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Volume 151, Number 1 � April 4, 2016

tax notes

Can Corporate Tax Reform Build on Apple’s Proposal?

Treaty Relief for Unregulated Investment Funds?

The Dubious Distinction Between Politics and Charity

Is There a Presumption Against Extraterritorial Taxes?

Transfers of Intangibles to an Existing Partnership

Limited Scope Tax Engagements Are Not as Limited as You Think

For more Tax Notes content, please visit www.taxnotes.com.

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ON THE COVER

93 Can Corporate Tax ReformBuild on Apple’s Proposal?by Bill Parks

7 Treaty Relief for UnregulatedInvestment Funds?by Lee A. Sheppard

13 The Dubious DistinctionBetween Politics and Charityby Joseph J. Thorndike

65 Is There a Presumption AgainstExtraterritorial Taxes?by Jasper L. Cummings, Jr.

77 Transfers of Intangibles toAn Existing Partnershipby W. Eugene Seago and Kenneth N. Orbach

87 Limited Scope Tax EngagementsAre Not as Limited as You Thinkby Scott F. Hessell and Erin W. Wolf

Cover graphic: Associated Press

5 FROM THE EDITOR

NEWS

17 Starr Forgoes Appeal, OptsTo Pursue Claim Under APAby Matthew R. Madara

18 IRS Inconsistent in Denying EstateTax Deduction for OVDP Penaltyby William Hoke

20 AbbVie Complaint on InversionMotives Dismissedby Amanda Athanasiou

22 Puerto Rico’s AMT Unconstitutional,U.S. Court Holdsby Alexander Lewis

23 Business Test Met, CommonControl Found in Sun Capitalby Marie Sapirie

24 Sentence Commuted for DrugDealer Who Filed False Returnsby David van den Berg

25 Tax Court Refuses to DisregardPeek in IRA Loan Caseby Andrew Velarde

27 Tax Court Issues Proposed andInterim Rules for Tax Law Changesby Nathan J. Richman

28 Pro Bono Clinic Days Offer NewOption to Help Pro Se Petitionersby Nathan J. Richman

32 Group Portrays Case as LastHope Against Dark Moneyby Paul C. Barton

33 Trump Attorneys DescribeIRS ‘Examinations’by Paul C. Barton

34 Calculator EstimatesCandidates’ Tax Hitsby William Hoffman

35 Hudson Institute Tax Plan StrivesFor Fiscal and Political Balanceby William Hoffman

37 States Largely Ignored in FederalTax Reform Plans, Panel Saysby Jonathan Curry

38 No Action on Comprehensive TaxReform in 2016, Survey Saysby Dylan F. Moroses

40 Ryan’s Comments on DistributionDraw Range of Responsesby Dylan F. Moroses

41 Roskam to Continue Oversight’sPush for Asset Forfeiture Reformby Kat Lucero

43 Taxpayer Advocate SchedulesMore ‘Future State’ Forumsby William Hoffman

44 Final Anti-Loss Importation RegsReject Most Recommendationsby Marie Sapirie

46 IRS Plans to Issue Proposed RegsDefining REIT Congregate Careby Amy S. Elliott

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CONTENTS

Volume 151 Number 1

TAX NOTES, April 4, 2016 3


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48 REIT Rule Missteps: Pay thePenalty or Bust the REIT?by Amy S. Elliott

49 Tax Policy Becomes UncommonCause for Rock Bandby William R. Davis

52 Transfer Pricing Roundupby Ryan Finley and Kristen Langsdorf

WEEKLY UPDATE

53 Guidanceby Joseph DiSciullo

57 Courtsby Joseph DiSciullo

61 Correspondenceby Joseph DiSciullo

SPECIAL REPORT

65 Is There a Presumption AgainstExtraterritorial Taxes?by Jasper L. Cummings, Jr.

TAX PRACTICE

77 Transfers of Intangibles toAn Existing Partnershipby W. Eugene Seago and Kenneth N. Orbach

87 Limited Scope Tax EngagementsAre Not as Limited as You Thinkby Scott F. Hessell and Erin W. Wolf

VIEWPOINTS

93 Can Corporate Tax ReformBuild on Apple’s Proposal?by Bill Parks

99 The Earned Income TaxCredit: Trust, but Verifyby J. Kent Poff

GRIST FOR THE MILL

105 Million-Dollar Dirt: A Look at theIRS Whistleblower Programby John Myrick

IN MEMORIAM

113 Ira Shepardby Calvin H. Johnson

TAX HUMOR

115 Happy April Fools’ DayFrom Tax Notes

LETTERS TO THE EDITOR

119 Technical Flaw in Anti-LossImportation Regs

121 TAX CALENDAR

IN THE WORKS

98 A look ahead to planned commentaryand analysis

CROSSWORD PUZZLE

126 April 2016 Tax Crossword Puzzleby Myles Mellor

4 TAX NOTES, April 4, 2016


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Corporate Tax Reform for All

By Ariel S. Greenblum —[email protected]

Comprehensive tax reform will not happen in2016, according to a survey of business tax execu-tives conducted by Miller & Chevalier Chtd. andthe National Foreign Trade Council, Dylan Morosesreports (p. 38). If and when it does eventuallyhappen (and 11 percent of those surveyed believe itnever will), respondents are already disappointedwith it because they believe that Congress won’tlower the corporate and individual rates farenough.

The conflation of tax reform and rate cutting isnot new, but the study is a disheartening example ofhow deep that misconception runs. The over-whelming majority of respondents prioritized de-creased rates over code simplification and revenueneutrality, Moroses says.

The definition of tax reform is many things,including perhaps cutting rates. But despite a lot ofdiscussion in Congress, its goals remain polarizing,and the survey results rightly point to the dismalchances of reform being achieved with a dividedgovernment. If only there were a compromise.

Apple Inc. proposed one that would apply tocorporate tax laws, and Bill Parks analyzes its call toeliminate all corporate tax expenditures, be revenueneutral, and impose a ‘‘reasonable’’ tax on foreignearnings, besides lowering the corporate rate andsimplifying the code (p. 93). Apple’s proposalwould make sense for the fisc and would makebusinesses happy because it changes the definitionof corporate income, from one that applies creditsand deductions, to one that uses book income, orrevenue less expenses, Parks says. Higher corporateincome across the board would allow for lowerrates, he writes. It’s a bold proposal, but with one ofthe biggest corporate players in the world alreadybehind it, maybe others will follow.

Using sales and income figures from financialstatements to determine jurisdictions’ shares of

taxable income, just as the states do, is in line withApple’s goal of imposing reasonable foreign rates,Parks says. Sales factor apportionment may notsatisfy political liberals who want to use worldwideincome as the tax base, but it could be used todistinguish between domestic and foreign profits,he adds.

House Speaker Paul D. Ryan is undoubtedly aninfluential person in tax (and according to thesurvey, the most influential). He recently talkedabout expanding everyone’s slice of the economicpie but emphasized that the government should notredistribute slices (p. 40). Parks says that what Ryanis truly after is tax relief and, by accomplishing that,Apple’s ideas could be ripe for breaking the grid-lock.

HighlightsThe D.C. Circuit in Validus held against the IRS

on its application of the foreign insurance excise tax,using logic that revealed the court’s unfamiliaritywith tax law, Jasper Cummings, Jr. says (p. 65). Thecourt held that because Congress did not clearlyindicate its intent to tax beyond the territory of theUnited States, the presumption against extraterrito-riality should limit the tax’s reach, he writes. Ac-cording to Cummings, it’s an odd conclusion, giventhat the whole point of the tax is to have extrater-ritorial effect. But he admits that he is in theminority and he said most commentators believethe D.C. Circuit got it right.

Tax attorneys often want to limit the scope ofclient representation to specific years or particulartransactions under audit. However, when things goawry, courts can overrule those limitations and findthat the attorneys’ duties to their clients extendedfurther than they anticipated, say Scott Hessell andErin Wolf (p. 87). The key to avoiding that situationis to include representation limitations upfront inthe written retention agreement, the authors say.However, Hessell and Wolf discuss cautionary talesof attorneys who lost malpractice cases because offlawed agreements with inadequate limitations pro-visions, and they describe the pitfalls to watch outfor.

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tax notes®

Copyright 2016, Tax Analysts ISSN 1048-3306

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NEWS ANALYSIS

Treaty Relief for UnregulatedInvestment Funds?

By Lee A. Sheppard — [email protected]

Yahoo Inc. has been a big subject of discussion inthese pages for its failed spinoff, which earned CEOMarissa Mayer a place in the 2015 International TaxReview 50 for the year’s biggest tax blooper. Yahoorecalibrated and announced that it would spin offits core business — whatever that is — instead of itsAlibaba Group investment.

What core business? Does Yahoo even have abusiness left? Yahoo’s business model may havebeen eclipsed over time anyway, but years of med-dling by hedge fund investors did not help. Incred-ible as it seems now, the company refused a $45billion purchase offer from Microsoft Corp. in 2008.Now Yahoo is shopping itself to everyone fromprivate equity to phone companies.

A hedge fund installed Mayer in the first place.She began her disastrous reign by telling employeeswho worked at home — presumably includingmothers of young children like herself — that theyhad to come to the office. Then she did a Vogueshoot, posing provocatively in expensive dresses. Ifonly the earnings were as glamorous!

Yahoo’s basic business is shrinking, but its earn-ings per share were flattered by recent buybacks.Then again, buybacks might make sense for acompany that is essentially in liquidation mode.Yahoo’s share price is 30 percent lower than it was15 months ago.

Now another hedge fund, which owns roughly 2percent of Yahoo, has begun a proxy contest toreplace Yahoo’s entire board, including Mayer, withthe aim of merging it with AOL Inc., anothermoribund walled garden of Internet search andemail for unsophisticated users. La Cucaracha, asAOL is nicknamed, happens to own The HuffingtonPost. But other than that, it’s not clear what AOL’sbusiness is either, or what a merger with Yahoowould accomplish. Yahoo responded by filling twoboard vacancies without talking to investors.

The moral of the story is that investment fundmanagers can sometimes be, as the British wouldsay, too clever by half. They turn out not to be thatgood at running the companies they criticize or take

over. Yahoo’s tormentor dismantled the board of theproprietor of Olive Garden just as middle-classrestaurant patronage hit the wall. Maybe if thebreadstick munchers could be persuaded to do alltheir searches on Yahoo. . .

Fund managers have been too clever by half intax and regulatory matters as well. They’ve arguedthat governments should trust them even thoughthey’ve set themselves up in tax and banking havenarrangements that would suggest that they shouldnot be trusted.

Unregulated investment funds don’t want regu-lation, but they want access to the institutionalmoney and retail investors for which regulation iswarranted. Investment fund managers don’t wantto pay taxes or subject their investors to taxes. Butthey want their investors not to be inconveniencedby withholding taxes. Investment funds want ano-nymity for their investors. But they want withhold-ing tax refunds for them too. They want treatybenefits for their investors without doing anythingto prove they are deserving.

Except, of course, being large and controllingvast amounts of investment capital that gives thempolitical sway in world financial capitals. When welast discussed investment fund whinges abouttreaty benefits and apparent tightening of treatyabuse concepts in the OECD’s base erosion andprofit-shifting project, we saw officials empathizingbut having difficulty fitting funds within the ac-cepted rules. (Prior analysis: Tax Notes, Feb. 9, 2015,p. 732.)

Now the OECD has put out a consultation abouthow to accommodate unregulated investmentfunds with treaty benefits. This call for commentscomes on top of treaty commentary calling forrecognition of regulated investment funds as treatyresidents of the countries in which they are orga-nized. Are unregulated investment funds any closerto treaty relief? Only if they manage to construct anarrative that makes tax administrators feel betterabout recommending it.

A parallel worry for unregulated investmentfunds is treaty relief for dividends and entitlementto the benefits of the EU parent-subsidiary direc-tive, 2011/16/EU. Substance requirements inspiredby the BEPS project and put into practice in theform of recent amendments to the parent-subsidiary directive and the proposed EU anti-avoidance directive, COM(2016) 26 final, are

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creating real problems for the business model ofunregulated investment funds.

Treaty Relief

Basically, unregulated investment funds are ask-ing for the same treatment as regulated investmentfunds, which are theoretically eligible for treatywithholding relief as beneficial owners of invest-ment income. Regulated funds are perceived asdeserving because they are regulated, diversified,widely held by ordinary citizens in their country oforganization, and file tax returns. The OECD’sTRACE project was modeled on the U.S. qualifiedintermediary program in that investor informationwould be bottled up at the intermediary level and

not passed on to governments except in cases of aninformation request (2010 OECD report, ‘‘TheGranting of Treaty Benefits With Respect to theIncome of Collective Investment Vehicles’’).

The project was translated into extensive addi-tions to the OECD model commentary recommend-ing that regulated investment funds be treated asbeneficial owners and treaty residents on their own(paras. 6.8 to 6.34 of the OECD model commentaryon article 1). The draft treaty language in thecommentary leaves room for competent authoritiesto grant treaty benefits to unregulated investmentfunds (para. 6.17). But given that regulated invest-ment funds, many of which are large and visible,aren’t getting much relief, the case for discretionaryrelief for unregulated funds appears weak.

The regulatory and enforcement justification fortreating regulated funds as treaty residents doesn’tapply to unregulated funds, which have flitted inand out of countries where they invest withoutfiling returns or paying tax on capital gains. Theyhave done everything possible to escape the juris-diction of the countries where their mind andmanagement is, and everything possible to keeptheir investor lists secret from the governments ofthose countries. The countries where these fundsare organized and tax resident are flags of conve-nience that maintain a veneer of regulation for theprotection of creditors, which do not include taxauthorities.

Unregulated investment funds don’t have to beorganized in any particular form. Fund feederscatering to U.S. investors are usually organized aspartnerships. For this reason, the United Statespersuaded other OECD countries to agree to lookthrough partnerships to permit treaty benefits foreligible partners (1999 OECD report ‘‘The Applica-tion of the OECD Model Tax Convention to Part-nerships’’).

Consistent with that report, the OECD amendedcommentary to article 1 of the model treaty to saythat the entitlement to treaty benefits should bedetermined by looking through to the investors in atransparent entity (paras. 2-6 of the commentary onarticle 1). The commentary advises source countriesto look through tax haven partnerships to theirtreaty-country investors to grant treaty benefits(para. 6.5). The source country should be treatinginvestors as though they earned the income itemsdirectly. Nonetheless, funds are unable or unwillingto give investor information to source countries.(Prior analysis: Tax Notes, Dec. 22, 2014, p. 1309.)

Unregulated investment funds organized aspassthroughs can’t prove that they are residents ofthe jurisdictions in which they are organized andcan’t or won’t indentify their owners. The consul-tation document recognizes those problems and

Associated Press

Yahoo CEO Marissa Mayer. If only the earningswere as glamorous!

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puts the onus on fund representatives to addressthem. Commentators suggested as an alternativeproof of substantial connection to the country ofclaimed residence, which did not get a warm recep-tion because it would still permit treaty shopping.

Substantial connection would be defined accord-ing to Dutch standards of residence for intermedi-ary companies. The Dutch standard for substance iscontained in two decrees that exalt job creation forDutch professional service providers over actualsubstance. Half the entity’s board members must beDutch residents qualified to do their jobs, and boardmeetings must be held in the Netherlands. Theentity must have staff at its disposal — with norequirement that they be resident or employees.Bank accounts and bookkeeping have to be Dutch.The entity cannot be a dual resident and shouldhave €2 million equity.

U.S.-managed fund feeders catering to foreigninvestors and tax-exempt investors are usually or-ganized as companies to spare them from U.S.effectively connected income and debt-financed in-come, respectively. Tax haven corporations, by defi-nition, are not eligible for treaty relief anywhereunless the haven is Ireland or Luxembourg. Why doU.S. funds insist on using the Cayman Islands?Because it has fund-friendly laws and infrastruc-ture, and it is easily reachable from New York.Readers, the whole treaty relief argument is aboutthe convenience of New York fund managers.

Moreover, deferral is not on the OECD’s list ofdesirable attributes prompting sympathy for inves-tors. The consultation document wants to preventboth tax avoidance by investors not entitled totreaty relief and deferral on the part of those whoare. Hedge funds, private equity funds, and evensocially deserving venture capital funds hang ontoinvestors’ money for a long time, and some makeno current distributions. The consultation docu-ment asks for proof of investor taxation on undis-tributed income.

Regulated investment companies, in contrast,may be legally required to distribute all their in-come (e.g., section 852). The consultation docu-ment’s proposed elective global-streamed regimewould require current distributions. Along the linesof the EU savings directive, 2008/48/EC, the pro-posal contemplates collection by the investor’scountry of residence and remittance of tax proceedsto the country that is the source of the income orgain. This would be extremely clumsy outside theEU even if funds were able to qualify for it.

The best argument that the unregulated fundshave is that the bulk of their investors are institu-tions in treaty countries, and the OECD BEPSnegotiators are willing to give treaty benefits topension funds, which do invest in unregulated

funds (see, e.g., article 22(2)(e) of the 2016 U.S.model treaty). Following through on this argumentwould still require providing investor informationto source countries. But the consultation documentworries about long chains of ownership, which aretypical, and taxable investors tagging along for theride.

Substance RequirementsAs previously noted, the outlook for holding

companies in Europe is bleak. But it is bleaker forthe kind of hollow entities used by investmentfunds. At the opposite end of the scale is that certainlocal activities undertaken by investment fundscould create a permanent establishment.

BEPS discussions usually conjure thoughts ofmultinationals that produce physical products orsell services to identifiable market countries. Nopersonnel in that stripped-risk distributor? ThatSwiss principal company is being managed out ofOmaha and not Zug? Move some people! For thevery largest groups, substance requirements areunlikely to be a barrier.

‘It is very difficult for pure passiveholding companies to survive,’ saidCollet.

For them, showing substance to newly empow-ered European tax administrators is a matter ofmoving bodies around or reassigning the bodiesalready in the suspect location. These giants canalso reassign activities. Group finance and intellec-tual property management can be put in holdingcompanies, as the discussion showed at the recentInternational Bar Association annual conference oncurrent international tax issues in cross-border cor-porate finance and capital markets in London.

‘‘It is very difficult for pure passive holdingcompanies to survive,’’ said Michel Collet of CMSBureau Francis Lefebvre in London.

Unregulated investment funds have an intrac-table problem. They often have a number of entitiesbetween investors and investments for the purposeof avoiding capital gains and withholding taxes,and ensuring entitlement to dividend exemptions.Many of these entities, set up in tax havens, have nopersonnel or premises. Nor can they possibly havethem, given that every private equity acquisitionhas its own clump of entities.

Many of these entities are in Luxembourg, afund-favoring jurisdiction that appears to be thelast place on earth anyone wants to put personnel.In the case of a private equity fund, there would beno business managers in Luxembourg, and the localmanagers of the portfolio companies would not be

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part of the chain of ownership. That leaves onlyback-office personnel eligible for Luxembourg duty.Would that be enough? It depends on the taxauthority. For the French, yes. For the Danes, no.

Discussions at the recent annual conference ontax planning strategies for the United States andEurope hosted by the American Bar Association,International Fiscal Association, and IBA in Milanreached some conclusions. Put some bodies in theLuxembourg entities. Try to have a nontax businessreason for each of them. Think about consolidatingthe entities for many investments into a singlemaster holding company with substance. It mightbe better to fund acquisitions with third-party debtinstead of shareholder debt.

In a private equity acquisition of a target com-pany in an EU country, there can be as many as fourhollow entities between the investment fund andthe target. The entities closest to the investors are ina tax haven like the Cayman Islands, the Nether-lands, or Luxembourg. The entities closest to thetarget are in its country of residence.

What do they all do? The acquisition or biddingcompany, which acquires the shares of the targetdirectly, is in the target’s home country. Above it,there may be a home country holding company thatdoes the acquisition borrowing. The holding com-pany or acquisition company is owned by a DutchBV or Luxembourg SARL. The BV or SARL wouldbe owned by a Dutch co-op or another LuxembourgSARL, respectively, that is owned by the fund. TheDutch entities are passthroughs. The Luxembourgentities are opaque and checked, and also financedwith hybrid debt, private equity certificates (PECs),or convertible private equity certificates (CPECs).

None of these entities, a set of which exists forevery deal, would usually have any substance.They automatically pay interest or dividends re-ceived to the next level. Local managers run thetarget companies, but they have no connection tothe ownership or the investment managers who tellthem what to do.

Nonetheless, Joan Arnold of Pepper HamiltonLLP isn’t giving up on Luxembourg. In Milan, sheargued that putting back-office personnel in theprincipality would be sufficient for substance. Howmany people? Three. A license issued under thealternative investment fund management directive(AIFMD), 2011/61/EU, would help the substanceargument.

The parent-subsidiary directive’s prescription fora common minimum antiabuse rule permits EUmember countries to adopt a safe harbor. Theamended directive commands that the benefits ofthe directive not be granted to arrangements thathave as a main purpose obtaining a tax advantagethat defeats the objects of the directive. It excuses

arrangements that have valid commercial reasonsthat reflect economic reality (16633/14). The con-cepts are similar to the proposed EU antiavoidancedirective (COM(2016) 26).

As vague as that wording appears, the point isthat the payee have substance and be the beneficialowner of the dividend for the payer’s country ofresidence to grant withholding relief under thedirective. The preamble to the amendment counselsthat when faced with a multistep arrangement, taxadministrators can attack the hokey part and leavethe genuine part alone. That means that even if theentities have substance, the tax administrator candeny benefits when the payee is not the beneficialowner of the dividend payment.

In Milan, Nikolaj Bjørnholm, a private practitio-ner, commented that in analyzing eligibility forexemption from withholding under the parent-subsidiary directive, Denmark looks for the recipi-ent’s obligation to pass on the payment. The taxauthorities require withholding on payments toentities that they consider conduits. The questionrattled through the Danish courts, which haverecently referred questions to the Court of Justice ofthe European Union. The Danish Ministry of Taxa-tion has admitted that the beneficial ownershiprules conflict with freedom of establishment.

Andrea Silvestri of Bonelli Erede Pappalardoexplained that Italy employs a substance test todetermine eligibility for exemption from withhold-ing under the parent-subsidiary directive when thepayer of a dividend is ultimately owned by anon-EU resident. The burden is on the taxpayer todemonstrate the main purpose of the arrangement.Italy also has an administrative practice for benefi-cial ownership, and the arrangement may be chal-lenged. If the payee automatically distributes thedividend, that may belie beneficial ownership, Sil-vestri noted. (Prior analysis: Tax Notes Int’l, Dec. 23,2013, p. 1133.)

Albert Collado of Garrigues explained that theSpanish treatment is similar to the Italian treatment.Before the 2015 Spanish tax reform, no exemptionfrom withholding under the parent-subsidiary di-rective was available when the payer of a dividendis directly or indirectly controlled by a non-EU resi-dent: unless the parent carried on a business relatedto the subsidiary’s business in Spain; or the parentmanaged the subsidiary using real human resources;or had a valid business reason for the arrangement.The tax authorities were very restrictive in their in-terpretation of the requirements. (See the Aromaticscases — Supreme Court, Apr. 4, 2012, Mar. 21, 2012,and Mar. 22, 2012; RHI case — National AppellateCourt, Nov. 25, 2010; Pilbrico case — Asturias HighCourt, Apr. 11, 2011; and Enbridge case — NationalAppellate Court, June 3, 2015.)

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The recent Enbridge decision affirmed that nar-row interpretation, Collado observed. In that case, aCanadian company owned a Danish company thatowned 25 percent of a Spanish company and had noother assets. The Danish company’s two employeeswere in Spain and Colombia. There was no sub-stance in Denmark and no purpose for the compa-ny’s formation. Therefore the benefit of the parent-subsidiary directive was denied. (Prior coverage:Tax Notes Int’l, May 9, 2011, p. 501.)

Spanish law was recently changed to accommo-date owners with AIFMD licenses. Exemption fromwithholding under the parent-subsidiary directiveis available when the EU resident owner owns atleast 5 percent or has invested at least €20 million.Mirroring the EU parent-subsidiary directive, theSpanish implementing antiabuse rule would notapply when ‘‘the formation and operations of therecipient of the dividend or royalty are based onvalid economic grounds and business reasons withsubstance.’’ The new Spanish law also introducedan antiabuse rule for royalties. (Prior analysis: TaxNotes Int’l, Sept. 29, 2014, p. 1112.)

An AIFMD license would help in the argumentthat there is a business reason for a holding com-pany, but if it were in Luxembourg, substancewould need to be demonstrated. Collado explainedthat is it not clear which entity must have substance— the Luxembourg vehicle closest to the Spanishacquisition, or perhaps a single Luxembourg hold-ing company that had substance, servicing all of thefund’s portfolio companies. There is no Spanishguidance on what is required for substance.

If the arrangement does not qualify for theparent-subsidiary directive, it may also fall out ofthe pertinent treaty, should a general antiabuse ruleas required by the proposed EU antiavoidancedirective come into force, Collado warned. Thecurrent OECD model commentary states that do-mestic general antiabuse rules do not conflict withtreaties and may be applied to treaty abuse whenthere is a main purpose to get benefits, whichwould conflict with the object and purpose of thetreaty provision (paras. 22-27 of the model com-mentary on article 1).

‘‘We’re all talking about BEPS action 6, but noone’s doing anything about it,’’ said Catherine Searof Proskauer Rose London. Sear predicted that theUnited Kingdom would sign the principal purposeclause that will feature in the multilateral instru-ment.

Internal FinanceThe biggest users of European holding compa-

nies are Americans. PECs and CPECs were createdfor them, and Americans love them. PECs andCPECs get equity treatment for U.S. tax purposesand debt treatment in Luxembourg despite their

boatload of equity features. Theoretically, thesehybrids could get banged up under the BEPS action2 hybrid mismatch report.

‘‘PECs are sacred,’’ Ayzo van Eysinga of Stibbecommented in London. Even if the antiavoidancedirective becomes EU law, Luxembourg would onlyput it into force vis-à-vis EU entities. The target’shome country may deny an interest deduction, SamKaywood of Alston & Bird LLP noted, but there isno problem with equity treatment under U.S. law.

In a typical private equity setup, the target islikely to be paying current interest on straight debtto the same-country acquisition company, withwhich it may join in a combined return. The acqui-sition company issues PECs or CPECs to its Lux-embourg owner. PECs or CPECs are issued all theway up the chain of Luxembourg entities, which arechecked for U.S. tax purposes. So in the U.S. view,only the ultimate payee matters, and the payment isa dividend given the predominant equity featuresof PECs and CPECs.

Treaty-benefited dividends are not the wholerationale for the chain of entities. The investorswant a handy entity that can be sold or liquidatedwhen they want to monetize their investment thetarget. When the target is sold, the lower-tier Lux-embourg SARL either liquidates into the upper-tierLuxembourg SARL or pays it a dividend, incurringno withholding either way. Kevin Keyes of KPMGLLP explained that for a partial exit, the partiesrepay the CPECs. The United States treats therepayment as a dividend out of the CPEC issuer’searnings and profits.

Keyes explained that if the acquisition companywere in the same jurisdiction as the target company,a direct shareholder loan from the former to thelatter should not be used if equity treatment for U.S.purposes could not be achieved under the localcountry law. In these cases, a separate financecompany organized in Luxembourg to issue CPECsto the fund could be considered. The acquisitioncompany would issue the shareholder loan to thefinance company, which would issue the CPECs tothe fund or its holding company.

Some countries have listing exceptions to with-holding on interest. The United Kingdom wouldwithhold on interest payments unless the debt islisted, so funds typically list on a Channel Islandsexchange. Otherwise, the finance company shouldbe located in a treaty jurisdiction to be eligible forreduced withholding, Keyes advised. There will in-evitably be questions whether the finance companyis the beneficial owner of interest payments it re-ceives.

Silvestri explained that Italy requires that thefinance company be the beneficial owner of the

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interest payments it receives. Under Italian benefi-cial ownership guidance, a beneficial owner mustachieve an economic benefit from the transaction;must have legal title and access to the income; andmust have adequate structure and ability to manageits financial risks. There is no guidance on the firstelement, the amount of spread, which would be atransfer pricing question. But the finance companyshould be able to manage its financial risks andshould not pay the interest income over to itsowners too quickly, according to Silvestri.

An unpublished Italian tax ruling was issued fora French special purpose vehicle (SPV) that ownedEU subsidiaries, which it financed with bank loansand debt sales. It had no employees, but it was partof a larger group that had employees. The loansbetween the French SPV and the subsidiaries didnot have commercial terms, that is, the terms didnot mirror those of the third-party loans to the SPV.An Italian subsidiary borrower did not guaranteethe third-party loans. Taking a very strict approach,the tax authorities used those factors to deny ben-eficial ownership, emphasizing the absence of em-ployees at the level of the French SPV.

Collado noted that in Spain, beneficial ownershipis not a concept of the law, but tax authorities doraise it to challenge some back-to-back structures.Spain is one country that asserts the right to taxgains on shares issued by its companies, and, asCollado described, bonds issued to finance Spanishassets. In a tax ruling he called scary, Spanish taxauthorities asserted the right to tax bonds issued bya Dutch issuer on a Dutch platform but used tofinance Spanish assets. There was no beneficialownership under Spanish law, the argument havinglost in court.

Distressed Debt BuyingEverything in Europe is for sale. And many

European lenders — which, unlike U.S. lenders,really do lend to businesses — have books full ofgarbage loans that they want to sell to investors.What happens when investment funds buy pools ofdodgy loans from their originators, then try to workthem out with same-country borrowers?

What if the fund takes equity in the borrowers?Does such a fund have a dependent agent PE in thecountry? In the United States, the IRS has made itsviews on private investment in public equity (PIPE)funds clear (ILM 201501013). Keyes noted that debtfunds are now using special purpose Irish entities topurchase and work out debt, so that they couldhave the advantages of the treaty in the event thereis a dependent agent PE. (Prior analysis: Tax Notes,Jan. 19, 2015, p. 298.)

If the fund is buying its dodgy debts in theUnited Kingdom, it can rely on the investmentmanagement exemption and the Luxembourg

treaty — unless it plans to work out the debts, inwhich case that would fall into the category oftrading and create a PE. As in U.S. law, only passiveinvestors are excused from being in a trade orbusiness (section 864(b)(2)(A)(ii)). In the UnitedKingdom, lending can be conducted through anindependent agent without the nonresident lenderbeing liable subject to tax (section 127, Finance Act1995; section 148(3)/Schedule 26, Finance Act 2003;and HMRC Statement of Practice 1/01).

Italy recently enacted laws to help banks get ridof their bad loans, but those laws focus on thesellers and not the nonresident purchasers (LawDecree 91). Investment funds can now lend intoItaly without tax obstacles, but activities on theground still raise questions. Local servicing of dis-tressed loans would create a dependent agent PE inItaly. Therefore, according to Silvestri, debt inves-tors should go into Italy using a SPV that is notorganized in a blacklisted tax haven like the Cay-mans. Ireland would be acceptable for that purpose.(Prior analysis: Tax Notes Int’l, Aug. 11, 2014, p. 447.)

Working out a debt would also create a PE inSpain, making all associated interest and gain tax-able, according to Collado. Moreover, once a PE iscreated, every asset it holds is part of the PE. TheSpanish tax authorities and courts have been veryactive in using the PE concept to generate nexus inSpain, so investors must consider this in planningdebt portfolio investments.

Funds generally use Luxembourg or Irish ve-hicles to buy debts in Spain, so that interest isexempt from withholding when the payee is an EUresident. Spanish law permits specialized funds toinvest in debt portfolios, which are taxed at acorporate rate of 1 percent. However, investorsmust factor in Spain’s domestic withholding tax oninterest, which, although it is recoverable, is anadditional financial cost, Collado explained.

Manager CompensationWhat about the part that really matters to the

managers — the top of the fund? After hammeringcitizens with unnecessary austerity and corporateincome tax cuts, the British Conservative govern-ment is doing something about lightly taxed invest-ment fund manager compensation. You have tohand it to those upper-class dilettantes — all thattime spent in the country enables them to recognizea pitchfork when they see one.

Under the latest budget, carried interest — Brit-ish managers borrow to purchase real capital inter-ests in their fund — is taxed as ordinary incomeunless it is subject to a hurdle rate. All income fromtrading or lending is taxed at the ordinary rate of 47percent to prevent recharacterization as carriedinterest. If the general partner waived fees, amountsreceived will be tested to see if they were received

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for services. In a separate change, capital gains fromproceeds of sales will be taxed at 28 percent, whichis higher than the normal capital gains rate.

Populism is raising its head in the usually tone-deaf American political system, and presidentialcandidates from both parties have said they wouldtax profits interests as ordinary income. Profitsinterests are income strips. Unlike British managers,American managers do not invest their own oranyone else’s capital to support them. Investorsshift 20 percent of the profits of a typical fund to themanagers, which has the effect of a deduction evenfor tax-exempt investors.

Even Senate Finance Committee member CharlesE. Schumer, D-N.Y., who represents the financierclass, now supports ordinary treatment of profitsinterests for as many industries as possible, which iscode for exempting real estate. It’s a quick and easyway to be seen as caring about fairness while hittinga generally despised class of financiers.

Ordinary treatment of profits interestsis a quick and easy way to be seen ascaring about fairness while hitting agenerally despised class of financiers.

Fund managers accept that enactment of legisla-tion, which has been kicking around for a decade, isinevitable. There are two competing bills ready tobe enacted. The older version, introduced by HouseWays and Means Committee ranking minoritymember Sander M. Levin, D-Mich., would treat allincome and gain on profits interests as ordinary,and would fence off losses from use against otherincome. Service partners would be treated as part-ners on their own capital investments in the fund(Carried Interest Fairness Act of 2015, H.R. 2889 andS. 1686).

The newer version is contained in the extensivetax reform draft released by then-Ways and MeansCommittee Chair Dave Camp. This version wouldimpute interest income to the service partner on adeemed loan of the capital that supports the profitsinterest. To the extent that it exceeds that imputedinterest, the service partner’s net capital gain,whether allocated or from disposition of his inter-est, would be treated as ordinary. It’s more convo-luted than this capsule description because theservice partner would have a running accountbalance for recharacterization. (Prior analysis: TaxNotes, Mar. 10, 2014, p. 1137.)

TAX HISTORY

The Dubious DistinctionBetween Politics and Charity

By Joseph J. Thorndike —[email protected]

A few months ago, Facebook founder MarkZuckerberg and his wife, Priscilla Chan, madeheadlines with an outsized venture into ‘‘hackerphilanthropy.’’ Announcing plans to donate 99 per-cent of their Facebook stock over the course of theirlifetimes to a new charitable venture, they estab-lished the Chan Zuckerberg Initiative, a limitedliability company that ‘‘seeks to advance humanpotential and promote equality.’’

The gift was notable for its size: roughly $45billion, based on share prices when the gift wasmade. But it was also striking for its vehicle. Ac-cording to the couple, the use of an LLC wouldallow greater flexibility in pursuing philanthropicgoals. ‘‘This enables us to pursue our mission byfunding nonprofit organizations, making privateinvestments and participating in policy debates —in each case with the goal of generating a positiveimpact in areas of great need,’’ they wrote.

Every element of this flexibility raised eyebrows— some admiring, others critical. But the intentionto engage in ‘‘policy debates’’ got special attention,probably because political action is a hallmark ofthe hacker philanthropy movement. As Napsterco-founder Sean Parker wrote to his fellow youngphilanthropists in The Wall Street Journal last June,‘‘political interventions might seem dirty, with thepotential to sully your reputation, but many of ourbig problems have a political dimension.’’

‘Political interventions might seemdirty, but many of our big problemshave a political dimension,’ Parkerwrote.

In recent years, the intersection of politics andcharity has been frequently in the spotlight, thanksto the section 501(c)(4) controversy. But in fact, theissue is an ancient one by tax standards. Since atleast the early 20th century, Americans have beenstruggling to define the proper relationship be-tween philanthropy and politics. In particular, theyhave been engaged in a long-running — not tomention problematic and unsuccessful — effort tokeep the two separate, at least when it comes totaxation.

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Probate CourtsThe line between politics and charity has always

been disputed, never less than when it was firstcreated. Olivier Zunz, a political and business his-torian at the University of Virginia, has outlined theargument in his 2012 book, Philanthropy in America:A History. Zunz argued that courts, lawmakers, andexecutive branch officials have ‘‘built an often arbi-trary divide between a political-neutral field of‘education,’ which they allow to philanthropy, andpolitical ‘action,’ which is off limits.’’

Zunz begins his story in the 19th century, whenprobate courts were the principal venue for argu-ments about charity and politics. American law hadtraditionally tried to protect heirs from the generousinstincts of their decedents. Charitable bequests hadto be limited and specific, and heirs had consider-able success in challenging gifts that didn’t meetthose requirements.

Eventually, however, both donors and social re-formers began to realize the potential inherent inlarge fortunes. ‘‘Much common ground was foundin the recognition that the large newly availablephilanthropic resources should not go directly tothe poor,’’ Zunz said of the developing alliance.‘‘Instead these resources were to be treated as publicassets, making it possible to address large questionsof social organization.’’

Gradually, courts began to loosen the strictureson bequests, giving donors more flexibility in howthey disposed of their assets. In particular, judgesbegan to make room for political activity — in away that later courts and Treasury regulators wouldnot. The decisions of the era ‘‘are very instructive ofthe arcane ways judges, when free from issues oftaxation, in effect recognized the indissoluble com-bination of giving and advocacy,’’ Zunz observed.

Politically engaged giving waspermissible as long ‘as it did nottechnically encroach upon theterritory of formal politics,’ Zunzwrote.

Gifts were sometimes contested in probate courtby angry heirs insisting that donations were tooovertly political, and judges were sometimes in-clined to agree. But increasingly they declined todraw bright lines. ‘‘Financing of a political cam-paign, even when the ultimate goal was to changethe law, was permissible, but only if the funds wereallocated for the education of the public and not fordirect lobbying of those in a position to act,’’ Zunzwrote. In other words, politically engaged givingwas permissible as long ‘‘as it did not technicallyencroach upon the territory of formal politics.’’

Ultimately, the courts developed a position thatwas more permissive than Treasury would lateradopt when regulating charities in the age of theincome tax. Zunz suggested that this was perhapsbecause judges were defending the interests ofgrasping heirs in their struggle against generousdecedents — a less compelling responsibility thanTreasury’s later responsibility to protect the fiscfrom aggressive tax avoiders.

Early ExemptionThe arrival of the income tax changed every-

thing. The first federal exemption for charitableentities appeared in the 1894 income tax, which theSupreme Court found to be unconstitutional beforeit was ever collected. The exemption reappeared inthe Revenue Act of 1909, which imposed a newexcise tax on corporate profits but exempted entities‘‘organized or operated exclusively for religious,charitable or educational’’ purposes. When Con-gress took another stab at the income tax in 1913, itleft the exemption more or less intact.

In 1917 lawmakers added a deduction for chari-table gifts, for the first time adding individualincentives to the philanthropic mix. ‘‘Personal de-ductions encouraged a great many more Americansto participate in philanthropy, and so became animportant factor in the success of mass philan-thropy,’’ Zunz wrote.

As the income tax grew, so did the expense of theexemption and the deduction. Predictably, lawmak-ers and Treasury officials set about trying to narrowits scope. Zunz drew special attention to a 1919Treasury regulation that attempted to limit thepolitical activity of exempt organizations. ‘‘Associa-tions formed to disseminate controversial or parti-san propaganda are not educational within themeaning of the statute,’’ Treasury declared.

And that was only the beginning. The Board ofTax Appeals, the forerunner of today’s Tax Court,joined the battle to limit political activity. ‘‘Thecompromise rulings of the probate courts, premisedon broad definitions of charity and judicial discre-tion, were no longer acceptable models,’’ Zunzwrote. ‘‘The mere intention of being charitable wasnot enough.’’ Treasury’s restriction on ‘‘controver-sial or partisan propaganda’’ took on a sharperedge, partly in a bid to protect the government’srevenue, but also as a matter of principle. ‘‘By usingexemption as a tool to regulate charity, Treasuryofficials sharpened the distinction between knowl-edge and advocacy, which judges had left vague,’’Zunz wrote.

Some rulings of the board seem puzzling, espe-cially in retrospect. The board denied exemption,for instance, to the League to Enforce Peace, a groupfounded in 1915 to support international bodies likethe League of Nations. The board found the group’s

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activities — especially after American entry inWorld War I — to be overtly political rather thansimply educational. The board also denied exemp-tion to the North American Civic League for Immi-grants, the Scientific Temperance Federation, theMassachusetts Anti-Saloon League, and the Massa-chusetts Anti-Cigarette League. In each case, theargument hinged on whether the group was in thebusiness of disseminating ‘‘controversial or partisanpropaganda.’’

Often the real issue (both for the board and forTreasury) was not a group’s activities but the natureof its policy focus. If a subject was politicallycontentious — as with temperance, for instance, orimmigration or the creation of the League of Na-tions — then almost any activity in support of thatissue could be cast as controversial or propagandis-tic. Only the most anodyne of issues was safe fromchallenge. ‘‘By the late 1920s, the Treasury Depart-ment was set on making the tax exemption avail-able only to those donors committed to helpingnoncontroversial educational causes that could notbe construed as remotely political or even merelyideological,’’ Zunz concluded.

Birth ControlThe problematic line between education and

advocacy was especially visible in decisions aroundthe birth control movement. The topic was highlycontentious during the 1920s and 1930s, as activistslike Margaret Sanger challenged social mores, aswell as legal structures, on the dissemination ofinformation about birth control. In many states, thismaterial was considered obscene. Sanger and herallies were determined to change the obscenitylaws, and they forged a diverse coalition in supportof their agenda.

The Birth Control League lost itsexemption when the Second Circuitheld that the group was engaging inovert political activity.

But Sanger had problems with the tax law. In1930 her organization, the Birth Control League,lost its exemption when the Second Circuit uphelda decision of the Board of Tax Appeals finding thatthe group was engaging in overt political activity. Inhis decision in Slee v. Commissioner, Judge LearnedHand expressed real sympathy for the league andits mission. But sympathy was not enough. Theorganization’s purposes ‘‘cannot be said to be ‘ex-clusively’ charitable, educational or scientific,’’ hewrote.

It may indeed be for the best interests of anycommunity voluntarily to control the procre-

ation of children, but the question before us iswhether the statute covers efforts to prosely-tize in that or other causes. Of the purposes itdefines ‘‘educational’’ comes the closest, andwhen people organize to secure the moregeneral acceptance of beliefs which they thinkbeneficial to the community at large, it iscommon enough to say that the public must be‘‘educated’’ to their views. In a sense that isindeed true, but it would be a perversion tostretch the meaning of the statute to suchcases; they are indistinguishable from societiesto promote or defeat prohibition, to adhere tothe League of Nations, to increase the Navy, orany other of the many causes in which ardentpersons engage.Hand seemed to recognize that distinctions be-

tween education and advocacy were hard to drawclearly. ‘‘There are many charitable, literary andscientific ventures that as an incident to their suc-cess require changes in the law,’’ he acknowledged.

A charity may need a special charter allowingit to receive larger gifts than the general lawsallow. It would be strained to say that for thisreason it became less exclusively charitable,though much might have to be done to con-vince legislators. A society to prevent crueltyto children, or animals, needs the positivesupport of law to accomplish its ends. It musthave power to coerce parents and owners, andit does not lose its character when it seeks tostrengthen its arm. A state university is con-stantly trying to get appropriations from theLegislature; for all that, it seems to us still anexclusively educational institution.Indeed, charitable groups deserved considerable

latitude in advocating for specific issues, he found,writing:

We should not think that a society of book-lovers or scientists was less ‘‘literary’’ or ‘‘sci-entific,’’ if it took part in agitation to relax thetaboos upon works of dubious propriety, or toput scientific instruments upon the free lists.All such activities are mediate to the primarypurpose, and would not, we should think,unclass the promotors. The agitation is ancil-lary to the end in chief, which remains theexclusive purpose of the association.Nonetheless, Hand found that the Birth Control

League had crossed a line separating permissibleadvocacy from political agitation. His reasoningwas strained, but it was just as clearly consistentwith the legislative, regulatory, and judicial history

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of the issue. Moreover, as Zunz pointed out, Handbelieved deeply in the distinction between educa-tion and advocacy, no matter how hard it was todefine. Like others of his day, Hand believed in thevalue of expertise and disinterested, ‘‘scientific’’knowledge. Insulating that knowledge — and theeducational efforts that bolstered it — from politicalactivity was crucial, even when it was difficult todo.

Power StrugglesUltimately, however, many arguments over tax

exemption were less high-minded than the oneHand offered in his decision. Frequently, in fact,exemption law was a matter of raw politics. Toillustrate, Zunz took a close look at the Revenue Actof 1934, which made the distinction between edu-cation and advocacy a matter of statutory law.

The story hinges on a battle between veteransand budget hawks. In particular, it pitted theAmerican Legion against the National EconomyLeague, a tax-exempt organization established toadvance the cause of budgetary restraint. In theearly years of the Great Depression, the leaguetargeted veterans’ benefits for severe cuts, arguingthat the country could no longer afford them. But inthe ensuing battle, the American Legion attackedthe league as simply a stalking horse for conserva-tive activists.

‘‘Your purpose is to influence legislation,’’ com-plained one senator when speaking to a represen-tative of the league. If true, that charge would haveendangered the league’s exempt status. But theleague’s leadership was quick to object. ‘‘Our pur-pose is to get the facts before the people, and Ibelieve they will influence legislation,’’ insisted thegroup’s director.

Veterans and their congressional champions con-tinued to pursue the exemption issue, proposingnew legislation to restrict the political activity ofmost exempt organizations. The target of thechange was clear. ‘‘There is no reason in the worldwhy a contribution made to the National EconomyLeague should be deductible as if it were a chari-table contribution,’’ declared Sen. David Reed onthe Senate floor. The gift was actually ‘‘a selfish onemade to advance the interests of the giver of themoney.’’

Lawmakers eventually agreed, adding languageto the Revenue Act of 1934 requiring that EOsdevote ‘‘no substantial part’’ of their activities to‘‘carrying on propaganda, or otherwise attempting,to influence legislation.’’

Notably, however, this language did not apply toall exempt organizations. Groups with special ex-emptions in the law, including veterans organiza-tions, fraternal groups, and labor unions, remainedfree of the new anti-propaganda language. For

Zunz, this was crucial. ‘‘Congress made for the firsttime a distinction that has become increasinglyimportant between different kinds of exemptgroups, a distinction that reflected political musclemore than logical categorization,’’ he wrote.

Indeed, the history of the 1934 change illustratesthe way that exemption restrictions can be weap-onized, Zunz concluded. Interest groups of the era‘‘saw the removal of tax exemption as a tool tosilence their opponents.’’

Ultimately, Zunz tells a valuable, if sobering,story — and one with obvious relevance for con-temporary critics of the way tax law treats EOs. Thedesire to shield charity from politics is understand-able. It seems wrong for the government to be ableto subvert political activity through an exemptionor deduction. But trying to draw the right line is adifficult, perhaps hopeless, task. ‘‘It is remarkablehow much effort lawmakers, regulators, and phi-lanthropists alike have invested throughout thetwentieth century in the nearly impossible task ofmaintaining a solid distinction between philan-thropy and politics,’’ Zunz concluded.

Interest groups of the era ‘saw theremoval of tax exemption as a tool tosilence their opponents,’ Zunz wrote.

It’s hard not to wonder: Is the distinction be-tween education and advocacy really viable?

At best, efforts to draw a bright line end up beinghigh-minded but arbitrary. At worst, they becomejust another front in the battle among interestgroups.

Maybe it’s time to toss in the towel.

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Starr Forgoes Appeal, OptsTo Pursue Claim Under APA

By Matthew R. Madara —[email protected]

Starr International Co. on March 24 filed anamended complaint seeking judicial review underthe Administrative Procedure Act (APA) followinga February decision by the U.S. District Court forthe District of Columbia that monetary relief wasnot available to the Swiss-domiciled company.

Starr, a former shareholder of American Interna-tional Group Inc., is seeking a refund under theSwitzerland-U.S. tax treaty of $38 million in with-holding on dividends received from AIG in 2007.

The amended complaint alleges that the IRSimproperly denied Starr’s request. Starr argued thatthe five reasons the IRS gave for denying treatybenefits were arbitrary, capricious, and an abuse ofdiscretion because ‘‘obtaining benefits under thetreaty was not a principal purpose of moving [its]residence from Ireland to Switzerland, but insteadits owners had substantial reasons for moving thatwere unrelated to obtaining treaty benefits.’’

Patrick J. Smith of Ivins, Phillips & Barker Chtd.said an interesting detail included in the amended

complaint is an allegation that the IRS acted in badfaith because the former deputy commissioner withthe IRS Large Business and International Divisionresponsible for denying the treaty benefits requesttold a Starr representative that ‘‘he intended to finda basis for denying’’ the company’s request.

The allegation that the deputy commissionerreached a decision without rationale and thenfound a basis to defend it ‘‘doesn’t sound like anappropriate position for an IRS official to be tak-ing,’’ Smith said. That assertion appears ‘‘to bepretty powerful evidence in favor of the taxpayer’sposition that the IRS acted arbitrarily and capri-ciously,’’ he said.

The allegation appears ‘to be prettypowerful evidence that the IRS actedarbitrarily and capriciously,’ Smithsaid.

The litigation initially raised the questionwhether the U.S. competent authority’s exercise ofdiscretion is subject to judicial review. In September2015 the court determined in Starr International Co.v. United States, No. 1:14-cv-01593 (D.D.C. 2015),that it had the required authority after concludingthat the government failed to demonstrate clear and

IRS CHANGES TUNE ABOUT HARD DRIVE IN MICROSOFT FOIA LITIGATION

The IRS has found a hard drive with retrievableinformation that belonged to Samuel Maruca, formertransfer pricing director in the IRS Large Businessand International Division, the Justice Departmenttold the U.S. District Court for the Western District ofWashington on March 25.

The admission that the hard drive was not ‘‘sani-tized,’’ as the Justice Department asserted in January,is the latest twist in Microsoft Corp.’s ongoing Free-dom of Information Act litigation (Microsoft v. IRS,No. 2:15-cv-00369; and Microsoft v. IRS, No. 2:15-cv-00850) with the IRS, which has recently drawnCongress’s attention. (Prior coverage: Tax Notes, Feb.15, 2016, p. 762; and Tax Notes, June 8, 2015, p. 1134.)

In October 2015 the court ordered the IRS to‘‘search for, process, and release’’ nonexempt recordsresponsive to Microsoft’s FOIA requests. The JusticeDepartment informed the court in January thatMaruca’s hard drive had been sanitized in April2015, despite a litigation hold instituted by the IRSOffice of Chief Counsel. (Prior coverage: Tax Notes,Jan. 25, 2016, p. 398.)

Maruca was included on a list of individuals whomight possess documents concerning the IRS’s con-tract with Quinn Emanuel Urquhart & Sullivan LLPwhen the company filed its first FOIA lawsuit inMarch 2015. Maruca left the IRS in August 2014, and

the hard drive should have been recycled within 30days under the IRS’s ordinary data managementpractices (CC-2012-17).

The latest Justice Department statement explainsthat the IRS has continued to look for responsiverecords to satisfy the court order. The statement saysthat potentially responsive documents from the harddrive were saved elsewhere in July 2014 beforeMaruca left the IRS. The IRS now says Maruca’s harddrive was not recycled in April 2015 and that itcontains user-generated content. According to theJustice Department, the IRS is now processing thecontent in search of responsive records.

The FOIA litigation is closely connected with thecompany’s failed attempt to quash designated sum-monses issued against it in the ongoing transferpricing audit of its 2004-2006 tax years. The JusticeDepartment sued Microsoft to enforce the sum-monses after it failed to comply with them. Microsoftargued that enforcing the summonses would be anabuse of the court’s process because the IRS engagedQuinn Emanuel, a private firm, to assist in thesummons process. (Prior coverage: Tax Notes, Nov.30, 2015, p. 1128.)

— Matthew R. Madara

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convincing evidence overcoming the presumptionof judicial review of federal agency action. (Priorcoverage: Tax Notes, Sept. 28, 2015, p. 1453; and TaxNotes, Mar. 16, 2015, p. 1306.)

The government filed a motion to reconsider,arguing that the court misapprehended the govern-ment’s arguments. The court in February grantedthe motion for reconsideration after determiningthat granting monetary relief to Starr would inter-fere with the executive branch’s prerogative toengage in diplomatic consultation through thetreaty process. The court did grant Starr an oppor-tunity to amend its complaint to pursue a claim toset aside the IRS’s decision denying treaty benefitsthrough the APA’s judicial review process. (Priorcoverage: Tax Notes, Feb. 8, 2016, p. 611; and TaxNotes, Dec. 7, 2015, p. 1231.)

Starr later filed a motion for an enlargement oftime to amend its case so it could consider its nextstep. Smith said he was surprised to see that Starrwas also considering filing a motion for reconsid-eration or seeking an order permitting it to file animmediate appeal.

According to Smith, the court clearly encouragedStarr to amend its complaint to pursue the APAclaim when it granted the government’s motion forreconsideration. ‘‘It would seem to me that a motionfor reconsideration wasn’t going to be successful,and an immediate appeal seemed unlikely toachieve anything better from the court of appealsthan they got from the district court,’’ he said,adding that ‘‘they might have got somethingworse.’’

‘‘Filing an amended complaint going the APAroute was the only reasonable thing to do,’’ Smithsaid.

The approach to the APA that the Justice Depart-ment is taking in Starr appears inconsistent with itsapproach in QinetiQ U.S. Holdings Inc. v. Commis-sioner, No. 15-2192 (4th Cir. 2016), Smith said. TheJustice Department in Starr appears to accept theidea that the company can bring a claim under theAPA arguing that the IRS’s decision on the treatybenefits request is arbitrary and capricious, he said.In QinetiQ, the Justice Department is asserting thatan IRS notice of deficiency is not reviewable in courtunder the APA, he said. (Prior coverage: Tax Notes,Feb. 15, 2016, p. 744.)

The notice of deficiency in QinetiQ is similarprocedurally to the refund claim in Starr, so ‘‘itseems to me that the Justice Department is takingclearly inconsistent positions’’ in the two cases,Smith said.

IRS Inconsistent in Denying EstateTax Deduction for OVDP Penalty

By William Hoke — [email protected]

By denying an estate tax deduction for the mis-cellaneous offshore voluntary disclosure programpenalty for the estate of a woman who died in 2012,the IRS is acting contrary to its internal position onthe issue, according to a lawyer involved in thecase.

