
Section(s)
IRS File
Number
Subject
Tax Analysts
Citation
Nov. 2
36B, 4980H
REG-143800-14
Healthcare plan credit
Tax Notes, Sept. 7, p. 1084
Nov. 2
432
REG-123640-15
Multiemployer pension plans
Tax Notes, Sept. 7, p. 1084
Nov. 12
6081
REG-132075-14
Filing extensions
Tax Notes, Aug. 17, p. 746
Nov. 25
199
REG-136459-09
Domestic production
activities deduction
Tax Notes, Aug. 31, p. 945
Nov. 25
937
REG-109813-11
Residency
Tax Notes, Aug. 31, p. 946
Nov. 26
6011, 6707A
REG-103033-11
Reportable transaction
penalty
Tax Notes, Aug. 31, p. 946
Nov. 30
951, 956
REG-155164-09
U.S. property held by CFCs
Tax Notes, Sept. 7, p. 1083
Dec. 7
7701
REG-148998-13
Same-sex marriage
Tax Notes, Oct. 26, p. 512
Dec. 9
2801, 877A
REG-112997-10
Gifts and bequests from
expatriates
Tax Notes, Sept. 14, p. 1221
Dec. 15
367, 482, 936
REG-139483-13
Outbound transfers
Tax Notes, Sept. 21, p. 1339
Dec. 17
871, 892, 894, 1441
REG-127895-14
Dividend equivalents
Tax Notes, Sept. 21, p. 1341
Dec. 17
170, 501
REG-138344-13
Charitable contribution
deductions
Tax Notes, Sept. 21, p. 1344
(Unless otherwise noted, all dates are 2015.)
As under the current rules, the new regs provide
that the issue price of bonds issued for money is the
first price at which a substantial amount of the
bonds is sold to the public. The new regs also retain
the current rules providing that 10 percent is a
substantial amount and that the issue prices of
bonds with different payment and credit terms are
determined separately. However, the new proposed
regs also describe an alternative method of determining the issue price for bonds, a substantial
amount of which is not sold under orders received
from the public as of the sale date. Under the
alternative method, an issuer may treat the initial
offering price to the public as the issue price if
specific requirements are met.
PFM considers the proposed regs ‘‘a step in the
right direction when compared to the 2013 proposal,’’ but says it still thinks the revised definition
may result in unintended consequences while not
generating a more representative issue price on
bonds. The firm warns that revisions to the definition of issue price will increase borrowing costs for
issuers of municipal bonds and reduce tax revenue
to Treasury because of higher tax-exempt interest
rates. Moreover, PFM says it believes that basing
issue price on subsequent post-sale trades or
changed market environments may lead to increased uncertainty about the bond issue’s economics at the time of sale. The firm also says
administrative and legal burdens will escalate and
an issue price may not be representative of current
market conditions at the time of sale.
Supplementing its general remarks regarding
issue price, PFM explains why the existing definition of issue price should remain unchanged for
competitive sales. First, negotiated sales are not an
option for many issuers. Second, the firm says,
‘‘injecting significant additional risk in the form of a
revised issue price definition would increase the
cost of all municipal bond transactions, including
competitive bond sales.’’ Third, PFM contends that
Treasury would forgo even more tax revenue.
Florida Division of Bond Finance Director J. Ben
Watkins III has expressed concern that the proposed
regs fail to differentiate between competitive and
negotiated bond sales. Under Florida law, bonds
must be sold by competitive sale (taking bids from
underwriters) to obtain the lowest interest cost for
taxpayers. This process differs from negotiated
sales, in which only specified underwriters are
invited to participate and prices for the bonds may
change over several days. The Division of Bond
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REG COMMENT CALENDAR
CORRESPONDENCE
Publicly Traded Partnerships
Andrews Kurth LLP has urged the IRS to clarify
and modify proposed regulations (REG-132634-14)
that provide guidance on whether income from a
publicly traded partnership’s activities regarding
minerals or natural resources under section
7704(d)(1) is qualifying income. The firm asks the
IRS to clarify the definition of mineral or natural
resource to include products of oil or gas, other than
plastics and similar petroleum derivatives. The firm
also suggests modifying the definition of refining
and processing to be consistent with congressional
intent as evidenced by the statute’s legislative history.
Michael Creel of Enterprise Products Partners LP
contends that the treatment of natural gas liquids in
the proposed regs is improper. The partnership says
it believes there should be a single standard for
applying the processing and refining provisions of
section 7704(d)(1)(E) to oil and natural gas production and that there is no basis to treat natural gas
and natural gas liquids different from crude oil.
Frank Bakker of OCI Partners LP has asserted
that the proposed regs incorrectly exclude methanol
from being considered a mineral or natural resource. The firm says it believes this omission is
inconsistent with the plain meaning of section
7704(d)(1)(E) and ignores the original intent of
Congress. Although not explicitly mentioned in the
statute or the related legislative history, the firm
notes, methanol is a product similar to those listed
in the legislative history and therefore should be
afforded comparable treatment.
Enviva Partners LP has recommended that the
proposed regs include separate definitions of processing and refining, limit qualifying income by
input rather than output, and permit the addition of
immaterial amounts of additives that protect or
enhance the natural resource input or are necessary
to meet environmental standards. The partnership
says the approach for addressing timber and timber
products in the proposed regs (and the list of
nonqualifying timber products) ‘‘reflects an indefensible narrowing of the words used by Congress
in section 7704(d).’’ The partnership also says the
regs represent a sharp departure from the IRS’s
long-standing interpretations regarding the processing of timber, as expressed in eight private letter
rulings spanning over 20 years.
Richard Carson of Cypress Energy Partners LP
requests that the proposed regs be clarified to
‘‘make explicit the concept plainly stated in the
legislative history to section 7704 that transportation by pipeline of minerals or natural resources is
not subject to the retail customer restriction.’’ The
partnership says infrastructure inspection services
should constitute an intrinsic activity under the
standards set forth in prop. reg. section 1.7704-4(d)
because they are specialized and essential to the
ongoing integrity of the physical infrastructure
used in the exploration, development, mining or
production, processing, refining, transportation, or
marketing of minerals or natural resources.
John Krutz of Calumet Specialty Products Partners LP says the proposed regs ‘‘erroneously limit
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Finance suggests that the regs include a presumption that when bonds are sold through a competitive sale, the issue price is the initial offering price at
the time the bonds are awarded to the best bidder
(lowest interest rate) on the sale date.
The division warns that issuers selling bonds
competitively will have difficulty complying with
the proposed regulations, in part because the elimination of the reasonable expectation test creates
uncertainty for issuers in calculating the issue price.
According to the division, ‘‘The alternative method
proposed in the regulations for such cases imposes
a significant administrative burden on the issuer to
track the information necessary to accurately calculate price and to recalculate yields.’’ The division
says it believes the competitive sale process provides the best evidence that the bonds are sold at
the lowest interest rate possible with none of the
cost or administrative burden created by the proposed regulations, and therefore an exception for
determining issue price should be made for bonds
sold by competitive sale.
Utah State Treasurer Richard Ellis contends that
the proposed regs ‘‘incentivize underwriters to act
less competitively when selling or bidding on
bonds to the detriment of the issuer and the federal
government.’’ He says that if the alternative method
is required, underwriters will sell bonds at higher
yields and lower prices to ensure that a substantial
amount of every maturity is sold at initial pricing.
Or, underwriters could (and almost certainly will)
require closing within five days of the sale date, or
a shorter time frame, to reduce their exposure to
market changes.
The treasurer also points out that issuers of
tax-exempt bonds lack the skills and tools required
to adequately perform the due diligence needed to
determine if certifications are false. Lastly, Ellis
agrees that the proposed regs do not address competitive sales adequately. To remedy those issues, he
recommends (1) allowing a safe harbor for advance
refunding bonds and conduit issues when issue
price must be known to size the issue on the date of
sale; and (2) eliminating the issuer certification
completely or clarifying that issuers may rely on
underwriter certifications unless they know, without investigation, that there is reason to doubt
them.
CORRESPONDENCE
Mortgage Interest Reporting
John Kinsella of the American Bankers Association has submitted a request under the IRS industry
issue resolution (IIR) program for guidance under
section 6050H on the reporting of accrued but
unpaid interest that becomes part of the principal of
a modified mortgage.
The association notes that section 6050H requires
a lender or party servicing a loan that receives $600
or more of interest on a mortgage from a borrower
to annually report the amount received to both the
borrower and the IRS on Form 1098, ‘‘Mortgage
Interest Statement.’’ The group says, however, that
an ambiguity arises when interest that is due to the
lender, but not paid, becomes part of the principal
of a modified mortgage.
The association says the issue is appropriate for
IIR consideration because it involves the proper tax
treatment of a common factual situation for which
there is insufficient guidance. The issue also deserves IIR attention, the group says, because it is
significant and affects a large number of taxpayers
either within an industry or across industry lines.
Moreover, the association says the issue is ripe for
consideration because it requires extensive factual
development and the IRS would benefit from an
understanding of industry practices and views.
The association describes a scenario in which
there is a modification or refinancing of a loan and
accrued but unpaid interest on the existing loan
becomes part of the principal of the new loan. In its
example, a borrower is having difficulty making
payments on a $200,000 mortgage, and there is
$4,000 of accrued but unpaid interest on the loan.
The lender and borrower agree to modify the loan
with a lower interest rate and extended payment
terms, including treatment of the $4,000 as part of
the principal of the new loan.
According to the association, some lenders are
reporting the accrued but unpaid interest as payments made on the new loan, others do not report
previously unpaid interest that has been included in
principal of the new loan, and still others may be
reporting all the interest as paid at the time the loan
is modified. The group emphasizes that borrowers
are ultimately responsible for determining the
amount of interest that is deductible on their individual returns and that they generally rely on
information furnished by their lending institutions,
even though Form 1098 is not determinative of the
borrower’s deduction.
Accordingly, the association recommends that
the IRS issue guidance on the subject with the
following premises in mind: (1) any reporting guidance should be applied on a prospective basis and
applied only to loans that are modified after the
effective date; (2) since there are significant technology and systems challenges associated with any
required changes in reporting, guidance should
allow for an appropriate amount of time for
changes to be made; and (3) consideration should
be given to borrowers who may need to make
changes in the interest deductions taken on previously filed returns with a view to avoid significant
levels of amended tax returns.
Julie Brienza, Eben Halberstam, Andy Sheets, and
Emily Vanderweide contributed to this column.
668
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certain qualifying activities from the processing and
refining of minerals and natural resources, and
reflect both a misconception of the refining industry
and a deviation from the interpretation of refining
and processing for the purposes of section
7704(d)(1)(E).’’ The partnership maintains that the
regs arbitrarily treat hydrocarbons from the natural
gas stream different from identical hydrocarbons in
crude oil. Moreover, the partnership suggests
amending the definition of marketing to include
common refining practices such as blending and
packaging, hedging, and the sale of renewable
identification numbers.
tax notes™
Private Equity Funds and the
Unrelated Business Income Tax
By Mark Berkowitz and Jessica Duran
Mark Berkowitz is an attorney and CPA who consults on
tax matters for the private equity and real estate industries.
Jessica Duran is a partner in the
San Francisco office of Deloitte
Tax LLP.
Mark Berkowitz
Tax-exempt organizations
are a major source of capital for
the private equity industry. In
this report, Berkowitz and Duran address the potential application of the unrelated business
income tax to common business practices of private equity
funds.
The views expressed herein
are
the authors’ own and do
Jessica Duran
not necessarily reflect the position of Deloitte Tax LLP. This report does not
constitute tax, legal, or other advice from Deloitte
Tax LLP, which assumes no responsibility with
respect to assessing or advising the reader as to tax,
legal, or other consequences arising from the reader’s particular situation.
Copyright 2015 Deloitte Development LLC.
All rights reserved.
Table of Contents
UBTI and the Private Equity Fund
Tax-exempt entities — particularly public and
private pension funds, endowments, and foundations — have long been major sources of capital for
private equity (PE) funds. According to one industry analyst, private pension funds, endowments,
and foundations account for 38 percent of the total
number of PE fund investors, contributing almost
30 percent of total capital.1 Sections 501 and 511
exempt these organizations from income tax, except
for unrelated business taxable income. Historically,
PE funds have rarely generated UBTI.2 But several
developments in how these funds conduct business
and changes in the industry have increased the
need to focus on this rather arcane area of the tax
law.
This report addresses several factors that have
the potential to create UBTI for the tax-exempt
investor in a PE fund: (1) borrowing to bridge the
need for cash between capital calls; (2) the fee offset
provisions, which can be exacerbated by management fee waivers; (3) a PE fund’s guaranty of its
portfolio company’s debt; and (4) the increasing use
of blocker corporations in light of the proliferation
of acquisitions by PE funds in passthrough entities.
Each of these factors has the potential to create
UBTI. Because most PE fund agreements have a
complete or partial prohibition on activities that
generate UBTI, PE fund managers must be vigilant
in maintaining compliance with those restrictions.3
The Basics
Section 511 imposes a tax on the UBTI of some
otherwise tax-exempt organizations.4 UBTI is defined as the gross income derived from an unrelated
UBTI and the Private Equity Fund . . . . . . . . . . 669
The Basics . . . . . . . . . . . . . . . . . . . . . . . . . . . . 669
1
Acquisition Indebtedness . . . . . . . . . . . . . . . . . 670
Bridging Calls . . . . . . . . . . . . . . . . . . . . . . . . . 670
Tracing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 672
Fee Offset Provisions . . . . . . . . . . . . . . . . . . . . 673
Management Fee Rebates . . . . . . . . . . . . . . . . . 674
Guaranty of Portfolio Company Debt . . . . . . . . 675
Guaranty Fee . . . . . . . . . . . . . . . . . . . . . . . . . . 676
Controlled Entities . . . . . . . . . . . . . . . . . . . . . . 677
2014 Preqin Global Private Equity Report.
Public pension funds often claim that they are not subject to
U.S. federal income tax because they are integral parts of a state
or because their income, if any, is excluded from U.S. federal
income tax under section 115(1).
3
Some fund agreements allow a percentage of income to be
from UBTI-generating sources — i.e., an UBTI basket. Often,
however, agreements require the general partner to use ‘‘best
efforts’’ or ‘‘reasonable best efforts’’ to avoid activities that
generate UBTI.
4
The unrelated business income tax generally applies to
organizations described in sections 401(a) and 501(c) (other than
U.S. instrumentalities described in section 501(c)(1)) that are
exempt from taxation by reason of section 501(a), as well as state
colleges and universities. Section 511(a). UBIT also generally
2
(Footnote continued on next page.)
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SPECIAL REPORT
COMMENTARY / SPECIAL REPORT
Although this provision appears all encompassing, section 512 excludes many categories of income
from UBTI, including most types of passive income.
Most important for PE funds, section 512 excludes
interest, dividends, and gains or losses from the
sale, exchange, or disposition of property other than
inventory and property held for sale to customers in
the ordinary course of business.8 But these exclusions are subject to an important exception for
debt-financed property.
Acquisition Indebtedness
In general, a percentage of gross income from
debt-financed property and the same percentage of
directly connected deductions are taken into account when calculating UBTI.9 Debt-financed property is property held for the production of income
that is subject to acquisition indebtedness.10 Debt
will be considered acquisition indebtedness if it is
(1) incurred to acquire or improve the property; (2)
applies to exempt IRAs (see section 408(e)(1)), exempt health
savings accounts (see section 223(e)(1)), and in other circumstances.
5
Section 512(a)(1). Special rules apply to foreign organizations; organizations described in section 501(c)(7), (9), (17), and
(20); and organizations described in section 501(c)(19). See
section 512(a)(2) to (a)(4).
6
Section 513(a).
7
Section 702(b).
8
Section 512(b)(1) and (b)(5). Note that sections 1245(a)(1)
and 1250(a)(1) provide that recapture income will be recognized
‘‘notwithstanding any other section of this subtitle.’’ Reg. sections 1.1245-6(b) and 1.1250-1(c)(2) specify that those provisions
override section 512(b)(5). Accordingly, tax-exempt entities will
recognize recapture income on the disposition of property. The
calculation of the amount of recapture income is made with
respect to the deductions that were taken into account in
calculating UBTI. Reg. sections 1.1245-5 and 1.1250-2(d)(6).
9
Section 512(b)(4). Section 514 provides some limited exceptions, including for debt incurred in the performance or exercise
of the purpose or function constituting the basis of the organization’s exemption. Section 514(c)(4).
10
Section 514(b).
incurred before acquisition of the property if the
debt would not have been incurred but for the
acquisition of the property; or (3) incurred after
acquisition and (a) the debt would not have been
incurred but for the acquisition, and (b) the need to
incur the debt was reasonably foreseeable at the
time of the acquisition.11
The percentage of gross income from property
subject to acquisition indebtedness that is included
in UBTI is based on the ratio of the average acquisition indebtedness to the average adjusted basis of
the property. The regulations refer to this ratio as
the debt/basis percentage.12 For this purpose, average basis is determined as the average of the basis
on the first and last days during the year that the
organization held the property.13 The average acquisition indebtedness is determined by averaging the
principal balance on the first day of each month that
the organization held the property.14 The average
acquisition indebtedness is determined differently,
however, for gain or loss on the sale or other
disposition of property. In that case, the numerator
is the highest acquisition indebtedness balance during the 12 months preceding the date of sale.15 As
discussed later, the highly specific nature of these
calculations provides important opportunities for
planning.
PE funds have historically invested in businesses
in corporate form. Accordingly, the fund’s primary
sources of income have been dividends and capital
gain. As noted earlier, this income should not be
subject to UBTI treatment when passed through to a
tax-exempt investor in the fund.16 But even in that
relatively simple construct, the potential for UBTI
may be present.
Bridging Calls
PE funds typically maintain limited cash reserves
despite the need for significant cash requirements
on short notice to close an acquisition. Maintaining
large cash reserves in low-yield accounts would
clearly hurt the fund’s internal rate of return and
the results for the investors and sponsors. Most
fund documents provide for a 10-day notice period
11
Section 514(c)(1). The regulations add a further gloss to this
limitation, however, stating that the need may not have been
actually foreseen but merely reasonably foreseeable. Reg. section 1.514(c)-1(a).
12
Reg. section 1.514(a)-1(a)(1).
13
Reg. section 1.514(a)-1(a)(2).
14
Reg. section 1.514(a)-1(a)(3).
15
Reg. section 1.514(a)-1(a)(1)(v). The percentage cannot exceed 100 percent.
16
A partner’s share of the gross income and deductions of a
partnership’s unrelated trade or business is included in the
partner’s calculation of its UBTI. Reg. section 1.512(c)-1.
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trade or business regularly carried on by an organization subject to section 511, less allowable deductions.5 A trade or business is unrelated if it is not
substantially related (aside from the organization’s
need for income or funds) to the purpose or function that constitutes the basis for the organization’s
tax-exempt status.6 For a partnership, the character
of any item of income or loss of a partner’s share of
partnership income is generally determined as if the
partner realized or incurred the item from its
source.7 Section 512(c)(1) provides that the income
derived by a tax-exempt organization from a partnership’s trade or business is included in the calculation of the organization’s UBTI if the trade or
business is unrelated to its exempt purpose.
COMMENTARY / SPECIAL REPORT
17
Fund agreements may give limited partners an opportunity to pre-fund capital in these situations. The fund specially
allocates the burden and tax benefit of the borrowing away from
those investors, arguably allowing them to avoid the risk of
acquisition indebtedness in this situation. The IRS has ruled
favorably in the case of a tax-exempt entity’s ownership of an
undivided interest in property subject to a mortgage when the
tax-exempt entity used equity for its share of the required
capital, even though the mortgage lien encumbered the entire
property. Rev. Rul. 76-95, 1976-1 C.B. 172. See LTR 9723025 and
LTR 9719041, in which the IRS, citing Rev. Rul. 76-95, reached
the same conclusion in a partnership context.
18
LTR 200320027; LTR 200235042; LTR 200233032; and LTR
200010061.
fifth letter ruling, the facts section did not state that
the proceeds would not be used for investments,
but the IRS stated so in its conclusion.19
In each of these five letter rulings, a primary
source of funds for the tax-exempt entity was the
liquidation of other portfolio holdings. Part of the
reason for the borrowing was to allow the taxexempt entity to liquidate its holdings on an orderly
basis and thus avoid a price decrease that might
result from large sale volumes. Also, in each of four
of these letter rulings, the tax-exempt entity represented that some of its cash needs resulted from the
use of available cash for previously committed
purchases as part of ongoing acquisition programs.20 Both of those facts could implicate the
second or third prongs of the definition of acquisition indebtedness under section 514(c)(1)(B) and
(C). But only LTR 200320027 specifically addressed
these issues, and it merely concluded that the
provisions did not apply because ‘‘there does not
appear any close connection between the debt and
the acquisition or improvement of any property.’’21
Perhaps of most interest, however, are the two
oldest of the seven letter rulings. In each of these, a
tax-exempt entity used a wholly owned title holding company to borrow funds and purchase investments when the tax-exempt parent lacked the
liquidity to do so because of benefit payment requirements.22 Once the parent tax-exempt entity
obtained the necessary liquidity, it would either
purchase the securities from the title holding company or make a capital contribution allowing a pay
down of the line within weeks of the borrowing.
Relying on Rev. Rul. 78-88, the IRS concluded that
the borrowing did not give rise to acquisition
indebtedness but rather was part of the ‘‘ordinary
and routine investment activities . . . in connection
with [an exempt organization’s] securities portfolio.’’
In all the letter rulings, the debt was incurred
largely because of distribution requirements. The
debt was transitory and, as noted by the IRS, there
was no intent to use the borrowing for acquisition
or to circumvent the debt-financed restrictions. To
the extent assets were acquired, it was part of an
ongoing scheduled investment program. The borrowing was not used to increase the size of the
portfolio through leverage. In each case, relying on
19
LTR 9644063.
See supra note 18.
21
As discussed later in this report, this is perhaps an example
of the IRS applying the tracing concept.
22
LTR 8721107 and LTR 8721104.
20
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to limited partners for capital calls. Some documents place restrictions on the maximum percentage of committed capital or minimum dollar
amount that may be called, but nonetheless, the
investor must have a ready source of liquidity to
meet its call notice. This in turn affects the investor’s
return on its assets because it must maintain this
cash in a highly liquid account. To alleviate this
burden for the investor, many funds routinely borrow the amount needed to close an acquisition and
then make a capital call.17 This course of action
raises the specter that the fund has now incurred
acquisition indebtedness under the first prong of
the section 514 definition because the debt was
incurred to acquire the investment.
The IRS has issued seven private letter rulings
addressing acquisition indebtedness in the context
of the use of short-term indebtedness by tax-exempt
entities. Each of the letter rulings cites Rev. Rul.
78-88, 1978-1 C.B. 163, for support in concluding
that the borrowing did not give rise to acquisition
indebtedness. Rev. Rul. 78-88 addressed the UBTI
consequences of a securities lending program in
which the tax-exempt entity was allowed to retain
the earnings from the collateral it held under the
program. Although the amount was clearly earned
with borrowed funds (the collateral had to be
returned if the tax-exempt entity’s securities were
returned), the IRS ruled that the income was not
subject to section 514 because the entity had not
incurred the indebtedness ‘‘for the purpose of making additional investments.’’
In each of the letter rulings, the tax-exempt entity
arranged for a line of credit to address liquidity
issues arising in part because of distribution requirements for benefits or for account redemptions
or transfers. In each case, the taxpayer represented
that the borrowing would be outstanding for short
periods (30 days or less) and that the line would be
used only infrequently. In four of the letter rulings,
there was a clear statement that borrowed funds
would be used not for additional investments but
rather to meet the distribution requirements.18 In a
COMMENTARY / SPECIAL REPORT
23
Note, however, that in LTR 8721107 and LTR 8721104 — the
only rulings in which the debt proceeds could be traced to the
purchase of an investment — the taxpayers represented that the
debt would be repaid in ‘‘days or weeks.’’
centage numerator for income other than
dispositions is the average during the year. Accordingly, if the debt is extinguished by the end of the
year prior to the receipt or recognition of interest or
dividend income from the debt-financed property,
the income will not be considered UBTI. Similarly, if
the debt is extinguished more than 12 months
before the disposition of the property, the gain or
loss on sale would not be subject to UBTI.
Tracing
Even if the acquisition indebtedness rules appear
to apply, the question arises as to which property
does the debt financing apply. For a loan to bridge
a capital call for an investment, the property acquired with the debt proceeds is clear. If the acquisition indebtedness rules apply, this would
arguably fall under the first prong of the regulation
— debt incurred to acquire property. It would
therefore seem appropriate to trace the financing to
the specific investment. Neither of the other prongs
of the test would appear applicable.
But often a PE fund will make one capital call
covering both an investment and the payment of
the fund’s expenses. Sometimes the capital call is
only for expenses. In that case, if bridge financing is
used, should any of the fund’s investments be
considered debt financed? The proceeds cannot be
traced to a particular investment, but arguably all
the fund’s investments benefit from the expenditure. The legislative history provides some indication that taxpayers need not apply an avoided cost
approach but that a tracing concept should apply.24
Also, the regulations provide an example clearly
tracing proceeds.25 The Tax Court applied a tracing
approach in determining that a tax-exempt entity’s
investment in Treasury notes (T-notes) was subject
to acquisition indebtedness. In Southwest Texas Electric Cooperative Inc. v. Commissioner,26 the taxpayer
drew down 50 percent of a loan to construct a
facility for use in its exempt purpose. It completed
the facility using its working capital but later borrowed the remaining balance of the loan and invested the proceeds in T-notes. The Tax Court
rejected the taxpayer’s argument that it would not
24
Joint Committee on Taxation, ‘‘General Explanation of the
Tax Reform Act of 1969,’’ JCS-16-70, at 64 (1970) (‘‘Thus, for
example, where a church has a portfolio of investments with no
debt, and subsequently incurs a debt to construct a church
related building, such as a seminary, such debt will not be
considered acquisition indebtedness with respect to the investment portfolio.’’). Accordingly, it does not appear that ‘‘old and
cold’’ investments would be tainted by new debt even if the
tax-exempt entity could have avoided incurring the debt by
liquidating the investments.
25
Reg. section 1.514(c)-1(a)(2), Example 1.
26
T.C. Memo. 1994-363.
672
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Rev. Rul. 78-88, the IRS noted that the debt was
incurred for administrative convenience of the organization.
Although the two older rulings provide the most
support, the analogy of any of the rulings to bridging capital calls in a PE fund is imperfect. But
providing partners additional time to satisfy a call
clearly allows them to more effectively manage the
liquidity of their investment portfolios. No doubt
many of the tax-exempt partners have redemption
or distribution requirements. Incurring the debt
allows these entities more time to manage their own
liquidity issues. As in the rulings, there is no intent
to circumvent the debt-financed property restrictions; the debt will clearly be transitory because it is
fully intended to be repaid through a capital call on
a short-term basis. Any impact on the investor’s
return is perhaps nominal. Nevertheless, in each of
the letter rulings, the taxpayer represented that
borrowing would be infrequent, and in several
rulings, the taxpayer maintained a cash reserve to
avoid the need for borrowing. In contrast, many PE
funds have begun to implement bridge arrangements systematically.
As noted, most PE fund agreements require
investors to fund capital within 10 days of a call
notice. Many advisers therefore suggest that bridge
financing not be outstanding for any period beyond
the time needed to call capital. Other advisers have
relied on the previously noted private letter rulings
and recommended that the debt be outstanding for
no more than 30 days.23 But more recently, banks
active in lending to PE funds have marketed products providing for 90- or even 180-day bridge loans.
Quarterly calls can provide significant administrative benefit to the partners. Typically, the PE fund is
required to pay a management fee quarterly, and
capital will accordingly be called on those dates.
Using a 90-day bridge allows the PE fund to bundle
its capital calls to be made quarterly. This arrangement provides the partners with certainty of timing
and allows them a significant benefit in managing
the liquidity of their investments.
Although the reasoning of the letter rulings may
be helpful to PE funds that bridge calls, there is no
specific precedent supporting the conclusion that a
capital call bridge loan used to acquire an investment does not give rise to acquisition indebtedness.
With proper care, however, it may be possible to
avoid UBTI, even if the fund has incurred acquisition indebtedness. As noted, the debt/basis per-
COMMENTARY / SPECIAL REPORT
Fee Offset Provisions
Another potential source of UBTI arises from the
economic provisions of the management fee arrangement entered into by most PE funds. In a
typical PE fund arrangement, the fund agrees to
pay a management fee to the general partner or a
separate management company formed by the
sponsor. The fee is most often paid quarterly or
semiannually in advance. Obviously, the fund’s
return is based on the performance of the portfolio
companies, and accordingly, it has an incentive to
obtain high-level consulting advice to allow the
portfolio company to optimize its operations. Because the fund will often have a significant ownership stake in the portfolio companies, its manager is
in a unique position to be able to provide the
consulting services. In reality, it is often the unique
expertise of the principals in the management company that creates the additional value in the portfolio company, providing the return to the fund on
exit or through a recapitalization.28 The management company will typically charge the portfolio
company for these services. Because the limited
partners are bearing a fee to the management
27
96 T.C. 845 (1991).
Some academics have questioned the value of these services. See Gregg D. Polsky, ‘‘The Untold Story of Sun Capital:
Disguised Dividends,’’ Tax Notes, Feb. 3, 2014, p. 556. Also, there
has been media focus on the various fees charged to portfolio
companies by sponsors. See Anne-Sylvaine Chassany and
Henny Sender, ‘‘Private Equity: A Fee Too Far,’’ Financial Times,
July 13, 2014.
28
company for asset management services, there is a
sense that the management company would be
compensated twice for the same service — management fee from the fund and fee from the portfolio
company. Thus, most management fee agreements
provide for a reduction (offset) in the management
fee to the extent the management company earns a
fee from the portfolio company for specified services.29
Offering memoranda for PE firms have historically disclosed the risk that the offset provision
could result in UBTI to the investors.30 Although the
offering memos have rarely described the nature of
the risk, the IRS could presumably assert either that
there has been assignment of income or that the
fund has obtained the economic benefit of the
portfolio company’s payment to the management
company and that the payment should accordingly
be viewed as the fund’s income. The recent decision
in Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund31 has shined a
spotlight on this latter risk.
Sun Capital involved the assertion by the Teamsters pension fund that two PE funds (Fund III and
Fund IV) formed by Sun Capital were liable for an
unfunded pension liability of a bankrupt portfolio
company owned entirely by the two funds. The
funds could be held liable under the Multiemployer
Pension Plan Amendment Act of 1980 only if they
were engaged in a trade or business under common
control with the portfolio company. Thus, to have
liability under the act, a fund would need to be
engaged in a trade or business as well as meet the
required ownership percentage. The First Circuit
concluded that Fund IV was engaged in a trade or
business for this purpose but remanded the case to
the trial court to determine whether Fund III was
also so engaged.32 Although the First Circuit cited
several factors in its discussion, the key distinction
between Fund III and Fund IV appeared to be the
trial court’s finding that Fund IV’s management fee
29
These arrangements can differ regarding the percentage
rebated and regarding which fees are subject to offset. The PE
principles of the Institutional Limited Partners Association
provides that ‘‘transaction, monitoring, directory, advisory, exit
fees and other consideration charged by the [general partner]
should accrue to the benefit of the fund.’’ Institutional Limited
Partners Association Private Equity Principles, ver. 2.0, at 5 (Jan.
2011).
30
This issue also implicates the potential for effectively
connected income for non-U.S. investors. To avoid that risk,
investors sometimes waive their right to all or part of the offset
income in side letters entered into at the inception of the fund.
31
724 F.3d. 129 (1st Cir. 2013).
32
The case was also remanded to determine whether the
funds met the common control test. Id. at 150.
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have made the borrowing but for its construction of
the new facility and that the T-notes should therefore not be considered debt-financed property. In
holding that the T-notes were debt financed, the Tax
Court stated, ‘‘Simply put, the debt the Petitioner
owed to the [Rural Electrification Administration] is
‘acquisition indebtedness’ because the debt was
used by Petitioner to acquire the T-Notes.’’
The Tax Court also applied a tracing approach in
Kern County Electrical Pension Fund v. Commissioner.27 In Kern, the pension fund pledged to a bank
three low-yield certificates of deposit subject to
early withdrawal penalties and invested the proceeds in a high-yield CD. The pension fund asserted
that the borrowing should be attributed to the old
CDs since it was incurred merely to increase the
yield. The Tax Court rejected the pension fund’s
argument and traced the debt to the new CD.
Accordingly, taking into account the ‘‘but for’’
and ‘‘reasonably foreseeable’’ tests of the second
and third prongs of the definition of acquisition
indebtedness, tracing the proceeds to the expenditure would appear supportable.
