IRS OPENS 3RD OFFSHORE VOLUNTARY DISCLOSURE PROGRAM

Taxpayers with unreported offshore accounts or entities now have a third bite at the apple. The IRS has reopened its offshore voluntary disclosure program to allow delinquent reporting with reduced penalty and criminal exposure.

The program is similar to the 2011 program, but there is presently no deadline to apply (unlike prior programs which had a fixed expiration date). However, taxpayers with an interest should not unduly delay, since the IRS has reserved the right to close the program or increase penalties at any time. The new program also has a penalty of 27.5% of the highest aggregate balance in the foreign bank account or entities or the value of the unreported assets during the eight full tax years prior to disclosure. This is up from the 25% that applied in the 2011 program.

Participants must file all original and amended tax returns and include payment for back taxes and interest, as well as paying accuracy-related and/or delinquency penalties. At times it may be beneficial to conduct reporting outside of the program. Consultation with a qualified tax professional is recommended.

IR-2012-5, Jan. 9, 2012

THAT’S A GOOD WAY TO AVOID INCOME ON DAMAGES

The starting point for most damages recovered by litigants is that the damages are gross income. The hunt then is on for some exception to gross income treatment. A recent private letter ruling illustrates one favorable path, if it fits the facts.

Here, the taxpayer recovered damages from a defendant that had interfered with the taxpayer’s agreement to buy assets of a unit investment trust. The effect was the taxpayer had to pay more for the acquired property than if there had been no interference.

Instead of treating the damages as an item of gross income, the ruling allows the taxpayer to treat it as a nontaxable return of capital in the acquired assets. Thus, the effect is no income tax on the proceeds received, to the extent they do not exceed the adjusted basis of the taxpayer in the subject assets. Should the damages exceed the total basis, then income to that extent would occur. Also, the adjusted basis of the taxpayer in the assets would be reduced for the damages received. This will increase the likelihood of future gains from the property if and when sold.

The key here was an injury to property. If a recovery compensates a taxpayer for injury or loss to the taxpayer's property, it is considered a restoration of capital to the extent of the taxpayer's capital interest therein. Rev.Proc. 67-33, 1967-2 CB 659. Therefore, a review of the facts in recovery situations to determine if there is a property interest that was damaged and compensated is a worthwhile endeavor.

PLR 201152010, December 30, 2011

BEWARE THE INTERMEDIARY SALE CORPORATION

There are acquisition companies out there that promote a benefit to ‘C’ corporation shareholders that are looking to sell their business. If the corporation sells its assets, there will often be substantial corporate gains and income tax. The acquisition companies instead offers to buy the shares of the company from the shareholders. The acquisition companies represent that they have available tax losses that can be used to offset the corporate gains, and thus indicate they can avoid or minimize the corporate taxes on the sale of assets. The assets of the corporation are sold and the proceeds of the sale are used to pay off the purchase price for the share purchase of the shareholders. The benefit to the shareholders in doing a stock sale is that the acquisition company will pay them more for their stock than they would receive if the corporation sold its assets, paid its income taxes on the sale, and then liquidated and distributed the remaining sale proceeds to the shareholders. Of course, the acquisition corporation retains some of the sale proceeds as its pay for its role. The additional payment to the shareholders and the compensation retained by the acquisition corporation is funded by the purported corporate tax savings from the tax losses of the acquisition corporation.

This is what occurred in a recent Tax Court case. Unfortunately, the Tax Court made three findings that potentially leave the shareholders in a bad place.

First, the Tax Court held that the asset sale by the corporation, followed by the sale of shares by the shareholders to the acquisition corporation, was recast as an asset sale followed by a liquidation and not a stock sale. This recharacterization alone may have been enough to blow up the tax planning, since presumably the acquisition corporation’s losses could not be used to offset the selling corporation’s gains on the asset sale – thus the anticipated tax savings that lubricated the transaction would not exist. The Tax Court did not need to take this tack. Instead, the Tax Court determined that the tax losses that the acquisition corporation claimed to have were not valid. The result was the same – the selling corporation had no losses to offset its gains, and thus unexpected corporate level taxes were incurred.

The third finding was that since the transaction was characterized as a corporate liquidation, the shareholders as recipient of corporate assets under the deemed liquidation were personally responsible for the unpaid corporate tax  liabilities as transferees under Code Section 6901. Since the acquisition corporation was paid through the retention of some of the sale proceeds that effectively should have gone for payment of corporate taxes, it is likely that the shareholders will end up with less after they pay the corporate taxes than if they had just sold the assets and liquidated. Of course, perhaps the shareholders can recover their shortfall, including potential interest and penalties, from the acquisition corporation. But then again, perhaps not.

It is notable here that the corporation sold its assets and ceased its business prior to the sale of the shares to the acquisition company. Perhaps if the sale of shares preceded the sale of assets, the court may not have found a constructive liquidation. However, it is likely that some risk of a constructive liquidation will nonetheless remain since one doubts whether the acquisition corporation would purchase the shares of the company absent a binding contract by the company to sell its assets to a third party shortly after the stock purchase. Such a binding arrangement would still leave plenty of room for a court to still impose its recharacterization.

Feldman, TC Memo 2011-297