James Gifford, an associate with Anaford AG,filed a Freedom of Information Act request fordocuments related to the IRS’s previously undis-closed position on the issue. Milan Patel, a partnerwith the firm, said the agency’s position appears tohave been formulated between 2013 and 2015. In amemo dated April 11, 2013, an unidentified IRSofficial expressed the agency’s ‘‘national position’’that if no person other than the decedent ‘‘wascognizant of the existence of the offshore account,or participated in the movement of the funds off-shore’’ before the estate tax return was filed, the IRSwould allow the estate to deduct the OVDP penal-ties from the taxable gross estate. The official added,however, that if anyone other than the decedent(including family members, accountants, attorneys,or anyone else with a material interest) was ‘‘cog-nizant’’ of the account’s existence and the executoror personal representative failed to make a disclo-sure by the due date of the return, no reduction ofthe penalty against the estate’s value would beallowed.

Patel said that position was contradicted by twomore recent internal memos sent by John Mc-Dougal, special trial attorney and division counsel,IRS Small Business and Self-Employed Division. Inthe first memo, dated November 17, 2014, McDou-gal said that ‘‘if the voluntary disclosure is madeonly on behalf of the decedent then the penalty isclearly deductible.’’ And in a memo dated March 9,2015, McDougal said, ‘‘The law is clear that, if theestate uses estate funds to pay a debt of the dece-dent — even if the debt is for a fine or penalty —then the estate is entitled to a deduction against thegross estate.’’

Patel said his firm’s client is the estate of a dualSwiss-U.S. citizen with U.S. residency who failed tomake a voluntary disclosure before her death. Thewoman’s daughter filed the disclosure promptly af-ter being named executrix and paid the penalty outof the estate’s assets, Patel said. The IRS audited theestate tax return and told Patel that it would notallow the penalty as an administrative deduction ofthe estate. That determination contradicts the IRS’sposition as stated in McDougal’s two memos, Patelsaid.

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Reg. section 20.2053-6(a)(1) states that in general,taxes are deductible in computing a decedent’s grossestate. Patel said penalties are considered taxes. Sec-tion 6671(a) says, ‘‘Except as otherwise provided,any reference in this title to ‘tax’ imposed by this titleshall be deemed also to refer to the penalties andliabilities provided by this subchapter.’’

Auditor’s Position ‘Nonsensical’Patel said the IRS auditor’s position is nonsensi-

cal. He gave as an example a U.S. resident whoseonly assets consisted of an undisclosed offshoreaccount valued at $5 million, which would besubject to a hypothetical OVDP penalty of $1 mil-lion. Patel said that assuming a 40 percent estate taxrate, no deductions for administering the estate,and no complications from state or foreign deathtaxes, if the individual paid the offshore penalty theday before dying, the estate would have a federalestate tax liability of $1.6 million (equal to 40percent of the $4 million remaining after paymentof the $1 million penalty). But Patel said that if thedecedent’s estate were to instead make the disclo-sure and at least one of the individual’s heirs hadknown about the undisclosed account before thedate of death, the IRS would demand an estate taxof $2 million (equal to 40 percent on the entire $5million value of the estate before payment of the $1million penalty). ‘‘The IRS is being punitive here,’’Patel said. ‘‘Why should it make any differencewhether the taxpayer dies before the disclosure ismade or after?’’

‘The IRS is hiding a secret policymeant to punish family members whoknew about a foreign account butcouldn’t do anything about it at thetime,’ Patel said.

Patel noted that the IRS has issued no publicguidance on the issue, forcing his firm to search forthe relevant policies through a FOIA request. ‘‘TheIRS is hiding a secret policy meant to punish familymembers who knew about a foreign account butcouldn’t do anything about it at the time,’’ he said.

Similarly Situated TaxpayersAn IRS official confirmed to Tax Analysts that the

agency has not published any guidance on theissue. However, it appears that McDougal ex-plained the IRS’s thinking when he discussed Ques-tion 41 in the OVDP frequently asked questions for2014 in his March 9, 2015, memo.

Question 41. If there are multiple individualswith signature authority over an OVDP assetheld in the name of a trust, does everyone

involved need to file delinquent [foreign bankaccount reports]? If so, must everyone pay theoffshore penalty?

Answer: Only one offshore penalty will beapplied with respect to voluntary disclosuresrelating to the same OVDP asset. The penaltymay be allocated among the taxpayers withbeneficial ownership making the voluntarydisclosures in any way they choose. The re-porting requirements for filing an FBAR, how-ever, do not change. Therefore, every personwho is required to file an FBAR must file one.

In his memo, McDougal said the IRS has:taken the position that the purpose of this FAQwas to avoid allocation controversies and pro-vide a convenience to taxpayers, not to allow afamily that happened to include a decedent topay a lower effective penalty rate than asimilarly situated family who were all living.In such cases, we have told the taxpayers thatwe will only allow allocation of the penaltyamong the living taxpayers. If they want topay with estate assets, we have conditionedacceptance of those payment arrangements onthe taxpayers’ agreeing that the payment ismade on behalf of the heirs. That way it is clearthat the payment is a distribution and not apayment of the decedent’s debt.

Patel said McDougal’s statement of the IRS’sposition in the memo supports his client’s casebecause McDougal went on to say that ‘‘if the onlydisclosing taxpayer is the decedent, then the estatewill be entitled to deduct the tax, interest, andpenalty.’’

Patel said the IRS should respect its internalposition, as expressed in the McDougal memos, andallow the deduction for the penalty as an adminis-trative expense because the estate made the disclo-sure and not the daughter. He added that if the IRSdoesn’t back down, his secondary argument will bethat the OVDP penalty reduces the value of thetaxable estate at date of death.

‘‘Since deductions are allowed by legislativegrace, a court could say that these people have dirtyhands, so we aren’t going to allow it,’’ Patel said.‘‘But that’s a different issue than the estate’s value atthe time of death, for which the body of law is evenstronger in our favor. In that case, it becomes asimple mathematical calculation.’’

Patel said the IRS told him it would issue hisclient a notice of deficiency a month ago. After threeweeks passed, Patel said he sent a letter demandingthe notice be issued but has yet to receive a re-sponse.

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AbbVie Complaint onInversion Motives Dismissed

By Amanda Athanasiou —[email protected]

A district court granted a motion by AbbVie Inc.and its CEO to dismiss a complaint by Shire PLCshareholders alleging that AbbVie downplayed theimportance of tax advantages expected from itsplanned $54 billion merger with Shire, terminatedin late 2014, despite finding that statements by theCEO may have been misleading.

The decision comes over one year after Shireshareholders filed suit in the U.S. District Court forthe Northern District of Illinois against AbbVie andits CEO and chair, Richard Gonzalez, claiming thedefendants had publicly made misleading state-ments in violation of U.S. securities laws regardingthe tax motives of the deal, thus understating thepotential impact that official action against inver-sions would have on the deal and inflating Shire’sshare price. Judge Robert M. Dow Jr. dismissed theplaintiffs’ complaint without prejudice, giving themuntil May 2 to file an amended complaint. (Priorcoverage: Tax Notes, Dec. 8, 2014, p. 1095.)

In an opinion filed March 29, the court found thatthe plaintiffs had asserted facts sufficient to supporta reasonable belief that a letter sent by Gonzalez toShire employees expressing his confidence in thepotential of the combined organizations and re-marking that the ensuing months would be verybusy in light of integration planning was false ormisleading, rather than immaterial ‘‘puffing’’ or‘‘corporate optimism.’’ Gonzalez’s letter was sentone week after Treasury issued the anti-inversionguidance, Notice 2014-52, 2014-42 IRB 712.

But the court further found that the plaintiffsfailed to ‘‘state with particularity facts giving rise toa strong inference’’ that Gonzalez acted with thescienter required to establish liability under section10(b) of the Securities Exchange Act of 1934 whenhe sent the letter dated September 29, 2014.

‘‘The complaint does not allege facts that consti-tute strong circumstantial evidence of consciousmisbehavior or recklessness,’’ the court said, addingthat the closeness in time between Gonzalez’s letterand AbbVie’s announcement that the deal would bereconsidered is not strong enough evidence thatGonzalez knew when he sent the letter that AbbViewould reconsider or call off the deal.

NEW PROCEDURES MAY EXPLAIN SURGE IN APA APPLICATIONS

A rush to apply for advance pricing agreementsbefore they must comply with Rev. Proc. 2015-41may help explain an almost 70 percent increase infiled applications from 2014 to 2015, according toHareesh Dhawale, director of the advance pricingand mutual agreement program in the IRS LargeBusiness and International Division.

Commenting on the annual statutory report onAPAs, which the IRS released March 30, Dhawalesaid the higher numbers in 2015 were largely drivenby record applications in the fourth quarter. Not onlydid executed APAs rise from 101 in 2014 to 110 in2015, but pending applications increased from 336 in2014 to 401 in 2015, according to the report.

The surge may indicate that taxpayers are stilldigesting the new procedure, Dhawale said. Rev.Proc. 2015-41, 2015-35 IRB 263, contains more de-tailed requirements for the submission of informa-tion but allows taxpayers to apply for an APA underthe 2006 procedure until December 29.

It’s possible that the OECD’s base erosion andprofit-shifting project report on transfer pricing hascontributed to the increase in multinationals seekingcertainty through APAs, but it’s too early to tell whatthe true impact will be, according to Dhawale. ‘‘Ithink it will take a little more time to see exactly howrevised guidelines are affecting exams and howtaxpayers are responding to questions,’’ he said.

Broadly consistent with previous years, most ofthe 2015 APAs (64 percent) involved a foreign parentand a U.S. subsidiary, and Japan and Canada jointlyaccounted for most of the executed bilateral APAs (69percent) and most APAs. Also as in prior years, thecomparable profit method was by far the mostcommonly used transfer pricing method (79 per-cent); distributors and providers of distribution-related services accounted for most of the testedparties; and most CPM analyses (62 percent) used theoperating margin (operating profit divided by rev-enue) as the profit level indicator. However, the useof the Berry ratio (gross profit divided by operatingexpenses) increased from 8 percent of all CPM analy-ses in 2014 to 25 percent in 2015.

One new development in 2015 was the executionof the first bilateral APA with Italy, according to thereport. It also says the model APA agreement isunder review for future changes, and Dhawale saidhe hopes it will be released in the coming months.

APMA is expecting applications to continue torise in 2016, in part because the IRS began acceptingapplications for bilateral APAs with India in Febru-ary. ‘‘We hope that we can move efficiently in man-aging the APA requests that will be coming,’’Dhawale said.

— Ryan Finley

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‘‘If AbbVie was concerned about hiding the im-portance of the tax consequences even after Treasuryissued its Notice, then why would its announce-ments that it was reconsidering and calling off thedeal make clear that the Notice was the reason?’’ thecourt asked in the opinion. The pleadings fail todemonstrate why Gonzalez would lie or act withreckless disregard for the truth by implying thetransaction was advancing if he knew at the timethat AbbVie’s board of directors would be reconsid-ering its approval, the court said.

The plaintiffs also failed to assert facts sufficientto support a reasonable belief that six additionalstatements or omissions by AbbVie raised in thecomplaint were misleading, according to the court.

Regarding the plaintiffs’ allegation that AbbVie’sJune 2014 announcement that it had approachedShire about a business combination was misleading,the court, quoting Stransky v. Cummins Engine Co.,51 F.3d 1329, 1331 (7th Cir. 1995), said, ‘‘Mere silenceabout even material information is not fraudulentabsent a duty to speak.’’

‘Mere silence about even materialinformation is not fraudulent absent aduty to speak,’ the court said.

The plaintiffs claimed that a number of publicstatements AbbVie made between June and August2014 about the strategic rationales for the proposedmerger with Shire downplayed the importance ofthe deal’s tax benefits, listing tax considerations asonly one of several rationales. The court said theplaintiffs did not assert facts sufficient to support areasonable belief that those statements were mis-leading by omission ‘‘such that AbbVie had a dutyto disclose that it might call off the merger if the taxrules changed.’’

The court found the facts insufficient to supporta reasonable belief that a statement by Gonzalezduring a July 2014 investor call regarding the im-portance of tax synergies to the deal was false.Gonzalez had said tax benefits were not the pri-mary rationale for the merger and that AbbViewould not be doing the deal ‘‘if it was just for thetax impact.’’

AbbVie’s loss of any benefit amounting to ap-proximately 3 percent of the deal value representedby the $1.64 billion breakup fee or more could beexpected to cause AbbVie to terminate the deal, thecourt said. ‘‘But it does not follow that any benefitof the deal that is worth at least 3% of the transac-tion value must be the ‘primary’ — i.e. the ‘mostimportant’ — reason for the deal,’’ the opinionstates.

The court found that the relevant period forexamining loss causation was from September 29,2014, the date of Gonzalez’s letter, to October 14,2014, when AbbVie announced its board was recon-sidering the merger. That is a much shorter periodthan what was alleged by the plaintiffs, whichstretched from the June 20, 2014, announcement ofAbbVie’s approach to Shire until October 14, 2014.The plaintiffs’ loss causation allegations were there-fore found insufficient as to several of the plaintiffsbut sufficient as to plaintiffs William McWade andVikas Shah, who bought or sold Shire shares be-tween September 29 and October 14.

Since the termination of the merger, Shire hasacquired New Jersey-based NPS PharmaceuticalsInc. and announced its agreement to acquireIllinois-based Baxalta Inc., which was spun off fromits U.S. parent company, Baxter International Inc., inJuly 2015. (Prior coverage: Tax Notes, Jan. 19, 2015, p.319; and Tax Notes, Jan. 18, 2016, p. 308.)

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Puerto Rico’s AMTUnconstitutional, U.S. Court Holds

By Alexander Lewis — [email protected]

Federal Judge José Antonio Fusté of the U.S.District Court for the District of Puerto Rico heldMarch 28 that a portion of Puerto Rico’s alternativeminimum tax is unconstitutional and has grantedWal-Mart an immediate injunction against the sec-retary of the commonwealth’s treasury to stopcollection of tax.

The 109-page decision in Wal-Mart Puerto RicoInc. v. Juan C. Zaragoza-Gomez, 3:15-CV-03018 (JAF),says the tangible property tax portion of the AMTapplies at a higher rate on transactions between acompany in Puerto Rico and a foreign related partythan it does on purely domestic transactions. Beforea May 2015 amendment as part of Act 72 of 2015,Wal-Mart paid a 2 percent tangible property tax onapplicable transactions. The rate under theamended provision is 6.5 percent.

In effect, every purchase of goods by Wal-MartPuerto Rico from its parent company in the UnitedStates after the May 2015 amendment was subject tothe higher tax rate. The court found that for the taxyear that ended on January 15, Wal-Mart PuertoRico paid more than $40 million in estimated in-come tax to Puerto Rico, around $30 million ofwhich was attributable to the amended AMT.

‘The AMT is a legislative money grab,pure and simple, funding the personalaccount of Puerto Rico’s insolventtreasury,’ Fusté said.

Puerto Rico argued that the case should bedismissed because by law, Wal-Mart must first paythe tax and then seek a refund. However, bothparties agreed that Puerto Rico would not be able topay Wal-Mart the refund because the government ispractically insolvent. ‘‘The AMT is a legislativemoney grab, pure and simple, funding the personalaccount of Puerto Rico’s insolvent treasury from thepresumably deeper pockets of large multistate cor-porations and their local affiliates,’’ Fusté said.

The court found that the tangible property taxprovisions of the AMT violate the legal doctrineknown as the dormant commerce clause, whichprovides that states cannot place excessive burdenson interstate commerce without congressional ap-proval. However, the tangible property tax in theAMT applies only if the seller or transferor is notsubject to income tax on the transaction in PuertoRico but the buyer is. In other words, the tax applies

only to cross-border sales or transfers by an out-of-state company to its local branch or office.

Fusté cited Comptroller of the Treasury v. Wynne,135 S. Ct. 1787 (2015), in writing that a state may nottax a transaction or incident more heavily when itcrosses state lines than when it occurs entirelywithin the state. To determine whether a tax dis-criminates against interstate commerce, the courtmust look to the practical or real economic effect ofthe tax, he said.

‘‘Puerto Rico’s AMT, on its face, clearly discrimi-nates against interstate commerce,’’ Fusté said,holding that the practical effect of the tax is to placean undue burden on multinational companies op-erating in Puerto Rico.

The court also held that the tax violates theFederal Relations Act and the equal protectionclause of the U.S. Constitution. The Federal Rela-tions Act provides that Puerto Rico can levy taxeson goods manufactured, sold, or brought intoPuerto Rico, provided that Puerto Rico does notdiscriminate between goods produced in PuertoRico and those produced in the United States orother foreign countries. The court found that theAMT violates the Federal Relations Act for the samereason it violates the dormant commerce clause — itclearly discriminates against products brought intoPuerto Rico from the United States.

The AMT violates the equal protection clause‘‘because it is both arbitrary in its discriminationand not rationally connected to a legitimate govern-mental purpose,’’ the court said. It found that theAMT was not intended to prevent abusive transferpricing practices, as Puerto Rico argued, but wasinstead intended to quickly raise revenue for itstreasury, which is not a legitimate purpose justify-ing a discriminatory tax.

However, Fusté said the AMT does not violatethe constitutional prohibition against a bill of attain-der law, as Wal-Mart claimed. The prohibition onbills of attainder in article 1, section 9 of the U.S.Constitution applies only to Congress, and theprohibition in article 1, section 10, applies only tothe states. The court held that because Puerto Ricois a territory, the prohibition on bills of attainderdoes not apply. However, while the court agreedwith Puerto Rico that the AMT does not violate theprohibition on bills of attainder, it still found theAMT unconstitutional.

Fusté lamented the condition of Puerto Rico’sfinances, but the court agreed with an expertwitness’s testimony that ‘‘at the end of the day, theCommonwealth should not rely on revenue thatit’s not entitled to, to try to pay for essentialservices.’’

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Business Test Met, CommonControl Found in Sun Capital

By Marie Sapirie — [email protected]

Two private equity funds were engaged in atrade or business and under the common control ofa bankrupt company, and thus were responsible forthe withdrawal liability for a multiemployer pen-sion fund, the U.S. District Court for the District ofMassachusetts held in a case on remand from theFirst Circuit.

The March 28 district court opinion in Sun CapitalPartners III LP v. New England Teamsters & TruckingIndustry Pension Fund, No. 10-10921 (Mass. 2016), isa complete win for the pension fund, said Steven M.Rosenthal of the Urban-Brookings Tax Policy Cen-ter. The decision ‘‘further undercuts the assertionsby private equity funds that they are merely passiveinvestors and are not subject to the tax and ERISArules that apply to a trade or business,’’ he said.

The First Circuit held in 2013 (No. 12-2312 (1stCir. 2013)) that one of the Sun Capital funds wasengaged in a trade or business under the multi-employer pension termination liability rules andasked the district court to examine the other. Thecircuit court also asked the district court whethereither of the funds satisfied the common control testsuch that they would be liable for a terminationpenalty under the Multiemployer Pension PlanAmendments Act.

The private equity funds, which sit under SunCapital Advisors Inc., filed a petition for certiorariwith the Supreme Court that was denied. (Priorcoverage: Tax Notes, Mar. 10, 2014, p. 1024.) Thepetition asserted that the First Circuit’s opinion‘‘obliterated [the Supreme Court’s] clear line be-tween an investor and a ‘trade or business’’’ andthat the ‘‘novel, multi-factor ‘investment plus-like’test’’ was unpredictable. (Prior coverage: Tax Notes,Nov. 25, 2013, p. 819.)

District Court Decision on RemandThe two main parts of the district court decision

on remand addressed whether the funds were en-gaged in a trade or business and whether the twofunds could be aggregated for purposes of deter-mining if there was common control of the bank-rupt company under the ERISA rules, whichnormally require 80 percent ownership of a com-pany to establish control. The Sun Capital fundsargued they did not control the company under theERISA rules because one fund owned 70 percent ofthe company and the other owned 30 percent of thecompany, each under 80 percent.

The trade or business aspect of the decisionhighlights the possibility that fee offsets might

represent some sort of phantom income to privateequity funds for tax purposes, said Peter J. Elias ofJones Day.

The court explained that Sun Fund III received aneconomic benefit in the form of an offset against themanagement fees it otherwise would have paid itsgeneral partner for managing the investment inScott Brass Inc. Elias said the trade or business partof the decision makes sense for the same reasonsthat were discussed in the First Circuit’s opinion,namely that the funds are investing and are receiv-ing economic benefits in the form of fee offsets.

The district court answered in the affirmative theFirst Circuit’s question whether Sun Fund III re-ceived any benefit from an offset from fees paid byScott Brass, a potential factor the First Circuit saidmight separate a passive investor from an activetrade or business. ‘‘The generation of ManagementFee offset carryforwards is a valuable benefit thataccrues to the Sun Funds as a result of the SunFunds’ management activities relating to ScottBrass, Inc.’’ that contributed to the trade or businessfinding, according to the district court.

The district court’s analysis of the question ofcommon control concluded that despite the funds’disclaimer in their agreements to co-invest withoutany intention to form a partnership, there was a‘‘deemed partnership’’ between Sun Fund III andSun Fund IV based on the record. The court lookedto the common practice of using funds that invest inparallel as evidence in support of aggregation.

‘‘That ownership interests sometimes can be ag-gregated across parallel funds illustrates why, as ageneral proposition, they sometimes can be aggre-gated across non-parallel funds,’’ the court wrote.The opinion further explains that all of the SunFunds, whether parallel or not, were formally inde-pendent entities with separate owners but ulti-mately made their investment and businessdecisions under the direction of two leaders. Thecourt also found that the funds decided on a 70-30split in their ownership stake, which it said dem-onstrates the existence of a partnership because thesplit did not ‘‘stem from two independent fundschoosing, each for its own reasons, to invest at acertain level.’’

The court called the de facto separateentity a ‘partnership-in-fact,’ which isan important development underERISA, Rosenthal said.

The court called the de facto separate entity a‘‘partnership-in-fact,’’ which is an important devel-opment under ERISA, according to Rosenthal.Withdrawal liability will be much easier to trip, he

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explained. Rosenthal also highlighted the districtcourt’s finding that the deemed partnership en-gaged in a trade or business, even though it did notreceive any fees or offsets. The district court heldthat the deemed partnership’s ‘‘active managementin pursuit of profits from restructuring was notmere passive investment but something more.’’

Elias said the conclusion that Sun Fund III andSun Fund IV formed a de facto partnership wassurprising. ‘‘Private equity funds set up parallelfunds and invest in conjunction with each other allthe time,’’ he said. ‘‘This suggests that any time thathappens, it creates a fictional partnership for taxpurposes.’’ He noted that the authorities relied on bythe district court are general tax lawauthorities that apply for all purposes of the taxlaw, which makes it harder to assert that thedistrict court’s analysis on the common control ques-tion applies only to the facts before the court.

Sentence Commuted for DrugDealer Who Filed False Returns

By David van den Berg —[email protected]

President Obama commuted the sentences of 61people on March 30, including Jesse Webster ofChicago, a man who had been sentenced to life inprison for intent to deal cocaine and for two countsof filing false tax returns.

A jury found Webster guilty of filing false taxreturns based on evidence that he had failed toreport income from drug dealing. Webster’s sen-tence is now scheduled to expire September 26, andthe balance of a $25,000 fine imposed on him will beremitted, the White House said in its March 30announcement of the sentence commutations.

Jessica Ring Amunson of Jenner & Block, whohas represented Webster pro bono since 2009, saidshe informed Webster of the commutation March30. He was ‘‘both excited and kind of a little bitstunned,’’ as well as grateful to her and to Obama,she said. ‘‘I assured him that although our legalfight is over, I certainly hope to continue to workwith him to make sure his transition is a successfulone,’’ she added.

Amunson started representing Webster when herfirm was appointed as his pro bono counsel by theSeventh Circuit in his appeal of a habeas corpuspetition regarding an unaccounted-for juror duringdeliberations, she said. It bothered her that Websterwas serving a life sentence for a nonviolent drugcrime and for filing false returns, and she found thepunishment disproportionate with the crime, shesaid, adding that she then offered to continuerepresenting Webster after he lost the appeal.

The judge who sentenced Webstersaid the term he was forced toimpose was ‘too high,’ FAMM said.

Amunson submitted Webster’s petition to theOffice of the Pardon Attorney in September 2013,and it included letters from the judge who sen-tenced him, the prosecutors who worked on hiscase, and many community and family members,she said. ‘‘When we first filed it, I thought it wasreally kind of a long shot because in past adminis-trations, clemency, and commutations of sentence inparticular, have been extremely rare,’’ Amunsonsaid.

In a March 30 release, Families Against Manda-tory Minimums (FAMM), an organization workingfor sentence reform, touted Webster’s commutation

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as one of several it championed. According to thegroup, Webster was sentenced in 1996 for his role ina cocaine conspiracy, his first and only drug offense.The judge who sentenced Webster said the term hewas forced to impose was ‘‘too high,’’ FAMM noted.

‘‘We are deeply gratified that the President hasused the power of the Oval Office to give relief topeople serving unjust sentences, for low-level, non-violent crimes,’’ Julie Stewart, FAMM’s president,said in the organization’s statement. ‘‘Unfortu-nately, clemency can’t change policy.’’

Webster’s case has attracted considerable atten-tion. The city of Chicago in January 2014 unani-mously passed a resolution calling for thecommutation of Webster’s sentence, according to aFebruary 2014 statement from Jenner & Block. TheNew York Times and other outlets have also reportedon the case.

Webster’s commutation follows the December2014 pardon of criminal defense attorney AlbertStork of Colorado, who died of terminal braincancer less than a month after receiving a pardonfor filing a false tax return. President Clinton issuedat least 15 pardons related to individual or corpo-rate income taxes, including the controversial par-don of Marc Rich in 2001, while President GeorgeW. Bush issued four pardons for income tax evasionand other tax-related offenses. (Prior coverage: TaxNotes, Jan. 12, 2015, p. 203.)

Tax Court Refuses to DisregardPeek in IRA Loan Case

By Andrew Velarde — [email protected]

A decision from the Tax Court on March 29should serve as further warning to taxpayers whowould seek to invest IRA funds in their ownbusiness, a practitioner told Tax Analysts.

‘‘There’s a fairly robust industry advising folkshow to use their retirement funds to invest in theirown businesses,’’ Alden Bianchi of Mintz, Levin,Cohn, Ferris, Glovsky, and Popeo PC said. ‘‘Theprohibitive transaction rules are godawful complex.What Congress really wanted to do is for the IRAsto be retirement vehicles, not a way to buy yourselfa job, or pump up your own investment, or use itfor seed money for your highly leveraged start-up.’’

‘What Congress really wanted to do isfor the IRAs to be retirement vehicles,not a way to buy yourself a job, orpump up your own investment, or useit for seed money for your highlyleveraged start-up,’ Bianchi said.

In Thiessen v. Commissioner, 146 T.C. No. 7 (2016),married petitioners acquired an incorporated busi-ness using funds from a retirement account on theadvice of a broker. The petitioners rolled over theirretirement funds into IRAs and caused the IRAs toacquire the stock of a newly formed C corporation(Elsara), which would acquire the unincorporatedbusiness (Ancona). The broker recommended thatthe acquisition of the existing business be struc-tured to include a loan from the seller so that theseller would have an interest in helping the buyer inthe future. Repayment on the loan was personallyguaranteed by the petitioners. The petitioners re-tained a CPA for the transaction and an indepen-dent attorney with no ties to either the CPA or thebroker to aid in the terms of the sale contract andfinancing arrangement.

The petitioners transferred the funds from theirretirement accounts as tax-free rollovers in 2003 andreported them as such to the IRS without disclosingtheir guaranties of the loan. In 2010, on the theorythat the distributions were prohibited transactionsunder section 4975 and therefore deemed distribu-tions to petitioners, the IRS determined that thepetitioners were liable for a deficiency attributableprimarily to unreported IRA distributions totaling$431,500, as well as a 10 percent additional taximposed under section 72(t) because of the prema-turity of the distributions.

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The court’s decision to side with the IRS ‘‘didn’tsurprise me in the least. . . . This is not breaking anynew ground,’’ Bianchi said.

Under section 4975(c)(1)(B), a prohibited transac-tion generally includes the direct and indirect lend-ing of money or other extension of credit between aplan and a disqualified person. A disqualified per-son includes one who exercises discretionary au-thority or control over management of the plan ordisposition of its assets.

The court agreed with the IRS on its primaryargument, citing its previous opinion in Peek v.Commissioner, 140 T.C. 216 (2013), and refusingpetitioners’ request to disregard or distinguish thatopinion. One argument advanced by the petitionerswas that the Department of Labor had the primaryauthority to interpret prohibited transaction rulesand that the court in Peek interpreted them incon-sistently with the department.

In Peek, an IRA funding structure had beenpromoted to two unrelated taxpayers, who rolledover funds in their retirement plans to self-directedIRAs and caused the IRAs to establish and whollyown a newly formed corporation, which purchasedassets of a business by receiving from the seller aloan that the taxpayers guaranteed. The court inPeek held that the taxpayers were disqualified per-sons and that the guaranties of the loan wereprohibited transactions. The petitioners in Thiessenasserted that Peek was distinguishable because El-sara, unlike the corporation in Peek, was an operat-ing company, which the court rejected.

‘‘We decline petitioners’ invitation to disregardor distinguish Peek. Congress included provisionson prohibited transactions in both title 26 and title29, and President Carter gave the Department ofLabor primary authority to interpret both sets ofthose provisions,’’ the court held. ‘‘That does notmean, however, that the Department of Labor hasthe final word as to the interpretation of thoseprovisions.’’ As a secondary matter, the court foundthat the department concluded in a similar settingto Peek that a personal guaranty would be a prohib-ited transaction. Further, in Peek, an operating com-pany was never mentioned, the court noted.

Richard Matta of Groom Law Group Chtd.agreed with the court’s holding, though not all of itstechnical analysis.

‘‘People are sort of testing every theory they cancome up with to find a way to do these deals,’’Matta said. ‘‘[They] invest in their own businesses,pay their salaries, get these guaranties inplace . . . though I think the Tax Court could havefound a simpler way to get from point A to point B.’’Although the court cited the Department of Labor’splan asset regulations, Interpretive Bulletin 75-2stands for the proposition that an indirect transac-

tion could not be used to accomplish a transactionthat could not be done directly, Matta argued.Interpretive Bulletin 75-2 was not cited in the opin-ion. Further, although the court ignored the peti-tioners’ argument that would distinguish anoperating company because the IRAs are related,the rules apply to relation in a common employer,Matta noted.

Although section 4975(d)(23), added to the codeas part of the Pension Protection Act of 2006,generally provides that prohibitions in section4975(c)(1)(B) do not apply to the lending of moneybetween a plan and a disqualified person in con-nection with the acquisition, holding, or dispositionof any security or commodity, if the transaction wascorrected before the end of the correction period,the petitioners’ acquisitions of assets failed to meetthe definition of security or commodity, the courtheld.

‘‘While petitioners gave the guaranties incidentto an overall plan that included petitioners’ IRAs’acquisition or holding of Elsara stock, the aim of thetransaction, to be sure, was to acquire Ancona’sassets rather than to acquire Elsara’s stock,’’ thecourt held, finding that the ‘‘more appropriatecharacterization’’ of the guaranties was that theywere given in connection with an asset acquisition.

Although the three-year limitations period forassessment expired, the IRS sought to rely on thesix-year period, which required a showing that thepetitioners failed to report gross income in excess of25 percent of the amount reported on the 2003return. Despite their contention, the amounts inquestion were not disclosed in the return, the courtheld in allowing the six-year assessment period.

‘‘Petitioners’ primary argument is flawed in thatit rests on the proposition that petitioners’ disclo-sure of the rollovers as tax-free is sufficient to putrespondent on notice that petitioners engaged in theprohibited transactions,’’ the court held. ‘‘The 2003joint return therefore offers not even a clue as to theexistence, nature, or amount of any omitted income.We conclude that a reasonable person would notdiscern from the 2003 joint return that petitionersomitted any gross income for 2003.’’

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Tax Court Issues Proposed andInterim Rules for Tax Law Changes

By Nathan J. Richman —[email protected]

The Tax Court released March 28 a batch ofproposed and interim rule changes to account forchanges in three pieces of tax legislation from theend of 2015, including interest abatement, partner-ship audits, and passports.

The rules relate to amendments made by theBipartisan Budget Act (BBA) of 2015 (P.L. 114-74),the Fixing America’s Surface Transportation Act(FAST Act) (P.L. 114-94), and the tax extenders bill(P.L. 114-113). The Tax Court asked for comments byApril 30. This is the second set of rule changesrelated to the extenders bill that the Tax Court hasreleased this year. (Prior coverage: Tax Notes, Mar. 7,2016, p. 1117.)

The BBA changes are proposed rules adding atitle governing the new default partnership auditregime, which will replace the 1982 Tax Equity andFiscal Responsibility Act and allow the IRS to assessand collect tax due on partnership adjustments atthe entity level. The proposed rules set out theprocedure for petitioning the Tax Court on a noticeof final partnership adjustment under section6231(a)(3), as well as those for joinder, pleadings,and the effect of the Tax Court’s decision on thepartnership and its partners. The Tax Court pro-posed those rule amendments because, while part-nerships may elect to apply the new rules early fortax years starting between November 3, 2015, andDecember 31, 2017, ‘‘it is unlikely that a petition towhich those amendments would apply will be filedin the near future,’’ according to the explanation inthe release. (Prior coverage: Tax Notes, Mar. 21, 2016,p. 1398.)

Miriam L. Fisher of Latham & Watkins LLP saidthat the new regime, replacing the tax matterspartner with a partnership representative and as-sessment of tax liabilities at the partnership level,required a new process for the partnership repre-sentative to file a petition in response to a finalpartnership adjustment. The proposed rules containstandard procedures accounting for the new re-gime, she said. ‘‘You have a new person who is theonly person authorized to file [the petition], it’s apartnership-level proceeding that only the partner-ship is participating in, so while it’s a little different[from TEFRA], the basic procedural mechanics forfiling a petition are the same,’’ she said. (Priorcoverage: Tax Notes, Nov. 2, 2015, p. 644.)

The FAST Act changes similarly create a new titleto govern challenges to IRS certification decisions.

Under section 7345, the IRS submits a certificationthat a taxpayer has a ‘‘seriously delinquent taxdebt’’ to Treasury, which passes that certification onto the State Department. It is the State Departmentthat chooses whether to deny, revoke, or limit ataxpayer’s passport at that point — the only IRSdecision, and thus the only decision subject to apetition in the Tax Court, is the certification, orfailure to reverse a certification, that the taxpayerhas a ‘‘seriously delinquent tax debt.’’ (Prior cover-age: Tax Notes, Dec. 14, 2015, p. 1365.)

The certification rules and thepartnership audit rules are proposed,rather than interim, because the TaxCourt does not expect those petitionsany time soon.

Like the partnership audit changes, the proposedcertification rules create new procedures for peti-tioning the Tax Court over an IRS certification orfailure to reverse a certification. The certificationrules are proposed, rather than interim, for the samereason as the partnership rules: The Tax Court doesnot expect those petitions any time soon.

Fisher said that the proposed certification peti-tion rules are necessary because the addition ofsection 7345 ‘‘creates new jurisdiction for the TaxCourt to hear an action which never existed before.’’She said that the proposed rules adopt normalprocedures for the new type of petition.

Michael J. Desmond of the Law Offices of Mi-chael J. Desmond said, ‘‘While the proposed rulesgoverning those proceedings look relativelystraightforward, when Congress has in the pastexpanded the court’s jurisdiction into a . . . newarea, a significant amount of litigation has followedas taxpayers, the IRS, and the courts wrestle withissues that Congress may not have fully consid-ered.’’

Interim RulesIn contrast to the BBA and FAST Act changes, the

Tax Court amended its rules in accordance with thetax extenders bill on an interim basis because it ‘‘hasdetermined that there is an immediate need toadopt the interim amendments,’’ although the sameprovisions are also proposed rules to allow forpublic comment. The interim rule changes relatedto the tax extenders include adoption of the FederalRules of Evidence in section 7453, the inclusion ofinnocent spouse relief and levy collection due pro-cess appeals under sections 6015 and 6330 in thebankruptcy suspension of the period to file a peti-tion, and the ability to petition a request to abate

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interest after 180 days have elapsed in addition toan explicit denial. (Prior coverage: Tax Notes, Jan. 4,2016, p. 60.)

The replacement of the rules of evidence used inthe U.S. District Court for the District of Columbiawith the general Federal Rules of Evidence has theeffect of applying the Golsen rule (named for Golsenv. Commissioner, 54 T.C. 742 (1970), aff’d, 445 F.2d 985(10th Cir. 1971)) to evidence issues as well assubstantive law issues. Under the Golsen rule, theTax Court applies the case law of the circuit towhich the petitioner’s case is appealable.

Because it applies to cases already pending in theTax Court after December 18, 2015, ‘‘to the extentthat it is just and practicable,’’ Desmond said thatthe change in the rules of evidence could have animmediate effect. ‘‘It will be interesting to see if anycases trigger the transition rule, particularly onissues like work product protection where theremay be a split in circuit court authority,’’ he said,referring to the circuit split between United States v.Textron, 577 F.3d 21 (1st Cir. 2009), cert. denied, 130 S.Ct. 3320 (2010), and United States v. Deloitte LLP, 610F.3d 129 (D.C. Cir. 2010).

The interim, and proposed, interest abatementpetition rules split the previous rules for petitionsfrom an affirmative denial by the IRS to addressboth denial and lapse of 180 days. Fisher said thatthe two roads to the Tax Court jurisdiction (denialor time lapse) now mimic the two roads for non-TaxCourt jurisdiction over refund claims.

Pro Bono Clinic Days Offer NewOption to Help Pro Se Petitioners

By Nathan J. Richman —[email protected]

Taxpayers seeking help navigating the Tax Courtnormally have two options: low-income taxpayerclinics (LITCs) or calendar call volunteer programsgenerally on the day of the trial session. Taxpayerswith incomes that don’t meet the qualifications forthe LITCs generally have few options for pro bonohelp before they set foot in court.

A Maryland pro bono clinic day could changethat. The pro bono day provides free tax advice andthe chance to talk with an IRS representative two tothree months before the Tax Court’s calendar call,according to Cheri P. Wendt-Taczak of Kelly DorseyPC. The program, which now rotates between thedowntown Baltimore LITC offices of the Universityof Maryland and the University of Baltimore, wasfirst launched in July 2013 by the Maryland Volun-teer Lawyers Service (MVLS), the University ofMaryland LITC, and the Maryland State Bar Asso-ciation (MSBA) Tax Section Pro Bono Committee,she said.

The program emerged from a March 2013 MSBATax Section study group meeting. Wendt-Taczak,then the program attorney for the LITC at MVLS,and Nancy M. Gilmore, associate area counsel (Bal-timore), IRS Small Business/Self-Employed Divi-sion, were discussing calendar calls and pro sepetitioners. Wendt-Taczak raised the possibility of‘‘providing something similar to the calendar callprogram that the court does but [offering] some-thing like that to petitioners ahead of time,’’Gilmore said.

The pro bono day’s sponsors jointly draft a letterfor the IRS to send out to pro se petitioners, usuallyfour or five weeks before the pro bono day, Wendt-Taczak said. The letter, accompanied by an IRScover letter, describes the opportunity for free taxadvice, including the chance to speak with an IRSrepresentative, related to the petitioners’ Tax Courtcases. The letter directs interested petitioners tocontact the MVLS to schedule appointments, shesaid. The letter states that the volunteers will pro-vide advice at the pro bono day but will not enteran attorney-client relationship on that day.

The IRS sends the letter because it cannot providethe petitioners’ addresses to the clinics and volun-teer programs under section 6103 disclosure rules,Gilmore said. The letter is distinct from the stuffernotices the court sends out notifying petitioners ofLITCs and volunteer programs, Wendt-Taczaknoted.

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Beverly Winstead of the LITC at the University ofMaryland Francis King Carey School of Law saidthat pro se petitioners can come to the pro bonodays with the notices they have received from theIRS and their records. If a petitioner falls within aclinic’s income guidelines, the clinic may take thecase, beginning an attorney-client relationship, andenter an appearance before the Tax Court, she said.‘‘But the thing that makes the [pro bono] days really,really great, I think, and beneficial for the LITCis . . . it gives the student attorneys the opportunityto really do thorough research, because we havemore resources to research issues at the pro bonoday than at calendar call, and we are not underpressure like when we are at calendar call,’’ shesaid.

Wendt-Taczak said that the appointments typi-cally last 30 to 45 minutes and provide a betterenvironment for tax advice, with four conferencerooms with large tables to spread out documents,compared with courthouse halls at calendar call.The pro bono day typically runs from 2 to 7 p.m.,she said. Appointments have run as long as twohours, Winstead said.

Gilmore said that she has been the IRS represen-tative at most of the pro bono days so far. She saidshe takes all of the legal files, and as many of theadministrative files as she can, for the cases sched-uled, and that she has a separate office space whereshe stays until one of the petitioner conferences asksfor IRS input. When that happens, someone takesher to the appropriate conference room where shecan provide information such as the IRS view of thecase, what issues have been raised (often needed ifthe petitioner has not retained the notice of defi-ciency or determination letter), and what informa-tion the IRS will need to settle the case, she said. ‘‘Itallows me to explain in shorthand to the otherattorney what’s going on so that that attorney canthen interpret it to the taxpayer,’’ Gilmore said.

While typically more than half of the petitionersat pro bono day ask for IRS input and often havedocuments to show her, Gilmore said that most ofthe time she does not reach a settlement that day. ‘‘Iwill take the documents and tell them what toexpect and when to expect it [or] what else theyneed to provide in addition to what they are givingus now,’’ she said.

Gilmore said that her day at the clinic is similarto her experience dealing with petitioners on theday of calendar call, ‘‘except we have more time tosit down and explain things to the taxpayers. Theyhave more time to understand it, to grasp what’sgoing on.’’

Program ResultsThe Maryland clinic sponsors said that atten-

dance has been consistent and substantial, if not

overwhelming. The benefits to taxpayers have beennoticeable, too, they said.

Wendt-Taczak estimated that one-quarter of thepetitioners who received the letter scheduled ap-pointments and only one or two typically cancel.Over 70 percent of the cases of petitioners whoattended a pro bono day are settled before calendarcall, she said. While the average pro bono day haseight or nine appointments, there have been asmany as 20 and as few as five, Wendt-Taczak said.

Wendt-Taczak estimated thatone-quarter of the petitioners whoreceived the letter scheduledappointments and only one or twotypically cancel.

Gilmore estimated there is a 25 percent responserate with ‘‘very few cancellations’’ and that approxi-mately 80 percent of attendees settle before calendarcall. While the settlement rate is close to the overallsettlement rate for Tax Court cases, the pro bonodays have led to far fewer continuances, she said,adding that almost half of pro se petitioner caseswithout the pro bono day meeting get continued(pushed to a later trial session) when the taxpayerfirst shows up at calendar call but that almost noneof those where the petitioner has been to pro bonoday do.

Some cases get settled at calendar call, Gilmoresaid, ‘‘but it is generally not as favorable to thetaxpayer because we are not able to get as muchinformation to support their position.’’ The moretime the IRS has to get information from the tax-payer, the more likely it will arrive at the correctresult, she said.

One of the biggest problems for the IRS and oneof the impediments to pro bono day attendance isthat petitioners often do not respond to mail fromthe IRS attorneys, according to Gilmore. The prob-lem for pro bono days is that the IRS has to send outthe invitations because of taxpayer privacy con-cerns.

Not only are pro se petitioners often unpreparedto try a case, but often the first time they providedocuments to the IRS is at the calendar call or on theday of trial, Gilmore said. ‘‘It creates a very chaoticscene and usually ends up actually harming thetaxpayer,’’ she said. Pro bono days can allow her toopen up communication between the IRS attorneysand the pro se petitioners, she said. ‘‘The attorneynow has a contact point, and somebody has actuallyspoken with the petitioner to tell them, ‘This iswhat’s going on, this is the attorney that is assignedto the case, you should expect to hear from them,and this is what you need to get to them,’’’ she said.

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Gilmore singled out collection due process hear-ing appeals as one area where the pro bono day canhelp a pro se petitioner. ‘‘A lot of times petitionersdon’t understand what a CDP case really en-tails. . . . They think that the court can give them thecollection alternative that they want; they don’tunderstand that that is not going to happen here,’’she said. Instead, at pro bono day, the volunteerattorneys explain to pro se petitioners that theywould be better off dismissing their cases and filingnew offers in compromise or installment agree-ments, she said.

Eric M. Bielitz, the attorney who organizes theMSBA calendar call volunteer program, praised theresponse from the practitioner community. Eventhough the program is still fairly new and there area few kinks to work out with regard to staffinglevels, ‘‘our issue is not not having enough handsbut having too many hands, which is a wonderfulproblem to have,’’ he said. ‘‘It is not uncommon togenerally have one or possibly two attorneys and acouple of law students helping out some of thesepro se folks at [pro bono day].’’

Bielitz pointed to two additional benefits forpetitioners beyond helping petitioners to under-stand the merits of their cases and to organize theirarguments and documents. First, the volunteers canexplain the basics of the rules of evidence andprocedure, he said. Second, the volunteers can helpease the petitioners’ suspicions of IRS counsel, hesaid, adding that petitioners can be afraid to turnover information the IRS needs in discovery.

Winstead said that even for cases that still go totrial, the pro se petitioners can get a lot out of probono day. Particularly in a substantiation case, thevolunteers can tell the petitioners, ‘‘Bring thesedocuments; this is what a judge is going to ask you;this is the stuff you need to get on the record,’’ shesaid. Pro bono day is a chance for petitioners tomeet with pro bono counsel in a much less stressfulenvironment than the courthouse at the calendarcall, she said.

Ciraolo said the pro bono dayprogram ‘was a success from dayone.’

Caroline Ciraolo, acting assistant attorney gen-eral in the Justice Department Tax Division, waspart of the initial conversation between Gilmoreand Wendt-Taczak while she was at RosenbergMartin Greenberg LLP. ‘‘This would not be a suc-cess without the Baltimore [IRS] office,’’ Ciraolosaid, attributing the success of the program to the

work of Wendt-Taczak and Gilmore as well asWinstead, who was also involved in organizing thepro bono day program.

Ciraolo said the pro bono day program ‘‘was asuccess from day one.’’ The first pro bono dayincluded six pro se petitioners, and several of thosecases were resolved before trial, she said. ‘‘It hasonly been fine-tuned from there,’’ Ciraolo said.

Gilmore said that one of the reasons the programhas been successful could be the geography ofMaryland. ‘‘We are very fortunate in Baltimore thateverything is very close together, so we are able tomake this a single-day event and actually havesomebody on site,’’ she said.

Gilmore said she thought that the act of petition-ers making appointments could have led to thesuccessful turnout for the program. ‘‘I think havingpeople call in to make an appointment makes itmore likely that they will actually appear. . . . Theyget it on their calendar and say, ‘Oh, I have to bethere at this time,’’’ she said.

‘‘One of the reasons for the success of this pro-gram is because so many of the Maryland law firmssupported their attorneys’ participation,’’ Ciraolosaid.

Expansion and ReactionsPro bono day in Baltimore has been well received

by the IRS, practitioners, and even the Tax Court,and similar programs are being tried all over thecountry.

Gilmore said that other cities have been tryingprograms similar to Baltimore’s pro bono day pro-gram. ‘‘Different people throughout the last coupleof years have contacted me to ask for our experi-ence,’’ she said.

Thomas Travers, assistant division counsel (taxlitigation), SB/SE, said, ‘‘We have had pro bonodays (or nights) in other cities, including Los Ange-les and Seattle.’’ He said that these other attemptsoften involve variations, such as video conferenc-ing.

Travers said that one of the main obstacles hasbeen the reluctance of pro se petitioners to meetwith the IRS or prepare for trial before the actualcalendar call. The programs have been successful tothe extent that those who have participated havebeen satisfied with the results in general, he said,‘‘but trying to increase the participation is thechallenge.’’

Tax Court Chief Special Trial Judge Peter J.Panuthos has encouraged the bar to find more waysto help pro se litigants. ‘‘The Tax Court is verysupportive of measures that help pro se petitionersresolve their tax issues more effectively and effi-ciently,’’ he told Tax Analysts. (Prior coverage: TaxNotes, May 19, 2014, p. 800.)

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Guinevere Moore of Johnson Moore LLC saidvolunteers have tried to hold pro bono days inChicago, but ‘‘unfortunately, the petitioners justdon’t come.’’ When it does work, though, she said,it could both help achieve a fairer settlement andhelp petitioners arrive at trial better prepared topresent their cases.

Moore highlighted a separate important benefit ifthe pro bono day is at least 30 days before thecalendar call: the opportunity to present a section7430(g) qualified offer. A qualified offer must bemade more than 30 days before trial and allows anaward of fees, even for pro bono services, treatingthe taxpayer as the prevailing party as long as thetotal outcome is less than what the taxpayer offeredthe government to settle. A qualified offer is gener-ally not an option for pro bono representation (asopposed to LITC representation) because the peti-tioner and pro bono counsel often first meet atcalendar call, which can be the day of trial. (Priorcoverage: Tax Notes, Mar. 7, 2016, p. 1118.)

‘‘I find qualified offers to be a helpful settlementtool, and I think that creating a way to use that tooleven if the attorney and the petitioner meet for thefirst time at the call would be a worthy use of timeand effort,’’ Moore said. The 30-day qualified offerperiod does not reflect the realities of calendar call,she said.

Andrew R. Roberson of McDermott Will & Emerysaid, ‘‘I think a lot of clinics around the country aretrying to do this with pro se taxpayers to see if theycan resolve issues before the calendar call.’’ He saidthat many times, early resolution depends on edu-cating petitioners on tax procedures and the docu-mentation they need to give to the IRS. Somepetitioners think the calendar call is when they aresupposed to first meet with the IRS, not realizing thattrial might be that week or even that day, he said.

Roberson said, ‘‘The Tax Court does a great job ofputting the information out there in basic terms forpro se taxpayers, but the legal process, whether inTax Court or elsewhere, can be very confusing topeople, and a layperson might not understand howthe process works.’’

In a written statement to Tax Analysts, theAmerican Bar Association Section of Taxation andits Pro Bono and Tax Clinics Committee said, ‘‘Weapplaud the efforts of these volunteers and IRScounsel to reach settlements in appropriate caseswithout the need for trial or involvement by the TaxCourt . . . and the ability to meet with pro se tax-payers prior to the calendar call is an important stepin ensuring that all taxpayers pay only the amountof tax that is legally due.’’

Jennifer E. Breen and Sheri A. Dillon of Morgan,Lewis & Bockius LLP are two of the new directorsof the Washington DC Center for Public Interest Tax

Law, the organization that helps match pro bonoattorneys with pro se petitioners. They said thatthey would be interested in a pro bono day programif IRS area counsel is interested. ‘‘We’d like to seewhat the best practices are and try to do somethingsimilar,’’ Dillon said. (Prior coverage: Tax Notes,Mar. 7, 2016, p. 1123.)

Breen said that she could see the benefit ofmeeting with pro se petitioners before the Tax Courttrial session. ‘‘I think that it would be a better use ofresources, especially the Tax Court’s, if they are ableto get some sort of resolution earlier,’’ she said.

Dillon said that the program could alleviate aninefficient use of court, IRS, and taxpayer resourcescaused by the delay of a continued case. Theywould want to know ‘‘why it worked well in onelarge city but not in others,’’ she said.

Dillon said that the program couldalleviate an inefficient use of court,IRS, and taxpayer resources causedby the delay of a continued case.

T. Keith Fogg, director of the federal tax clinic atHarvard Law School, said that he had been part ofan effort to launch a pro bono day program inPhiladelphia while at Villanova University but thatpetitioners did not participate that day. He saidhaving the IRS send a letter notifying petitionersabout the clinic and using relatively inaccessible IRSoffices in downtown Philadelphia could have ham-pered the effort. ‘‘You have to find a place to hold itthat’s convenient to the people who might be com-ing,’’ he said.

Fogg said that resolving the case more than 15days before trial would save the IRS attorneys fromhaving to prepare pretrial memoranda and motionsto dismiss for lack of prosecution. He said that thejudges also benefit from having fewer cases in atrial session and would be able to better managetravel away from Washington.

In addition to those in Seattle and Los Angeles,Fogg said that he has heard of a successful programin Miami that uses multiple sites and video confer-encing.

The pro bono day clinic is ‘‘another tool, and itsounds like a promising tool if we get the rightplaces and the right time so that it’s convenient fortaxpayers,’’ Fogg said.

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Group Portrays Case asLast Hope Against Dark Money

By Paul C. Barton — [email protected]

Public Citizen says in a new fundraising appealthat its pending lawsuit against the Federal ElectionCommission represents a legal last stand against theproliferation of undisclosed political spendingthrough politically oriented nonprofits and othergroups.

The advocacy group says oral arguments in themore than two-year-old case could come as early asMay in the U.S. District Court for the District ofColumbia. The case involves the FEC’s handling ofthe classification of Crossroads GPS, a group re-cently granted official section 501(c)(4) social wel-fare status by the IRS. (Prior coverage: Tax Notes,Feb. 15, 2016, p. 759.)

‘‘If we win in court, it will take a serious bite outof Citizens United and all the Dark Money groupscorrupting our democracy,’’ Robert Weissman,president of Public Citizen, said in the March 28fundraising email. But he added, ‘‘If we lose thislawsuit, the Dark Money groups will have a greenlight to continue abusing Citizens United to lock inever more power for their plutocratic puppet mas-ters.’’

‘If we win in court, it will take aserious bite out of Citizens Unitedand all the Dark Money groupscorrupting our democracy,’ Weissmansaid.

The reference is to the 2010 Supreme Courtdecision in Citizens United vs. FEC, 558 U.S. 310(2010), which held that corporations could spendunlimited amounts on politics as long as they werenot donating to particular candidates. The case iscredited with spurring political activity throughsection 501(c)(4) groups, which are not required topublicly disclose donors. Such spending is widelyreferred to as dark money.

In its lawsuit, Public Citizen accuses the FEC ofdereliction of duty in not declaring that CrossroadsGPS had acted in 2010 more like a section 527political committee, requiring disclosure of donorsunder campaign finance laws. The FEC insteaddeadlocked on the matter in December 2013 anddismissed the case. Public Citizen, leading a groupof campaign finance reform advocates, then filedsuit. (Prior coverage: Tax Notes, Dec. 1, 2014, p. 989.)

Crossroads GPS won the right to intervene in thecase in June 2015. It is now regarded as anintervenor-defendant. (Prior coverage: Tax Notes,June 15, 2015, p. 1269.)