COMMENTARY / SPECIAL REPORT
33
Fund IV was managed through a management company
owned by the general partner of the fund. The management
agreement provided for a fee offset — the management fee was
reduced to the extent of fees paid by the portfolio companies to
the management company.
34
724 F.3d at 143.
35
Id. at 150.
section 512(b). Thus, without imputing the management company’s trade or business to the fund, it is
difficult to envision this resulting in UBTI. Some
academic discussions have analogized PE funds to
real estate developers and asserted that the funds
hold the portfolio company investments with an
intent to sell.36 However, there is no precedent to
date that would directly support this result.37
Management Fee Rebates
When offsets are coupled with the use of a fee
waiver, the offset can sometimes result in an actual
payment to the fund.38 This clearly increases the
profile of this issue and requires the fund to categorize the amount on its income tax return. Most
funds reflect this as other portfolio income. This
raises the question whether the amount constitutes
UBTI since it does not fit specifically within any of
the exclusions provided by section 512(b). However,
sections 511 and 513 subject amounts to UBIT only
if earned in an unrelated trade or business. Absent
the attribution argument made in Sun Capital, it
would seem unlikely that a typical PE fund would
be deemed engaged in a trade or business. In a
similar context, the IRS has ruled that a management fee rebate will be qualifying income for a
regulated investment company and as such treated
as part of its investment activity.39 In summary, it
appears inconsistent that a fund receiving a cash
rebate of a fee should result in UBTI.
36
Some commentators believe that Sun Partners lends credence to the so-called corporate developer theory. See Steven M.
Rosenthal, ‘‘Taxing Private Equity Funds as Corporate ‘Developers,’’’ Tax Notes, Jan. 21, 2013, p. 361. Under this theory, PE
firms should be viewed in the same lens as a land developer
holding parcels for sale in the ordinary course of business. The
theory finds little support in the tax law but has nonetheless
managed to generate interest in academic and political circles. If
successfully pursued, the result would be highly detrimental for
tax-exempt and taxable investors.
37
But see Farrar v. Commissioner, T.C. Memo. 1988-385.
38
On July 23, 2015, the IRS published proposed regulations
(80 F.R. 43652) addressing disguised payments for services
under section 707(a)(2)(A) (REG-115452-14). In attempting to
distinguish an interest in a partnership from a fee, the regulations focus largely on the level of entrepreneurial risk inherent
in the arrangement. Although the regulations were issued in
proposed form, their preamble states that ‘‘the position of the
Treasury Department and the IRS is that the proposed regulations generally reflect Congressional intent as to which arrangements are appropriately treated as disguised payments for
services.’’ 80 F.R. 43657. The preamble also announces the IRS’s
views on the application of Rev. Proc. 93-27, 1993-2 C.B. 343, to
some profits interest arrangements and provides notice that the
IRS will further amend the revenue procedure to exclude
specific arrangements. The regulations and the changes to the
revenue procedure will cause taxpayers and advisers to rethink
the components of any fee waiver provisions.
39
Rev. Rul. 92-56, 1992-2 C.B. 153.
674
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was subject to a management fee offset provision.33
The First Circuit reasoned that through the operation of that provision, Fund IV received the economic benefit of the management company’s
activities in providing services to the portfolio company. Applying a somewhat expansive view of
agency law, the court concluded that ‘‘the Sun
Funds’ active involvement in the management under the agreements provided a direct economic
benefit to at least Sun Fund IV that an ordinary,
passive investor would not derive: an offset against
the management fees it otherwise would have paid
its general partner for managing the investment in’’
the portfolio company.34 The court did not find
Fund III to be engaging in a trade or business, citing
the lack of a trial record on whether its documents
included an offset provision. In footnote 20 of the
opinion, the First Circuit stated, ‘‘We do not determine if Sun Fund III is a ‘trade or business’ because
we cannot tell from the record before us if the Fund
received an economic benefit from the offset.’’35
The court’s opinion has engendered much commentary and a fair degree of criticism. It is questionable whether a passive investment fund whose
sources of income are solely from interest, dividend,
and capital gain should be viewed as engaging in a
trade or business merely because of a negotiated
adjustment in the overall cost charged to it to
manage its investments made on the basis that the
manager can obtain compensation from another
and more direct source. It does not seem to follow
that a reduction in the cost of making passive
investments results in a change in the nature of an
investment activity to one of a trade or business.
Imputing the management company’s business to
the fund appears overreaching because it would
result in the fund being deemed to be in the trade or
business of the entity to which the fund is paying a
fee to manage its investment activity. Nonetheless,
and although the case was not decided under
section 162 or specifically with respect to UBTI or
effectively connected income, the opinion stands as
a stark warning to funds with offset provisions.
However, even if the fund is deemed to be in a
trade or business, the effect may be minimal with
respect to UBTI. A PE fund’s primary sources of
income are interest, dividends, and capital gain.
Unless debt-financed, those amounts will not constitute UBTI because of the exclusions provided in
COMMENTARY / SPECIAL REPORT
40
462 F.2d 712 (5th Cir. 1972).
The existence of this loan, subordinated to the purchase
money notes, would seem to provide support for the taxpayer’s
position as evidence that another party was willing to lend
without a guarantee. However, the government established that
the motivation for this loan was an agreement by the buyer to
employ the lender’s son in its business. Thus, the court refused
to consider this loan as evidence of borrowing capacity. As an
alternative, the taxpayer asserted that because of its subordination, the third-party loan should be considered preferred equity,
thus improving the debt-equity ratio to 4 to 1. In a surprising
conclusion, the court also rejected this approach. It maintained
that the issues should be analyzed viewing the fully subordinated loan as debt.
41
$600,000 in money or property to [the buyer] without the personal guarantee.’’42 On appeal, the Fifth
Circuit analyzed the notes applying the typical
debt-versus-equity principles. In affirming the Tax
Court, it concluded that ‘‘the guarantee enabled
[the shareholder] to create borrowing power for the
corporation which normally would have existed
only thorough the presence of more adequate capitalization.’’43
The Fifth’s Circuit’s analysis included a focus on
both the objective tests associated with the standard
debt-equity analysis and consideration of a more
subjective standard of whether there was a reasonable expectation that the debt would be repaid
without resort to the guarantee and thus whether
the guarantee allowed the company to borrow
when it otherwise could not.44 Subsequent cases
have not always included both factors. For example,
in Smyers v. Commissioner,45 the Tax Court, in applying a debt-equity analysis, stated that the fact that
loans could not have been obtained without the
guarantee did not alone cause the transaction to be
recast.
The IRS has provided little guidance in this area.
In Rev. Rul. 79-4, 1979-1 C.B.150, the sole shareholder of a corporation guaranteed the corporation’s debt. The IRS offered little analysis in
concluding that the shareholder should be viewed
as the borrower, stating merely that ‘‘the facts and
circumstances, including but not limited to [the
corporation’s] thin capitalization,’’ led to that conclusion.
Subsequent to the ruling, the IRS issued final
regulations under section 385 that included a specific section addressing guaranteed loans. Reg. section 1.385-9(a) stated a general rule:
If . . . [the] shareholder in a corporation guarantees a loan made to the corporation (either
directly or indirectly, e.g., by pledging collateral), and . . . [u]nder relevant legal principles
(applied without reference to the regulations
under section 385), the loan is treated as made
to the shareholder, then the shareholder is
treated as making a contribution to the capital
of the corporation.
42
462 F.2d at 723.
Id. at 722.
44
Taxpayers have used the Plantation Patterns analysis to
successfully assert basis in an S corporation for a third-party
loan to the corporation guaranteed by the shareholder. Selfe v.
United States, 778 F.2d 769 (11th Cir. 1985).
45
57 T.C. 189, 198 (1971).
43
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Guaranty of Portfolio Company Debt
Banks have combined the capital call line of
credit discussed earlier with an ability for a fund’s
portfolio company to draw on the same line of
credit for relatively short-term borrowing. Although terms vary, the credit line is most often
guaranteed by the fund and secured only by the PE
fund’s ability to make future capital calls from its
limited partners. The line is usually funded within
several days of a request by a portfolio company,
and the bank does not perform due diligence on the
company other than a request for organizational
documents. This course of action raises the question
whether the fund should be considered the borrower under a substance-over-form analysis, most
famously demonstrated in Plantation Patterns Inc. v.
Commissioner.40
The shareholders of Plantation Patterns agreed to
sell their stock to a corporate buyer in return for a
cash payment and a purchase money note. The
buyer was a shell corporation formed for the purchase and capitalized with $5,000 of equity and a
subordinated note of $150,000 from a third party.41
The purchase money note was subordinated to all
creditors other than the third-party debt. To secure
the purchase money note, the sellers required the
shareholders of the buyer to guarantee the buyer’s
note. The buyer made all required principal and
interest payments on the third-party debt and the
purchase money notes over the next four years.
Despite the positive operating history, upon audit
the IRS disallowed the buyer’s interest expense on
the purchase money notes and recharacterized the
payments of principal and interest as dividends to
the shareholders on the basis that the purchase
money notes should be viewed as owed by the
shareholders, not the buyer corporation. Noting
that treating the purchase money notes as debt
resulted in a debt-equity ratio of 125 to 1, the Tax
Court sustained the IRS’s determination. The court
stated, ‘‘The question here is not whether other
sources would have made such advances under the
facts, but whether any source would have advanced
COMMENTARY / SPECIAL REPORT
to clarify — it is hoped beyond doubt — that
the section 385 regulations are not intended to
change existing case law relating to the circumstances under which a third party loan to
a corporation which is guaranteed by a shareholder will be recharacterized as a loan to the
shareholder followed by a capital contribution
by the shareholder to the corporation. Thus
existing case law, including such cases as
Plantation Patterns, Inc. v. Commissioner, 462
F.2d 712 (5th Cir. 1972), cert. denied, 404 U.S.
1076 (1972), aff’g T.C. Memo. Dec. 1970-82
(1970), will continue to govern whether such
recharacterization is appropriate.
In summary, the law has not advanced greatly
from the issuance of the Plantation Patterns decision.
Taxpayers should therefore analyze shareholderguaranteed loans using both the objective debtequity test applied as if the shareholder had lent the
funds and the more subjective consideration of
whether there was a reasonable expectation that the
debtor and not the guarantor would satisfy the debt
— that is, whether the company could have obtained funds without the guarantee.47 Taxpayers
would be well-advised to maintain contemporaneous documentation supporting the portfolio company’s borrowing ability.48
Guaranty Fee
The existence of a fund-level guarantee raises the
question whether the fund should be compensated
for providing its credit. If the answer is yes, what is
the character of the payment — compensation for
46
T.D. 7747, 45 F.R. 86459 (Dec. 31, 1980). ‘‘The final regulations make it plain that these rules are essentially a restatement
of existing case law.’’
47
Although the courts do not appear to have given great
weight to the guarantor’s position in the transaction, taxpayers
may also be wise to consider these factors in their analysis. The
guarantor’s position should be distinguishable from that of the
primary obligor. It is therefore helpful for the guarantor to
obtain a right of reimbursement or subrogation against the
primary obligor and establish that the lender is required to
proceed first against the primary obligor upon default — i.e.,
collection guaranteed but not payment guaranteed.
48
Preferably, this should include a commitment letter or an
investment-committee-approved term sheet indicating the
bank’s willingness to lend funds on commercially reasonable
terms. Without more, a letter from a bank representative may be
inadequate. See, e.g., Murphy Logging Co. v. Commissioner, 239 F.
Supp. 794 (D. Or. 1965), rev’d, 378 F.2d 222 (9th Cir. 1967).
services? And does that compensation give rise to
UBTI? Based on existing precedent, it is unclear that
a fee should be charged or imputed if not charged.
In determining whether a guarantee fee paid to a
shareholder is deductible or treated as a
distribution/dividend, courts have stated five criteria that must be considered:
1. Is the amount reasonable?
2. Is it customary in the industry for shareholders to charge a guaranty fee?
3. Did the shareholder demand compensation
for providing the guarantee?
4. Could the company have paid a dividend
but refrained from doing so?
5. Is the payment in proportion to stock ownership?49
Using this framework, it is unlikely that a payment made or imputed for a guaranty would be
considered a fee in the typical PE fund context. It is
not customary to charge a fee in that industry; the
shareholders would not demand it; it is likely the
company using the guaranteed line is not highly
profitable; and it is likely that the amount would be
paid in proportion to ownership. Moreover, the Tax
Court has recognized that a shareholder may provide a guarantee, not with the expectation of remuneration, but rather in essence as a capital
contribution made to protect the shareholder’s existing investment.50
Even if the IRS were successful in imputing a
guaranty fee to compensate the PE fund for its
guaranty, it would seem unlikely that that amount
would give rise to UBTI. Section 512(a)(1) defines
UBTI as ‘‘gross income derived by any organization
from any unrelated trade or business (as defined in
section 513) regularly carried on by it’’ (emphasis
added). Most practitioners would agree that a PE
fund is not engaged in a trade or business.51 It is
questionable whether infrequently providing a
guaranty to a portfolio company investment should
be viewed as an activity that is ‘‘regularly carried
49
Seminole Thriftway Inc. v. United States, 42 Fed. Cl. 584
(1998).
50
Centel Communications v. Commissioner, 92 T.C. 612 (1989).
Further, the section 482 regulations do not yet address guarantee fees, other than to except them from the service cost method.
Reg. section 1.482-9(b)(4)(viii). The IRS has previously ruled that
under section 482, guarantees provided by a parent to its
subsidiary should be treated as services. See, e.g., GCM 38499
(Sept. 19, 1980); and LTR 7822005. Before amendment, the
regulations under section 482 provided that if the guarantees are
not an integral part of the business of the guarantor or recipient,
the arm’s-length charge would be deemed equal to the cost and
therefore presumably minimal. Former reg. section 1.482-2(b)(3)
and (7).
51
But see Sun Capital, 724 F.3d 129.
676
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The preamble clarifies that the IRS believed that
this regulation merely restated current case law.46
The final regulations were withdrawn, and new
regulations proposed shortly thereafter omitted reg.
section 1.385-9. The preamble to the proposed regulations explains that this was done:
COMMENTARY / SPECIAL REPORT
Controlled Entities
With the advent of limited liability companies,
limited liability partnerships, and the check-the-box
regulations, the number of businesses organized in
passthrough form has accelerated greatly in the last
decade. PE funds have always been organized as
limited partnerships. But, more recently, the PE
industry has used the passthrough form as a preferred method of portfolio company acquisition.
This form provides many benefits to the industry
but comes with the clear potential to generate
UBTI.53 As noted earlier, a partner’s share of the
gross income and deductions of a partnership’s
unrelated trade or business is included in the partner’s calculation of its UBTI.54 Accordingly, an unrelated trade or business carried on by a
passthrough portfolio company would result in
UBTI for a tax-exempt partner in the PE fund. To
avoid this result, tax-exempt entities will usually
make these investments through a domestic or
foreign corporation (a blocker). The trade or business activities of a blocker are generally not attributed to its equity holders.55 This reduces the UBTI
concern but comes at the cost of corporate-level tax.
In general, this structure places the tax-exempt
entity in the same position it would have been in
52
The IRS has ruled that a one-time receipt of a brokerage
commission by a tax-exempt entity did not constitute UBTI
because the activity was not regularly carried on. LTR
201015037. In the letter ruling, the tax-exempt entity represented
that it had not received such a fee in the prior five-year period.
See also Museum of Flight Foundation v. United States, 63 F.
Supp.2d 1257 (W.D. Wash. 1999).
53
See Jessica Duran and Mark E. Berkowitz, ‘‘Private Equity
Firms Finding Value in Passthrough Opportunities,’’ PEI Manager (Dec. 2012).
54
Section 512(c); reg. section 1.512(c)-1.
55
See LTR 200251016, LTR 200251017, and LTR 200251018, for
examples of the IRS accepting the use of a blocker for taxexempt equity holders’ leveraged investments. In the rulings,
the IRS acknowledged the taxpayer’s representations that the
blocker entity had a substantive business purpose, including
increased flexibility in disposing of the fund’s debt-financed
investments, further insulation against liabilities, and more
efficient management of the investments. The IRS also noted
that but for the blocker, the income would be UBTI to the
tax-exempt entity. The blocker effectively converted the income
to a dividend exempt under section 512(b)(1).
had the portfolio company been structured as a C
corporation — that is, earnings are subject to corporate tax.
Nonetheless, investors use different methods to
attempt to limit this tax leakage. Structuring the
blocker’s capital as partly in the form of shareholder
loans has become a primary approach. The debt
financing can provide interest deductions reducing
the blocker’s taxable income, and the resulting
interest income would be excluded from UBTI
under section 512(b).56 However, the tax-exempt
entity’s ability to use this tax planning approach
may be limited by section 512(b)(13), particularly
because of the sunset of a highly used exception to
these rules.
Section 512(b)(13) was enacted in 1969 to prevent
tax-exempt entities from stripping earnings from
taxable or tax-exempt corporate subsidiaries invested in unrelated businesses.57 In general, the
provision operates to subject to UBIT otherwise
excludable payments, such as interest, rent, and
royalties, to the extent the payment reduces the net
unrelated income or increases any net unrelated
loss of the controlled entity.58 Net unrelated income
of a controlled entity that is not exempt from tax
under section 501(a) is the portion of that entity’s
taxable income that would be UBTI if that entity
were exempt under section 501(a) and had the same
exempt purposes as the controlling organization.59
Net unrelated income of a controlled entity that is
exempt under section 501(a) is the amount of UBTI
of the controlled entity.60 Net unrelated loss is the
net operating loss adjusted under rules similar to
the rules that apply to net unrelated income.61
Under this provision, all or part of interest, annuities, royalties, and rent (but not dividends) received
by a controlling organization from a controlled
56
Structuring this debt requires careful attention to the
debt-equity analysis as well as the limitations under section 267
(related parties), section 163(j) (earnings stripping), and section
163(i) (applicable high-yield discount obligation), as well as
other factors.
57
See JCT, supra note 24, at 71, for a discussion of the intent in
enacting what is now section 512(b)(13) to monitor payments
that would be considered deductible in computing the taxable
income of a corporation but would be exempt from tax if
received by a tax-exempt organization. The explanation describes a transaction potentially viewed as giving tax-exempt
entities an unfair competitive advantage (‘‘Some exempt organizations ‘rent’ their physical plant to a wholly owned taxable
corporation for 80 percent or 90 percent of all the net profits
(before taxes and before the rent deduction). This arrangement
enables the taxable corporation to escape nearly all of its income
taxes because of the large ‘rent’ deduction.’’).
58
Section 512(b)(13)(A); reg. section 1.512(b)-1(l)(1).
59
Section 512(b)(13)(B)(i)(I).
60
Section 512(b)(13)(B)(i)(II).
61
Section 512(b)(13)(B)(ii).
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on.’’52 Funds may make other arguments why such
a fee should not be considered UBTI. A guaranty is
to some extent similar to a commitment fee in that
the fund stands by, ready to advance capital if
called. The receipt of a commitment fee is excepted
from UBTI under section 512(b)(1). In summary,
although there is no precedent on point, it would
seem unlikely that if a fee were imputed it would
constitute UBTI in this circumstance.
COMMENTARY / SPECIAL REPORT
Many commentators questioned the rigidity of
the statute.65 In 2006, in connection with the Pension Protection Act of 2006, Congress limited its
application to payments exceeding an arm’s-length
amount as determined under section 482.66 As
originally enacted, the exception for arm’s-length
payments would have sunset at the end of 2007. But
it has been continually extended by Congress until
its most recent expiration on December 31, 2014. It
is important to note that this exception applies only
to payments received under contracts in place at the
date of enactment (August 16, 2006) of the provision
or payments regarding renewals of those contracts.67
In the typical PE fund structure, the ownership of
the blocker is relatively diverse and thus avoids the
application of the limitation. But the trend toward
separate accounts and significant co-investment vehicles is increasing and has become a primary area
of growth for PE funds.68 Thus, with the sunset of
the limited exception for arm’s-length transactions
and the trend toward separate accounts, the absence
of a relief provision takes on increasing importance.
At least one major organization has recommended
that legislation be introduced to reenact the relief
provision and make it permanent.69 But until legislation is introduced and enacted, as of 2015, any
tax-exempt entity that owns more than 50 percent of
a blocker will be faced with determining the application of section 512(b)(13) to the payments it
receives without benefit of an arm’s-length exception.
62
Section 512(b)(13)(C).
Section 512(b)(13)(D)(i)(I). As originally enacted, the statute
required 80 percent ownership to attain control. This was
reduced to 50 percent by the Taxpayer Relief Act of 1997 because
of the perception that the rule was being circumvented: ‘‘Because section 512(b)(13) was narrowly drafted, organizations
were able to circumvent its application through, for example,
the issuance of 21 percent of nonvoting stock with nominal
value to a separate friendly party or through the use of tiered or
brother/sister subsidiaries.’’ JCT, ‘‘General Explanation of Tax
Legislation Enacted in 1997,’’ JCS-23-97, at 239 (Dec. 17, 1997).
64
Section 512(b)(13)(D)(ii).
65
See David A. Brennen, ‘‘Congress Finally Adopts New
UBIT Standards in 512(b)(13) for Controlled Entities,’’ 26 ABA
Section of Taxation News Quarterly 6 (Fall 2006), for a brief but
thorough discussion of the history of section 512(b)(13) from
1950-1997 and the objectives of the amendments thereto.
66
Section 512(b)(13)(E); P.L. 109-280, section 1205(a).
63
67
Section 512(b)(13)(E)(iii).
See Tony James, ‘‘Blackstone Scales Through New Ideas,
Products,’’ PE Hub (Apr. 17, 2015); Chris Witkowsky, ‘‘Apollo
Cites Separate Accounts as Big Growth Area,’’ PE Hub (Aug. 8,
2014). According to one report, 43 percent of institutional
investors intend to or are participating in PE through separate
accounts. Bain & Co. Global Private Equity Report 2015, at 32.
69
See American Institute of Certified Public Accountants,
‘‘Compendium of Tax Legislative Proposals — Simplification
and Technical Proposals,’’ at 74 (Mar. 17, 2015) (‘‘Proposal: Make
permanent the fair market value exception under Section
512(b)(13).’’).
68
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Tax Notes welcomes submissions of commentary and
analysis pieces on federal tax matters that may be of
interest to the nation’s tax policymakers, academics,
and practitioners. To be considered for publication,
articles should be sent to the editor’s attention at
tax.notes@taxanalysts.org. Submission guidelines and
FAQs are available at taxanalysts.com/submissions.
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entity will be included in UBTI.62 For a corporation,
control is defined as ownership of more than 50
percent of the corporation’s stock, determined by
vote or value.63 Ownership is determined by applying the constructive ownership rules of section
318.64
tax notes™
Inflation Adjustments Affecting
Individual Taxpayers in 2016
A. Standard Deduction Amounts . . . . . . . .
B. Additional Deductions for Elderly and
Blind . . . . . . . . . . . . . . . . . . . . . . . . . .
C. Limitation for Dependents . . . . . . . . . . .
D. Exemption Amount . . . . . . . . . . . . . . .
E. Exemption Phaseout . . . . . . . . . . . . . . .
IV.
Overall Limitation on Itemized
Deductions . . . . . . . . . . . . . . . . . . . . . . .
A. Threshold Amount . . . . . . . . . . . . . . . .
V.
Tax Rate Schedules . . . . . . . . . . . . . . . . . .
VI.
Alternative Minimum Tax Items . . . . . . . .
A. Exemption . . . . . . . . . . . . . . . . . . . . . .
B. Exemption Phaseout . . . . . . . . . . . . . . .
C. 28 Percent Bracket . . . . . . . . . . . . . . . . .
VII.
Unearned Income of Minor Children . . . . .
A. Net Unearned Income . . . . . . . . . . . . . .
B. Placing Unearned Income on Parent’s
Return . . . . . . . . . . . . . . . . . . . . . . . . .
C. AMT Exemption . . . . . . . . . . . . . . . . . .
VIII.
Child Tax Credit . . . . . . . . . . . . . . . . . . . .
IX.
Gift and Estate Tax Items . . . . . . . . . . . . . .
A. Annual Gift Tax Exclusion . . . . . . . . . . .
B. Unified Estate and Gift Tax Exclusion . . .
X.
Earned Income Tax Credit . . . . . . . . . . . . .
XI.
Adoption Expenses Credit and Exclusion . .
XII.
Educational Savings Bonds . . . . . . . . . . . .
A. Phaseout of Benefit . . . . . . . . . . . . . . . .
XIII.
Education Tax Credits . . . . . . . . . . . . . . . .
A. Phaseout of Credits . . . . . . . . . . . . . . . .
XIV.
Education Interest Expense . . . . . . . . . . . .
XV.
Qualified Transportation Fringe Benefits . .
XVI.
Medical Savings Accounts . . . . . . . . . . . . .
A. Contribution Limitations . . . . . . . . . . . .
XVII. Health Savings Accounts . . . . . . . . . . . . . .
XVIII. Long-Term Care Insurance Premiums . . . . .
XIX.
Long-Term Care Insurance Benefits . . . . . .
XX.
Traditional IRA Contributions/Phaseouts . .
XXI.
Roth IRA Contributions/Phaseouts . . . . . .
XXII. Section 179 Expensing . . . . . . . . . . . . . . . .
XXIII. 5-Year Summary of Key Information . . . . .
XXIV. Conclusion . . . . . . . . . . . . . . . . . . . . . . .
By James C. Young
James C. Young is the
Crowe Horwath Professor of
Accountancy in the Department of Accountancy at
Northern Illinois University
in DeKalb, Illinois.
Without inflation adjustments to key portions of the
tax system, individuals
would be faced with an eroJames C. Young
sion of their purchasing
power. Beginning in 1985, Congress implemented
an indexing system to adjust various income tax
components, including the tax rate schedules, standard deduction, and personal and dependency
exemptions. Although suspended by the Tax Reform Act of 1986, indexation resumed in 1989 and
now applies to many items in the tax system.
In this report, Young discusses 2016 inflation
adjustments to specific portions of the individual
tax system that are tied to a consumer price index
year ending in August. Items adjusted include the
tax rate schedules, standard deductions and exemption and itemized deduction phaseouts, several
minimum tax items, the gift and estate tax exclusions, and some computational elements related to
the unearned income of minor children, the child
credit, the earned income tax credit, adoption expenses, education savings bonds, education credits,
education loan interest, qualified transportation
fringe benefits, medical savings accounts, health
savings accounts, long-term care insurance premiums, long-term care insurance benefits, traditional
and Roth IRA income phaseouts and contribution
limits, and the section 179 expense election.
Copyright 2015 James C. Young.
All rights reserved.
Table of Contents
I.
II.
III.
Introduction . . . . . . . . . . . . . . . . . . . . . . .
2016 Inflation Adjustments . . . . . . . . . . . .
A. 2016 Inflation Factors . . . . . . . . . . . . . .
Standard Deduction/Exemption
Amounts . . . . . . . . . . . . . . . . . . . . . . . . .
681
681
682
682
682
682
682
682
682
683
683
684
684
685
685
685
685
685
685
685
685
686
686
687
687
687
687
687
688
688
688
688
688
689
689
689
689
689
I. Introduction
679
680
680
681
Some provisions of the Internal Revenue Code
are structured to reflect the impact of inflation.
These provisions require reference to non-IRC information (that is, a cost of living index) to make the
computations. Indexation and taxation generally
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SPECIAL REPORT
COMMENTARY / SPECIAL REPORT
Item
Standard deduction
Unearned income of minor child (base amount)
Exemptions
Educational savings bonds
Exemption phaseout
Itemized deduction limitation (3% of AGI)
Tax rate schedules:
10% bracket
15%, 25%, and 28% brackets
33% and 35% brackets
39.6% bracket
AMT exemption/phaseout/28% bracket
Earned income tax credit:
Base amounts; maximum earned income amount
Married phaseout base
Standard deduction for employed dependents
Medical savings accounts
Annual gift tax exclusion
Unified gift/estate exclusion
Qualified transportation fringe benefits:
Categories 1 and 2
Category 3
HOPE, lifetime learning, and child tax credits
Education loan interest
Adoption expenses/credit:
Credit/exclusion amount
Phaseout base
Traditional and Roth IRA:
Income phaseouts
Contribution limit
Base Period CPI
Adjustment First
Occurs in
Calendar Year
August
August
August
August
August
August
31,
31,
31,
31,
31,
31,
1987
1987
1988
1989
2012
2012
111.9833333
111.9833333
116.6166667
122.1500000
228.1494167
228.1494167
1989
1989
1990
1991
2014
2014
August
August
August
August
August
31,
31,
31,
31,
31,
2002
1992
1993
2012
2011
178.6750000
138.9250000
143.1750000
228.1494167
222.4325000
2004
1994
1995
2014
2013
August
August
August
August
August
August
31,
31,
31,
31,
31,
31,
1995
2008
1997
1997
1997
2010
151.0750000
213.6050000
159.4916667
159.4916667
159.4916667
217.1632500
1997
2010
1999
1999
1999
2012
August
August
August
August
31,
31,
31,
31,
2001
1998
2000
2001
175.8750000
162.1833333
170.3083333
175.8750000
2003
2000
2002
2003
August 31, 2009
August 31, 2001
214.0023333
175.8750000
2011
2003
August 31, 2005
August 31, 2007
192.7666667
204.8725000
2007
2009
became intertwined in the Economic Recovery Tax
Act of 1981 (P.L. 97-34). Because inflation erodes the
value of the various fixed dollar amounts specified
in the code to determine tax liability, Congress
enacted inflation adjustment mechanisms for several provisions. The number of code provisions
subject to inflation adjustment continues to expand.
Also, the manner in which calculations are made
often differs across the code provisions. This report
provides information related to inflation adjustments based on a consumer price index year ending
in August.
The measure used most often for making adjustments to amounts specified in the code is the
consumer price index for all urban consumers (CPIU). This index, issued monthly by the Bureau of
Labor Statistics, is intended to reflect changes in a
market basket of goods and services purchased by
consumers and the weighting factors for items in
the market basket. The CPI reports changes in
prices for a fixed group of items rather than the
amount of money spent. It is based on the assump-
tion that the same items in the market basket are
purchased in the same proportions (or weight)
month after month. Technically, it is a price index
rather than a cost of living index.
II. 2016 Inflation Adjustments
The annual inflation adjustments are determined
by examining the increase in the CPI-U (section
1(f)(5)). The increase in CPI is determined by comparing the average CPI for any 12-month period
ending August 31 with the average CPI for the
appropriate base period specified by statute. The
table above summarizes the various base periods
and their related CPIs.
A. 2016 Inflation Factors
For the 12-month period that ended August 31,
2015, the average CPI-U is 236.7489167 — an increase of a less than 0.5 percent from the average for
the 12-month period that ended August 31, 2014.
Based on those data, inflation adjustments can be
determined for the 2016 calendar year. The resulting
680
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Base Period Is the
12-Month Period
Ending
COMMENTARY / SPECIAL REPORT
236.7489167 - 111.9833333 = 124.7655833
236.7489167 - 111.9833333 = 124.7655833
236.7489167 - 116.6166667 = 120.1322500
236.7489167 - 122.1500000 = 114.5989167
236.7489167 - 228.1494167 = 8.5995000
236.7489167 - 228.1494167 = 8.5995000
2.1141442
2.1141442
2.0301465
1.9381819
1.0376924
1.0376924
236.7489167 - 178.6750000 = 58.0739167
236.7489167 - 138.9250000 = 97.8239167
236.7489167 - 143.1750000 = 93.5739167
236.7489167 - 228.1494167 = 8.5995000
236.7489167 - 222.4325000 = 14.3164167
1.3250254
1.7041491
1.6535632
1.0376924
1.0643630
236.7489167
236.7489167
236.7489167
236.7489167
236.7489167
236.7489167
-
151.0750000
213.6050000
159.4916667
159.4916667
159.4916667
217.1632500
=
=
=
=
=
=
85.6739167
23.1439167
77.2572500
77.2572500
77.2572500
19.5856667
1.5670953
1.1083491
1.4843968
1.4843968
1.4843968
1.0901887
236.7489167
236.7489167
236.7489167
236.7489167
-
175.8750000
162.1833333
170.3083333
175.8750000
=
=
=
=
60.8739167
74.5655833
66.4405833
60.8739167
1.3461204
1.4597611
1.3901194
1.3461024
236.7489167 - 214.0023333 = 22.7465833
236.7489167 - 175.8750000 = 60.8739167
1.1062913
1.3461204
236.7489167 - 192.7666667 = 43.9822500
236.7489167 - 204.8725000 = 31.8764167
1.2281632
1.1555915
Item
Standard deduction
Unearned income of minor child (base amount)
Exemptions
Educational savings bonds
Exemption phaseout
Itemized deduction limitation (3% of AGI)
Tax rate schedules:
10% rate bracket
15%, 25, and 28% brackets
33% and 35% brackets
39.6% bracket
AMT exemption/phaseout/28% bracket
Earned income tax credit:
Base amounts; maximum earned income amount
Married phaseout base
Standard deduction for employed dependents
Medical savings accounts
Annual gift tax exclusion
Unified gift/estate exclusion
Qualified transportation fringe benefits:
Categories 1 and 2
Category 3
HOPE, lifetime learning and child tax credits
Education loan interest
Adoption expenses/credit:
Credit/exclusion amount
Phaseout base
Traditional and Roth IRA:
Income phaseouts
Contribution limit
2016 inflation factors are presented in the table at
the top of the following page.