Election Code IssueCraig Holman of Public Citizen told Tax Analysts

that the IRS decision on Crossroads would have nobearing on the lawsuit. ‘‘The [501(c)(4)] issue is a taxcode issue overseen by the IRS,’’ he said. ‘‘PublicCitizen’s lawsuit is an election code issue overseenby the FEC. The case is whether Crossroads GPSshould declare that it has as its major purpose theconduct of federal election activity and that the FECitself is negligent in its duties by not making adecision on this question in compliance with estab-lished law and its own rules.’’

But in February, Holman said of the IRS decision:‘‘What I’m counting on is that a number of Cross-roads and IRS records used in the application [forsection 501(c)(4) status] are about to be made public.We may find some useful information for the law-suit.’’ (Prior coverage: Tax Notes, Feb. 29, 2016, p.984.)

Tara Malloy of the Campaign Legal Center,which is providing legal help to the Public Citizengroup, said ‘‘it would have been nice’’ if the IRS haddenied social welfare status to Crossroads, addingthat that shouldn’t affect findings under electionlaw. ‘‘These are really two very different bodies oflaw,’’ Malloy said.

David Keating, president of the Center for Com-petitive Politics, said he sees little chance of PublicCitizen succeeding. ‘‘At most the court is going tosend it back to the FEC and say, ‘Do it over,’’’ hesaid in an interview. ‘‘I think the courts are gener-ally going to defer to the FEC’s judgment on this.’’

The lead attorney for Crossroads in the case,Thomas W. Kirby of Wiley Rein LLP, did notrespond to a request for comment.

But in a recently filed motion seeking dismissalof the lawsuit, Crossroads argues that Public Citi-zen bases its case on a method of calculatingpolitical activity never mentioned by the FederalElection Campaign Act (FECA) of 1971. PublicCitizen contends that Crossroads’ Form 990, ‘‘Re-turn of Organization Exempt From Income Tax,’’ for2010 and other information make clear that it spentwell over half of its funds that year on politics. ButCrossroads, which was started by GOP politicaloperatives Karl Rove and Ed Gillespie in June 2010,argues that FECA says nothing about measuringpolitical activity by a ‘‘single-calendar-year metric.’’

It adds: ‘‘Using any other available measuringperiod, such as Crossroads GPS’s disbursementscollectively during 2010 and 2011 or during its firstfiscal year, the opposite balance is seen. Becauseneither FECA nor court precedent commands a

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narrow, rigid calendar-year approach to consider-ing an organization’s major purpose, the controllingFEC Commissioners reasonably refused to engineertheir analysis in that artificial way.’’

In its fundraising appeal, Public Citizen says thatin less than six years, Crossroads spent $142 millionon politics. ‘‘Folks, this is a defining moment,’’ saidWeissman. ‘‘We are taking on both the federalgovernment and one of the all-time worst exploitersof Citizens United.’’

Trump Attorneys DescribeIRS ‘Examinations’

By Paul C. Barton — [email protected]

Republican presidential front-runner DonaldTrump on March 30 released a letter from hisattorneys that purports to explain what he hasportrayed as nonstop IRS audits of his tax returns.

Trump has pointed to ongoing audits over thepast 12 years as preventing him from releasingcopies of his tax returns, even though several otherpresidential candidates, including his two remain-ing rivals for the GOP nomination, Sen. Ted Cruz ofTexas and Ohio Gov. John Kasich, have releasedtheirs.

But many tax law practitioners and academics —as well as the IRS itself — have said that beingunder audit does not bar someone from releasing areturn. (Prior coverage: Tax Notes, Mar. 7, 2016, p.1083.)

But many tax law practitioners andacademics — as well as the IRS itself— have said that being under auditdoes not bar someone from releasinga return.

However, the March 7 letter, from Sheri A. Dillonand William F. Nelson of Morgan, Lewis & BockiusLLP, does not use the word ‘‘audit.’’

Instead, it describes Trump’s business empire asspanning roughly 500 entities collectively called theTrump Organization. ‘‘These entities engage in hun-dreds of transactions, deals, and new enterprisesevery year,’’ they wrote. ‘‘Because you operate thesebusinesses almost exclusively through sole propri-etorships and/or closely held partnerships, yourpersonal federal tax returns are inordinately largeand complex for an individual.’’

As a result, they said, his returns have beenunder ‘‘continuous examination’’ since 2002, ‘‘con-sistent with the IRS’s practice for large and complexbusinesses.’’ The examinations for 2002-2008 havebeen closed ‘‘without assessment or payment, on anet basis, of any deficiency.’’

The letter then says examinations of returns foryears 2009 forward are ongoing and involve ‘‘con-tinuing transactions or activities’’ that were alsoreported on Trump’s returns for 2008 and earlier.‘‘In this sense, the pending examinations are con-tinuations of prior, closed examinations,’’ the lettersays.

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‘‘This is incomprehensible,’’ Neil H. Buchanan,professor of tax law at George Washington Univer-sity, told Tax Analysts. ‘‘As far as I can tell, they aretrying to say that he was not caught doing anythingbad before 2009, because those investigations areclosed, but that none of the returns can be released,because the older transactions are somehow rel-evant to the current audits. . . . This is, as far as I cantell, deliberately vague.’’

Jay Soled, tax law professor at Rutgers Univer-sity, said many large businesses have to maintain ‘‘abuilt-in office for the IRS’’ because ‘‘whatever theyhave going on requires constant oversight.’’ Soledsaid he suspects the IRS’s overarching concernabout Trump’s returns involves whether they arereporting all his income. There is a six-year statuteof limitations on substantial understatement of in-come, defined in section 6501(e) as 25 percent ormore, and that may explain the 12-year span, hesaid, as well as why still-pending examinationscould refer to what was reported on earlier returns.

Soled has also speculated that the IRS might beconcerned about any captive insurance arrange-ments Trump might have. The IRS has long beenwary of them because of their potential to serve asa tax dodge. (Prior coverage: Tax Notes, Mar. 21,2016, p. 1381.)

Anthony J. Nitti, CPA at WithumSmith + Brown,said the letter ‘‘seems to choose its language care-fully. It refers to ‘continuous examination,’ whichmeans that Trump’s return is likely reviewed eachand every year by the IRS, which does not happento all taxpayers.’’ But Nitti added that that does notmean Trump is under continuous audit. ‘‘I thinkthey use the word ‘examination’ rather than auditby design, because most people who read that willthink they are one and the same,’’ he said.

Bottom line, ‘‘to me this is a well-crafted excusefor not releasing any returns,’’ Nitti said.

Calculator EstimatesCandidates’ Tax Hits

By William Hoffman —[email protected]

With a few simple numbers and a click of yourmouse, you can get a glimpse of how much, onaverage, your federal tax liability would be underfour presidential candidates’ tax plans.

The Urban-Brookings Tax Policy Center (TPC)and the online news site Vox teamed up to providea simple calculator for individual taxpayers curi-ous whether real estate developer and Republicanfront-runner Donald Trump’s plans to slash incometax rates and social safety net programs would netyou a better tax bill than the proposal by Demo-cratic candidate Sen. Bernie Sanders, I-Vt., to raisetaxes on almost everyone — especially the rich —while expanding government programs.

The online calculator, posted March 25 and in-spired by a request from Vox and fortified with theTPC’s data and expertise, asks only for the taxpay-er’s 2015 adjusted gross income, whether the tax-payer is single or married, and how many children(none, one, or two-plus) are in the household.

‘This is more of an average across arange of incomes and familycategories,’ Williams said.

‘‘It’s not really a tax calculator where you put ina certain set of numbers and out comes your tax,’’said Roberton Williams, senior fellow at the TPC.‘‘This is more of an average across a range ofincomes and family categories.’’

The TPC posted its own presidential candidates’tax calculators in 2008 and 2012, after the partiesmade their nominations, Williams said. This is thefirst time the center has posted so early, he said,noting that the group still plans to release itspost-convention calculator sometime later this year.

The calculations for the TPC-Vox calculator weremade by analyzing the five remaining major candi-dates’ tax plans, Williams said. Ohio RepublicanGov. John Kasich’s plan was too vague, so he hasbeen left out, but plans from Trump, Sanders,Democratic former Secretary of State Hillary Clin-ton, and Texas Republican Sen. Ted Cruz providedenough to start, he added.

The TPC sent questionnaires to the latter fourcandidates in an effort to increase the plans’ speci-ficity, Williams said. Clinton and Sanders replied;

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Trump and Cruz did not, he said. ‘‘We had enoughdetail to evaluate the plans with some precision,’’he added.

The Vox-TPC calculator leaves out a whole rangeof deductions, exemptions, itemizations, and otherstaples of tax return practice and preparation, Wil-liams noted. It includes individual income taxes,payroll taxes, excise taxes, and corporate incometaxes. The TPC plans to post to its website the tablesthat support the Vox-TPC calculator, which willallow visitors to see clearly what the calculator canand cannot do, he said.

The Tax Foundation is also launching a taxcalculator soon, which will be posted on the USAToday website, said Kyle Pomerleau, the founda-tion’s director of federal projects. The Tax Founda-tion’s calculator will best serve individual wageearners, allowing them to estimate not only their taxliability under various candidates’ plans, but alsotheir eligibility for some credits, such as the earnedincome tax credit, Pomerleau said.

Calculations for investment, real estate, and othertypes of income won’t be supported, Pomerleausaid. ‘‘But for the majority who rely on wage income,not a plethora of itemized deductions, it will showhow your tax bill will change,’’ he said.

Hudson Institute Tax Plan StrivesFor Fiscal and Political Balance


Tax economists and public policy researchersagreed March 30 that a new Hudson Institute taxplan offers a more fiscally responsible and politi-cally realistic roadmap for tax reform than many ofthe current crop of Republican and Democraticpresidential candidates’ proposals.

Each candidate’s tax plan tries to balance abewildering variety of competing political, eco-nomic, and fiscal interests, said Kyle Pomerleau ofthe Tax Foundation during a panel discussion at theHudson Institute in Washington.

Each candidate’s tax plan tries tobalance a bewildering variety ofcompeting political, economic, andfiscal interests, said Pomerleau.

‘‘Generally on the Republican side, the focus intax policy has been on fundamental tax reform,’’including reducing marginal income and corporatetax rates, said Pomerleau. ‘‘The Democrats havebeen less interested in fundamental reform andmore interested in new programs,’’ with highertaxes either on everyone or mostly on upper-incomeearners, he said.

The Hudson Institute’s Main Street Tax Plan‘‘attempts to balance all these things — get someprograms [started] in there, with some features thata lot of reformers want, but make sure that it paysattention to the politics and the arithmetic of fiscalpolicy,’’ Pomerleau said.

The Hudson plan’s author, Jeffrey H. Anderson,said most presidential candidates’ tax plans wouldbenefit the top 1 percent of income earners morethan typical Americans and that most would bal-loon the federal debt. The Hudson plan will spureconomic growth, ‘‘clearly benefit the typicalAmerican,’’ and improve the nation’s fiscal situa-tion by allowing the economy to grow its way out ofdebt, he said.

The Hudson plan would eliminate the Medicarepayroll tax for employers and employees and fundMedicare from general revenues, make the topindividual income tax rate 33 percent, create a new20 percent individual rate to prevent the shock oflow-income earners moving directly from the cur-rent 15 percent bracket to the 25 percent bracket,and cut the child tax credit by half while increasingthe child care tax credit.

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For businesses, the Hudson plan would reducethe corporate tax rate to 25 percent, allow full ex-pensing of capital investments, and end interna-tional business tax deferrals while taxing foreignprofits at one-third the difference between the U.S.and foreign corporate tax rates. In the short term, theplan would deem repatriation of previously de-ferred profits to be taxed at one-half the differencebetween the current U.S. rate of 35 percent and theapplicable foreign tax rate, payable over a decade.

Anderson said the Tax Foundation estimated thatthe Hudson plan would result in economic growthof $2 trillion over a decade. The typical Americanwould see benefits twice as large as the top 1percent, according to the Tax Foundation’s scoring.And while the plan would provide a $1.1 trillion taxcut, over 10 years it would increase federal rev-enues by $679 billion ‘‘as a result of the taxes on theincreased growth being greater than the lost rev-enue from the tax cuts themselves,’’ Anderson said.

‘Within the Realm of Reality’‘‘What’s good about this plan is that it makes a

decision to try to present something that could beadopted,’’ said Alan D. Viard of the AmericanEnterprise Institute. ‘‘It’s more than just tinkering. Itoccupies an intermediate space, which makes sig-nificant changes but not absolutely radical restruc-turing of the system.’’

Given both the demands for revenue neutralityand continuing support for popular governmentprograms, the Hudson plan does not propose mar-ginal tax rate cuts of a magnitude contemplated bymany GOP tax proposals, Viard noted. Nor does itsubstantially reduce what he called the ‘‘work dis-incentives’’ of the current tax system, he added.Nevertheless, noting that the plan reduces savingsand investment disincentives with full expensing ofcapital investments, lower corporate tax and estatetax rates, and other changes, Viard said, ‘‘I thinkthis plan measures up pretty well.’’

Eric Toder, co-director of the Urban-BrookingsTax Policy Center, challenged a central assumptionof the Hudson Institute’s plan, saying, ‘‘I think thetax system raises insufficient revenue. I think we’velearned in this [presidential campaign] that Repub-lican voters particularly don’t want to touch entitle-ments, don’t want to touch Social Security andMedicare. And we’re not going to be able to, withthe aging of the baby boomers . . . get the deficitunder control without higher taxes, unless we dosomething about Social Security and Medicare.’’

The Hudson plan makes some progress in reduc-ing what Toder called ‘‘gratuitous complexity’’ inthe tax code by eliminating phaseouts and reducingthe alternative minimum tax, although he ques-

tioned the continued need for the AMT under theHudson plan, which removes the state and local taxdeduction, reducing the amount the AMT wouldcollect. Toder added that he likes the plan’s inter-national tax reform components, although he saidthey do not resolve the trade-off embodied in thecurrent U.S. hybrid territorial and international taxsystem. ‘‘On a positive note, this is certainly, unlikemany of the other plans, one that’s within the realmof reality,’’ Toder said.

Who Cares?Henry Olsen, senior fellow at the Ethics and

Public Policy Center, said Republican tax reformplans should be geared less toward promotinggrowth and more toward resolving the GOP’s long-standing political problem.

‘‘The broad Republican problem is that peopleknow the Republicans care about money,’’ Olsensaid. ‘‘They don’t know that [Republicans] careabout life. So the Main Street Tax Plan, I think,needs to be measured in light of the degree to whichit talks less about money and more about life, theway a person would perceive that. And on this, Ithink the Main Street Tax Plan has a number ofgreat advantages over any of the tax plans that arebeing offered by any of the Republican presidentialcandidates.’’

Eliminating the Medicare payroll tax would putmore money into lower-income taxpayers’ pockets,Olsen said. Increasing the child care tax credit ‘‘tellspeople in the working class that we understand thatraising children is something that’s expensive, issomething that’s necessary, and we’re here to helpyou out,’’ he said, adding that the new 20 percentindividual income tax bracket has a similar effect inshowing lower-income taxpayers that the GOP rec-ognizes their financial struggles.

Even cutting corporate rates and permitting fullexpensing ‘‘tells the average American that ourpriority is your priority, that we care about peoplelike you, and we’re going to bring the people whohelp you out back home to America, rather thanpunitively allowing them — or actually kickingthem out the door to go somewhere else,’’ Olsensaid.

Toder said that when it comes to the particularsof tax reform — whether the Medicare tax should bereduced, or what the corporate tax rate should be —most American taxpayers are uninformed andtuned out.

‘‘I think the public cares about the size of the taxburden, and they care about how big government isand how small government is,’’ Toder said. ‘‘But I

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think when we start getting into the weeds, I don’tthink we gain much by appealing to public opin-ion.’’

Correction: April 4, 2016: The original article mis-quoted Viard’s reference to the work disincentives he saidwere involved in the current tax system.

States Largely Ignored in FederalTax Reform Plans, Panel Says

By Jonathan Curry — [email protected]

Given the challenges of accomplishing any sortof tax reform at the federal level, policymakersoften give little thought to the effects that their taxreform proposals will have at the state and locallevel, according to panelists speaking March 31.

‘‘Tax reform doesn’t happen in a vacuum,’’ mod-erator Liz Farmer of Governing magazine said at aforum hosted by the Urban Institute State and LocalFinance Initiative and the Urban-Brookings TaxPolicy Center. Panelists agreed that the ripple ef-fects of federal tax policies are not felt uniformlyacross the many state tax codes.

‘Tax reform doesn’t happen in avacuum,’ Farmer said.

A carbon tax, for example, would have a signifi-cantly greater effect on states that mine and pro-duce carbon products, said Frank Sammartino ofthe Tax Policy Center. Likewise, proposals to elimi-nate the federal deduction for state and local taxeswould recoup nearly $500 billion in federal revenueover the next five years, but ending the deductionwould have a disproportionately stronger effect onstates that have high income taxes, particularly inNortheastern states like New York. ‘‘It’s a blue-state, red-state thing,’’ he added.

According to Sammartino, states will respond toan increase or decrease in their revenues, and placeslike California have responded to the state and localtax deduction, which he called a ‘‘subsidy to stateand local governments,’’ by raising taxes on theirhigh-income taxpayers, knowing that most stateand local tax deductions are claimed by taxpayerswith incomes over $100,000. The state tax increasewould be largely offset by the federal tax deduction,he said. A March 31 report by the Tax Policy Centerexamines the effect that eliminating the state andlocal tax deduction would have on the revenue andspending of state and local governments.

State and Federal Taxes LinkedJeffrey Friedman of Sutherland Asbill & Brennan

LLP said that states often ‘‘hitch their wagons’’ tofederal tax policy, which benefits the states bysimplifying the administration of their own taxcodes and saves them from having to design rules.State constituents tend to prefer conformity be-tween federal and state tax codes because it makesfiling tax returns simpler, he said.

TAX ANALYSTSBOARD OF DIRECTORS

Christopher E. BerginTax Analysts

Falls Church, Virginia

Thomas L. EvansKirkland & Ellis LLP

Chicago, Illinois

Lawrence B. GibbsMiller & ChevalierWashington, D.C.

David J. KautterRSM US LLP

Washington, D.C.

Larry R. LangdonMayer Brown LLP

Palo Alto, California

Richard G. LarsenDistinguished Professor of Accounting

George Mason UniversityRetired Partner

National Tax DepartmentEY LLP

Fairfax, Virginia

Martin Lobel, Esq.Lobel, Novins & Lamont LLP

Washington, D.C.

Pamela F. OlsonPwC LLP

Washington, D.C.

Deborah H. SchenkNYU School of Law

New York, New York

Arthur W. WrightProfessor Emeritus of Economics

University of ConnecticutStorrs, Connecticut

Eric M. ZoltUCLA School of Law

Los Angeles, California

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Friedman added, however, that the federal gov-ernment does not have to balance its budget andcan use deficit spending to enact expensive taxpolicies, while state budgets are more limited andmay require balancing under a constitutional man-date.

The bottom line for senior elected officials is howa federal tax proposal will increase or decreaserevenue, said Scott Pattison, executive director andCEO of the National Governors Association.

Pattison stressed the importance of tax-exemptmunicipal bonds for states, adding that proposals tomodify tax-exempt bonds are seen less as a taxreform debate and more as an infrastructure debate.If Congress does not raise gas taxes, municipalbonds will continue to be a ‘‘critical component ofinfrastructure funding.’’

Elizabeth McNichol, senior fellow at the Centeron Budget and Policy Priorities, said that while itseems states are often ignored in the federal taxreform debate, there are some reasons to be opti-mistic, citing cooperation between state and federalagencies on issues like the earned income tax credit.

ProposalsThe panelists weighed in on various tax propos-

als ranging from those of the presidential candi-dates to more specific policies.

Friedman said a VAT would probably be animprovement over the current system, adding thatthe sales tax used by many states is inefficientbecause it taxes sales between businesses. He alsosaid he didn’t think a VAT-style tax, like the oneproposed by Republican presidential candidate Sen.Ted Cruz of Texas, would be enacted at the federallevel.

McNichol cautioned that sweeping tax reformproposals, such as replacing the income tax with aVAT, would interfere with the ability of states withsales and use taxes to continue collecting thosetaxes. On average 30 percent of state budgets arefunded with federal revenue, and any efforts to-ward revenue-neutral tax reform and deficit reduc-tion would likely shrink state budgets, she said.

Sammartino warned against plans like the oneoffered by Democratic presidential candidate Sen.Bernie Sanders, I-Vt., to raise the tax rate on capitalgains to around 64 percent. ‘‘Raising tax ratessqueezes the states,’’ he said, adding that significanttax increases could result in the federal governmentengaging in ‘‘tax cannibalism,’’ when it begins to eatinto its own tax base.

Pattison and Friedman agreed that states arelooking for Congress to vote on the MarketplaceFairness Act. Friedman said states and large busi-nesses like Amazon largely support the act, and thateven opponents who talk of ‘‘fixing’’ it acknowl-edge some type of legislation is needed.

No Action on ComprehensiveTax Reform in 2016, Survey Says

By Dylan F. Moroses — [email protected]

Divided government will continue to gridlockCongress, preventing any meaningful tax legisla-tion this year, according to an annual tax surveyproduced by the National Foreign Trade Counciland Miller & Chevalier Chtd. and released March30.

‘‘None of this year’s respondents believe taxreform will happen,’’ according to the report, com-piled by surveying top industry stakeholders ontheir thoughts on the prospects for tax action in2016.

The survey results point to the current politicallandscape, in which lawmakers are discussing taxpolicy and reform but little action is being taken,with an administration unwilling to pass legislationfor the short term, said Marc J. Gerson, vice chair ofthe tax department at Miller & Chevalier. ‘‘There isa view that Congress has tried, but it’s not a priorityfor the [Obama] administration,’’ Gerson told TaxAnalysts. Gerson formerly served as majority taxcounsel to the House Ways and Means Committee.

Gerson said he believes that the next president,from either party, could have a pivotal role inprioritizing and eventually enacting tax reform,citing President Reagan’s influence in passing theTax Reform Act of 1986. ‘‘Tax reform being made atop priority of the new administration would be agame changer to the dynamics of tax reform and itsprospects for enactment,’’ Gerson said.

‘When the executives surveyed byMiller & Chevalier talk about taxreform, they mean something verydifferent: substantial tax cuts forthemselves,’ Gardner said.

Republicans dominate as far as which presiden-tial candidate respondents viewed as having themost favorable tax policy for business income, buttwo of the top three — former Florida Gov. Jeb Bushand Sen. Marco Rubio, also of Florida — havedropped out of the race (real estate developerDonald Trump placed second). Nearly 80 percent ofrespondents thought Democratic candidate Sen.Bernie Sanders, I-Vt., would have the worst taxpolicies for business income. Former Secretary ofState Hillary Clinton, the Democratic front-runner,placed second at approximately 11 percent.

Matthew Gardner, executive director for the In-stitute on Taxation and Economic Policy, said the

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survey was essentially created by executives forexecutives. ‘‘It’s hardly surprising that corporateleaders would say Republicans offer the best shot attax reform — but really that just speaks volumesabout what corporate leaders think tax reformmeans,’’ Gardner told Tax Analysts. ‘‘When theexecutives surveyed by Miller & Chevalier talkabout ‘tax reform,’ they mean something very dif-ferent: substantial tax cuts for themselves.’’

Corporate taxes in the United States are ‘‘so low,as a share of the economy, compared to othernations, that a basic benchmark for sensible corpo-rate tax reform should be revenue neutrality,’’something Republicans have historically not sup-ported, Gardner said.

Chris Edwards, director of tax policy studies atthe Cato Institute, said the OECD’s base erosion andprofit-shifting project has resulted in challenges forcorporations. ‘‘The survey reveals that today’s taxexecutives have a more complex political climate tooperate within because negative tax rules can comefrom many different levels of government,’’ he said.

The survey also found that businesses are mostconcerned with rates being reduced and with ‘‘theenactment of revenue-raising provisions withoutoffsetting tax rate reductions.’’ Most executivesthink tax reform should involve a top corporate

statutory rate between 25 and 28 percent and a topindividual rate of 35 percent, according to thesurvey results.

Edwards said he found it interesting that reduc-ing statutory rates ‘‘was far more important thansimplifying the tax code.’’ Nearly 46 percent ofrespondents said rate reduction was the most sig-nificant issue to address through tax reform, com-pared with just 14 percent saying code complexitywas.

‘‘Liberal tax critics often talk as if corporationscan pay whatever rate they want because there aresupposedly so many loopholes in the tax code. Ifthat were true, then these tax executives wouldn’tcare about the statutory rate that much,’’ Edwardssaid.

Moreover, a majority of survey respondents be-lieve Congress is again heading to a tax extendersmeasure at the end of the year to incorporate someof the provisions that were not made permanent inthe 2015 deal (P.L. 114-113). However, just over halfof the survey respondents believe it will come afterthose provisions expire.

The survey also found that House Speaker PaulD. Ryan, R-Wis., is easily considered the mostinfluential figure in tax policy in 2016, followed byHouse Ways and Means Committee Chair KevinBrady, R-Texas, and President Obama.

IRS CHASTISED OVER DELAY IMPLEMENTING HEALTH COVERAGE TAX CREDIT

Senate Finance Committee members SherrodBrown, D-Ohio, and Rob Portman, R-Ohio, criticizedthe IRS for announcing that it would not meet thedeadline to begin issuing payments under thehealthcare coverage tax credit, according to a state-ment released March 30.

The healthcare coverage tax credit is a refundabletax credit available to some individuals to pay 72.5percent of qualified health insurance premiums. Af-ter expiring on January 1, 2014, the credit wasmodified and reinstated by the Trade PreferencesExtension Act of 2015 (P.L. 114-27), signed into lawby President Obama on June 29, 2015. (Prior cover-age: Tax Notes, July 6, 2015, p. 26.)

The credit is available to eligible trade adjustmentassistance (TAA) recipients, alternative TAA recipi-ents, reemployment TAA recipients, eligible PensionBenefit Guaranty Corp. pension payees, and qualify-ing family members. Section 7527 provides thatqualified health insurance providers can receive ad-vance payments of the credit on behalf of eligibleindividuals.

The IRS is required to establish a program to makepayments under section 35 within one year of thelaw’s enactment. Guidance on the IRS website notedthat the agency ‘‘expects to begin making paymentsfor the advance monthly program in January 2017.’’

Brown and Portman said it is ‘‘entirely unaccept-able’’ for the IRS not to meet the legal deadline forthe advance payment program. ‘‘Many of our con-stituents have already had to take out home equitylines of credit, withdraw money from retirementaccounts early, or take other extraordinary measuresto pay for health insurance while the IRS gets the[advance monthly payment] program up and run-ning,’’ they said.

They also said it was unfair for the IRS to give‘‘taxpayers little notice that they won’t be receivingany premium assistance for the second half of theyear — when many are already locked into healthinsurance plans with set payments.’’

IRS Commissioner John Koskinen, in writtentestimony to a March 8 hearing of the SenateAppropriations Financial Services and General Gov-ernment Subcommittee, told lawmakers that thereauthorization of the credit was one of severalunfunded legislative mandates added to the IRS’sworkload during a time of limited resources. (Priorcoverage: Tax Notes, Mar. 14, 2016, p. 1240.)

— Matthew R. Madara

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Ryan’s Comments on DistributionDraw Range of Responses

By Dylan F. Moroses — [email protected]

House Speaker Paul D. Ryan, R-Wis., sparkedvarious responses from lobbyists and tax scholarsafter saying in a recent interview that he does notbelieve that policy proposals should be influencedby distributional tables, which depict how the taxburden is dispersed among income groups in theUnited States.

‘‘I do not like the idea of buying into thesedistributional tables. What you’re talking about iswhat we call static distribution. It’s a ridiculousnotion,’’ Ryan told John Harwood of CNBC onMarch 17. ‘‘What it presumes is life in the economyis some fixed pie, and it’s not going to change. Andit’s really up to government to redistribute the slicesmore equitably. That is not how the world works.That’s not how life works. You can shrink or expandthe economy, and what we want to maximize iseconomic growth and upward mobility so thateverybody can get a bigger slice of the pie.’’

William Signer, executive managing director ofthe Carmen Group, told Tax Analysts that Ryan wasaccurate about the use of distributional tables, butthe perception of inequality poses problems for theRepublican Party and its opponents during anelection year.

‘‘While Ryan is correct — distribution should notbe static, and things change — there would be anoptics issue if revenue neutrality resulted in thosewith higher income brackets having a significantlylower tax burden as a result of reform,’’ Signer said,adding that ‘‘this has been an issue for both sidesduring the campaign.’’

‘By raising the notion of ‘‘staticdistribution,’’ Ryan describes thegrowth and distribution effects of taxpolicy as if they are the same thing.They are not,’ Gleckman said.

Howard Gleckman of the Urban Institute said ina March 23 blog post for the Urban-Brookings TaxPolicy Center that Ryan ‘‘cleverly conflates twoideas: By raising the notion of ‘static distribution,’he describes the growth and distribution effects oftax policy as if they are the same thing. They arenot.’’

Chris Edwards, director of tax policy studies atthe Cato Institute, told Tax Analysts that Congressshould encourage incorporating distributionaltables that include growth effects based on tax

changes, commonly referred to as dynamic scoring.Edwards said static distributional tables pose prob-lems because the resulting data can easily be ma-nipulated to serve a stakeholder’s best interest.

Data issued by organizations like the Tax PolicyCenter are in the form of static distributional tables,based on a ‘‘slice in time,’’ but some agencies, in-cluding the Congressional Budget Office, have theability to include the growth changes, Edwards said,adding that static tables and lifetime distributiontables can show very different pictures of economicgrowth, especially related to consumption-basedtaxes.

‘‘Consumption-based taxes look very bad onthese slice-in-time distribution tables, but actuallyseem successful in distribution tables over a life-time,’’ Edwards said.

Matthew Gardner, executive director of the Insti-tute on Tax and Economic Policy, said that while thearguments between static distribution over a life-time and dynamic scoring are the heart of the issue,static analysis ‘‘gets right to the heart of claims thatlawmakers are pitching when proposing tax breaks.Policymakers focus primarily on who gets the taxcut.’’

‘‘Static distributional tables are the bedrock ofeconomic analysis for tax plans,’’ Gardner said.‘‘Anything else is speculative at best, and moreoften worse.’’

Ryan’s disregard for static analysis, which theInstitute on Tax and Economic Policy relies on forits research, makes his comments on seriously im-proving economic growth seem disingenuous,Gardner said.

‘‘You can’t evaluate the long-term effects withouthaving a grip on the short term. It matters a lot whoyou give tax cuts to right now,’’ Gardner said.

Jared Bernstein of the Center on Budget andPolicy Priorities, in a March 18 op-ed in The Wash-ington Post, criticized Ryan’s view on distributionaltables and his promoting of a traditional conserva-tive policy in which the wealthy shoulder a lesserportion of the tax burden.

‘‘In this regard, distributionally neutral tax plansare actually a low bar. What many would like to seeis more progressive tax reform to offset some of theincrease in pretax inequality,’’ Bernstein wrote. ‘‘Wecan argue whether that’s a reasonable desire, but Ifind it very hard to argue a) what people reallywant is the opposite: more regressive tax plans, orb) families would be better off if they didn’t knowthe impact of tax proposals on their incomes.’’

James Pethokoukis of the American EnterpriseInstitute was also critical of the House speaker in aMarch 18 guest column in The Week that addressedthe rise of Republican presidential candidate Don-ald Trump. ‘‘Not only does Ryan’s position [on

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significant tax cuts for the wealthy] clash with theTrumpist truths of 2016 — his position makes littlesense from a policy standpoint,’’ Pethokoukiswrote. That type of policy affirms the idea that theRepublican Party leadership is disconnected fromvoters and has allowed a ‘‘populist candidate’’ likeTrump to command the race for the GOP presiden-tial nomination, he added.

Roskam to Continue Oversight’sPush for Asset Forfeiture Reform

By Kat Lucero — [email protected]

When Rep. Peter J. Roskam, R-Ill., investigatedthe IRS’s civil asset forfeiture policy, he told agencyofficials they were just like Javert from Les Mis-érables.

‘‘The guy that everybody hates,’’ Roskam re-called in a March 22 interview with Tax Analysts,invoking the villainous police inspector who pur-sues an ex-convict-turned-benefactor in Victor Hu-go’s epic novel about 19th-century French politicsand society.

The IRS was operating in a similarly uncompro-mising manner through its forfeiture program, ac-cording to the chair of the House Ways and MeansOversight Subcommittee, a key watchdog post withjurisdiction over federal tax administration.

For years the IRS had unfairly seized people’sbank accounts, Roskam said. It had accused smallbusiness owners of ‘‘structuring,’’ a serial practiceoften tied to criminal syndicates that involves keep-ing financial transactions under $10,000 to avoid thereporting requirements of the Bank Secrecy Act.

As a result of the subcommittee’s work, the IRSchanged its policy to pursue only cases with signsof wider criminal activity. The IRS also returnedover $150,000 to a North Carolina store owner afterdetermining that the funds had been wrongly con-fiscated, according to a February 19 release from theInstitute for Justice. (Prior coverage: Tax Notes, Feb.16, 2015, p. 869.)

But Roskam wants to do more for individualswho had assets confiscated under the IRS’s oldpolicy. That is why he is working on legislation thatwould force the IRS to review older cases andreturn assets it took from small business owners,specifically targeting the IRS’s policy on structur-ing, the lawmaker said. The legislation would be incontrast to broader measures such as the FifthAmendment Integrity Restoration Act (S. 255), in-troduced in January 2015, which would require acourt hearing within 14 days regarding any prop-erty seized as a result of an alleged structuringviolation. (Prior coverage: Tax Notes, Feb. 2, 2015, p.587.)

Roskam and the subcommittee’s ranking minor-ity member, Rep. John Lewis, D-Ga., requested in aMarch 23 letter that the IRS, Treasury, and theJustice Department review all civil asset forfeiturecases, appropriately remit funds, and give dueconsideration to all pending petitions. The letterwas signed by all members of the subcommittee

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and follows up on a similar request from August2015. (Prior coverage: Tax Notes, Mar. 28, 2016, p.1524.)

IRS Commissioner John Koskinen, however,pushed back March 23, arguing that the IRS hasalready changed its structuring policy after thesubcommittee put a spotlight on some unwarrantedcases. He said the agency would review cases ifrequested and that the bulk of them are judicialcases under the domain of the Justice Department,not the IRS.

Small business owners didn’t realize‘they were running afoul of atechnical banking statute, and all of asudden the IRS shakes them down,’Roskam said.

Early in 2015 Roskam launched an investigationand held hearings on civil asset forfeiture. He saidthe inquiry revealed wrongful convictions that‘‘made no sense whatsoever from an actual justicepoint of view,’’ because there was no underlyingcriminal case. The cases involved small businessowners who didn’t realize ‘‘they were running afoulof a technical banking statute, and all of a suddenthe IRS shakes them down,’’ he said, adding, ‘‘Thisis not a meth lab. It’s not a human traffickingoperation.’’

The full Ways and Means Committee consideredthe work on civil asset forfeiture as one of its majorwins in 2015. Koskinen apologized before the Over-sight Subcommittee for the IRS’s past mistakes andremitted funds to a few affected individuals. TheIRS and the Justice Department also changed theirpolicies so that they would pursue only cases withsigns of criminal activity.

Not Always BipartisanWhile the subcommittee’s ongoing work on civil

asset forfeiture reform has been hailed as bipartisan,some critics say the rest of Roskam’s projects tend tobe politically driven. Oversight Subcommitteemember Joseph Crowley, D-N.Y., told Tax Analyststhat although he has a good working relationshipwith Roskam, some of his hearings have been onissues ‘‘that I don’t really see as moving legisla-tion.’’

Roskam received some criticism at the March 3subcommittee hearing about free speech on collegecampuses. Lewis in his opening statement immedi-ately questioned the hearing’s purpose. ‘‘Mr. Chair-man, I do not understand why we are here,’’ Lewissaid, noting that the subcommittee does not overseefreedom of speech, college curriculum, or schoolresources. Some of the witnesses’ testimony at the

hearing was better suited for hearings in otherHouse committees, Lewis said. (Prior coverage: TaxNotes, Mar. 7, 2016, p. 1103.)

In the interview, Roskam defended his motives.‘‘These speech issues are obviously sensitive andcan be misinterpreted. If an institution like George-town law school is misstating the law, we’ve got achallenge on our hands,’’ he said.

While in law school, Roskam worked in hisparents’ nonprofit organization, which providedcollege scholarships to thousands of students. Thelawmaker claimed that he is not ‘‘an expert by anystretch of the imagination’’ in the area, but he saidthe experience gave him a deeper appreciation ofthe nonprofit sector. ‘‘Our civil society is inextrica-bly linked to our strength as a nation,’’ Roskamsaid. ‘‘We absolutely need a thriving and dynamiccivil society’’ that depends on section 501(c)(3).

One nonprofit-related win in 2015 for the sub-committee chair was the passage of his measurethat permanently prohibited the IRS from imposingthe gift tax on donations to some tax-exempt orga-nizations, including those under section 501(c)(4).The House adopted it earlier in April and includedit as part of the year-end tax and spending package(P.L. 114-113). (Prior coverage: Tax Notes, Dec. 21,2015, p. 1451.)

Roskam served in the Illinois state legislature forover a decade. He was elected to Congress in 2006,replacing his mentor, former Rep. Henry Hyde. Hehas served on the Ways and Means Committeesince 2009 and as Oversight Subcommittee chairsince the beginning of the 114th Congress. He is alsoon the Health Subcommittee.

‘‘As Ways and Means chairman, I worked closelywith Peter on a number of oversight issues,’’ HouseSpeaker Paul D. Ryan, R-Wis., said in a statement toTax Analysts. ‘‘He has been a leader on everythingfrom stopping IRS abuse to reining in Medicarefraud. I appreciate the seriousness and tenacityPeter brings to the subcommittee.’’

Paying for CybersecurityWhile Roskam admits he is not an information

technology expert, he said he does understand the‘‘natural tension’’ between convenience and secu-rity when it comes to taxpayers accessing theirpersonal information online. However, the days ofeasy access ‘‘may be an indulgence,’’ Roskam said,adding that ultimately the federal government mayhave to front-load its IT systems with more security.When asked if he would recommend allocatingadditional funding to IRS cybersecurity because ofthe latest attacks, the lawmaker said, ‘‘I wouldn’tpresume that right now.’’

The IRS has faced budget cuts since 2010, but lastyear Congress agreed to an additional $290 millionfor the agency for fiscal 2016 for the sole purpose of

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improving customer service. Many lawmakers haveresisted providing increased funding primarily be-cause of the IRS’s political targeting controversy.Roskam, who took part in Congress’s investigationof the controversy, said the full committee continuesto seek a ‘‘good assessment’’ of IRS spending. (Priorcoverage: Tax Notes, Dec. 21, 2015, p. 1452.)

A Ways and Means Committee source said ahearing on IRS administration issues may takeplace near the return filing deadline.

Taxpayer RightsRoskam has been an advocate for taxpayers he

sees as victims of IRS abuse, sponsoring measuressuch as the Taxpayer Bill of Rights Act of 2015 (H.R.1058), which also passed as part of the year-end taxand spending package.

Roskam attended a public forum heldby the Taxpayer Advocate Service toget taxpayer input on the IRS’s ‘futurestate’ vision.

On March 9 Roskam attended a public forum inhis congressional district with National TaxpayerAdvocate Nina Olson, the second of several eventsacross the country planned by the Taxpayer Advo-cate Service to get taxpayer input on the IRS’s‘‘future state’’ vision. (Prior coverage: Tax Notes,Mar. 14, 2016, p. 1232.)

Roskam also attended a local volunteer incometax assistance clinic. He said the operation was‘‘sophisticated’’ and met the needs of his constitu-ents. ‘‘I was particularly impressed with the caliberof the volunteers. These were people who havebackground and training and technical expertise,and [a] willingness to walk [clients] through somevery complicated situations.’’

Oversight’s 2016 AgendaFor the rest of 2016, the Oversight Subcommittee

will continue to work on last year’s investigationsand initiatives, including preventing U.S. compa-nies from benefiting from the potential waiver bythe Obama administration of tax code provisionsgiving unfavorable treatment to income earned inIran in light of the nuclear deal with that country,Roskam said. The subcommittee held a hearing onthe issue in November 2015. (Prior coverage: TaxNotes, Nov. 9, 2015, p. 784.)

The subcommittee will also once again look at thefavorable tax treatment of large university endow-ments, carrying on its investigation from last year,Roskam said, adding that he is awaiting a responsefrom the IRS on an inquiry regarding endowments.(Prior coverage: Tax Notes, Oct. 12, 2015, p. 230.)

Taxpayer Advocate SchedulesMore ‘Future State’ Forums


Taxpayers and tax practitioners will get anotherchance to give the IRS and the Taxpayer AdvocateService (TAS) a piece of their mind when the TASholds its fourth public forum on the IRS’s ‘‘futurestate’’ vision of technology-oriented taxpayer ser-vice in Hendersonville, North Carolina, on April 4,followed by another in Harrisburg, Pennsylvania,on April 8.

Rep. Mark Meadows, R-N.C., will attend thetwo-hour event in North Carolina, which the IRSofficially announced (IR-2016-49) March 28. Mead-ows is a member of the House Oversight andGovernment Reform Committee and chair of theGovernment Operations Subcommittee.

Sen. Robert P. Casey Jr., D-Pa., a member of theSenate Finance Committee and ranking minoritymember of the Taxation and IRS Oversight Subcom-mittee, will attend the Pennsylvania forum.

The TAS is still finalizing plans regarding otherlocations, attending lawmakers, and panelists as itsolicits comments nationwide about the IRS’s futurestate vision. The public forums could stretch intothe summer. National Taxpayer Advocate NinaOlson launched the forums earlier this year overwhat she considered the IRS’s overreliance on tech-nology solutions to its taxpayer service obligations.IRS Commissioner John Koskinen has a differentview. (Prior coverage: Tax Notes, Feb. 29, 2016, p.966.)

Koskinen told a group of IRS employees on aconference call March 28 that the agency is ‘‘verysupportive’’ of the TAS’s public forums, the IRS toldTax Analysts. Koskinen spoke at the first TAS forumin Washington.

‘The IRS is considering input from awide variety of sources for itscontinuing work and development ofthe Future State,’ the IRS said.

‘‘The IRS is considering input from a wide vari-ety of sources for its continuing work and develop-ment of the Future State,’’ the IRS said in a March 28statement. ‘‘The Advocate’s sessions are anotherway of people providing insight into the taxpayerexperience as we develop future state processes andservices. We are monitoring the sessions as part ofour efforts on the Future State.’’

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Lively DiscussionsThe first three TAS panels featured discussions

with politicians, practitioners, and activists aboutproblems with IRS tax administration, the conse-quences of those problems, and potential solutions.

‘‘An agency fixated on efficiency and deliveringservices at the lowest possible short-term cost,without knowing the impact and burdens of itsactions, may find itself pushing more serious prob-lems down the road, while at the same time jeop-ardizing taxpayer rights,’’ said Leslie Book,professor at Villanova University School of Law, atthe first TAS forum February 23 at IRS headquartersin Washington.

Andrew VanSingel, director of the low-incometax clinic at Prairie State Legal Services, said at theMarch 9 forum in Illinois, ‘‘If the IRS gets out of thebusiness of talking to taxpayers through these tra-ditional mediums, it will force some of our mostvulnerable populations to pay someone just tocomply with the tax laws. And it’s unknown if theService will even have the authority to regulatethese people that [taxpayers] are paying to help.’’(Prior coverage: Tax Notes, Mar. 14, 2016, p. 1232.)

At the March 18 TAS forum in New York, Rep.José E. Serrano, D-N.Y., ranking minority memberof the House Appropriations Financial Services andGeneral Government Subcommittee, tied the IRS’sservice problems to its budget woes. ‘‘Every timewe have a budget cut, we have less services to givethe taxpayer,’’ he said. ‘‘Taxpayers should be able tomake a phone call and get somebody on the phoneright away.’’ (Prior coverage: Tax Notes, Mar. 28,2016, p. 1528.)

Final Anti-Loss Importation RegsReject Most Recommendations

By Marie Sapirie — [email protected]

Final regulations governing nonrecognitiontransfers of loss property to corporations undersections 334(b)(1)(B) and 362(e)(1) generally adoptthe framework of the proposed regulations andaddress some commentators’ concerns, but mostrecommendations were rejected.

In the final regs (T.D. 9759), released March 25,several issues were reserved for future guidanceprojects, and others were described as being outsidethe scope of the regulation package. ‘‘The goodnews is we have final regulations now that can berelied on,’’ said Scott M. Levine of Jones Day.

The proposed regulations (REG-161948-05) un-der sections 334(b)(1)(B) and 362(e)(1), published inSeptember 2013, provided rules for when the taxbasis of built-in loss property would be reduced tofair market value upon an ‘‘importation’’ of theproperty from a person not subject to U.S. tax(generally, a non-U.S. or tax-exempt person) to aU.S. corporation in a transferred basis transaction.

To determine whether a transferor is subject toU.S. tax, the proposed regs included a look-throughrule for some flow-through entities such as partner-ships. The New York State Bar Association TaxSection submitted a report in 2014 on the proposedregulations that asked the government to recon-sider the look-through rule for some widely held orpublicly traded partnerships, citing the difficulty ofadministering the rule for those entities. The reportalso recommended tentatively dividing debt-financed property transferred by a tax-exempt en-tity under section 501(a) so that the transferor isnotionally split into a taxable transferor and atax-exempt transferor, thereby avoiding a cliff effectunder which property subject to only a de minimisamount of indebtedness could entirely avoid clas-sification as importation property subject to section362(e)(1).

The final regulations confirm that the look-through approach applies to widely held or pub-licly traded partnerships, and the preamble notesthat ‘‘the statute explicitly contemplates that part-ners, not partnerships, are the focus of the inquiryunder section 362(e)(1).’’

‘‘I think people will be somewhat disappointedby the failure to deal with publicly traded andwidely held partnerships,’’ said Stuart L. Rosow ofProskauer Rose LLP. ‘‘I understand why [the gov-ernment] may feel constrained on that, but I’m notsure how [the rules are] really workable.’’

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The final rules do, however, treat debt-financedproperty as subject to federal income tax in propor-tion to the amount of the gain or loss that would beincludable in the transferor’s unrelated taxablebusiness income on a sale under sections 511through 514. Rosow said the changes to the rules fortax-exempt transferors of debt-financed propertyare sensible. ‘‘While they may be more complicatedto apply, it is sensible to say that when a tax-exemptentity transfers property that would be partiallytaxable as unrelated business or debt-financedproperty, to the extent it would be taxable, it isexcluded from the loss imputation rules, but to theextent it isn’t taxable, it shouldn’t be excluded,rather than to have it as a cliff, as the proposedregulations did,’’ he said.

The preamble explains that in the context of asection 367(b) inbound liquidation or reorganiza-tion, ‘‘the final regulations affirmatively state thatthe basis reduction does not affect the calculation ofthe all earnings and profits amount.’’ Under thenew rules, taxpayers are required to recognize thereg. section 1.367(b)-3 ‘‘all E&P’’ amount while also

losing the built-in loss in the transferred assets, saidLevine. That result can be harsh in many circum-stances because ‘‘it seems unfair to require thepickup of the all E&P amount and also cause thetaxpayer to lose its basis in the built-in loss asset.We think it’s duplicating the tax cost,’’ he said.

‘I think people will be somewhatdisappointed by the failure to dealwith publicly traded and widely heldpartnerships,’ Rosow said.

‘‘E&P is generally tied to the basis of assets usedin a business; as a corporation earns profits, it alsoexpends costs that are capitalized into the basis ofits assets,’’ Levine said. ‘‘In this sense, it’s unreason-able to tax a corporation on its E&P and alsoeliminate the basis created in the course of generat-ing that E&P.’’ He noted that if the built-in loss assethad been sold immediately before the inboundtransaction, the recognized loss would have re-duced the all E&P amount.

COMING REGS WILL ADDRESS REPORTING GAP IN FOREIGN-OWNED LLCs

Treasury will soon issue proposed regulationsrequiring foreign-owned single-member limited li-ability companies to report their beneficial owners tothe IRS and obtain taxpayer identification numbers,according to Robert Stack, Treasury deputy assistantsecretary (international tax affairs).

According to a March 30 statement issued byStack, the new requirements will be applied bytreating those entities as corporations for purposes ofsection 6038A. The IRS included issuing the newregulations in its 2015-2016 priority guidance plan,released last year.

‘‘As we announced when we released the PriorityGuidance Plan last August, we have been workingon and expect to release soon proposed regulationsthat will treat these foreign-owned single-memberLLCs as corporations solely for purposes of report-ing under Section 6038A of the Code. This willprovide a mechanism for us to require the filing of aninformation return, which will therefore requirethese foreign-owned LLCs to obtain a [taxpayer]identification number and thereby disclose who theirforeign owner is,’’ Stack said.

Although the U.S. federal tax information report-ing system is generally strong, the coming regula-tions are necessary to address a gap in reportingrequirements that allows ‘‘a narrow class of foreign-owned U.S. entities, typically single-member LLCs,’’with specific types of income to avoid disclosurebased on a lack of sufficient U.S. business activity orU.S. bank accounts, according to Stack. This mayallow those entities to evade taxes or conceal theirownership, he said.

Stack said that although a change in the law isneeded to fully resolve the issue of beneficial own-ership, the new regulations will narrow the gap inreporting requirements. ‘‘Once these regulations arefinalized, the IRS will be far better equipped toensure that these entities are not facilitating U.S. taxavoidance and to respond to requests about theseentities from other tax authorities as appropriateunder our tax treaties and tax information exchangeagreements,’’ according to Stack.

The United States faces growing internationalcriticism over individual states’ business registrationlaws that allow domiciled LLCs to withhold theidentity of their beneficial owners. The FinancialTimes (‘‘Fear and Regulatory Loathing MakesAmerica the Top Tax Haven’’), Forbes (‘‘The World’sNext Top Tax Haven Is . . . America’’), BloombergBusinessWeek (‘‘The World’s Favorite New Tax HavenIs the United States’’), and The Economist (‘‘TheBiggest Loophole of All’’) have all published piecesthis year criticizing the United States for its lack ofadequate disclosure requirements and its refusal tojoin the group of more than 90 countries adopting theOECD’s common reporting standard, despite havingpressured other countries to implement the ForeignAccount Tax Compliance Act. (Prior coverage: TaxNotes, Mar. 21, 2016, p. 1400.)

— Ryan Finley

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The new rules clarify that even if the tax basis inan asset is lost under section 362(e)(1), the asset isstill treated as having a transferred basis for mostfederal income tax purposes. ‘‘This is a welcomeclarification,’’ said James S. Wang of Jones Day. ‘‘Forexample, this will clarify that a transferee still gets atacked holding period under section 1223 evenwhen it receives an asset whose basis has beenreduced to fair market value under section362(e)(1).’’

The government reserved some of the harderissues, particularly the interaction of the anti-lossimportation rules with sections 362(e)(2) and704(c)(1)(C). ‘‘I think that probably makes sense,’’Rosow said. Integrating the loss imputation schemewith the loss duplication rules requires carefulreflection, he added. The preamble says the govern-ment will try to integrate the three schemes whenthe proposed regs on section 704(c)(1)(C) are final-ized.

The final regulations exhibit some caution on thegovernment’s part regarding trusts or otherpassthrough entities as well as concern about allow-ing electivity in the rules. ‘‘I think these regs aresomewhat cautious in that regard in trying to limitthe taxpayer’s ability to manipulate, even if in somecases you may get funny results,’’ Rosow said.

IRS Plans to Issue Proposed RegsDefining REIT Congregate Care

By Amy S. Elliott — [email protected]

The IRS plans to develop proposed regulationsdefining what real property qualifies as a congre-gate care facility for purposes of the real estateinvestment trust rules despite recent calls from theindustry that guidance is not needed.

Labeling a property as a congregate care facilityunder section 856(e)(6)(D)(ii), and therefore aqualified healthcare property under section 856(e)(6)(D)(i), is important for a REIT, said AndreaHoffenson, branch 2 chief, IRS Office of AssociateChief Counsel (Financial Institutions and Products),on March 30.

‘‘Not getting it right can have pretty devastatingconsequences, so we do believe that guidance isneeded to provide a standard definition of what iscongregate care,’’ Hoffenson said at a conference inWashington sponsored by the National Associationof Real Estate Investment Trusts (NAREIT). ‘‘We doexpect this guidance to come out in a proposedformat for notice and comment.’’

The project first showed up on the 2015-2016priority guidance plan, although the plan did notspecify that it would likely take the form of regu-lations.

On March 23 NAREIT submitted a letter to theIRS and Treasury stating that healthcare REITs‘‘have developed a good working understanding’’of what — in the government’s eyes — constitutes acongregate care facility. ‘‘We do not believe thatadditional guidance is needed or merits priorityattention,’’ NAREIT wrote.

‘We do not believe that additionalguidance is needed or merits priorityattention,’ NAREIT wrote.

Joseph G. Howe III of Arnold & Porter LLP toldpractitioners at the conference that in recent years,the IRS has issued at least three letter rulings (LTR201509019, LTR 201429017, and LTR 201250019)concluding that some senior living communitiesconstitute congregate care facilities.

Even though those rulings all dealt with age-restricted communities, ‘‘there may be thingsbroader than that that fit within the definition ofcongregate care,’’ Howe said. If the IRS wants toexpand the types of communities that might qualifyas congregate care, it should still require a modicumof health-related services or wellness programs tomaintain a level playing field, he said, adding,

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‘‘Otherwise we’re concerned that we could find outthat something such as student housing, which alsohas some healthcare services on a campus, could bepulled into it inadvertently.’’

The IRS has issued two letter rulings (LTR201320007 and LTR 201317001) concluding thatsome correctional facilities (for example, prisons)don’t constitute congregate care facilities eventhough they provide some medical care to resi-dents, Howe pointed out.

NAREIT is concerned that guidance in the formof regulations can be rigid and has asked that if thegovernment insists on developing rules, that theybe general in nature and contain an effective dateprovision that grandfathers the treatment affordedto existing facilities, Howe said. ‘‘We’d hate to findout that something today that we think is a quali-fied healthcare facility no longer satisfies it or viceversa,’’ he said. ‘‘If you do change the landscape,you can change the tax implications rather quickly.’’

Preferential DividendsJulanne Allen, assistant to the branch 3 chief, IRS

Office of Associate Chief Counsel (Financial Insti-tutions and Products), said the IRS has receivedseveral questions on the repeal of the preferentialdividend rule contained in the 2015 extenders leg-islation, the Protecting Americans From Tax HikesAct of 2015 (PATH Act), which became law as partof P.L. 114-113.