These factors are applied to specified dollar
amounts in the appropriate IRC provision. Rounding conventions differ and are specified by statute.
III. Standard Deduction/Exemption Amounts
According to section 1(f) (and sections 63(c)(4)
and 151(d)(3)), the standard deduction and exemption amounts are to be adjusted by the appropriate
CPI increase (section 1(f)(5)). Any increases computed for these items are rounded down to the
nearest $50 multiple ($25 for married, filing separately) (section 1(f)(6)). Similar adjustments are
made to the adjusted gross income amounts used to
phase out exemptions and limit itemized deductions.
A. Standard Deduction Amounts
The standard deduction amounts specified by
section 63(c) are adjusted annually for inflation. The
standard deduction for married taxpayers filing a
joint return is specified by law to be twice the
standard deduction for single taxpayers (section
63(c)(2)). After adjustment for inflation, the standard deduction amounts for 2016 and 2015 are:
Single individual
Married filing jointly and
surviving spouse
Head of household
Married filing separately
2016
2015
$6,300
$6,300
$12,600
$9,300
$6,300
$12,600
$9,250
$6,300
B. Additional Deductions for Elderly and Blind
For a taxpayer (and spouse) who is elderly (age
65 or over) or blind, the following applies (section
63(f)):
1. Unmarried taxpayer: An additional $1,550 (no
change from 2015) standard deduction is allowed ($3,100 for a taxpayer who is both
elderly and blind).
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CPI Difference
Inflation Adjustment
Factor
[1 + (CPI Difference/
Base Period CPI)]
COMMENTARY / SPECIAL REPORT
Single individual
Married filing jointly and surviving spouse
Head of household
Married filing separately
2015
Phaseout
Begins When
AGI Exceeds
Phaseout
Completed
When AGI
Exceeds
Phaseout
Begins When
AGI Exceeds
Phaseout
Completed
When AGI
Exceeds
$259,400
$311,300
$285,350
$155,650
$381,900
$433,800
$407,850
$216,900
$258,250
$309,900
$284,050
$154,950
$380,750
$432,400
$406,550
$216,200
2. Married taxpayer: An additional $1,250 (no
change from 2015) standard deduction is allowed ($2,500 for a taxpayer who is both
elderly and blind).
C. Limitation for Dependents
If an individual may be claimed as a dependent
on another taxpayer’s return, the basic standard
deduction is limited (section 63(c)(5)). For dependents with earned income (but with total income
less than the basic standard deduction), a slightly
increased standard deduction (of up to $250) is
available. Both the limited standard deduction
($500) and the additional earned income standard
deduction ($250) are indexed annually for inflation.
In 2016 a dependent’s basic standard deduction is
limited to the lesser of:
1. the basic standard deduction for single
taxpayers ($6,300); or
2. the greater of:
a. $1,050 (no change from 2015); or
b. the dependent’s earned income plus
$350 (no change from 2015).
In 2015 a dependent’s basic standard deduction
is limited to the lesser of:
1. the basic standard deduction for single
taxpayers ($6,300); or
2. the greater of:
a. $1,050 (up from $1,000 in 2014); or
b. the dependent’s earned income plus
$350 (no change from 2014).
D. Exemption Amount
After adjustment for inflation, the 2016 exemption amount will be $4,050 (up from $4,000 in 2015).
The 1989 exemption amount of $2,000 is used as the
base.
E. Exemption Phaseout
Under the exemption phaseout provision (section 151(d)(3)), all exemption amounts claimed on a
return are reduced by 2 percent for each $2,500 (or
fraction thereof) of AGI exceeding the appropriate
threshold amount ($1,250 for a married individual
filing separately). After adjustment for inflation, the
AGI threshold amounts for 2016 are as presented in
the table at the top of this page (2015 amounts for
comparison).
IV. Overall Limitation on Itemized Deductions
Total itemized deductions otherwise allowable
are reduced by 3 percent of a taxpayer’s AGI
exceeding specified threshold amounts (section 68).
This overall limitation applies to itemized deductions after all other floors have been applied. After
application of the 3 percent floor, the net itemized
deductions remain.
A. Threshold Amount
The AGI threshold amounts for 2016 will be as
follows (2015 amounts for comparison):
Single individual
Married filing jointly and
surviving spouse
Head of household
Married filing separately
2016
2015
$259,400
$258,250
$311,300
$285,350
$155,650
$309,900
$284,050
$154,950
V. Tax Rate Schedules
The minimum and maximum dollar amounts for
each rate bracket (section 1(a) through (e)) are
adjusted annually for inflation (section 1(f)(6)). Any
increases computed for these items are rounded
down to the nearest $50 multiple ($25 for married
filing separately). After adjustment for inflation, the
2016 tax rate schedules are presented in Table 1. The
2015 tax rate schedules appear in Table 2.
VI. Alternative Minimum Tax Items
The American Taxpayer Relief Act of 2012 (ATRA,
P.L. 112-240) provided alternative minimum tax relief by increasing the individual AMT exemption
and related phaseout amounts for 2012 and adjusting those amounts for inflation beginning in 2013
(section 55(d)(1), (3), and (4)). The amount at which
the 28 percent rate applies (section 55(b)(1)(A)(i)) is
also adjusted for inflation. Any increases computed
for these items are rounded to the nearest $100 multiple (the married filing separately amount is half of
the married filing jointly amount).
682
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2016
COMMENTARY / SPECIAL REPORT
Table 1. 2016 Tax Rate Schedules
The tax is:
10% of taxable income.
$927.50, plus 15% of the excess over $9,275.
$5,183.75, plus 25% of the excess over $37,650.
$18,558.75, plus 28% of the excess over $91,150.
$46,278.75, plus 33% of the excess over $190,150.
$119,934.75, plus 35% of the excess over $413,350.
$120,529.75, plus 39.6% of the excess over $415,050.
The tax is:
10% of taxable income.
$1,325.00, plus 15% of the excess over $13,250.
$6,897.50 plus 25% of the excess over $50,400.
$26,835.00 plus 28% of the excess over $130,150.
$49,417.00, plus 33% of the excess over $210,800.
$116,258.50, plus 35% of the excess over $413,350.
$125,936.00, plus 39.6% of the excess over $441,000.
The tax is:
10% of taxable income.
$1,855.00, plus 15% of the excess over $18,550.
$10,367.50, plus 25% of the excess over $75,300.
$29,517.50, plus 28% of the excess over $151,900.
$51,791.50, plus 33% of the excess over $231,450.
$111,818.50, plus 35% of the excess over $413,350.
$130,578.50, plus 39.6% of the excess over $466,950.
The tax is:
10% of taxable income.
$927.50, plus 15% of the excess over $9,275.
$5,183.75, plus 25% of the excess over $37,650.
$14,758.75, plus 28% of the excess over $75,950.
$25,895.75, plus 33% of the excess over $115,725.
$55,909.25, plus 35% of the excess over $206,675.
$65,289.25, plus 39.6% of the excess over $233,475.
The tax is:
15% of taxable income.
$382.50, plus 25% of the excess over $2,550.
$1,232.50, plus 28% of the excess over $5,950.
$2,100.50, plus 33% of the excess over $9,050.
$3,206.00, plus 39.6% of the excess over $12,400.
A. Exemption
The AMT exemption amounts for 2016 are presented in the table to the right (2015 amounts for
comparison).
B. Exemption Phaseout
The AMT exemption is phased out as alternative
minimum taxable income exceeds a specified base
amount (section 55(d)(3)). Under the phaseout provision, the AMT exemption is reduced by 25 percent
of AMTI over the base amount until it reaches zero.
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Single [section 1(c)]:
If taxable income is:
Not over $9,275 . . .
Over $9,275 but not over $37,650 . . .
Over $37,650 but not over $91,150 . . .
Over $91,150 but not over $190,150 . . .
Over $190,150 but not over $413,350 . . .
Over $413,350 but not over $415,050 . . .
Over $415,050 . . .
Head of Household [section 1(b)]:
If taxable income is:
Not over $13,250 . . .
Over $13,250 but not over $50,400 . . .
Over $50,400 but not over $130,150 . . .
Over $130,150 but not over $210,800 . . .
Over $210,800 but not over $413,350 . . .
Over $413,350 but not over $441,000 . . .
Over $441,000 . . .
Married Filing Jointly and Surviving Spouse [section 1(a)]:
If taxable income is:
Not over $18,550 . . .
Over $18,550 but not over $75,300 . . .
Over $75,300 but not over $151,900 . . .
Over $151,900 but not over $231,450 . . .
Over $231,450 but not over $413,350 . . .
Over $413,350 but not over $466,950 . . .
Over $466,950 . . .
Married Filing Separately [section 1(d)]:
If taxable income is:
Not over $9,275 . . .
Over $9,275 but not over $37,650 . . .
Over $37,650 but not over $75,950 . . .
Over $75,950 but not over $115,725 . . .
Over $115,725 but not over $206,675 . . .
Over $206,675 but not over $233,475 . . .
Over $233,475 . . .
Estates and Trusts [section 1(e)]:
If taxable income is:
Not over $2,550 . . .
Over $2,550 but not over $5,950 . . .
Over $5,950 but not over $9,050 . . .
Over $9,050 but not over $12,400 . . .
Over $12,400 . . .
Single individual
Married filing jointly and
surviving spouse
Head of household
Married filing separately
Estates and trusts
2016
2015
$53,900
$53,600
$83,800
$53,900
$41,900
$23,900
$83,400
$53,600
$41,700
$23,800
In 2016 the base amounts are presented in the small
table on the following page (2015 for comparison).
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COMMENTARY / SPECIAL REPORT
Table 2. 2015 Tax Rate Schedules
Single individual
Married filing jointly and
surviving spouse
Head of household
Married filing separately
Estates and trusts
2016
2015
$119,700
$119,200
$159,700
$119,700
$79,850
$79,850
$158,900
$119,200
$79,450
$79,450
C. 28 Percent Bracket
In 2016 the 28 percent AMT rate bracket for all
taxpayers except married filing separately will be-
The tax is:
10% of taxable income.
$922.50, plus 15% of the excess over $9,225.
$5,156.25, plus 25% of the excess over $37,450.
$18,481.25, plus 28% of the excess over $90,750.
$46,075.25, plus 33% of the excess over $189,300.
$119,401.25, plus 35% of the excess over $411,500.
$119,996.25, plus 39.6% of the excess over $413,200.
The tax is:
10% of taxable income.
$1,315.00, plus 15% of the excess over $13,150.
$6,872.50, plus 25% of the excess over $50,200.
$26,722.50 plus 28% of the excess over $129,600.
$49,192.50, plus 33% of the excess over $209,850.
$115,737.00, plus 35% of the excess over $411,500.
$125,362.00, plus 39.6% of the excess over $439,000.
The tax is:
10% of taxable income.
$1,845.00, plus 15% of the excess over $18,450.
$10,312.50, plus 25% of the excess over $74,900.
$29,387.50, plus 28% of the excess over $151,200.
$51,577.50, plus 33% of the excess over $230,450.
$111,324.00, plus 35% of the excess over $411,500.
$129,996.50, plus 39.6% of the excess over $464,850.
The tax is:
10% of taxable income.
$922.50, plus 15% of the excess over $9,225.
$5,156.25, plus 25% of the excess over $37,450.
$14,693.75, plus 28% of the excess over $75,600.
$25,788.75, plus 33% of the excess over $115,225.
$55,662.00, plus 35% of the excess over $205,750.
$64,998.25, plus 39.6% of the excess over $232,425.
The tax is:
15% of taxable income.
$375.00, plus 25% of the excess over $2,500.
$1,225.00, plus 28% of the excess over $5,900.
$2,107.00, plus 33% of the excess over $9,050.
$3,179.50, plus 39.6% of the excess over $12,300.
gin at $186,300 (up from $185,400 in 2015). For
married taxpayers filing separately, the 28 percent
rate bracket will begin at $93,150 (up from $92,700
in 2015).
VII. Unearned Income of Minor Children
The federal tax liability of a minor child having
gross income is computed in the same manner as
for any other taxpayer. However, intrafamily transfers of income-producing property will not reduce
the family’s overall income tax liability by shifting
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Single [section 1(c)]:
If taxable income is:
Not over $9,225 . . .
Over $9,225 but not over $37,450 . . .
Over $37,450 but not over $90,750 . . .
Over $90,750 but not over $189,300 . . .
Over $189,300 but not over $411,500 . . .
Over $411,500 but not over $413,200 . . .
Over $413,200 . . .
Head of Household [section 1(b)]:
If taxable income is:
Not over $13,150 . . .
Over $13,150 but not over $50,200 . . .
Over $50,200 but not over $129,600 . . .
Over $129,600 but not over $209,850 . . .
Over $209,850 but not over $411,500 . . .
Over $411,500 but not over $439,000 . . .
Over $439,000 . . .
Married Filing Jointly and Surviving Spouse [section 1(a)]:
If taxable income is:
Not over $18,450 . . .
Over $18,450 but not over $74,900 . . .
Over $74,900 but not over $151,200 . . .
Over $151,200 but not over $230,450 . . .
Over $230,450 but not over $411,500 . . .
Over $411,500 but not over $464,850 . . .
Over $464,850 . . .
Married Filing Separately [section 1(d)]:
If taxable income is:
Not over $9,225 . . .
Over $9,225 but not over $37,450 . . .
Over $37,450 but not over $75,600 . . .
Over $75,600 but not over $115,225 . . .
Over $115,225 but not over $205,750 . . .
Over $205,750 but not over $232,425 . . .
Over $232,425 . . .
Estates and Trusts [section 1(e)]:
If taxable income is:
Not over $2,500 . . .
Over $2,500 but not over $5,900 . . .
Over $5,900 but not over $9,050 . . .
Over $9,050 but not over $12,300 . . .
Over $12,300 . . .
COMMENTARY / SPECIAL REPORT
A. Net Unearned Income
The net unearned income computation contains a
base amount that is subject to an inflation adjustment each year. Also, the computation allows a
subtraction for a portion (or all) of the child’s
standard deduction, which is also subject to an
inflation adjustment (discussed previously). For
2016 net unearned income is computed as follows
(section 1(g)(4)):
Unearned Income
$1,050 (no change from 2015)
The greater of:
(1) $1,050 of the standard deduction (or $1,050 of
itemized deductions) (no change from 2015)
OR
(2) The amount of allowable deductions that are
directly connected with the production of the
unearned income
Equals: Net Unearned Income
Less:
Less:
If net unearned income is $0 (or negative), the
child’s tax is computed without regard to this
provision.
B. Placing Unearned Income on Parent’s Return
If specified requirements are met (section
1(g)(7)(A)), a parent may elect to include the unearned income of a minor child on his return
(section 1(g)(7)). Form 8814 is used to make the
election. Making the election eliminates the need for
the child to file a tax return. The section 1(g)(7)
election amounts are linked to the inflationadjusted amounts used in computing net unearned
income (section 1(g)(4)).
In 2016 the section 1(g)(7) election can be made if
a child has gross income (exclusively from interest
and dividends) between $1,050 and $10,500 (no
change from 2015) and the other requirements of
section 1(g)(7)(A) are met. In 2016 the tax on a
child’s first $2,100 of unearned income will be the
lesser of $105 ($1,050 x 10 percent) or 10 percent of
unearned income exceeding $1,050. If the child has
unearned income exceeding $2,100, it will be taxed
at the parent’s highest marginal tax rate.
C. AMT Exemption
Minor children with unearned income face a
reduced AMT exemption amount (section 59(j)). In
general, the AMT exemption is limited to the child’s
earned income plus $5,000 (but no more than the
AMT exemption for single taxpayers). The $5,000
amount is subject to an annual inflation adjustment
and rounded to the nearest $50 multiple. In 2016 the
addition to earned income will be $7,400 (no change
from 2015).
VIII. Child Tax Credit
The child tax credit provisions allow taxpayers to
take a tax credit based on the number of eligible
dependent children (section 24). The child tax credit
is $1,000 per child through 2017, but absent congressional intervention, it will decrease to $500 in 2018.
For higher-income taxpayers, the available credit
begins to phase out when AGI reaches $110,000 for
married couples filing a joint return, $55,000 for
married couples filing separately, and $75,000 for all
other taxpayers. These threshold amounts are not
indexed for inflation. For lower-income taxpayers,
the child tax credit is refundable to the extent of 15
percent of the taxpayer’s earned income exceeding
$10,000 (section 24(d)). Although normally this
$10,000 earned income floor is adjusted for inflation
each year and rounded to the nearest $50 multiple,
the floor has been reduced to $3,000 through 2017
by the American Recovery and Reinvestment Act of
2009 (ARRA, P.L. 111-5); the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation
Act of 2010 (P.L. 111-312); and ATRA. Absent congressional intervention, a $10,000 earned income
floor (adjusted for inflation) will return in 2018.
IX. Gift and Estate Tax Items
A. Annual Gift Tax Exclusion
Since 1999 the annual gift tax exclusion is subject
to an inflation adjustment, with any increase
rounded down to the nearest $1,000 multiple (section 2503(b)). The 1998 exclusion amount of $10,000
is used as the base. For 2016 the annual gift tax
exclusion will be $14,000 (unchanged from 2015).
B. Unified Estate and Gift Tax Exclusion
The unified exclusion (section 2010(c)(3)) was set
at $5 million in 2011 and is adjusted for inflation in
subsequent years, with any increase rounded to the
nearest $10,000 multiple. For 2016 the unified exclusion will be $5.45 million (up from $5.43 million in
2015). These are also the generation-skipping transfer tax exemption amounts for 2016 and 2015 (section 2631(c)).
X. Earned Income Tax Credit
The earned income tax credit authorized by
section 32 is determined by multiplying an
inflation-adjusted maximum amount of earned income by a specified credit percentage (based on the
number of qualifying children). The credit is reduced by a specified percentage of income over an
inflation-adjusted phaseout amount. For married
taxpayers filing a joint return, the phaseout base
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income from the parents’ (generally higher) marginal tax rate to a child’s (generally lower) tax
bracket. Instead, the net unearned income of a
minor child (section 1(g)(2)) is taxed at the parents’
marginal tax rate (section 1(g) and reg. section
1.1(i)-1T).
COMMENTARY / SPECIAL REPORT
2016
2015
Number of
Qualifying Children
Married Filing Jointly:
No children
One child
Two children
Three or more children
Other Taxpayers:
No children
One child
Two children
Three or more children
Married Filing Jointly:
No children
One child
Two children
Three or more children
Other Taxpayers:
No children
One child
Two children
Three or more children
Credit
Percentage
$6,610
$9,920
$13,930
$13,930
7.65
34.00
40.00
45.00
$6,610
$9,920
$13,930
$13,930
Phaseout
Base
Phaseout
Percentage
Phaseout
Ends at
Income of
$506
$3,373
$5,572
$6,269
$13,820
$23,740
$23,740
$23,740
7.65
15.98
21.06
21.06
$20,430
$44,846
$50,198
$53,505
7.65
34.00
40.00
45.00
$506
$3,373
$5,572
$6,269
$8,270
$18,190
$18,190
$18,190
7.65
15.98
21.06
21.06
$14,880
$39,296
$44,648
$47,955
$6,580
$9,880
$13,870
$13,870
7.65
34.00
40.00
45.00
$503
$3,359
$5,548
$6,242
$13,750
$23,630
$23,630
$23,630
7.65
15.98
21.06
21.06
$20,330
$44,651
$49,974
$53,267
$6,580
$9,880
$13,870
$13,870
7.65
34.00
40.00
45.00
$503
$3,359
$5,548
$6,242
$8,240
$18,110
$18,110
$18,110
7.65
15.98
21.06
21.06
$14,820
$39,131
$44,454
$47,747
amount is normally increased by $3,000 (after adjustment for inflation). ARRA made two changes to
the EITC. First, it increased the $3,000 base amount
to $5,000 in 2009 — adjusting this amount for
inflation beginning in 2010. Second, it created an
additional taxpayer category (three or more children) with a credit base of 45 percent. Both of these
changes were extended through 2017 by ATRA. The
income used for this phaseout is the greater of a
taxpayer’s AGI or earned income. Finally, investment income exceeding a specified inflationadjusted target disqualifies an individual from the
EITC (section 32(i)(1) and (2)).
The maximum earned income and phaseout base
amounts (which are to be used for inflation adjustment purposes) are specified in section 32(b)(2).
Base amounts determined in the inflation calculations are then rounded to the nearest $10 multiple.
The inflation-adjusted disqualified income amount
is rounded down to the nearest $50 multiple.
The EITC percentages and phaseout percentages
are specified in section 32(b)(1). The earned income
base amounts and phaseout information for 2016
and 2015 are presented in the table above.
In 2016 the section 32(i) disqualified income
amount will be $3,400 (unchanged from 2015).
XI. Adoption Expenses Credit and Exclusion
If a taxpayer incurs expenses related to the
adoption of a qualified child (for example, adoption
fees, attorney and court costs, social service review
costs, and transportation costs), an adoption ex-
Maximum
Credit
penses credit is available (section 23). The tax credit
covers the first $10,000 of adoption expenses paid
by a taxpayer. The available credit is phased out
ratably over a range of $40,000 for taxpayers whose
modified AGI (section 23(b)(2)(B)) exceeds $150,000.
Both the $10,000 ceiling on qualified expenses and
the $150,000 modified AGI phaseout target are
adjusted annually for inflation (and rounded to the
nearest $10 multiple).
In 2016 the first $13,460 of adoption expenses will
qualify for the credit (up from $13,400 in 2015), and
the credit will begin to phase out when a taxpayer’s
AGI exceeds $201,920 (up from $201,010 in 2015). If
employers provide adoption assistance, an income
exclusion is available to the employee. In 2016 the
total income exclusion available is $13,460 per child
(up from $13,400 in 2015).
XII. Educational Savings Bonds
Interest income earned on a qualified U.S. Series
EE savings bond used to finance the higher education of the taxpayer, spouse, or dependents is
excluded from gross income (section 135). The
exclusion (reported on Form 8815) applies to savings bonds purchased and redeemed in tax years
beginning after December 31, 1989. No exclusion is
allowed to married individuals filing separate returns.
If the principal and interest amounts received do
not exceed the qualified higher education expenses,
all interest is excludable subject to an inflationadjusted modified AGI phaseout. If the principal
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Tax
Year
Earned
Income
Base
Amount
COMMENTARY / SPECIAL REPORT
A. Phaseout of Benefit
The tax exclusion is subject to a phaseout that is
tied to the taxpayer’s modified AGI (section
135(c)(4)). The excludable interest is reduced (but
not below zero) by applying the following formula:
Excludable interest x
Modified AGI - AGI base
$15,000 ($30,000 for married filing jointly)
When modified AGI exceeds the AGI base, the
exclusion is completely phased out. The AGI bases
(section 135(b)(2)(A); $60,000 for married filing
jointly; $40,000 for single and head of household)
are adjusted for inflation, with the adjusted
amounts rounded to the nearest $50 multiple. The
AGI base amounts for 2016 and 2015 are:
Married filing jointly
Single (including head of household)
2016
2015
$116,300
$77,550
$115,750
$77,200
XIII. Education Tax Credits
ARRA replaced the HOPE scholarship credit
(section 25A(b)) with the American opportunity tax
credit for 2009 and 2010 (section 25A(i)). The Tax
Relief, Unemployment Insurance Reauthorization,
and Job Creation Act and ATRA extend this change
through 2017. Both the American opportunity tax
credit and the lifetime learning credit (section
25A(c)) are available to help qualifying individuals
defray the cost of higher education. The credits are
available for qualifying tuition and related expenses
incurred by students pursuing undergraduate or
graduate degrees or vocational training. Books and
other course materials are eligible for the American
opportunity tax credit, but not the lifetime learning
credit (section 25A(i)(3)). Room and board are ineligible for both credits.
The American opportunity credit permits a maximum credit of $2,500 per year (100 percent of the
first $2,000 of tuition expenses plus 25 percent of the
next $2,000 of tuition expenses) for the first four
years of postsecondary education. The lifetime
learning credit permits a credit of 20 percent of
qualifying expenses (up to $10,000 per year) incurred in a year in which the American opportunity
credit is not claimed for a given student. As a result,
the lifetime learning credit is generally used for
individuals who are beyond the first four years of
postsecondary education.
Neither the American opportunity credit amount
nor the lifetime learning qualifying expense limits
are subject to an annual inflation adjustment. The
American opportunity credit is partially refundable
and may be used to offset a taxpayer’s AMT liability
(the lifetime learning credit is neither refundable
nor an AMT liability offset).
Should Congress not extend the American opportunity credit, the HOPE credit will return in
2018. The HOPE scholarship credit is available
during an eligible student’s first two years of postsecondary education. The $1,000 qualifying expense
base (section 25A(b)(1)) that is part of the credit is
adjusted for inflation and rounded down to the
nearest $100 multiple.
A. Phaseout of Credits
Both education credits are subject to a phaseout
that is tied to the taxpayer’s modified AGI (section
25A(d)(3)). The education credits are reduced by
applying the following formula:
Education credits x
Modified AGI - AGI base
$10,000 ($20,000 for married filing jointly)
The phaseout bases differ for 2016 and 2015. The
American opportunity credit amount is phased out
beginning when the taxpayer’s modified AGI
reaches $80,000 ($160,000 for married taxpayers
filing jointly). These amounts are not adjusted for
inflation. The lifetime learning credit (and HOPE
credit, should it return) phaseout is adjusted for
inflation annually. For 2016 the lifetime learning
credit will begin to phase out when the taxpayer’s
modified AGI reaches $55,000 ($111,000 for married
taxpayers filing jointly). These amounts are $55,000
and $110,000 in 2015.
XIV. Education Interest Expense
Up to $2,500 of interest expense paid on qualified
education loans (as defined in section 221(d)(1))
may be deducted for AGI. The deduction is subject
to a phaseout for taxpayers whose modified AGI
(section 221(b)(2)(C)) exceeds specified targets. The
interest expense deduction is reduced by applying
the following formula:
Education interest
Modified AGI - AGI base
x
expense
$15,000 ($30,000 for married filing jointly)
The AGI bases (section 221(b)(2)(B); $100,000 for
married taxpayers filing jointly; $50,000 for all other
taxpayers) are adjusted for inflation and rounded
down to the nearest $5,000 multiple. The AGI base
amounts for 2016 and 2015 are:
Married, filing jointly
Single (including head of household)
2016
2015
$130,000
$65,000
$130,000
$65,000
XV. Qualified Transportation Fringe Benefits
To encourage the use of mass transit for commuting to and from work, some employee benefits,
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and interest amounts received exceed the qualified
higher education expenses, only a pro rata portion
of the interest will qualify for the exclusion (the
ratio of qualified higher education expenses to total
principal and interest received).
COMMENTARY / SPECIAL REPORT
Commuter vehicle/transit pass
Qualified parking
2016
2015
$130
$255
$130
$250
XVI. Medical Savings Accounts
Medical savings accounts (Archer MSAs) were
established by the Health Insurance Act of 1996 and
are available to a limited number of eligible individuals. An individual is eligible for an Archer MSA
if he is self-employed or elects to be covered under
a high-deductible plan of a small employer (an
employer that on average employs 50 or fewer
workers). The high-deductible plan definition includes amounts that are adjusted for inflation (section 220(c)(2)).
For 2016 a high-deductible plan is a health plan
with the following deductibles and limitations on
out-of-pocket expenses:
1. Individual coverage. An annual deductible of
at least $2,250 and not more than $3,350 (up
from $2,200 and $3,300 in 2015) and maximum
out-of-pocket expenses for covered benefits
not exceeding $4,450 (no change from 2015).
2. Family coverage. An annual deductible of at
least $4,450 and not more than $6,700 (up from
$4,450 and $6,650 in 2015) and maximum
out-of-pocket expenses for covered benefits
not exceeding $8,150 (no change from 2015).
A. Contribution Limitations
The amount that can be contributed to an MSA is
a function of the deductible of the high-deductible
health plan. For individual coverage, the annual
contribution limit is 65 percent of the deductible; for
family coverage, contributions are limited to 75
percent of the deductible. As a result, the contribution ranges for 2016 and 2015 are as follows:
Individual coverage
Family coverage
2016
2015
$1,463 - $2,178
$3,338 - $5,025
$1,430 - $2,145
$3,338 - $4,988
XVII. Health Savings Accounts
Health savings accounts can be established by
individuals who are covered by a high-deductible
health plan and not covered under any other health
plan that is not a high-deductible health plan (section 223(c)). The Tax Relief and Health Care Act of
2006 (P.L. 109-432) made several changes to the
HSA provisions (including changing the inflation
adjustment year-end from August 31 to March 31).
Inflation-adjusted figures for 2016 were released by
the IRS in May 2015 (Rev. Proc. 2015-30, 2015-20 IRB
970).
In 2016 a high-deductible health plan has an
annual deductible of at least $1,300 for individual
coverage ($2,600 for family coverage) and maximum out-of-pocket expenses of $6,550 for individual coverage ($13,100 for family coverage). The
2015 amounts are $1,300, $2,600, $6,450, and
$12,900, respectively.
The maximum annual contribution to an HSA is
the sum of the limits determined separately for each
month, based on status, eligibility, and health plan
coverage as of the first day of the month. For 2016
the maximum monthly contribution for eligible
individuals with self-only coverage under a highdeductible health plan is one-twelfth of $3,350 (no
change from 2015). For eligible individuals with
family coverage under a high-deductible health
plan, the maximum monthly contribution is onetwelfth of $6,750 (up from $6,650 in 2015).
XVIII. Long-Term Care Insurance Premiums
Long-term care insurance premiums that do not
exceed specified dollar limits based on the insured’s
age qualify as a medical expense (section
213(d)(10)). The dollar limits are adjusted for inflation by comparing the medical care component of
each August’s CPI-U to the August 1996 CPI-U
medical care component. Any increase is rounded
to the nearest $10 multiple. After adjustment for
inflation, the 2016 limitations will be as follows
(2015 amounts for comparison):
Insured’s Age Before Close of Tax Year
40 or less
41 to 50
51 to 60
61 to 70
More than 70
2016
2015
$390
$730
$1,460
$3,900
$4,870
$380
$710
$1,430
$3,800
$4,750
XIX. Long-Term Care Insurance Benefits
In general, long-term care insurance policies are
treated the same as accident and health plans.
When benefits are received from a long-term care
insurance policy, whether funded by an employer
or self-funded, an exclusion from gross income is
provided (section 7702B). The exclusion is the
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called qualified transportation fringe benefits, are
excluded from income (section 132(f)(2) and (6)).
These benefits consist of expenses related to:
1. transportation from the employee’s residence to work in a commuter highway vehicle;
2. a transit pass; and
3. qualified parking.
Categories 1 and 2 above are combined and
limited to a maximum of $100 per month. Category
3 has a separate limit of $175 per month. Both
amounts are adjusted annually for inflation and
rounded down to the nearest $5 multiple. After
adjustment for inflation, the 2016 and 2015 limitations are:
COMMENTARY / SPECIAL REPORT
XX. Traditional IRA Contributions/Phaseouts
Any individual under age 70½ can establish an
IRA. The contribution ceiling is the lesser of (1) a
statutory dollar limit ($5,000, increased to $6,000 for
those age 50 or older), or (2) 100 percent of the
individual’s compensation for that year. The tax
treatment of a contribution will depend on whether
the taxpayer is an active participant in a qualified
retirement plan.
The $5,000 statutory dollar limit (section
219(b)(5)) is adjusted annually for inflation and
rounded down to the nearest $500 multiple. In 2016
the statutory dollar limit will be $5,500 (unchanged
from 2015).
If the taxpayer is not an active participant, the
contribution is fully deductible. If the taxpayer is an
active participant, the IRA contribution deduction
in 2016 is phased out beginning at modified AGI of
$61,000 for single taxpayers or heads of household
(no change from 2015), $98,000 for a married taxpayer filing a joint return (no change from 2015),
and $0 for a married taxpayer filing separately. The
phaseout range is $20,000 for married taxpayers
filing a joint return and $10,000 for all others. If the
taxpayer is not an active participant but his spouse
is, the contribution deduction in 2016 is phased out
proportionally for modified AGI between $184,000
and $194,000 (up from between $183,000 and
$193,000 in 2015).