The rule was repealed for publicly offered REITs,defined as REITs required to file annual and peri-odic reports with the SEC. The change means thatpublicly offered REITs are no longer required toissue dividends pro rata, so that preferred divi-dends may now count toward the dividends paiddeduction that reduces a REIT’s corporate federalincome tax liability.

‘‘We do understand that publicly offered REITsmay still be impacted if they are shareholders ofREITs that don’t qualify’’ as publicly offered, Allensaid. She added that the PATH Act gave the IRSdiscretion to provide relief in some cases when aREIT issued a dividend that inadvertently ran afoulof the preferential dividend rule. She said the IRS isopen to suggestions on whether guidance is neededin that area.

‘Bad Boy’ Guarantee MemoRichard M. Lipton of Baker & McKenzie said

NAREIT and the Real Estate Roundtable both con-tacted the IRS following its recent release of a legalmemorandum (ILM 201606027) that suggests thatthe use of a so-called bad boy guarantee could causea nonrecourse real estate loan to be treated asrecourse. (Prior coverage: Tax Notes, Feb. 29, 2016, p.971.)

If the conclusion in the memorandum is correct,REITs that provide financing to developers whoissue carveouts similar to the bad boy guarantees inthe memo will now have to allocate the liabilitiesaway from their operating partnerships and to thedevelopers, Lipton said.

‘‘We’re all pressuring the IRS to withdraw [thememo] as soon as possible,’’ Lipton said. ‘‘Thisthing is just wrong, and it’s not particularly defen-sible. They have had meetings. They have said theyare studying it. They are looking at putting outsome clarifications at some point in time in the nearfuture.’’

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REIT Rule Missteps: Pay thePenalty or Bust the REIT?

By Amy S. Elliott — [email protected]

There are so many potential foot faults in the realestate investment trust rules that even a savvy REITmay accidentally fail a requirement. In extremecases, a wayward REIT could be better off filing asa traditional C corporation without a REIT electionrather than avail itself of a statutory relief provisionrequiring payment of a penalty.

In what would admittedly be an outlier situation,‘‘you’re almost sometimes in a better position eco-nomically if you had just filed as a C corp. Thatseems to me at least to be a little bit disproportion-ate a penalty to the crime,’’ Dianne Umberger of EYsaid March 31 at a conference in Washington spon-sored by the National Association of Real EstateInvestment Trusts.

Section 857(b)(5) states that if a REIT fails to meeteither the 95 percent income test or the 75 percentincome test due to reasonable cause and not willfulneglect, it may nevertheless be treated as havingsatisfied those tests if it, among other things, pays a100 percent tax on the net income attributable to theexcess bad gross income as calculated by a formulaprescribed in the statute.

Umberger asked IRS officials at the conference ifthere is any wiggle room in coming up with adifferent amount. ‘‘It seems like it would be overlyharsh to pay out a gross amount of money, where ifwe were a C corp, we’d actually pay less tax. Wouldyou consider that in formulating an appropriate tollcharge to a closing agreement?’’ she asked.

Peter J. Genz of King & Spalding said the IRScould simply tell that REIT that it didn’t havereasonable cause so that the section 857(b)(5) pen-alty isn’t even available. ‘‘We’re now a taxable Ccorp instead of just a busted REIT that’s still a goodREIT but has to pay a penalty. That’s sort ofperverse,’’ he said. A busted REIT technically has towait five years before it can make another REITelection.

But Les Honig, senior program specialist (North-eastern compliance practice area), IRS Large Busi-ness and International Division, indicated that suchan option isn’t as extreme as it sounds. ‘‘If you bustyourself, you could probably do that if you want toshow you’re not reasonable. But then you have theissue of how soon you could re-REIT yourself,’’ hesaid. ‘‘In theory you might end up busted for oneyear and have permission to re-REIT in a subse-quent year.’’

Umberger asked if the IRS would give permis-sion to do so in a closing agreement. Honig said it

could but reminded her that the busted but re-REITed REIT will still incur a built-in gains tax atthe highest corporate rate on any property sold bythe REIT within five years.

David Silber, IRS deputy associate chief counsel(financial institutions and products), was skepticalof REITs seeking a more appropriate toll charge,pointing out that the IRS is compelled to follow thestatute. ‘‘It’s not as if we can look at the statute thatgives you what the penalty is and say we thinkthat’s too high and just do a closing agreement andcome up with some other number. We follow thelaw in the closing agreement,’’ he said.

Silber added that it isn’t just officials within LB&Iwho have jurisdiction to enter into closing agree-ments. In some circumstances, officials within hisoffice can do that as well, even for cases involvingfiled returns, he said.

Honig pointed out that LB&I’s reorganizationinto nine practice areas has not resulted in a cen-tralized group that just handles REIT closing agree-ments. ‘‘Everyone in the IRS is workingconsistently,’’ he said. ‘‘We all approach these thesame way, so your REIT should be handled thesame way no matter where’’ it’s located geographi-cally, he said.

Honig emphasized that IRS Exam doesn’t havesettlement authority. If there are arguments on bothsides of a REIT disqualification case, ‘‘we take aposition and we say, ‘If you disagree, we can assessyou, and you can go to Appeals,’’’ he said.

Genz said if the case involves an issue that’s notfree from doubt and Exam can’t compromise, ‘‘thenExam’s going to call it up or down, and there’s achance they could call it up — we won’t pay apenalty but still get a closing agreement that re-solves this issue with finality.’’

Reasonable CauseHonig said that in 2011 the instructions to Form

1120-REIT, ‘‘U.S. Income Tax Return for Real EstateInvestment Trusts,’’ were changed to require that areasonable cause statement be attached to the Form1120-REIT at the time it’s filed for failures involvingthe asset test, the gross income test, ‘‘or otherqualification requirements under sections 856-859.’’He said that in 2012 the ‘‘or other’’ language wasdropped from the instructions for some reason butthat it should return to the 2016 instructions.

‘‘There is no prohibition on putting a reasonablecause statement on a return,’’ Honig said, addingthat he thinks the inclusion ‘‘is probably goodpractice.’’

Genz said that in 1995 the IRS issued a letterruling (LTR 9550019) concluding that a REIT’s fail-ure to satisfy section 856(c)(2) was due to reasonablecause and not to willful neglect. He wanted to knowwhy the IRS isn’t willing to issue those rulings

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today, given that they would seem to mirror thekind of determinations required to grant so-called9100 relief — reg. section 301.9100 relief for footfaults involving regulatory elections. ‘‘These kindsof busts . . . occur with regularity, and many of themare mistakes. They’re not abusive behavior,’’ hesaid.

‘There is no prohibition on putting areasonable cause statement on areturn,’ Honig said, adding that hethinks such an inclusion ‘is probablygood practice.’

Rev. Proc. 2016-3, 2016-1 IRB 126, states that theIRS won’t issue rulings on whether reasonablecause ‘‘or other similar terms that require a factualdetermination exist.’’

Silber said the 1995 ruling was an anomaly.‘‘Reasonable cause is a different standard altogetherthan the 9100 standard,’’ he said, adding that rea-sonable cause ‘‘is very much based on facts.’’

Umberger said that even though reasonablecause isn’t required for 9100 relief, ‘‘whenever wefile [for 9100 relief], we usually try to set forth thosekind of circumstances that basically would amountto reasonable cause.’’

Genz said the IRS has an interest in ruling onreasonable cause, because the status quo creates a‘‘no man’s land.’’ Today, if an attorney won’t givean opinion that a REIT has reasonable cause for itsfoot fault, the REIT has little choice but to seek aclosing agreement — or maybe just fire the lawyerand find one who will, he said.

Tax Policy Becomes UncommonCause for Rock Band

By William R. Davis — [email protected]

During the first night of a two-night sold-out stayat Washington’s 9:30 Club, Brooklyn-based LakeStreet Dive used a break between songs to encour-age the crowd to learn about high-income earnersusing offshore tax havens to avoid taxes. You readthat right — a popular rock band was discussingtaxes during a show.

The band has partnered with Oxfam America, anonprofit organization that works on poverty, hun-ger, and injustice issues, to help promote its cam-paign against tax havens. Oxfam works with manymusicians — such as Radiohead, Coldplay, andAngélique Kidjo — on a variety of issues. Oxfamtold Tax Analysts that Lake Street Dive is among thefirst musicians to support the nonprofit on itscampaign. Bands such as Ra Ra Riot and Thao &The Get Down Stay Down will soon follow, Oxfamsaid.

‘Oxfam has a long history of workingwith social-justice-minded musicartists like Lake Street Dive,’ saidFerguson.

‘‘Oxfam has a long history of working withsocial-justice-minded music artists like Lake StreetDive,’’ said Bob Ferguson, Oxfam America’s man-ager of creative alliances and music outreach. ‘‘Weknow that when a band speaks from the stage aboutan issue we are working on together, like ourcurrent inequality campaign, we can all make adifference. At Oxfam, we truly believe that musiccan change the world.’’

Musicians have always been at the leading edgeof the fight for social justice, but tax policy hasnever been a popular topic. If Ferguson is correct inarguing that musicians can inspire change, is LakeStreet Dive’s support of fighting tax avoidance thebeginning of a larger social shift in consciousnessabout tax issues?

Lake Street Dive, founded in 2004 while itsmembers were students at the New England Con-servatory of Music in Boston, has a growing fanbase — giving it a larger platform for its anti-tax-haven work. The band performs a hybrid of non-edgy pop and soul. It is driven by singer RachaelPrice, who is backed up by stand-up bassist BridgetKearney; guitarist, trumpeter, and keyboardistMike Olson; and drummer Mike Calabrese. Theband’s most recent album, Side Pony, is on the top

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100 most downloaded albums on iTunes. It hasrecently been featured on such late-night staples asThe Late Show With Stephen Colbert and Conan.

Ferguson explained that artists’ level of engage-ment with their fans depends on their own prefer-ences. Some musicians host Oxfam informationtables at their shows — as Lake Street Dive is doingwith its anti-tax-haven campaign — donate musicto raise funds for humanitarian relief work, or sendOxfam information out with mail orders for CDsand merchandise. Bands also share informationthrough social media and newsletters and talkabout the issues during a performance, he said. ‘‘Weare very grateful to all of them for partnering withus to inspire their fans to make a difference,’’Ferguson said.

Lake Street Dive declined to comment for thisstory. Its publicist, Jim Merlis of Big Hassle, told TaxAnalysts that the band’s participation in Oxfam’santi-tax-haven effort is the first time he has heard aband discuss taxes.

Oxfam Tax Haven CampaignThe tax haven campaign stems from an Oxfam

January 2016 report on income inequality. In thereport, the group notes that just 62 individuals havethe same amount of wealth as the bottom half of theworld’s population — 3.6 billion people — and thatthe wealth of the world’s 62 richest people has risen

44 percent in the past five years, while the wealth ofthe world’s poorest has decreased.

‘‘A powerful example of an economic system thatis rigged to work in the interests of the powerful isthe global spider’s web of tax havens and theindustry of tax avoidance, which has blossomedover recent decades,’’ the report says. ‘‘It has beengiven intellectual legitimacy by the dominant mar-ket fundamentalist world view that low taxes forrich individuals and companies are necessary tospur economic growth and are somehow goodnews for us all. The system is maintained by ahighly paid, industrious bevy of professionals in theprivate banking, legal, accounting and investmentindustries.’’

The report estimates that 30 percent of richAfricans’ wealth, which amounts to $500 billion, isheld offshore in tax havens, costing African coun-tries $14 billion a year in lost revenue, an amountthat would cover healthcare for 4 million childrenand provide schooling for every African child.Oxfam says the International Bar Association hasidentified tax avoidance as an abuse of humanrights because it harms the poor and offers a havenfor trafficking and corruption.

In the United States, Oxfam is supporting theStop Tax Haven Abuse Act (S. 174), which was mostrecently introduced by Sen. Sheldon Whitehouse,D-R.I., in January 2015. The measure would require

THE BIRDS AND BEES — AND TAXES

It’s not news that taxes and the IRS are generallyunpopular in America, but a recent survey by Wallet-Hub reveals that taxpayers are so uncomfortablefiling their returns, that many of them would ratherhave ‘‘the talk’’ with their children.

The results come from WalletHub’s 2016 onlinesurvey of 1,000 taxpayers nationwide. In a questionabout what taxpayers would be willing to do if theycould avoid paying taxes forever, 27 percent ofrespondents said they would get an IRS tattoo, 8percent said they would name their first-born child‘‘Taxes,’’ and a worrying 4 percent said they wouldkill someone for a tax-free life — if they could getaway with it.

Another question about what taxpayers wouldprefer to do instead of prepare their tax returnsreveals that household chores are far more appealing(77 percent would be more willing to do laundry, and60 percent would rather mow the lawn) and thatchildren would become more knowledgeable (48percent would prefer to teach their kids how tobudget, and 35 percent would rather talk to theirkids about sex). Spending a night in jail was moreappealing for 13 percent.

Other survey results seem to portray taxpayers ina nobler light. Eighty-one percent said they would

not hide money offshore, even if they knew theywould not be caught. And although more than halfof respondents thought their tax rates were too high,36.3 percent thought the amount of taxes they paidwas just right, and another 5.1 percent thought theyought to pay more in taxes.

Asked whom they would most like to punch,Republican presidential candidate Donald Trumpwas the decisive winner of the vote at 52 percent,while ‘‘an IRS agent’’ was the top choice of only 4percent of respondents. And only 14.4 percent saidthe IRS should be abolished.

The survey caught the attention of IRS Commis-sioner John Koskinen. In March 24 remarks at theNational Press Club, Koskinen mentioned that thesurvey found that for some respondents, RussianPresident Vladimir Putin was more popular than theIRS. Koskinen acknowledged that the IRS won’t bewinning any popularity contests, then added, ‘‘Butdon’t look for a shot of me on CNN, without a shirt,riding a horse.’’

— Jonathan Curry

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banks and brokers that discover, through moneylaundering due diligence, that the beneficial ownerof a foreign account is a U.S. taxpayer to disclosethat information to the IRS.

The bill would require investment advisers andcorporate formation agents to establish anti-money-laundering procedures (31 U.S.C. section 5312).Investment advisers would be required to submitsuspicious activity reports. The bill would alsopenalize jurisdictions and financial intermediariesfound to be significantly impeding U.S. tax enforce-ment by preventing them from using U.S. corre-spondent accounts (31 U.S.C. section 5318A). Acompanion bill was introduced in the House. (Prioranalysis: Tax Notes, Mar. 16, 2015, p. 1295.)

‘The tax burden is falling on ordinarypeople, while the richest companiesand individuals pay too little,’ theOxfam report says.

Ultimately, Oxfam and its partnering musiciansare calling on world leaders to agree on a globalapproach to end the era of tax havens. ‘‘The taxburden is falling on ordinary people, while therichest companies and individuals pay too little.Governments must act together to correct this im-balance,’’ the report says.

Musicians and PolicyMusicians have a long history of acting as mar-

keting arms for nonprofit organizations. Revolu-tions Per Minute (RPM) is a San Francisco-basednonprofit organization that provides musicianswith strategy and support for their activism andphilanthropy. RPM will also match up musicianswith nonprofit organizations based on the bands’interests.

RPM told Tax Analysts that it does not have anyartists working on tax campaigns. Although thereisn’t much history between tax advocacy and rock-and-roll, there are success stories that could provideoptimism for Oxfam’s effort.

In 2009 California — faced with a fiscal crisis —had decided to cut $16 million in funding fordomestic abuse services. The artist Moby decided todonate all of the profits from two sold-out concertsin California to a domestic abuse organization andworked with the California Partnership to EndDomestic Abuse. Moby was able to raise awareness,and the California State Legislature eventually re-instated the $16 million funding.

Since 1985, Farm Aid has been putting on anannual benefit concert, working with local, re-gional, and national organizations to promote fair

farm policies. Through its advocacy efforts, tens ofthousands of petitions have been delivered to thesecretary of agriculture.

Performance and songwriting have also provento be powerful ways for musicians to make animpact, as Lady Gaga did when she co-wrote thesong ‘‘Til It Happens to You’’ for the documentaryThe Hunting Ground, which raised awareness aboutsexual assault on college campuses. The song wasnominated for a Grammy and an Academy Award,and Lady Gaga gave a critically acclaimed perfor-mance at the Oscars that was introduced by VicePresident Joe Biden.

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Transfer Pricing Roundup

By Ryan Finley — [email protected] andKristen Langsdorf — [email protected]

Albemarle Corp.

Jurisdiction(s): Undisclosed

Albemarle Corp., a chemical company headquar-tered in Baton Rouge, Louisiana, reported in aMarch Form 10-K that its liabilities regarding un-certain tax positions were reduced by $50.9 millionin 2015 and $22.1 million in 2014 because of offset-ting benefits due in part to the effects of potentialtransfer pricing adjustments.

Allergan PLC

Jurisdiction(s): United States

Allergan PLC, a global pharmaceuticals com-pany headquartered in Dublin, reported in a Feb-ruary Form 10-K that on December 29, 2015, the IRSand Warner Chilcott Corp. agreed to amend theterms of its advance pricing agreement to end in2015 rather than 2017. Allergan said it believes itstransfer pricing arrangements still comply withexisting tax rules.

AmTrust Financial Services Inc.

Jurisdiction(s): Undisclosed

AmTrust Financial Services Inc., a property andcasualty insurance company based in New York,reported in a February Form 10-K that during 2015,its provision for income tax benefited from a returnto provision adjustment during the third quarter ofapproximately $80 million. The return was drivenprimarily by changes to permanent transfer pricingtax adjustments.

Baxter International Inc.

Jurisdiction(s): United States

Baxter International Inc., an American healthcarecompany headquartered in Deerfield, Illinois, re-ported in a February Form 10-K that factors ad-versely affecting its effective tax rate in 2015included charges related to contingent tax mattersregarding transfer pricing and the separation of itsbiopharmaceuticals business, Baxalta.

Denali Holding Inc.Jurisdiction(s): UndisclosedDenali Holding Inc., a Delaware holding com-

pany for Dell Inc., reported in a March Form S-4/Athat as of January 29, its accrued interest andpenalties were $950 million, offset by tax benefits of$372 million from transfer pricing, interest deduc-tions, and state income tax.

Marriott International Inc.Jurisdiction(s): United StatesMarriott International Inc., a hospitality com-

pany and hotel chain headquartered in Bethesda,Maryland, reported in a February Form 10-K that itrecorded a $14 million increase in 2015, largelyattributable to a U.S. federal tax issue regardingtransfer pricing. The company said it believes it isreasonably possible that during the next 12 monthsit will resolve the issue for 2014-2015, for which ithas an unrecognized tax balance of $15 million.

Mosaic Co.Jurisdiction(s): UndisclosedMosaic Co., a specialty products mining com-

pany headquartered in Plymouth, Minnesota, re-ported in a February Form 10-K that it received abenefit of $14.5 million primarily for changes inestimates associated with an advance pricing agree-ment.

SL Industries Inc.Jurisdiction(s): China, United StatesSL Industries Inc., an American manufacturing

company headquartered in Mount Laurel, NewJersey, reported in a March Form 10-K that itseffective tax rate from continuing operations during2015 decreased from 33 percent to 31 percent from2014, partially due to a favorable settlement withthe U.S. Treasury regarding the company’s transferpricing policies in China.

Voltari Corp.Jurisdiction(s): IndiaVoltari Corp., a commercial real estate business

based in New York, reported in a March Form 10-Kthat in 2016 it received notification of a tax assess-ment from the Indian tax authorities asserting un-derreported transfer pricing income by thecompany’s subsidiary, Motricity India Pvt. Ltd., forthe fiscal year ended March 31, 2012. The assess-ment could result in tax, penalties, and interesttotaling approximately $400,000.

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Final Anti-Loss Importation RegsGenerally Adopt Proposed Rules

By Joseph DiSciullo — [email protected]

Final regulations (T.D. 9759) under sections334(b)(1)(B) and 362(e)(1) apply to some nonrecog-nition transfers of loss property to corporationssubject to specified federal income tax. The anti-lossimportation provisions were added by the Ameri-can Jobs Creation Act of 2004 to prevent erosion ofthe corporate tax base when a person transfersproperty to a corporation and the result would bean importation of loss into the federal tax system.(Related coverage: p. 44.)

Effective March 28, the final regs adopt, withsome changes and clarifications, the proposed regs(REG-161948-05) issued in September 2013. Theregs also adopt, in part and without change, theproposed regs (REG-163314-03) issued in March2005 that included amendments to the regulationsunder sections 332 and 351 to reflect statutorychanges. The regs make nonsubstantive changes tothe final regs (T.D. 9633) issued in September 2013under sections 362(e)(2), 705, and 1367 to conformthe terminology to that adopted in the new finalregs and to correct errors and clarify cross-references.

The 2013 proposed regs provided specific rules toimplement the statutory framework of the anti-lossimportation provisions, such as rules for identifyingimportation property and for determining whetherthe transfer of that property occurs in a transactionsubject to the anti-loss importation provisions. Thefinal regs generally adopt the provisions of the 2013regs, with some changes and clarifications in re-sponse to comments. Most of the comments ad-dressed issues involving partnerships.

Under the 2013 proposed regs, the determinationof whether gain or loss on property transferred by apartnership is subject to federal income tax wouldbe made by reference to the treatment of the part-ners, taking into account all partnership items forthe year of a section 362 transaction. The final regsdo not allow the use of a closing of the booksmethod and clarify that a partnership agreement, aswell as any applicable rules of law, is considered indetermining to which partner an item would beallocated and thus its federal income tax treatment.Treasury and the IRS rejected a suggestion thatwidely held partnerships and publicly traded part-

nerships not be subject to the look-through ruleapplicable to all partnerships.

The final regs do not adopt suggestions to makechanges to strengthen the antiavoidance rule, aswell as changes regarding foreign non-grantortrusts and trusts with no distributable net income.The final regs modify the rule in the proposed regsthat if a tax-exempt entity transferred debt-financedproperty, the disposition of that property would besubject to federal income tax, and thus could not beimportation property. The final regs adopt an ap-proach that treats debt-financed property as subjectto federal income tax in proportion to the amount ofgain or loss that would be includable in the transf-eror’s unrelated business taxable income on a saleunder sections 511 through 514. The regs providethat portions of property determined under thisrule are generally treated under the anti-loss impor-tation provisions in the same way as portions ofproperty tentatively divided to reflect multipleowners of gain or loss on the property.

The final regs do not adopt a suggestion regard-ing the effect of a basis reduction required undersection 334(b)(1)(B) or 362(e)(1) on earnings andprofits and any inclusion required by reg. section1.367(b)-3, affirming that the basis reduction doesnot affect the calculation of the all-earnings-and-profits amount. The final regs provide that despitethe application of the anti-loss importation or anti-duplication provisions to a transaction, the transfer-ee’s basis is generally considered to be determinedby reference to the transferor’s basis for federalincome tax purposes. However, when determiningthe adjustment to the basis of partnership propertyunder section 755 when a partnership interest istransferred in a loss importation transaction, thetransferee’s basis in the interest will be treated asnot determined by reference to the transferor’sbasis.

The final regs clarify that if the anti-loss impor-tation provisions applied to a transaction, otherprovisions of law would continue to apply. The regsalso make other changes to clarify the purpose andscope of some cross-references, as well as nonsub-stantive corrections and clarifications suggested bycommentators.

The final regs are applicable to transactions oc-curring after March 27, unless completed under abinding agreement that was in effect before March28. The final regs also apply to transactions occur-ring before March 28 resulting from entity classifi-cation elections that are filed after March 27.

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Taxpayers may apply the rules to any transactionoccurring after October 22, 2004.

Transportation Excise TaxesProposed regulations (REG-103380-05) reflect

legislative changes and court decisions on the excisetaxes imposed on the sale of highway tractors,trailers, trucks, and tires; the definition of highwayvehicle for purposes of those taxes and others; andthe use of heavy vehicles on the highway. The regsprovide an opportunity for comment on provisionsof several sets of temporary regs (T.D. 7882, T.D.8050, T.D. 8200, T.D. 8774, and T.D. 8879) that havebeen published since 1982 and that are restated andunchanged. The regs generally are proposed toapply on and after the date the final regs arepublished in the Federal Register.

The proposed regs define a highway vehicle asany self-propelled vehicle, or any truck trailer orsemitrailer, designed to perform a function of trans-porting a load over public highways. To illustratethe definition of highway vehicle, the regs providetwo examples: one on the off-highway vehicle ex-ception and the other on the mobile machineryexception. The regs provide exceptions for specifiedmobile machinery, off-highway vehicles, non-transportation trailers, and semitrailers for pur-poses of the tax on the sale of heavy vehicles, thehighway use tax, and the credits and paymentsallowed for some nontaxable uses. The regs alsoinclude a change announced in prior guidance(Notice 2005-4, 2005-1 C.B. 28) that current rulesregarding some vehicles specially designed for off-highway transportation would not apply to calen-dar quarters beginning after October 22, 2004.

The proposed regs reorganize and partially re-state the temporary regs that address the retail taxon tractors, trailers, and trucks. The proposed regsprovide a model certificate for sellers to establishthe tax status of incomplete chassis cabs. No tax isimposed on the sale of those cabs when accompa-nied by a qualifying certificate.

Consistent with the temporary regs, the pro-posed regs define tractor and truck by reference tothe primary design of a vehicle, providing anexample and reflecting 2004 guidance (Rev. Rul.2004-80, 2004-2 C.B. 164). Under the proposed regs,the definition of truck trailer would include anymanufactured home on a frame that has axles andwheels, and as a result, a vehicle that tows amanufactured home is taxable as a tractor. The regsprovide exclusions from the tax imposed by section4051 for some trucks and trailers below a specifiedweight, and modify the temporary regs to reflectthe statutory increase in the aggregate dollar valueof parts and accessories that may be installed on ataxable article without incurring a tax liability. The

regs also supplement the existing definition oftaxable sale to include the resale of an unusedarticle that had been previously sold tax free.

The proposed regs provide that if a chassis is acomponent part of a highway vehicle, its taxabilityis determined independent of the body installed onthe chassis. The same rule applies if a body is acomponent part of a highway vehicle. The pro-posed rule is contrary to the result of Rev. Rul.69-205, which predates and is inconsistent with thelanguage in section 4051(a)(1), and will be renderedobsolete after the final regs are published. Theproposed regs reflect changes to the section 4071 taxon tires, define related terms, and address multipleload ratings and the consequences of tamperingwith a tire’s maximum load rating. The regs alsoprovide rules under section 4073 for making tax-free sales of tires for specified uses.

Disaster ReliefThe IRS has granted (MS-2016-21) tax relief to

victims of severe storms and flooding in parts ofMississippi, postponing until July 15 various taxreturn filing and tax payment deadlines that oc-curred starting March 9, including the April 18deadline for filing 2015 income tax returns and theApril 18 and June 15 deadlines for making quarterlyestimated tax payments.

A variety of business tax deadlines are alsoaffected, including the May 2 deadline for quarterlypayroll and excise tax returns. The IRS is waivingfailure-to-deposit penalties for employment andexcise tax deposits due on or after March 9, as longas the deposits were made by March 24.

President Obama declared that a major disasterexists in Mississippi and that individuals who re-side or have businesses in Bolivar, Coahoma, andWashington counties may qualify for tax relief.

Affected taxpayers include individuals who livein the covered disaster area and businesses withprincipal places of business there; taxpayers that arenot in the covered disaster area but have recordsthere that are necessary to meet deadlines; reliefworkers affiliated with recognized government orphilanthropic organizations assisting in the reliefactivities in the covered disaster area; and anyindividual visiting the covered disaster area whowas injured or killed as a result of the disaster.

Empowerment ZonesThe IRS has explained (Notice 2016-28, 2016-15

IRB 1) how a state or local government may amendan empowerment zone nomination to provide for anew termination date of December 31.

Under section 1391, a state or local governmententity may nominate areas in its jurisdiction for

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designation as an empowerment zone. The desig-nations of all empowerment zones now have atermination date of December 31, 2014. The Protect-ing Americans From Tax Hikes Act of 2015 (PATHAct) extended by two years the period for which anempowerment zone designation is in effect. Thus,section 1391(d)(1), as amended by the act, providesthat any designation of an empowerment zone endson the earliest of (a) December 31, 2016, (b) thetermination date designated by the state or localgovernments in its nomination, or (c) the date adesignation is revoked.

Under the PATH Act, an entity must amend itsnomination to provide for a new termination dateof December 31, 2016, to retain an empowermentzone designation that is effective through that date.Notice 2016-28 provides those procedures. Theguidance further provides that any nomination foran empowerment zone with a current terminationdate of December 31, 2014, is deemed to beamended to provide for a new termination date ofDecember 31, 2016, unless the nominating entitysends written notification to the IRS by May 24. Thewritten notification must affirmatively decline theextension of the empowerment zone nomination.

Retirement Plan DistributionsThe IRS has reminded (IR-2016-48) taxpayers

who turned 70½ during 2015 that in most cases theymust start receiving required minimum distribu-tions (RMDs) from IRAs and workplace retirementplans by April 1.

The April 1 deadline applies to the requireddistribution for only the first year. For all subse-quent years, the RMD must be made by December31. For example, an individual who turned 70½ in2015 and receives the first required payment onApril 1, 2016, must still receive the second RMD byDecember 31, 2016. The April 1 deadline applies toowners of traditional IRAs but not owners of RothIRAs.

Although the deadline is mandatory for all own-ers of traditional IRAs and most participants inworkplace retirement plans, some individuals withworkplace plans can wait longer to receive theirRMD. For example, employees who are still work-ing can, if their plan allows, wait until April 1 of theyear after they retire to start receiving the distribu-tions.

Julie Brienza and Emily Vanderweide contributed tothis column.

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Eleventh Circuit AffirmsEnforcement of IRS Summonses


The Eleventh Circuit, in a case remanded by theSupreme Court, affirmed a district court decisionthat enforced IRS summonses and denied an evi-dentiary hearing regarding whether the sum-monses were issued for an improper purpose(United States v. Clarke, Nos. 15-11663, 15-11996 (11thCir. 2016)).

The disputes in the case arise from an IRS exami-nation of the tax returns of a limited partnership forthe years 2005 through 2007. Over the course of theinvestigation, the partnership agreed twice to one-year extensions of the three-year statute of limita-tions for the IRS to conduct its examination. In 2010the partnership refused a third extension. Later thatyear, the IRS issued five administrative summonsesto four individuals associated with the limitedpartnership, none of whom complied. The IRS didnot seek enforcement of the summonses from thedistrict court before the limitations period expiredand instead issued a final partnership administra-tive adjustment proposing various adjustments tothe partnership’s returns. The limited partnershipfiled a timely challenge to the FPAA in Tax Court,but those proceedings were stayed in light of thedispute developing in the district court.

In April 2011 the IRS filed five petitions in districtcourt to enforce the previously issued 2010 sum-monses, submitting an affidavit stating that it fol-lowed all administrative steps of the tax code,required the information sought in the summonsesto further the investigation, did not already possessthe information, and did not issue the summonsesfor an improper purpose. The district court foundthat the IRS made a prima facie showing to enforcethe summonses and that the appellants respondedby requesting a hearing to determine whether thesummonses were issued for the improper purposeof retaliating for the partnership’s refusal to extendthe limitations period or to circumvent Tax Courtdiscovery limitations. The district court denied therequest for a hearing and enforced the summonses,finding that the appellants failed to make anymeaningful allegation that the IRS issued the sum-monses for an improper purpose.

On appeal, the circuit court concluded that thedistrict court abused its discretion by denying the

request for an evidentiary hearing because underEleventh Circuit precedent an allegation of im-proper purpose in issuing a summons was suffi-cient to require a hearing. The IRS appealed to theU.S. Supreme Court (134 S.Ct. 2361 (2014)), whichgranted certiorari, noting that the Eleventh Circuitwas alone in asserting that a ‘‘bare allegation ofimproper motive entitles a person objecting to anIRS summons to examine the responsible officials.’’The Supreme Court rejected that view and providedthe clear standard that a ‘‘taxpayer is entitled toexamine an IRS agent when he can point to specificfacts or circumstances plausibly raising an inferenceof bad faith.’’ The Court remanded to the EleventhCircuit, which in turn remanded to the district courtwith instructions to use the new standard. Ulti-mately, the district court found that none of thegrounds on which the appellants challenged the IRSsummons were improper as a matter of law.

The circuit court noted that the IRS’s authority toinvestigate is extensive but that its summons au-thority is subject to limitations. The court disagreedwith the district court opinion that none of thealleged purposes for issuing the summons wereimproper as a matter of law. The circuit court saidthat issuing a summons only to retaliate against ataxpayer would be improper as a matter of lawbecause it would be ‘‘akin to improper harassmentof the taxpayer.’’ Moreover, the court decided thatissuing a summons in bad faith for the sole purposeof circumventing Tax Court discovery would be animproper purpose as a matter of law but found thatthe circumstances under which a taxpayer couldsuccessfully make this challenge ‘‘are exceptionallynarrow.’’

Although the Eleventh Circuit held that the dis-trict court erred in finding the allegations set forthby the appellants could not constitute an improperpurpose as a matter of law, the circuit court heldthat the appellants failed to meet their burdenunder the standard established by the SupremeCourt. The court concluded that the appellantsfailed to show facts giving rise to a plausibleinference of improper motive because they relied onconjecture and bare assertions. Moreover, the dis-trict court’s decision not to hold a status conferenceor permit additional evidence was appropriate inlight of the summary nature of a summons enforce-ment proceeding, the court said.

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Foreign Tax CreditA district court held that the estate of a U.S.

citizen who lived and worked in the Philippines forseven years is entitled to a $1.2 million tax refund,finding that the IRS’s substitute returns for thatperiod failed to take into account foreign taxes hepaid from his overseas work and failed to apply theforeign earned income exclusion (Estate of Herrick v.United States, No. 2:12-cv-00671 (D. Utah 2016)).

The estate sought a tax refund from the IRS forthe calendar years 2000 through 2006, during whichtime the decedent lived and worked in the Philip-pines but mistakenly believed that he would notowe any U.S. taxes on the income he earned in thatcountry because of the high rate of tax he paidthere. When the decedent failed to file U.S. incometax returns, the IRS prepared substitute returns forthe years in question but did not account for theforeign taxes he paid. The IRS determined that thedecedent owed $1,330,162.66 in U.S. taxes and lev-ied that amount from his American investmentaccounts to pay the assessed liabilities.

The decedent’s daughter, who was the adminis-trator of the estate, learned of the tax issues and hadU.S. income tax returns prepared and filed for taxyears 2000 through 2006. Unlike the returns pre-pared by the IRS, these tax returns took into accountthe decedent’s foreign taxes paid and applied theforeign earned income exclusion. The partiesagreed that the estate satisfied the three jurisdic-tional requirements for seeking a tax refund: (1) fullpayment of the tax assessed; (2) timely filing of arefund claim with the IRS; and (3) compliance withthe statute of limitations for filing a refund suit.They could not reach agreement, however, onwhether the estate was entitled to the foreign taxcredit and the foreign earned income exclusion.

The estate provided the IRS with copies of thedecedent’s tax returns that he submitted to thePhilippines Bureau of Internal Revenue (BIR). Theestate also obtained the decedent’s employmentrecords relating to tax filings from 2000 through2006 and a certification from the BIR regarding thetaxes paid from 2001 through 2006. The BIR did notprovide a certification for the year 2000 becauseneither the BIR nor the decedent’s employer couldlocate the specific form showing the transmittal ofthe tax payment. Accordingly, the IRS argued thatthe tax returns from the decedent’s records and hisemployer’s records were insufficient for the year2000 and that the information for the years 2001through 2006 did not demonstrate whether subse-quent adjustments were made that could haveresulted in a reduced amount of those liabilities.

The district court found no evidence that theamount of taxes on the year 2000 returns wasincorrect or that adjustments were later made to the

taxes paid for 2001 through 2006, which werecertified by the Philippines BIR. The court said theIRS was merely speculating that there might beadditional information and that to defend against amotion for summary judgment, the Federal Rules ofCivil Procedure require more than speculation thatadditional facts could be found. Therefore, the courtconcluded that the estate was entitled to the FTC.

The IRS contended that the estate was not en-titled to the foreign earned income exclusion undersection 911 because that exclusion is available onlyif a taxpayer makes an election on a timely filedincome tax return or an amendment to a timely filedreturn, or files within one year after the due date ofthe return. The court also rejected that claim, point-ing out that the regulations under section 911 allowa taxpayer to make the foreign earned incomeexclusion after the prescribed time periods haveexpired in specified situations. Specifically, section911 applies if there is still some tax liability owingbut the IRS has not yet discovered that the taxpayerfailed to elect the exclusion. Accordingly, the courtconcluded that the estate made a timely section 911election of the foreign earned income exclusion thatcan be applied to the decedent’s tax returns for 2000through 2006. Summary judgment for the estatewas therefore granted.

Return Information Disclosure

A U.S. bankruptcy court denied a debtor’s mo-tion to prohibit testimony by IRS witnesses and tostrike IRS exhibits as a violation of section 6103 in ahearing on the conversion or dismissal of theirbankruptcy case, finding that the return informa-tion at issue was related to the resolution of the caseand could be disclosed and used in the hearing (Inre Wendell Lawrence Jr., No. 14-00950 (Bankr. D.Idaho)).

Although several bankruptcy plans have beenproposed, none progressed to consideration of con-firmation because the debtor failed to obtain theprerequisite approval of a disclosure statement. TheU.S. trustee and the IRS moved to convert ordismiss the case, and a secured creditor filed twoseparate motions for stay relief. Consistent with thebankruptcy court’s requirements for prehearingevidentiary disclosures, the IRS disclosed its pro-spective witnesses and exhibits.

The debtor sought to prohibit the testimony ofthe proposed witnesses — an IRS revenue officerand an IRS revenue agent — and to strike all of theIRS’s proposed exhibits except its filed proof ofclaim. The debtor argued that the testimony ordocumentary evidence is prohibited by section6103(h)(4), at least in the context of the hearing onconversion or dismissal.

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The IRS responded that the evidence is proper inconnection with its arguments for conversion ordismissal, including the debtor’s failure to paypost-petition taxes, unreasonable delay, and theabsence of a reasonable likelihood of rehabilitation.Under section 6103(h)(4), ‘‘a return or return infor-mation’’ may be disclosed in a federal or statejudicial or administrative proceeding pertaining totax administration if: (1) the taxpayer is a party tothe proceeding, or the proceeding arose out of or inconnection with the taxpayer’s civil or criminalliability or the collection of that liability; or (2) thetreatment of an item reflected on the return isdirectly related to the resolution of an issue in theproceeding.

The bankruptcy court agreed, noting that a bank-ruptcy case in which a taxpayer is a party canimplicate the enforcement of tax law in severalways. According to the court, a debtor files forbankruptcy with the intent that all of the debtor’sassets and liabilities, including tax liability, will bedetermined and accounted for in a payment plan.The intent to adjudicate tax liability is inherent inthe bankruptcy filing, regardless of the final out-come, the court explained.

The bankruptcy court rejected the debtor’s claimthat the word ‘‘proceeding’’ in section 6103(h)(4)encompasses the IRS’s filing of a proof of claim butnot the IRS’s motion to convert or dismiss, whichthe debtor said had nothing to do with the deter-mination of its own tax liability. ‘‘Such a construc-tion is inappropriately and unreasonably narrow,’’the court said, adding that there is no dispute thatsection 6103(h)(4)(A) authorizes the disclosure ofreturn information in judicial proceedings involv-ing a taxpayer’s civil or criminal liability.

The fact that the IRS’s assertions and its proposedsupporting documentary and testimonial evidenceregarding the debtor’s tax liability might be moredirectly addressed through claim objection does notmake the evidence irrelevant to the issues raisedunder the motion seeking dismissal or conversion,the court said. According to the bankruptcy court,the debtor’s ‘‘attempt to cabin the evidence andallow it only in later claim-specific litigation’’ ad-vanced by the debtor ‘‘but foreclose its use inconnection with the matters brought by credi-tors . . . is unpersuasive and untenable.’’

Prohibited TransactionsThe Tax Court held that a couple participated in

prohibited transactions in 2003 by personally guar-anteeing loans to a company owned by their IRAs

in their acquisition of a metal fabrication business,leaving them liable for tax on deemed distributionsfrom the accounts and a 10 percent early distribu-tion penalty (Thiessen v. Commissioner, 146 T.C. No. 7(2016)). (Related coverage: p. 25.)

As part of the couple’s decision to buy the assetsof a metal fabrication business, they rolled overtheir tax-deferred retirement funds into newlyformed IRAs, which acquired the initial stock of anewly formed company. The new company ac-quired the assets of the business they had set out tobuy. The couple guaranteed the repayment of a loanthat the company received from the seller as part ofthe acquisition price.

The couple reported on their 2003 income taxreturn a nontaxable rollover of retirement fundsinto IRAs but failed to indicate that they hadguaranteed the loan and made no mention of thenew company or its 2003 corporate return. In 2010the IRS determined that the couple was liable for a$180,129 deficiency attributable primarily to unre-ported IRA distributions. The IRS asserted that thecouple’s guaranties were prohibited transactionsunder section 4975(c)(1)(B) that resulted in deemeddistributions of their IRA assets.

The IRA funding structure the couple used wassimilar to that described in Peek v. Commissioner, 140T.C. 216 (2013), and, in fact, was implemented bythe same CPA and brokerage firm that were in-volved in the Peek case. The Tax Court agreed withthe IRS’s primary argument in both cases — thatprohibited transactions occurred when the petition-ers guaranteed the loan. The court, rebuffing thecouple’s attempts to distinguish their case fromPeek, explained that the guaranties were the cou-ple’s indirect extensions of credit to their IRAs andthat their participation in the prohibited transac-tions caused the IRAs to lose their status as IRAsand be deemed to have distributed their assets tothe couple in a taxable transaction. The court fur-ther held that the couple was liable for the 10percent additional tax under section 72(t)(1) be-cause neither petitioner was at least 59½ years oldduring 2003.

The court concluded its decision with an exami-nation of the three-year statute of limitations onassessments under section 6501(a), finding that sec-tion 6501(e)(1) extends that period to six yearsbecause of the couple’s failure to report grossincome in excess of 25 percent of the amount ofgross income reported on their return.

Linda Friedman and Patrice Gay contributed to thiscolumn.

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Wherestate legislatorsdiscover theirbest tax ideas.

“The question is not whether states will

raise the necessary money. Rather, it’s

which groups they will tax.”

— David Brunori, Deputy Publisher Only in the publications of Tax Analysts


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Commentators Seek ClarificationOf Proposed CbC Reporting Regs


The American Bar Association Section of Taxa-tion is among the organizations that have submittedcomments on proposed regulations (REG-109822-15) on country-by-country (CbC) reporting for mul-tinational enterprise parent entities, advisingagainst a delayed U.S. effective date and encourag-ing the IRS to continue to let taxpayers exercisereasonable discretion in completing the report.

Section members applaud many aspects of theproposed regs but warn that the U.S. effective datedelay would cause hardships for U.S. companiesbecause they would be required to submit CbCreports directly to foreign tax authorities for fiscal2016, which in turn would result in multiple filingsand potentially weaker data confidentiality protec-tions. Members also describe problems that mayarise when a U.S. MNE has foreign constituententities with annual accounting periods that differfrom the U.S. parent’s tax year. If the proposed regsare finalized in mid-2016 as contemplated, sectionmembers say, a calendar year-end U.S. MNE mayhave no filing obligation for its tax year beginningJanuary 1, 2017, if any one of its foreign constituententities has a 2016 annual accounting period thatbegins before the publication date of the final regsand carries over into 2017.

Regarding the time and manner of filing CbCreports, members note that the proposed regs pro-vide for the reports to be filed with the U.S. MNEparent’s income tax return — a deadline that isearlier than that recommended by the OECD andwould mean the reports could be filed within 12months after the end of the accounting period towhich they relate. Members ask the IRS to recon-sider the accelerated deadline because it may im-pose a significant burden on U.S. MNEs andundermine the flexibility afforded to them else-where in the proposed regs to choose the source ofthe data used to generate their CbC reports. The taxsection also would like the final regs to confirm thata taxpayer may use local tax reporting data forjurisdictions where the data are available, whileusing other approved sources of data for jurisdic-tions where local tax reporting data are not avail-able.

Section members express concern about tie-breaker rules for residency determinations when aparty may be subject to CbC reporting in more thanone jurisdiction, noting that the ‘‘effective place ofmanagement’’ test under the OECD model is some-times uncertain. The tax section suggests that whenresidency is being used to define information re-porting obligations and not to determine substan-tive rights under an income tax convention, the IRSshould consider an alternative, bright-line tie-breaker rule.

The tax section asks the IRS to clarify the mean-ing of the term ‘‘tax jurisdiction of residence’’ inprop. reg. section 1.6038-4(b)(6) as it applies toterritorial tax regimes, and also to clarify the treat-ment of subpart F income and similar items toprevent potentially misleading double counting.Lastly, section members request additional guid-ance on the treatment of partnerships and partner-ship attributes to ensure that reporting is consistentacross countries.

In a separate letter, the American Institute ofCPAs has recommended allowing U.S. MNE groupsto elect on a voluntary basis to apply the proposedregs for tax years beginning on or after January 1,and before the effective date of the final regulations.

The institute requests clarification that a U.S.MNE group’s reporting is based solely on its ownannual accounting period and is not contingent onthe timing of the annual accounting periods of itsforeign constituent entities. The AICPA would alsolike the IRS to clarify the classification of specifiedassets as tangible, intangible, or cash equivalents, aswell as issues related to the reporting of the numberof full-time equivalent employees for each tax juris-diction.

The institute asks for confirmation of the statusof U.S. possessions and territories and whethertheir treatment as foreign jurisdictions is correct.Lastly, the AICPA suggests a national security ex-ception for information contained in the CbC re-ports.

The Tax Executives Institute has urged the IRS toadopt a filing deadline consistent with the OECDstandard — one year after the end of the relevanttax year — even if it necessitates a separate filingwith the IRS. The institute believes this wouldpreserve the flexibility provided to taxpayers by theregulations when choosing the data to populate theCbC report.

TEI recommends that the final regs be consistentwith the OECD standard prescribed in the final

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action 13 report for purposes of determining thelocation of an employee. The institute thinks theregs should let taxpayers report their employeesbased on the tax residence of their employer. TEIalso proposes that taxpayers be allowed to report anemployee as a ‘‘full-time equivalent’’ based on theirusual practice as long as the company does soconsistently from year to year and across entities,and as long as the method does not materiallydistort the relative distribution of employees acrossthe various tax jurisdictions.

TEI suggests that CbC reports not be included ininformation shared by the IRS with state and localjurisdictions in the United States and that publicguidance include a statement to that effect. Theinstitute also asks the IRS to publish a list ofcountries with which it is exchanging the reports,on its website or elsewhere, to enable taxpayers toproperly anticipate and react to direct requests forthe CbC report in those and other jurisdictions.

The Financial Accountability and CorporateTransparency (FACT) Coalition has commented onthe proposed regs, recommending that U.S. parententities be required to provide CbC reporting forconstituent entities that are accounted for under theequity method as well as for those included in theparent’s consolidated financial statements.

The coalition suggests adding deferred taxes anduncertain tax provisions as data elements in theCbC report, and requiring each parent entity filingthe report to provide, in addition to a taxpayeridentification number, an international legal entity

identifier for itself and each constituent entity. TheFACT Coalition believes U.S. multinational groupsshould be permitted to count as employees onlythose individuals for whom they pay payroll, SocialSecurity, or other employment taxes, and multina-tionals should be required to perform an internalreconciliation or, at a minimum, retain the workpapers needed to substantiate their CbC reportdata.

Other coalition recommendations include requir-ing CbC reports to be publicly available, treatingCbC reports as Treasury reports rather than taxreturn information, mandating the issuance of anannual public summary containing aggregated in-formation from the CbC reports, and sharing CbCinformation through the multilateral exchangeagreement created for that purpose instead ofthrough the U.S. network of bilateral tax agree-ments.

Dividend Equivalents

The New York State Bar Association Tax Sectionhas submitted a report on final, temporary, andproposed regulations (T.D. 9734, REG-127895-14)under section 871(m) on the use of derivatives toavoid withholding tax on U.S.-source dividends.

Regarding the final regs, the tax section recom-mends clarifying when delta should be tested andexplaining how issuers can ensure that over-allotment options have the same section 871(m)status as the original issuance. Section members

REG COMMENT CALENDARThe 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 Code IRS File Tax AnalystsDate Section(s) Number Subject Citation

Apr. 6 401, 414(d), 411 REG-147310-12 Governmental pension plans Tax Notes, Feb. 1, p. 542

Apr. 28 401, 410 REG-125761-14 Retirement plans Tax Notes, Feb. 1, p. 541

May 2 42 REG-123867-14 Low-income housing credit Tax Notes, Mar. 7, p. 1126

May 4 704, 704(c), 743 REG-100861-15 Partnerships Tax Notes, Feb. 8, p. 673

May 19 501(c)(3), 509(a)(3),4942, 4943, 4945,4958, 4966

REG-118867-10 Supporting organizations Tax Notes, Feb. 22, p. 879

May 23 103 REG-129067-15 Tax-exempt bonds Tax Notes, Feb. 29, p. 1006

May 25 42 REG-150349-12 Low-income housing credit Tax Notes, Feb. 29, p. 1005

June 2 1014, 6018, 6035,6081

REG-127923-15 Estate tax filing requirements Tax Notes, Mar. 7, p. 1127

(Unless otherwise noted, all dates are 2016.)

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also suggest modifying the safe harbor for indiceswith a relatively modest U.S. component.

The tax section believes the final regs strike areasonable balance by ordinarily basing the divi-dend equivalent on the actual dividend but allow-ing taxpayers to elect to use an estimate as long asthis choice is made in advance. Section membersthink it is important, however, for the IRS andTreasury to enforce the requirement that estimateshave to be reasonable.

Referring to the provision in the final regs underwhich section 871(m) withholding is not requiredwhen section 305(c) already imposes withholding,the report recommends that similar relief be offeredwhen a section 871(m) transaction is subject towithholding for a reason other than section 305(c),such as when a periodic payment is treated as fixed,determinable, annual, or periodical income. Re-garding the provision in the final regs that generallydefers withholding until a payment is made, the taxsection requests confirmation that the provision isintended to delay the foreign holder’s tax liabilityand not just the obligation to withhold.

The report suggests that the final regs needclarification regarding which party is responsiblefor determining whether equity-linked notes aresection 871(m) transactions and for withholding onthese instruments. The tax section says furtherguidance is also needed on what information theresponsible party has to provide.

Regarding the temporary regs, section membersrecommend clarifying that the test for simple con-tracts should be used whenever transactions offereconomic exposure to an ascertainable number ofshares, including instruments that include an auto-matic adjustment for mergers and stock splits,instruments that are ‘‘net share settled,’’ and putand call spreads. For purposes of comparing com-plex contracts with ‘‘closely comparable’’ simplecontracts under the temporary regs, the tax sectionsuggests adding guidance on the criteria for deter-mining that a simple contract is closely comparable.

Deemed Asset Sale ElectionsThe District of Columbia Bar Taxation Section

has recommended changes to the final deemedasset sale election regulations (T.D. 9619), asking theIRS to mitigate the issues arising from creepingqualified stock dispositions (QSDs) by requiringthat a section 336(e) election may be made only forthose dispositions in which a purchaser acquires‘‘stock meeting the requirements of section1504(a)(2) from a selling consolidated group, aselling affiliate, or the S corporation shareholders’’in a QSD.

The tax section asks the IRS and Treasury toaccommodate flexibility in the scope of property

included in a target’s plan of liquidation by provid-ing a rule that, unless a formal plan of liquidationthat contemplates the section 336(e) election isadopted on an earlier date, the making of theelection is considered to be the adoption of a plan ofliquidation immediately before the deemed liquida-tion described in reg. section 1.336-2(b)(1)(iii).

Section members suggest limiting the applicationof the step transaction doctrine (or similar rule oflaw) and clarifying the circumstances in which theinstallment sale provisions might apply to gainrealized by a target in a deemed asset dispositionunder reg. section 1.336-2(b)(2)(i). The tax sectionwould also like the IRS and Treasury to confirm therole that target stock redemptions play in effecting aQSD and the ability to make a section 336(e) elec-tion when the seller completely liquidates undersection 336 by distributing an amount of targetstock that would constitute a QSD.

The tax section recommends adding section 1239to the list of related party exceptions under reg.section 1.336-2(b)(2)(ii)(C). Lastly, section membersrequest clarification of the substantive requirementsnecessary to make a valid section 336(e) election.

WithholdingBaker & McKenzie has asserted that any regula-

tions under section 897(l)(3) should confirm that aninvestment in U.S. real property interests throughtiers of wholly owned entities does not disqualifyan eligible qualified foreign pension fund (QFPF)from the benefits of the withholding exemptionunder the Protecting Americans From Tax Hikes Actof 2015 (PATH Act).

The PATH Act generally provides QFPFs anexemption from income and withholding tax im-posed under the 1980 Foreign Investment in RealProperty Tax Act on the disposition of U.S. realproperty interests within the meaning of section897(c). The act authorizes Treasury to issue neces-sary or appropriate regulations.

Baker & McKenzie recommends that as a matterof proper statutory interpretation, legislative intent,and sound tax policy, any future regulations shouldconfirm that a QFPF holding a U.S. real propertyinterest indirectly through one or more tiers ofwholly owned entities remains entitled to theFIRPTA exemption provided in the PATH Act.

The firm says the regs should confirm that aQFPF investing in U.S. real property interests alongwith other QFPFs through an aggregate investmentvehicle that is owned solely by multiple QFPFsremains entitled to the FIRPTA exemption providedin the PATH Act.

Lastly, the firm requests confirmation that aQFPF owning an interest in a real estate investmenttrust indirectly through a tax-transparent entity

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(such as a partnership) remains entitled to theFIRPTA exemption in the PATH Act for distribu-tions attributable to the REIT’s disposition of a U.S.real property interest.

Julie Brienza, Eben Halberstam, Andy Sheets, andEmily Vanderweide contributed to this column.

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Is There a Presumption AgainstExtraterritorial Taxes?

By Jasper L. Cummings, Jr.