XXI. Roth IRA Contributions/Phaseouts
Introduced by Congress to encourage retirement
savings, individuals may make nondeductible contributions to a Roth IRA (whose earnings and
distributions are tax free). The contribution ceiling
is the lesser of (1) a statutory dollar limit ($5,500 in
2016, unchanged from 2015), or (2) 100 percent of
the individual’s compensation for that year. Roth
IRA contributions are subject to income limits. In
2016 the maximum annual contribution to a Roth
IRA is phased out beginning at modified AGI of
$117,000 for single taxpayers or heads of households (up from $116,000 in 2015), $184,000 for
married taxpayers filing a joint return (up from
$183,000 in 2015), and $0 for a married taxpayer
filing separately.
XXII. Section 179 Expensing
Section 179 allows taxpayers to expense business
property that normally would be capitalized and
depreciated. In general, this provision limits the
amount of property that can be expensed ($25,000)
and phases this amount out (dollar for dollar) once
an acquisition cost ceiling is exceeded ($200,000).
When initially enacted, these amounts were adjusted for inflation (with the expense limit rounded
to the nearest $1,000 multiple and the phaseout
amount rounded to the nearest $10,000 multiple).
Over the past few years, both these amounts
have been subject to congressional modifications.
The Small Business Jobs Act of 2010 (P.L. 111-240)
increased the maximum amount of modified accelerated cost recovery system property that can be
expensed to $500,000 and also increased the acquisition cost ceiling to $2 million in 2010 and 2011
(section 179(b)). Further, the act allowed up to
$250,000 of specified qualified real property to
qualify for the expense election in 2010 and 2011
(section 179(f)(2)). ATRA and the Tax Increase Prevention Act of 2014 (P.L. 113-295) extended these
changes through 2014.
As part of ATRA, the inflation adjustment clause
(section 179(b)(6)) was repealed. As a result, in 2016,
absent a legislative change, the expense amount
and acquisition cost ceiling will be $25,000 and
$200,000, respectively (the same as in 2015; the
pre-2003 amounts) without any inflation adjustment.
XXIII. 5-Year Summary of Key Information
Table 3 presents a five-year summary of key
inflation-adjusted information (tax rate schedules,
standard deduction amounts, exemption amounts
and related AGI phaseout thresholds, and the AGI
phaseout thresholds related to the overall limitation
on itemized deductions).
XXIV. Conclusion
The code includes many provisions subject to
annual inflation adjustments. Identifying some of
these provisions and communicating the adjusted
amounts will hopefully assist taxpayers and tax
practitioners in the tax planning process.
(Table 3 appears on the following page.)
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greater of a daily rate (adjusted annually for inflation) or the actual cost of the care. In 2016 the daily
exclusion rate will be $340 (up from $330 in 2015).
COMMENTARY / SPECIAL REPORT
Year
2016
2015
2014
2013
2012
Year
2016
2015
2014
2013
2012
15%
$9,275
$9,225
$9,075
$8,925
$8,700
15%
$18,550
$18,450
$18,150
$17,850
$17,400
25%
$37,650
$37,450
$36,900
$36,250
$35,350
Indicated Rate Applies to Taxable Income in Excess of Specified Amounts
Single
Head of Household
28%
33%
35%
39.6%
15%
25%
28%
33%
$91,150 $190,150 $413,350 $415,050 $13,250 $50,400 $130,150 $210,800
$90,750 $189,300 $411,500 $413,200 $13,150 $50,200 $129,600 $209,850
$89,350 $186,350 $405,100 $406,750 $12,950 $49,400 $127,550 $206,600
$87,850 $183,250 $398,350 $400,000 $12,750 $48,600 $125,450 $203,150
$85,650 $178,650 $388,350
$12,400 $47,350 $122,300 $198,050
35%
39.6%
$413,350 $441,000
$411,500 $439,000
$405,100 $432,200
$398,350 $425,000
$388,350
Indicated Rate Applies to Taxable Income in Excess of Specified Amounts
Married Filing Jointly
Married Filing Separately
25%
28%
33%
35%
39.6%
15%
25%
28%
33%
35%
$75,300 $151,900 $231,450 $413,350 $466,950
$9,275 $37,650 $75,950 $115,725 $206,675
$74,900 $151,200 $230,450 $411,500 $464,850
$9,225 $37,450 $75,600 $115,225 $205,750
$73,800 $148,850 $226,850 $405,100 $457,600
$9,075 $36,900 $74,425 $113,425 $202,550
$72,500 $146,400 $223,050 $398,350 $450,000
$8,925 $36,250 $73,200 $111,525 $199,175
$70,700 $142,700 $217,450 $388,350
$8,700 $35,350 $71,350 $108,725 $194,175
39.6%
$233,475
$232,425
$228,800
$225,000
Table 3. 5-Year Summary
Standard Deduction Amounts
Year
Single
2016
2015
2014
2013
2012
$6,300
$6,300
$6,200
$6,100
$5,950
Additional Standard
Deduction (Elderly/Blind)
Basic Standard Deduction
Head of
Married
Household
Filing Jointly
$9,300
$9,250
$9,100
$8,950
$8,700
Married
Unmarried
Single
$6,300
$6,300
$6,200
$6,100
$5,950
$1,250
$1,250
$1,200
$1,200
$1,150
$1,550
$1,550
$1,500
$1,500
$1,450
$12,600
$12,600
$12,400
$12,200
$11,900
Table 3. 5-Year Summary
Exemption Amount and Related AGI Phaseout Thresholds
Year
Exemption
Amount
2016
2015
2014
2013
2012
$4,050
$4,000
$3,950
$3,900
$3,800
Single
Exemption Phaseout Threshold Amounts
Head of
Married, Filing
Married, Filing
Household
Jointly
Separately
$259,400
$258,250
$254,200
$250,000
$285,350
$284,050
$279,650
$275,000
$311,300
$309,900
$305,050
$300,000
$155,650
$154,950
$152,525
$150,000
Table 3. 5-Year Summary
Overall Limitation on Itemized Deductions (AGI Phaseout Thresholds)
Year
Single
Head of Household
Married, Filing
Jointly
Married, Filing
Separately
2016
2015
2014
2013
2012
$259,400
$258,250
$254,200
$250,000
$285,350
$284,050
$279,650
$275,000
$311,300
$309,900
$305,050
$300,000
$155,650
$154,950
$152,525
$150,000
690
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Table 3. 5-Year Summary
Tax Rate Schedules
tax notes™
FATCA and the Road
To Expatriation
By Matthew A. Morris
Matthew A. Morris is a
partner at Kerstein, Coren &
Lichtenstein LLP.
In this article, Morris suggests ways to fix the expatriation tax so that it better
targets bad actors rather
than benign actors. He proposes requiring taxpayers to
certify that they have not
willfully structured their afMatthew A. Morris
fairs or assets to fall below
the applicable net income and net worth thresholds
and adding an exception to the expatriation tax for
individuals who have returned to compliance with
U.S. income tax and reporting requirements.
A. Introduction
Expatriation is a controversial term laden with
heavy political implications. In the United States,
the standard definition of the verb ‘‘expatriate’’ is to
relinquish one’s U.S. citizenship, but the political
connotation is best captured by the term ‘‘expatriot,’’ referring to a former patriot who has
renounced his political allegiance to the United
States. Also, the verb expatriate can easily be confused with the noun expatriate, which refers to a
U.S. citizen living abroad. The common association
of an expatriate in the United States may be either
that of a wealthy American living a life of luxury in
a foreign country or a 20-something college student
or recent graduate who opts for the peripatetic
backpacker experience before finally returning to
his permanent home in the United States. Because
of images like these, the verb expatriate has picked
up a host of unjustified assumptions and associations.
Perhaps the most widely shared assumption regarding expatriation is that relinquishing or renouncing one’s citizenship expresses an underlying
political belief — the desire to dissociate from the
United States because of a political disagreement or
because of allegiance to another country. However,
despite this common assumption, there are several
nonpolitical reasons U.S. citizens may wish to relin-
quish or renounce their citizenship. For example,
some countries outlaw dual citizenship, which
makes it impossible for residents of those countries
— some of whom reside there for economic or social
(family) reasons rather than political reasons — to
remain legal residents there without formally renouncing or relinquishing their U.S. citizenship.1
Other U.S. citizens relinquish or renounce their
citizenship to avoid the burdensome U.S. income
tax and information reporting requirements under
the Foreign Account Tax Compliance Act. The problem here is threefold:
1. FATCA — and the IRS disclosure initiatives
designed to encourage compliance with
FATCA before the IRS’s announcement of the
streamlined filing compliance procedures in
June 2014 — does not distinguish between
‘‘bad actors’’ who intentionally failed to disclose foreign income and assets from ‘‘benign
actors’’ who did not know about the U.S.
income tax and reporting requirements (discussed in Section B);
2. FATCA and the United States’ citizenshipbased taxation system have made it prohibitively expensive for expatriates and
‘‘accidental’’ U.S. citizens to become compliant
and meet the U.S. income tax and information
reporting requirements (discussed in Section
C); and
3. the expatriation tax, or ‘‘exit tax,’’ under
section 877A imposes a harsh mark-to-market
regime on taxpayers who meet the applicable
net worth or net income threshold or who fail
to certify under penalty of perjury that they
have met U.S. income tax and reporting requirements for the five tax years preceding the
tax year in which they renounce their U.S.
citizenship, regardless of whether the taxpayers are benign actors or bad actors (discussed
in Section D).
1
The countries that either ban or impose significant restrictions on dual citizenship include (but are not limited to)
Andorra, Austria, Bahrain, China, El Salvador, Estonia, India,
Indonesia, Japan, Lithuania, Malaysia, Montenegro, the Netherlands, Norway, Panama, Poland, Singapore, Slovakia, Thailand,
Ukraine, the United Arab Emirates, and Venezuela. Andrew
Henderson, ‘‘Which Countries Allow Dual Citizenship?’’ Nomad Capitalist, Apr. 25, 2014.
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VIEWPOINT
COMMENTARY / VIEWPOINT
B. An Overview of FATCA
An ancillary consequence of FATCA is that millions of benign actors — a term originally coined by
National Taxpayer Advocate Nina Olson in her 2012
Benign actors who sought to retain their U.S.
citizenship and come into U.S. tax compliance were
2
FATCA was enacted as subtitle A (sections 501 through 541)
of title V of the 2010 Hiring Incentives to Restore Employment
(HIRE) Act. See P.L. 111-147, title V, subtitle A, sections 501-547
(Mar. 18, 2010).
3
FATCA also imposed a reporting requirement on U.S.
citizens, resident aliens (who meet the green card or substantial
presence test under section 7701(b)(1)(A)), and specific nonresident aliens (those who elect to be treated as resident aliens and
bona fide residents of American Samoa or Puerto Rico) to report
specified foreign financial assets on Form 8938 to be filed with
their Form 1040 annually. See IRS ‘‘FATCA Information for
Individuals’’ (Apr. 2, 2015); section 6038D (mandating the
disclosure of information regarding foreign financial accounts
required by Form 8938).
4
See IRS, Foreign Account Tax Compliance Act. FATCA
added sections 1471 to 1474 to the code, which set forth the
withholding requirements for nonsignatory foreign governments and FFIs.
5
As of July 15, 2015, 68 countries have signed IGAs to
implement FATCA, and 44 countries have reached agreements
in substance with the United States to implement FATCA.
Treasury Resource Center, FATCA-Archive.
6
National Taxpayer Advocate, ‘‘2012 Annual Report to Congress,’’ at 134 (Dec. 31, 2012).
7
The State Department estimates that as of May 2014, 7.6
million U.S. citizens live abroad. State Department, Bureau of
Consular Affairs, ‘‘Who We Are and What We Do: Consular
Affairs by the Numbers’’ (May 2014). Foreign accounts maintained by these estimated 7.6 million expatriate U.S. citizens —
not to mention foreign accounts owned by dual citizens and
other taxpayers with substantial connections to foreign countries — are subject to the same reporting requirements under
FATCA as foreign accounts owned by bad actors who specifically intend to evade U.S. income tax and reporting requirements.
8
See section 7701(b)(3) (setting forth the number of days of
physical presence in the United States required to treat noncitizen, nonpermanent residents as U.S. citizens or permanent
residents for federal income tax purposes).
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The most significant nonpolitical reason for renouncing one’s U.S. citizenship can be summarized
in five letters. FATCA, which became law in the
United States in 2010,2 imposes comprehensive reporting requirements on individuals3 with foreign
accounts, on foreign financial institutions, and on
foreign governments.4 The basic premise of the law
is that (1) foreign governments that enter into
intergovernmental agreements to implement
FATCA agree to report to Treasury information
regarding accounts held by U.S. citizens in that
country, and (2) FFIs that agree to register with the
IRS and provide the names of their U.S. account
holders will avoid an automatic withholding tax of
30 percent on any U.S.-source payments made to
the FFIs. This means that individuals with accounts
in foreign countries that have signed on to FATCA
— or holders of accounts at FFIs that have registered with the IRS — can no longer shield these
accounts from U.S. income tax and disclosure requirements.5 FATCA is rapidly becoming a worldwide disclosure regime, and U.S. citizens who
maintain accounts in foreign countries without disclosing them to Treasury on Financial Crimes Enforcement Network Form 114 (foreign bank account
reports) or reporting the income on their Forms
1040 may seek to avoid harsh civil or criminal
penalties by renouncing their U.S. citizenship before their names and account information are
turned over to the IRS.
Report to Congress6 — have been swept into
FATCA’s net despite the original purpose of FATCA
to identify and investigate bad actors evading their
U.S. income tax requirements.7 For example, there
are thousands of ‘‘accidental’’ U.S. citizens who
were born in the United States but moved at a
young age with their families to a foreign country
and became citizens there. These U.S. citizens by
birth may have never set foot in the United States
since childhood or may have returned to the United
States after many years living and working in what
they consider to be their home countries. Most
accidental U.S. citizens, especially those who never
returned to the United States, are unaware that the
United States imposes tax on its citizens, permanent
residents, and substantial presence residents8 on
their ‘‘worldwide income,’’ regardless of whether
that source of income is subject to tax in their
country of residence. This particular class of benign
actors may not have complied with U.S. income tax
and reporting requirements for many years or may
have been minimally compliant with these requirements by filing returns reporting only U.S.-source
income without filing other necessary information
returns such as FBARs. This means that many
benign actors are forced to choose between two
equally unappealing alternatives: either (1) comply
with the United States’ exceedingly complex international income tax and information reporting regime or (2) relinquish or renounce their U.S.
citizenship to avoid these burdensome tax and
disclosure requirements, a process that involves its
own complex set of tax procedures (discussed in
Section D, below).
COMMENTARY / VIEWPOINT
9
See, e.g., National Taxpayer Advocate, supra note 6, at 136
(‘‘The IRS ‘strongly encouraged’ everyone with an FBAR violation and unreported income (including benign actors) to participate in its OVD programs and initially discouraged them
from opting out.’’).
10
See Matthew A. Morris, ‘‘One Size Does Not Fit All:
Unintended Consequences of the Offshore Voluntary Disclosure
Program,’’ Int’l Tax J. (CCH) (2013) (summarizing the terms of
the 2009, 2011, and 2012 programs).
11
Compare IR-2012-89 (‘‘In a typical year, we used to get 100
or so taxpayers who used our voluntary disclosure program.
When we first set up our new program in 2009, we thought that
figure would rise to maybe 1,000.’’), with IR-2011-14 (‘‘The first
special voluntary disclosure program closed with 15,000 voluntary disclosures on Oct. 15, 2009. Since that time, more than
3,000 taxpayers have come forward to the IRS with bank
accounts from around the world.’’).
12
See, e.g., IRS Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers, at A27 (July 15, 2015)
(‘‘The certification process is less formal than an examination
and does not carry with it all the rights and legal consequences
of an examination. For example, the examiner will not send the
usual taxpayer notices . . . [and] the taxpayer will not have
appeal rights with respect to the Service’s determination.’’).
percent of the highest aggregate balance of the
taxpayer’s foreign accounts for the years under
investigation).13 Even though benign actors constituted the vast majority of OVDP applicants, very
few opted out because of the risk of these potentially devastating FBAR penalties.14
Since the first OVDP in 2009, the program has
been substantially revised and expanded to account
for non-willful tax and information return compliance problems. In June 2014 the IRS announced the
streamlined filing compliance procedures, which
offer both residents and nonresidents of the United
States the opportunity to resolve their compliance
issues simply by filing the delinquent tax returns
for the past three tax years and FBARs for the past
six calendar years, paying the additional income tax
and interest thereon, paying a miscellaneous offshore penalty equal to 5 percent of the highest
balance of their year-end balances in their foreign
accounts over a six-year lookback period (for residents only — nonresidents are not responsible for
paying a miscellaneous offshore penalty), and filing
a certification of non-willful conduct.15
C. The Rising Costs of Compliance
Despite the significant progress the IRS has made
in simplifying the compliance process for benign
actors, accidental U.S. citizens with few connections
13
See 31 U.S.C. section 5321(a)(5)(C) (establishing a maximum penalty of the greater of $100,000 of 50 percent of the
amount reportable for any willful failure to file an FBAR — a
penalty that can be imposed for each unfiled FBAR rather than
for each individual nonfiler). The IRS recently issued guidance
stating that ‘‘in most cases, the total penalty amount for all years
under examination will be limited to 50 percent of the highest
aggregate balance of all unreported foreign financial accounts
during the years under examination’’ rather than a cumulative
penalty of 50 percent of the highest account balance for each
year in which an FBAR violation (i.e., non-filing) occurred. See
SBSE-04-0515-0025, ‘‘Interim Guidance for Report of Foreign
Bank and Financial Accounts (FBAR) Penalties’’ (May 13, 2015).
This interim guidance reverses the IRS’s previously held position that a willful failure-to-file FBAR penalty should apply for
each year in which an FBAR violation occurred. See, e.g., United
States v. Zwerner, Dkt. No. 1:13-cv.22082-CMA (S.D. Fl., June 11,
2013) (The IRS assessed a willful FBAR penalty equal to
approximately 200 percent of the highest aggregate account
balance — 50 percent of the highest aggregate account balance
for four consecutive calendar years; the jury found Zwerner
liable for three years of willful penalties, equal to approximately
150 percent of the highest aggregate account balance.).
14
The Internal Revenue Manual acknowledges the potential
for confiscatory FBAR penalties. See, e.g., IRM section 4.26.16.4
(‘‘FBAR civil penalties have varying upper limits, but no
floor. . . . Examiner discretion is necessary because the total
amount of penalties that can be applied under the statute can
greatly exceed an amount that would be appropriate in view of
the violation.’’).
15
See generally IRS, ‘‘Streamlined Filing Compliance Procedures’’ (Oct. 9, 2014).
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initially encouraged to participate in the IRS offshore voluntary disclosure program (OVDP).9 This
program was originally designed to offer bad actors
the opportunity to come forward without the threat
of criminal prosecution to file their delinquent or
amended returns for an eight-year lookback period,
pay the additional income tax plus interest, pay a
substantial understatement penalty equal to 20 percent of the additional income tax, and pay an
‘‘offshore’’ or miscellaneous penalty (originally 20
percent but currently equal to 27.5 percent of the
highest aggregate account balance during the eightyear lookback period for most foreign accountholders).10 Faced with significantly more OVDP
applications than originally expected,11 the IRS focused primarily on the administrative complexity
of processing, assigning, reviewing, and closing
these OVDP cases within a reasonable amount of
time. In consideration of these administrative burdens, the IRS was not well-equipped to address the
specific nuances of each case that tended to establish non-willfulness or the larger questions of fundamental fairness in the OVDP process as a whole.
The standard IRS party line regarding the OVDP
was (and to a large extent still is) that it is a
settlement initiative, and thus it affords taxpayers
no statutory appeal rights or any of the other
procedural protections found in the code.12
Once benign actors committed to participating in
the OVDP, they had only one way out — a process
referred to as an ‘‘opt-out’’ in which they would
forgo the OVDP penalty structure for a much more
ambiguous, open-ended scenario involving the full
gamut of civil penalties (including the draconian
willful failure-to-file FBAR penalty equal to 50
COMMENTARY / VIEWPOINT
Example 1: Geoffrey was born in the United
States in 1962. His father was a U.S. citizen
only, and his mother was an Australian citizen
only. Under Australian law at the time of
Geoffrey’s birth, it was not possible to obtain
Australian citizenship at birth in a country
outside of Australia unless the child (or the
parent on behalf of the child) applied for and
was granted citizenship.16 Geoffrey’s parents
did not apply for Australian citizenship on his
behalf. Geoffrey moved to Australia with his
mother when he was 7 years old and acquired
Australian permanent residency status. He has
worked in Australia as a self-employed attorney since he was 25 years old and has made
contributions to his Australian retirement account (referred to as a superannuation account
in Australia) since that time. He became a
citizen of Australia in 1997. When he was 50
years old, in 2012, he inherited his father’s
shares of a closely held Australian software
company, becoming a 25 percent owner. The
company was valued at USD $1 million as of
the date of his father’s death. Geoffrey is now
53 years old. He has never filed a U.S. income
tax return or information return (such as an
FBAR). To come into compliance with his U.S.
income tax and information reporting requirements, Geoffrey must prepare and file the
following forms:
• Forms 1040 for tax years 2012, 2013, and
2014. The Forms 1040 must include the
following tax and information forms:
• Form 3520 for tax year 2012, reporting his
receipt of shares from a foreign estate;17
16
Another barrier to Geoffrey obtaining dual Australian-U.S.
citizenship at birth is that the United States did not allow dual
citizenship before the Supreme Court decision in Afroyim v.
Rusk, 387 U.S. 253 (1967), which held that Congress has no
power under the Constitution to divest a person of U.S. citizenship under the Fourteenth Amendment without that person’s
voluntary relinquishment thereof.
17
See section 6039F (requiring the disclosure of foreign gifts
and bequests from foreign persons or estates); Form 3520, Part
IV, at 6 (2014); and Instructions to Form 3520, at 12 (2014).
• Form 3520 and Form 3520-A for tax years
2012 to 2014, reporting his Australian
superannuation account as a foreign
grantor trust for U.S. income tax purposes;18
• Forms 5471 for tax years 2012, 2013, and
2014, reporting the balance sheet information regarding the Australian software
company (required because he owns
more than 10 percent of the total value of
a foreign corporation’s stock);19
• Forms 8621 for tax years 2012, 2013, and
2014, reporting the passive foreign investment company gains and losses on his
Australian superannuation account;20
• Forms 8938 reporting his specified foreign
financial assets in Australia;21 and
• Form 8275, ‘‘Disclosure Statement,’’
claiming an exemption from the requirement to report self-employment tax to the
United States because he is already contributing to the Australian social security
system under an Australia-U.S. Social Security Agreement (including a letter from
the U.S. Social Security Administration
indicating that his wages are not covered
by the U.S. Social Security system).22
18
The U.S. income taxation of earnings on Australian superannuation accounts is far from a settled area, but there is some
authority within the international tax practitioner community to
suggest that these accounts should be treated as foreign grantor
trusts subject to information reporting on Form 3520 and Form
3520-A and that any foreign mutual funds held in these superannuation accounts should be taxed as PFICs. See, e.g., LTR
200807003 (concluding that Australian superannuation funds
should be treated as trusts for U.S. income tax purposes under
reg. section 301.7701-4(a), which provides that an ‘‘arrangement
will be treated as a trust if it can be shown that the purpose of
the arrangement is to vest in trustees responsibility for the
protection and conservation of property for beneficiaries who
cannot share in the discharge of this responsibility’’). Some tax
law practitioners agree that superannuation accounts might
qualify as trusts (and more specifically, grantor trusts) for U.S.
income tax purposes. See, e.g., Phil Hodgen, ‘‘Form 3520-A Filing
Deadline Is March 15, 2011,’’ HodgenLaw PC International Tax
Blog (Mar. 11, 2011) (‘‘Australian citizen sticks money into a
superannuation account. Immigrates to the United States. Same
result: Form 3520-A . . . will be required.’’).
19
See section 6046 (requiring the disclosure of information
regarding foreign corporations when a U.S. citizen or resident
becomes a 10 percent shareholder of the foreign corporation);
Form 5471 (rev. Dec. 2012).
20
See generally sections 1291-1297 (containing the PFIC rules);
Form 8621 (rev. Dec. 2014); Instructions to Form 8621 (rev. Dec.
2014).
21
See supra note 3 (discussing the Form 8938 requirement
under FATCA).
22
See IRS, ‘‘Social Security Tax Consequences of Working
Abroad’’ (Nov. 2, 2014) (explaining that an individual working
in a foreign country must continue to pay Social Security tax to
(Footnote continued on next page.)
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to the United States may feel that their U.S. citizenship is not worth the costs of participating in the
streamlined foreign offshore procedures and the
annual costs associated with preparing ‘‘true, correct, and complete’’ U.S. income tax and information returns. For many nonresident U.S. citizens, the
annual tax and information returns required to be
filed are exceedingly complex and in most cases
cannot be prepared without some form of professional assistance.
COMMENTARY / VIEWPOINT
Not only must Geoffrey file the above income tax
and information returns for previous tax years to
come into U.S. tax compliance, he needs to continue
filing these forms annually to remain in compliance.
Because it would be very difficult for Geoffrey to
prepare all of the necessary returns and information
returns on his own, even with the assistance of a
software program such as TurboTax, this could
result in significant annual tax and information
return preparation fees.
More importantly, however, the U.S. tax on PFIC
income from the Australian mutual funds in his Australian superannuation account provides a major
disincentive to retaining U.S. citizenship. Although
his superannuation account is a qualified taxdeferred investment and retirement vehicle under
Australian law, the account becomes a significant
annual drain on his net income for U.S. tax purposes
under the mark-to-market regime of section 1296 or
the ‘‘excess distribution’’ deferred tax and interest
regime under section 1291. After application of the
foreign tax credit, Geoffrey’s U.S. income tax on his
Australian self-employment income and family
business dividend income is de minimis. However,
the income generated by the foreign mutual funds in
his Australian superannuation account is likely subject to U.S. tax because (1) this category of income is
not addressed in the Australia-U.S. income tax
treaty, (2) no specific exception applies to the general
rule that ‘‘gross income means all income from whatever source derived,’’23 and (3) no U.S. FTC is available to offset the U.S. income tax liability even
though the contributions to the superannuation account (and the annual earnings on those contributions) are taxed in Australia at a 15 percent rate, as
these taxes are paid at the fund level rather than at
the shareholder level.24 Subjecting the PFIC earnings
the United States unless an exception applies or there is a Social
Security totalization agreement between the United States and
that country); Social Security Administration, ‘‘U.S. International Social Security Agreements’’ (listing the countries with
Social Security agreements currently in force).
23
Section 61(a).
24
This assumes that Geoffrey’s contributions to his superannuation account were ‘‘concessional’’ (pretax) contributions. If
Geoffrey made ‘‘non-concessional’’ (after-tax) contributions, the
within Geoffrey’s superannuation account to both
U.S. and Australian income taxes undermines the
central purpose of the Australian superannuation
system, which is to provide an adequate source of
retirement savings for Australian citizens.
For Geoffrey and other U.S. expatriates, accidental U.S. citizens, and U.S. citizen-residents with
accounts and investments abroad, the professional
and tax costs of complying with U.S. income tax
and information return requirements has become
prohibitively expensive. Taxpayers like Geoffrey —
with minimal connections to the United States, no
present or future plans to return to the United
States, and an overwhelming tax and information
return compliance burden — might therefore conclude that expatriation is the only prudent option
from a practical, economic, and tax standpoint.
D. The Expatriation Tax Under Section 877A
The expatriation tax rules set forth in section 877A
apply to (1) U.S. citizens who renounced their citizenship on or after June 17, 2008,25 and (2) ‘‘longterm residents’’ who ended their U.S. resident status
for federal tax purposes on or after June 17, 2008.
Long-term resident is defined in section 877(e)(2) as
any individual who is a lawful permanent resident
of the United States (green card holder) in at least
eight of the 15 tax years ending with the tax year in
which the individual gives up resident status for
federal tax purposes.26 An individual will be treated
as relinquishing or renouncing U.S. citizenship on
the earliest of the following: (a) the date the individual ‘‘renounces his United States nationality before a diplomatic or consular officer of the United
States,’’ (b) the date the individual provides to the
State Department ‘‘a signed statement of voluntary
relinquishment of United States nationality,’’ (c) the
date the State Department issues to the individual a
earnings on those contributions would not be subject to tax
while they remain in the superannuation account. See Australian Taxation Office, ‘‘Super and Tax.’’ Geoffrey’s inability to
claim a U.S. FTC for the Australian income taxes paid on his
concessional contributions results from the lack of proper documentation regarding the tax payment. Because the fund pays
the tax, rather than the individual accountholders, the trustee of
the superannuation account cannot provide Geoffrey with any
documentation regarding the amount of taxes paid. Although
U.S. mutual funds or other regulated investment companies can
pass the amount of the fund-level taxes paid on to individual
shareholders by issuing a Form 1099-DIV or similar statement,
Australian superannuation accounts are not designed with U.S.
tax compliance in mind and therefore are not equipped to pass
this information on to individual accountholders. See IRS Publication 514, Foreign Tax Credit for Individuals, at 6 (2014) (summarizing the rules for foreign taxes paid by U.S. mutual funds
and passed on to shareholders).
25
The rules for expatriations before June 17, 2008, which are
not discussed in this article, are set forth in section 877.
26
Section 877(e)(2).
(Footnote continued in next column.)
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• FBARs for calendar years 2009, 2010, 2011,
2012, 2013, and 2014. Geoffrey will need to
prepare and file these FBARs for the six
previous calendar years for which the FBAR
deadline has already passed under the terms
of the streamlined foreign offshore procedures and will need to prepare and file these
FBARs by June 30 of each subsequent calendar year to remain in compliance with his
requirements under FATCA.
COMMENTARY / VIEWPOINT
27
Id. Section 877A(g)(4).
Section 877(e)(2); section 877A(a)(1).
29
Section 877(e)(2); section 877A(a)(2)(B).
30
Rev. Proc. 2014-61, 2014-47 IRB 860.
31
Deferred compensation items include an item of deferred
compensation such as a qualified retirement plan listed in
section 219(g)(5) (e.g., section 401(a) or 403(a) plans), any foreign
pension plan or similar arrangement, any item of deferred
compensation, and any property received in exchange for
services to the extent not already included in gross income
28
U.S. retirement accounts) are not marked to
market, but the payer of these items must
withhold 30 percent of any taxable distribution to a covered expatriate. All other items of
deferred compensation are treated as having
been distributed to the covered expatriate to
the extent of the expatriate’s accrued benefit
(or the amount that the individual is entitled
to transfer without a substantial risk of forfeiture) on the day before the expatriation date.32
No early distribution tax will apply by reason
of the deemed distribution of non-eligible deferred compensation items, and adjustments
must be made to subsequent distributions
from the plan to reflect the tax impact of the
deemed distribution on the covered expatriate
(that is, the expatriate will get a step-up in
basis for the amount deemed distributed on
the day before expatriation).33
2. Specified tax-deferred accounts.34 The amount
of a specified tax-deferred account is treated as
having been distributed to the covered expatriate on the day before expatriation. No early
distribution tax will apply by reason of the
deemed distribution of non-eligible deferred
compensation items, and adjustments must be
made to subsequent distributions from the
plan to reflect the tax impact of the deemed
distribution on the covered expatriate (that is,
the expatriate will get a step-up in basis for the
amount deemed distributed on the day before
expatriation).35
under section 83. Section 877A(d)(4). Eligible deferred compensation items include deferred compensation items if the payer of
these items is a U.S. person (or elects to be treated as one for U.S.
tax purposes) and the covered expatriate (i) notifies the payer of
his status as a covered expatriate and (ii) makes an irrevocable
waiver of the right to claim any treaty benefits associated with
the income. Id. Section 877A(d)(3).
32
Section 877A(d)(2)(A). Deferred compensation items other
than eligible deferred compensation items are treated as having
been distributed to the taxpayer on the day before expatriation.
Eligible deferred compensation items are not treated as having
been distributed to the taxpayer on the day before expatriation,
but the payers of these items must withhold 30 percent of any
payment to a covered expatriate.
33
Section 877A(d)(2)(B) and (C).
34
Id. Section 877A(e)(2) (‘‘‘Specified tax-deferred account’
means an individual retirement plan (as defined in section
7701(a)(37)) other than any arrangement described in subsection
(k) (‘simplified employee pension’) or (p) (‘simple retirement
account’) of section 408, a qualified tuition program (as defined
in section 529), a Coverdell education savings account (as
defined in section 530), a health savings account (as defined in
section 223), and an Archer MSA (as defined in section 220).’’).
35
Id. Section 877A(e)(1)(B) and (C).
(Footnote continued in next column.)
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‘‘certificate of loss of nationality,’’ or (d) the date that
a U.S. court ‘‘cancels a naturalized citizen’s certificate of naturalization.’’27
Assuming that the individual who relinquishes
or renounces U.S. citizenship meets the definition of
a ‘‘covered expatriate’’ under section 877A(g)(1)(A)
(see discussion below), the mechanics of the expatriation tax under section 877A are as follows. The
expatriating taxpayer must file three tax returns for
the year of renunciation of U.S. citizenship (to be
filed on or before April 15 of the calendar year
following renunciation, or by June 15 if the taxpayer
is living outside of the United States):
1. Form 1040 from January 1 to the day on
which the individual renounces U.S. citizenship (reporting the individual’s worldwide
income and assets);
2. Form 1040NR for the day after the renunciation of U.S. citizenship until December 31
(reporting only U.S.-source income); and
3. Form 8854, ‘‘Initial and Annual Expatriation
Statement’’ (to determine whether the renouncing taxpayer is a covered expatriate and,
if so, whether any expatriation tax or exit tax is
due).
The expatriation tax or exit tax is a mark-tomarket tax. The mark-to-market regime under section 877A treats all worldwide property of a covered
expatriate as sold for its fair market value on the
day before the expatriation date.28 Standard rules of
gain and loss then apply — the FMV of the property
on the day before expatriation is treated as the
amount realized, and the taxpayer compares the
amount realized with his basis in the property to
determine if there is any taxable gain or loss. Both
gains and losses on the deemed sales are recognized, but the wash sale rules of section 1091 are
inapplicable.29 The amount that would be includable by reason of the deemed sale rules is reduced
by an exclusion amount ($690,000 for expatriations
in tax year 2015).30
These mark-to-market rules do not apply to the
following types of property:
1. Deferred compensation items.31 Eligible deferred compensation items (such as qualified
COMMENTARY / VIEWPOINT
Section 2801 (enacted in June 2008)39 imposes
major estate and gift tax consequences if covered
expatriates attempt to gift or devise cash or property to U.S. persons after the expatriation date.40
Unlike the standard rules that impose gift and
estate tax on the donor or decedent’s estate if the
amount of the gift or value of the gross estate
exceeds the applicable threshold amount, section
2801 states that the donee of a gift from a covered
expatriate or the devisee of cash or property received from a covered expatriate’s estate will be
responsible for paying tax equal to the product of
the highest rate of estate tax under section 2001(c)
or the highest rate of gift tax under section 2502(a)
times the value of the gift or bequest. The rationale
for this rule appears to be that a covered expatriate
should not be entitled to repatriate cash or property
to the United States by means of a gift or estate
planning strategy without incurring a serious tax
penalty. Because the covered expatriate is presumably beyond the IRS’s reach after expatriation, the
gift and estate tax is imposed on the donee or
devisee instead of on the covered expatriate or the
estate.
As mentioned above, the expatriation tax under
section 877A applies only to ‘‘covered expatriates.’’
The following individuals are exempted from the
definition of a covered expatriate:
A. individuals who (i) ‘‘became at birth a
citizen of the United States and a citizen of
another country and, as of the expatriation
date, continues to be a citizen of, and is taxed
as a resident of, such other country,’’ and (ii)
have ‘‘been a resident of the United States as
defined in section 7701(b)(1)(A)(ii)’’ (under the
substantial presence test) for not more than 10
of the prior 15 tax years;41 or
B. individuals who (i) relinquish their U.S.
citizenship before age 18½ and (ii) have been
U.S. residents (under the substantial presence
test of section 7701(b)(1)(A)(ii)) for not more
than 10 tax years before the date of relinquishing their U.S. citizenship.42
If neither of the above exceptions under (A) and
(B) applies, individuals will be considered covered
expatriates under section 877A(g)(1)(A) (by reference to section 877(a)(2)) if they meet any of the
following criteria43:
A. The individual’s average annual net income
tax in the five tax years preceding the renunciation or relinquishment of citizenship is
greater than $160,000 (originally $124,000, as
adjusted for inflation). The computation of
average annual net income tax is determined
under section 38(c)(1).44 That section defines
‘‘net income tax’’ as the sum of the regular
income tax and alternative minimum tax, reduced by the credits allowable under ‘‘Subparts A and B of this part’’ (sections 21 through
30D).45
B. The net worth of the individual as of the
date of expatriation is $2 million or more (not
adjusted for inflation). The net worth test is a
standard balance sheet analysis of the taxpayer’s assets and liabilities. The values of assets
and liabilities are measured according to the
valuation principles set forth in section 2512
‘‘without regard to any prohibitions or restrictions on such interest’’ (for example, discounts
for marketability and lack of control) as of the
date of expatriation.46
C. The individual fails to certify on Form 8854
under penalty of perjury that he is compliant
with his U.S. income tax and information
return compliance responsibilities for the preceding five tax years. The certification says
nothing regarding the timing of the compliance, except for the implicit requirement that
the taxpayer must meet the requirements before completing the form.47
42
Id. Section 877A(g)(1)(B)(ii).
The criteria for covered expatriate status under section
877A(g)(1)(A) are objective standards rather than rebuttable
presumptions: If an expatriating taxpayer meets either the net
income, net worth, or noncompliance criteria, then he is a
covered expatriate even if U.S. income tax avoidance has
nothing to do with his decision to expatriate.
44
Id. Section 877(a)(2)(A).
45
Id. Section 38(c)(1).
46
Notice 97-19, 1997-1 C.B. 394, section III, ‘‘Tax Liability and
Net Worth Tests,’’ at 2.
47
Form 8854 is required to be filed with the expatriating
taxpayer’s final Form 1040 for the year that includes the
43
36
See id. Section 877A(f)(3) (an individual will be treated as
holding an interest in a nongrantor trust if the trust does not
meet any of the grantor trust rules set forth in sections 671 to
679); sections 671-679 (the grantor trust rules).
37
Id. Section 877A(f)(1)(A).
38
Id. Section 877A(f)(1)(B).
39
See P.L. 110-245, section 301(b)(1) (June 17, 2008).
40
Section 2801.
41
Id. Section 877A(g)(1)(B)(i).
(Footnote continued on next page.)
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3. Any interest in a non-grantor trust.36 For
distributions of property from a non-grantor
trust, the trustee deducts 30 percent of the
taxable portion of the distribution to the covered expatriate.37 If the FMV of the property
distributed exceeds the trust’s basis in the
property, then the trust will recognize gain as
if the property were sold to the covered expatriate for FMV.38
COMMENTARY / VIEWPOINT
individual’s expatriation date. Instructions to Form 8854, at 3
(rev. 2014). Thus, for U.S. citizens or residents living outside the
United States and renouncing their citizenship on October 1,
2015, the due date for Form 8854 is the same due date as for the
taxpayers’ 2015 Form 1040 (June 15, 2015, which is the standard
April 15 due date plus an automatic two-month extension of
time to file for U.S. citizens and resident aliens living abroad).
48
P.L. 108-357, section 804(a)(1) (Oct. 22, 2004).
49
Section 877(a)(1).
50
Id. Section 877(a)(2).
51
P.L. 108-357, section 804(a)(2) (Oct. 22, 2004).
52
Notice 97-19, section I, at 1.
The assumption that high-income and high-networth taxpayers are necessarily motivated by a
tax-avoidance purpose is problematic. As described
in Sections B and C, above, the taxpayer’s decision
may be more closely related to the duplicative
burden and professional costs of complying with
two countries’ tax laws. In Example 1 (Section C)
above, Geoffrey has little if any U.S. income tax
liability on his Australian wage and dividend income after the application of the U.S. FTC. Even
assuming for the sake of argument that Geoffrey’s
superannuation account were not subject to U.S.
income tax, he would still need to hire a qualified
international tax professional to prepare all of the
complex information returns reporting his foreign
accounts and assets each year. Attorney Phil Hodgen perfectly summarizes this problem: ‘‘Imagine
what it is like to [pay] $2,000, $3,000, or more for tax
return preparation, with a zero tax bill. It is a
pointless [and] expensive exercise.’’53
The third criterion for covered expatriate status
— failing to certify U.S. tax compliance under
section 877(a)(2)(C) — also targets a tax-avoidance
motive: The IRS assumes that a taxpayer who
cannot certify compliance with tax and information
return obligations must have renounced for taxavoidance purposes. The assumption is problematic
not only because expatriation may be related to the
burdens of compliance (as discussed above), but
also because it is unclear whether filing amended or
delinquent returns for the five years preceding
expatriation meets the compliance requirement.
Form 8854 simply requires taxpayers to certify that
they have ‘‘complied with all of [their] tax obligations for the 5 preceding tax years’’ and not that
they have timely filed true, correct, and complete
income tax and information returns for those years.
Thus, it appears (although it is not entirely clear)
that taxpayers can restore compliance for previous
years by filing amended or delinquent information
returns for the past five tax years and paying any
additional income tax due (assuming that all returns and forms are filed and all taxes are paid
before completing the Form 8854).
Further, taxpayers who are compliant with their
U.S. income tax and information return requirements may still be motivated by a tax-avoidance
purpose to renounce or relinquish their U.S. citizenship.
Example 2: Jack, a wealthy businessman, was
born in the United States to American parents
and has lived his entire life in the United
States. Starting in the mid-1980s, Jack opened
53
Hodgen, ‘‘Why People Expatriate,’’ HodgenLaw PC International Tax Blog (June 5, 2012).
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Each of the criteria for covered expatriate status
listed in section 877(a)(2) is intended to determine
whether the taxpayer’s decision to renounce is
motivated by tax avoidance. Until the statute was
amended under the American Jobs Creation Act of
2004, section 877 also contained a subjective test to
determine whether a taxpayer was motivated by tax
avoidance.48 Before the 2004 amendment, section
877(a)(1) stated that an individual renouncing citizenship is responsible for the expatriation tax under
section 877 ‘‘unless such loss [of citizenship] did not
have for one of its principal purposes the avoidance
of taxes.’’49 Section 877(a)(2) also stated before the
2004 amendments that an individual ‘‘shall be
treated as having a principal purpose to avoid such
taxes’’ if either the net worth or the annual net
income tests are met.50 The 2004 act removed all
references to subjective intent in the statute, opting
instead for the objective standards of (a) annual net
income, (b) net worth, and (c) failing to certify tax
compliance.51
The first two criteria of the amended statutory
definition of covered expatriate are based on unjustified assumptions regarding net worth and annual
income. For example, if an individual’s net worth
and average annual net income for the past five tax
years exceed the thresholds set forth under section
877(a)(2)(A) and (B), the IRS assumes that the
individual’s motivation to renounce was tax avoidance. Notice 97-19 states that under section
877(a)(2), a former citizen is considered ‘‘to have
lost U.S. citizenship with a principal purpose to
avoid U.S. taxes if the former citizen’s tax liability
or net worth exceeded specific amounts on the date
of expatriation.’’52 Although the notice is referring
to a now-superseded version of section 877(a)(2),
the general presumption remains that a taxpayer’s
decision to expatriate is motivated by a taxavoidance purpose if the taxpayer exceeds the tax
liability or net worth thresholds in the current
version of the statute. If there is any doubt that the
purpose of sections 877 and 877A is to discourage
expatriation to avoid U.S. income tax, one need only
look to the title of section 877: ‘‘Expatriation to
Avoid Tax.’’
COMMENTARY / VIEWPOINT
54
This is not mere academic speculation regarding a loophole
that few taxpayers are likely to exploit. Although statistics on
the actual number of taxpayers who employ these strategies are
impossible to obtain, several tax practitioner websites discuss
tax planning strategies for falling below the net income and net
worth thresholds of section 877(a)(2). See, e.g., Hodgen, ‘‘How to
Compute Net Tax Liability for Form 8854,’’ HodgenLaw PC
International Tax Blog (‘‘If you are thinking about expatriating
at some point in the future, start filing your tax returns using the
status ‘Married Filing Separately’ rather than ‘Married Filing
Jointly’. You may be able to avoid covered expatriate status that
way.’’); Chi-Yu Liang, ‘‘A Few Things to Know Before Breaking
Up With Uncle Sam,’’ Stout Risius Ross Inc. (Spring 2015)
(‘‘Accordingly, there are several ways in which a taxpayer may
be able to plan in order to fall under the $2 million net worth
threshold. The individual may wish to make completed gifts to
others by giving annual exclusion gifts, making payments for
educational or medical expenses, or making use of his or her
$5.43 million federal gift tax exemption.’’).
under section 877A(g)(1)(B)(i),55 and (2) he never
rearranged his assets to fall below the net income
and net worth thresholds. As explained further in
Section E below, there is a broken link between the
requirements in the covered expatriate definition
and the question of willfulness.
E. Restoring the Purpose of the Expatriation Tax
Before considering ways to revise section 877A so
as to mitigate its impact on benign actors, one must
first determine the overarching legislative purpose
behind the section 877A mark-to-market regime. Is
the goal to discourage expatriation (1) for political
reasons (to keep as many U.S. citizens from renouncing their citizenship as possible), regardless
of the existence of tax-avoidance motives; (2) for
economic reasons (to compensate Treasury for the
loss of future tax revenue from the expatriating
citizens), regardless of the existence of taxavoidance motives; or (3) specifically to discourage
U.S. citizens from expatriating for purposes of tax
avoidance? The legislative history of section 877 —
which, as discussed in Section D above, contains a
subjective tax-avoidance motive test that was later
replaced with the objective tests for net income, net
worth, and compliance certification — suggests that
its purpose is primarily to discourage expatriation
to avoid U.S. income tax.56
Proposal 1: Require expatriating taxpayers to
certify non-willfullness. If the purpose of the expatriation tax is to discourage or even punish U.S.
citizens for renouncing for tax-avoidance purposes,
as suggested by the legislative history, this purpose
would be better served by requiring taxpayers to
certify that they have not willfully (1) structured
their affairs to fall below the net income threshold
of section 877(a)(2)(A), (2) structured their assets to
fall below the net worth threshold of section
877(a)(2)(B),57 or (3) failed to comply with their U.S.
income tax and information return requirements in
the five full tax years preceding the expatriation.
The specific language regarding non-willfulness
55
See supra text accompanying note 41 (discussing dual
citizen exception to covered expatriate status under section
877A(g)(1)(B)(i)). Geoffrey does not qualify for the dual citizen
exemption from the expatriation tax under section
877A(g)(1)(B)(i) because he was not a citizen of Australia at birth
but acquired Australian citizenship many years later.
56
See supra notes 49-50.
57
As a public policy matter, the $2 million net worth threshold of section 877(a)(2)(B) should be both increased and indexed
for inflation if the purpose is to target the wealthiest echelon of
expatriate U.S. taxpayers. For the sake of simplicity, the net
worth threshold could track the inflation-adjusted threshold
value of the taxpayer’s gross estate for federal estate tax
purposes ($5,430,000 for tax year 2015). See section 2010(c)(3)(A);
IRS Form 706 instructions (for decedents dying after December
31, 2014).
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several bank accounts in offshore tax havens
such as Switzerland and the Cayman Islands.
Jack’s sole reason for opening these foreign
accounts was to shield his considerable assets
from U.S. income tax. Jack married Jill, also a
lifetime U.S. citizen, approximately 20 years
ago. Fully aware of the expatriation tax rules,
Jack liquidated the assets in these foreign
accounts 10 years ago (in 2005) and gifted the
proceeds and other assets to Jill (who became
the sole owner, not a joint or co-owner with
Jack). Jack also started to file his U.S. income
tax returns as ‘‘married filing separately.’’ As a
result of Jack’s gifts to Jill and his choice to file
as ‘‘married filing separately,’’ Jack does not
meet the net income test of section 877(a)(2)(A)
or the net worth test of section 877(a)(2)(B).
Further, Jack signed the certification of compliance on Form 8854 under penalty of perjury
because he has been fully compliant with his
U.S. income tax and reporting requirements
for the past five years, despite his noncompliance from the mid-1980s to 2005. Jack renounces his citizenship in 2015 and is not
responsible for the mark-to-market expatriation tax under section 877A because he falls
under the net income and net worth tests and
meets the compliance certification requirement.
Example 2 illustrates that tax compliance in the
five-year period preceding expatriation should not
be considered persuasive evidence of the lack of a
tax-avoidance motive. Individuals like Jack are free
to structure their affairs to shield their assets from
the net worth test and keep their incomes below the
net income threshold to avoid the expatriation tax,54
whereas a taxpayer like Geoffrey in Example 1 may
not be so lucky because (1) he does not fall under
the dual citizen exception to the expatriation tax
COMMENTARY / VIEWPOINT
I certify that I have not at any time intentionally structured my affairs and/or assets in
order to fall below the applicable net income
threshold under section 877(a)(2)(A) of the
Internal Revenue Code (the ‘‘Code’’) or the
applicable net worth threshold under section
877(a)(2)(B) of the Code in such a way as to
avoid the expatriation tax (or ‘‘exit tax’’) under
section 877A of the Code. I further certify that
any tax non-compliance within the five (5) tax
years preceding the date of my expatriation
was due to non-willful conduct. I understand
that non-willful conduct is conduct that is due
to negligence, inadvertence, mistake, or conduct that is the result of a good-faith misunderstanding of the requirements of the law.
I recognize that if the Internal Revenue Service
receives or discovers evidence of willfulness,
fraud, or criminal conduct, it may open an
examination or investigation that could lead to
civil fraud penalties, FBAR penalties, information return penalties, or even referral to Criminal Investigation.
As discussed in Section D above, it is not entirely
clear whether taxpayers who eventually come into
compliance with their U.S. income tax and information return requirements by filing amended or
delinquent income tax and information forms after
the applicable due dates for these forms but before
the date of expatriation are entitled to ‘‘certify
under penalty of perjury that [they have] met the
requirements of this title for the 5 preceding taxable
years’’ under section 877(a)(2)(C). To clarify this
point, the IRS should issue guidance to say that
taxpayers who have satisfied all the requirements of
either the OVDP or the streamlined filing compliance procedures — including taxpayers that have
opted out of the OVDP and have paid all applicable
taxes, interest, and penalties — are deemed to have
met the requirements of this title for the five preceding tax years under section 877(a)(2)(C).
58
See Form 14653, ‘‘Certification by U.S. Person Residing
Outside of the United States for Streamlined Foreign Offshore
Procedures’’ (Jan. 2015); Form 14654, ‘‘Certification by U.S.
Person Residing in the United States for Streamlined Domestic
Offshore Procedures’’ (Jan. 2015).
Proposal 2: Add a new category of ‘restored
compliance’ taxpayers to the list of taxpayers exempt from covered expatriate status. In this author’s opinion, clarifying that participants in the
OVDP or the streamlined filing compliance procedures are entitled to certify compliance for the five
preceding tax years does not go far enough to
further the IRS’s objectives of encouraging voluntary compliance and discouraging tax evasion. If
the IRS truly wishes to encourage delinquent taxpayers with foreign income and assets to come into
compliance with their U.S. income tax and information return requirements, the IRS should ask Congress to add a new exception to the covered
expatriate rules under section 877(c). This new
section (section 877(c)(4)) might read as follows:
(4) Taxpayers who restore past noncompliance. The Secretary shall prescribe such
regulations as may be appropriate to exempt
individuals who restore non-compliance with
the requirements of this title for the 5 preceding taxable years by satisfying the applicable
requirements of the (1) Offshore Voluntary
Disclosure Program (either through an executed Closing Agreement or through a completed examination following an opt-out of
this Program), (2) Streamlined Filing Compliance Procedures, or (3) similar settlement initiative.
The IRS could promulgate a new regulation
under section 877 stating as follows:
A taxpayer meets the section 877(c)(4) exception from the ‘‘covered expatriate’’ definition
of section 877A(g)(1) if:
1. the Secretary and taxpayer have fully
executed a Form 906 Closing Agreement
and the taxpayer has (a) applied for participation in the Offshore Voluntary Disclosure Program or similar settlement
initiative, (b) completed that program’s
certification process, and (c) paid all applicable tax, penalties, and interest in
accordance with the terms of that Form
906 Closing Agreement prior to execution
of the Form 8854: Initial and Annual
Expatriation Statement;
2. the taxpayer has (a) applied for participation in the Offshore Voluntary Disclosure Program or similar settlement
initiative, (b) has made an irrevocable
election to ‘‘opt out’’ of that Program, and
(c) the taxpayer has paid all applicable
tax, penalties, and interest assessed by
the Internal Revenue Service in a civil
examination following the taxpayer’s
election to ‘‘opt out’’; or
700
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could be borrowed from the certification forms
required for participation in the streamlined filing
compliance procedures.58 These new certification
forms, which could be titled ‘‘Certification by U.S.
Person of Non-Willfulness for Purposes of the Expatriation Tax,’’ might require taxpayers to certify
something like the following under the penalty of
perjury:
COMMENTARY / VIEWPOINT
59
See 2014 OVDP FAQs, supra note 12, at 7.2 (explaining that
a miscellaneous penalty of 50 percent of the highest aggregate
account balance will be imposed only when the U.S. government is investigating the FFI in which the account is held or
when another facilitator assisted in establishing the offshore
account); id. at 7 (imposing a default miscellaneous penalty rate
of 27.5 percent of the highest aggregate account balance in all
other circumstances).
compliance procedures have already certified under
the penalty of perjury that their compliance problems are attributable to non-willful conduct.60 This
certification in itself should be sufficient to overcome the presumption that the taxpayer expatriated
for purposes of tax avoidance.
F. Conclusion
When section 877 was initially enacted, its purpose was clear — to impose a harsh penalty, in the
form of an expatriation tax, on those expatriating to
avoid U.S. income tax. Unfortunately, the subjective
method that the statute initially used to assess the
expatriating taxpayer’s motivation was too difficult
to enforce. To ease the administrative burden on the
IRS, Congress replaced the subjective test with an
objective one: Under the current version of section
877 (and the newly enacted section 877A), a taxavoidance motive can be inferred only when a
taxpayer meets specific objective criteria such as
exceeding the net income or net worth thresholds or
failing to certify compliance with U.S. income tax
and reporting requirements.
The problem with the new test is that the objective test (1) has lost much of the spirit and intent of
the original statute, and (2) is vulnerable to abuse
by bad actors who are able to shift their income and
assets to fall below the applicable thresholds. Congress and the IRS could help to restore some of the
original spirit and intent of section 877 by requiring
taxpayers to certify that they have not willfully
structured their affairs or assets to fall below the
applicable net income and net worth thresholds of
section 877(a)(2) and by adding an exception to the
expatriation tax for individuals that have completed the OVDP or streamlined filing compliance
procedures. This would (a) discourage expatriation
for tax-avoidance motives without unnecessarily
punishing taxpayers who have voluntarily disclosed and resolved their past noncompliance and
(b) encourage compliance for the vast majority of
benign actors who want to remain U.S. citizens.
60
See supra note 58 (discussing Form 14653 and Form 14654).
Also, participants in the streamlined domestic offshore procedures are required to pay a miscellaneous penalty equal to 5
percent of the highest end-of-year balance over the six-year
lookback period. Participants in the streamlined foreign offshore procedures are not responsible for paying a miscellaneous
penalty. See streamlined filing compliance procedures, supra
note 15.
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3. the taxpayer has completed all of the
requirements of the Streamlined Filing
Compliance Procedures (either the Domestic or Offshore Procedures), including
paying all applicable tax, penalties, and
interest in accordance with the terms of
those Procedures.
Narrowing the covered expatriate definition
could potentially undermine U.S. public policy interests by making it easier to expatriate. Even so,
excepting OVDP and streamlined participants from
the rules — regardless of those individuals’ annual
incomes or net worth — is more likely to advance
the overarching legislative goals of sections 877 and
877A by more specifically targeting bad actors who
seek to expatriate to avoid past, present, and future
U.S. tax obligations.
Adding an exception to covered expatriate status
for OVDP and streamlined participants would encourage voluntary compliance and facilitate the
expatriation process for those taxpayers who have
restored compliance through the OVDP or streamlined procedures. Forcing taxpayers who have restored compliance to pay the expatriation tax is
particularly unfair because (1) formerly noncompliant taxpayers who have completed the OVDP process have already been punished by paying a
miscellaneous penalty as high as 50 percent (but
27.5 percent for most taxpayers in the OVDP)59 of
their highest aggregate offshore account balance
over an eight-year voluntary disclosure period (in
addition to the additional income tax, substantial
understatement penalties, failure-to-file and failureto-pay penalties (if applicable), and interest on the
unpaid tax); (2) noncompliant taxpayers who have
opted out of the OVDP have already been punished
by paying additional income tax, interest, and (if
applicable) civil penalties (including non-willful or
willful failure-to-file FBAR and other information
return penalties) in the course of a civil examination
following the opt out; and (3) noncompliant taxpayers who have completed the streamlined filing
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tax notes™
Kinder Morgan’s Choice of Entity
By W. Eugene Seago
W. Eugene Seago is the R.B. Pamplin Professor of
Accounting at Virginia Tech University.
In this article, Seago examines the motivations
for the merger of Kinder Morgan Inc.’s master
limited partnership Kinder Morgan Energy Partners LP.
The 2014 Kinder Morgan Inc. (KMI) merger of its
master limited partnership Kinder Morgan Energy
Partners LP (KMP) may seem like old news,1 but it
remains intriguing because of the counterintuitive
nature of the transaction.
KMP, a publicly held partnership, owned and
operated pipelines. In general, pipelines produce a
steady stream of distributable income, making the
partnership interests very appealing to investors
seeking cash flow. As a transporter of oil and gas,
KMP was exempt from the corporate system of
double taxation2 typically applicable to publicly
held entities whether or not they are incorporated.
The KMI-KMP merger brought assets from a system
of single taxation into the world of double taxation;
moreover, the merger was taxable to the partners
other than the controlling partner, KMI.3 Thus, from
a purely tax point of view, the KMI-KMP merger
seemed to be a move in the wrong direction. But of
course, tax consequences were not the only consideration in the merger decision.
According to the prospectus, the motivations for
the merger were as follows. KMP was at the bottom
1
On November 26, 2014, KMI completed three separate
merger agreements involving all the outstanding common units
of KMP and El Paso Pipeline Partners LP (EPB) and all the
outstanding shares of Kinder Morgan Management LLC that
KMI did not already own. This article focuses on the merger of
KMP. See David Cay Johnson, ‘‘Kinder Morgan’s Evolving Tax
Strategy,’’ Tax Notes, Aug. 18, 2014, p. 881; Amy S. Elliott,
‘‘Williams Follows Kinder’s Lead, Abandons MLP Structure,’’
Tax Notes, May 18, 2015, p. 727; and Elliott, ‘‘Kinder Morgan
Consolidates, Converting 2 PTPs,’’ Tax Notes, Aug. 18, 2014, p.
770.
2
Section 7704(d)(1)(E). EPB was also merged into KMI as part
of the same general plan.
3
See, e.g., Elliott, ‘‘Darden to Pursue REIT Spin; More OpCoPropCo Structures to Come?’’ Tax Notes, June 29, 2015, p. 1502.
of a complex organization with KMI at the top.
Although KMI owned only 12 percent of KMP’s
equity, KMI could receive as much as 50 percent of
KMP’s cash flow.4 For financial reporting purposes,
KMI controlled KMP through KMI’s control over
KMP’s general partner. According to the prospectus, this ownership arrangement increased KMP’s
cost of capital, limiting KMP’s ability to make
competitive bids for new acquisitions and its ability
to finance large development projects. In short,
KMI’s prospects for KMP’s future growth were
dim.5 Some public investors may have been content
to sit back and receive their regular distributions,
but KMI was not satisfied with the stagnation.
Perhaps KMP’s cost of capital problems could have
been remedied if KMI had reduced its incentive
distributions, but KMI was unwilling to make the
change.
The prospectus mentioned that other benefits of
the merger arose from the organizational changes.
The transactions would greatly simplify the Kinder
Morgan family’s corporate structure, creating operating efficiencies and savings in administrative and
interest costs, including6:
• simplification of SEC filing requirements;
• reduction of costs associated with multiple
public companies; and
• elimination of potential conflicts of interests
between KMI, KMP, and other members of the
group.
Of course these merger benefits largely accrued
to KMI, the acquiring corporation, and its shareholders. However, the KMP members were allowed
to share in this newly created wealth by accepting
KMI stock as the primary consideration for the
merger, though this had a price: The exchanges of
stock for partnership interests were taxable transactions for the KMP members other than KMI. The
transactions did not satisfy section 351 (because the
KMP members owned only 31 percent of the KMI
stock after the exchange) and did not constitute a
reorganization because only one corporation was
involved.7 Therefore, the difference between a
member’s basis in the partnership and the value of
4
See Kinder Morgan Merger Proposal, at 3.
Id. at 31.
6
Id. at 51.
7
Id. at 1.
5
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VIEWPOINT
COMMENTARY / VIEWPOINT
The Transactions, Rev. Rul. 99-6, and Section 1060
The taxable merger seemed to fit the framework
of Rev. Rul. 99-6,8 in which one partner buys the
interest of its other partner. In the merger, only one
owner (KMI) remained after the exchange of stock
for partnership interests. Under the revenue ruling,
this meant that the partnership was terminated and
all of the assets were distributed to the partners in a
liquidating distribution; then the selling partners
exchanged their KMP assets for KMI stock. As a
result, the KMP members (other than KMI) recognized gain or loss. KMI acquired the assets from the
other KMP members and acquired a new basis in
the assets equal to the fair market value of the KMI
stock and cash given in the exchange. KMI acquired
its share of KMP assets as a liquidating distribution,
and KMI did not recognize gain or loss because
KMI did not receive an amount of cash greater than
its basis in the assets.
It should be noted that the exchange of stock for
partnership interests was intended to yield a 12 to
17 percent premium to the KMP partners.9 This
premium would most likely become goodwill or
some other intangible acquired by KMI and therefore would be eligible for 15-year amortization.10
Section 1060 should apply because the partnership
assets likely constituted a trade or business to
which goodwill or going concern value would
attach.11
The KMI Financial Accounting Implications
For KMI the acquisition of the interest was simply a section 1032 transaction for tax purposes —
stock for assets — that did not require KMI to
recognize gain or loss but allowed KMI to obtain a
tax basis in the KMP assets equal to the value of the
publicly traded KMI stock and cash given in the
exchange. The step-up in tax basis was $28 billion.12
This resulted in an expected increase in future
benefits of about $10 billion (0.35 x $28 billion).
However, KMI’s financial statement values of the
KMP assets received in the exchange remained the
same because before the merger, KMI controlled
KMP’s general partner. Therefore for financial accounting purposes, KMI’s and KMP’s financial
statements were consolidated. Once control was
established, subsequent acquisition of KMP’s equity did not result in adjustments to the bases in
KMP assets on the consolidated financial statements, except for the creation of a deferred tax asset,
as explained below.13
The net result of the merger on the consolidated
balance sheet was the elimination of KMI’s $5
billion deferred tax liability and the creation of a $5
billion deferred tax asset for KMI. The deferred tax
liability was largely a result of depreciation taken
on the tax return before the expense appeared on
the financial statements. Because the book bases in
the assets were increased by the issuance of the
stock (recorded at its market value), the future tax
expense would be less than the cash payments for
tax — analogous to prepaid tax. Assuming financial
analysts give some credence to deferred tax assets
and liabilities, these financial statement adjustments should improve KMI’s credit standing, a
principal objective of the merger.
A major point for investors, however, is that for
KMI to improve its balance sheet, the KMP partners
had to pay income taxes sooner than might have
otherwise been required. The amounts paid in taxes
were no longer available to KMI or the KMP
partners, which raises the question whether the
objectives of the merger could have been met by the
KMP partners contributing additional capital, instead of paying taxes on their gains (and KMI
reducing its incentive distributions).
Another point the KMP partners, other than
KMI, should recognize is that they paid 100 percent
of the taxes on the transactions but received only a
31 percent interest in KMI. Therefore, the KMI
shareholders before the merger will reap 69 percent
of the benefits of the basis step-up made possible by
the KMP partners absorbing a tax on their gain.
Implications for Publicly Traded Partnerships
The exemption of some types of publicly held
businesses from the corporate tax may or may not
8
1999-1 C.B. 432.
Supra note 4, at 28.
10
Reg. section 1.338-6(b)(2).
11
Reg. section 1.1060-1(b)(2).
9
12
Supra note 4, at 102.
See Financial Accounting Standards Board Codification at
810-10-15-8A.
13
704
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the stock received was taxable gain. The additional
bad news for the former KMP members was that a
portion of the gain could be ordinary income under
section 751 (for example, depreciation recapture).