Table of Contents

I. The IRS Backs Down . . . . . . . . . . . . . . . . . 65A. An Insurance Excise Tax Case . . . . . . . . . 65B. Another Big Legal Deal Some of Us

Missed . . . . . . . . . . . . . . . . . . . . . . . . . 67C. The Anti-Regulation Agenda . . . . . . . . . . 68

II. Facts of Validus . . . . . . . . . . . . . . . . . . . . . 69III. The Foreign Insurer Excise Tax . . . . . . . . . . 70IV. Plaintiff Sells the Hot Dog . . . . . . . . . . . . . 70

A. To the Trial Court . . . . . . . . . . . . . . . . . 70B. To the D.C. Circuit . . . . . . . . . . . . . . . . . 71

V. Chevron . . . . . . . . . . . . . . . . . . . . . . . . . . . 74VI. Extraterritoriality of U.S. Tax Generally . . . . 74

A. A Common Issue . . . . . . . . . . . . . . . . . . 74B. The Foreign Yacht Tax . . . . . . . . . . . . . . 75

VII. Back to the Revenue Ruling . . . . . . . . . . . . 75VIII. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . 75

I. The IRS Backs Down

A. An Insurance Excise Tax Case

1. Court rewrites the statute. Just over a year ago,the D.C. Circuit held against the IRS in Validus,1 aforeign insurance excise tax case. That might notseem like news except for one thing: The IRS hassince issued Rev. Rul. 2016-3, 2016-3 IRB 282, whichrevokes Rev. Rul. 2008-15, 2008-1 C.B. 633, andeffectively acquiesces in the Validus holding. TheIRS gave up on collecting the foreign insurancecompany excise tax from what must be a lot ofBermudan insurance companies.

The D.C. Circuit did not interpret the foreigninsurance excise tax sections but rather applied apresumption against extraterritoriality of a U.S.statute. It did so by defining extraterritorialuniquely. As far as I could find, this is the first timein the history of U.S. taxation that an excise tax hasbeen interpreted not to apply to a foreign transac-tion solely on the basis of a presumption againstextraterritoriality. And Validus is one of only threecases in which a U.S. tax has been interpreted not toapply to a foreign subject, even in part, on thatbasis.2 The court seemed not to comprehend thesingularity of its decision.

The D.C. Circuit created a new excise tax regimethat converts what looks like a two-or-more-excise-taxes regime into a one-excise-tax regime. For asingle U.S. risk, the D.C. Circuit will allow only oneforeign insurance company to be taxed — either theone that issued the policy or one of the reinsurers.The result is to negate the most likely reasonCongress chose to tax primary foreign insurers at 4percent of the premium and reinsurers at only

1Validus Reinsurance Ltd. v. United States, 786 F.3d 1039 (D.C.Cir. 2015), aff’g 19 F. Supp.3d 225 (D.D.C. 2014).

2As discussed below, the Supreme Court in United States v.Goelet, 232 U.S. 293 (1914), held that an excise tax on foreign-built and -used yachts was not intended to apply to an ownerwho was a nonresident citizen, but it relied on other statutoryindicators. In Holsten v. Commissioner, 35 B.T.A. 568 (1937), aff’d,93 F.2d 1002 (2d Cir. 1937), the Board of Tax Appeals held that aforeigner’s stocks and bonds issued by U.S. corporations werenot subject to the estate tax if their situs by physical presencewas not in the United States. This decision was based more onthe historical importance of situs than on the presumptionagainst extraterritoriality. See infra discussion of the withholdingtax on royalties.

Jasper L. Cummings, Jr.

Jasper L. ‘‘Jack’’ Cum-mings, Jr., practices law inRaleigh, North Carolina.

Late last year, the IRS ac-quiesced in a D.C. Circuitfederal excise tax decisionagainst the government. Theeffect is to severely limit theapplication of a nearly 100-year-old tax on foreign in-surers when they are not

foreign enough. The court relied on the most ex-treme statement of a relatively new version of thepresumption against extraterritoriality. Cummingsargues that tax professionals need to consider thepotential application of this presumption to otherforeign situations when they don’t want the code toapply.

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one-fourth that rate (1 percent of the premium):because the taxes might apply in tandem.3

The D.C. Circuit applied the foreign insuranceexcise tax this way:

• Case 1: X, a U.S. insurer, writes insurance onU.S. risks and buys reinsurance from foreigninsurer Y, which buys reinsurance from foreigninsurer Z. Assume that Y is doing business inthe United States but Z is not. The premiumthat Y pays to Z in a foreign-to-foreign trans-action is subject to the 1 percent excise tax onpremiums paid to foreign reinsurers because Yis doing business in the United States. Thepremium paid by X to Y is exempt under theterms of the statute because it is taxable to Y aseffectively connected income.

• Case 2: Same facts as Case 1, but Y is not doingbusiness in the United States. The foreign-to-foreign premium that Y pays to Z is not subjectto the 1 percent excise tax on premiums paid toforeign reinsurers because Y is not doing busi-ness in the United States, but the premium thatX pays to Y is subject to that tax. This is theValidus scenario.

• Case 3: Same facts as Case 2, but there is noinsurer X, and Y sells the primary insurance ona U.S. risk. The premium paid to Y is subject tothe 4 percent tax on premiums paid to foreigninsurers, but the foreign-to-foreign premium Ypays to Z is not subject to the 1 percent taxunder the reasoning of the D.C. Circuit’s opin-ion (because Y is not doing business in theUnited States). Rev. Rul. 2016-3 agreed to Case3 (Situation 1 of Rev. Rul. 2008-15), as well asCase 2.

Using the words of the D.C. Circuit, ValidusReinsurance Ltd. and similar foreign reinsurers willnot be subject to the excise tax on the foreign-to-foreign reinsurance premiums they pay because thetransaction is ‘‘wholly foreign.’’ That term waslifted from the plaintiff’s brief because foreign cor-poration Validus was not doing business in theUnited States. If this seems confusing enough to beinteresting, read on. There may be some refunds tobe claimed.2. What were they thinking? In issuing Rev. Rul.2016-3, the IRS and Treasury must have been think-ing that (1) if the solicitor general would not peti-tion for certiorari in Validus (and he makes that call),the IRS Office of Chief Counsel does not have thehorsepower to defend the government’s rejectedposition; and (2) continuing to set up assessments

against foreign insurers of this type would be futilebecause, like Validus, they would pay the tax andsue for a refund in the U.S. District Court for theDistrict of Columbia (the refund venue for foreigninsurance companies that don’t have a U.S. officeand don’t file4), which would be bound by theValidus decision as circuit precedent.

The solicitor general likely did not want to peti-tion for certiorari because although the decisioninvolves a minor tax, the opinion’s reasoning impli-cates a huge political-legal issue that theRepublican-appointed justices on the SupremeCourt (a majority at the time) would almost cer-tainly decide against the Obama administration(discussed below).

Commentators seem to think the D.C. Circuit gotit right.5 This report presents the contrary view.Probably few readers practice insurance excise taxlaw, but Validus is worth knowing about for thesereasons:

• The plaintiff can be viewed as a foreign taxhaven corporation organized by U.S. hedge orprivate equity funds, which implicates manytax planning features of wide appeal.

• The recent revenue ruling shows how oneappellate defeat can stymie Treasury. This isgreat for taxpayers but raises the huge issue ofhow the government responds to one-off ad-verse court holdings (it does not respond well— a subject for another day).

• The case suggests a practical explanation ofwhy the government sometimes takes wildlyaggressive positions against foreign non-taxpayers (say a Bermudan insurer): If it is

3In the 1939 code, primary insurance was taxed at 3 percent,and reinsurance was exempt. The Revenue Act of 1942 changedthat to 4 percent and 1 percent, respectively.

428 U.S.C. section 1402(a)(2). The statute actually sets up aninteresting choice for some foreign non-taxpayers. In somecases, foreign corporations that do not think they owe U.S. taxfile protective returns to claim deductions. Protective income taxreturns must be filed in the Utah IRS office. If the IRS assessesincome tax and the foreign corporation pays, a suit for refundwill have to be filed in Utah, in the Tenth Circuit, rather than inthe District of Columbia, the venue for foreign persons with noU.S. office and no return filings.

5See Ajay Gupta, ‘‘Checking the IRS’s Extraterritorial Reach,’’Tax Notes, Mar. 2, 2015, p. 1066 (generally applauding theholding); William R. Davis, ‘‘Insurance Sees Interesting Devel-opments, Little From IRS,’’ Tax Notes, Jan. 4, 2016, p. 27; Davis,‘‘Validus Court Applies Morrison in Insurance Industry Victory,’’Tax Notes, June 1, 2015, p. 994; and Mark Leeds, ‘‘A Matter ofSemantics: Validus Reinsurance Invalidates Foreign-to-ForeignWithholding,’’ Mayer Brown LLP (July 2015) (suggesting thatforeign-to-foreign withholding might be required by the IRSunder section 1441 but could run afoul of the Validus argument,and contrasting the Foreign Account Tax Compliance Act). Seealso Stuart B. Katz, ‘‘Is Insurance Premium FDAP Income?’’ TaxNotes, Oct. 26, 2015, p. 545 (discussing whether premiums notsubject to the excise tax could now be subject to 30 percentwithholding and concluding they should not be, although theissue is uncertain). See T.D. 9610.

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going to lose cases in the international area thatit ought to win (arguably this one), it may aswell take more shots at the basket.

• The D.C. Circuit’s opinion purported to applyyet another limit on Chevron deference, similarto that applied in the Tax Court’s Altera hold-ing.6

• Most important, the circuit’s opinion promotedto the status of a positive rule of law aninterpretive presumption that Congress doesnot intend extraterritorial application of U.S.statutes. This was the first time that has beendone in a federal tax case. That promotion is aRepublican idea that generally serves businessinterests wanting to limit the reach of U.S.business regulations — and now taxes. AfterValidus, we may see this rule asserted moreoften in tax cases, including those involvingthe important Quill issue (although the contextis different).7

B. Another Big Legal Deal Some of Us Missed1. The presumption. Like Chevron deference,8 butslightly less famous in the nontax legal world, is theretooled presumption against extraterritorial appli-cation of U.S. statutes. Tax lawyers — at least theolder ones — are likely oblivious to this hot aca-demic topic, given its general irrelevance to theincome tax. Also, many tax lawyers became awareof Chevron only recently, when the Supreme Courtfinally applied it in a tax case: Mayo.9 But now theD.C. Circuit has applied the presumption againstextraterritoriality in a tax case, albeit an excise taxcase.

Chevron deference and the presumption havesimilar features. Both doctrines purport to reducecourts’ ability to use traditional judging tools tointerpret statutes. They replace those tools withdeference to agency interpretations and with apresumption, respectively. And yet some SupremeCourt justices seem to have realized that bothdoctrines tend to strip judges of the power to dowhat judges do. Consequently, the Republican-

appointed justices in particular have pulled backfrom Chevron.10 And there is some evidence inMorrison,11 the Supreme Court’s most recent opin-ion on the presumption against extraterritoriality,that Justice Antonin Scalia was pulling back fromthe presumption. In that case, he introduced a newway for judges to trump the presumption — byfinding that the ‘‘focus’’ of the transaction is mostlydomestic.12

The Chevron-like nature of the presumption issueis also shown by the fact that Shepard’s CitationService lists more than 2,000 citations to the 2010Morrison opinion. The Chevron citations similarlyare large and are too many for Shepard’s to post(more than 20,000), but Chevron had a 26-year headstart. Validus shows what can happen when nontaxdoctrines are parachuted into tax disputes. Thegeneral jurisdiction court judges know more aboutthose doctrines than they know about tax law, andthey can tend to be overly influenced by them.

2. By another name. The tax community got anearly warning of the presumption against extrater-ritoriality in 1996, when the Tax Court held in SDINetherlands13 that the IRS could not impose what thecourt called a ‘‘cascading’’ withholding tax on for-eign royalties. The Tax Court gave no evidence ofknowing about the presumption, but as an addi-tional observation, it stated that it did not believethat Congress intended the cascading tax.

In SDI Netherlands, royalties were paid from theUnited States to a Netherlands corporation, and notaxes were withheld because of an exemption underthe Netherlands tax treaty. Then the Netherlandscorporation paid almost the same royalty to aBermuda corporation for the U.S. use of the patent.The IRS tried to impose withholding tax on theNetherlands-to-Bermuda royalty, but the court dis-allowed it.

An insightful article on the decision speculatedthat the anti-cascading idea might be applied to theforeign insurance excise tax, and it cited TAM

6Altera Corp. v. Commissioner, 145 T.C. No. 3 (2015). See JasperL. Cummings, Jr., ‘‘Holding Treasury to Its Word: Altera andCapricious Regulations,’’ Tax Notes, Oct. 26, 2015, p. 519.

7See Leeds, supra note 5; and Lea Brilmayer, ‘‘The NewExtraterritoriality: Morrison v. National Australia Bank, Legisla-tive Supremacy, and the Presumption Against ExtraterritorialApplication of American Law,’’ 40 Sw. U. L. Rev. 655, 677 (2011)(discussing Quill Corp. v. North Dakota, 504 U.S. 298 (1992)).

8Chevron U.S.A. Inc. v. NRDC Inc., 467 U.S. 837 (1984). SeeCummings, The Supreme Court’s Federal Tax Jurisprudence, Ch.VI.D. (2010); and Cummings, ‘‘The Supreme Court’s Deferenceto Tax Administrative Interpretation,’’ 69 Tax Law. No. 2 (2016).

9Mayo Foundation for Medical Education and Research v. UnitedStates, 562 U.S. 44 (2011).

10See United States v. Home Concrete & Supply LLC, 132 S. Ct.1836 (2012), discussed in Cummings, ‘‘Tax Decisions of theSupreme Court’s 2011 Term,’’ Tax Notes, Oct. 1, 2012, p. 93.

11Morrison v. Nat’l Austl. Bank Ltd., 561 U.S. 247 (2010).12See Brilmayer, supra note 7, at 667-668 (‘‘Closet judicial

activists now have the best of both worlds: grand protestationsof deference to the elected branches together with virtually totalflexibility to decide the case as they see fit.’’). This is the sameflexibility the Supreme Court retained for itself to decide that astatute is not ambiguous and hence that the agency interpreta-tion is not due Chevron deference. See Home Concrete, 132 S. Ct.1836. See Cummings, supra note 10.

13SDI Netherlands BV v. Commissioner, 107 T.C. 161 (1996).




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9621001 as a possible target (approving both the 4percent tax and the 1 percent tax).14 The article wasproved right.

C. The Anti-Regulation Agenda1. Holmes’s interpretive tool. For any who stilldon’t believe that factions on the Supreme Courthave agendas that have been pursued over decades— aided by presidents who appoint like-mindedsuccessors to fill vacant seats — consider the pre-sumption against extraterritoriality. It began simplyenough as an aid to statutory interpretation inJustice Oliver Wendell Holmes Jr.’s American Bananaopinion.15 Holmes reasoned that when there isdoubt about a statute’s territorial scope, it should beinterpreted to apply to the territory over which thelegislature has jurisdiction. The idea was rooted inthe conflict-of-law views of his contemporary, Har-vard Law School professor Joseph Henry Beale, andwas based on a now-archaic belief that the sover-eignty of nations is limited to their geographicalfootprints.16

The Sherman Antitrust Act was the statute atissue in American Banana, decided in 1909. One U.S.banana company had induced Panama and CostaRica to seize the property of the other U.S. bananacompany. The Court refused to award treble dam-ages under the Sherman act. It found it improbablethat Congress would have tried to criminalize thatconduct in a foreign country, so treble damagesshould not be allowed as the alternate civil penalty.The opinion weighed only two considerations: (1)that the statute used general terms and did not referto foreign acts one way or the other; and (2) the lawof nations that each sovereign holds the power tomake particular conduct legal or illegal within itsborders (monopolization was not illegal inPanama).

Within four years, the Court backpedaled in a taxcase, and Holmes joined the opinion.17 And in 1962the Court said that American Banana had been

negated by other contrary holdings.18 More gener-ally, the presumption against extraterritorialityfragmented over the years.2. The modern era. In 1991 when William H.Rehnquist as chief justice revived and retooled thepresumption in Aramco,19 he didn’t even cite Ameri-can Banana. The Court in Aramco dismissed anEqual Employment Opportunity Commission com-plaint against a U.S. corporation for firing a U.S.citizen in Saudi Arabia because of his race andreligion. The holding relied in part on a presump-tion against extraterritoriality. The Court created theprocedural theory (picked up by the D.C. Circuit)that two plausible interpretations of a statuteshould be resolved by application of the presump-tion.20 Justices Thurgood Marshall, Harry A. Black-mun, and John Paul Stevens dissented, protestingRehnquist’s inaccurate rewrite of the evolution ofthe Holmes presumption:

Contrary to what one would conclude fromthe majority’s analysis, this canon is not a‘‘clear statement’’ rule, the application ofwhich relieves a court of the duty to give effectto all available indicia of the legislative will.Rather, as our case law applying the presump-tion against extraterritoriality well illustrates,a court may properly rely on this presumptiononly after exhausting all of the traditional tools‘‘whereby unexpressed congressional intentmay be ascertained.’’21

Professor Larry Kramer explained that theAramco dissent identified two different appropriateroles for the presumption: (1) to fill gaps when theintent of Congress cannot otherwise be determinedby normal means (a role similar to Chevron defer-ence); and (2) to apply when important issuesconcerning the president’s control over foreign af-fairs are at stake.22 Neither use was implicated inAramco, according to the dissent. They aren’t impli-cated in Validus, either.

Then in 2010, Scalia (writing for Chief JusticeJohn G. Roberts Jr. and justices Anthony M. Ken-nedy, Clarence Thomas, and Samuel A. Alito Jr.)held in Morrison that a recovery under SEC Rule10b-5 could not be obtained by a foreign securitiesbuyer against foreign and U.S. defendants, relying

14Susan Jacobini Harrington et al., ‘‘Tax Court Ends the‘Cascading Royalty’ Problem,’’ 86 J. Tax’n 108 (Feb. 1997). Othersnoted the potential connection between the two taxes. See DeanMarsan, ‘‘Global Financial System Must Now Implement a NewU.S. Reporting and Withholding System for Foreign AccountTax Compliance, Which Will Create Significant New Exposures— Managing This Risk (Part IV — Withholdable Payments),’’ 89Taxes 21 n.239 (2011). See also Rev. Proc. 2003-78, 2003-2 C.B.1029, which appears to take the same approach to the insurancetax that the IRS tried to take to back-to-back royalties and treatyabuse — to override treaty exemptions.

15American Banana Co. v. United Fruit Co., 213 U.S. 347 (1909).16See Larry Kramer, ‘‘Vestiges of Beale: Extraterritorial Ap-

plication of American Law,’’ 1991 Sup. Ct. Rev. 179 (1991).17It held that goods shipped on a fraudulent invoice made

outside the United States could be forfeited under the CustomsTariff Act of August 5, 1909, even though the conduct could not

be prosecuted as criminal. United States v. Twenty-Five Packages ofPanama Hats, 231 U.S. 358 (1913).

18Continental Ore Co. v. Union Carbide & Carbon Corp., 370 U.S.690 (1962).

19EEOC v. Arabian Am. Oil Co. (Aramco), 499 U.S. 244 (1991).See Kramer, supra note 16.

20Aramco, 499 U.S. at 250.21Id. at 261.22Kramer, supra note 16, at 201.


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in part on the presumption against extraterritorial-ity. This time Stevens, joined by Justice Ruth BaderGinsburg, dissented, stating:

First, the Court seeks to transform the pre-sumption from a flexible rule of thumb intosomething more like a clear statement rule. Wehave been here before. In the case on which theCourt primarily relies, EEOC v. Arabian Ameri-can Oil Co., 499 U.S. 244, 111 S. Ct. 1227, 113 L.Ed. 2d 274 (1991) (Aramco), Chief Justice Reh-nquist’s majority opinion included a sentencethat appeared to make the same move. . . .

Yet even Aramco — surely the most extremeapplication of the presumption against extra-territoriality in my time on the Court — con-tained numerous passages suggesting that thepresumption may be overcome without a cleardirective. See id., at 248-255, 111 S. Ct. 1227, 113L. Ed. 2d 274 (majority opinion) (repeatedlyidentifying congressional ‘‘intent’’ as thetouchstone of the presumption). And our casesboth before and after Aramco make perfectlyclear that the Court continues to give effect to‘‘all available evidence about the meaning’’ ofa provision when considering its extraterrito-rial application, lest we defy Congress’will. . . . Contrary to Justice Scalia’s personalview of statutory interpretation, that evidencelegitimately encompasses more than the en-acted text. Hence, while the Court’s dictumthat ‘‘[w]hen a statute gives no clear indicationof an extraterritorial application, it hasnone’’ . . . makes for a nice catchphrase, thepoint is overstated. The presumption againstextraterritoriality can be useful as a theory ofcongressional purpose, a tool for managinginternational conflict, a background norm, atiebreaker. It does not relieve courts of theirduty to give statutes the most faithful readingpossible.23

And then in 2015, the D.C. Circuit stated thefollowing in Validus:

The Supreme Court has instructed that a courtmust presume that a statute has no extraterri-torial application ‘‘‘unless there is the affirma-tive intention of the Congress clearlyexpressed’ to give a statute extraterritorialeffect’’ [citing Morrison, which cited Aramco].

Yet in Morrison even Scalia denied he was apply-ing a clear statement rule.24

All three judges on the D.C. Circuit panel wereoriginally appointed to the federal bench by Repub-lican presidents, although the opinion’s author waselevated to the circuit by President Clinton. You cansay that the D.C. Circuit was just following theSupreme Court. But it would be more accurate tosay that it was following the strictest version of theRepublican-appointed Supreme Court (then) ma-jority’s view of an interpretive presumption. Andyou also should understand that this presumptionhas been turned into an ideological, if not political,tool rather than an interpretive legal tool as Holmesoriginally conceived it.

II. Facts of ValidusValidus was a foreign reinsurance company that

reinsured policies issued by other insurers in theUnited States. Validus itself bought reinsurancefrom foreign companies, which is called retroces-sion in the insurance industry but is here calledre-reinsurance.25 Although the court and the partiesassumed that re-reinsurance (cases 1 and 2, above)is an unremarkable event, it is important to under-stand that it was also an unremarkable event in1942, when the excise tax was amended to approxi-mately its current form. Also, reinsurance was thencommonly bought across national borders as it istoday, although World War II upset the business ofmany of the European reinsurers.26

Validus was organized as a Bermudan corpora-tion in 2006 and engaged in a U.S. public offering ofstock at original issue plus some shares held by theoriginal shareholders, private equity funds, orhedge funds organized by Goldman Sachs andother investment bankers.27 Validus reinsured U.S.insurers and received premiums that were notsubject to either U.S. or Bermudan income tax; theywere not income effectively connected with a U.S.trade or business, and Bermuda did not have acorporate income tax.

The IRS determined in 2012 that Validus owedthe section 4371 excise tax on the premiums it paidin 2006 to other foreign reinsurers. Validus paid the

23Morrison, 561 U.S. at 278-279 (this opinion also invented arule that can make the presumption inapplicable if the focus ofthe transaction is in the United States, with focus being a morediffuse concept than the location of events).

24Id. at 265; see Brilmayer, supra note 7, at 660.25The taxpayer and the court insisted on calling the second

reinsurance retrocession, which may be the usage in somecircles, but it tends to cause prejudgment of the outcome of thecontroversy by making the second reinsurance appear not tomeet the statutory term ‘‘reinsurance.’’

26See J. Harry LaBrum, ‘‘The Future of Re-insurance in theAmericas,’’ 15 Ins. Counsel J. 81 (1948) (‘‘one insurer or re-insurercontracts with another’’).

27Available at http://www.sec.gov/Archives/edgar/data/1348259/000095012307010068/e28184a6sv1za.htm.




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tax and sued for refund in the U.S. District Court forthe District of Columbia, where it won summaryjudgment.28 The tax at issue was 1 percent of thegross premium Validus paid on reinsurance itbought.

The district court’s opinion did not spend muchtime on the facts. It did not even state that a 1percent excise tax had been paid on the reinsurancepremiums that Validus received, although thatmust have been the case. The district court’sgrounds were narrower than the circuit court’s: thatreinsurance could refer only to the first reinsurancepolicy issued by a foreign reinsurer to the originalinsurer, as discussed below. It did not restrict theexcise tax to one application per domestic risk,because it allowed a foreign insurer without ECI tobe taxed on its premiums received at 4 percent andits reinsurer to be taxed at 1 percent. Thus, thecircuit’s grounds are likely to reduce the yield fromthe tax more than the district court’s grounds.

III. The Foreign Insurer Excise TaxIf you had not heard the plaintiff’s argument or

read the two opinions, you probably could notguess how the taxpayer won. Sections 4371-4374impose excise taxes solely on premiums paid toforeign insurers, which specifically include foreignreinsurers. The issue in Validus was whether theyalso include foreign re-reinsurers on the particularfacts of the case (that is, when the first reinsurerboth has not earned ECI and has not written theprimary insurance).

Section 4371(3) imposes the 1 percent tax on thereinsurance premium, and section 4372(f) definesreinsurance. It does so in the broadest possibleterms to include the reinsurance of all domesticrisks insured by underlying primary insurance con-tracts.29 Section 4373(1) exempts premiums that areECI (unless exempt from income tax under a treaty,which could not apply to a Bermuda reinsurer). Thestatute assumes (correctly) that foreign issuers caninsure U.S. risks without doing business in theUnited States for income tax purposes. The tax rateis 4 percent on the primary insurance premium paidto a foreign insurer and 1 percent on a reinsurancepremium paid to a foreign reinsurer.

Therefore, without even addressing re-reinsurance, section 4371 appears to create the po-tential for at least two excise taxes totaling 5 percent

for the same underlying risk for a single reinsur-ance,30 which might be called cascading taxes. Theobvious potential for cascading may be why Con-gress set the rate on the primary policy at 4 percentand on the reinsurance at 1 percent. Neither party inValidus came up with a historical explanation for thedifference in rates.

But the appearance is wrong, according to Rev.Rul. 2016-3. The revenue ruling sets out Case 2above (the Validus scenario) and concludes that the1 percent reinsurance tax cannot be applied, al-though the 4 percent tax can. Nothing in the statuteprecludes multiple excise taxes or their applicationto foreign reinsurers. Indeed, the whole point of thestatute is, and always has been, to tax foreigninsurers and reinsurers that are not subject to theincome tax. That bears repeating: The whole pointof the tax is to have extraterritorial effect — a pointthat the Justice Department valiantly tried to argue.

So how did Validus win?

IV. Plaintiff Sells the Hot Dog

A. To the Trial Court

The trial court bought the plaintiff’s primaryargument that the statute taxes only reinsurancepremiums paid by the primary insurer. However,that argument was by no means straightforward. Itinvolved focusing on the word ‘‘cover’’ in section4371(3) and depended on wholly ignoring an alter-nate use of the word. One would think that thebroader definition of reinsurance in section 4372(f)was sufficiently expansive not to be limited to theoriginal insurer. It describes reinsurance of theunderlying risk, however achieved. But the trialcourt held that the references to ‘‘cover’’ and ‘‘con-tract’’ in section 4371(3) meant that the reinsuredparty had to be a party to the primary insurancecontract. The trial court in effect read the 1 percent

28Validus, 19 F. Supp.3d 225.29Section 4372(f) says: ‘‘For purposes of section 4371(3), the

term ‘policy of reinsurance’ means any policy or other instru-ment by whatever name called whereby a contract of reinsur-ance is made, continued, or renewed against, or with respect to,any of the hazards, risks, losses, or liabilities covered bycontracts taxable under paragraph (1) or (2) of section 4371.’’

30Section 4371 says:There is hereby imposed, on each policy of insurance,indemnity bond, annuity contract, or policy of reinsur-ance issued by any foreign insurer or reinsurer, a tax atthe following rates:

1. Casualty insurance and indemnity bonds. 4 cents oneach dollar, or fractional part thereof, of the premiumpaid on the policy of casualty insurance or the indem-nity bond, if issued to or for, or in the name of, aninsured as defined in section 4372(d);2. Life insurance, sickness and accident policies, andannuity contracts. 1 cent on each dollar, or fractionalpart thereof, of the premium paid on the policy of life,sickness, or accident insurance, or annuity contract; and3. Reinsurance. 1 cent on each dollar, or fractional partthereof, of the premium paid on the policy of reinsur-ance covering any of the contracts taxable under para-graph (1) or (2).




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tax to apply to ‘‘reinsurance covering any of the[primary] contracts’’ written by the person buyingthe reinsurance.

That interpretation was doubly wrong, as theD.C. Circuit more or less realized. First, the trialcourt refused to read the definition of reinsuranceas informing the meaning of the taxing clause. Thatis the standard method of interpretation: The defi-nition is a more specific part of the statute, and themore specific parts govern.31 Tax folks are alwayslooking for a definition to plug into the operativesection and would naturally do so here. However,the circuit court also accepted the novel argumentthat Congress intended to state a broad definitionand then to use only part of it in the taxing section.

Second, the trial court interpreted the statute torequire that the primary contract be written byValidus because the reinsurance it purchased had to‘‘cover’’ the primary contract — something thatcould occur only if Validus wrote the primaryinsurance.

That makes no sense. Does it mean that if thestatute had not referred to the primary contract, theJustice Department might have won? But howcould Congress have defined reinsurance, whichmight be far removed from the primary policy,without referring to the primary policy? Withoutthe primary policy, there is nothing to reinsure,either the first or the second time. All Congress didin section 4371(3) was to define (by reference tosection 4372(f)) the set of primary contracts withwhich it was concerned, and then to levy a tax onreinsurance ‘‘covering,’’ meaning reinsuring, risksof the insured based on those primary contracts.32

Wily tax planners saw the flaw in the trial court’slogic: A Bermudan reinsurer like Validus couldavoid all excise taxes (not just the tax on thereinsurance Validus bought) by arranging for somesort of reinsurance to be obtained by the originalU.S. insurer, first from a U.S. reinsurer and thenfrom Validus, which then could buy its own rein-surance. That way Validus would never be reinsur-ing the original insurer and could never be taxed,either by the income tax or the excise tax.33

B. To the D.C. Circuit1. On its own terms. Although the D.C. Circuit’sopinion wandered around, in effect it reasoned asfollows:

• The plaintiff’s definition of ‘‘covering’’ is plau-sible but not unambiguously correct (in reality,the D.C. Circuit rejected the trial court’s analy-sis).34

• The Justice Department’s interpretation like-wise is plausible but not unambiguously cor-rect.35

• The plaintiff’s interpretation of covering wouldproduce a result contrary to the known andclear purpose of Congress to tax re-reinsuranceby foreign reinsurers. Observe this point well:The circuit agreed that re-reinsurance could betaxed, as long as it could not cascade as mul-tiple 1 percent taxes on multiple reinsurancecontracts.36

• Courts should adopt an interpretation thatavoids such an anomalous result (meaningdefeating the purpose of Congress to tax re-reinsurance) when other interpretations areavailable. This is the first correct presumption.

The D.C. Circuit could have stopped right thereand held for the government, but it did not becausethe plaintiff had argued the Supreme Court’sAramco line of decisions. As a result, the opinionproceeded to analyze the second presumption,which it said applied only if there were two plau-sible interpretations of the statute. The D.C. Circuitsaid:

• The Validus re-reinsurance was wholly foreign.• When there are two merely plausible interpre-

tations and one would give extraterritorialeffect to a statute, and Congress did not clearly

31See, e.g., Commissioner v. Kowalski, 434 U.S. 77 (1977).32The opinions made much of the Justice Department’s

awkward definition of cover by analogy to blankets, which thecourt rejected. If the Justice Department had simply argued thatcovering meant reinsuring risks originating in the primarycontracts, it would have been better off. This is effectively whatreg. section 46.4371-2(c)(2) says.

33See Davis, ‘‘Insurance Sees Interesting Developments,’’supra note 5 (‘‘Observers said the decision was well-reasoned,and that the court did a good job of rejecting the lower court’sdecision, holding that the section 4371(3) excise tax does notapply to retrocession transactions. The lower-court decisionopened up an interesting way around the excise tax, which took

the form of reinsuring risks within the United States and thenretroceding those risks to an offshore reinsurer, observerssaid.’’).

34Note, however, that the ‘‘plausible’’ interpretation as ex-plained by the D.C. Circuit was that a taxable reinsurancecontract not only must reinsure the primary insurer, but alsomust assume direct liability to that insurer’s customer, whichsurely is an erroneous reading of the meaning of reinsurance.See Validus, 786 F.3d at 1044 (fourth paragraph of Section II.A ofthe opinion, discussing privity). The D.C. Circuit did notrecognize the distinction between assumption reinsurance andindemnity reinsurance. See Internal Revenue Manual section4.42.5. Reg. section 46.4374-1(a) assumes the tax applies to both,but the issue has never been specifically addressed. See T.D.9024.

35Although the D.C. Circuit might read the definition ofreinsurance as broadly as the Justice Department, it doubtedthat definition partly because the court gave weight to Validus’sargument that Congress defined reinsurance broadly and thentaxed it narrowly. If that is plausible, it stretches the definition ofplausibility.

36Validus, 786 F.3d at 1045 (Section II.A., para. 8).





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indicate its intent to tax beyond the territory ofthe United States, the interpretation that doesnot tax beyond the territory of the UnitedStates wins. Here that applies to the whollyforeign reinsurance bought by a foreign rein-surer that did not itself earn ECI. That is anindicator of being wholly foreign, according tothe D.C. Circuit.

2. Evaluation of the circuit’s reasoning. I count atleast eight problems with the circuit’s reasoning,most of which should have dictated a governmentvictory.

a. Two presumptions. The circuit should havestopped with the first presumption, as stated above.

b. Wholly foreign? Second, when the circuit’sopinion launched into the extraterritorial presump-tion, it first had to make the presumption factuallyapplicable to the Validus re-reinsurance as con-trasted with other foreign-to-foreign reinsurance.That was necessary to leave room for the tax toapply to some re-reinsurance, which the circuit saidCongress intended. To do that, the circuit had to (1)adopt the invented term ‘‘wholly foreign’’ from theplaintiff’s brief, and (2) reason that Validus’s re-reinsurance was wholly foreign because Validus didnot earn ECI. If Validus had earned ECI, its re-reinsurance would not be wholly foreign, eventhough written between two foreign corporationswholly outside the United States.

That odd definition of wholly foreign allowedthe circuit to draw a fine distinction between Case 1and Case 2, above. It did so by stating that theValidus re-reinsurance was ‘‘materially different’’from the case in which the first reinsurer is a foreigncorporation whose earned premium income is ECI.In that case, according to the circuit, the firstreinsurer would be a ‘‘U.S. entity.’’ Really? A U.S.entity?

That use of the term ‘‘U.S. entity’’ is contrary tostandard tax terminology or any other kind ofterminology. To the small extent the term has beenused in a handful of regulations without definition,it always means a corporation or partnership orga-nized under the laws of a state of the UnitedStates.37 It never means a foreign corporation thatearns ECI. Moreover, the D.C. Circuit failed tonotice that the excise tax statute refers to the statusof the income and not the status of the foreigninsurer; it does not exempt insurers that are en-gaged in a U.S. business, but rather exempts ECI.38

The whole basis of the circuit’s reasoning is theextraterritoriality presumption. Therefore, youwould think that more care would be taken indetermining what it means to be extraterritorial. Weknow that the historical origins of the presumptionrelated to physical jurisdiction.39 Nevertheless, thecircuit drew a line between two very similar typesof foreign-to-foreign transactions, simply by ob-serving a U.S. federal income tax distinction andadopting, without thought, the term ‘‘wholly for-eign’’ from the plaintiff’s brief.

The distinction might have made some policysense if the circuit had reasoned that (1) the UnitedStates has taxing authority over a foreign insurerbecause it does business in the United States, and so(2) that gives the United States authority to requirethe foreign insurer to also pay an excise tax onpremiums it pays. But the circuit did not explainitself that way, and the decision was not based onlegislative power.

Instead, the opinion justified its conclusion in anentirely different way: by reference to hypotheticalcascading taxes being imposed if multiple foreign-to-foreign reinsurances were taxed. As a result ofthe circuit’s reasoning, it is impossible for both the4 percent tax and the 1 percent tax on reinsurance tobe applied for the same risk, or for the 1 percent taxon reinsurance to be applied twice for the same risk.

The circuit never exactly identified the relevanceof the cascading tax theory to the presumptionagainst extraterritoriality, and there is none. Inreality, the cascading tax theory was a third ground,based on an unstated presumption against cascad-ing taxes that has no basis in the law. As noted, theholding precludes not only more than one 1 percenttax but also the 4 percent plus 1 percent combina-tion, even though that is hardly a cascade. Theplaintiff offered no evidence of actual cascadingbeyond its own facts, which would have amountedto a total of 2 percent tax on reinsurance and noneof the horribles the amicus brief described. AmiciInternational Underwriting Association of LondonLtd. (IUA) and the London & International Insur-ance Brokers’ Association (LIIBA) asserted thatthere could be as many as four reinsurance trans-actions on which the tax could be levied, but theydid not prove that.40

The cascading tax problem is discussed furtherbelow.

37See, e.g., reg. section 1.1471-5(f)(4)(viii).38Actually, the statute’s exemptions for foreign insurers with

domestic activities are more complicated than that. For reinsur-ers, there also is an exemption if the policy is signed in theUnited States for the issuers. There are different exemptions for

different types of policies. But for a reinsurer that does not havea U.S. signer, the exemption is for ECI.

39See Kramer, supra note 16, at 181.40Brief of Amici Curiae IUA and LIIBA, Validus v. United

States, 786 F.3d 1039 (D.C. Cir. 2015) (No. 14-5081).





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c. Congress’s intent. Third, the extraterritorialitypresumption can apply on its own terms only ifCongress did not express its intent to apply the taxto events outside the United States. But extraterri-torial application is what the excise tax is all about:It applies only to foreign insurers that do not earnECI.41 The excise tax statute is totally different fromthe statutes at issue in the earlier Supreme Courtdecisions: the Sherman Act, the Equal EmploymentOpportunity Act as originally written, or SEC Rule10b-5. Those statutes and regulation did not by theirterms target foreign transactions, and they usedgeneral terms. In contrast, the foreign insurancecompany excise tax does specifically target foreignpersons.

The excise tax has only one domestic nexusstated in section 4372(d) and (e): The insured risk onthe primary insurance must be domestic. Thatshows Congress thought about identifying a do-mestic nexus that justified the taxation of foreignpersons, did so, and did not intend for a court tocreate another nexus requirement.

A large part of the circuit’s speculation aboutCongress’s intent concerned the complications thatthe IUA and LIIBA projected might occur if the IRStried to collect the tax from more remote reinsurers.Since that was not the case before the court, itshould not have taken such a central role in theanalysis. Most likely the circuit’s strange pivot tothe cascading tax theory revealed its discomfortwith saying that a tax clearly aimed at extraterrito-rial transactions fell under the presumption againstextraterritoriality.

d. Clear indication. Fourth, the circuit adoptedthe ‘‘clear indication’’ version of the presumptionthat the two dissents quoted above said was notreflected in the case law when all relevant precedentwas considered. And Scalia agreed that there is noclear indication rule.

In any event, Congress did give a clear indica-tion: It wrote the statute clearly to apply to foreigninsurers. The D.C. Circuit had already decided thatthe presumption should apply to re-reinsurance.Re-reinsurance will be the third insurance contracton an underlying risk. The reinsurance businesswas known to be international in 1942 when the taxoriginated. Congress aimed the statute at foreignreinsurers. What more indication do you want?

e. Follow the risk. Fifth, regarding the ‘‘cover’’argument, the circuit went back through prior ver-sions of the statute to reach the conclusion that thedefinition of reinsurance did not follow the risk.

The court refused to give primary importance to thewords of section 4372(f) that define reinsurance as‘‘with respect to’’ risks covered by the primarycontracts of insurance.

f. Let’s get our story straight. Sixth, after hingingits analysis entirely on the near-conclusive pre-sumption, the opinion’s final paragraph states thatthe circuit has interpreted the statute in a mannerthat is the ‘‘most faithful reading of the text.’’ Butthe court just got through telling us that it could notinterpret the text and had to rely on a presumption.

g. Northumberland. Seventh, the 1981 Northum-berland42 opinion seems directly in conflict with theD.C. Circuit’s opinion. But the plaintiff and amiciargued that the facts of Northumberland were differ-ent. They were different, in that the reinsurer filedsome sort of income tax returns for the years atissue. The facts of Northumberland are confused;nevertheless that opinion stated:

In the first instance, the excise tax was withheldfrom the premiums ceded by the direct insur-ers to Northumberland as reinsurer. This servedto equalize Northumberland’s position as aforeign reinsurer. In the second instance, the taxwas imposed on the premiums as transferredto AIM RE as a separate foreign reinsurer, or inthis case, retrocessionaire. Imposition of thetax to this transaction thus serves to furtherthe legislative policy.43 [Emphasis added.]

This quotation shows that the Northumberlandcourt approved the same double excise tax (totaling2 percent) that the D.C. Circuit in Validus said wasimpossible. The D.C. Circuit said that the Northum-berland opinion did not consider the presumptionagainst extraterritoriality. Of course, the presump-tion did not exist in its retooled form in 1981.Nevertheless, the earlier opinion interpreted thestatute and allowed cascading.

h. No conflict of laws. Eighth, the extraterritori-ality presumption originated in part to coordinatethe law of nations and to enforce a 16th-centuryview of sovereign power: Each nation thinks it candetermine the consequences of conduct within itsown borders, and without conflict-of-laws prin-ciples, which the presumption is, chaos or conflict-ing rules reign.44 That is the context of the bananacase, the EEOC case, and the Rule 12(b)-5 case.45

41Aramco ignored a less clear indication that Congress in-tended the statute to apply to citizens employed abroad: Thestatute did not apply to aliens employed abroad.

42United States v. Northumberland Ins. Co., 521 F. Supp. 70(D.N.J. 1981).

43Id. at 78-79.44See Kramer, supra note 16, at 188.45Another prominent citation in the history of the presump-

tion is Foley Bros. Inc. v. Filardo, 336 U.S. 281 (1949). But it, too,involved a generic requirement with no textual indication offoreign application and legislative history plus prior attorney


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But choice of law is not needed in federal taxa-tion, as illustrated by the U.S. choice to tax theworldwide incomes of citizens and residents. To theextent conflicts arise in taxation, the remedy ofchoice is the tax treaty, which can and does apply tothe insurance excise tax. Therefore, the Justice De-partment should have argued that the presumptionwas simply inapplicable and had never been ap-plied by the Supreme Court to a federal tax.

V. ChevronOn appeal, the Justice Department asserted for

the first time that under the Chevron doctrine, thecourt should give deference to a Treasury regulationunder section 4371. The D.C. Circuit refused, partlybecause the government did not show that Treasuryhad considered the presumption against extraterri-toriality in adopting the regulation — in 1970. If thecourt was right, this could be a major addition tothe reasons to crowd out Chevron deference, but thecircuit was wrong on several grounds.

The government wanted to rely on reg. section46.4371-2(c)(2), which melded the definition of re-insurance into the taxing section in the normalway.46 It was adopted in 1970, before Chevron, andbefore Rehnquist had revived the presumption. Asthe Justice Department brief pointed out, that regu-lation harmonized the taxing part of the statute andthe definitional part by logically imposing the ex-cise tax on reinsurance of a risk whose underlyingprimary insurance contract was otherwise identi-fied in the statute. This is the interpretation that thetrial court rejected completely and that the circuitsaid ‘‘fits awkwardly.’’

For this new Chevron requirement, the D.C. Cir-cuit relied again on Scalia’s opinion in Morrison, butit did not get the cite exactly right. Scalia said onlythat the Court would not give deference to agency

rulings that relied on case law that it had alreadyrejected because the cases, not the rule, did not relyon the presumption.

Maybe few Treasury regulations run the risk ofnot considering the presumption. Or do they? Forexample, reg. section 1.1012-1(a) says the basis ofproperty is its cost, and we assume that applies toforeign persons that have not yet touched the U.S.tax system. But does it? Should Treasury haveinvestigated that point when it wrote the regulationin 1957? Stay tuned for an article on the tax attri-butes of foreigners.

VI. Extraterritoriality of U.S. Tax Generally

A. A Common Issue

The D.C. Circuit wrote as if there were no federaltax context surrounding the extraterritorial tax is-sue, and yet there is a context. For starters, theincome tax assumes that all of subtitle A has world-wide effects. Section 7701(a)(14) defines taxpayersas any persons subject to any internal revenue laws,which include the insurance excise tax. The phrase‘‘subject to’’ is generally understood to mean poten-tially subject to.47 New York University professorHarvey P. Dale used to say that a baby born todayin China is a U.S. taxpayer.

Every preexisting foreign corporation that is ac-quired by a U.S. citizen or resident springs into theU.S. tax system with adjusted tax basis for its assets,earnings and profits, etc., even if its prior ownersnever expected the code would require that book-keeping. That means those foreign corporationswere subject to U.S. tax laws before they becameliable for U.S. taxes.48 If there were no tax history tobe wiped out, corporate buyers of the stock offoreign corporations from corporate sellers wouldnot be so keen to make section 338(g) elections.Therefore, the income tax is necessarily assumed tohave extraterritorial effect without anyone sayingso, thinking about it, or considering the extraterri-toriality presumption.

There is also an extraterritorial context for federalexcise taxes. In fact, the tax on foreign insurancewas before the Supreme Court in 1994, when IBMCorp. contested its application to foreign insurancebought by IBM’s foreign subsidiaries on goodspurchased by the subsidiaries from IBM’s U.S.plants.49 The application of the tax on insurance

general guidance that it applied only within the U.S. territory.Another prominent citation, Smith v. United States, 507 U.S. 197(1993), involved the Federal Tort Claims Act and waiver ofsovereign immunity, which is always strictly construed.

46Reg. section 46.4371-2(c), ‘‘Reinsurance.’’:Section 4371(3) imposes a tax on each policy of reinsur-ance, certificate, binder, covering note, receipt, memoran-dum, cablegram, letter, or other instrument by whatevername called, whereby a contract of reinsurance is made,continued, or renewed, if issued:

(1) By a nonresident alien individual, a foreign partner-ship, or a foreign corporation, as reinsurer (unless thepolicy or other instrument is signed or countersigned byan officer or agent of the reinsurer in a State, Territory,or the District of Columbia in which such reinsurer isauthorized to do business); and(2) To any person against, or with respect to, any of thehazards, risks, losses, or liabilities covered by contractsof the type described in section 4371(1) or (2).

47See Morse v. United States, 494 F.2d 876 (9th Cir. 1974).48See Harvey P. Dale, ‘‘Tax Accounting for Foreign Persons,’’

37 Tax L. Rev. 275 (1981).49United States v. IBM, 517 U.S. 843 (1994).




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bought by foreign corporations from foreign insur-ers was assumed, and the case was decided on thebasis of the constitutional prohibition against tax onexports.

Likewise, the Supreme Court assumed Congressintended Prohibition and its taxes to apply toforeign ships in U.S. waters, but Treasury did notattempt to apply them beyond those waters.50

The most important foreign excise tax cases in-volved foreign-built yachts, and they producedseveral important decisions of the Supreme Courtbefore World War I. The government cited one ofthose decisions in its Validus brief regarding thetaxpayer’s constitutional claim, but the citation gen-erated no interest.

B. The Foreign Yacht TaxThe cited case was Bennett,51 which involved a

1909 excise tax imposed on the use of foreign-builtyachts. The tax was assessed against severalwealthy yacht owners, who mounted a series ofmostly unsuccessful court challenges. Like the in-surance excise tax, the yacht excise tax was aimeddirectly at a foreign target. Mr. Bennett argued thatbecause his yacht at all times remained outside thejurisdiction of the United States, it was not subjectto the tax.

Chief Justice Edward D. White Jr. rejected theargument, finding that the statute referred to useand did not restrict that to use inside the UnitedStates. Had White known about the presumptionagainst extraterritoriality or thought it applicable,he might have said that the statute did not saywhere the use should be and that the presumptionprecluded foreign use. But he did not.

However, another taxed yacht owner, Mr. Goelet,objected that not only was his yacht abroad, but sowas he, and the tax should not apply to a nonresi-dent citizen.52 Goelet won because the Court’s ex-perience up to that point was that Congress neverundertook to tax citizens abroad. The opinion ac-knowledged the contrary approach of the new 1913income tax but reasoned it was an exception thatproved the rule.

The Goelet opinion did not rely solely on theinference from prior practice, which might be analo-gized to the presumption. It went on to point outthat the yacht tax statute directed that the tax becollected by the collector of customs in the districtnearest to the residence of the yacht owner. Thiswas proof in the text of the statute that Congress

expected the taxpayer to be a resident, and so theforeign-built yacht excise tax did not apply to anonresident citizen.

The yacht tax decisions really are the closestanalogues to the insurance excise tax case. In thosecases, the Supreme Court did not use a presump-tion but an inference from prior congressional prac-tices. The Court did not rely solely on the inferencebut also on the text of the statute. Even though theexcise tax was a tax on use, the use did not have tobe in the territory of the United States. That isprecisely the way Holmes conceived the presump-tion against extraterritoriality and the way it wasused up to 1991. The Aramco and Morrison opinionsat least give lip service to that approach. Theproblem comes when lower federal courts thatperhaps do not understand the nuances of thepresumption ram it down as a positive rule of law.

VII. Back to the Revenue RulingThis report began with the current event, Rev.

Rul. 2016-3. The ruling states that the IRS will notapply the 1 percent tax to foreign-to-foreign rein-surance when the reinsured company is not earningECI, either as a primary insurer or as a reinsurer. Sothe Bermuda reinsurance companies can be homefree so far as the insurance excise tax is concerned.

A likely explanation for Rev. Rul. 2008-15 and theassessment against Validus is that the IRS has otherreasons to be concerned about some Bermuda rein-surers. They may operate like hedge funds but arenot treated as passive foreign investment compa-nies; these have been on the IRS’s radar for sometime.53 Presumably Validus is not such a companybecause it is public.54

This may suggest another reason why the IRSgave up on Validus: It was a sideshow to the mainconcern with foreign insurers.

VIII. ConclusionSpeakers on the art of negotiation say, ‘‘You have

to care, but not too much.’’ The same is true for theIRS.

The IRS always thinks it is right, but sometimes itis not. At other times, it is right but loses anyway.The organization has to take a philosophical ap-proach to the losses or else someone would go nuts.

Tax professionals have a completely differentmind-set. You usually can’t worry about whichargument is more right or wrong; you must argue

50Cunard S.S. Co. v. Mellon, 262 U.S. 100 (1923).51United States v. Bennett, 232 U.S. 299 (1914).52United States v. Goelet, 232 U.S. 293 (1914).

53See Notice 2003-34, 2003-1 C.B. 990.54Indeed, it has been suggested that as a real operating

insurer, Validus has aided the hedge fund insurers. See SonaliBasak and Selina Wang, ‘‘Wyden Targets Hedge Funds inReinsurance Tax Legislation,’’ 123 DTR G-5 (June 26, 2015).




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for the taxpayer’s position as an advocate, althoughit really helps to be right.

But courts ought to have their own mind-set.They have an institutional obligation not to besnowed under by great advocacy. The Tax Court hasrecognized it has the power to decide a case ongrounds not even argued by the parties:

Thus, the parties cannot prevent the Courtfrom deciding the case upon what it considersto be the correct basis, simply by failing toplead correctly, or by attempting to control theissues to be considered by the Court throughadmission and/or stipulation. It is the Court’sright and obligation to decide the case uponwhat it considers to be the correct applicationof the law, based upon the record presented,whether the parties have properly pleaded thecontrolling issues or not.55

I seriously doubt that the D.C. district court andthe D.C. Circuit would have held the way they didif they had had a more regular diet of federal taxcases. They would have sensed, as did White in theyacht excise tax cases in 1914, that tax laws nor-mally have extraterritorial effect, particularly whenthe section at issue targets solely foreign insurers.

55Barnette v. Commissioner, T.C. Memo. 1992-595 (Korner, J.);followed by Williams v. Commissioner, T.C. Memo. 1997-326;Metrocorp Inc. v. Commissioner, 116 T.C. 211 (2001).

Call for Entries:

Tax Analysts’ Annual

Student Writing CompetitionTax Analysts is pleased to announce the opening of its annual student writing competition for 2016. This global com-petition enables students who win to publish a paper in Tax Notes, State Tax Notes, or Tax Notes International and receive a 12-month online subscription to all three weekly magazines after graduation. Submissions are judged on originality of argument, content, grammar, and overall quality.

• Students must be enrolled in a law, business, or public policy program.

• Papers should be between 2,500 and 12,000 words and focus on an unsettled question in federal, international, or U.S. state tax law policy.

• Papers must not have been published elsewhere.

• Deadline for entries is May 31, 2016.

Submissions should be sent to:[email protected]




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Transfers of Intangibles to anExisting Partnership

By W. Eugene Seago andKenneth N. Orbach

Under section 704(c), ‘‘income, gain, loss, anddeduction with respect to property contributed tothe partnership by a partner shall be shared amongthe partners so as to take account of the variationbetween the basis of the property to the partnershipand its fair market value at the time of contribu-tion.’’ The rationale for section 704(c) is that ‘‘specialrules are needed to prevent artificial shifting of taxconsequences between partners with respect to pre-contribution gain or loss.’’1 Thus, when pre-contribution gains and losses (the differencebetween the value of the property contributed andthe contributing partner’s basis in the property) arerealized, those gains or losses should affect only thetaxable income of the contributing partner.2Changes in value that occur after the contribution ofthe property are subject to the general rules forpartnership allocations.3

This article analyzes the possible application ofsection 704(c) principles to the amortization of thezero-basis intangibles transferred to a partnershipfor an interest in the partnership profits, losses, andcapital.

A. Contributed Property Subject to Cost RecoveryWhen depreciable or amortizable property is

contributed to a partnership and the partnershipuses the property in the operations of the businessrather than disposing of it in a taxable transaction,the cost recovery deductions must be allocatedbetween the contributing partner and the noncon-tributing partners so as to account for the differencebetween the property’s basis and FMV at the time ofthe contribution. The allocation of the asset’sbuilt-in gain to the contributing partner is accom-plished indirectly. Under the ‘‘traditional method,’’as prescribed in the regulations,4 in effect, thebuilt-in gain or loss from depreciable or amortizableproperty is allocated to the contributing partnerthrough adjustments to the annual cost recovery.That is, the regulations require the noncontributingpartner to be allocated tax depreciation to the extentof book depreciation (using FMV) of the asset5 andthe contributing partner to be allocated the remain-der of the depreciation taken for tax purposes. Forexample, if a partner (T) with a 50 percent interest inprofits contributes amortizable or depreciable (bythe straight-line method)6 property with a basis of$6,000, FMV of $10,000, and a remaining cost recov-ery period of 10 years, then each year the noncon-tributing partner will be allocated $500 [($10,000/10) x 0.5] cost recovery, and the contributing partnerwill be allocated the remaining $100. Over the life ofthe asset, the cost recovery will reduce T’s share of

1Joint Committee on Taxation, ‘‘General Explanation of theRevenue Provisions of the Deficit Reduction Act of 1984,’’JCS-41-84 (1985), at 425.