The possible amount of the ordinary income was
not disclosed in the prospectus. However, a substantial portion of the deemed sales proceeds would
be for the depreciable assets and thus subject to
ordinary income treatment under section 1245. The
prospectus did discuss a benefit for the KMP partners: Because the exchanges were taxable, KMI
would enjoy a step-up in basis for the assets,
reducing future income tax and thus increasing
KMI’s cash flow available for dividends to the
former KMP partners. But this benefit would also
be enjoyed by the original KMI shareholders.
COMMENTARY / VIEWPOINT
14
See Emily Cauble, ‘‘Redefining Qualifying Income for
Publicly Traded Partnerships,’’ Tax Notes, Oct. 6, 2014, p. 107.
IN THE WORKS
A look ahead to planned commentary and analysis.
Eyes on e-commerce: What Europe’s excessive
tax burdens on e-commerce can teach us
(State Tax Notes)
George Isaacson and Matthew Schaefer provide insight on tax and legal developments
in the area of electronic commerce.
Finding a cure: Apportionment illness in the
biotech and pharmaceutical industries (State
Tax Notes)
Kenny Gast explores the state tax problems
caused by upfront, milestone, and royalty
payments, and attempts to provide a general
overview of the sales factor apportionment
issues taxpayers face in the biotech and pharmaceutical industries.
Goodwill hunting . . . without a license:
Proposed section 367 regulations openly defy
legislative intent (Tax Notes)
Ken Brewer questions the validity of proposed regulations that would eliminate the
favorable tax treatment of goodwill and going concern value in outbound transfers.
Friends don’t let corporations pay tax (Tax
Notes)
Jasper L. Cummings, Jr., examines the many
ways that corporations with related entities
can avoid gain recognition, highlighting
how the related party section 1031 can be
used in cross-border transactions.
Belgium’s new CFC rule: The ‘Cayman tax’
(Tax Notes International)
Giovanni Smet and Virginie Derouck discuss
Belgium’s new Cayman tax, a controlled
foreign corporation provision that allows
Belgian authorities to look through lowtaxed offshore structures to tax Belgian resident founders and beneficiaries of the
structure’s income.
Do China’s revisions to Circular 2 localize
BEPS actions? (Tax Notes International)
Yansheng Zhu discusses China’s revisions to
Circular 2, asking whether the changes reflect China’s localization of the OECD’s base
erosion and profit-shifting actions or simply
summarize the country’s own antiavoidance
practice.
TAX NOTES, November 2, 2015
705
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be deserved, but abandoning this tax benefit seems
illogical.14 The partnership is appealing to investors
because the entity is not encumbered by the corporate tax, but a substantial part of the income must
be distributed because the investors must pay the
tax on the income whether or not it is distributed.
Investors should not anticipate tremendous growth
from business expansion when the only funds available exist because some expenses (primarily depreciation and amortization) do not require the use of
cash. If an influential investor, such as KMI, is
ambitious and not willing to settle for meager
growth, the partnership is not an appropriate investment vehicle. It is inefficient to subject the
business to a corporate tax if it is not required to do
so. Why not preserve the business’s steady flow of
income available for distribution and keep it outside the realm of corporate taxation? And why not
save the corporate form for investors who are not
enamored with the cash flow from their investments and are willing to accept capital gains in the
future?
KMP was in the business of owning and operating pipelines, regulated by the Federal Energy
Regulatory Commission, much the same as the
public utilities, who must have envied KMP for its
exemption from the corporate income tax. Converting these partnerships to a corporation was a mismatch of the attributes of the tax system and the
financial markets. If legitimate business considerations indicate that incorporation is warranted despite the significant additional tax burden, that
suggests that the business eligible for tax exemption
should be owned by those who can take advantage
of what the tax law offers.
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tax notes™
Investment Assets in
Corporate Separations
By Stanley Barsky
Stanley Barsky is a partner with Fox Rothschild LLP
in New York.
In this article, Barsky analyzes the concerns expressed
in Notice 2015-59 regarding
investment assets in section
355 distributions.
Stanley Barsky
A. Introduction
The recently issued Notice 2015-59 expresses
significant concerns with the application of section
355 to certain corporate separations, including
transactions that result in distributing corporation
(Distributing) or distributed corporation (Controlled) having large amounts of investment assets.1
The notice suggests that those transactions may run
afoul of section 355 and circumvent the purposes of
General Utilities repeal.
This article focuses on corporate separations that
result in Distributing or Controlled owning a sub-
1
Notice 2015-59, 2015-40 IRB 467, discusses a grab bag of
corporate separation variants, including (1) transactions that
result in Distributing or Controlled owning a substantial
amount of investment assets in relation to the value of all its
assets and the assets of its trades or businesses used to satisfy
the section 355(b) active conduct of a trade or business requirement; (2) transactions that result in Distributing or Controlled
having a significantly higher ratio of investment assets to
non-investment assets than the other corporation; (3) transactions in which Distributing or Controlled owns a small amount
of assets used to satisfy the section 355(b) active conduct of a
trade or business requirement compared to its other assets; (4)
intragroup corporate separations; and (5) certain corporate
separations involving regulated investment companies or real
estate investment trusts. Rev. Proc. 2015-43, 2015-40 IRB 459,
issued concurrently with Notice 2015-59, adds certain section
355 distributions to the list of transactions on which the IRS will
not issue private rulings. For a discussion of an IRS official’s
comments on the guidance, see Amy S. Elliott, ‘‘IRS Official
Gives Direct Answers to No-Rule Guidance Questions,’’ Tax
Notes, Oct. 5, 2015, p. 25.
stantial amount of investment assets, for example,
in relation to the value of all of their assets and the
gross assets of the trades or businesses used to
satisfy the section 355(b) active conduct of a trade or
business requirement. While the IRS’s concern with
investment assets is understandable, corporate
separations are incredibly complicated transactions,
and the IRS should dismiss the idea of using
arbitrary formulas to determine whether nonrecognition treatment should be disallowed. Instead the
IRS should analyze all facts and circumstances to
determine whether investment assets prevent a
corporate separation from satisfying the business
purpose requirement or the device requirement.
Specific factors that can be helpful with the factsand-circumstances analysis are discussed below.
Also, the IRS’s focus on General Utilities’ repeal
misses the mark.
B. Background
Section 355 generally provides nonrecognition
treatment for Distributing and its shareholders in
connection with certain distributions of stock of
Controlled by Distributing.2 The following is a brief
summary of the relevant requirements under section 355.
1. Active trade or business. Section 355(b) requires
that each of Distributing and Controlled (or their
respective groups) must have been engaged in an
active conduct of a trade or business for five years
before the distribution and must be so engaged
immediately after the distribution.
‘‘Trade or business’’ refers to a group of activities,
carried on for the purpose of earning income or
profit, that (1) include every operation that forms a
part of, or a step in, the process of earning income
or profit, and (2) ordinarily include the collection of
income and the payment of expenses.3
2
Basic section 355 distribution variants include (i) a pro rata
distribution of controlled stock among all Distributing shareholders, and (ii) a non-pro-rata exchange of Controlled stock for
Distributing stock, with only some of Distributing shareholders
participating. See section 355(a)(2).
3
See reg. section 1.355-3(b)(2)(ii).
TAX NOTES, November 2, 2015
707
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VIEWPOINT
COMMENTARY / VIEWPOINT
4
See reg. section 1.355-3(b)(2)(iii). There are special rules for
satisfying the active conduct of a trade or business requirement
when business is conducted through an entity taxed as a
partnership.
5
See Rev. Rul. 73-44, 1973-1 C.B. 182, clarified by Rev. Rul.
76-54, 1976-1 C.B. 96. See also Robert W. Willens, ‘‘Dispelling
Cash-Rich Split-Off Myths,’’ Tax Notes, Apr. 23, 2012, p. 503.
6
See reg. section 1.355-2(b)(1). The regulations explain that
the principal reason for this requirement is to ensure that the
distribution is incident to readjustments of corporate structures
required by business exigencies and affects only readjustments
of continuing interests in property under modified corporate
forms.
7
See reg. section 1.355-2(b)(2).
8
Id.
9
See Rev. Proc. 96-30, 1996-1 C.B. 696, Appendix A. The IRS
stopped ruling on whether a distribution satisfies the business
purpose requirement in 2003. See Rev. Proc. 2003-48, 2003-2 C.B.
86.
10
Cf. Thomas F. Wessel et al., ‘‘Corporate Distributions Under
Section 355’’ in Tax Strategies for Corporate Acquisitions, Dispositions, Spin-Offs, Joint Ventures Financings, Reorganizations & Restructurings VI.C (2012).
of stock of Distributing or Controlled, and the
retention of the stock of the other corporation.11
Whether the device requirement is satisfied is determined based on all facts and circumstances,
including specific factors outlined in the Treasury
regulations.12
Device factors include (1) the distribution is
substantially pro rata among Distributing’s shareholders, (2) sale or exchange of stock of Distributing
or Controlled after the distribution, and (3) nature
and use of assets, which takes into account (A) the
existence of assets that are not used in a trade or
business that satisfies the active conduct of a trade
or business requirement and (B) whether the principal function of Distributing or Controlled is to
serve the business of the other corporation for a
significant period of time after the separation and, if
so, whether that supporting business can be sold
without adversely affecting the business of the
corporation it supports.13
Non-device factors include (1) the corporate
business purpose for the transaction; (2) that Distributing is publicly traded and widely held, with
no shareholders who own, directly or indirectly,
more than 5 percent of any class of stock; and (3)
that Distributing’s shareholders are domestic corporations that would qualify for a dividends received
deduction that is greater than the standard section
243(a)(1) deduction.14 Also, the Treasury regulations
provide the following guidelines for weighing the
strength of corporate business purposes as nondevice factors: (1) the importance of achieving the
purpose to the success of the business; (2) the extent
to which the transaction is prompted by outside
factors beyond the control of Distributing; and (3)
the immediacy of the conditions prompting the
transaction.15
Also, some transactions are ordinarily not considered as a device, including (1) distributions
involving Distributing and Controlled that have no
current or accumulated E&P, and (2) distributions
that in the absence of section 355 would qualify
under section 302(a) or section 303(a).16
The IRS has addressed the ‘‘nature and use of
assets’’ device factor’s application to the proportion
of the active trade or business assets to overall
11
See section 355(a)(1)(B); reg. section 1.355-2(d)(1).
See reg. section 1.355-2(d)(1).
13
See reg. section 1.355-2(d)(2).
14
See reg. section 1.355-2(d)(3).
15
See reg. section 1.355-2(d)(3)(ii).
16
See reg. section 1.355-2(d)(5). The split-off exceptions do not
apply to distributions of multiple controlleds that facilitate
avoidance of the dividend provisions of the code through the
subsequent sale or exchange of one Controlled and retention of
another Controlled.
12
708
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Whether the ‘‘active conduct’’ requirement is
satisfied is determined based on all facts and circumstances; in general, active and substantial management and operational functions must be
performed without the use of independent contractors.4
Section 355(b) does not require that the assets
used in the active conduct of a trade or business
constitute any particular percentage of Distributing’s or Controlled’s total assets.5
2. Business purpose. The distribution must be
motivated in whole or in substantial part by one or
more corporate business purposes.6 A corporate
business purpose is a nonfederal tax purpose germane to the business of Distributing (or its affiliated
group) or Controlled; whether there is a valid
business purpose for the distribution is determined
based on all facts and circumstances.7 A shareholder
purpose, such as personal planning, is not a corporate business purpose, although if a shareholder
purpose is coextensive with a corporate business
purpose, the business purpose requirement would
be satisfied.8
Before the IRS stopped issuing private rulings on
whether a transaction satisfies the business purpose
requirement, it published a list of some of the
acceptable business purposes and the factors that
the IRS would use to evaluate those business purposes.9 This list generally continues to be used by
taxpayers and their tax advisers in structuring
section 355 distributions.10
3. Device. The distribution must not be a device for
bailing out corporate earnings and profits; that is, it
must not facilitate avoidance of dividend provisions of the code through the later sale or exchange
COMMENTARY / VIEWPOINT
C. Analysis
Corporate separations are usually incredibly
complicated and labor-intensive.21 The IRS and the
courts already have all the necessary tools at their
disposal to distinguish transactions that should
qualify for nonrecognition treatment from ones that
should not qualify. Business purpose and device
requirements, which are intended to consider all
facts and circumstances, should be rigorously applied to determine whether investment assets prevent a corporate separation from qualifying under
section 355.22 A resource-conscious attempt by the
IRS to replace the business purpose and device
requirements with arbitrary investment asset formulas would be inappropriate because that would
almost certainly result in denial of nonrecognition
treatment to some transactions that would otherwise qualify under section 355. Nor are the purposes of the legislation that repealed General
Utilities appropriate for judging whether a particular investment asset ratio should disqualify a corporate separation from nonrecognition treatment.
1. The business purpose requirement. Notice
2015-59 does not examine the business purpose
requirement in any detail. That is unfortunate because business purpose is the only section 355
requirement aside from device (and section 355(g))
that is suited for analyzing whether a corporate
separation results in an impermissible allocation of
investment assets between Distributing and Controlled.23
17
See Rev. Rul. 73-44, 1973-1 C.B. 185, clarified by Rev. Rul.
76-54, 1976-1 C.B. 96. Although the rulings predate the current
Treasury regulations, the device test in effect when the rulings
were issued contained a ‘‘nature and use of assets’’ factor that
considered whether substantially all of Distributing’s and Controlled’s assets were used in the active conduct of a trade or
business. See reg. section 1.355-2(b)(3).
18
See Rev. Rul. 73-44, supra note 17.
19
The Tax Reform Act of 1986, inter alia, generally repealed
the General Utilities doctrine and significantly expanded
corporate-level tax on distributions of appreciated property. See,
e.g., section 311(b).
20
See H.R. Rep. No. 100-391 (II) WL 61524, at 2313-699 (1987).
This report described the purpose of section 337(d) in the
context of proposing technical amendments to section 337(d)
that were ultimately enacted in 1988.
For an in-depth discussion of the legislative history of
section 337(d) and an early proposal for Treasury regulations to
be issued under section 337(d), see New York State Bar Association Tax Section, ‘‘Report on Proposals for Treasury Regulations Under Section 337(d) Relating to Section 355
Distributions’’ (Dec. 7, 1989).
21
Rarely, if ever, is Controlled’s business neatly siloed and
ready for independence without advance planning. While tax
considerations require significant attention, usually vastly more
resources are devoted to various other operational and legal
issues, including (but by no means limited to): Recruiting
Controlled’s entire board of directors and entire C-suite; making
all other personnel decisions, with careful attention paid to
everything from staffing needs to compensation to employee
morale; negotiating various contracts that cover everything
from financing to transition services; in the case of publicly
traded companies, preparing disclosure statements; and, in the
case of companies in regulated industries, addressing the regulators’ concerns.
22
The investment assets that concern the IRS are the ones
described in section 355(g)(2)(B), as modified by Rev. Proc.
2015-3, 2015-1 IRB 129, section 5.01(26). See Notice 2015-59.
Those investment assets do not include any assets held for use
in the active and regular conduct of (1) a lending or finance
business, (2) a banking business, or (3) an insurance business.
See section 355(g)(2)(B)(ii).
23
As Notice 2015-59 observes, section 355(g) provides brightline rules for denying nonrecognition treatment to certain
(Footnote continued on next page.)
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acquire stock representing a 50 percent or greater
interest in Distributing or Controlled. In general, an
acquisition can be tainted regardless of whether it
occurs before or after the distribution or whether it
is taxable or tax-free.
assets in Rev. Rul. 73-44.17 The IRS concluded that a
spinoff qualified for nonrecognition when (1) less
than half of Controlled’s assets were used in the
active conduct of a trade or business, (2) stock of
Distributing was widely held and publicly traded,
(3) investment assets were not involved, (4) the
distribution was compelled by valid business purposes, and (5) Controlled’s assets represented operating businesses.18
4. Sections 337(d), 355(d), and 355(e). Section 337(d)
authorizes Treasury to promulgate regulations that
may be necessary to ensure that the purposes of the
Tax Reform Act of 1986 are not circumvented.19 The
legislative history of section 337(d) provides that
the purposes to be protected by the regulations
include ‘‘clarification that a current corporate level
tax is to be paid when an appreciated subsidiary or
other property is effectively disposed of outside of
the group, and a reiteration that acquirers of a
corporation should not be favored over the original
owners in the tax consequences of a sale of subsidiaries or other assets of that corporation.’’20
Section 355(d) disallows tax-free treatment to
Distributing (but not to Distributing’s shareholders)
if a distribution otherwise qualifies under section
355 and if immediately after the distribution at least
50 percent of Distributing or Controlled is held by a
person who acquired such Distributing stock (or
Distributing stock for which it received such Controlled stock) by purchase within five years before
the distribution.
Section 355(e) disallows tax-free treatment to
Distributing (but not to Distributing’s shareholders)
if a distribution that otherwise qualifies under
section 355 is part of a plan or series of related
transactions under which one or more persons
COMMENTARY / VIEWPOINT
Second, the IRS should inquire whether the business purpose for the separation explains the allocation of investment assets between Distributing and
Controlled. For example, some separations are undertaken to achieve business purposes that require
a significant amount of liquid assets. In the private
ruling context, the IRS previously accepted at least
two business purposes that were consistent with a
high proportion of investment assets. Those business purposes were (1) borrowing and (2) facilitating an acquisition by Distributing or Controlled.26
In both cases it would be expected that immediately
or shortly after the distribution, Distributing or
distributions involving investment assets, but its scope is too
narrow to address the IRS’s concerns with allocations of investment assets in a wide variety of transactions.
24
See T.D. 8238.
25
See Rafferty v. Commissioner, 452 F.2d 767 (1st Cir. 1971)
(expressing concern over the ‘‘somewhat uncritical nature’’ of
the Tax Court’s finding of business purpose); Commissioner v.
Wilson, 353 F.2d 184 (9th Cir. 1965) (noting the Tax Court’s
finding that the asserted business purposes were not bona fide;
concluding that absence of a tax avoidance motive is not
sufficient to satisfy the business purpose requirement).
26
Regarding borrowing, taxpayers had to demonstrate that
(i) Distributing or Controlled needed to raise a substantial
amount of capital quickly for business needs; (ii) the separation
would enable Distributing or Controlled to borrow significantly
more money or borrow on significantly better nonfinancial
terms; (iii) the funds raised in the borrowing would, under all
circumstances, be used for the business needs of Distributing or
Controlled; and (iv) the borrowing would be completed within
one year after the distribution. See Rev. Proc. 96-30, Appendix A,
section 2.03.
Regarding facilitating an acquisition by Distributing or Controlled, taxpayers had to demonstrate that (i) the combination of
the target corporation with Distributing or Controlled would
not be undertaken unless Distributing and Controlled are
separated; (ii) the acquisition could be accomplished by an
alternative nontaxable transaction that would not involve the
distribution of Controlled stock and was neither impractical nor
unduly expensive; (iii) the target corporation was not related to
Distributing or Controlled; and (iv) the acquisition would be
completed, generally within one year of the distribution. Rev.
Proc. 96-30, Appendix A, section 2.08.
Controlled would have a significant amount of
investment assets. The factors used by Rev. Proc.
96-30 to establish those business purposes could be
used to help identify whether there is a business
need for the high proportion of investment assets.
2. The device requirement. Notice 2015-59 observes
that an investment asset allocation may cause a
corporate separation to fail the device requirement
and asks whether some non-device factors, that is,
public trading and non-pro-rata structure of a distribution, are sufficient to overcome some disproportionate allocations of investment assets between
Distributing and Controlled. The IRS is correct that
it is inappropriate to view those non-device factors
as providing carte blanche for taxpayers regarding
allocating investment assets between Distributing
and Controlled.27 However, it would be just as
inappropriate for the IRS to deny nonrecognition
treatment based on arbitrary investment asset apportionment formulas because corporate separations (especially involving publicly traded
companies) are very complicated and each one
should be analyzed on the basis of its own specific
facts.
The IRS’s device analysis should focus on
whether the investment asset allocation is consistent with the needs of Distributing’s and Controlled’s businesses. Some businesses (in addition to
the financial trades or businesses contemplated by
section 355(g)(2)(B)(ii)) require high amounts of
liquidity. In that context, investment assets should
not be treated with the suspicion evident in Notice
2015-59. For example, high liquidity is required for
businesses that do not have a steady revenue stream
over the course of a year, especially if they have
high operating costs. Those businesses require a
significant amount of investment assets in order to
survive the lean periods, especially during uncertain economic times. Also, businesses with high
research and development costs require high liquidity, especially if they don’t (yet) generate substantial
revenues.
Also, where applicable, the IRS could ask
whether the proposed allocation of investment assets between Distributing and Controlled is consistent with the historic allocation of investment assets
between the businesses that would be operated by
Distributing and Controlled. There is precedent for
this type of inquiry: The IRS used to review historic
27
Although split-offs are ‘‘ordinarily’’ considered not to
constitute device, the rule has two limitations. First, it is a
stretch to read ‘‘ordinarily’’ as ‘‘always.’’ Second, in the context
of a publicly traded Distributing, it is often impossible to predict
with certainty whether the split-off will be fully subscribed,
which raises the possibility of a cleanup spinoff.
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There are two ways in which the IRS can use the
business purpose requirement in evaluating the
nature of the assets. First, the IRS should confirm
the existence of a corporate business purpose for
the distribution. As stated in the preamble to reg.
section 1.355-2, ‘‘a transaction that is not carried out
for a corporate business purpose should not qualify
under section 355, even if it was not used principally as a device for the distribution of earnings and
profits.’’24 The court decisions also encourage a
critical examination of the business purpose for the
separation.25 The IRS could use the business purpose guidance in Rev. Proc. 96-30, Appendix A to
confirm the existence of a corporate business purpose for the distribution.
COMMENTARY / VIEWPOINT
frustrated does not turn on the amount of investment assets. For example, if Distributing has low
tax basis in Controlled stock, the distribution has
the potential of frustrating the purposes of the
General Utilities repeal legislation even if Controlled
has only insignificant amounts of investment assets.
By contrast, if Distributing’s tax basis in Controlled
stock immediately before the distribution is approximately equal to the value of that stock, the
distribution would not frustrate the purpose of the
General Utilities repeal legislation even if Controlled
has many investment assets because Distributing
would not recognize any gain on the distribution
even if it were taxable. Also, the concerns evinced
by section 337(d) are arguably already addressed in
the section 355 context by section 355(d) and (e),
which deny nonrecognition treatment to Distributing if outsiders end up with Controlled stock.30
28
See Elliott, ‘‘IRS Rethinking Repayments of Distributed
Debt in Spinoffs,’’ Tax Notes, Oct. 10, 2011, p. 144.
29
See H.R. Rep. 100-391 (II) WL 61524, at 2313-699 (1987). See
also supra note 20.
30
Cf. supra note 10, at V.E.5 (observing that after the enactment of section 355(d) and (e) ‘‘it would seem . . . unlikely that
any regulations under section 337(d) limiting the availability of
section 355 will be promulgated’’).
D. Conclusion
Section 355 can provide opportunities for the
bailout of corporate E&P, and it is understandable
that policing of corporate separations has led the
IRS to focus on investment assets. Unfortunately for
the IRS and taxpayers alike, corporate separations
are simply too varied and complicated to be susceptible to shortcut formulaic evaluations of investment asset apportionment. The factors discussed
herein can aid with a facts-and-circumstances
analysis of investment assets in the context of
corporate separations intended to qualify under
section 355.
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debt levels for purposes of determining whether a
distribution of debt securities qualified for nonrecognition treatment under section 361(c) in the context of an otherwise tax-free corporate separation.28
Finally, in evaluating the investment asset allocation between Distributing and Controlled, it is
important to consider that there is no general section 355 rule that would prevent corporations with
high investment assets from effecting a tax-free
corporate separation. In other words, Distributing’s
aggregate investment assets must be allocated between Distributing and Controlled, and thus the
IRS should take into account the total amount of
Distributing’s pre-distribution investment assets in
evaluating whether an allocation of investment
assets is consistent with the business purpose for
the distribution and with the needs of Distributing’s
and Controlled’s businesses.
3. Purposes of the General Utilities repeal legislation. The purposes behind the General Utilities repeal legislation cannot and should not be read to
address corporate separations that involve corporations with arguably excessive investment assets.
The legislative history of the General Utilities repeal
legislation shows that Congress was concerned
with ensuring that (1) current corporate-level tax
would be paid when, inter alia, an appreciated
subsidiary was distributed outside of the group,
and (2) acquirers of a corporation would not receive
nonrecognition treatment on the sale of that corporation’s subsidiaries.29 Whether those purposes are
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tax notes™
Increasing Student Loans and
Rising Tuition: The Latest Research
By Mark J. Warshawsky
Mark J. Warshawsky was formerly Treasury
assistant secretary for economic policy and is now a
senior research fellow at the Mercatus Center at
George Mason University.
In this article, Warshawsky discusses a study by
a group of economists who examined the causal
relationship between tuition increases and expansions in federal student aid programs.
Introduction and Summary
The rising cost of higher education has gotten
more political attention recently. Some presidential
candidates and the Obama administration have
proposed significantly increasing federal funding to
students. This would be on top of already substantial federal support given to the higher education
sector through tax policy,1 direct student subsidies,
and the allocation of credit (subsidized and unsubsidized student loans).
Yet the policy consequences of this flood of
money to higher education have been less considered. Does it increase student enrollment and degree attainment, or is it simply a transfer of
resources from taxpayers to students (and their
parents) who would have paid tuition and attended
college anyway? If college attendance and completion rates increase, does that lead to better paying
jobs for the students and improved productivity for
the economy, or is it just a waste of the potentially
vibrant time in young people’s lives when they
could have been working and learning skills on the
job? Perhaps the most immediate concern at the
lowest rung of the policy and political ladder is
whether this large flow of resources is a net benefit
to students (or their parents) that reduces their
out-of-pocket spending on higher education. Or do
colleges and universities just raise tuition and fees
to sop up the increase in federal resources coming
through student grants and loans, perhaps moving
1
Mark J. Warshawsky, ‘‘Federal Tax Expenditures for Higher
Education,’’ Tax Notes, Oct. 20, 2014, p. 327.
that money to increase administrators’ and faculty
salaries, decrease their educational work effort, or
reduce the institutional effort to obtain other
sources of external funds.
That question was addressed by a comprehensive and carefully designed staff working paper,
released by the Federal Reserve Bank of New York
this summer. Economists from the New York Fed,
David O. Lucca and Karen Shen, and Brigham
Young University professor Taylor Nadauld examined the causal relationship between expansions in
federal student aid programs and tuition increases.2
Solving the simultaneity problem of not knowing
whether cost pressures lead to increased borrowing
or increased loan supply leads to higher tuition, the
authors exploit detailed student-level financial data
and changes in federal student aid programs to
identify how increased student loan financing affects tuition. Lucca, Nadauld, and Shen found that
higher education institutions that are more exposed
to changes in the subsidized federal loan program
increased their tuition disproportionately, with a
significant passthrough effect on tuition of about 65
percent. The effect is most pronounced for expensive, private institutions that are somewhat, but not
the most, selective in admissions. That is a concerning result for the efficacy and fair distribution of
federal higher education spending and allocation of
resources, at an initial level of impact, without even
addressing the longer-term consequences on enrollment and economic improvement.
Background and Method
Noting similarities to the expansion of housing
credit availability and the housing boom in the
mid-2000s, Lucca, Nadauld, and Shen begin their
study by reviewing the statistics on student loans
and tuition in the last decade. They note that yearly
student loan originations grew from $53 billion to
$120 billion between 2001 and 2012, with about 90
percent in recent years coming through federal
student aid programs. The increases were particularly large between 2008 and 2010. Average sticker
tuition rose 46 percent in real terms from 2001 to
2012, from about $7,000 to more than $10,000, or at
2
Lucca, Shen, and Nadauld, ‘‘Credit Supply and the Rise in
College Tuition: Evidence From the Expansion in Federal Student Aid Programs,’’ Staff Report Number 733 (July 2015).
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POLICY PERSPECTIVE
COMMENTARY / POLICY PERSPECTIVE
Basic Results of the Study
In three separate first stage regressions for yearly
changes in subsidized loans, unsubsidized loans,
and Pell grants, Lucca, Nadauld, and Shen found
that the effect of the cap increases is to raise
dollar-for-dollar the amount of loans or grants
disbursed to the students exposed to a policy cap
change. This extremely high elasticity is not surprising for grants, but loans, even if subsidized, presumably must be eventually repaid, so it is more
surprising there. The high elasticity is confirmed by
other data on household borrowing — looking at
the distribution of student loan origination
amounts, there was a noticeable shift in the mass
points of the loan distribution from the old caps to
the new ones. The Pell grant instrument enters each
loan regression with a negative sign, implying that
the greater availability of Pell grants displaces these
other forms of aid, likely because of lower demand
or reduced eligibility.
In the second stage, with controls for all forms of
aid, the authors found that each additional Pell
grant dollar to an institution leads to about a
55-cent increase in sticker price tuition. For subsidized loans, they a found a somewhat larger
passthrough effect of 70 percent, and for unsubsidized loans, the loading of tuition is about 30
percent. Those results, which are identified through
cross-sectional exposures to the changes in student
federal aid programs between 2007 and 2010 and
contain numerous controls for other effects, support
the hypothesis that increases in federal support for
higher education lead to increases in tuition and not
the other way around. The finding for subsidized
loans is quite strong across different regression
specifications in both magnitude and statistical significance.
Other Results of the Study
To address the potential criticism that sticker
tuition is paid by relatively few and it is tuition net
of institutional grants that matters, Lucca, Nadauld,
and Shen show that in the medium run, changes in
sticker prices are largely reflected in the net tuition
of all students, although the changes are somewhat
smaller for those who receive high amounts of
institutional grants. That result is consistent with
other studies that find that institutions alter institutional grants (scholarships) as a means of capturing
the federal aid provided through the Pell grant
program. The authors also found that the
passthrough of subsidized loan aid to tuition is
highest among relatively expensive, mostly private,
four-year institutions with relatively high-income
students but with average selectivity, as measured
by their admittance rates. It could be that the tuition
rates of the most academically elite institutions are
influenced more by the investment performance of
their endowments or have significant extra demand
coming from wealthy foreign students and that
tuition rates at public institutions are at least partially determined by political considerations.
Finally, using the same instrument, the authors
examine whether in the short-run student aid expansion increased access to higher education, looking for differential growth in enrollments around
the policy changes. They found an effect only for
changes in Pell grant availability, which makes
some sense, given that Pell grants are only given to
low-income students who may be on the margin of
attending college.
Conclusion
It is my sense that the political system has reacted
to the obvious problems of rapidly increasing college costs and rapidly increasing student loan balances held by young workers by proposing and
actually throwing more money and resources at the
problems without pausing to consider interactions
and untoward results. Indeed, the evidence presented by the Lucca, Nadauld, and Shen study is
714
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an annual average rate of increase, again after
removing general price inflation, of about 3.5 percent.
Lucca, Nadauld, and Shen then proposed a solution to the key identification challenge in determining the causal relationship between these two
trends. Borrowing from standard econometric techniques in studies of the labor market, they use
changes in the maximum disbursable amounts of
per-student aid in subsidized and unsubsidized
student loan programs and Pell grants, legislated
between 2006 and 2008 and put into effect between
the 2007-2008 and 2010-2011 school years. The authors also use a data set containing student-level
funding and family income information for a representative sample of higher education institutions.
They note that some institutions had many more
students who would be able to take advantage of
the increases in student loans and grants because of
variation in eligibility and participation. They use
this pre-policy, cross-sectional variation to construct
an instrument for student loan credit by interacting
the shift in federal aid supply and the exposure of
an institution to each shift, as measured by the ex
ante fraction of students borrowing at a particular
policy cap. They estimate in a first stage the impact
of the federal policy changes on the amounts of
loans and grants given to students. Then in a
second stage, with suitable controls for time trends
and fixed institutional-level effects and other variables, the authors relate the yearly change in each
institution’s sticker tuition to the instrumented
yearly change in each institution’s per-student federal aid.
COMMENTARY / POLICY PERSPECTIVE
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that increasing loan and grant programs has largely
resulted in corresponding tuition increases, with
little net benefit to students and seemingly small
increases in enrollment. Policymakers should be
clear on their policy goals, for example, reducing
the cost of higher education to those who would not
enroll otherwise and who enroll in economically
valuable educational and job training programs.
They should then carefully design programs that
specifically support those goals. There is every
prospect that those goals can be accomplished
through tailored programs at much lower fiscal cost
to the federal government than the myriad and
massive current and proposed programs, with little
net loss incurred by college students and perhaps
with improved efficiency in the higher education
sector.
108th Annual
Conference on Taxation
Boston Park Plaza, Nov. 19-21, 2015
The National Tax Association’s Annual
Conference on Taxation comes to
Boston for the largest program in its
history: 80 sessions with nearly 300
presentations covering a wide range
of topics in the economic, accounting, and legal aspects of taxation
and related Àelds.