2The relationships may be ‘‘thawed’’ when the ceiling rule isencountered, as will be discussed below. For example, if thebuilt-in gain was $5,000 but the asset later declined in value sothat the realized gain was only $4,000, the contributing partnerwould be allocated the $4,000 gain.

3Reg. section 1.704-1(b)(2)(iv)(f)(5) and -1(b)(1)(iv). If thepartnership agreement is inconsistent with the partnership taxaccounting rule for the built-in gain or loss, the partner and thepartnership will be forced to follow specific rules. For example,suppose the partner transfers property with a built-in gain,

which the partnership immediately sells for FMV. If the part-nership agreement calls for less than all of the realized gain to beallocated to the contributing partner, the IRS will reallocate theentire gain to the contributing partner. If a partnership agree-ment does not permit the contributing partner’s capital toinclude the entire built-in gain, that is a violation of the basiccapital maintenance rules of reg. section 1.704-1(b)(2)(iv), whichcalls into question the entire partnership profits and loss for-mula.

4Reg. section 1.704-3(b).5Reg. section 1.704-3(b)(1).6It should be noted that unless the remedial method is

elected, book amortization or depreciation is the same percent-age of book value as tax depreciation is to adjusted basis. Seereg. section 1.704-1(b)(2)(iv)(g)(3) and -3(d)(2).

W. Eugene Seago is the Curling Professor ofAccounting at Virginia Tech. Kenneth N. Orbach isa professor of accounting at Florida Atlantic Uni-versity.

In this article, Seago and Orbach explain whytransferring intangibles with zero basis and a posi-tive fair market value to a partnership will likelylead to application of the ceiling rule, and theydiscuss when partners may prefer to elect theremedial allocation method.

tax notes™

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the income by $1,000, and the noncontributingpartners’ income would be reduced by $5,000. As-suming the partnership uses the property for theremainder of the 10-year cost recovery period, thecontributing partner will be allocated $4,000 [($500-$100) x 10 = $4,000] more income than the noncon-tributing partners. Thus, T’s built-in gain is notrecognized at the time of the transfer but is allo-cated at the rate of $400 per year over the 10-yearcost recovery period.

In the example above, T was allocated only$1,000 of depreciation in arriving at taxable income,even though his 50 percent share of economicdepreciation was $5,000. This $4,000 difference —his built-in gain — was all recognized over the costrecovery period for the contributed property. Thedrafters of the regulations could have instead pro-vided that some or all of the difference betweenbasis and value be taken into account when thepartner’s interest is liquidated. Thus, the regula-tions could have permitted T to deduct $3,000 indepreciation (50 percent of the partnership’s basis)over the life of the asset, while reducing his bookcapital account by $5,000 (50 percent of FMV). T’sliquidating distribution would have been $10,000 -$5,000 = $5,000, but his basis would have been$6,000 - $3,000 = $3,000. At liquidation, T wouldhave had a $2,000 gain. The additional $2,000 indepreciation ($3,000 rather than $1,000) would havebeen countered by the $2,000 gain at liquidation,and the contributed asset would have reduced T’stotal taxable income by $1,000 under either method.

Instead, the drafters of the regulations opted foran approach that does not defer the adjustmentsuntil liquidation. However, the ceiling rule createsan exception.

1. The ceiling rule. With the traditional method, thecomplete allocation of the built-in gain during thecost recovery period may be prevented by theceiling rule, which is a product of the regulations.According to this rule, ‘‘the total income, gain, loss,or deduction allocated to the partners for a tax yearwith respect to a property cannot exceed the totalpartnership income, gain, loss, or deduction withrespect to that property for the taxable year.’’7Suppose T has property with 10 years remaining inits cost recovery period, a basis of $4,000, and aFMV of $10,000. When T contributes this propertyfor a 50 percent interest in the partnership capitaland profits, only $400 in depreciation is deductibleeach year, all of which must be allocated to thenoncontributing partners.8 While the correct answer

might appear to be an allocation of $500 of annualcost recovery to the noncontributing partners and$100 of income ($500 - $400) to the contributingpartner, the ceiling rule prohibits the allocation ofmore depreciation than the partnership can recog-nize ($400 each year in the example). This will resultin the correct answer in terms of total income: T willrecognize all of the built-in gain in this examplebecause of the application of the accounting for thepartners’ bases, capital accounts (with potentialcharacter of income issues), and gain and loss atliquidation. However, a portion of the adjustment isdeferred until T’s interest in the partnership isliquidated, as will be seen below.

Partners recognize taxable income from partner-ship operations and also generally from gain or lossfrom the liquidation of their interest: liquidating(cash) distribution - tax basis = gain or loss.9 Apartner’s book capital account determines what thepartner will receive when all of the partnership’sassets are sold for book value, all of the liabilitieshave been paid, and the partnership is liquidated.10

The partner’s book capital account is increased bythe FMV of property he contributes to the partner-ship, while the calculation of the partnership’staxable income is computed using the partner’sbasis in the contributed property.11 The book costrecovery deduction, calculated using the FMV atcontribution, reduces that partner’s capital account.The partner’s basis in the partnership (outsidebasis) is increased by his basis in the contributedproperty (rather than FMV) and his share of taxableincome. The cost recovery deductions used to com-pute taxable income are calculated using the part-ner’s basis in the contributed property.12 Thus, thebuilt-in gain is ‘‘booked’’ when it is contributed,before the gain has been realized, and must not bebooked a second time when the gain is actuallyrealized. Once the cost recovery process is com-plete, capital and basis calculations will be broughtinto agreement — unless the ceiling rule applies, inwhich case the accounting systems are not harmo-nized, potentially, until the partner’s interest isliquidated.

Returning to the cost recovery example, T con-tributes an asset subject to cost recovery that has abasis of $4,000 and a FMV of $10,000. The otherpartner, B, contributes $10,000 in cash. The partner-ship has $20,000 in revenue from operations and$10,000 in expenses, other than cost recovery. At theend of the remaining 10 years of its cost recovery

7Reg. section 1.704-3(b)(1).8Reg. section 1.704-3(b)(2), Example 1(ii).

9Section 731.10Reg. section 1.704-1(b)(2)(ii)(b)(2).11Section 723.12Section 168(i)(7).

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period, the equipment has no value, and the part-nership’s only asset is $20,000 cash:

The partners’ capital accounts must be reducedby the book depreciation over the remaining depre-ciable life of the asset.13 B’s correct share of depre-ciation is 0.5 x $10,000 = $5,000, but the ceiling rulelimits the deduction to $4,000. The results of apply-ing the traditional method are presented below:

T contributed property with a basis of $4,000 anda FMV of $10,000, and he received $10,000 atliquidation. T’s total taxable income was $6,000, thecorrect amount, but the operation of the ceiling ruledeferred $1,000 of gain until the partnership liqui-dated. B contributed property with a basis andvalue of $10,000 and received from the partnership$10,000; therefore, B’s total gain was $0. Economi-cally, B’s share of depreciation was $5,000, but theceiling rule limited B’s deduction to $4,000. As aresult, B was taxed on $1,000 from operations thatwas not ‘‘real’’ income, but he was allowed an‘‘unreal’’ loss at liquidation, which may be a capitalloss.14 Thus, the ceiling rule distorts the timing ofincome and may also affect the character of the

income (by shifting between income from opera-tions and capital gain from liquidation).

As a general matter, the ceiling rule applieswhenever the contributing partner’s percent inter-est in partnership profits is less than the apprecia-tion in the contributed property as a percentage ofthe property’s FMV. For example, there would be aceiling problem if a contributing partner with a 10percent interest contributed property that was ap-preciated by 15 percent. When this happens, thenoncontributing partners cannot get their correctshare of cost recovery under the traditional method.As a result, the contributing partner and the non-contributing partners will have deferred gains andlosses.

The shift is extreme when the contributing part-ner has a zero basis in the property. Appreciation inthis case is 100 percent of the property’s value, andthe contributing partner’s share of the profit15 is lessthan 100 percent. Assume in the above example thatthe contributing partner, T, has a zero basis inproperty with a FMV of $10,000. The partners agreethat the property T contributed has a limited lifeand no value at the end of the relevant time period.Therefore, for book purposes, the $10,000 value ofthe asset will be allocated to the partners as costrecovery.16 T would recognize a total of $10,000 inincome ($10,000 liquidating distribution - $0 assetbasis): $5,000 taxable income from operations and$5,000 gain at liquidation. B, who contributed$10,000 in cash and received $10,000 at liquidation,would recognize $5,000 in income from operationsand a $5,000 loss at liquidation. These calculationsare presented in Table 3.

Thus, under the traditional method, if the ceilingrule applies, the difference between the noncontrib-uting partner’s cost recovery deduction for bookand cost recovery for tax becomes a loss at liquida-tion. Conversely, the difference between the contrib-uting partner’s cost recovery deduction for bookand cost recovery for tax becomes a gain at liqui-dation.

As discussed above, when the ceiling rule doesnot apply, none of the effects of the built-in gain aredeferred until liquidation; rather, the built-in gain isspread over the cost recovery period. There seemslittle justification for this incongruity that the ruleintroduces. As will be seen below, the regulations

13Reg. section 1.704-1(b)(2)(iv)(g)(3).14Section 731(a).

15Sharing profits is a primary attribute of a partnership.Commissioner v. Tower, 327 U.S. 280 (1946).

16This appears to be a reasonable method because thepartners agree that the allocations will actually affect what thepartner is to receive at liquidation. Reg. section 1.704-1(b)(2)(iv)(g)(3). See Monte A. Jackel and Shari R. Fessler, ‘‘TheMysterious Case of Partnership Inside Basis Adjustment,’’ TaxNotes, Oct. 23, 2000, p. 529.

Table 1Capital contribution from B $10,000Revenues $20,000Less cash expenses -$10,000

$20,000

Table 2Book CapitalT B

Equipment $10,000Cash $10,000Revenue less cash expenses $5,000 $5,000Depreciation on equipment -$5,000 -$5,000Ending capital = liquidatingdistribution

$10,000 $10,000

Tax BasisEquipment $4,000Cash $10,000Revenue less cash expenses $5,000 $5,000Depreciation on equipment $0 -$4,000Operating taxable income $5,000 $1,000Outside basis $9,000 $11,000Liquidating distribution (cash) $10,000 $10,000Gain (loss) at liquidation $1,000 -$1,000Total taxable (operations +liquidation)

$6,000 $0




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provide alternative elective methods that preventdeferral of the gain until liquidation.2. Traditional method with curative allocations.The regulations allow partners to avoid the distor-tions of the ceiling rule by making a ‘‘curativeallocation’’: an allocation of other income, gain, loss,or deduction for tax purposes that differs from thepartnership’s allocation of the corresponding bookitem.17 However, these corrective allocations aresubject to vague tests for reasonableness, and theremust generally be a sufficient amount of otherincome or deductions to complete the adjustment.The simpler adjustment process is provided in the‘‘remedial allocation method.’’3. Remedial allocation method. Under this method,the partnership creates an item of income or deduc-tion to correct the noncontributing partner’s taxableincome and creates an offsetting item of income ordeduction of the same character for the contributingpartner.18 Thus, in the previous example of contrib-uted property with a basis of $4,000, a FMV of$10,000, and 10 years remaining on a 15-year costrecovery period, the noncontributing partnerwould be allocated an additional $1,000 of deduc-tions ($200 in each of years 11-15), instead ofrecognizing a $1,000 loss at liquidation, and thecontributing partner would be allocated an addi-tional $1,000 of income ($200 in each of years 11-15),instead of recognizing a $1,000 gain at liquidation.19

The use of the traditional method, the traditionalmethod with curative allocations, or the remedialallocation method is elective. In the discussionbelow, it will be presumed that the remedialmethod has been elected.

4. Zero-basis depreciable property and the reme-dial method. When depreciable or amortizableproperty contributed to the partnership has a zerobasis and a positive FMV, the ceiling rule applies.Assume that T contributes depreciable propertywith a zero basis and $750,000 FMV to LargePartnership for a 25 percent interest. The partner-ship’s tax basis in the contributed property is zero,but T’s book capital account will be increased by$750,000, the FMV of the property.20 Assume thatLarge Partnership had assets with adjusted basisand value of $2.25 million before the contribution,and assume that book depreciation of the contrib-uted property on a straight-line basis over 15 yearsis reasonable for purposes of the section 704(b)capital account maintenance rules.21 Because theproperty contributed by T has built-in gain, section704(c) applies, and tax items for the property mustbe allocated to reduce the book-tax difference. Thepartnership will allocate the $750,000 of book de-preciation by giving $187,500 to T and $562,500 tothe legacy partners, whether Large Partnershipadopts the traditional method or remedial. Underthe traditional method, there would be zero taxamortization, as befits the property’s zero basis.Thus, even after 15 years, because of the ceilingrule, T’s tax and capital accounts would be unequal($0 and $562,500, respectively), as would be thelegacy partners’ ($2,250,000 and $1,687,500, respec-tively), and the goal of section 704(c) would not yetbe attained.

If the remedial method were elected, there wouldbe remedial items of negative $562,500 allocated tothe legacy partners (equal to their book deprecia-tion) over 15 years and a corresponding positive$562,500 of remedial items allocated to T. T’s taxand book capital accounts would be equal($562,500), as would be those of the legacy partners

17Reg. section 1.704-3(c)(1).18Reg. section 1.704-3(d)(1) and (3).19Reg. section 1.704-3(d)(2) requires book depreciation to be

computed differently under the remedial method than underthe traditional method (with or without curative allocations).

Here the contributed property is 15-year property with 10 yearsremaining. For book purposes, $4,000 (the amount of tax basis)is recovered over 10 years just like for tax depreciation, and theremaining $6,000 is treated as newly purchased property with a15-year life. Assume straight-line depreciation is chosen. Thus,there is $800 of book depreciation for each of the first 10 years($4,000/10 + $6,000/15) and $400 book depreciation for each ofyears 11-15.

20Reg. section 1.704-1(b)(2)(iv)(b).21Reg. section 1.704-1(b)(2)(iv)(g)(3), last sentence.

Table 3Book CapitalT B

Equipment $10,000Cash $10,000Revenue less cash expenses $5,000 $5,000Depreciation on equipment -$5,000 -$5,000Ending capital = liquidatingdistribution

$10,000 $10,000

Tax BasisEquipment $0Cash $10,000Revenue less cash expenses $5,000 $5,000Depreciation on equipment $0 $0Operating taxable income $5,000 $5,000Outside basis $5,000 $15,000Liquidating distribution (cash) $10,000 $10,000Gain (loss) at liquidation $5,000 -$5,000Total taxable (operations +liquidation)

$10,000 $0





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($1,687,500). Thus, the remedial method would rec-tify the distortion caused by the ceiling rule underthe traditional method, and the section 704(c) goalwould be attained.

Conceptual and technical problems arise if thezero-basis property contributed by T is not depre-ciable or amortizable in T’s hands. Would theproperty be non-amortizable in Large Partnership’shands for tax or book purposes? We consider thissituation next.5. Intangibles and the remedial method. Assumethat the zero-basis property contributed by T toLarge Partnership is intangible (such as goodwill,workforce in place, or client files). This is typicallythe case with the assets of a service business. If thebusiness assets were sold, the amount paid for theintangibles would generally be subject to amortiza-tion under section 197 by the purchaser. But if theywere contributed, as discussed above, the adjust-ments caused by the ceiling rule can result indeferral of the built-in gain until the partner’sinterest is liquidated. The remedial method, whichis elective, can eliminate the deferral but can havesignificant unfavorable tax consequences for thecontributing partner.

Assume T is the sole proprietor of a professionalpractice and merges his practice into Large Partner-ship. T does not transfer any tangible assets, but hehas a ‘‘stable of clients,’’ for which his annualbillings are $750,000. These clients are expected tofollow him to Large Partnership. Under the part-nership agreement, all of the fees earned from theformer proprietorship’s clients after the merger willbe partnership income. Assume that a proprietor-ship will typically sell for one-time annual billingplus the book value of the tangible assets (approxi-mate FMV). Under the one-year-billing rule ofthumb, T transfers self-created goodwill and othernon-amortizable intangibles with a value of$750,000. T has a zero basis in the intangibles. Treceives a 25 percent interest in Large Partnership’scapital, profits, and losses. In accordance with thecapital account maintenance regulations,22 T’s part-nership book capital account begins at $750,000.Under sections 722 and 723, T’s initial tax (outside)basis is zero (assuming the partnership had noliabilities), and the partnership’s basis in the intan-gibles is zero. Assume that Large Partnership hadassets with adjusted basis and value of $2.25 millionbefore the contribution and that the anti-churningrules do not apply.

Because the value of the intangibles exceeds T’sbasis at the time of the transfer, the goodwill is

section 704(c) property.23 Therefore, the differencein value and basis must be taken into account inallocating the partnership’s income, gains, losses,and deductions. We will discuss how this is accom-plished24 after we examine how intangibles areamortized under section 197.6. Section 197. The legislative history of section 197reveals that Congress was concerned with the dis-parate amortization of purchased intangibles.25 Tax-payers who could afford expert testimony toestablish the useful life of an intangible were per-mitted to amortize the asset, while those who couldnot afford to challenge an IRS assertion that aparticular asset did not have a determinable usefullife were effectively denied this benefit. Section 197was intended to resolve this issue by generallypermitting taxpayers to amortize the cost of apurchased intangible over 15 years, regardless ofthe asset’s economic life.

Under section 197(c)(2), amortization of self-created intangibles is generally not permitted. Inour example, the proprietor’s intangibles are self-created, and thus the contributing partner wouldnot be allowed an amortization deduction, even ifhe had a nonzero basis in the asset. Because thepartner’s tax attributes of property contributionsgenerally carry over to the partnership,26 the ques-tion arises regarding whether the non-amortizableintangibles in T’s hands remain non-amortizable fortax and book purposes once transferred to thepartnership. The regulations are helpful but do notprovide a clear answer. According to reg. section1.197-2(g)(4), transferred intangibles are generallyineligible for amortization unless the intangiblescould be amortized by the contributing partner. Inour case, the proprietorship intangibles were self-created and are therefore not amortizable. This ispure aggregate theory reasoning. The regulation,however, provides for an election that appears to bebased on entity theory, which applies even whenthe person who contributed the intangible is ineli-gible for an amortization deduction:

If a partner contributes a section 197 intangibleand the partnership adopts the remedial alloca-tion method for making section 704(c) alloca-tions of amortization deductions, thepartnership may make remedial allocation de-ductions with respect to the contributed sec-tion 197 intangible. [Emphasis added.]

22Reg. section 1.704-1(b)(2)(iv)(d).

23Reg. section 1.704-3(a)(3).24See generally reg. section 1.704-3.25See statement of then-IRS Commissioner Fred T. Goldberg

Jr., hearings before the House Ways and Means Committee onthe tax treatment of intangible assets, 102 Cong., 2d. Sess. (Oct.2, 1991), at 76.

26See, e.g., sections 723 and 168(i)(7).




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As will be seen, under the election, the noncon-tributing partner can claim amortization deductionsjust as if the partners purchased their interests, butat an additional tax cost to the contributing partner.The added cost is the result of applying the reme-dial method to address the ceiling problem. Accord-ing to this method, if the ceiling rule causes:

the book allocation of an item to a noncontrib-uting partner to differ from the tax allocationof the same item to the noncontributing part-ner, the partnership creates a remedial item ofincome, gain, loss, or deduction equal to thefull amount of the difference and allocates it tothe noncontributing partner. The partnershipsimultaneously creates an offsetting remedialitem in an identical amount and allocates it tothe contributing partner.27

The technical bone of contention is whether thenon-amortizable intangible contributed by T re-mains non-amortizable for book purposes in thepartnership’s hands. In other words, does reg. sec-tion 1.197-2(g)(4)(ii) cause the contributed non-amortizable intangible to be non-amortizable forbook purposes as well as for tax purposes (unlessremedial is elected)? One leading commentator says‘‘yes.’’28 If correct, Large Partnership would haveonly two choices: Do not amortize the intangible forbook and tax purposes, or use the remedial method.We disagree with this flat prohibition of bookamortization under the traditional method. In ourexample the partners agree that the intangibleshave a limited 15-year life, and thus for bookpurposes the decline in value should be reflected inthe partners’ capital accounts: After the 15-yearstipulated economic life, the book values of theinterests should reflect the agreed zero value of theintangible.

Others believe reg. section 1.197-2(g)(4)(ii) ap-plies only for tax purposes and not for book pur-poses: The zero basis non-amortizable intangiblecannot be amortized for tax purposes (unless reme-dial is elected) but can be amortized for bookpurposes even without adopting the remedialmethod. Of course, if the non-amortizable intan-gible had a nonzero basis in T’s hands (and there-fore in Large Partnership’s hands) and the capitalaccount maintenance rules were followed, reg. sec-tion 1.704-1(b)(2)(iv)(g)(3) would preclude bookamortization.

In our analysis, we will compare the results ofallowing book amortization under the traditional

method with the results of amortization (tax andbook) under the remedial method. In either case,the ceiling rule applies because the tax amortizationis zero, while the total book amortization is $50,000per year, and the noncontributing partners’ bookallocation of amortization is 0.75 x $50,000 =$37,500. Under the remedial method, each year thenoncontributing partners would be allocated anadditional $37,500 in ordinary tax deductions thatare not actual expenses, and the contributing part-ner would be allocated $37,500 of additional in-come. Total partnership income would beunaffected — only the allocation among the part-ners.29 The net result of applying the remedialmethod is equivalent to the contributing partnerselling the intangible in installments, except that thecontributing partner’s corresponding incomewould all be ordinary.30 This is consistent with reg.section 1.704-3(d)(2), which requires the ordinarydeductions of the noncontributing partners to bematched with ordinary income to the contributingpartner.

B. Section 704(c) Applied to IntangiblesHere we compare the results without amortiza-

tion of the intangibles with the application of thetraditional and remedial methods in the case of Tcontributing self-created intangibles with zero basisand $750,000 FMV to the partnership. The partner-ship had assets with a basis and value of $2.25million before T’s capital contribution. T’s capitalaccount is credited for the FMV of the intangibles,$750,000, and T will be allocated a 25 percentinterest in the partnership’s profits and losses.31

Further assume that (1) the partnership has taxableincome and cash flow of $200,000, (2) the partner-ship distributes all of its book income before amor-tization, and (3) the partnership agreement calls fordistributions at liquidation as though the intangiblehas no value at the end of 15 years (and thus theamortization will reduce the amount the partnerreceives at liquidation). The assumption of no valueis realistic because of prior experience regardingclient turnover.32 Thus, the book capital accountsare maintained in a manner consistent with thepartner’s interest in the partnership, and over the 15

27Reg. section 1.703-3(d).28See Jackel and Fessler, supra note 16, at 533 notes 27 and 28,

and accompanying text.

29Reg. section 1.704-3(d)(4).30See Andrew H. Braiterman, comments on prop. reg. section

1.197-2(g)(2)(vi) (Feb. 19, 1997), which would have deniedamortization of the intangibles by the noncontributing partners.

31It should be noted that if T were not given credit throughhis capital account for the value of the intangibles, in essence hewould be shifting economic capital to the other partners,perhaps for an increased share of profits, which would raiseissues under section 707.

32See Newark Morning Ledger v. United States, 507 U.S. 546(1993).




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years T will bear the burden of 25 percent (his shareof profit and loss) of the loss of the intangibles’value.1. Traditional method.33 There is no tax amortiza-tion because the contributed property had zerobasis. However, for book purposes, the value of thecontributed property is amortized over 15 years.34

As seen below, over the 15 years, T must recognize$750,000 of ordinary taxable income, and at liqui-dation of his interest, he must recognize a $562,500gain. No other partner is liquidated at that time.The gain will be capital unless the transactionqualifies (that is, for a general partner) in part undersection 736(b)(2), and is structured accordingly, tocreate ordinary income to T and an ordinary deduc-tion for the partnership. Assuming T’s gain istreated as capital gain, the partnership can make asection 754 election to increase the basis of its assetsin an amount equal to T’s gain. Thus, the $562,500represents future deductions by the partnership.

It should be noted that T’s liquidating distribu-tion is equal to the value of his capital contributionless his one-fourth share of the amortization. Theeffect of the traditional method is to tax T as though

he sold three-fourths of his interest in the goodwilland realized capital gain at liquidation.2. Remedial method. Applying the remedialmethod, the original Large Partnership partners areallocated three-fourths of the amortization on T’scontributions of intangibles, 0.75 x $750,000 =$562,500, and T is allocated the same amount asordinary gross income. Thus, over the 15 years, T’sordinary income from operations will be $1,312,500,and he will have no gain or loss at liquidation.

The effects of the options on the contributing andnoncontributing partners are summarized below:

It should be apparent that the noncontributingpartners benefit from the amortization, but at a costto the contributing partner, who is required toincrease his taxable income by the amount of thenoncontributors’ amortization deductions. More-over, the remedial method converts what wouldhave been traditional method capital gain at liqui-dation into ordinary income from operations. But

33Perhaps ‘‘traditional method’’ is a misnomer because un-like the examples in the regulations in which the noncontribut-ing partner is allowed a deduction, in our example there is nobasis to amortize. A better heading would simply be ‘‘noamortization.’’

34Reg. section 1.704-1(b)(2)(iv)(g)(3) and -3(d)(2) (the amor-tization period for purchased goodwill).

Table 4Tax — Traditional Method

ContributingNon-

Contributing TotalBeginning basis $0 $2,250,000 $2,250,000Revenue $750,000 $2,250,000 $3,000,000Amortization $0 $0 $0Taxable income $750,000 $2,250,000 $3,000,000Distributions -$750,000 -$2,250,000 -$3,000,000Ending basis (outside) $0 $2,250,000 $2,250,000

Book — Traditional MethodBeginning capital $750,000 $2,250,000 $3,000,000Revenue $750,000 $2,250,000 $3,000,000Amortization (0.25 x $750,000) + (0.75 x $750,000) -$187,500 -$562,500 -$750,000Book income $562,500 $1,687,500 $2,250,000Distributions -$750,000 -$2,250,000 -$3,000,000Ending capital = liquidating distributions $562,500 $1,687,500 $2,250,000Less tax basis $0 -$2,250,000 -$2,250,000Gain from T’s liquidation and partnership basis increase $562,500 -$562,500 $0Taxable — operations $750,000 $2,250,000 $3,000,000Total taxable income $1,312,500 $1,687,500 $3,000,000Taxable ordinary income $750,000 $2,250,000 $3,000,000Capital gain for T and basis adjustments (increase) for the partnership $562,500 -$562,500 $0

Table 5Traditional

ContributingPartner

Non-Contributing

PartnerOrdinary income $750,000 $2,250,000Capital gain (increasein inside basis)

$562,500 -$562,500

RemedialOrdinary income $1,312,500 $1,687,500Capital gain $0 $0




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the intangible regulations give a choice: (1) amorti-zation with the remedial method, or (2) no amorti-zation. Thus, the ability to apply the remedialmethod is an additional variable that may requirenegotiation between the partners.

C. Reverse Section 704(c)In the previous examples, the contributed assets

had built-in gains, but the existing assets of thepartnership had no built-in gains. Consider the casein which T’s basis in the intangibles contributed isequal to their FMV ($750,000) — or T contributes$750,000 in cash — and the partnership’s non-amortizable intangibles have zero basis and FMV of$2.25 million. The partnership profit and loss for-mula must change as a result of T entering thepartnership. The partnership can elect to revaluethe original partner’s capital account to reflect theFMV of the intangibles (as well other assets) whenT becomes a partner. This is a reverse section 704(c)situation,35 in which T is deemed to be the noncon-tributing partner (even though T is actually thecontributing partner).

If the election is made to revalue the assets andcapital, the regulations36 require that the same pro-cedures for allocating tax items for a contributingpartner under section 704(c) be applied to thebuilt-in gains reflected in the original partners’capital accounts. In our example, if the partnershipelects to revalue assets when T enters the partner-ship, and the remedial allocation method is used,

the partnership will amortize $2.25 million, treatingthe original partners as the contributing partners.Thus, T will be allocated 0.25 x $2.25 million =$562,500 of ordinary deductions, and the otherpartners will recognize $562,500 of ordinary in-come.

However, while the section 704(c) procedures aregenerally required in the forward section 704(c)situation,37 the application of those procedures tothe reverse section 704(c) facts are generally electiveon the part of the partnership.38 If the originalpartners are willing to forgo revaluation of assetsand do not otherwise amend the agreement toallocate built-in gains to themselves — and thuspotentially transfer a share of built-in gains to thenew partner — then, upon first impression, theregulations do not explicitly provide for immediatetax consequences. That is, a reverse section 704(c)accounting can be avoided, but there must be aproper accounting for the forward section 704(c)transaction. But when rational persons surrendervalue to another party, the IRS can look to the

35See reg. section 1.704-1(b)(2)(iv)(f).36Reg. section 1.704-1(b)(2)(iv)(g)(1).

37Special treatment and problems arise when non-amortizable intangibles are contributed. Reg. section 1.197-2(g)(4)(ii).

38Reg. section 1.704-1(b)(2)(iv)(f) warns that other code sec-tions may be applicable if there is no revaluation of the assetsfollowing a change in partners. However, we are not aware ofthe IRS creating taxable income for the noncontributing partnerswho did not revalue the assets.

Table 6Tax — Remedial Method

Contributing Non-Contributing TotalBeginning basis $0 $2,250,000 $2,250,000Net income before amortization $750,000 $2,250,000 $3,000,000Remedial amortization $562,500 -$562,500 $0Taxable income $1,312,500 $1,687,500 $3,000,000Distributions -$750,000 -$2,250,000 -$3,000,000Ending basis (outside) $562,500 $1,687,500 $2,250,000

Book — Remedial MethodBeginning capital $750,000 $2,250,000 $3,000,000Net income before amortization $750,000 $2,250,000 $3,000,000Amortization (0.25 x $750,000) + (0.75 x $750,000) -$187,500 -$562,500) -$750,000)Book income $562,500 $1,687,500 $2,250,000Distributions -$750,000 -$2,250,000 -$3,000,000Ending capital = liquidating distributions $562,500 $1,687,500 $2,250,000Less, tax outside basis -$562,500 -$1,687,500 -$2,250,000Gain or loss from liquidation (capital) $0 $0 $0Taxable — operations $1,312,500 $1,687,500 $3,000,000Total taxable income (all ordinary income) $1,312,500 $1,687,500 $3,000,000




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motivation for the transfer and may find disguisedexchanges or compensation.39

D. Forward and Reverse Section 704(c)Continuing the example, if the contributed prop-

erty is intangible and the partnership has intan-gibles with FMVs greater than their bases, all of theparties may have additional income and offsettingdeductions. Assume T and the partnership have azero basis in their intangibles and respective valuesof $750,000 and $2.25 million. As a forward section704(c) transfer, T would recognize an additional$562,500 of ordinary income (0.75 x $750,000). As areverse section 704(c) transfer, viewing T as thenoncontributing partner, T gets $562,500 in ordinarydeductions (0.25 x $2.25 million); thus, the amorti-zation would not affect T’s ordinary income andcapital gain.

The contributing partner’s share of profit andloss may differ from his contributed intangibles as aproportion of the total partnership’s zero-basis in-tangibles. This would change the benefits and bur-dens of the election to use the remedial method. Forexample, assume T is to receive 25 percent of theprofits and losses but that his contributed zero-basisintangibles are 30 percent of the total of the part-nership’s intangibles. Therefore, the total value ofthe intangibles is $750,000/0.30 = $2.5 million, andthe value of the partnership’s intangible before thetransfer is $2.5 million - $750,000 = $1.75 million.Under the election, T would be allocated $562,500[(1 - 0.25) x $750,000) in additional income and$437,500 (0.25 x $1.75 million) in amortization de-ductions — a net increase in ordinary income of$125,000 and an equal reduction in capital gain.Conversely, the legacy partners would be allocated$437,500 in additional income and $562,500 in ad-ditional deductions.

E. The Partners’ Choices

The fact that successful service businesses typi-cally have valuable non-amortizable intangibleswith no basis means that transferring ownership ofthose intangibles to a partnership has section 704(c)implications. Moreover, because the intangibles of-ten have a zero basis, the ceiling rule comes intoplay. The section 197 regulations provide the part-ner and partnership with options: amortize usingthe remedial method, or do not amortize for taxpurposes.

From a policy perspective, if the underlyingpurpose of section 704(c) is worthy and the reme-dial method is consistent with the purpose of thatsection, why should the partner who contributeszero-basis intangibles be permitted to defer built-ingains through the use of the traditional method?While the zero-basis property contributor can attaindeferral, a partner who contributes property withless appreciation (that is, appreciation as a percent-age of contributed value that is less than his profitsratio) cannot defer gain until liquidation.

F. Other Conclusions

The ceiling rule will always apply to contribu-tions to a partnership of intangibles with a zerobasis and a positive FMV. As demonstrated above, ifthe remedial method is not elected, much of thetransferor’s built-in gain will be deferred until liq-uidation. On the other hand, when the contributingpartner’s share of the profits is equal to or greaterthan the built-in gain as a percentage of the value ofthe contributed property, the entire built-in gainwill be included in the transferor’s income duringthe cost recovery period. Moreover, all of the trans-feror’s built-in gain will become ordinary income.What is the right answer? Deferral with capitalgain, or no deferral and all ordinary income? Itwould seem that the answer should not dependupon a difference between the partner’s profit ratioand the appreciation of contributed assets as apercentage of value.

39See, reg. section 1.704-1(b)(5), Example (14)(iv). The timingof the shift (e.g., at T’s admission or at a subsequent sale) isunclear.




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Limited Scope Tax EngagementsAre Not as Limited as You Think

By Scott F. Hessell and Erin W. Wolf

There are several good reasons for attorneys andclients to have written retention agreements. In fact,they are encouraged by the American Bar Associa-tion and required by the model rules for contin-gency fee agreements. From an attorney’sperspective, a written retention agreement mayhelp prevent malpractice liability by clearly defin-ing the scope of a relationship — stating exactlywhat the attorney is being hired to do and, in somecircumstances, detailing what the attorney is notbeing hired to do. These agreements may alsoprevent conflicts of interest by limiting relation-ships so as to prevent them from spilling over intoareas where the attorney’s interests might not bealigned with those of the client.

Practitioners should be cautious about duties toclients that remain intact even in a contractuallydefined (or limited-scope) representation. Like mostspecialists, tax practitioners often limit the scope ofrepresentation to address a client’s tax liability foronly a specific year or particular transaction underaudit. Tax controversy lawyers also often want tomake clear that they do not represent their clientregarding any other aspects of a transaction besidesthe tax owed, such as potential malpractice claimsof the accountant or tax return preparer who mayhave referred the client. This article will addresspotential pitfalls in defining the scope of represen-tation and provide tips gathered from cases aroundthe country and from our firm’s experience to assistpractitioners in narrowing the scope of representa-tion while still fulfilling ethical duties to clients.

Limitation Reasonable Under the CircumstancesLawyers should review the rules of professional

conduct (and associated comments) in their statewhen preparing for a meeting, drafting a letter, orcreating a retention agreement that involves limit-ing the scope of representation. According to rule1.2(c) of the ABA’s Model Rules of ProfessionalConduct (MRPC), which has been adopted in vari-ous forms by all states:

A lawyer may limit the scope of the represen-tation if the limitation is reasonable under thecircumstances and the client gives informed con-sent.1 [Emphasis added.]

According to MPRC rule 1.0(h), ‘‘‘reasonable’ or‘reasonably’ when used in relation to conduct by alawyer denotes the conduct of a reasonably prudentand competent lawyer.’’ Further explanation of‘‘reasonable under the circumstances’’ can be foundin comment 7 to MPRC rule 1.2(c):

If, for example, a client’s objective is limited tosecuring general information about the law theclient needs in order to handle a common andtypically uncomplicated legal problem, thelawyer and client may agree that the lawyer’sservices will be limited to a brief telephoneconsultation. Such a limitation, however,would not be reasonable if the time allottedwas not sufficient to yield advice upon whichthe client could rely.

What is ‘‘reasonable under the circumstances’’can be less than clear in practice, however. The keyis to be overly cautious and follow the guidelinescourts have set when interpreting MRPC rule 1.2(c)(and the state counterparts to the ABA’s modelrule), as discussed in more detail below.

Courts have generally upheld limitations on thescope of representation as long as they are clear,sensible, and made with client consent. See, forexample, Kane, Kane & Kritzer Inc. v. Altagen2 (ascope limitation based on the course of dealing overthe years was enforced when a lawyer was retainedby a sophisticated client to send collection lettersbut not to file or discuss the suit unless requested);

1The ABA publishes a list of the applicable state rules andcomments.

2Kane, Kane & Kritzer, 165 Cal. Rptr.3d 534, 537 (Cal. Ct. App.1980).

Scott F. Hessell ([email protected]) andErin W. Wolf are attorneys at Sperling & Slater PCin Chicago. Hessell co-leads the firm’s tax shelterliability practice, which pursues claims against pro-fessionals who design, market, and implementsham tax strategies.

In this article, Hessell and Wolf provide tips onhow attorneys can narrow the scope of representa-tion with clients while still fulfilling ethical duties.

tax notes™

TAX PRACTICE



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Johnson v. Jones3 (a scope limitation was enforcedwhen a lawyer was retained under a retentionagreement to draw up a contract but not to adviseon the rights under it); Delta Equipment and Con-struction Co. Inc. v. Royal Indemnity Co. Inc.4 (a scopelimitation was enforced based on an oral agreementto defend a workers’ compensation claim but not awage claim or any other claim, even when theattorney inadvertently mailed documents related toa wage claim); and Martini v. Leland5 (an attorneyretained to consult on a pending suit against theplaintiff but not to conduct the litigation had noduty to appear for the claimant).

In AmBase Corp. v. Davis Polk & Wardwell,6 a lawfirm successfully litigated an IRS tax dispute butwas later sued by the client for malpractice on thebasis that the firm had failed to question whether anagreement entered into between the client and arelated company (seven years before the attorney-client relationship was formed) may have relievedthe plaintiff of the tax liability.7 The court found thatthe law firm was retained to litigate the amount ofthe tax liability with the IRS and not the issue ofwhether the client had underlying tax liability.8Moreover, both AmBase and the IRS had taken theposition — for approximately seven years beforeDavis Polk’s retention — that AmBase was respon-sible for all the tax obligations at issue.9

Informed ConsentUnder MRPC rule 1.0(e), ‘‘‘informed consent’

denotes the agreement by a person to a proposedcourse of conduct after the lawyer has communi-cated adequate information and explanation aboutthe material risks of and reasonably available alter-natives to the proposed course of conduct.’’ Com-ment 6 to rule 1.0 provides additional guidance:

The lawyer must make reasonable efforts toensure that the client or other person possessesinformation reasonably adequate to make aninformed decision. Ordinarily, this will requirecommunication that includes a disclosure ofthe facts and circumstances giving rise to thesituation, any explanation reasonably neces-sary to inform the client or other person of thematerial advantages and disadvantages of theproposed course of conduct and a discussionof the client’s or other person’s options andalternatives. In some circumstances it may be

appropriate for a lawyer to advise a client orother person to seek the advice of other coun-sel. A lawyer need not inform a client or otherperson of facts or implications already knownto the client or other person; nevertheless, alawyer who does not personally inform theclient or other person assumes the risk that theclient or other person is inadequately in-formed and the consent is invalid. In deter-mining whether the information andexplanation provided are reasonably ad-equate, relevant factors include whether theclient or other person is experienced in legalmatters generally and in making decisions ofthe type involved, and whether the client orother person is independently represented byother counsel in giving the consent.

Under MRPC rule 1.2(c), the client must knowand explicitly consent to the scope limitations, andthe agreement limiting the representation must beclear. Johnson v. Board of County Commissioners10 (anattorney failed to consult with her sheriff client ormake clear that she was representing the sheriff inhis official capacity only and not also in his personalcapacity); In re Samad11 (the limit on the scope ofrepresentation to a mere consulting role not includ-ing motion practice must be clearly communicatedto and understood by the client); and IndianapolisPodiatry PC v. Efroymson12 (comparing the disclo-sure required when limiting the scope of represen-tation to that required regarding a conflict ofinterest).

There are cautionary tales of lawyers who havefailed in their attempts to limit the scope of services.Most often, the key problem is the lack of informedconsent. In Wildey v. Paulson,13 Wildey (an attorneyherself) sued her attorney, Paulson, for failing to tellWildey that the letter Wildey wrote and sent on herown (before the retention agreement was signed)did not include the information necessary to triggerliability under a particular statute. The court uphelda finding of negligence against the attorney forfailing to provide competent representation andadvice.14 Even though the attorney claimed she hadlimited her representation to simply drafting acomplaint and ‘‘appearing’’ in order to demonstratethe plaintiff’s intent to pursue the suit, the attorneyknew (and the client did not) that the pre-suit noticeletter sent by her client to the defendant did not

3Johnson, 652 P.2d 650, 652 (Idaho 1982).4Delta Equipment, 186 So.2d 454, 458 (La. Ct. App. 1966).5Martini, 455 N.Y.S.2d 354, 355 (N.Y. Civ. Ct. 1982).6AmBase, 866 N.E.2d 1033, 1037 (N.Y. 2007).7Id.8Id.9Id.

10Johnson, 85 F.3d 489, 493-494 (10th Cir. 1996).11In re Samad, 51 A.3d 486, 497 (D.C. 2012).12Indianapolis Podiatry, 720 N.E.2d 376, 380-381 (Ind. Ct. App.

1999).13Wildey, 894 N.E.2d 862, 869 (Ill. App. Ct. 2008).14Id. at 870.




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comply with the requirements under the act. Thecourt found that this information disparity alonecan trigger liability, regardless of whether the attor-ney had limited the representation in her engage-ment letter.15

When working out the limitations on the scope ofservices, it is vital to inform clients when theselimitations might create a need to obtain additionaladvice. In Keef v. Widuch,16 an attorney was foundnegligent for failing to advise the client about apotential third-party action and the attendant stat-ute of limitations when the scope of representationby the attorney was limited to a different legalcourse of action.17

Even when the representation of a client is lim-ited in the retention agreement, attorneys remainsubject to the duty to provide competent represen-tation and sound legal advice.18 How far this dutyextends in the face of an agreement expresslylimiting the scope of services can vary dependingon the circumstances. While the available case lawsheds light on how to best limit the scope ofrepresentation, with malpractice claims lurking inthe shadows, it is wise to err on the side of cautionand make sure that clients fully understand thelimits on representation from the very start.

Limitations on the scope of representation do notalways absolve attorneys of the duty to providecompetent representation and sound legal advicewhen legal problems outside of what was agreed toare reasonably apparent:

One of an attorney’s basic functions is toadvise. Liability can exist because the attorneyfailed to provide advice. Not only should an

attorney furnish advice when requested, buthe or she should also volunteer opinions whennecessary to further the client’s objectives. Theattorney need not advise and caution of everypossible alternative, but only of those that mayresult in adverse consequences if not consid-ered.19

In Nichols v. Keller,20 an attorney representing hisclient on a workers’ compensation claim with alimited-scope retention agreement failed to informthe client about a potential third-party tort claimagainst the general contractor who was on site atthe time of injury.21 The client learned of the claimonly after it was time-barred and sued the attorneyfor failing to advise him of the potential claim. Thecourt held that the attorney was negligent andneeded to have informed the client not only of thelimitations on the attorney’s services but also of thepossible adverse implications of the limited-scoperepresentation.22

The Nichols court noted that an attorney should:(1) disclose that there may be other remedies thatthe attorney is not looking into (here, third-partytort claims); (2) disclose any (reasonably) apparentlegal problems pertaining to the limited scope ofservices (such as statutes of limitations); (3) advisethe client to consult different counsel for otheraspects of the client’s legal matter; and (4) evenconsider noting that the client received contactinformation for other counsel.23 It would be wise forany practitioner limiting services to include thesedisclosures in the retention letter and to discussthem in meetings with the client.24 Attorneysshould also consider having the client initial next tothose specific aspects of the retention agreement.

Based on Nichols, it may be that as long as a firmrepresenting a tax client in an IRS proceedingcautions the client about other remedies againstthird parties that the firm is not looking into andinforms the client of potential statute of limitationsproblems (and advises the client to consult anotherattorney on those issues), the firm has covered itselffrom potential malpractice liability. Attorneysshould use common sense, and if they spot some-thing, they should say something. A key to avoidingliability in a situation like Nichols is to follow the

15Id. at 867. See Janik v. Rudy, Exelrod & Zieff, 14 Cal. Rptr.3d751, 758-759 (Cal. Ct. App. 2004). In Janik, the court found thatclass counsel had the duty to evaluate and inform class repre-sentatives of alternate theories of recovery available to the class,even those not included in the certification order. Analogizingretainer agreements with scope limitations to the certificationorder, the court found that the law firm should have at leastbrought to the attention of the class representative ‘‘additionalor greater claims that may exist arising out of the circumstancesunderlying the certified claims that class members will beunable to raise if not asserted in the pending action.’’ Id. See alsoin re Samad, 51 A.3d at 497-498 (a lawyer purporting to limit thescope of representation to a consultant role knew that theclient’s objective in hiring him was to request a reducedsentence, yet he failed to clearly communicate the limitation andconsequently had his license suspended); and in re Chavez, 299P.3d 403, 407 (N.M. 2013) (it was unreasonable for a lawyer tolimit the scope of representation solely for the purpose ofnegotiating a plea deal).

16Keef, 747 N.E.2d 992, 998 (Ill. App. Ct. 2001).17Id. at 996-997. See also Johnson, 85 F.3d 489, 493-494 (10th Cir.

1996).18Wildey, 894 N.E.2d at 869-870. See also in re Seare, 493 B.R.

168, 188 (D. Nev. 2013).

19Nichols v. Keller, 19 Cal. Rptr.2d 601, 608 (Cal. Ct. App.1993); see also Janik, 14 Cal. Rptr.3d at 758-759.

20Nichols, 19 Cal. Rptr.2d 601.21Id. at 606.22Id. at 608.23Id. at 609-610.24Note that an attorney does not have to anticipate a possible

malpractice action and discuss the hypothetical relief that mightbe available to the client. Fitch v. McDermott, Will and Emery, 929N.E.2d 1167, 1184-1185 (Ill. App. Ct. 2010).




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advice of the court on obtaining informed consentand disclose to the client what the attorney is and isnot looking into, the risks associated with thelimited scope of the representation, and the possi-bility of consulting with different counsel for issuesthat lie outside the scope of the attorney’s represen-tation. Although the holding in Nichols may appeardaunting, the ABA has provided helpful insightinto what needs to be disclosed to obtain theappropriate informed consent:

We do not suggest that a lawyer has an affir-mative duty to look for, and advise clientsabout collateral legal problems that are notreasonably apparent or related to the primaryproblem. Rather, the duty is limited to givingclients notice of reasonably apparent and re-lated legal problems and remedies in the pro-cess of limiting the scope of the representationto exclude them. It is, therefore, part of theprocess of obtaining the client’s informed con-sent to the limits of the representation.25

In the same article, the ABA provides an exampleof the type of information that should be given tothe client:

In interviewing the client about one legalproblem (the ‘‘first problem’’), it may be rea-sonably apparent that the client has anotherrelated legal problem (the ‘‘second problem’’).The lawyer should alert the client to the sec-ond problem even though the lawyer andclient have limited the scope of representationto the first problem. The lawyer should alsomake it clear, including in the written retaineragreement, that the lawyer is not representingthe client on the second problem, and that thelawyer has advised the client to seek separaterepresentation for that problem . . . if the clientwishes to pursue it.26

Letting the client know that (a) the agreement islimited in scope, (b) some issues are not beinglooked into, and (c) another professional should beconsulted to address those issues is the key tomeeting the rules of professional conduct whenlimiting representation.

Put Scope Limitations in WritingEnsuring that the limitations placed on represen-

tation are reasonable and that client consent isinformed are both vital to successful scope-limitation arrangements. Although not necessary inall states or in all circumstances, capturing the

agreement in writing is a helpful practice, encour-aged by the ABA.27 Lawyers must ensure that theyare diligent not only in discussions with clients butalso when committing those discussions and agree-ments to paper. Attorneys should be as clear aspossible about the scope of representation in theretention agreement and when speaking with cli-ents. This includes making sure the client under-stands what the attorney will and will not be doing,as well as the consequences of this scope limitation,and would agree to a statement such as, ‘‘Becauseyou are not retaining me to evaluate potentialmalpractice claims, the statute of limitations mayrun on such claims if you do not obtain advice fromanother attorney.’’ A court may not believe that aclient could provide informed consent without ap-preciating the consequences of doing so.

In some circumstances, it may be important todiscuss whether and how the attorney and clientcan later modify the initial agreement if there is aneed or desire to do so. As cases evolve, if issuesarise that the attorney is qualified to handle andboth parties agree to expand the relationship, theretention agreement (and other controlling docu-ments) should be revisited and revised in writing.Otherwise, the willingness to act on matters outsidethe scope of the initial retention agreement could beinterpreted as voiding the limits on the scope ofrepresentation. Consider including language dis-cussing the circumstances under which the relation-ship will end in order to further clarify the scope ofrepresentation.

Courts routinely uphold limitations on represen-tation in the face of malpractice actions. In thesecases, detailed writings such as agreements, instruc-tions, and disclosures can provide strong evidenceagainst a finding of malpractice liability. In Lerner v.Laufer,28 for example, the lawyer carefully crafted aretention letter explaining the limited services hewas agreeing to provide in a divorce case. The letterindicated that the attorney was retained for thepurpose of reviewing a property settlement agree-ment between the wife and husband29 and statedthat the attorney had not conducted any discoveryin the case.30 When the client later claimed fraud byher husband for failing to disclose that a company,which was part of the marital estate, was about toproceed to a public offering, she sued her attorneyfor negligence. The court, relying on MRPC rule

25Mark H. Tuohey III et al., Handbook on Limited Scope LegalAssistance: A Report of the Modest Means Task Force of the ABASection of Litigation 69-70 (2003).

26Id. at 68.

27See, e.g., MRPC rule 1.5(b) (‘‘preferably in writing’’); com-ment 2 to MRPC rule 1.5 (‘‘desirable’’); and MPRC rule 1.5(c)(‘‘contingent fee agreement shall be in writing’’).

28Lerner, 819 A.2d 471, 473-474 (N.J. Super. Ct. App. Div.2003).

29Id. at 473.30Id.




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1.2(c), found no liability,31 holding that it ‘‘is not abreach of the standard of care for an attorney undera signed precisely drafted consent agreement tolimit the scope of representation to not performsuch services in the course of representing a matri-monial client that he or she might otherwise per-form absent such a consent.’’32 The court suggestedthat it would have been better if the attorney hadincluded a citation to the applicable rule of profes-sional conduct (MRPC rule 1.2(c)) in the retentionagreement when discussing the limitation on thescope of representation.33

ConclusionWhen limiting the scope of representation, it is of

utmost importance to advise clients of the potentialclaims or matters that are and are not being inves-tigated and, further, what the attorney will and willnot be doing. Because of the duties to clients, it isvital that clients know where to get the help theyneed for things that are outside the scope of repre-sentation but that are reasonably related to thematter. A good practice is to follow the advice of thecourt in Lerner and expressly cite the applicablestate or ABA rule of professional conduct in theagreement.34 It may also be worth memorializingany other discussions concerning the scope of therelationship. One should keep Nichols in mind andwatch for potential third-party claims or otherpossible legal problems related to the representa-tion. Erring on the side of caution will serve attor-neys well when defining the limits of theirrepresentation.

31Id. at 483.32Id. See also AmBase Corp., supra note 6; Heller v. Donaldson,

No. 194219, 1998 WL 2016612, at *1 (Mich. Ct. App. Mar. 13,1998) (upholding an agreement to limit representation to aparticular business dispute, specifically excluding any potentialmalpractice claim against a former attorney from the contractualterms of that relationship); Flatow LLP v. Ingalls, 932 N.E.2d 726,729-731 (Ind. Ct. App. 2010) (a lawyer was not liable formalpractice for not responding to a cross motion for summaryjudgment when the retention agreement covered bringing sum-mary judgment motion but not defending a cross-summaryjudgment motion); and Dunn v. Westbrook, 971 S.W.2d 252,254-255 (Ark. 1998) (an attorney hired to revise a partnershipagreement solely to address tax issues was not required toinclude or recommend a buyout provision to ensure resolutionof a dispute in the event that a partner was removed).

33Lerner, 819 A.2d at 483 n.2.34Id.

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against tax loopholes, not high taxes.”

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Can Corporate Tax ReformBuild on Apple’s Proposal?

By Bill Parks

IntroductionAlthough many are calling for Congress to re-

form the broken corporate tax system, agreementon fixes remains elusive. A compromise is needed— a reform acceptable to business and to lawmak-ers across the political spectrum. Almost three yearsago, in testimony before the Senate HomelandSecurity and Governmental Affairs Permanent Sub-committee on Investigations, Apple Inc. proposedthat Congress pass legislation dramatically simpli-fying the U.S. corporate tax system. That reform, itargued, should:

• eliminate all corporate tax expenditures;• lower corporate income tax rates;• implement a reasonable tax on foreign earn-

ings that allows for free movement of capitalback to the United States; and

• be revenue neutral.In identifying those characteristics of compre-

hensive reform, the company stated:Apple recognizes these and other improve-ments to the U.S. corporate tax system mayincrease the company’s taxes. Apple is notopposed to such a result, if it occurs in thecontext of an overall improvement in effi-ciency, flexibility, and competitiveness. Applebelieves the changes it proposes will stimulate

the creation of American jobs, increase domes-tic investment, and promote economicgrowth.1

Republicans and Democrats agree that the corpo-rate tax system is broken and needs to be fixed.Some Republicans want a territorial system, andsome Democrats want to end deferral and taxworldwide income at domestic rates. Do compro-mises exist that would meet most, if not all, ofApple’s requirements and still be acceptable to bothpolitical parties? What type of resolution wouldthey agree on?

Proposals have been presented, but they haveoften been contentious. Rep. Devin Nunes, R-Calif.,has put forth a plan — the American BusinessCompetitiveness Act — that has some appealingfeatures (although it also suggests changes that arenot germane to my proposal). What changes wouldlawmakers accept if they were free of the manyindividuals, companies, and institutions so investedin the current system? Given the many interestedparties, the question of how to tax corporate incomeis inherently controversial. But there are simplesolutions. Unfortunately, simple does not alwaysmean easy.

Defining Corporate IncomeWhen you eliminate all tax expenditures,2 as

Apple and several presidential candidates pro-posed, the result is financial, or book, income. Bookincome is created by taking all revenue and sub-tracting all expenses to give pretax income.