Includes keynote speeches by Martin Feldstein and James Poterba, as
well as a special plenary session on
the use of administrative tax data.
Join NTA President, Alan Auerbach,
and the leading Àgures in tax
research for this annual tradition.
For further information
Contact: Charmaine Wright
E-mail: natltax@aol.com
Or visit us at:
www.ntanet.org
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tax notes™
How Would Cardin’s VAT Affect
Social Security Recipients?
By Alan D. Viard
Alan D. Viard is a resident scholar at the American
Enterprise Institute. He
thanks Alex Brill and Adele
Hunter for their helpful
comments. Viard is solely responsible for any errors.
In this article, Viard discusses how the VAT proposed by Senate Finance
Alan D. Viard
Committee member Benjamin L. Cardin, D-Md., would affect Social Security
recipients. The program’s automatic cost of living
adjustment ensures that the VAT would have little
impact on real benefits for current retirees. However, the VAT would reduce future recipients’ real
benefits because it would reduce real wages, which
are used to compute Social Security benefits. Viard
recommends that VAT proposals include provisions
to prevent unintended interactions with the Social
Security program.
Copyright 2015 Alan D. Viard.
All rights reserved.
On December 11, 2014, Senate Finance Committee member Benjamin L. Cardin, D-Md., introduced
S. 3005, the Progressive Consumption Tax Act of
2014, which calls for the adoption of a 10 percent
VAT.1 The adoption of a VAT would have farreaching effects on the economy, including the
Social Security program.
In a recent Tax Notes article, Blaise Sonnier and
Nancy Nichols discuss the impact of the proposed
VAT on Social Security recipients and other groups.2
Unfortunately, an important part of their analysis of
the VAT’s impact on Social Security recipients is
incorrect. Their assertion that the tax would reduce
current retirees’ real benefits by 10 percent is invalid
1
William R. Davis, ‘‘Cardin Releases Progressive Consumption Tax Bill,’’ Tax Notes, Dec. 15, 2014, p. 1216.
2
Blaise M. Sonnier and Nancy B. Nichols, ‘‘The Progressive
Consumption Tax’s Impact on Low-Income Taxpayers,’’ Tax
Notes, July 27, 2015, p. 431.
because the program’s automatic cost of living
adjustment would compensate the retirees for any
price increase caused by the VAT.
Sonnier and Nichols’ analysis is closer to the
mark for future recipients, however, as the proposed VAT would reduce their real benefits by 9.09
percent. The benefit reduction would occur through
the VAT’s effect on real wages, which play a crucial
role in the formula determining recipients’ real
benefits. Examination of the Social Security benefit
formula reveals that a VAT has significantly more
adverse effects on recipients who turn 60 in the year
in which the tax is introduced than on those who
turn 60 in the preceding year.3 To prevent that
unwarranted disparity and other unintended interactions with the Social Security program, the adoption of a VAT should be accompanied by
appropriate revisions to the Social Security tax and
benefit structure.
Cardin’s Proposed VAT
Cardin’s bill would impose a comprehensive
VAT while lowering other taxes. The bill would
provide a large exemption from individual income
taxes, reduce individual and corporate income tax
rates, and offer rebates to some low-income households.4
The bill would set the VAT rate at 10 percent on
a tax-exclusive basis.5 If the consumer price of an
item was $100, the VAT liability would be $9.09, and
the price excluding tax would be $90.91, so that the
tax would equal 10 percent of the price excluding
tax. The 10 percent tax-exclusive rate would be
3
This analysis draws on Alan D. Viard, ‘‘Responding to VAT:
Concurrent Tax and Social Security Reforms,’’ in The VAT Reader:
What a Federal Consumption Tax Would Mean for America 127-128
(Tax Analysts 2011); and Robert Carroll and Viard, Progressive
Consumption Taxation: The X Tax Revisited 166-170 (2012). See also
Eric Toder et al., ‘‘Methodology for Distributing a VAT,’’ UrbanBrookings Tax Policy Center, Apr. 2011, at 11, 20, 23 (discussing
the impact of a VAT on Social Security benefits).
4
Previous analyses of the bill include Davis, ‘‘Cardin’s VAT
Bill: Driving Debate or Another Back-Seat Attempt?’’ Tax Notes,
Jan. 19, 2015, p. 329; Davis, ‘‘Cardin Addresses Consumption
Tax as Part of Reform,’’ Tax Notes, Mar. 23, 2015, p. 1451; and
Harry L. Gutman, ‘‘Cardin’s Key to the Tax Kingdom: Where Is
the Business Community?’’ Tax Notes, Apr. 20, 2015, p. 341.
5
The bill’s proposed new section 3901(b)(1) would impose a
10 percent tax on value added, and proposed new section
3902(a)(2) would exclude the tax from the base on which the tax
is imposed.
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ON THE MARGIN
COMMENTARY / ON THE MARGIN
6
This analysis draws on Viard, ‘‘Tax Increases and the Price
Level,’’ Tax Notes, Jan. 6, 2014, p. 115.
7
For further discussion of the possible accommodation of
various taxes, see Viard, supra note 6, at 120-122.
718
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VAT’s Effect on Prices and Wages
It is generally believed that the adoption of a VAT
would automatically increase the consumer price
level. In reality, a price increase would not be
automatic because the price level depends on the
Federal Reserve’s monetary policy. Nevertheless, a
price increase would likely occur because of the
Fed’s probable response to the VAT.6 The introduction of a VAT reduces the real wages that employers
pay to workers, and the Fed would likely increase
the consumer price level to avoid the need for an
economically disruptive decline in nominal wages.
Consider a worker whose labor has a marginal
product of 100 apples. With competitive markets
and no taxes, the worker is paid a wage equal to the
consumer price of 100 apples; if apples sell for $1
each, the wage is $100. Now, suppose that a VAT
with a 10 percent tax-exclusive rate is introduced.
Also, assume that there is no immediate change in
the supply of labor and capital, so that the worker’s
marginal product remains unchanged.
What happens if the Federal Reserve’s monetary
policy keeps the tax-inclusive consumer price of
apples unchanged at $1? Then, the employer clears
only 90.91 cents for each apple sold, with the other
9.09 cents paid in VAT. Because the 100 apples have
an after-tax value of only $90.91 to the employer, the
market-clearing wage falls to $90.91, a 9.09 percent
decline.
Although nominal wages could easily decline by
9.09 percent in the frictionless economies sometimes
assumed in economics textbooks, it is difficult to
reduce nominal wages in the actual economy. With
downward rigidity of nominal wages, the adoption
of a VAT would pose a monetary policy challenge. If
the Federal Reserve kept the consumer price of
apples at $1 and the worker’s nominal wage remained fixed at $100 rather than falling to the
$90.91 market-clearing level, significant job losses
would occur. To continue paying the $100 wage
while also paying the 10 percent VAT, the employer
would cut back on hiring until the marginal product
of labor rose to 110 apples. If the marginal worker
produced 110 apples, each of which sold for $1, the
employer could pay both the $100 wage and the $10
VAT.
The Federal Reserve could avert the potential job
losses by altering monetary policy to allow the
consumer price of apples to rise to $1.10. Because
the market-clearing nominal wage would then be
unchanged at $100, nominal wages would not need
to fall. A monetary policy that increases the consumer price level in response to the introduction of
a tax is commonly referred to as ‘‘accommodation’’
of the tax. The accommodation would cause a
one-time increase in the price level, not an ongoing
increase in the inflation rate.
Regardless of the Federal Reserve’s actions, the
VAT would reduce workers’ market-clearing real
wages by 9.09 percent, from 100 apples to 90.91
apples. If the Fed does not accommodate, marketclearing nominal wages would fall from $100 to
$90.09, and the price of apples would remain unchanged at $1. If it does accommodate, the marketclearing nominal wage would remain unchanged at
$100, and the price of apples would rise from $1 to
$1.10. In either case, the VAT would impose a tax
burden on workers by reducing their real wages.
Taxes do not require monetary accommodation
unless they impose a tax on labor and are collected
from the employer. Only those types of taxes, which
include VATs, retail sales taxes, and employer payroll taxes, reduce the market-clearing value of the
real wage paid by the employer to the worker. For
example, there is no need to accommodate individual income taxes and employee payroll taxes.
Because those taxes are paid by workers out of their
wages and do not reduce the real wage paid by the
employer, prices and nominal wages paid by employers can both remain unchanged. Although
those taxes reduce employees’ nominal after-tax
wages, no monetary policy challenge arises because
nominal after-tax wages, unlike nominal wages
paid by the employer, are not downwardly rigid.
Similarly, there is no need to accommodate the
corporate income tax because, thanks to the deduction for wage costs, it does not tax labor.7 The
individual and corporate income tax reductions in
the Cardin bill would therefore not reduce the
potential need for monetary accommodation of the
VAT.
As explained below, the impact of a VAT on
current and future Social Security recipients is
largely independent of whether the Federal Reserve
accommodates the tax. However, it is important to
equivalent to a 9.09 percent tax-inclusive rate because the $9.09 tax liability would be 9.09 percent of
the price including tax. Sonnier and Nichols appear
to incorrectly treat the proposed VAT as having an
11.11 percent tax-exclusive rate or 10 percent taxinclusive rate.
To understand the impact of a VAT on Social
Security recipients, it is necessary to examine the
VAT’s effects on prices and wages and the effects of
prices and wages on Social Security benefits.
COMMENTARY / ON THE MARGIN
Social Security
Social Security is the federal government’s largest spending program. The program is primarily
funded by a 12.4 percent payroll and selfemployment tax, which applies to wages and selfemployment earnings below a ceiling. The ceiling is
$118,500 in 2015 and is adjusted each year based on
the two-year-lagged change in national average
wages. The program is expected to pay $894 billion
in benefits in 2015: $747 billion in retirement and
survivor benefits and $147 billion in disability benefits.8
I focus on retirement benefits in this article. Two
features of the Social Security benefit rules are
important in the analysis.
First, under 42 U.S.C. section 415(i), recipients
receive a COLA at the beginning of each year. Each
year’s adjustment is based on the average value of
the Consumer Price Index for Urban Wage Earners
and Clerical Workers in July, August, and September of the preceding year.
Second, under 42 U.S.C. section 415(a) and (b),
the starting value of each recipient’s retirement
benefit is based on her past earnings. Changes in
real wages can therefore change real benefits.
Workers may begin drawing retirement benefits
at any age between 62 and 70. Each recipient’s
benefit is equal to her primary insurance amount
(PIA) if she begins drawing benefits in the month in
which she reaches her normal retirement age, which
is 67 for recipients born in and after 1960 but lower
for those born earlier. The recipient’s benefit is
lower than her PIA if she begins drawing benefits
before she reaches her normal retirement age; her
benefit is larger than her PIA if she waits to begin
drawing benefits until after she reaches her normal
retirement age.
Each recipient’s PIA depends on her past indexed
earnings. Earnings are included in the computation
only if they were subject to Social Security payroll
or self-employment tax. Earnings in years before
the year in which the recipient turned 60, which I
refer to as the recipient’s benefit-computation base
year, are adjusted to reflect the change in the
National Average Wage Index (NAWI) between the
year in which the earnings occurred and the base
year. For example, if the NAWI is five times higher
in the base year than in an earlier year, earnings in
8
Social Security Administration Board of Trustees, ‘‘Annual
Report of the Board of Trustees of the Federal Old-Age and
Survivor Insurance and Federal Disability Insurance Trust
Funds,’’ at 42, 45, 47 (July 2015).
the earlier year are multiplied by five. Earnings in
years after the base year are not adjusted.
The recipient’s PIA is based on the average of her
35 highest years of indexed earnings. Recipients
with higher average indexed earnings receive
higher, but less than proportionally higher, annual
benefits. If Smith has double the average indexed
earnings of Jones, Smith receives higher annual
benefits than Jones, but less than double Jones’s
annual benefits.
The introduction of a VAT in 2016 would have
different effects on three groups of Social Security
recipients.9 The first group, whom I call current
retirees, consists of recipients who were born in or
before 1955 and who do not work in or after 2016.
The second group, whom I call near-term retirees,
consists of recipients who were born in or before
1955 and who work in or after 2016. The third
group, whom I call future retirees, consists of recipients born in or after 1956.
Current Retirees
For recipients who were born in or before 1955,
the benefit-computation base year is 2015 or earlier,
before the VAT takes effect. That feature protects
them from the adverse effects experienced by future
retirees.
Initially, suppose that the Federal Reserve does
not accommodate the VAT, so that consumer prices
would not change and nominal wages would fall by
9.09 percent. In this case, the introduction of the
VAT would not change current retirees’ nominal
benefits because all of the earnings used to compute
their benefits would have occurred before the VAT
took effect. Because nominal benefits and prices are
unchanged, real benefits are unchanged.
Alternatively, suppose that the Federal Reserve
accommodates the tax so that consumer prices
would rise 10 percent and nominal wages would
remain unchanged. Because current retirees would
face higher consumer prices when they spend their
benefits, it may seem that they would bear a tax
burden. However, that conclusion overlooks the
annual COLA, which increases their nominal benefits to offset the higher prices. Once the COLA
takes effect, current retirees’ real benefits would be
unaffected by the VAT.
Nevertheless, current retirees’ real benefits
would be temporarily reduced before the COLA
takes effect. Throughout 2016 they would pay 10
percent higher prices while receiving unchanged
nominal benefits, thereby suffering a 9.09 percent
9
For simplicity, I use the January 1, 2016, effective date
proposed in the bill. As Gutman, supra note 4, at 351, observed,
that date is unrealistic. It would be straightforward to modify
the analysis to account for a later effective date.
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understand both possible Fed policies to accurately
determine how recipients would be affected in each
case.
COMMENTARY / ON THE MARGIN
Years
Earnings
1987-2014
2015
2016-2021
$50
$50
$50
NAWI
With VAT
Indexed
Earnings
Earnings
$50
$50
$50
$50
$50
$45.45
$100
$100
decline in real benefits. However, their real benefits
would be unchanged in 2017 and subsequent years.
The COLA that would take effect at the beginning
of 2017 would offset the 10 percent price increase
because it would be based on prices in July, August,
and September 2016.10
In summary, the VAT would have little or no
effect on current retirees. If the Federal Reserve
does not accommodate the VAT, they would suffer
no reduction in real benefits. If the Fed accommodates the VAT, as it is likely to do, they would suffer
a reduction in real benefits during 2016 but not
thereafter.
Near-Term Retirees
Some recipients born in or before 1955 may work
in or after 2016. Recipients born in 1954 and 1955,
who cannot begin drawing benefits until 2016 or
2017, are likely to work for at least a little while in
or after 2016. Some recipients may work for longer
periods, particularly those who wait until age 70 to
claim benefits.11
Starting in 2016 the VAT would reduce real
wages by 9.09 percent for all workers, including
near-term retirees. In addition to bearing a tax
burden from the wage reduction, they may also
experience a reduction in real Social Security benefits.
10
The duration of the real benefit reduction depends on the
month in which the tax takes effect. If the VAT takes effect in
June, the real benefit reduction lasts only seven months because
the COLA at the beginning of the next year would fully offset
the price increase. If the VAT takes effect in October, then the
real benefit reduction would last 16 months. The COLA at the
beginning of the next year would not reflect the higher prices
because it would be based on prices in the three months before
the VAT took effect; recipients would not be compensated for
the price increase until they receive the adjustment at the
beginning of the following year.
11
A recipient can work while drawing benefits, although the
earnings test set forth in 42 U.S.C. section 403 may require the
recipient to defer some or all of her benefits if she works
between age 62 and the normal retirement age. Recipients who
are required to defer benefits are compensated with higher
benefits in later years in the same manner as recipients who
delay claiming benefits. If a recipient works while drawing
benefits, her PIA is recomputed each year and benefits are
increased if the most recent work year is one of her 35 years with
the highest indexed earnings.
NAWI
$100
$100
Indexed
Earnings
$50
$50
$45.45
For example, consider a recipient who was born
in 1955 and therefore has a 2015 benefitcomputation base year. The recipient works from
1987 through 2021 and always earns wages equal to
half of the NAWI. For simplicity, assume that the
NAWI remains constant at $100 if the VAT is not
adopted; the conclusions are similar if the NAWI
rises over time, as it actually does.
The left-hand panel of Table 1 shows the recipient’s earnings history without the VAT. The recipient’s earnings in years before the 2015 base year are
adjusted based on the 2015 NAWI. The 2016-2021
earnings are not adjusted; the NAWI entry for those
years is left blank because it does not affect the
benefit computation. Because indexed earnings are
$50 in every year, the recipient’s average indexed
earnings are $50.
The right-hand panel shows the impact of the
VAT. Because the VAT would be introduced in 2016,
it would not change the recipient’s 1987-2015 earnings or the base-year 2015 value of the NAWI.
Indexed earnings for 1987 through 2015 would
remain equal to $50. However, the VAT would
reduce real earnings in 2016 through 2021 by 9.09
percent, from $50 to $45.45. The reduction in the last
six years of earnings would reduce the recipient’s
35-year average of indexed earnings from $50 to
$49.22, or 1.56 percent.
Because the PIA responds less than proportionally to average indexed earnings, the percentage
reduction in the recipient’s PIA would be smaller
than the 1.56 percent reduction in her average
indexed earnings. The PIA formula has three brackets: 90 percent, 32 percent, and 15 percent. The first
bracket ends when average indexed earnings reach
22.09 percent of the base-period NAWI, and the
second bracket ends when average indexed earnings reach 133.14 percent of the base-period NAWI.
Without the VAT, the recipient’s average indexed
earnings of $50 would yield a PIA of $28.81 (90
percent of the first $22.09 plus 32 percent of the
remaining $27.91). With the VAT, the recipient’s
average indexed earnings of $49.22 would yield a
PIA of $28.56 (90 percent of the first $22.09 plus 32
percent of the remaining $27.13). The recipient’s
PIA, and her benefits, would fall by 0.87 percent.
The actual impact on various near-term retirees
may be smaller or larger than the impact shown in
the example. The impact would be smaller if the
720
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Table 1. Effect of VAT on Near-Term Retiree
Without VAT
COMMENTARY / ON THE MARGIN
Years
1988-2015
2016
2017-2022
Earnings
$50
$50
$50
NAWI
With VAT
Indexed
Earnings
Earnings
$50
$50
$50
$50
$45.45
$45.45
$100
$100
recipient works for only a couple years after 2015.
There would be no impact if the recipient’s post2015 earnings are not among her 35 highest years of
indexed earnings, as may be true if the recipient
transitions to part-time work after a long career of
full-time work. On the other hand, the impact
would be larger if the recipient works to an advanced age and has many years of earnings after
2015.
Because the change in real benefits is caused by
changes in real earnings, it makes no difference
whether the decline in real earnings is caused by a
decline in nominal wages (which would occur if the
Federal Reserve does not accommodate) or a price
increase (which would occur if the Fed accommodates).
Future Retirees
The VAT would have considerably more severe
effects on recipients born in or after 1956 because it
would lower their real average indexed earnings
throughout their entire lifetimes.
Consider a recipient similar to the one considered in Table 1, except that she had the bad luck to
have been born in 1956 rather than 1955 and therefore has a benefit-computation base year of 2016
rather than 2015. I assume that her earnings history
is the same as the recipient in Table 1 but delayed by
one year. The left-hand panel of Table 2 shows that
without the VAT, the recipient’s indexed earnings
would be $50 in each year. Her 35-year average of
indexed earnings would be $50, and her PIA would
be $28.81.
The right-hand panel shows the impact of the
VAT, which would be more severe than the impact
shown in Table 1. To begin, the 9.09 percent realwage reduction caused by the VAT would apply to
seven years of the recipient’s earnings rather than
six.
Much more importantly, the VAT would reduce
the 2016 base-year NAWI from $100 to $90.91,
which would reduce indexed earnings in 1988
through 2015 from $50 to $45.45. The reduction
occurs because the earnings value of $50 in each
year would be multiplied by the ratio of the
NAWI’s $90.91 base-year value to its $100 value in
each previous year. The recipient’s entire lifetime
history of indexed earnings would end up being
revised downward by 9.09 percent. The recipient’s
NAWI
$100
$90.91
Indexed
Earnings
$45.45
$45.45
$45.45
35-year average of indexed earnings would therefore fall from $50 to $45.45.
The 9.09 percent decline in average indexed
earnings would be much larger than the 1.56 percent decline experienced by the one-year-older recipient considered in Table 1. If the PIA bracket
ranges remain unchanged, the 9.09 percent decline
in average indexed earnings would reduce the
recipient’s PIA by 5.05 percent. But one more shoe
has yet to drop.
The PIA bracket ranges, specified as percentages
of the base-year NAWI, would also change. Because
the VAT reduces the base-year NAWI to $90.91, the
first bracket would end at $20.08 (22.09 percent of
$90.91) rather than $22.09. The recipient’s PIA
would be $26.19 (90 percent of the first $20.08 plus
32 percent of the remaining $25.37), which is 9.09
percent lower than the no-VAT value of $28.81. The
9.09 percent reduction in the recipient’s average
indexed earnings and the 9.09 percent reduction in
the ending values for the PIA brackets would
combine to reduce the recipient’s PIA by 9.09 percent.
It is much better to turn 61 in the year the VAT
takes effect than to turn 60 in that year. Because the
year in which the recipient turns 60 is the base year
used to index all of the recipient’s past earnings and
to set the PIA bracket ranges, it would be better to
have already passed through that year before the
VAT takes effect and reduces real wages.12
Policy Implications
The real benefit reduction triggered by the VAT
would reduce the Social Security program’s real
outlays. The outlay savings would be gradual because the benefit reduction would affect only future
recipients; it would take a generation for real outlays to fall by the full 9.09 percent. By itself, the
outlay reduction would improve the program’s
finances.
12
The impact on recipients of Social Security disability benefits is similar. The VAT would have little effect on recipients
who become eligible for disability benefits at least two years
before the VAT takes effect but would reduce real benefits by
9.09 percent for recipients who become eligible in or after the
year before the VAT takes effect.
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Table 2. Effect of VAT on Future Retiree
Without VAT
COMMENTARY / ON THE MARGIN
This article describes the impact of a VAT on
Social Security recipients if no changes are made to
the program’s tax and benefit structure. The impact
is not particularly appealing. The VAT would have
sharply disparate effects on recipients who turn 60
in the year of the VAT’s introduction relative to
those who turn 60 in the preceding year. It would
also adversely affect the solvency of a program
already projected to exhaust its trust fund in 2034.14
The unappealing and unintended results arise from
the mechanical application of Social Security rules
that were adopted without considering the potential adoption of a VAT.
Proposals to adopt a VAT should therefore include provisions to prevent these effects. Unfortunately, the current version of the Cardin bill does
not address this effect of the VAT on Social Security.
Nor do other VAT proposals.15
13
If the Federal Reserve accommodates the VAT, there would
be another adverse effect on the system’s finances. The Social
Security Trust Fund is expected to hold $2.8 trillion of bonds
issued by the general treasury at the end of 2015. Supra note 8,
at 47. Because the bonds are not inflation indexed, a 10 percent
unexpected increase in the price level would reduce their real
value by 9.09 percent. That devaluation would reduce the real
budgetary resources available to the Social Security program by
approximately $250 billion and would increase the real budgetary resources available to other federal programs by the same
amount. If desired, that shift of resources could be reversed
through a transfer from the general treasury to the trust fund.
14
After the trust fund is exhausted, the program will be able
to pay only 79 percent of promised benefits. Supra note 8, at 64.
15
For a list of recent VAT proposals, see Viard, supra note 6,
at 123. Since that article was written, Republican presidential
candidate Sen. Rand Paul of Kentucky has proposed the adoption of a 14.5 percent VAT, accompanied by sweeping individual
income tax reductions and the repeal of payroll and selfemployment taxes, the corporate income tax, and the estate and
gift tax.
These unintended effects arise because Social
Security’s tax and benefit rules treat VAT differently
from individual income taxes. VAT payments reduce the real wages that employees receive from
employers, while individual income taxes are paid
by employees from their real wages.16 As a result,
the wages on which payroll taxes are imposed, the
wages that are included in recipients’ earnings
records, and the wages used to compute the NAWI
are expressed net of VAT but gross of individual
income taxes. A proposal like Cardin’s that substitutes a VAT for individual income taxes has the
unintended effect of shrinking payroll taxes, reducing recipients’ earnings records, and lowering the
NAWI.
The disparity in treatment between VAT and
individual income taxes could be corrected by applying payroll taxes to, and computing benefits in
terms of, VAT-inclusive wages. If a worker is paid
$90.91 in wages while a 10 percent VAT is in effect,
payroll taxes should be imposed on $100, consisting
of the $90.91 wages plus the $9.09 VAT collected
from the employer. The $100 amount should also be
included in the worker’s benefit computation and
in the computation of the NAWI.
No significant adjustment is needed for current
retirees. Because the VAT would not reduce their
real benefits, except possibly during the first year it
is in effect, attempting to compensate them for a
perceived benefit reduction would give them a
windfall.
Analysis of the VAT’s impact on Social Security
illustrates the need to think clearly about how VATs
operate. It is tempting to conclude that a VAT
imposes a burden on all consumers. However, if the
consumption is financed by a transfer payment, one
must consider how the transfer payment will be
affected by the VAT. If the transfer payment’s real
value remains unchanged, there would be no tax
burden on consumption financed by the payment.
To determine the VAT’s impact on the transfer
payment, it is generally necessary to examine the
rules of the transfer payment program. If a VAT is
adopted, there is no substitute for a careful inquiry
into its effects on all transfer payment programs.
16
As discussed above, the same distinction accounts for the
taxes’ different monetary policy implications. The Social Security computations are based on the wage paid by the employer
to the worker, which is also the wage subject to downward
nominal rigidity.
722
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However, another effect of the VAT would harm
the program’s finances. Because the 10 percent VAT
would reduce real wages by 9.09 percent, it would
reduce the Social Security payroll tax base by 9.09
percent. With an unchanged statutory payroll tax
rate, real payroll tax revenue would fall by 9.09
percent. That type of revenue reduction is often
called the ‘‘excise tax offset’’ because it arises under
excise taxes as well as VATs. Because the revenue
loss would immediately take full effect, it would
have larger financial effects than the outlay reduction.13
tax notes™
Effectively Updating
Effectively Representing
Reviewed by Bryan T. Camp
Effectively Representing Your Client Before the IRS:
A Practical Manual for the Tax Practitioner With
Sample Correspondence and Forms, edited by T. Keith
Fogg. Published by the American Bar Association
Section of Taxation (6th ed. 2015). Paperback, 1,700
pages. Price: $300. Camp thanks Linda Beale for her
excellent suggestions and comments regarding this
review. He takes full responsibility for any errors or
hurt feelings.
We all know there is no IRS, no Tax Court, no
Congress, and no Justice Department. That is, when
we pause to reflect, we know that institutions
cannot speak, cannot feel, and cannot ever truly be
the subject of a transitive verb. We’ve known this
for a long, long time. As Lord Thurlow famously
put it in 1612, an institution simply has ‘‘no soul to
be damned and no body to be kicked.’’1 Institutions
act only through the individuals who form their
constituent parts.
Yet writers and commentators, including myself,
constantly anthropomorphize institutions. In fact, I
consider it a highly useful metaphor to think of tax
law as the product of institutional conversations
between institutional players, including the IRS, the
Justice Department, the courts (most notably, the
Tax Court), and Congress.
One of the few happy results of the Internal
Revenue Service Restructuring and Reform Act of
1998 was the creation of two new institutional
conversationalists in tax law: the Taxpayer Advocate Service (TAS) and the low-income taxpayer
clinics (LITCs). To be sure, some clinics existed
1
Sutton’s Hospital, 77 Eng. Rep. 960 (1612). I first came across
this well-used quote when reading John C. Coffee Jr., ‘‘‘No Soul
to Damn: No Body to Kick’: An Unscandalized Inquiry Into the
Problem of Corporate Punishment,’’ 79(3) Mich. L. Rev. 386
(1981). According to professor Coffee, early Christian Church
leaders responded to corporate misbehavior by excommunicating the corporation. Pope Innocent IV, a canon lawyer of some
eminence, put an end to this practice in the mid-1200s, thus
becoming, in Coffee’s wry estimation, ‘‘the first legal realist in
this area.’’
before 1998, but it was the statutory funding mandate and, more importantly, the subsequent yearly
appropriations, that enabled the growth from 34
LITCs funded by $1 million in grants in 1999 to 131
LITCs funded by $10 million in grants in 2014.2
While it may be obvious how the TAS is an
institutional voice, it may be less evident how
LITCs, scattered as they are across the United
States, can be considered a single institution. The
mechanism for this institutionalization comes
through the American Bar Association Section of
Taxation, the publisher of the book I am reviewing.
The Pro Bono and Tax Clinics Committee, formed
through the merger of two previously separate
committees, provides a collective voice for the
LITCs. Through the committee listserv, thriceyearly committee meetings, and the tax section’s
comment process, individual LITC lawyers can
come together to share and spread ideas and strategies about how clinics can approach tax issues
important to low-income taxpayers; band together
to respond to IRS requests for comments; and
collectively inform the TAS of issues affecting this
increasingly large population of taxpayers.
LITCs can even act as an institutional player in
litigation. For example, I recall the coordination of
litigation vehicles in the fight against the Treasury
regulations imposing a two-year limitations period
for taxpayers to claim relief under section 6015(f).
That coordinated response was part of the reason
the IRS revised its thinking on the issue even
though the government was winning in the courts.3
The ability to share briefs, share client experiences,
and discuss which cases to appeal can have a
significant effect on the development of the law.
Why should the IBMs, the Exxons, the Justice
Department, and other repeat appellate players get
to have all the strategizing fun?
A big obstacle faced by the lawyers working in
LITCs is a lack of experience (and the lack of
2
TAS, ‘‘Low Income Taxpayer Clinics: Program Report,’’ at 6,
Table 1 (Dec. 2014). For an excellent review of the history of
LITCs, see T. Keith Fogg, ‘‘Taxation With Representation: The
Creation and Development of Low-Income Taxpayer Clinics,’’
67 Tax Lawyer 3 (2013).
3
In 2013 Treasury proposed revising the regulations to eliminate the two-year rule for section 6015(f) relief requests. See
REG-132251-11. The preamble reviews the litigation. Treasury
has not yet issued the final regulation revision.
TAX NOTES, November 2, 2015
723
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BOOK REVIEWS
COMMENTARY / BOOK REVIEWS
4
Fogg, supra note 2, at 61.
then discusses strategies for specific client situations that affect different aspects of assessment and
collection, such as handling clients with potential
criminal problems, helping military clients, and
dealing with clients in bankruptcy.
The sixth edition widens the scope of previous
editions by adding new chapters. Two are particularly noteworthy because they address two new
and quickly evolving tax administration issues:
identity theft and the Affordable Care Act. Tamara
Borland and Christine Speidel do a fine job on the
ACA chapter, providing a coherent picture of the
law and its uncertainties. Likewise, in the chapter
on identity theft, Rachael Rubinstein and her team
comprehensively describe the problem, discuss
how identify theft affects various IRS operations,
and explain which IRS functions can help in this
situation.
The scope of the book is matched by its depth.
Each chapter informs the reader about the key
statutes, cases, and regulations pertinent to the
subject and provides an in-depth look at key Internal Revenue Manual provisions, IRS guidance
documents, IRS forms, and other documents useful
in representing clients, including sample letters to
the IRS (such as qualified offers), sample Kovel
letters, sample protests, sample complaints, and
much, much more.
The chapters are like having an experienced
practitioner down the hall to consult for practical
advice. Take Chapter 13, authored by Mark Matthews and Scott Schumacher, on handling cases
with potential criminal problems. The authors bring
extensive knowledge of the law — Schumacher
teaches this topic at the University of Washington
School of Law — and deep practical experience —
Matthews was, after all, the deputy IRS commissioner and deputy assistant attorney general at the
Justice Department dealing with criminal prosecutions. So the chapter not only explains the law but
also tells the reader exactly how matters proceed
inside the IRS, giving sound advice on deciding
what levels of cooperation may be appropriate in
so-called eggshell audits (and even how to recognize an eggshell audit).
In reviewing each of the chapters, I found only
trivial errors, far outweighed by solid presentations
of the basic concepts and higher-level explanations
of more subtle points, exactly the kind of advice
desired from an experienced colleague. In Chapter
10, for example, Willard Timm mislabels the 1998
restructuring act as the ‘‘Revenue Reform Act.’’ But
this is minor. He does a superlative job describing
automated collection service (ACS) operations and
provides a sophisticated discussion on how to think
about representing your client before ACS or the
724
TAX NOTES, November 2, 2015
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mentors with experience).4 This is certainly true in
academic clinics in which one director typically
supervises eight or more third-year law students.