In the United States, the American Institute ofCPAs and its rules (generally accepted accountingprinciples) define the appropriate revenue and ex-penses for a company. In most of the rest of theworld, the International Accounting StandardsBoard and its principles (international financial

1Apple Inc., ‘‘Testimony of Apple Inc. Before the SenatePermanent Subcommittee on Investigations’’ (May 21, 2013), at16.

2‘‘Corporate tax expenditures’’ is a euphemism for credits,deductions, and loopholes that exempt some or all corporateincome from taxation — often with the best of intentions.

Bill Parks

Bill Parks ([email protected])is a retired finance professorand founder of NRS Inc., anIdaho-based paddle sportsaccessory maker.

In this article, Parks ex-amines the call for corporatetax reform and proposessales factor apportionmentas a compromise for elimi-nating all tax expenditures.

tax notes™

VIEWPOINT



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reporting standards) do the same.3 GAAP and IFRSare expected to conform soon. Allowing multina-tional enterprises to use either or both accountingsystems would not produce substantially differentmeasures of pretax income in a low-inflationeconomy.4 That change could cut accounting costssignificantly, and there would be commensurate IRSsavings, thereby meeting Apple’s call for efficiencyand competitiveness. Because book income is sub-stantially higher than today’s taxable income, thechange would allow significantly lower rates.

Removing or Reducing Interest DeductionsFormer Florida Gov. Jeb Bush and some current

presidential candidates, as well as many respectedeconomists, such as Douglas Holtz-Eakin,5 haveargued for eliminating or at least reducing theinterest deduction. The distortions from excessivedebt capital structures substantially harm oureconomy and further weaken it in times of crisis.Some also assert that the government should notinfluence capital structure by making the cost ofonly one form of financing tax deductible.

There are many smart reasons for at least par-tially disallowing interest. For instance, Nuneswants to end the interest deduction except forfinancial institutions. Others would argue that re-moving the interest deduction might prevent finan-cial institutions from overleveraging, whichcontributed to the Great Recession. To strengthencommunity financial institutions, it might also beappropriate to allow a partial deduction for intereston government-insured deposits. To minimize dis-tortion, interest deductions could be reduced over a10-year period. There is evidence that a partialinterest deduction paired with a tax rate reductionwould both strengthen the economic structure ofbusiness and partially insulate the economy fromsome of its excesses.

An argument against removing the interest de-duction is the fact that many small and medium-

size enterprises depend on loans and paysubstantially higher rates than larger competitors.Reducing or removing the interest deduction couldtherefore harm those comparatively fragile compa-nies. However, as discussed in the next section,lower tax rates for SMEs would benefit most com-panies much more than the interest deduction.

Graduated Corporate Tax RatesGraduating corporate taxes to be far below the

individual rates for up to $2 million in incomewould provide a powerful incentive for small busi-nesses to be taxed as C corporations and to onceagain concentrate on retaining earnings.6 HouseSpeaker Paul Ryan, R-Wis., has pointed out that therate for small businesses is 44.6 percent in theUnited States versus 15 percent in Canada.7 Forgrowing businesses that still elect to be taxed ascorporations, the credit crunch from the high ratescan be extreme.

Indeed, tax experts and economists seem un-aware that the Tax Reform Act of 1986 caused manysmall businesses to avoid reinvesting the earningsnecessary for growth by becoming S corporations orlimited liability companies. TRA 1986 penalizedsmall businesses that elected to become, or werealready, C corporations by adding a surtax thatbrought the total federal marginal tax rate to 39percent for income between $100,000 and $335,000.That ‘‘nasty notch’’ had the unintended conse-quences of not only discouraging C corporationformation but also causing existing small C corpo-rations to switch to S corporation or LLC status atthe first opportunity.8 By electing to be taxed aspassthrough entities, small businesses haveavoided the corporate tax, but at the same time,they have less incentive to retain the earnings thatare critical to growing a successful business.9

Many growing companies should be retainingearnings by being taxed as corporations.10 By ac-tively encouraging businesses to become

3IFRS is required in more than 90 countries and permitted inanother 25.

4The shame of GAAP is the acceptance of last-in, first-outinventory accounting. While LIFO may be indefensible, it hasbeen in use for more than 75 years, and ending it should bemade as painless as possible for the companies since it is not thefault of their current stockholders or management.

5‘‘Corporate interest expenses are a deductible expense,while dividends and returns to equity are not. The tax disparitybetween debt and equity financing is glaring: According to theU.S. Department of the Treasury, debt financing exposes firms toa marginal effective tax rate of -2.2 percent, compared to 39.7percent on equity financing. This disparity considerably distortscorporate finance decisions and firm capital structure.’’ Holtz-Eakin and Gordon Gray, ‘‘Global Competitiveness and theCorporation Income Tax,’’ The Heritage Foundation (Apr. 30,2009), at 2.

6The Tax Reform Act of 1986 prevented high-income taxpay-ers from turning themselves into corporations because it re-pealed the General Utilities doctrine. Under that doctrine, acompany could liquidate its assets at more than book value andpass the resulting proceeds through to stockholders without thecompany having to pay income tax on the gains. As a result ofthe repeal, any gain from liquidation is taxed twice: once at thecorporate level and again at the shareholder level.

7Ryan interview by Greta Van Susteren, ‘‘On the Record,’’Fox News Television Network (Nov. 4, 2015).

8Since 1986, while S corporations have grown at approxi-mately 7 percent per year and LLCs multiplied manyfold, Ccorporations have declined by approximately 1.5 percent a year.

9Bill Parks, ‘‘For Corporate Taxes: Lower Rates, Raise Rev-enues,’’ Tax Notes, Aug. 15, 2011, p. 745.

10There is no need to change the business form. LLCs canelect to be taxed as a corporation by submitting a simple IRS

COMMENTARY / VIEWPOINT

(Footnote continued on next page.)



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passthrough entities, the government is failing todifferentiate between companies that are really vo-cations, such as dental practices or dry cleaners, andentrepreneurial companies that may provide sub-stantial future payroll and economic develop-ment.11

Many experts believe that venture capital andother outside funding sources fill small businesses’investment needs and that those needs are fosteredby reducing the capital gains tax rate. High-techindustries, for example, do depend on outsidecapital, but many owners wouldn’t want outsideinvestors, even in the unlikely event they wereavailable. Self-financing is the norm for small busi-ness, and it is accomplished through second mort-gages, home equity loans, and even credit cards.Why does this matter? Because once a businessreaches a particular size, those financing methodsare inadequate, and it will likely become chronicallyunderfinanced. Businesses with the most growthpotential are the ones most likely to be stymied bya lack of funds.

The tax situation actually discourages small-business growth. To encourage new C corporationformation, the corporate tax rate should be muchlower — lower than individual tax rates for up to $2million in income. The debilitating effects of capitalconstraints cry out for more cash flow. The need forgreater cash flow is real, but the ‘‘solution’’ is notjust inefficient but inserts the government into acompany’s decision-making process. Give SMEslower tax rates and let them decide where to spendthe money to finance growth. Don’t use targetedrelief such as the research credit, accelerated depre-ciation, or even the expensing of all capital expen-ditures. Instead, reduce the tax rate, particularly forSMEs. The amount of the potential reduction fromremoving all tax expenditures would require fur-ther analysis, but the schedule listed below wouldbe within the ballpark.

Having a graduated rate is equally important tocounter the incentives to merge companies. Al-though some efficiency savings (that is, job losses)are the stated reasons for mergers, the overridingreason is often the increased market power of themerged company. Buying a competitor is seldom abad business decision. Unfortunately, except in themost egregious cases, the government agencieshave given up on fighting mergers.

Further research must be done to accuratelyestimate the percentages necessary to achieve theneutral-revenue goal. The combination of allowingat most a partial interest deduction and equatingbook and taxable income might support the follow-ing tax rate schedule. To support small business anddiscourage mergers, tax rates might be graduatedup to $100 million. The following schedule couldprovide the necessary incentives for growth-oriented SMEs to elect to be taxed as corporations aswell as discourage some mergers:

• 15 percent up to $2 million;• 20 percent from $2 million to $20 million;• 25 percent from $20 million to $100 million;

and• 30 percent exceeding $100 million.That schedule provides a lower rate for all com-

panies but particularly for SMEs.

Calculating the U.S. Share of Global ProfitsThe United States should use sales and income

figures from financial statements to allocate taxableincome between jurisdictions. States define theirshare of taxable corporate income in different waysand so could countries.12 Other countries mightchoose another formula or even a different methodof calculating the share of profits that could betaxed by that country. Just as the U.S. states havecoexisted with many formulas, so can countries.Although the proposed system would allocate in-come to the United States using GAAP or IFRS,other countries should be free to massage the num-bers to create their taxable base.

At one time, the most common way that statesapportioned taxes included three factors: payroll,property, and sales. More recently, states have mi-grated to use formulas that are heavily weightedtoward sales or use sales exclusively. The use ofsales exclusively best meets the needs of the UnitedStates because it does not discourage investment inplant and personnel and captures destination-(sales-) related profits regardless of the source. Thequestion of what produces profits is contentious,but many in the business community would assertthat only customers produce sales and that withoutsales, there would not only be no profits but also nocompany.

A Tamper-Proof Territorial SystemBusiness keeps calling for a territorial corporate

tax system. And it makes sense. Companies furtherdecry the tax rate as too high and therefore non-competitive on the world stage — and they are

form. The IRS could make the process even easier by allowingthe form to be submitted year-round and not just during thefirst 75 days of the tax year.

11Edward D. Kleinbard, ‘‘Why Corporate Tax Reform CanHappen,’’ Tax Notes, Apr. 6, 2015, p. 91.

12The United Kingdom essentially uses IFRS to define tax-able income. And it could allocate profits based on the percent-age of sales in the United Kingdom.




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right. But is the answer a low-tax territorial system?That would be revenue-depleting on a massivescale. To apportion to the United States the profitsfor an MNE that may operate in many countries,one should start with global sales and apportion theshare of profits in proportion to the share of sales.That could lead to lower rates and avoid increasingthe deficit.

Taxing the profits from sales, often called salesfactor apportionment (SFA),13 is a powerful tool.Although SFA might not satisfy some on the leftwho want to tax worldwide income, it could still beused to differentiate between domestic and foreignprofits. Domestic profits might be taxed at 30 per-cent, and only 15 percent of foreign profits might betaxed at 30 percent, for a 4.5 percent effective taxrate.14 Although SFA would not satisfy those whowant to tax worldwide profits at a full rate, it wouldmore than meet Apple’s requirement of a reason-able tax on foreign earnings. Likewise, some on theright might disagree because the system is not 100percent territorial. Whether to apply any tax toforeign sales, and the rate at which to do so, wouldbe subject to negotiation.

While some will argue for less inclusive measure-ments that allow separate accounting, any disinter-ested observer would note that it is precisely thatseparation that has allowed multinational corpora-tions to avoid paying income taxes in many of thehigh-tax countries of the world and instead transfertheir income to low- or no-tax jurisdictions. It isestimated that the United States lost between $77billion and $111 billion in 2012 from corporate profitshifting.15

It is clear that those fighting hardest againstconsolidated reporting in financial statements andSFA have a vested interest in the current brokensystem, and that vesting is often not a financialinterest but a career and reputation interest. Thesupport of the arms-length principle by those per-sons also has a fatal flaw: The internal pricing of aproduct is subject to many legitimate rationales,and it would be unrealistic to expect a company tochoose a system that results in greater profits in ahigh-tax country than in a low-tax country.

Some have argued that since the current systemallows a credit for foreign income taxes paid, thereshould at least be a deduction for foreign incometaxes. However, because the tax calculation startswith pretax profits, there is no reason to allow a

deduction for income taxes. In a territorial system,taxes paid in one country should not reduce taxespaid in another.16

Implementing Sales Factor Apportionment

Because the percentage of sales made in theUnited States will determine a company’s tax liabil-ity, some companies will be tempted to manipulatethat percentage. For example, a company might sellto an ‘‘independent’’ entity, which would thenimport goods for domestic sale. This and otherschemes can be frustrated by a simple change incalculating U.S. sales: Rather than tasking the gov-ernment with proving the sales were not outside theUnited States, shift the burden of proof to thecorporation to document the location of sales. Thatmethod is widely used by governments in othercontexts. Business income statements as well as taxforms depend on starting with total revenue andsubtracting expenses and deductions. In a similarmanner, MNEs would be taxed on their total salesbut credited with sales that they showed were madeoutside the United States. That simple change in thecalculation would negate almost all the concernsexpressed by those scrutinizing SFA.17

However, if the product was changed signifi-cantly, it should be considered a sale outside theUnited States, and profit from that sale would notbe taxed. For example, if Malden Mills Industries inMassachusetts sells its Polartec fleece to Bosung

13Also called ‘‘single sales factor’’ and ‘‘destination-basedcorporate tax.’’

14The same formula used in the 2004 corporate tax holiday.15Kimberly Clausing, ‘‘The Effect of Profit Shifting on the

Corporate Tax Base,’’ Tax Notes, Jan. 25, 2016, p. 427.

16Daniel N. Shaviro, ‘‘Rethinking Foreign Tax Creditability,’’63 Nat’l Tax J. 709-722 (2010). See also Donald L. Barlett andJames B. Steele, America: Who Really Pays the Taxes? 183-189(1994). One of the underreported stories is how first the oilcompanies and then all resource companies finagled royaltypayments into income taxes so they could be credited againstU.S. tax liability. The substitution of income taxes for whatotherwise would be royalties or extraction taxes has denied theUnited States its share of taxes on the income of resourcecompanies, particularly petroleum companies.

17Again and again experts bring up an Irish distributor thatsells Apple products into the United States with a very lowmarkup. This is not a valid objection, because this is not howApple handles international business. Three randomly chosendistribution agreements each specify the countries that thedistributor is authorized to sell to as well as those that areforbidden. Therefore, Apple will never allow a low-margindistributor in Ireland or elsewhere to sell outside its territory.

Legislation should be drafted to clearly prohibit sales to U.S.customers by distributors outside the United States, and it couldprovide a safe harbor for distributor agreements that spell outthat restriction. Congress would just need to include in thelegislation wording that would require companies to take somesimple steps to ensure that products sold outside the UnitedStates remain outside the United States. I believe that using thesubtraction method for SFA solves many problems. As ReuvenS. Avi-Yonah says, ‘‘All imports fully taxed and all exports fullyexcluded.’’ Simple. And that makes SFA essentially a border-adjustable tax, which has many international trade advantages.




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Engineering Co. Ltd. in Korea, which in turn pro-duces jackets for The North Face Inc. in the UnitedStates, the jackets will come into the United Stateswith an entirely different International HarmonizedTariff System (HTS) code than was used for thefabric exported to Korea. Malden Mills wouldtherefore count the Bosung sale as a non-U.S. saleand would not pay corporate tax on the appor-tioned income from that sale. It may be that Polarteccomes under HTS code 6001.22.000, and The NorthFace jacket might be imported under HTS code6110.30.3040. Legislation would need to specify thelevel of difference required to qualify an intermedi-ate sale as ‘‘outside the United States’’ when thefinal product is imported into the United States.

One valid objection is that a company couldpurchase a low-profit, high-volume foreign com-pany, which could dilute its profits in a sales-basedsystem. But purchasing low-profit, high-sales com-panies is not for the faint of heart. Those low profitsare generally the result of intense competition, andthe line between profit and loss can be very thin.Legislation requiring a minimum gross margin,such as 15 percent, might be necessary to make itmore difficult for a multinational to purchase alow-profit, high-volume company for the tax ad-vantages. There is also the possibility that the stockmarket would punish such a diverse company.

Permanent EstablishmentPermanent establishment requirements may

present another stumbling block to implementingSFA. Though first conceived over a century ago, PEis increasingly irrelevant in the digital age. Forinstance, a foreign MNE could establish a salesoffice in Windsor, Ontario, and cross the interna-tional Peace Bridge daily to sell to American auto-makers in Detroit without creating a PE. One cantherefore imagine revenue of $1 billion without theestablishment of a PE in the United States. NewYork considers the PE requirement satisfied for anycompany with $1 million in New York sales. Pro-fessor Reuven Avi-Yonah and others have advo-cated that the threshold for PE should be revenuebased.18

State BenefitsAnother factor to consider is that states have

been unable to appropriately tax MNEs because ofwater’s-edge legislation. This legislation was force-fully advocated by the Reagan administration in the1980s. SFA would provide substantial additionalstate revenues without raising rates. It would be

unnecessary to change the water’s-edge exclusionbecause SFA would deem the increased taxableincome domestic.

SFA Benefits

SFA has many appealing qualities, not the least ofwhich is that it is territorial. But it is much morethan that. Companies will go to any lengths toincrease sales and reduce expenses. Although theyare expenses, payroll and property are highly de-sired by states and countries, and even though theyare highly valued by the taxing authority, compa-nies will minimize these expenses, particularly iftaxed. Because companies so highly value sales,taxing sales is least likely to change companydecisions in ways that distort the economy.

Additional SFA revenues would come from cur-rent tax-avoiding MNEs, and that additional raisedrevenue could be used for infrastructure projects ordebt and deficit reduction. In other words, theelimination of tax expenditures and the eliminationor reduction of the interest deduction could goentirely to rate reduction and increased graduation.However, any added revenues from multinationals,both foreign and domestic, that are not a result ofthe elimination of tax expenditures and the elimi-nation or reduction of the interest deduction mightbe used to fund infrastructure projects or reduce thedeficit and debt.

Because SFA treats all companies, domestic andinternational, the same, there would be no competi-tive disadvantage or advantage in internationalmarkets for the United States having a significantlydifferent corporate tax rate than the rest of theworld. And because profits from exports are nottaxable, there would be a substantial incentive fordomestic companies to emphasize foreign marketsand sales.

Companies that now receive large tax expendi-ture reductions in pretax income would oppose thischange. That would be particularly true for invertedcompanies because there would no longer be anyadvantage to their inversions. However, other com-panies that have been paying close to the ‘‘rack’’rate would benefit. The tension between these twogroups might give the SFA proposal a chance. Andbecause SMEs would receive the most benefit, thereshould be substantial support for the change. Theold countervailing power dynamic could be used tohelp get an agreement. As Christine Lagarde, man-aging director of the IMF, said, ‘‘There would bemore revenue for all if countries resisted the temp-tation to compete with each other on taxes to attractbusiness. By definition a race to the bottom leaveseverybody at the bottom.’’ SFA would allow theUnited States to sidestep that race.

18Further research will be needed to establish the appropri-ate threshold for a PE, but it almost certainly would be between$1 million and $10 million.




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ConclusionThis proposal not only meets Apple’s require-

ments but provides additional economic benefits aswell. And it would seemingly meet Ryan’s need fortax relief to grow the economy while also meetingmany of Nunes’s requirements. Although the pro-posal could be revenue positive, the added revenuewould be derived from companies that currentlyare not paying their fair share of taxes. Starting withbook income helps remove the government frombusiness decisions and provides additional rev-enues that can be channeled to reduce corporateincome rates. Reducing or eliminating the interestdeduction would strengthen our economy and helpto further lower corporate tax rates. Graduatingtaxes encourages SME growth and discouragesmega-mergers. SFA treats all businesses the sameand provides a tamper-proof territorial system thatis by far the strongest of the proposals suggested forfixing the undisputedly broken corporate tax sys-tem. It is territorial, would avoid all or most of theways that companies use to game our currentsystem, and would provide much-needed revenueto states while raising more revenue at lower rates.

IN THE WORKS

A look ahead to planned commentary and analy-sis.

IBM — the prequel: The MTC election andthe single business tax (State Tax Notes)

Lynn Gandhi examines the Michigan Courtof Appeals’ recent finding that the state’sSingle Business Tax Act did not implicitlyrepeal the election of the Multistate TaxCompact by taxpayers and that the state’sPublic Act 282 of 2014 did not bar taxpayersfrom refund claims.

A brief review of corporate tax articles of2014-2015 (Tax Notes)

Jordan M. Barry and Karen C. Burke reviewnotable corporate tax law literature from2014 and 2015, including an article onwhether corporations should have to pub-licly disclose their returns in light of recentaggressive international corporate tax mini-mization strategies and the theory that pub-lic shaming could affect corporate behavior.

Significant issue rulings leave lots to theimagination (Tax Notes)

Jasper L. Cummings, Jr., analyzes two letterrulings on spinoffs and is critical of one thatinvolves the continuity of business enter-prise requirement.

Taxpayer rights: Coping with globalizationand uncertainty (Tax Notes International)

Duncan Bentley redefines the terminology oftaxpayer rights, explores the concept of prag-matic rights founded in soft law, and showsthat when the principles and legal rules thatform the basis for protecting taxpayer rightsare reinforced by a strong rule of law, rightsexpand through taxpayer engagement.

A catalog of confusion — VAT repayments(Tax Notes International)

Trevor Johnson discusses a long-runningand complex appeal, involving four compa-nies and several different VAT repayments,heard by the U.K. Supreme Court.




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The Earned Income TaxCredit: Trust, but Verify

By J. Kent Poff

AbstractThe earned income tax credit program is criti-

cized because of overpayments that come fromfraud and abuse of the program. This article showsthat the IRS contributes to the problem because insome circumstances, a taxpayer that follows IRSrules receives a substantially larger credit than thelaw allows.

In an example taken from an actual return, ataxpayer follows IRS rules and receives a credit thatis $2,450 larger than allowed by law. The overpay-ment of the credit results from tables prepared bythe IRS that do not properly reflect phaseout of thecredit as income increases. The improper phaseoutoccurs when the taxpayer has earned income that isless than the maximum allowed for the credit buthas enough other income to cause the credit tophase out. Fortunately, that does not occur fre-quently.

IntroductionThe EITC has been criticized politically, often by

Republicans, because of fraud.1 Consistent withthose criticisms, President Obama ordered a study

because of suspected improper payments and wastein the EITC and other programs.2

Responding to the executive order, the TreasuryInspector General for Tax Administration publisheda report stating that the ‘‘IRS has made little im-provement in reducing improper Earned IncomeTax Credit payments since being required to reportestimates of these payments to Congress.’’3 In fact,the report estimates that approximately 22.8 percentof EITC payments totaling approximately $12.6billion were improperly paid.4 Those estimates sug-gest that EITC payments total approximately $55billion annually. A major source of improper pay-ments of the EITC program is the IRS itself.

Calculation of the CreditThe EITC is designed to give low-income taxpay-

ers an incentive to work. The basic EITC is calcu-lated by multiplying the taxpayer’s earned income5

(up to a maximum amount) by the earned incomepercentage.6 However, the basic EITC is phased outwhen adjusted gross income is above a minimumamount.7 That phaseout depends on marital statusand number of children in the household. Forexample:

Example 1: Suppose that a taxpayer is single, hastwo qualifying children, and has earned incomeand AGI of $31,125. In this case, the maximumearned income available for the credit is 40 percentof $13,870. However, the credit is phased out at21.06 percent of the excess of the AGI over thephaseout limitation of $18,110.8 The results are asfollows:

1Steve Contorno, ‘‘Rand Paul Says Earned Income Tax CreditHas 25 Percent Fraud Rate That Costs Up to $30 Billion,’’PolitiFact (Jan. 30, 2015), available at http://www.politifact.com/truth-o-meter/statements/2015/jan/30/rand-paul/rand-paul-says-earned-income-tax-credit-has-25-per.

2White House, ‘‘Executive Order 13520, Reducing ImproperPayments and Eliminating Waste in Federal Programs’’ (Nov.20, 2009).

3TIGTA, ‘‘The Internal Revenue Service Is Not in ComplianceWith Executive Order 13520 to Reduce Improper Payments’’(Aug. 28, 2013).

4Between 21 and 24.6 percent (22.8 percent point estimate) ofthe EITC payments totaling between $11.6 and $13.6 billion($12.6 billion point estimate) were paid improperly (TIGTAreport, supra note 3, at 27).

5Earned income is taxable employee compensation andself-employment income. Section 32(c)(2)(A).

6Section 32(a)(1).7Section 32(a)(2).8Rev. Proc. 2014-61, 2014-47 IRB 860; section 32(b)(1).

J. Kent Poff

J. Kent Poff is an associateprofessor of accounting inthe Mike Cottrell College ofBusiness at the University ofNorth Georgia.

In this article, Poff dis-cusses criticism of theearned income tax creditprogram and argues that theIRS contributes to the prob-lem of overpayments.

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From the earned income credit worksheet A(Appendix A) and the EITC table (Appendix C), theearned income credit in Example 1 is calculatedcorrectly in the tables and is $2,807.9

Example 2: Suppose the same facts as in Example1, except that the taxpayer has earned income of$6,125, while still having AGI of $31,125. Therefore:

From the earned income credit worksheet A(Appendix B) and the EITC table (Appendix C), the

earned income credit in Example 2 is $2,450, whichis incorrect. As seen in the calculation above, IRStables do not take into account that the taxpayer didnot have the maximum earned income before thephaseout starts. That is inconsistent with section32(a)(1), which requires that the credit on incomeactually earned — not the credit on the maximumincome that might be earned — be reduced by thephaseout.

Summary, Conclusion, and Recommendations

The EITC program assists low-income taxpayers,but it is criticized because it is subject to fraud andabuse. The president issued an executive order toreduce improper payments and waste in federalprograms, including the EITC program. The IRS hasbeen criticized by TIGTA for inadequately comply-ing with the president’s executive order.

In addition to inadequately reducing improperEITC payments, the IRS contributes to the problemby publishing tables that give a larger credit thanallowed by the law. The credit overpayment occursbecause the published tables do not properly reflectphaseout of the credit as income increases. Theimproper phaseout occurs when the taxpayer hasearned income that is less than the maximumallowed for the credit but has other income that isenough to cause a phaseout of the credit.

This article has shown the correct credit calcula-tions. Therefore, the IRS should comply with thelaw, reduce improper payments of the EITC, andincrease compliance with the president’s executiveorder by developing tables that use the correctformulas to compute the credit.

(Appendices appear on the following pages.)9IRS, ‘‘Form 1040 Instructions.’’

Basic credit:Maximum income subject to the credit $13,870Credit percentage 0.40Basic credit $5,548Phase out of the credit:Greater of earned or adjusted gross income $31,125Phase out starts $18,110Excess of income over phase out $13,015Credit percentage 0.2106Phase out $2,741Net earned income credit: $2,807

Basic credit:Income subject to the credit $6,125Credit percentage 0.40Basic credit $2,450Phase out of the credit:Greater of earned or adjusted gross income $31,125Phase out starts $18,110Excess of income over phase out $13,015Credit percentage 0.2106Phase out $2,741Net earned income credit: $0




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Appendix A

Worksheet A - 2015 EIC

Part 1 1 Enter your earned income from Step 5. 1 31,125

All Filers Using

Worksheet 2 Look up the amount on line 1 above in the EIC Table (right after 2 2,807

A Worksheet B) to find the credit. Be sure you use the correct column

for your filing status and the number of children you have. Enter the

credit here.

If line 2 is zero, STOP, You cannot take the credit.

Enter "No" on the dotted line next to line 66A

3 Enter the amout from Form 1040, line 38 3 31,125

4 Are the amounts on line 3 and 1 the same?

X YES. Skip line 5; enter the amount from line 2 on line 6.

NO. Go to line 5.

Part 2 5 If you have:

a No qualifying children, is the amount on line 3 less than $8,250

Filers Who ($13,750 if married filing jointly)?

Answered b 1 or more qualifying children, is the amount on line 3 less than

"No" On $18,150 ($23,650 if married filing jointly)?

Line 4

YES. Leave line 5 blank; enter the amount from line 2 on line 6.

NO. Look up the amount on line 3 in the EIC Table to find the

credit. Be sure you use the correct column for your filing 5

status and the number of children you have. Enter the credit

here.

Look at the amounts on lines 5 and 2.

Then, enter the smaller amount on line 6.

Part 3 6 This is your earned income credit 5 2,807

Your Earned

Income Credit

Appendix A




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Appendix B

Appendix B

Worksheet A - 2015 EIC

Part 1 1 Enter your earned income from Step 5. 1 6,125

All Filers Using

Worksheet 2 Look up the amount on line 1 above in the EIC Table (right after 2 2,450

A Worksheet B) to find the credit. Be sure you use the correct column

for your filing status and the number of children you have. Enter the

credit here.

If line 2 is zero, STOP, You cannot take the credit.

Enter "No" on the dotted line next to line 66A

3 Enter the amout from Form 1040, line 38 3 31,125

4 Are the amounts on line 3 and 1 the same?

YES. Skip line 5; enter the amount from line 2 on line 6.

X NO. Go to line 5.

Part 2 5 If you have:

a No qualifying children, is the amount on line 3 less than $8,250

Filers Who ($13,750 if married filing jointly)?

Answered b 1 or more qualifying children, is the amount on line 3 less than

"No" On $18,150 ($23,650 if married filing jointly)?

Line 4

YES. Leave line 5 blank; enter the amount from line 2 on line 6.

X NO. Look up the amount on line 3 in the EIC Table to find the

credit. Be sure you use the correct column for your filing 5 2,807

status and the number of children you have. Enter the credit

here.

Look at the amounts on lines 5 and 2.

Then, enter the smaller amount on line 6.

Part 3 6 This is your earned income credit 5 2,450

Your Earned

Income Credit




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Appendix C. Earned Income Credit Table

Earned IncomeSingle, Head of Household, Widow(er) Married, Filing Jointly

0 1 2 3 0 1 2 3$5,800 $5,850 $5,825 $446 $1,981 $2,330 $2,621 $446 $1,981 $2,330 $2,621$5,850 $5,900 $5,875 $449 $1,998 $2,350 $2,644 $449 $1,998 $2,350 $2,644$5,900 $5,950 $5,925 $453 $2,015 $2,370 $2,666 $453 $2,015 $2,370 $2,666$5,950 $6,000 $5,975 $457 $2,032 $2,390 $2,689 $457 $2,032 $2,390 $2,689$6,000 $6,050 $6,025 $461 $2,049 $2,410 $2,711 $461 $2,049 $2,410 $2,711$6,050 $6,100 $6,075 $465 $2,066 $2,430 $2,734 $465 $2,066 $2,430 $2,734$6,100 $6,150 $6,125 $469 $2,083 $2,450 $2,756 $469 $2,083 $2,450 $2,756$6,150 $6,200 $6,175 $472 $2,100 $2,470 $2,779 $472 $2,100 $2,470 $2,779$6,200 $6,250 $6,225 $476 $2,117 $2,490 $2,801 $476 $2,117 $2,490 $2,801$6,250 $6,300 $6,275 $480 $2,134 $2,510 $2,824 $480 $2,134 $2,510 $2,824$6,300 $6,350 $6,325 $484 $2,151 $2,530 $2,846 $484 $2,151 $2,530 $2,846$6,350 $6,400 $6,375 $488 $2,168 $2,550 $2,869 $488 $2,168 $2,550 $2,869$6,400 $6,450 $6,425 $492 $2,185 $2,570 $2,891 $492 $2,185 $2,570 $2,891$30,800 $30,850 $30,825 $0 $1,327 $2,870 $3,564 $0 $2,209 $4,033 $4,726$30,850 $30,900 $30,875 $0 $1,319 $2,860 $3,553 $0 $2,201 $4,022 $4,716$30,900 $30,950 $30,925 $0 $1,311 $2,849 $3,543 $0 $2,193 $4,012 $4,705$30,950 $31,000 $30,975 $0 $1,303 $2,839 $3,532 $0 $2,185 $4,001 $4,695$31,000 $31,050 $31,025 $0 $1,295 $2,828 $3,522 $0 $2,177 $3,991 $4,684$31,050 $31,100 $31,075 $0 $1,287 $2,818 $3,511 $0 $2,169 $3,980 $4,674$31,100 $31,150 $31,125 $0 $1,279 $2,807 $3,501 $0 $2,161 $3,970 $4,663$31,150 $31,200 $31,175 $0 $1,271 $2,797 $3,490 $0 $2,154 $3,959 $4,653$31,200 $31,250 $31,225 $0 $1,263 $2,786 $3,479 $0 $2,146 $3,948 $4,642$31,250 $31,300 $31,275 $0 $1,255 $2,775 $3,469 $0 $2,138 $3,938 $4,631$31,300 $31,350 $31,325 $0 $1,247 $2,765 $3,458 $0 $2,130 $3,927 $4,621$31,350 $31,400 $31,375 $0 $1,239 $2,754 $3,448 $0 $2,122 $3,917 $4,610$31,400 $31,450 $31,425 $0 $1,231 $2,744 $3,437 $0 $2,114 $3,906 $4,600$31,450 $31,500 $31,475 $0 $1,223 $2,733 $3,427 $0 $2,106 $3,896 $4,589$31,500 $31,550 $31,525 $0 $1,215 $2,723 $3,416 $0 $2,098 $3,885 $4,579$31,550 $31,600 $31,575 $0 $1,207 $2,712 $3,406 $0 $2,090 $3,875 $4,568$31,600 $31,650 $31,625 $0 $1,200 $2,702 $3,395 $0 $2,082 $3,864 $4,558$31,650 $31,700 $31,675 $0 $1,192 $2,691 $3,385 $0 $2,074 $3,854 $4,547$31,700 $31,750 $31,725 $0 $1,184 $2,681 $3,374 $0 $2,066 $3,843 $4,537$31,750 $31,800 $31,775 $0 $1,176 $2,670 $3,364 $0 $2,058 $3,833 $4,526$31,800 $31,850 $31,825 $0 $1,168 $2,660 $3,353 $0 $2,050 $3,822 $4,516




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Million-Dollar Dirt: A Look at theIRS Whistleblower Program

By John Myrick

A. Little Socrates the ArsonistThe law of the playground is taught by morally

questionable figures. The same person who teachesyou not to tattle is usually also the one who tellsyou that crayons are edible or that it’s a good ideato stick peanuts up your nose. And he’s probablythe one who benefits most from your silence. Nev-ertheless, these lessons — particularly the rule ontattling — burrow deep into our system of ethics.But at some point they’re worth reconsidering andperhaps amending for the next generation: If yourplayground companion is a budding sociopath wholikes to set things on fire, maybe it’s better to tell theteacher he found a box of matches, even if it costsyou a friendship.

This strong resistance to tattling, whatever itsorigin, plays a role in the discussion of whistleblow-ers in the workplace. In a 1998 debate on whetherthe IRS should pay informants for leads on taxenforcement, Sen. Harry Reid, D-Nev., describedthe IRS program at the time as the ‘‘Award for RatsProgram’’ and the ‘‘Snitch Program.’’1 Reid did notprevail; the IRS program was not eliminated and infact was substantially expanded in 2006 to furtherencourage tax whistleblowers to come forward. Notlong after those statutory changes took effect, Brad-ley Birkenfeld blew the whistle on the tax evasionpractices of Swiss bank UBS AG,2 which resulted in

a $780 million settlement and kick-started furtherefforts that have led to billions more collected fromother Swiss banks and their U.S. taxpayer clients.3

But to those who strictly adhere to the no-tattlingrule, maybe the results don’t justify the means. Afterall, Birkenfeld got a nice payday for his dirt: $104million. And he was not entirely squeaky clean him-self. He had worked for UBS to help clients hideassets and evade taxes and once smuggled funds fora client by stuffing diamonds into a tube of tooth-paste.4

Ultimately, to accept the idea of a whistleblowerprogram, you have to be OK with giving taxpayersa financial incentive to rat on their co-workers andwith the government paying potentially bad actorsfor good information. If that doesn’t bother you,you’ll like that the whistleblower program has beenone of the IRS’s most cost-effective sources ofrecovering unpaid taxes.

But if you don’t like the program, there’s goodnews for you, too — its shortcomings have beenheavily criticized by both government officials andpractitioners. Recent reports by the GovernmentAccountability Office5 and the Taxpayer AdvocateService (TAS)6 reveal that the IRS program movestoo slowly, leaves whistleblowers in the dark on thestatus of their claims, and pays awards in only atiny percentage of cases. Some major critics, such asSenate Finance Committee member Chuck Grass-ley, R-Iowa, argue that this reluctance to embracewhistleblowers reflects the IRS Office of ChiefCounsel’s disdain for the program.7

1Michelle M. Kwon, ‘‘Whistling Dixie About the IRS Whistle-blower Program Thanks to the IRC Confidentiality Restric-tions,’’ 29 Va. Tax Rev. 447, 449 (2010), citing 144 Cong. Rec.S4379-S4405, at S4397-S4398 (statement of Reid).

2Jeremiah Coder, ‘‘IRS Pays Birkenfeld $104 Million Whistle-blower Award,’’ Tax Notes, Sept. 17, 2012, p. 1359; and Justice

Department press release, ‘‘UBS Enters Into Deferred Prosecu-tion Agreement’’ (Feb. 18, 2009).

3William Hoke, ‘‘Focus Shifting Away From Switzerland,Investigators Say,’’ Tax Notes, Nov. 2, 2015, p. 628; and Nathan J.Richman, ‘‘Swiss Bank Non-Prosecution Penalties Pass $1 Bil-lion,’’ Tax Notes, Jan. 4, 2016, p. 62.

4David D. Stewart, ‘‘Judge Denies Former UBS Banker’sRequest to Delay Prison Term,’’ Tax Notes, Jan. 11, 2010, p. 175.Birkenfeld did serve 30 months in prison for his crimes. LauraSaunders, ‘‘UBS Whistleblower Released From Prison,’’ The WallStreet Journal, Aug. 1, 2012.

5GAO, ‘‘IRS Whistleblower Program: Billions Collected, butTimeliness and Communication Concerns May DiscourageWhistleblowers,’’ GAO-16-20 (Oct. 2015).

6TAS, ‘‘National Taxpayer Advocate Annual Report to Con-gress, 2015’’ (Dec. 31, 2015).

7Andrew Velarde, ‘‘Chief Counsel Undermining Whistle-blowers, Grassley Says,’’ Tax Notes, Feb. 16, 2015, p. 859.

John Myrick is a legal editor with Tax Notes. Hiscolumn takes a second look at some of the moreunique, provocative, and noteworthy stories cov-ered by Tax Analysts reporters.

In this column, Myrick examines the IRS policyof paying informants to betray the tax secrets oftheir employers and colleagues.

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B. Value by the NumbersThe IRS is missing out on potentially billions in

revenue by failing to take full advantage of thewhistleblower program, according to Dean Zerbe ofZerbe, Fingeret, Frank & Jadav PC, interviewed byAndrew Velarde in a December 2015 story for TaxNotes. ‘‘Bang for buck for honest taxpayers — it’shard to beat a program that is bringing in $6 frombig-time tax cheats for every $1 it pays in awards,’’he said.8

A 1999 study found that the use of whistleblowerinformation had a better cost-benefit ratio and alower no-change rate than other IRS enforcementmethods. For every dollar collected from the infor-mant program in audits of 1996-1998 returns, theIRS ‘‘incurred slightly over four cents in cost (in-cluding personnel and administrative costs),’’ com-pared with a cost of over 10 cents per dollarcollected through other programs.9 At its best, thewhistleblower program should provide the IRSwith direct information on tax fraud and put good,usable evidence in the hands of agents. Comparethis with the IRS’s other primary tool for discover-ing fraud: a statistical method called the discrimi-nant index function, which scores income taxreturns based on their likelihood of error and po-tential profitability and leaves auditors with thetask of finding the smoking gun.

There is a lot of money to be made by improvingenforcement. The net tax gap — the amount thattaxpayers owed but did not voluntarily and timelypay — was estimated to be $385 billion for 2006, themost recent year for which this estimate is avail-able.10

And the IRS’s resources available for enforce-ment have been shrinking. Congress has cut backon the IRS’s budget in recent years, which has costthe IRS enforcement personnel, and the agencyexpects to lose another 2,000 to 3,000 employeesoverall in 2016.11 Given the decline in resources, itshould be a nice treat for the IRS when it can forgoa fishing expedition for information and havewhistleblowers throw the fish directly in the boat.

Recognizing the value of the program, Congressoverhauled it in 2006 to improve the award deter-mination process.12 Before then, payments towhistleblowers were largely discretionary, ranging

from 1 percent to 15 percent of proceeds collected,and whistleblowers had little ability to challengeIRS decisions. The program — which had been inoperation since 1867 — was not advertised, and IRSemployees were told not to encourage taxpayers toprovide information in exchange for awards.13 The2006 act was meant to remedy those perceivedproblems. It established the IRS Whistleblower Of-fice (WO) and, for claims involving amounts indispute in excess of $2 million,14 allows whistle-blowers to appeal IRS determinations to the TaxCourt and mandates in most cases a minimumpayment of 15 percent of collected proceeds (but nomore than 30 percent).15

C. What Could Possibly Go Wrong?1. A glut of frivolous claims. Tax Analysts DeputyPublisher David Brunori brings up an interestingpoint in explaining why he dislikes whistleblowerprograms: He argues that financial incentives toreport tax fraud tend to generate frivolous claimsagainst businesses thought to have deep pockets.16

The experience with whistleblower law at thestate level has shown this to be a real problem.Some states go beyond what the IRS program offersand allow whistleblowers to bring lawsuits on theirown under qui tam statutes, with or without theintervention of the government. In the federal pro-gram, by contrast, whistleblowers must presenttheir claims to the IRS, which then decides whetherto proceed with an audit.

If there is a symbol of the excesses that can occurunder a do-it-yourself regime, it’s probably StephenB. Diamond of Chicago, who as of January 5, 2016,had filed 938 qui tam tax actions. As discussed byAmy Hamilton in State Tax Notes, Diamond’s basicstrategy is ‘‘to purchase products from out-of-statebusinesses over the Internet and file qui tam actionsalleging fraud when companies fail to collect use orliquor excise taxes on the purchases or on a portionof the shipping and handling charges.’’17 Thesepirate whistleblowers can use (abuse?) the law tojump on a small mistake, sue a business to getaccess to its books and records, and then hope to hit

8Velarde, ‘‘GAO Faults Whistleblower Program Over Time-liness, Communication,’’ Tax Notes, Dec. 7, 2015, p. 1238.

9TAS, supra note 6, at 145, discussing IRS, ‘‘The Informants’Project: A Study of the Present Law Reward Program’’ (Sept.1999).

10GAO, supra note 5, at 2.11William Hoffman, ‘‘Budget Boost Lends Hope for Better

IRS Filing Season,’’ Tax Notes, Jan. 18, 2016, p. 284.12Tax Relief and Health Care Act of 2006, P.L. 109-432.

13Kwon, supra note 1, at 452-453.14Also, if the taxpayer reported on is an individual, for the

2006 act protections to apply, his gross income must exceed$200,000 for any tax year subject to the action.

15GAO, supra note 5, at 24; section 7623(b). Factors canreduce the minimum 15 percent payment in some cases, such aswhen the information provided by the informant was alreadypublicly disclosed.

16Brunori, ‘‘Qui Tam and a Nation of Rats,’’ State Tax Notes,Oct. 12, 2015, p. 147.

17Amy Hamilton, ‘‘Chicago Whistleblower Has Filed 938FCA Tax Cases, Attorney Says,’’ State Tax Notes, Jan. 11, 2016, p.114.

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the jackpot. And the taxpayers who must defendthemselves in these lawsuits do so without thenormal rights they would have in audits before theIllinois Department of Revenue.

Because of the explosion of these ‘‘vigilante taxadministration’’ lawsuits, the Illinois DOR is hesi-tant to issue voluntary compliance bulletins —which help notify businesses of potential areas ofconcern so they can return to compliance — becauseof the ‘‘fear that they will provide a roadmap tothose who seize on areas where the law may not beclear to file for [qui tam tax] actions,’’ Illinois Rev-enue Director Connie Beard said.

There is some evidence that the IRS is similarlyawash in a sea of frivolous information. Of all theclaims closed in fiscal 2014, the IRS paid an awardon only 3.65 percent.18 In fiscal 2015 that numberfell to 1.9 percent.19 But these low percentages couldalso be the result of other factors, discussed below,such as not having enough manpower or adequateprocesses to efficiently evaluate all claims.

The argument in favor of qui tam lawsuits is thatthey overcome the problem of limited resources orlack of government interest. If the government willnot pursue a legitimate case, for whatever reason,whistleblowers can take it to the courts and achievesome justice on society’s behalf. Some types of caseswould be off limits, of course (namely, those requir-ing sophisticated legal or economic analysis), but,the argument goes, whistleblowers could handlestraightforward cases of fraud.

And qui tam regimes might avoid the Illinoisproblem by setting the right limits on claims. TheNew York statute, for example, allows qui tamactions only against businesses that net more than$1 million annually and knowingly defraud thegovernment of more than $350,000 in taxes.20 Thecurrent flag bearer for the success of that state’sregime is the ongoing litigation against Sprint Nex-tel Corp., in which the company is alleged to haveknowingly avoided about $130 million of sales taxobligations.21 Unfortunately for Sprint, under theNew York whistleblower act, those guilty of taxfraud must pay triple the amount of tax owed, plus

penalties and interest, which increases the amountat issue to almost $400 million. This could result ina nice check for the whistleblower, who will receiveup to 25 percent of any revenue the state collectsbased on the information he provided.

2. Clogs in the federal pipeline. According to theIRS, of the claims it closed in fiscal 2014, 39.6percent did not involve a ‘‘tax issue,’’ 7.9 percentcontained unclear or nonspecific allegations, 4.2percent involved information the IRS already knew,and 4.5 percent weren’t worth developing becausethe statute of limitations had already expired.22

About 1.2 percent of cases were closed explicitlybecause the IRS lacked the resources to pursuethem.23

But clearly some claims have substance. The IRScollected about $501 million in fiscal 2015 based onthe information whistleblowers provided, payingapproximately $103 million in rewards (around 20.6percent of the amount collected).24 The GAO reportsuggests that time pressures and inefficient pro-cesses sharply reduce what the IRS might be able torecover:

WO staff told us that in some cases it wasobvious in the mail processing administrativereview that some submitted claims were notworthy of pursuit, but such claims are movedalong to ensure all claims receive a fair andhonest consideration. They told us that theseclaims came in with only vague insinuationsof wrongdoing and that a small number ofwhistleblowers submit multiple claims of thistype per month. . . . However, the process isnot set up to allow the [Initial Claim Evalua-tion (ICE)] unit to deny such claims. As aresult, the ICE unit ends up performing ad-ministrative functions on claims that are likelyto be denied [later]. The result is added costs

18IRS WO, ‘‘Fiscal Year 2014 Report to the Congress,’’ at 16(July 2015). Of 6,520 claims closed in fiscal 2014, awards werepaid on 238, about 3.65 percent.

19IRS WO, ‘‘Fiscal Year 2015 Annual Report to the Congress’’(Feb. 2016), at 17.

20Hamilton, ‘‘Which Tax Whistleblower Model Should StatesFollow?’’ State Tax Notes, Feb. 16, 2015, p. 367.

21New York v. Sprint Nextel Corp., 42 N.E.3d 655 (2015). SeeDavid Sawyer and Hamilton, ‘‘New York High Court UpholdsFalse Claim Act Suit Against Sprint,’’ State Tax Notes, Oct. 26,2015, p. 273; and Hamilton, ‘‘New York Court Again RejectsSprint’s Motion to Dismiss $400 Million Qui Tam Case,’’ State TaxNotes, Mar. 3, 2014, p. 519.

22IRS WO, supra note 18, at 16. The IRS used two categoriesfor claims denied because of expired statutes of limitations; Icombined the numbers to calculate the figure of approximately4.5 percent.

23The IRS WO fiscal 2015 report combines several of thecategories used in the 2014 report. The overall numbers appearsimilar, except that in 2014, 24.8 percent of claims are describedas ‘‘closed — other.’’ The WO noted in the 2015 report that itprovided additional training to reduce the number of claimsthat fall into this miscellaneous category. However, the numbersin the ‘‘other’’ category do not appear on their own in the 2015report but are combined with claims from two other 2014categories: ‘‘information already known’’ and ‘‘lack of IRSresources.’’

24IRS WO, supra note 19, at 11. $103 million represents theamount that would have been paid if not for sequestration,which reduced the actual award payments by $7.5 million.




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and time to the overall review process becauseclaims known to be of poor quality are al-lowed to advance.25

By spending too much time on clear losers, theIRS could be missing deeper evaluation of the casesthat do have merit. And there is already too littletime to evaluate claims: As of the publication of theGAO report in October 2015, the WO had a backlogof over 11,000 cases.26

Some whistleblowers, after their claims weredenied, have taken their cases to the Tax Court. Thecourt has been receptive, establishing that it hasjurisdiction over denial determinations,27 but itcannot force the IRS to undertake audits that theagency would not otherwise pursue. And if the IRSdoes not collect proceeds in a case, the whistle-blower has no claim for payment, no matter howgood the information might have been.28

D. The High Cost for WhistleblowersThe TAS report discusses a study of 64 whistle-

blowers in which the authors found that a ‘‘signifi-cant percentage [of whistleblowers] remain out ofwork or underemployed, bitter about their punish-ment, and uncertain of ever being able to restoretheir lives fully.’’29

Even though Birkenfeld hit the jackpot with a$104 million payday, most whistleblowers face astarkly different reality. Of the lucky few who do getpaid, most generally receive nothing until yearsafter they submit their initial claims. In the mean-time, they have little contact with the IRS regardingtheir cases and zero legal protection under the taxcode for retaliatory actions their employers maytake.1. Slow is too fast a word. The IRS, understandably,doesn’t pay whistleblowers upfront. Before awhistleblower can get an award, the IRS mustaccept the case, successfully recover from the tax-payer, and then wait for all rights regarding poten-tial appeals and requests for refunds to beexhausted. Then the WO must decide on an awardamount, which takes a surprisingly long time — 18

to 54 months, according to the GAO,30 slightlylonger than the IRS target completion time of lessthan 90 days.

As shown in the chart below, agents from the WObegin and end the process, accepting claims anddetermining award payments, but agents from otheroperating divisions decide whether to act on theinformation. For claims paid in 2015, whistleblowershad to wait on average six to nine years to receive anaward following the submission of a claim.31

2. The veil of secrecy. One of the biggest complaintsabout the program is how little communication theIRS has with a whistleblower once a case is under-way, particularly once it has reached the field officefor audit. This can be frustrating for whistleblowersand also costs the IRS the opportunity to use thewhistleblowers’ inside knowledge to further de-velop cases.

There are important reasons why communicationis limited, however. Namely, the tax code forbidsIRS employees from disclosing confidential infor-mation, a rule they could violate by discussing caseswith whistleblowers. The prohibition is prettybroad, even preventing the IRS from disclosingwhether the whistleblower’s information led to anaudit or, if not, why.32

Various fines and penalties are associated withreleasing confidential information, and they dohave some teeth: In 2013, former IRS employeeDennis Lerner faced up to 10 years in prison fordisclosing the identity of a whistleblower.33 Heultimately accepted a plea deal and received threeyears’ probation and a $10,000 fine.34 (The facts ofthe case don’t inspire a lot of confidence in thewhistleblower process: Lerner expressed his frus-tration with his IRS co-workers in an email, sayinghe ‘‘work[s] with fools’’ and got ‘‘paid next tonothing’’ for it. According to the charges againsthim, his disclosure was made to an executive of thebank the whistleblower reported on. And less thana year after revealing the whistleblower’s identity,Lerner accepted a job with the bank.35)

25GAO, supra note 5, at 19.26Id. at 17.27See, e.g., Comparini v. Commissioner, 143 T.C. 274 (2014); and

Whistleblower 11332-13W v. Commissioner, 142 T.C. 396 (2014).28See, e.g., Whistleblower One 10683-13W v. Commissioner, 145

T.C. No. 8 (2015) (‘‘We agree with petitioners that their entitle-ment to an award turns on two issues: first, whether there wasa collection of proceeds, and, second, whether that collectionwas attributable in some way to the information that petitionersprovided.’’).

29TAS, supra note 6, at 412.

30GAO, supra note 5, at 15. These data are based on 17 casesthe GAO examined that closed in 2015.

31Velarde, ‘‘2015 Whistleblower Report Touts Big Year,’’ TaxNotes, Feb. 15, 2016, p. 761.

32Section 6103; TAS, supra note 6, at 146.33Eric Kroh, ‘‘Former IRS Employee Pleads Guilty to Disclos-

ing Information,’’ Tax Notes, Mar. 18, 2013, p. 1311.34Justice Department press release, ‘‘Former IRS Official

Sentenced in Manhattan Federal Court for Violating Conflict ofInterest and Audit Disclosure Laws’’ (July 16, 2013).

35Janet Novack, ‘‘Former IRS Auditor Gets Probation forTaxpayer Info Leak, Conflict of Interest,’’ Forbes, July 16, 2013.




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There is a solution for the confidentiality restric-tions in the tax code, however. Section 6103(n) givesthe IRS the authority to enter into agreements withwhistleblowers to disclose returns and return infor-mation to the extent necessary for purposes of taxadministration. These agreements allow the IRS to

discuss cases with whistleblowers and requirewhistleblowers to keep all disclosed informationconfidential.36

Despite releasing memos in 2012 and 2014 ex-pressing its interest in using these agreements, the

36Reg. section 301.6103(n)-2(c).

Whistleblower 7623(b) Claims Process at the IRS

Source: GAO analysis of IRS data (GAO-16-20).




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IRS has never entered into one with a whistle-blower.37

The IRS is not completely opposed to thoseagreements, however. Although the agency is notrequired to report the number of disclosures it hasmade under section 6103(n) specifically, it said in2012 that it has made more than 8 billion disclosuresof tax returns and return information under section6103 generally, although they were primarily madeto other government agencies.38 One high-profileexample of a section 6103(n) contract is the one theIRS entered into with Quinn Emanuel Urquhart &Sullivan LLP in May 2014 so the law firm could‘‘assist with the evaluation, analysis, presentationand defense of claims or adjustments related to theissues under examination’’ in the transfer pricingcase against Microsoft Corp.39 (The agreement withQuinn Emanuel has raised some strong objectionsregarding the high fee the IRS paid for the firm’sservices in the audit phase of the case, around $2.2million,40 but the fee pales in comparison with whatthe IRS has paid to some whistleblowers.)

To its credit, the IRS has used other, more limiteddisclosure exceptions under section 6103 to commu-nicate with whistleblowers.41 As Velarde reports,however, the IRS could take any of a number ofsteps to expand this communication without violat-ing the existing statutory regime; it just chooses notto.

In fact, the IRS’s most recent undertaking in thisarea was to reduce communication with whistle-blowers, not increase it. In March 2015 it launched apilot project to test the effect of sending letters toeligible whistleblowers each year simply to let themknow that their cases are still open.42

This is not new information — whistleblowerscould already call the IRS to ask about the status oftheir cases. The point of the pilot is to preemptwhistleblowers from doing so. What’s interesting isthat the IRS has said it will not verify the success ofthis program by calling participants and askingthem whether they found the letters helpful. The

rationale is that speaking with taxpayers about theprogram would undermine the effort to reduce thevolume of phone calls. However, the IRS did say itwould monitor press coverage and Internet mes-sage board discussions.43

3. Old technology and ill-delivered mail. Com-pounding the silence with whistleblowers is the factthat the IRS has had a difficult time keeping up withwhere to find them. The IRS does not automaticallyupdate whistleblowers’ addresses when they reportnew ones on their personal returns. To make anaddress change, a whistleblower must separatelycontact the WO with the information; even then, theWO has said that updating addresses can be a‘‘challenging and time-consuming’’ process.44 Andwhen cases drag out over seven years, the likeli-hood a whistleblower will change mailing ad-dresses a time or two is pretty high.

The result has been that letters have been sent tothe wrong places. Whistleblowers, for good reason,are protective of their secrecy, so this can be a bigproblem. Making matters worse, on at least oneoccasion, the IRS identified itself in the returnaddress as ‘‘IRS Whistleblower Office,’’ which onehopes went unnoticed by any of the whistleblow-er’s co-workers who may have seen the envelope.

Why is updating addresses so difficult? Thecomputer software the WO uses to store case infor-mation, E-TRAK, was not designed for how it isbeing used, and it sounds like a pain to deal with.The GAO report indicates that for some purposes,the WO forgoes using E-TRAK and just keeps theinformation in separate spreadsheets — eventhough the data is not tied to E-TRAK and must bemanually entered and updated.

To update a whistleblower’s address in the sys-tem, an IRS agent can’t simply enter a new one inthe whistleblower’s E-TRAK profile. The agent hasto individually update every file associated with thewhistleblower’s name, a process that most of uswould justifiably describe as ‘‘challenging andtime-consuming.’’45

4. Hyper-technical arguments. The IRS has beencriticized for aggressively seeking to minimize pay-ments to whistleblowers and step around the gen-erous award provisions of the tax code. Grassleydescribed his feelings on the situation in a questionto IRS Commissioner John Koskinen:

I again find myself frustrated with an IRSChief Counsel office that seems to wake upevery day seeking ways to undermine thewhistleblower program both in the courts and

37See Velarde, ‘‘IRS Provides Welcome Update to Whistle-blower Program Goals,’’ Tax Notes, Aug. 25, 2014, p. 922. TAS,supra note 6, at 153.

38Coder, ‘‘The Increasing Importance of the WhistleblowerProvisions in U.S. Tax Administration: Clash for Cash: TheConflict Over Tax Whistleblower Contracts,’’ 59 Vill. L. Rev. 409(2014).

39Ajay Gupta, ‘‘Why Has the IRS Outsourced Microsoft’sTransfer Pricing Audit?’’ Tax Notes, Dec. 8, 2014, p. 1089.

40Ryan Finley, ‘‘The IRS Doesn’t Need Outside Law Firms,Observers Say’’ (Nov. 4, 2015).

41Velarde, ‘‘TAS Calls for Earlier Start for WhistleblowerProceedings,’’ Tax Notes, Jan. 11, 2016, p. 146.

42Velarde, ‘‘Whistleblower Status Letters Seen as a GoodStart but Not Enough,’’ Tax Notes, Mar. 23, 2015, p. 1457.

43GAO, supra note 5, at 37-38.44Id. at 39-41.45Id. at 41.




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the awards. I am especially concerned thatchief counsel is throwing every argument itcan think of against whistleblowers in taxcourt. It appears at times that the Chief Coun-sel’s office thinks its job is to come up withhyper technical arguments and seek to denyawards to whistleblowers who have riskedtheir lives to uncover big time tax cheats. I askthat your office and the director of the whistle-blower office review the chief counsel’s waste-ful and harmful litigation positions thatundermine the whistleblower program and godirectly against your support for the whistle-blower program.46

When awards are challenged in the Tax Court,the court has often sided with whistleblowers,taking an expansive interpretation of its jurisdictionand the information available in discovery. In arecent case, for example, the IRS denied an award,even though the whistleblowers claimed to haveprovided information leading to more than $70million of tax adjustments from an offending cor-poration. The IRS argued, however, that it could notconfirm or deny the amount of the adjustmentsbecause it was outside the ‘‘administrative record.’’In a somewhat incredulous tone, the Tax Courtordered the IRS to comply with the request forinformation:

How could evidence related to whether therewas a collection of proceeds and whether thatcollection was attributable to the whistleblow-er’s information not be part of any purportedadministrative record? Any such evidencegoes to the very basic factual inquiries re-quired by section 7623(b). Respondent’s lackof direct response to petitioners’ motions ap-pears to indicate that the current ‘‘administra-tive record’’ is incomplete.47

5. No legal protection against retaliation. By thenature of their act, whistleblowers burn bridgeswith the people they report on — and sometimesthose people strike back. Because of this, manymajor whistleblower laws include provisions todiscourage or punish retaliation. For example, thefederal False Claims Act provides that whistle-blower employees and contractors are entitled to allrelief necessary to make them whole followingdiscriminatory actions taken against them, includ-ing job reinstatement at the same seniority level,twice the amount of back pay owed, interest on the

back pay, and compensation for special damagessustained as a result of the discrimination, includ-ing litigation costs and attorney fees.48

However, the act excludes tax whistleblowersfrom its statutory regime, and there are no corre-sponding rules in the tax code protecting whistle-blowers.

The retaliation threat is not hypothetical. Taxwhistleblowers take a major risk by passing infor-mation to the government, particularly when thestakes are high and the people involved havealready shown a willingness to break the law. A2014 Tax Court opinion discusses the dangers facedby a whistleblower who reported on a group thatthe government described as ‘‘linked to violentevents and terrorist organizations’’ and which, asalleged by the whistleblower, had murdered a per-son who previously spoke up about the group’sactivities. When the whistleblower initially raisedthe concerns about tax fraud to his employer, hewas fired, and the employer used ‘‘physical forceand armed men to intimidate the whistleblowerand prevent disclosure.’’ According to the opinion:

The whistleblower received a death threatfrom the targets, communicated through theircounsel. After learning of the individuals andentities involved, the Government offered toplace the whistleblower in the witness protec-tion program. The whistleblower declinedplacement in the witness protection program,but requested and was granted confidentialinformant status. The whistleblower was alsoforced to hire counterterrorism experts to ad-vise the whistleblower’s family on safety andprotect the whistleblower on trips abroad. Thisprotection cost the whistleblower tens of thou-sands of dollars.49

In extreme cases like this one, no further legalprotections should be necessary to discouragephysical violence or murder, but Congress shouldadd protections against the loss of one’s livelihoodand reputation. This would be an easy (and seem-ingly noncontroversial) fix for Congress. The newprovisions could simply be patterned after those inthe False Claims Act or any number of other lawsthat work to the same effect.

In February, Lee Martin, who took over as WOdirector in August 2015, called for Congress to pass

46‘‘Questions for the Record’’ (including Koskinen’s re-sponses to follow-up questions to a Feb. 3, 2015, FinanceCommittee hearing on IRS operations and the president’s fiscal2016 budget).

47Whistleblower One 10683-13W, 145 T.C. No. 8.

4831 U.S.C. section 3730(h); TAS, supra note 6, at 411.49Whistleblower 11332-13W v. Commissioner, T.C. Memo. 2014-

92, at *4 (granting the whistleblower’s motions to seal the recordand proceed anonymously).




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this type of protection for whistleblowers.50 Accord-ing to the recent WO report, anti-retaliation mea-sures for whistleblowers have been among theObama administration’s budget proposals since fis-cal 2014.51

E. ConclusionWhistleblowers may have to betray an expecta-

tion of trust and loyalty to share their information,and some may have been complicit to a degree inthe bad actions, but from an enforcement perspec-tive, their contributions are cost effective and highlyvaluable.

Interestingly enough, the IRS in 2015 had to dealwith a whistleblower of its own, William Henck,who exposed what he called the ‘‘secret law’’ of theIRS, in which a few senior officials would makedecisions for the agency based on personal orunknown reasons and sometimes in disregard ofthe tax code. He described it as follows:

The decision-making process for a particularcase or type of case is corrupted or compro-mised by high-level executives basically on awhim or fiat or in an arbitrary fashion. . . . Ifthey inquire, agents and attorneys are told thatthe matter was ‘‘vetted’’ at the highest leveland that is that. . . . In every case where I haveseen this happen, it has benefited well-connected taxpayers. I have never seen thistype of corrupted or compromised decision-making benefit the public fisc. Basically, this isa white-collar version of a smash-and-grabrobbery.52

Henck said that as a result of his disclosures, hefaced an investigation by the Treasury InspectorGeneral for Tax Administration and could wind upgetting suspended or fired.53

Whether you love or hate whistleblowers, Con-gress has opened the IRS’s doors to hear them, andalthough IRS procedure is far from streamlined andmay be operating under a few ‘‘secret law’’ deci-sions contrary to congressional mandates, it pro-duces some good results. The government isn’tperfect — and that shouldn’t be the expectation ordemand — but improvement in its treatment ofwhistleblowers would seem to benefit both thegovernment and the American public.

50WO 2015 report, supra note 19, at 4.51Id. at 10.52Hoffman, ‘‘Black Liquor: The Loophole That Won’t Quit,’’

Tax Notes, Apr. 7, 2014, p. 18; and Jeremy Scott, ‘‘WhistleblowerHighlights Undue Influence at the IRS,’’ Forbes, June 10, 2014.

53Hoffman, ‘‘IRS Whistleblower Says He’s Being Investi-gated by TIGTA,’’ Tax Notes, Sept. 21, 2015, p. 1320.

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To see why so many tax professionals put their

trust in us, please visit taxanalysts.com.

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In Memoriam: Ira ShepardBy Calvin H. Johnson

Ira Shepard, professor emeritus at University ofHouston Law Center, died March 27 of renal failure,after a battle with cancer, at age 78. He graduatedfrom the Bronx High School of Science, majored inmath and competed on the math team at HarvardUniversity, and became a member of Harvard LawReview at Harvard Law School.

The new chemo had produced total remission,with no perceptible cancer. I emailed him ‘‘To Life’’(English for ‘‘L’Chaim’’), and he said, ‘‘I will toast tothat.’’ Then renal failure killed him, almost imme-diately. He knew. He was ready.

Ira is irreplaceable. For the past 25 years, he andMarty McMahon have provided the first cut onhistory by digesting current developments in tax forcontinuing legal education presentations all overthe country. ‘‘Spin and Marty’’ (Does anyone else goback that far to the Disney TV series of the ’50s?)would play off each other, with Marty playing thestraight-man liberal and Ira the right-wing quip.1 Ithink I was the matchmaker. Florida Tax Review hasin recent years published the annual outlines. Ihope the full archives will be available onlinesomewhere. Tax law is a sedimentary rock of oldcases laid down and now hardened. When courtsdecided them, we did not yet know where they

would fit into the grand framework — what partthey built up and what they changed — but Ira andMarty helped us see.

Apart from his politics, Ira was an astute ob-server of tax current events. He could supply ameaning to separate the chaff and the germ as thenews went by. He remembered the history. Heloved a good story, as long as it led to a good quip.He was always a pleasure to talk to, provided thatwe kept on the topic of tax. Ira was the Bronx HighSchool of Science kid, and I am the White PlainsHigh School kid. Who would have thought that wewould grow very fond of each other?

In the summer of 1970, he was assigned as thePaul, Weiss, Rifkind, Wharton & Garrison LLP NewYork associate to help orient incoming summerassociates. We were a radical bunch back then,having successfully canceled finals across variouslaw schools to protest the U.S. invasion of Cambo-dia, and my class was willing to play off priorsuccess and shut down the world. (I was away fromcampus on an externship so only read about it fromafar.) Ira was a former naval officer, and I had aPurple Heart from Vietnam at that point. He satnext to me at a long table, with me at the end. Westarted to talk about student unrest — I was un-doubtedly in favor of it — and we were off. Foryears. He did no further orienting of anyone elsethat day.

The highlight of American Bar Association TaxSection meetings for me was talking to Ira in thecourtesy lounge. Over time, Ira (and Marty) took upmore of those days, and the official presentationstook up less. Who cared about the panels whenthere was Ira? In the last meeting before his retire-ment, I didn’t make it to any presentation, and yetit was a wonderful meeting.

Ours has been a continual conversation since1970, with a deep underlying affection. Alas, it wasnot cleaned up and resolved at his death. He left usway too quickly.

Earth, take this worthy man.1Dan Simmons and Bruce McGovern later joined in the

outlines.

Calvin H. Johnson is the John T. Witt Chair inLaw at the University of Texas Law School.

Copyright 2016 Calvin H. Johnson.All rights reserved.

tax notes™

IN MEMORIAM



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Tax insight fromMartin Sullivan.

Written in Virginia.

Published in DC.

Read wherever you want.

We now offer small-screen optimized versions of our daily publications.Visit taxanalysts.com on your phone or tablet and see for yourself.


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Happy April Fools’ DayFrom Tax Notes

tax notes™

CONTENTSVolume 151 Number 1

Apple’s Overseas Cash Hoard ‘Offensive,’ Smaug Says

Congress Authorizes LOL Carryback, Memories Now Hilarious

‘Feeling the Bern’ Classified as Deductible Medical Expense

New Partnership Audit Bill Follows ‘Choose Your Own Adventure’ Model

In Lieu of Repatriation Tax Holiday, Congress Offering Coupons to Applebee’s

‘Can Someone Please Answer the Phone?’ Koskinen Shouts From Sofa

IRS Engages Gambino Family for New Private Debt Collection Initiative

OECD Reorganizes Under Cayman Islands Holding Structure

IRS Nicknames New ‘Future State’ Program ‘Skynet’

Ryan Vows Not to Shave Until Comprehensive Tax Reform Passes

tax notes™

TAX HUMOR



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IRS Future State Plans TakeUnexpected, Fuzzy Twist

Details continue to emerge regarding the IRS’ssecretive plans for its ‘‘future state,’’ and the latestnews happens to be some of the cutest. The agencyhas long said that it plans to increase the roletechnology will play in tax administration, and itannounced April 1 that it will be distributing auto-mated ‘‘Tax Buddies’’ to every household inAmerica.

‘‘I never thought I would say this, but the IRSbought the rights to Teddy Ruxpin,’’ said Gil Dan-iels of Tax Tacklers LLP. ‘‘The former owners hadmillions of those talking bears, unused since the’80s, and they were headed for the incinerator. Itwas a right-place, right-time kind of deal. The firstwords out of those bears’ mouths should be, ‘Thankheavens for the IRS.’’’

‘‘It’s an incredible brand enhancer,’’ an IRSspokesperson said. ‘‘The Tax Buddy can answertax-related questions, you can access a data screenby rubbing its belly, and we’ve programmed it withsome excellent tax jokes. I think this could changethe whole ballgame. I mean, it’s hard to hate the taxman when he’s also your best friend.’’

Results from the pilot program indicate a toughroad ahead, however. ‘‘The voice sounds a lot likeSiri,’’ said Jill Anderson of The Taxtonics. ‘‘Is thatlegal? Can you just steal Apple’s technology? I findit works OK, but for some reason when I ask itabout passive losses, it directs me to the nearestOutback Steakhouse.’’

Abe Flowers of Tax-Ability said, ‘‘My Tax Buddyis great. I’m hoping for the best. He brings backmemories, and he has a real smile factor that the IRSdesperately needs.’’ Still, Flowers added, ‘‘He’s atough cookie when it comes to deductions. I actu-ally sent him back to the agency because I thoughthe was broken. Denied, denied, denied. He’s funnyabout it — he once asked me whether I was ‘furreal.’ But I need him to be a little less teddy bearfriendly and a little more taxpayer friendly.’’

Cathy Miller from Totally Tax was less enthusi-astic: ‘‘It’s creepy. That’s all I can really say. It juststares at you with those dead little eyes and droneson and on about the Pease limitation. Every nightbefore I go to sleep, that thing goes in a drawer,which I then lock. I’ve been thinking about movingto Canada, and maybe it’s finally time.’’

According to the IRS, rollout will proceed onschedule, and taxpayers in most major cities shouldexpect to see their Tax Buddy waiting on thedoorstep no later than June 1.

Kansas Celebrity Given StatutoryMaximum for ‘Leaver’ Account

In one of the first criminal prosecutions directlyattributable to a Swiss bank program non-prosecution agreement (NPA) disclosure, DorothyGale of Kansas was sentenced to the statutorymaximum of five years in prison for tax evasionlinked to an undeclared foreign account, the JusticeDepartment announced April 1.

According to the announcement, Gale closed herSwiss account in 2013 and transferred the funds toan account in an Emerald City, Oz, bank under thename of a close friend, Albert C. Lion. The JusticeDepartment Tax Division received the details of thetransfer as part of the disclosures required underthe Swiss bank program when Gale’s former bankentered into an NPA with the Justice Department in2015. The Justice Department declined to nameeither bank.

The district court judge for the U.S. District Courtfor the District of Kansas sentenced Gale to 60months, the statutory maximum Gale faced for herconvictions under section 7201 and 31 U.S.C. sec-tion 5322(a). Gale sought a downward departurefrom the sentencing guidelines determination basedon her long history of good works and charity,particularly in Oz. She attempted to compare hercase favorably with that of Beanie Babies founderH. Ty Warner, whose sentence of probation wasrecently affirmed, in part due to a history of goodworks.

The sentencing judge rejected the comparison,noting that unlike Warner, Gale never tried todisclose her accounts and also moved her accountout of Switzerland in an attempt to hide it. ‘‘Click-ing your heels together and hoping the problemwill go away as though waking up from a dream isno way to solve a financial disclosure problem,’’ theJustice Department said.

Gale’s attorney, S. Reginald Crow of Crow,Woods & Mann SA, an Oz-based law firm, said Galeplans to appeal her convictions — claiming that theevidence of willfulness is lacking — as well as hersentence.

Emily Baum of Frank & Baum LLP told TaxAnalysts that the appeal of the conviction will beparticularly challenging because of the timing ofGale’s account transfer. Being a so-called leaver isstrong evidence of intentional violation of a knownlegal duty, the standard for willfulness in criminaltax, she said.

COMMENTARY / TAX HUMOR



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Candy Man Indicted for FailingTo Pay Employment Taxes

The Justice Department announced April 1 theindictment and arrest of chocolate magnate William‘‘Willy’’ Wonka on employment-tax-related charges.

According to the announcement and chargingdocuments, the IRS became suspicious when themultibillion-dollar business reported one, and onlyone, employee every year since resuming opera-tions. Wonka is now the third largest chocolateproducer in the world.

Arthur Slugworth, a competing chocolate manu-facturer, told Tax Analysts, ‘‘Chocolate industryautomation has advanced rapidly since Mr. Wonkasuspended his business operations, but not so farthat a whole factory could be run by just one man;he obviously has other people working for him.’’

The indictment contains six charges of failing toeither collect or pay employment taxes under sec-tion 7202, one for each open year of the criminalstatute of limitations under section 6531. While thelimitation period for criminal tax charges is nor-mally three years under section 6531, the indict-ment asserts that Wonka’s complete failure to reportany information about his workers to the IRS placeshis case in the willfulness exception, expanding theperiod to six years.

Charles Bucket, Wonka’s attorney and friend,told Tax Analysts that the dispute would be bettercharacterized as an accidental, or at best negligent,mistake. ‘‘He pays his workers in lodging and foodthey particularly love — cocoa beans — andthought that fit the exceptions for convenience ofthe employer.’’

Bucket is the only person, other than Wonka,known to have entered and returned from Wonka’sfactory since it resumed operations. Being a generalbusiness attorney, Bucket said he is looking for alawyer who specializes in criminal tax cases to takeover Wonka’s defense, especially because Bucketmay be called as a witness concerning Wonka’semployment practices.

Have an April Fools idea for us? Email it to [email protected].

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How the tax exemptstay tax aware.

“Most charities comply with the tax

laws. Of course, it’s the ones that

don’t that make the headlines.”

— Fred Stokeld, Contributing Editor Only in the publications of Tax Analysts


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Technical Flaw in Anti-LossImportation Regs

To the Editor:I read with interest the news story on the final

regulations (T.D. 9759) regarding transfers of lossproperty to corporations under sections 334(b)(1)(B)and 362(e)(1). (Related coverage: p. 44.) I write thisletter to point out a technical error of law in the finalregulations that I thought would have been cor-rected based on comments I had previously made.(See Monte A. Jackel, ‘‘Transferred Partnership In-terests in Incorporation Transactions,’’ Tax Notes,Nov. 14, 2011, p. 877, for general background on theinteraction between section 357(d), section 752, andRev. Rul. 80-323, 1980-2 C.B. 124; I made extensiveoral comments to the government about the issuenoted here at about the time the section 362(e)(2)regulations were finalized and the section 362(e)(1)regulations were proposed a few years back.)

Specifically, the technical error is that section357(d), as I pointed out in my referenced Tax Notesarticle, effectively overruled Rev. Rul. 80-323. Thatrevenue ruling applies section 752(d) in testing forgain recognition under section 357 and in applyingthe tax basis consequences under section 358 on thetransfer of a partnership interest to a corporationwhen the transferred interest has allocated to it ashare of partnership debt. The problem is that after

the enactment of section 357(d) over a decade ago,transfers of property along with attributable debt,including partnership interests, to corporations aretreated as ‘‘assumed’’ (including being ‘‘subject to’’)based on the rules of section 357(d).

This statute may well provide a different answeron a transfer of a partnership interest with a shareof debt to a corporation as compared with theanswer under section 752 and its underlying regu-lations. It is hard to tell exactly where differencesbetween sections 357(d) and 752 may arise, becausealthough section 357(d) applies to transfers of allencumbered property, including partnership inter-ests, there are no regulations or other meaningfulgovernment guidance on the operation of section357(d).

The final section 362(e)(1) regulations clearlyapply section 752 on the transfer of partnershipinterests with a share of partnership debt withoutany mention in either the preamble or the text of theregulation to section 357(d). (See reg. section 1.362-3(c)(4)(ii) and -3(f), Example 5(iv).) How could thegovernment issue these regulations in final formwithout at least mentioning that section 357(d)could be an issue on a transfer of a partnershipinterest in specific cases? The error persists as wellin the final section 362(e)(2) regulations. Will thistechnical error of law ever be corrected?

Monte A. JackelJackel Tax LawMar. 27, 2016

SUBMISSIONS TO TAX NOTES

Tax Notes welcomes submissions of commentary andanalysis pieces on federal tax matters that may be ofinterest to the nation’s tax policymakers, academics,and practitioners. To be considered for publication,

articles should be sent to the editor’s attention [email protected]. Submission guidelines andFAQs are available at taxanalysts.com/submissions.

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GOVERNMENTEVENTS

Monday, April 4

TAS. The Taxpayer Advocate Servicewill hold a public forum in Henderson-ville, North Carolina, to discuss the IRS’sfuture state vision and what taxpayerswant and need from the IRS in order tofulfill their tax obligations. National Tax-payer Advocate Nina Olson and Rep.Mark Meadows, R-N.C., will lead theforum. For more information, visit: http://www.taxpayeradvocate.irs.gov/news/next-public-forum-on-taxpayer-service-needs-and-preferences-to-be-held-in-hendersonville-nc-on-april-4.

Tuesday, April 5

IRS/TAP. The Taxpayer AdvocacyPanel Special Projects Committee hasscheduled an open meeting to be held viateleconference at 1 p.m. ET. For moreinformation, contact Kim Vinci at (888)912-1227.

Friday, April 8

TAS. The Taxpayer Advocate Servicewill hold a public forum in Harrisburg,Pennsylvania, to discuss the IRS’s futurestate vision and what taxpayers want andneed from the IRS in order to fulfill theirtax obligations. Senate Finance Commit-tee member Robert P. Casey Jr., R-Pa., willbe present for the event. For more infor-mation, visit: http://www.taxpayeradvocate.irs.gov/public-forums.

Wednesday, April 13

IRS/TAP. The Taxpayer AdvocacyPanel Taxpayer Assistance Center Im-provements Project Committee has sched-uled an open meeting to be held viateleconference at 2 p.m. ET. For moreinformation, contact Otis Simpson at (888)912-1227.

Thursday, April 14IRS/TAP. The Taxpayer Advocacy

Panel Tax Forms and Publications ProjectCommittee has scheduled an open meet-ing to be held via teleconference at 1 p.m.ET. For more information, contact DonnaPowers at (888) 912-1227.

Sunday, April 17IRS. The IRS will host an information

session for its ‘‘Tax Design Challenge,’’ acontest open to the public with a top prizeof $10,000 that is soliciting designs fororganizing and presenting online tax in-formation based on the IRS’s future statevision. Online registration: https://www.eventbrite.com/e/tax-design-challenge-kickoff-at-1776-tickets-23103120054.

Wednesday, April 20IRS/TAP. The Taxpayer Advocacy

Panel Toll-Free Phone Line Project Com-mittee has scheduled an open meeting tobe held via teleconference at 2:30 p.m. ET.For more information, contact Linda Ri-vera at (888) 912-1227.

Thursday, April 21IRS/TAP. The Taxpayer Advocacy

Panel Communications Project Commit-tee has scheduled an open meeting to beheld via teleconference at 3 p.m. ET. Formore information, contact AntoinetteRoss at (888) 912-1227.

Wednesday, April 27IRS/TAP. The Taxpayer Advocacy

Panel Notices and Correspondence Proj-ect Committee has scheduled an openmeeting to be held via teleconference at 12p.m. ET. For more information, contactTheresa Singleton at (888) 912-1227.

Thursday, May 19IRS. The IRS has scheduled a hearing

on proposed regulations (REG-125761-14)that would modify the nondiscriminationrequirements applicable to specified re-tirement plans that provide additionalbenefits to a grandfathered group of em-

ployees following some changes in thecoverage of a defined benefit plan orformula. The hearing is set for 10 a.m. inthe IRS Auditorium. For more informa-tion, contact Oluwafunmilayo Taylor at(202) 317-6901.

MEETINGS ANDSEMINARS

Tuesday, April 5

Tax Compliance for Exempt Hospi-tals — Webinar. The American Bar Asso-ciation Section of Taxation has scheduledthis program to discuss how tax-exempthospitals can comply with the IRS’s finalsection 501(r) regulations. Online registra-tion: http://shop.americanbar.org/ebus/ABAEventsCalendar/EventDetails.aspx?productId=238715855.

Wednesday, April 6

Planning for ACA Reporting Re-quirements — Webcast. Deloitte TaxLLP has scheduled a webcast reviewingthe Affordable Care Act’s tax reportingchallenges faced by businesses in 2015,tax reporting changes for 2016, as well asstrategies for reducing complexities in2016 reporting. Online registration: http://www2.deloitte.com/us/en/pages/dbriefs-webcasts/events/april/2016/dbriefs-tax-reporting-for-the-affordable-care-act-what-did-2015-teach-us-and-how-do-we-plan-for-2016.html.

Understanding Administrative TaxControversy Cases — Webinar. Thisprogram from the American Bar Associa-tion Section of Taxation will provide apractical discussion on how to representclients during examination and appealsconferences, with a focus on the variousissues that may come up during an ad-ministrative tax controversy case. Onlineregistration: http://shop.americanbar.org/ebus/ABAEventsCalendar/EventDetails.aspx?productId=238445186.

Monday, April 11

Enrolled Actuaries Meeting —Washington. The American Academy ofActuaries and the Conference of Consult-ing Actuaries will hold their 41st annualEnrolled Actuaries Meeting. This three-day event will include panel discussionsand workshops covering a variety of em-ployee plans issues. Online registration:http://www.ccactuaries.org/eventregistration/details?meetingid={718A2A8A-7160-E411-84E3-00505683000D}.

tax notes™

TAX CALENDAR

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, staffassistant, House Ways and Means Committee, is required. Call (202) 225-3625. Thetelephone request should be followed by a formal written request to Jennifer Safavian,Staff Director, House Ways and Means Committee, Room 1102, Longworth HouseOffice Building, Washington, DC 20515.



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Tuesday, April 12

Talking Tax Series — Webcast. Thisprogram from PwC will provide an up-date on the latest tax policy news, includ-ing legislative developments, corporateidentity theft, and the changes beingmade to the IRS Large Business and Inter-national Division. Online registration:http://meetpwc.cvent.com/events/talking-tax-webcast-22/event-summary-fc0f990bee274ebfbbc51c1f7694c0f5.aspx?i=f0c13262-6c00-45be-8275-8d2fd81a91df.

Wednesday, April 13

Global Country-by-Country Report-ing — Webcast. This program from De-loitte Tax LLP will discuss country-by-country reporting of transfer pricinginformation and the technologies andprocesses available for simplifying report-ing compliance. Online registration: http://www2.deloitte.com/us/en/pages/dbriefs-webcasts/events/april/2016/dbriefs-global-country-by-country-reporting-technologys-expanding-role.html.

Current Tax Developments — Webi-nar. The American Bar Association Sec-tion of Taxation has scheduled a webinarto review major legislative enactments,judicial decisions, rulings, and regula-tions over the past year concerning indi-vidual, corporate, partnership, and estateand gift taxation. Online registration:http://shop.americanbar.org/ebus/ABAEventsCalendar/EventDetails.aspx?productId=239942321.

ALI-CLE Employee Benefits Confer-ence — San Francisco. The AmericanLaw Institute-Continuing Legal Educa-tion will hold a three-day conference toexamine insights and strategies for retire-ment, health, and executive compensationplans. This event will feature discussionsby leading legal experts on importantchanges from 2015 and what to expect in2016. Online registration: https://www.ali-cle.org/index.cfm?fuseaction=courses.course&course_code=CX031&utm_source=Real+Magnet&utm_medium=Email&utm_campaign=CX031%20%281/25%29%20EM2.

Tax Audits and Litigation Series —Washington. The District of ColumbiaBar will hold a luncheon program spon-sored by the Tax Audits and LitigationCommittee of the D.C. Bar Taxation Sec-tion. This event is part six of a seven-partseries hosted by the D.C. Bar on tax auditsand litigation issues. Online registration:https://www.dcbar.org/marketplace/event-details.cfm?productCD=161654TTACS&type=event.

Monday, April 18

Passthrough Taxation Update —Webcast. This webcast from Deloitte TaxLLP will provide a review of recent fed-eral tax developments concerning part-nerships and S corporations, with a focuson new rules concerning IRS audits ofpartnerships. Online registration: http://www2.deloitte.com/us/en/pages/dbrief

s-webcasts/events/april/2016/dbriefs-quarterly-federal-tax-roundup-a-passthroughs-update.html.

Introduction to U.S. InternationalTax — New York. Networking Seminarshas scheduled this two-day program onthe fundamentals of U.S. internationaltaxation. This program will discuss thetax code and tax reporting requirementsfor U.S. companies with operationsabroad. Online registration: http://www.networkingseminars.com/seminars/intro-ny.

Transfer Pricing Update — NewYork. Networking Seminars will hold thistwo-day program on transfer pricing.This program will cover recent develop-ments affecting transfer pricing, with afocus on the OECD’s base erosion andprofit-shifting project, as well as the latesttransfer pricing technologies. Online reg-istration: http://www.networkingseminars.com/seminars/tp-ny.

Tuesday, April 19

NYU/KPMG Global Tax Symposium— New York. New York University andKPMG LLP will jointly host a one-daysymposium on changes in internationaltaxation. Throughout the day, panels willdiscuss topics such as U.S. tax treatypolicy, international tax reform, and for-eign reactions to the OECD’s base erosionand profit-shifting project. Online regis-tration: http://events-meetings.kpmg.com/events/16th-annual-nyu-kpmg-tax-lecture/event-summary-b52ac0a9f2e94cfe9e15c683db82a145.aspx.

Corporate Tax Series — Washing-ton. The District of Columbia Bar willhold a luncheon program sponsored bythe Corporate Tax Committee of the D.C.Bar Taxation Section. This event is partfour of a five-part series of luncheons oncorporate tax issues. Online registration:https://www.dcbar.org/marketplace/event-details.cfm?productCD=161647TCTCS&type=event.

Wednesday, April 20

Arm’s-Length Standard Seminar —New York. The International Tax Institutewill host a seminar on the OECD’s baseerosion and profit-shifting project, the Al-tera decision, and whether the arm’s-length standard can be applied to allrelated-party transactions. Online regis-tration: http://www.shop.internationaltaxinstitute.org/.

Thursday, April 21

Improving Tax Provision Processes— Webcast. Deloitte Tax LLP has sched-uled a webcast on evolving tax depart-ment challenges and how to redesign thetax provision process to improve perfor-mance. Online registration: http://www2.deloitte.com/us/en/pages/dbriefs-webcasts/events/april/2016/dbriefs-tax-provision-process-assessment-and-redesign-strategies-for-continuous-improvement.html.

Global Tax Attribute Tracking —Webcast. Grant Thornton LLP has sched-uled a webcast on recent developmentsand possible opportunities affecting mul-tinational companies’ global tax attri-butes. This program will includediscussion of earnings and profits, foreigntax credits, and how a company’s globaltax attributes affect its financial state-ments. Online registration: http://event.on24.com/eventRegistration/prereg/register.jsp?eventid=1160589&sessionid=1&key=0203D0A53C742FECCA246FA2216A914C&_cldee=dG50X2VkaXRvcnNAdGF4Lm9yZw%3d%3d\.

Tax Practice Monthly — Webcast.This program from the American Instituteof Certified Public Accountants will pro-vide tax practitioners with the opportu-nity to reflect on the 2016 tax filing seasonand discuss tips and best practices formanaging clients and workflow in thefuture. Online registration: http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/Tax/PRDOVR~PC-WC1125110/PC-WC1125110.jsp.

Monday, April 25

Tax Reporting and WithholdingConference — Arlington, Va. The TaxReporting Group will hold its 30th annualTax Reporting and Withholding Confer-ence. This three-day event will cover thelatest developments in reporting andwithholding; reporting savings, health,and retirement plan contributions anddistributions; and the Foreign AccountTax Compliance Act. Online registration:http://www.taxreportinggroup.com/trainingevents.html.

Tuesday, April 26

Tax Planning for Partnerships,LLCs, and Joint Ventures — Chicago.The Practising Law Institute will hold aconference on tax planning in 2016 fordomestic and foreign partnerships, lim-ited liability companies, joint ventures,and other strategic alliances. This eventwill provide a general overview of part-nership taxation as well as more ad-vanced sessions on a variety ofpartnership taxation issues. Online regis-tration: http://www.pli.edu/Content/Seminar/Tax_Planning_for_Domestic_Foreign_Partnerships/_/N-4kZ1z11j8y?Ns=sort_date%7c0&ID=259142.

Construction: Accounting, Audit-ing, and Tax — Webcast. This coursefrom the American Institute of CertifiedPublic Accountants examines the mostrecent updates and key issues affectingconstruction accounting, auditing, andtaxation. This program will review auditplanning and procedures, long-term con-tracts, and tax issues for small to largecontractors. Online registration: http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/Tax/PRDOVR~PC-CAAT/PC-CAAT.jsp.

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Thursday, April 28

BEPS Update — Webcast. DeloitteTax LLP has scheduled a webcast to pro-vide an update on the OECD’s base ero-sion and profit-shifting project with afocus on global supply chains and intel-lectual property and how companies canplan for the new global tax environment.

Financial Products Tax Series —Washington. The District of ColumbiaBar will hold a luncheon program spon-sored by the Financial Products Commit-tee of the D.C. Bar Taxation Section. Thisis the final event in a five-part series ofluncheons on financial products issues.Online registration: https://www.dcbar.org/marketplace/event-details.cfm?productCD=161643TFPCS&type=event.

Sunday, May 1

OffshoreAlert Conference — Miami.The 14th annual North American Off-shoreAlert Conference will feature discus-sion from clients, providers, andinvestigators of high-end financial prod-ucts and services and discuss a variety offinancial issues, including tax fraud andevasion. Online registration: http://www.offshorealert.com/conference/miami/.

Monday, May 2

Taxation of Intellectual Property —San Francisco. Networking SeminarsInc. will hold its fifth annual seminar onthe taxation of intellectual property. Thistwo-day event will provide a technicalupdate on the latest tax planning tech-niques for maximizing the value of intel-lectual property. Online registration: http://www.networkingseminars.com/seminars/taxation-of-intellectual-property.

Introduction to U.S. InternationalTax — San Francisco. Networking Semi-nars has scheduled this two-day programon the fundamentals of U.S. internationaltaxation. This program will discuss thetax code and tax reporting requirementsfor U.S. companies with operationsabroad. Online registration: http://www.networkingseminars.com/seminars/intro-sf.

Thursday, May 5

ABA May Meeting — Washington.The American Bar Association Section ofTaxation will hold its 2016 May meeting,bringing together the nation’s top taxpractitioners and government officials todiscuss the latest tax-related develop-ments, topics, and legislation. Online reg-istration: http://shop.americanbar.org/ebus/ABAEventsCalendar/EventDetails.aspx?productId=203364691.

Friday, May 6

Business Aviation Taxes Seminar —Washington. The National BusinessAviation Association will hold a seminarexamining federal tax policy concerningbusiness aviation tax issues and strategiesfor preparing for tax audits. Online regis-

tration: https://www.nbaa.org/events/taxes-seminar/2016/.

Monday, May 9Construction: Accounting, Audit-

ing, and Tax — Webcast. This coursefrom the American Institute of CertifiedPublic Accountants examines the mostrecent updates and key issues affectingconstruction accounting, auditing, andtaxation. This program will review auditplanning and procedures, long-term con-tracts, and tax issues for small to largecontractors. Online registration: http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/PRDOVR~PC-VCAAT/PC-VCAAT.jsp.

Tuesday, May 10International Tax Planning for Small

Tax Practitioners — Webcast. This pro-gram from the American Institute of Cer-tified Public Accountants will help smalltax practitioners better understand inter-national tax and asset-reporting formsand issues that can affect ordinary clients.Online registration: http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/PRDOVR~PC-WC1128793/PC-WC1128793.jsp.

Tax Planning for Partnerships,LLCs, and Joint Ventures — New York.The Practising Law Institute will hold aconference on tax planning in 2016 fordomestic and foreign partnerships, lim-ited liability companies, joint ventures,and other strategic alliances. This eventwill provide a general overview of part-nership taxation as well as more ad-vanced sessions on a variety ofpartnership taxation issues. Online regis-tration: http://www.pli.edu/Content/Seminar/Tax_Planning_for_Domestic_Foreign_Partnerships/_/N-4kZ1z11j8y?Ns=sort_date%7c0&ID=259142.

Professional Responsibility and theIRS — Webcast. This program from TaxTalk Today will feature a panel of IRS andindustry experts discussing changes tothe rules governing practice before theIRS and the likelihood of further rulechanges in the future. This program willalso cover ethical problems frequentlyfaced by tax practitioners. Online registra-tion: https://www.taxtalktoday.com/programs/051016.cfm.

Employee Benefit Plans Conference— Las Vegas. The American Institute ofCertified Public Accountants will hold aconference on employee benefit plans.This three-day event will cover a varietyof accounting topics concerning employeebenefit plans, including plans for tax-exempt organizations and multiemployerplans. Online registration: http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/EmployeeBenefitPlans/PRDOVR~PC-EMPBEN/PC-EMPBEN.jsp.

Wednesday, May 11

ACA Tax and Insurance Ramifica-tions — Webcast. This program from theAmerican Institute of CPAs will discuss

the ongoing implementation of the Af-fordable Care Act’s tax and insuranceprovisions, including premium tax cred-its, the individual and employer man-dates, and the small business healthinsurance tax credit. Online registration:http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/PRDOVR~PC-VCL4HCRA/PC-VCL4HCRA.jsp.

Thursday, May 12

Tax Basis Step-Up Transactions —Webcast. Grant Thornton LLP has sched-uled a webcast to discuss the pros andcons of tax basis step-up transactions andthe various options for structuring thesetransactions. Online registration: http://www.grantthornton.com/events/tax/2016/05-12-tax-basis-step-up-transactions.aspx?_cldee=dG50X2VkaXRvcnNAdGF4Lm9yZw%3d%3d.

Monday, May 16

New Tax Laws for Partnerships —Webcast. This webcast from the Ameri-can Institute of Certified Public Accoun-tants will review the new IRS examinationand tax collection regime for partnershipsand limited liability companies. This pro-gram will cover how the new rules com-pare to the old rules and provide advisersand clients with issues to be aware of con-cerning existing or future partnership orLLC agreements. Online registration: http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/PRDOVR~PC-WC1128384/PC-WC1128384.jsp.

Intermediate U.S. International TaxSeminar — Washington. NetworkingSeminars has scheduled a seminar on keyconcepts in tax planning for U.S. multina-tional companies. This two-day event willprovide tax practitioners with details onhow to reduce taxes on worldwide in-come through effective tax planning. On-line registration: http://www.networkingseminars.com/seminars/interm-tax-dc.

Tuesday, May 17

Corporate Tax Series — Washing-ton. The District of Columbia Bar willhold a luncheon program sponsored bythe Corporate Tax Committee of the D.C.Bar Taxation Section. This event is partfive of a five-part series of luncheons oncorporate tax issues. Online registration:https://www.dcbar.org/marketplace/event-details.cfm?productCD=161648TCTCS&type=event.

Wednesday, May 18

Tax Audits and Litigation Series —Washington. The District of ColumbiaBar will hold a luncheon program spon-sored by the Tax Audits and LitigationCommittee of the D.C. Bar Taxation Sec-tion. This event is the final session in aseven-part series of luncheons hosted bythe D.C. Bar on tax audits and litigationissues. Online registration: https://www.dcbar.org/marketplace/event-details.cfm?productCD=161655TTACS&type=event.

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Thursday, May 19

Chicago-Kent Annual Federal TaxInstitute — Chicago. The Illinois Insti-tute of Technology’s Chicago-Kent Col-lege of Law will hold its 35th annualFederal Tax Institute. This event will fea-ture tax experts providing a comprehen-sive update on the latest legal, legislative,and policy developments concerning taxplanning and compliance. Online regis-tration: http://cle.kentlaw.edu/registration.asp?id=367.

Wednesday, May 25

International Tax Series — Washing-ton. The District of Columbia Bar willhold a luncheon program sponsored bythe International Tax Committee of theD.C. Bar Taxation Section. This event ispart six of a six-part series of luncheonson international tax issues. Online regis-tration: https://www.dcbar.org/marketplace/event-details.cfm?productCD=161627TITCS&type=event.

Wednesday, June 1

Dealing With Tax Related IdentityTheft — Webcast. The American Insti-tute of CPAs has scheduled a webcast toexamine how taxpayers and tax practitio-ners can identify when fraud is takingplace, properly report identity theft, andrepair the damage caused by identitytheft. Online registration: http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/PRDOVR~PC-WC1103615/PC-WC1103615.jsp.

Friday, June 3

Advising Nonprofit Organizations— New York/Webcast. This one-dayseminar from the Practising Law Institutewill examine fundamental concepts andnew developments in federal and statelaws concerning nonprofits. Online regis-tration: http://www.pli.edu/Content/Seminar/Advising_Nonprofit_Organizations_2016/_/N-4kZ1z11hp4?Ns=sort_date%7c0&ID=260108.

Monday, June 6

Basic Income Tax Accounting —Los Angeles. This two-day event fromNetworking Seminars will help tax prac-titioners better understand taxes payableor refundable for the current year anddeferred tax assets and liabilities. Onlineregistration: http://www.networkingseminars.com/tax-seminars/acs-la.

Introduction to U.S. InternationalTax — Los Angeles. Networking Semi-nars has scheduled this two-day programon the fundamentals of U.S. internationaltaxation. This program will discuss thetax code and tax reporting requirementsfor U.S. companies with operationsabroad. Online registration: http://www.networkingseminars.com/tax-seminars/intro-la.

Tuesday, June 7

Tax Planning for Partnerships,LLCs, and Joint Ventures — San Fran-

cisco. The Practising Law Institute willhold a conference on tax planning in 2016for domestic and foreign partnerships,limited liability companies, joint ventures,and other strategic alliances. This eventwill provide a general overview of part-nership taxation as well as more advancedsessions on a variety of partnership taxa-tion issues. Online registration: http://www.pli.edu/Content/Seminar/Tax_Planning_for_Domestic_Foreign_Partnerships/_/N-4kZ1z11j8y?Ns=sort_date%7c0&ID=259142.

Wednesday, June 8

International Tax Withholding andReporting Forum — New York. The Ex-ecutive Enterprise Institute will hold its28th annual International Tax Withhold-ing and Information Reporting Forum,featuring discussion of the latest with-holding and reporting issues by industryexperts and IRS officials. This three-dayconference will examine compliance is-sues with the Foreign Account Tax Com-pliance Act, upcoming section 871(m)rules, and how to manage the risks of anIRS audit. Online registration: http://www.cvent.com/events/28th-annual-forum-on-international-tax-withholding-information-reporting-in-new-york/event-summary-81af046489b94e948a4312164fcf24a8.aspx.

U.S.-Latin America Tax PlanningStrategies — Miami. The American BarAssociation Section of Taxation will holdits 9th annual conference on U.S. andLatin America tax planning strategies.This three-day event will feature work-shops on wealth and asset planning, aswell as a workshop for tax executivesmanaging a multinational corporation’stax compliance, tax reporting, and taxplanning. Online registration: http://shop.americanbar.org/ebus/ABAEventsCalendar/EventDetails.aspx?productId=238714218.

Thursday, June 9

Historic Tax Credit Conference —Washington. The Institute for Profes-sional and Executive Development willhold its Annual Historic Tax Credit Sum-mit. This two-day event will give inves-tors, developers, and tax practitioners acomprehensive look at the current envi-ronment for the historic tax credit (HTC).Sessions will cover how to combine theHTC with other development-related taxcredits and how to comply with IRS rulesand regulations concerning the HTC. On-line registration: http://www.ipedconference.com/conferences/Annual_Historic_Tax_Credit_Summit_2016_IPED.aspx.

CERCA Spring Meeting — Arling-ton, Va. The Council for Electronic Rev-enue Communication Advancement willhold its spring meeting, featuring IRSCommissioner John Koskinen and KenCorbin, director (return integrity andcompliance services), IRS Wage and In-

vestment Division. Online registration:http://www.cerca.org/meetings/upcoming.cfm.

Wednesday, June 22International Estate and Tax Plan-

ning — New York/Webcast. The Practis-ing Law Institute has scheduled a seminaron international estate and tax planningissues, including compliance with theForeign Account Tax Compliance Act,strategies for dealing with double taxa-tion, and foreign account voluntary dis-closure programs. Online registration:http://www.pli.edu/Content/Seminar/International_Estate_Tax_Planning_2016/_/N-4kZ1z11h7n?Ns=sort_date%7c0&ID=260442.

TAXADMINISTRATION

April 6Social Security, Medicare, and with-

held income tax. Deposit the tax forpayments on March 30-April 1.


held income tax. Deposit the tax forpayments on April 2-5.

April 11Employees who work for tips. If you

received $20 or more in tips duringMarch, report them to your employer. Youcan use Form 4070.

April 12Communications and air transpor-

tation taxes under the alternativemethod. Deposit the tax included inamounts billed or tickets sold during thefirst 15 days of March.


held income tax. Deposit the tax forpayments on April 6-8.

April 14Regular method taxes. Deposit the

tax for the last 16 days of March.

April 18Individuals. File a 2015 income tax

return (Form 1040, 1040A, or 1040EZ) andpay any tax due. If you are a resident ofMassachusetts or Maine, Patriots’ Day(April 18) delays the due date for filingyour income tax return until April 19. Ifyou want an automatic six-month exten-sion of time to file the return, file Form4868. For more information, see Form4868. Then, file Form 1040, 1040A, or1040EZ by October 17.

Individuals. If you aren’t paying your2016 income tax through withholding (orwon’t pay in enough tax during the year

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that way), pay the first installment ofyour 2016 estimated tax. Use Form 1040-ES. For more information, see Publication505.

Household employers. If you paidcash wages of $1,900 or more in 2015 to ahousehold employee, you must fileSchedule H (Form 1040), ‘‘Household Em-ployment Taxes.’’ If you are required tofile a federal income tax return (Form1040), file Schedule H (Form 1040),‘‘Household Employment Taxes,’’ withthe return and report any household em-ployment taxes. Report any federal unem-ployment (FUTA) tax on Schedule H(Form 1040) if you paid total cash wagesof $1,000 or more in any calendar quarterof 2014 or 2015 to household employees.Also, report any income tax you withheldfor your household employees. For moreinformation, see Publication 926.

Partnerships. File a 2015 calendaryear return (Form 1065). Provide eachpartner with a copy of their Schedule K-1(Form 1065), ‘‘Partner’s Share of Income,Deductions, Credits, etc.,’’ or substituteSchedule K-1 (Form 1065).

To request an automatic five-monthextension of time to file the return, fileForm 7004. Then file the return and pro-vide each partner with a copy of theirfinal or amended (if required) ScheduleK-1 (Form 1065) by September 15.

Electing large partnerships. File a2015 calendar year return (Form 1065-B).See March 15 for the due date for furnish-ing Schedules K-1 or substitute SchedulesK-1 to the partners.

To request an automatic six-month ex-tension of time to file the return, file Form7004. Then file the return and provideeach partner with a copy of theiramended (if required) Schedule K-1(Form 1065-B) by October 17.

Corporations. Deposit the first in-stallment of estimated income tax for2016. A worksheet, Form 1120-W, is avail-able to help you estimate your tax for theyear.

Social Security, Medicare, and with-held income tax. If the monthly depositrule applies, deposit the tax for paymentsin March.

Nonpayroll withholding. If themonthly deposit rule applies, deposit thetax for payments in March.

Household employers. If you paidcash wages of $1,900 or more in 2015 to ahousehold employee, you must fileSchedule H (Form 1040). If you are re-quired to file a federal income tax return(Form 1040), file Schedule H (Form 1040)with the return and report any householdemployment taxes. Report any federalunemployment (FUTA) tax on ScheduleH (Form 1040) if you paid total cashwages of $1,000 or more in any calendar

quarter of 2014 or 2015 to householdemployees. Also, report any income taxyou withheld for your household em-ployees. For more information, see Publi-cation 926.

Social Security, Medicare, and with-held income tax. Deposit the tax forpayments on April 9-12.

April 20


April 22


April 27

Communications and air transpor-tation taxes under the alternativemethod. Deposit the tax included inamounts billed or tickets sold during thelast 16 days of March.


April 29

Regular method taxes. Deposit thetax for the first 15 days of April.


May 2

Social Security, Medicare, and with-held income tax. File Form 941 for thefirst quarter of 2016. Deposit or pay anyundeposited tax under the accuracy ofdeposit rules. If your tax liability is lessthan $2,500, you can pay it in full with atimely filed return. If you deposited thetax for the quarter timely, properly, and infull, you have until May 10 to file thereturn.

Federal unemployment tax. Depositthe tax owed through March if more than$500.

Form 720 taxes. File Form 720 for thefirst quarter of 2016.

Wagering tax. File Form 730 and paythe tax on wagers accepted during March.

Heavy highway vehicle use tax. FileForm 2290 and pay the tax for vehiclesfirst used in March.

May 4


May 6

Social Security, Medicare, and with-held income tax. Deposit the tax forpayments on April 30-May 3.

May 10Employees who work for tips. If you

received $20 or more in tips during April,report them to your employer. You canuse Form 4070.

Social Security, Medicare, and with-held income tax. File Form 941 for thefirst quarter of 2016. This due date appliesonly if you deposited the tax for thequarter timely, properly, and in full.

May 11Communications and air transpor-

tation taxes under the alternativemethod. Deposit the tax included inamounts billed or tickets sold during thefirst 15 days of April.

Social Security, Medicare, and with-held income tax. Deposit the tax forpayments on May 4-6.

May 13Regular method taxes. Deposit the

tax for the last 15 days of April.Social Security, Medicare, and with-

held income tax. Deposit the tax forpayments on May 7-10.

May 16Social Security, Medicare, and with-

held income tax. If the monthly depositrule applies, deposit the tax for paymentsin April.

Nonpayroll withholding. If themonthly deposit rule applies, deposit thetax for payments in April.





May 25Communications and air transpor-

tation taxes under the alternativemethod. Deposit the tax included inamounts billed or tickets sold during thelast 15 days of April.

Social Security, Medicare, and with-held income tax. Deposit the tax forpayments on May 18-20.

May 27Regular method taxes. Deposit the

tax for the first 15 days of May.Social Security, Medicare, and with-


May 31Wagering tax. File Form 730 and pay

the tax on wagers accepted during April.Heavy highway vehicle use tax. File

Form 2290 and pay the tax for vehiclesfirst used in April.

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April 2016 TaxCrossword Puzzle

By Myles Mellor

Across1 Senator proposing a bill to end the prescrip-

tion drug advertising deduction5 Prominent politician proposing a flat tax9 C-level member, abbr.12 Unpaid portions14 Trial attorney’s concern in criminal cases16 Tokyo coin17 State that recently passed a cigarette tax hike,

abbr.18 Jupiter’s moon20 Political figure21 New Hampshire governor who ran a success-

ful tax amnesty program in 201524 Get off the fence27 Brit finance system28 Punishment for tax related identity theft29 Gross receipts style tax in force in Texas30 Secretary of the Treasury, Jack ___32 You, in old British court parlance34 Now I understand!35 Think through36 It refers to the negative effect of multinational

companies’ tax avoidance strategies on na-tional tax bases, a subject now under consid-eration by the IRS

38 Abbreviation for dealer40 Celebrity42 It’s being phased out by digital43 Association urging Treasury to update the taxation of

cross-border savings in relation to the U.S. and Canada45 Commissioner of Internal Revenue was created under

this president47 Distinguished48 Make a wrong move49 Justice Alito has indicated the Supreme Court may

accept a case to review the constitutionality of these lawsin the future

50 One who often gets an inheritance

Down1 State tax organization in California, abbr.2 Unite3 Philadelphia mayor proposing a tax on sugary beverages4 Reason for some grants6 Pacific ___7 Greek letters8 House Ways and Means Committee Chairman, first

name10 Roman eleven11 Cook, for Apple13 ___ Lingus (Irish airline)15 National Tax Payer Advocate, Nina ____

19 Government org. that is featured in The Firm movie21 California Democrats voted to extend higher income tax

brackets for this demographic, 2 words22 A. Onassis, familiarly23 Everyone25 British wage and tax system which records changes in

earnings in real time26 Agreement between nations regarding exchange of tax

information27 Seize31 Funding this was the original reason income tax was

imposed in the U.S.33 Technicality in tax law35 Change a property’s tax assessment amount37 Supreme Court Judge recently passed38 Case lists39 ___ the ante41 Kind of button, pressed when under severe stress44 React to (2 words)46 After tax amount

See p. 64 for the solution.

tax notes™

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Documents

Can Corporate Tax Reform Build on Apple’s Proposal?taxmuseum.org › www › website.nsf › Web › FederalTaxNews › $file › t… · 93 Can Corporate Tax Reform Build on Apple’s