But all LITCs need a repository of institutional
knowledge and wisdom so that new members do
not constantly have to rediscover the paths to
successful representation of their clients. The hallmark of an institution is that even as individual
members come and go, the institution retains some
identifiable expression of its voice.
Effectively Representing Your Client Before the IRS is
that repository, that institutional voice. It was created just after the 1998 restructuring act through the
collaboration of several committees of the ABA tax
section, under the guiding hand of Jerry Borison.
The tax section has been able to produce new
editions approximately every three years. Borison
edited the first three editions, the fourth edition was
a shared responsibility, and T. Keith Fogg has
served as an eminently capable editor-in-chief for
the fifth edition and the current (sixth) edition, the
subject of this review. The sixth edition represents
the collective efforts and wisdom of 40 chapter
authors, 14 contributing editors, and 19 reviewers,
building on the work of the 58 former contributors
to previous editions. The institutional nature of the
book is both its strength and weakness, as I will
explain in the following comments.
The biggest strength of this book is the breadth
and depth given by its stable of authors. The
extensive coverage means that the treatise is useful
not only for LITCs but also for any tax practitioner
representing low-income clients. Its 1,700 pages are
divided into 29 chapters, each addressing a discrete
topic that might arise in practice, following much
the same order as Borison’s original edition. Thus,
the 12 chapters in Volume 1 start by explaining the
organization of the IRS and the ethical rules applicable to client representation. The following chapters broadly discuss the tax determination process
— from information gathering to examination, Appeals, and then litigation in Tax Court (the longest
chapter in the book, coming in at 284 pages including appendices). The last chapters provide introductory coverage of basic tax collection concepts,
including chapters on tax liens, tax levies, and the
variety of collection alternatives the IRS pursues
and what taxpayers can do about them. Volume 2
contains 17 chapters, first addressing issues that
arise in specific types of examination or collection
situations, such as interest on overpayments and
underpayments, civil penalties, section 6672 matters (trust fund recovery penalty), section 6015
spousal relief issues, and attorneys’ fees. Volume 2
COMMENTARY / BOOK REVIEWS
book. It answers that most important question:
‘‘Who ya gonna call?’’ All of the authors are active
practitioners committed to the mission of the Pro
Bono and Tax Clinics Committee.
These authors build on the efforts of equally
distinguished previous authors, and this feature of
the work is what makes it an institutional voice. So
while chapter subjects stay the same, their contents
change over time as new wisdom emerges and new
authors update the treatise. Consider again my
example of Chapter 10, in which Timm gives his
keen insights into dealing with ACS that reflect his
past practice experience at the IRS and his current
experience with an LITC. But ACS will change. The
IRS will change. Processes will continue to evolve,
as will the law. Eventually, a different author with
an equally excellent background will need to revise
Chapter 10 to reflect the cumulative effect of these
inevitable changes — not just the changes in statutes, regulations, and IRM provisions, but also
those in IRS culture, process, perception, and practice. And this deeper revision will need to be
implemented consistently across the entire treatise.
This last point exposes the potential weakness of
the treatise, inherent in any institutional product: It
does not write itself. The quality of an institutional
product arises not only from the collective efforts of
individuals who constitute the institution but also
from the leadership that guides those efforts. This
sixth edition is a quality product precisely because
a strong editor-in-chief has recruited and inspired a
wide array of able authors. The tax section will need
to find leaders willing and able to undertake the
significant burden of overseeing a full revamp of the
treatise when the next edition rolls around. Without
that, the treatise might suffer as it did in the fourth
edition, when the admirable efforts of many individual authors were insufficient to create the kind of
work product that everyone wanted. That was not
the fault of any individual; it was simply an example
of the weakness of an institutional work product
when there is no strong leadership to pull together
the diverse threads into a clearer, more cohesive
whole. For the treatise to survive, tax section leaders
must identify and recruit strong editors-in-chief to
manage the work. And for that to happen, the tax
section must encourage a culture of service and promote and reward those who freely offer so much of
their time and talents.
LITCs have become an institutional player in the
world of tax law. This edition of Effectively Representing Your Client Before the IRS is an institutional
work product that not only proclaims that status
but promotes it. It is a remarkably useful offering
that deserves widespread recognition and adoption.
TAX NOTES, November 2, 2015
725
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field. It’s the kind of insider knowledge that comes
from his years of experience in the IRS Office of
Chief Counsel.
Adding to the depth of this treatise is the accompanying CD, which contains searchable bonus materials that discuss developments since the sixth
edition went to print. While I miss having an index
in the back of the volumes, the CD format allows
word searches that perform the same function. For
example, one can search for ‘‘Allen’’ to find a
discussion of that case or ‘‘6501(c)’’ to see the five
chapters that discuss that section.
A second great strength of the treatise is its
redundancy. As one might expect when 40 principal
authors write 29 chapters, specific key concepts of
tax procedure, tax administration, and tax representation keep popping up. That’s a good thing. If I
have learned nothing else about teaching in my 15
years in front of the classroom, it is that repetition is
a necessary feature of learning. You cannot expect
students to learn a concept when you give only one
explanation one time. And this treatise is not designed to be read like a novel. It is designed to be a
reference tool. Extensive cross-references noting relevant discussions in other chapters alert the reader
to these redundancies.
For example, while one expects (and finds) a
thorough discussion of Circular 230 in Chapter 2,
‘‘Practicing Before the IRS and Professional Responsibility in Tax Practice,’’ one also finds references to
ethical rules in chapters 3, 4, 6, 10, 13, 14, 16, and 19,
when the specific rules are relevant to those chapters’ topics. Similarly, several chapters explain how
the IRS makes assessments, what an account transcript is, and how the TAS and the Office of Appeals
function. Instructions and examples of how to write
a Kovel letter are found in both chapters 4 and 14,
with the different authors of those chapters providing slightly different takes but giving the same
sample Kovel engagement letter. It makes sense to
put the sample letter in both chapters where it is
most likely to be useful to the reader rather than to
confine it to one of the two.
The third strength of the book is the diversity of
authorship. Without exception, each of the 40 primary authors of this edition is the kind of person
you want in your corner when representing clients
in tax matters. Each author brings a distinguished
background in the subject area. I have already
mentioned some. Many, such as Larry Campagna,
Megan Brackney, Caroline Ciraolo, Ken Weil, come
from a substantial private practice background.
Others, such as Michelle Drumbl, Diana Leyden,
Fogg, and Timm, are leaders of LITCs. In both
groups, one finds lawyers with extensive experience with either the IRS or the Justice Department’s
Tax Division. And that is another benefit of this
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For more Tax Notes content, please visit www.taxnotes.com.
tax notes™
an open meeting via teleconference at 3
p.m. ET. For more information, contact
Otis Simpson at (888) 912-1227 or (202)
317-3332.
GOVERNMENT
EVENTS
Tuesday, November 3
IRS/TAP. The Tax Advocacy Panel Tax
Forms and Publications Project Committee has scheduled an open meeting via
teleconference at 1 p.m. ET. For more
information, contact Donna Powers at
(888) 912-1227 or (954) 423-7977.
Wednesday, November 4
IRS. The IRS has scheduled a webinar
to discuss general employment tax issues,
including worker classification, fringe
benefits, and backup withholding and
information return penalties. Online registration: https://www.webcaster4.com/
Webcast/Page/445/11225.
Thursday, November 5
IRS/TAP. The Tax Advocacy Panel
Special Projects Committee has scheduled
an open meeting via teleconference at 2
p.m. ET. For more information, contact
Kim Vinci at (888) 912-1227 or (916) 9745086.
IRS/TAP. The Tax Advocacy Panel
Taxpayer Communications Project Committee has scheduled an open meeting via
teleconference at 3 p.m. ET to discuss
comments and suggestions on how to
improve customer service at the IRS. For
more information, contact Antoinette
Ross at (888) 912-1227 or (202) 317-4110.
Thursday, November 12
IRS/TAP. The Tax Advocacy Panel Notices and Correspondence Project Committee has scheduled an open meeting via
teleconference at 12 p.m. ET. For more
information, contact Theresa Singleton at
(888) 912-1227 or (202) 317-3329.
IRS/TAP. The Tax Advocacy Panel
Taxpayer Assistance Center Improvements Project Committee has scheduled
http://www.cpa2biz.com/AST/AICPA_
CPA2BIZ_Specials/Related_Products/Re
lated_Conferences/PRDOVR~PC-NTA/P
C-NTA.jsp.
Wednesday, November 18
Tuesday, November 3
IRS/TAP. The Tax Advocacy Panel
Toll-Free Phone Line Project Committee
has scheduled an open meeting via teleconference at 2:30 p.m. ET. For more information, contact Linda Rivera at (888)
912-1227 or (202) 317-3337.
Bush Tax Reform Lessons —
Washington/Webcast.
The
UrbanBrookings Tax Policy Center will commemorate the 10th anniversary of the
release of the President’s Advisory Panel
on Federal Tax Reform by hosting a discussion of the economic and political lessons for tax reform going forward. Online
registration: http://www.brookings.edu
/events/2015/11/03-how-do-we-get-to-ta
x-reform-lessons-from-the-bush-panel.
Wednesday, November 25
IRS/TAP. The Tax Advocacy Panel
Joint Committee has scheduled an open
meeting via teleconference at 1 p.m. ET.
For more information, contact Lisa Billups at (888) 912-1227 or (214) 413-6523.
MEETINGS AND
SEMINARS
Monday, November 2
‘Cadillac’ Tax Effect and Outlook —
Webcast. This program from the Practising Law Institute will feature a panel
discussion about the 40 percent nondeductible excise tax on high-cost employerprovided healthcare plans. Discussion
will focus on which entities are liable for
the tax, how it works, and when it will
apply and strategies for reducing the effects of the tax. Online registration: http:
//www.pli.edu/Content/Seminar/ACA
s_Cadillac_Tax_Impact_and_Outlook/_/
N-4kZ1z1174b?Ns=sort_date%7c0&ID=26
7023.
National Tax Conference — Washington. The American Institute of Certified Public Accountants will hold its twoday 2015 National Tax Conference,
intended to clarify changes in tax law and
to help practitioners with planning and
assisting clients. Online registration:
CONTACT INFORMATION
For further information regarding the hearings listed, contact:
Internal Revenue Service: Regulations Unit, CC:CORP:T:R, Assistant Chief Counsel
(Corporate), Internal Revenue Service, Room 5288, Washington, DC 20224. Telephone:
(202) 622-7180, ask for Hearing Clerk Funmi Taylor.
Senate Finance Committee: Press Officer, Senate Finance Committee, Room SD-219,
Dirksen Senate Office Building, Washington, DC 20510. Telephone: (202) 224-4515.
House Ways and Means Committee: A telephone request to Matt Hittle, staff
assistant, House Ways and Means Committee, is required. Call (202) 225-3625. The
telephone request should be followed by a formal written request to Jennifer Safavian,
Staff Director, House Ways and Means Committee, Room 1102, Longworth House
Office Building, Washington, DC 20515.
Estate Planning Series — Washington. The District of Columbia Bar will
hold a luncheon program sponsored by
the Estate Planning Committee of the
D.C. Bar Taxation Section. This event will
feature discussion of proposed regulations under section 2801 that may affect
the tax treatment of gifts and bequests
from U.S. expatriates. This is the third
event in an eight-part series on estate
planning topics. Online registration:
https://www.dcbar.org/marketplace/ev
ent-details.cfm?productCD=161604TEPCS
&type=event.
Tax Audits and Litigation — Washington. The District of Columbia Bar will
hold a luncheon program sponsored by
the Tax Audits and Litigation Committee
of the D.C. Bar Taxation Section. This
event is the second in a seven-part series
on tax audits and litigation. Online registration: http://www.dcbar.org/marketpl
ace/event-details.cfm?productCD=161650
TTACS&type=event.
Wednesday, November 4
California Bar Annual Conference
— La Jolla, Calif. The State Bar of California will hold its 2015 Annual Meeting
of the California Tax Bar and California
Tax Policy Conference. This three-day
event will include discussion on the estate
and gift tax, tax procedure and litigation,
and the latest updates to a variety of tax
issues including income tax, corporate
tax, and international tax. Online registration: https://www.ieventreg.com/event/
long.php?event_id=5fc1f88ea828a06cad11
9425c68f7c05.
Thursday, November 5
Employment Tax for the Global
Workforce — Webcast. This program
from Grant Thornton LLP will discuss
payroll reporting options in home and
host countries, how to report earnings for
foreign employees, and common reporting pitfalls. Online registration: https://
TAX NOTES, November 2, 2015
727
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TAX CALENDAR
TAX CALENDAR
Corporate Tax Series — Washington. The District of Columbia Bar will
hold a luncheon program sponsored by
the Corporate Tax Committee of the D.C.
Bar Taxation Section. This event is the
second event in a five-part series on corporate tax issues, and it will focus on
recently issued corporate tax guidance,
particularly as it concerns section 355.
Online registration: https://www.dcbar.
org/marketplace/event-details.cfm?prod
uctCD=161645TCTCS&type=event.
BTI Annual Conference — Orlando,
Fla. The Bank and Capital Markets Tax
Institute will hold its 49th annual meeting
over three days on major tax issues relevant to financial institutions and accounting firms, including IRS happenings, tax
reporting, and tax processing. Online
registration: http://www.banktaxinstitut
e.com/ehome/bti-east/home/.
ABA Tax Conference — Philadelphia. The American Bar Association Section of Taxation will hold its 26th annual
Philadelphia Tax Conference over two
days to discuss ‘‘the latest federal, state,
and international developments and
planning opportunities.’’ Online registration: http://shop.americanbar.org/ebus/
ABAEventsCalendar/EventDetails.aspx?
productId=201890280.
Monday, November 9
ASPPA Cincinnati Regional Conference — Cincinnati. The American Society of Pension Professionals and
Actuaries will hold its 2015 Cincinnati
Regional Conference. This two-day event
will allow retirement plan professionals
to interact with industry leaders and will
feature discussion on the latest trends and
ideas in the retirement plan industry. Online registration: http://aspparegionals.
org/cincinnati/cincinnati-hotel-general-i
nformation/.
High Tech Tax Institute — Palo Alto,
Calif. The Tax Executives Institute and
San José State University will jointly host
the High Tech Tax Institute. This two-day
event will include panel discussions on
the latest developments in U.S. taxation of
high-tech companies and the consequences of the OECD’s base erosion and
profit-shifting project. http://www.cob.
sjsu.edu/acct&fin/tax-institute/fees.html.
Tax Strategies for Corporate
Transactions — Chicago. This three-day
program from the Practising Law Institute will focus on tax issues related to
major corporate transactions, including
single-buyer acquisitions, multiparty joint
ventures, cross-border mergers, and complicated acquisitions of public companies
with domestic and foreign operations.
Online registration: http://www.pli.edu/
Content/Seminar/Tax_Strategies_for_Cor
porate_Acquisitions/_/N-4kZ1z129yy?N
s=sort_date%7c0&ID=223967.
Wednesday, November 11
Private Investment Fund Issues —
Webinar. This program from the American Bar Association will cover tax issues
affecting private investment funds and
their managers and will discuss proposed
regulations on management fee waivers
and the pricing of tax attributes in a
private equity auction process. Online
registration: http://shop.americanbar.or
g/ebus/ABAEventsCalendar/EventDetai
ls.aspx?productId=224859071.
William & Mary Tax Conference —
Williamsburg, Va. The College of William
& Mary Law School will hold its 61st Tax
Conference. This three-day event will provide an in-depth look at current topics in
tax law for lawyers and accountants. Online registration: http://law.wm.edu/aca
demics/intellectuallife/conferencesandle
ctures/taxconference/index.php.
Thursday, November 12
Employee Benefits Research Guide
— Webinar. The American Bar Association Section of Taxation will host a webinar on researching employee benefits
issues, including IRS and tax-related issues and resources. Online registration:
http://shop.americanbar.org/ebus/ABA
EventsCalendar/EventDetails.aspx?prod
uctId=224372340.
U.S. International Tax System —
Webinar. Networking Seminars will host
a webinar to offer an overview of the U.S.
international tax system, with discussion
of income sourcing, inbound and outbound taxation, and the foreign tax credit.
Online registration: http://www.network
ingseminars.com/webinars/overviewintl
nov12.
SWBA Benefits Compliance Conference — Dallas. The SouthWest Benefits
Association will hold its 26th Annual Benefits Compliance Conference. This event
will feature discussion from top government officials and industry experts to
provide insight on employee benefit plan
issues. Online registration: https://sw
ba.org/swba-nov2015-26th/registration.p
hp.
Friday, November 13
Tax and Financial Planning for Estates — Webcast. This program from the
American Institute of Certified Public Accountants will examine estate planning
strategies, including how to improve tax
efficiency through asset location. Online
registration: http://www.cpa2biz.com/A
ST/Main/CPA2BIZ_Primary/PRDOVR~
PC-WBC15192I/PC-WBC15192I.jsp.
Sunday, November 15
Institute on Federal Taxation Conference — San Francisco. The New
York University School of Professional
Studies Institute on Federal Taxation’s
six-day event will provide an overview of
all major areas of tax, including recent tax
developments, corporate tax, international tax, tax controversies, executive
compensation, and employee benefits.
Online registration: http://www.cvent.
com/events/74th-institute-on-federal-tax
ation-san-francisco/invitation-b0bc071b0
e8c43f9ab9386c8abc5ca6c.aspx?tw=12-3081-04-B1-1C-8F-E3-4C-CE-D4-B1-DD-71-C
9-54.
Monday, November 16
Financial Reporting Issues Conference — New York. Financial Executives
International will hold its 34th Annual
Current Financial Reporting Issues Conference. This two-day event will include
discussion of new areas of comment and
accounting implementation and perspectives on topics including cybersecurity
and major standards for revenue recognition and leases. Online registration:
http://cfri.financialexecutives.org/registr
ation.php.
Executive Compensation Institute
— Washington. The American Bar Association will hold its Executive Compensation National Institute. This two-day
event will address issues concerning compensation for senior corporate executives
and will include discussion on the latest
issues from a panel of industry practitioners and government officials. Online registration: http://shop.americanbar.org/e
bus/ABAEventsCalendar/EventDetails.a
spx?productId=185828979.
Tax Planning Conference — Boston.
The American Institute of Certified Public
Accountants will hold its 2015 Sophisticated Tax Conference. This two-day event
will feature presentations on topics that
affect affluent individuals, including new
income tax legislation and the capital
gains tax, as well as techniques for retirement and estate planning and asset protection. Online registration: http://www.
cpa2biz.com/AST/Main/CPA2BIZ_Prim
ary/PersonalFinancialPlanning/EstatePla
nning/PRDOVR~PC-SOP/PC-SOP.jsp.
Income Tax Accounting — Houston.
This entry-level seminar from Networking Seminars will review, over two days,
basic tax accounting principles and the
latest tax accounting rules. Online registration: http://www.networkingseminar
s.com/asc-ny/.
Outbound International Tax Planning — Houston. This intermediate-level
seminar from Networking Seminars will
cover in detail an understanding of international tax codes and tax reporting requirements
for
corporations
with
operations abroad. The two-day program
will discuss tax developments in intangible transfers, the IRS’s definition of intellectual property, transfer pricing
considerations, and tax planning for joint
ventures. Online registration: http://
www.networkingseminars.com/out-hou
/.
Tuesday, November 17
Passthrough Entities Taxation —
Webcast. Tax Talk Today will host a live
discussion featuring a panel of IRS and
industry representatives on the proper
728
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www.grantthornton.com/events/tax/201
5/11-05-employment-tax-global-workforc
e-part-1.aspx.
TAX CALENDAR
Wednesday, November 18
The Tax Council Annual Meeting —
Washington. The Tax Council’s annual
meeting and luncheon will include panel
discussions of innovation box proposals
and a legislative update from industry
and government officials, including
House Ways and Means Committee Chair
Paul Ryan, R-Wis. Online registration:
http://www.thetaxcouncil.org/event/ttc
s-annual-meeting-holiday-luncheon-2015
/?instance_id=151.
Exempt Organizations Tax Series —
Washington. The District of Columbia
Bar will hold a luncheon program sponsored by the Exempt Organizations Committee of the D.C. Bar Taxation Section.
This event is the second in a five-part
series of luncheons on taxation of exempt
organizations. Online registration: https:
//www.dcbar.org/marketplace/event-de
tails.cfm?productCD=161635TEOCS&typ
e=event.
IRS/National Taxpayer Advocate —
Washington. The national taxpayer advocate will hold its first International
Conference on Taxpayer Rights. This
event will feature discussion from government officials and tax practitioners
worldwide on issues including the right
to confidentiality and privacy, taxpayer
rights in audits and collections, the impact of taxpayer service on compliance,
and the role of taxpayer advocates. Email:
tprightsconference@irs.gov.
Thursday, November 19
Tax Practice Monthly — Webcast.
This program from the American Institute
of Certified Public Accountants will discuss how to prepare for the 2016 tax
season through best practices and strategies and will review key ethical guidance
standards for tax practitioners. Online
registration: http://www.cpa2biz.com/A
ST/Main/CPA2BIZ_Primary/PRDOVR~
PC-WBC15171I/PC-WBC15171I.jsp.
Financial Products Tax Series —
Washington. The District of Columbia
Bar will hold a luncheon program sponsored by the Financial Products Committee of the D.C. Bar Taxation Section. This
event is the second in a five-part series of
luncheons on financial products issues.
Online registration: https://www.dcbar.
org/marketplace/event-details.cfm?prod
uctCD=161640TFPCS&type=event.
Annual Conference on Taxation —
Boston. The National Tax Association
will hold its 108th Annual Conference on
Taxation. This three-day event will feature discussion on a variety of tax topics
including corporate tax evasion, the
earned income tax credit, and international corporate tax policy. Online regis-
tration: http://www.ntanet.org/events/1
08-101st-annual-conference-on-taxation.ht
ml.
Oil and Gas Tax Conference —
Houston. The University of Texas will
hold its 13th Biennial Parker C. Fielder Oil
and Gas Tax Conference. The two-day
event will feature discussion of various
topics on oil, gas, and energy taxation.
Online registration: https://utcle.org/con
ferences/OX15.
Tax-Exempt Organizations Conference — Los Angeles. The Loyola Law
School will hold its Western Conference
on Tax Exempt Organizations. This event
will feature discussions on tax developments important to charities and other
nonprofit organizations. Online registration: http://events.lls.edu/event/19th-an
nual_western_conference_on_tax_exempt
_organization#.VdTFCPlVhBe.
Income Tax Accounting — Orlando,
Fla. The Executive Enterprise Institute
will hold a course on income tax accounting. This session will review effective tax
reconciliation, valuation allowance, and
disclosure requirements. Online registration: https://www.cvent.com/events/in
come-tax-accounting-and-advanced-inco
me-tax-accounting-in-orlando/registratio
n-868ba72dd1a547d396e01af7152a27ee.as
px.
Friday, November 20
Annual Tax Update — Webcast. This
program from the American Institute of
Certified Public Accountants will examine what has changed in federal individual income taxation, including the
latest tax legislation, court rulings, and
IRS pronouncements concerning individuals and sole proprietors. Online registration: http://www.cpa2biz.com/AST
/Main/CPA2BIZ_Primary/Tax/Business
/PRDOVR~PC-ATCP/PC-ATCP.jsp.
USC Trust and Estate Conference —
Los Angeles. The University of Southern
California Gould School of Law will hold
its Trust and Estate Conference. This
event will include an overview of recent
updates to federal tax law and a variety of
topics concerning trust and estate planning. Online registration: http://weblaw.
usc.edu/why/academics/cle/te/.
Advanced Income Tax Accounting
— Orlando, Fla. The Executive Enterprise
Institute will offer a program covering
advanced income taxaccounting that can
be combined with the institute’s November 19income tax accounting session. This
course will examine more advancedaccounting topics and will discuss mergers
and acquisitions, uncertaintax positions,
and interim reporting. Online registration: https://www.cvent.com/events/inc
ome-tax-accounting-and-advanced-incom
e-tax-accounting-in-orlando/registration868ba72dd1a547d396e01af7152a27ee.aspx.
Monday, November 23
Financial Products and Services
Conference — London. The 4th Annual
OffshoreAlert Conference will feature discussion from clients, providers, and investigators of high-end financial products
and services from Europe and North
America to discuss a variety of financial
issues including tax fraud and evasion.
Online registration: https://www.cvent.
com/events/offshorealert-conference-lon
don-2015/registration-d5e260a0a93f4dd4a
8447b2b9e16fbb3.aspx.
Wednesday, December 2
IRS Collections Options — Webinar.
This program from the American Bar Association will cover the basics of IRS
collection alternatives and will feature
discussion from a panel of guests including National Taxpayer Advocate Nina Olson. Online registration: http://shop.ame
ricanbar.org/ebus/ABAEventsCalendar/
EventDetails.aspx?productId=225988896.
Information Return Reporting and
Withholding Conference — New York.
The Executive Enterprise Institute will
host this meeting to provide an overview
of information return reporting and withholding rules and Foreign Account Tax
Compliance Act compliance. Online registration: http://www.cvent.com/events
/30th-annual-tax-withholding-informatio
n-reporting-conference-in-new-york/cust
om-18-1f626450613b4bfaa94bc1069b05c34
2.aspx.
Tax Basics for Special Needs Families — Webinar. This program from the
American Bar Association will feature a
panel discussion of the tax regulations,
bookkeeping protocols, and public benefits for families with special needs. Online registration: http://shop.american
bar.org/ebus/ABAEventsCalendar/Even
tDetails.aspx?productId=222122509.
Tax Strategies for Corporate Transactions — Los Angeles. This three-day
program from the Practising Law Institute will focus on tax issues related to
major corporate transactions, including
single-buyer acquisitions, multiparty joint
ventures, cross-border mergers, and complicated acquisitions of public companies
with domestic and foreign operations.
Online registration: http://www.pli.edu/
Content/Seminar/Tax_Strategies_for_Cor
porate_Acquisitions/_/N-4kZ1z129yy?N
pp=100&Ns=sort_date|0&ID=223966.
UT Law Taxation Conference —
Austin, Texas. The University of Texas at
Austin School of Law will hold its 63rd
Annual Taxation Conference. This twoday event will feature speakers discussing current trends and updates in tax
regulation and policy. Online registration:
https://utcle.org/conferences/TX15#feat
ures.
Thursday, December 3
Annual Audit Conference — New
York. Baruch College will hold its 10th
Annual Audit Conference. This event will
feature discussion from policymakers and
experts in business, public accounting,
and academics on best practices for ethics
TAX NOTES, November 2, 2015
729
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(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
reporting of tax liability for the principals
and beneficiaries of passthrough entities.
Online registration: https://www.taxtalk
today.com/programs/111715.cfm.
TAX CALENDAR
Annual Tax Withholding and Reporting Conference — New York. The
Executive Enterprise Institute will hold
its 30th Annual Tax Withholding and
Information Reporting Conference. This
two-day event will include discussion on
the common reporting standard and the
challenges of keeping documentation for
multiple reporting regimes. Online registration: https://www.cvent.com/event
s/30th-annual-tax-withholding-informati
on-reporting-conference-in-new-york/reg
istration-1f626450613b4bfaa94bc1069b05c
342.aspx.
Monday, December 7
Taxation of Financial Institutions —
Las Vegas. This two-day event from the
Executive Enterprise Institute will include
discussion of bank-specific code sections
in the Internal Revenue Code and markto-market rules for financial institutions.
Online registration: https://www.cvent.
com/events/taxation-of-financial-instituti
ons-in-las-vegas/registration-62a32082c7f
84b2387889dce302c8873.aspx.
Employee Benefit Plans Conference — Washington. The American
Institute of Certified Public Accountants
will hold its Employee Benefit Plans
Accounting, Auditing, and Regulatory
Update conference. This two-day event
will feature presentations and discussion
from regulators, administrators, and industry experts on the latest regulations
and standards for employee benefit
plans. Online registration: http://www.
cpa2biz.com/AST/Main/CPA2BIZ_Prim
ary/EmployeeBenefitPlans/PRDOVR~PC
-AAR/PC-AAR.jsp.
Tuesday, December 8
Tax Audits and Litigation — Washington. The District of Columbia Bar will
hold a luncheon program sponsored by
the Tax Audits and Litigation Committee
of the D.C. Bar Taxation Section. This
event is part three of a seven-part series
hosted by the D.C. Bar on tax audits and
litigation issues. Online registration:
https://www.dcbar.org/marketplace/ev
ent-details.cfm?productCD=161651TTAC
S&type=event.
Wednesday, December 9
International Tax — Washington.
The District of Columbia Bar will hold a
luncheon program sponsored by the International Tax Committee of the D.C. Bar
Taxation Section. This event is part three
of a six-part series of luncheons on international tax issues. Online registration:
https://www.dcbar.org/marketplace/ev
ent-details.cfm?productCD=161624TITCS
&type=event.
Tax Fraud and Tax Controversy
Conference — Las Vegas. The American
Bar Association will hold its 32nd Annual
National Institute on Criminal Tax Fraud
combined with the Fifth Annual National
Institute on Tax Controversy. This joint
event will feature government and industry representatives providing insight on
various aspects of tax controversy, tax
litigation, and criminal tax defense. Online registration: http://shop.american
bar.org/ebus/ABAEventsCalendar/Even
tDetails.aspx?productId=203592094.
TAX
ADMINISTRATION
During November
Income tax withholding. Ask employees whose withholding allowances
will be different in 2016 to fill out a new
Form W-4 or Form W-4(SP). The 2016
revision of Form W-4 will be available on
the IRS website by mid-December.
November 2
Social Security, Medicare, and withheld income tax. File Form 941 for the
third quarter of 2015. Deposit or pay any
undeposited tax under the accuracy of
deposit rules. If your tax liability is less
than $2,500, you can pay it in full with a
timely filed return. If you deposited the
tax for the quarter timely, properly, and in
full, you have until November 10 to file
the return.
Certain small employers. Deposit
any undeposited tax if your tax liability is
$2,500 or more for 2015 but less than
$2,500 for the third quarter.
Federal unemployment tax. Deposit
the tax owed through September if more
than $500.
Form 720 taxes. File Form 720 for the
third quarter of 2015.
Wagering tax. File Form 730 and pay
the tax on wagers accepted during September.
Heavy highway vehicle use tax. File
Form 2290 and pay the tax for vehicles
first used in September.
November 4
Social Security, Medicare, and withheld income tax. Deposit the tax for
payments on October 28-30.
November 6
Social Security, Medicare, and withheld income tax. Deposit the tax for
payments on October 31-November 3.
November 10
Employees who work for tips. If you
received $20 or more in tips during October, report them to your employer. You
can use Form 4070.
Social Security, Medicare, and withheld income tax. File Form 941 for the
third quarter of 2015. This due date applies only if you deposited the tax for the
quarter timely, properly, and in full.
November 12
Communications and air transportation taxes under the alternative
method. Deposit the tax included in
amounts billed or tickets sold during the
first 15 days of October.
Social Security, Medicare, and withheld income tax. Deposit the tax for
payments on November 4-6.
November 13
Regular method taxes. Deposit the
tax for the last 16 days of October.
November 16
Social Security, Medicare, and withheld income tax. If the monthly deposit
rule applies, deposit the tax for payments
in October.
Nonpayroll withholding. If the
monthly deposit rule applies, deposit the
tax for payments in October.
Social Security, Medicare, and withheld income tax. Deposit the tax for
payments on November 7-10.
November 18
Social Security, Medicare, and withheld income tax. Deposit the tax for
payments on November 11-13.
November 20
Social Security, Medicare, and withheld income tax. Deposit the tax for
payments on November 14-17.
November 25
Communications and air transportation taxes under the alternative
method. Deposit the tax included in
amounts billed or tickets sold during the
last 16 days of October.
Social Security, Medicare, and withheld income tax. Deposit the tax for
payments on November 18-20.
November 27
Regular method taxes. Deposit the
tax for the first 15 days of November.
November 30
Wagering tax. File Form 730 and pay
the tax on wagers accepted during October.
Heavy highway vehicle use tax. File
Form 2290 and pay the tax for vehicles
first used in October.
Social Security, Medicare, and withheld income tax. Deposit the tax for
payments on November 21-24.
730
TAX NOTES, November 2, 2015
For more Tax Notes content, please visit www.taxnotes.com.
(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
and recent trends in the auditing profession. Online registration: https://zsbapp.
baruch.cuny.edu/zicklin/ccievents/regist
ration.aspx?eTitle=Ensuring%20Integrity:
%20The%2010th%20Annual%20Audit%2
0Conference%20&eDate=12/3/2015&eHe
ading=The%20Robert%20Zicklin%20Cent
er%20for%20Corporate%20Integrity&rid=
6867T2015-10-14T10-26-39.