Author Archive

To Minimize Taxes For Years To Come, Consider Incorporating Your Business In 2013

April 22, 2013

By Dustin Covello

Choice of entity is one of the first and most important tax-planning decisions that any entrepreneur must make. Conventional wisdom holds that most entrepreneurs should organize their businesses as “pass-through” entities – primarily limited liability companies, partnerships, subchapter S corporations, or sole proprietorships. Pass-through entities are not themselves taxable. Rather, all of their income is “passed through” and taxable to their owners. By contrast, operating a business in the other main form – a corporation – subjects the business’s income to the dreaded “double tax” because the corporation itself is subject to tax, and then the shareholder is subject to tax when he receives dividends from the corporation or sells its stock at a gain.

Historically, the expense associated with the double tax has varied, depending on the prevailing tax rates, but it almost always exceeded the tax expense on pass-through income. At this unique time, however, entrepreneurs following the conventional wisdom may be missing a valuable tax-planning opportunity:  two features of the American Taxpayer Relief Act of 2012 make corporations much more attractive compared to pass-through entities. (more…)

By Appeasing the United Kingdom, Starbucks May Have Relocated Its Tax Problems Into The United States

December 12, 2012

By:  Dustin Covello

As one of many U.S. multinationals that reportedly implemented the Double Irish international tax structure, Starbucks has reportedly paid a U.K. tax rate of 2.8 percent over the last decade.  Not satisfied with this levy, last month the British Parliament called Starbucks and other U.S. multinationals before the body to discuss the structure.  Last week, in response to Parliament’s pressure, Starbucks announced that it would voluntarily forgo U.K. deductions to ensure it pays £10 million ($16 million) in tax during 2013 and 2014.  It remains to be seen whether Starbucks’ announcement will placate Parliament.  By making this gesture, however, has Starbucks caused a U.S. tax problem?  (more…)

TARP’s “Godfather” Investment Should Give Rise To Deductible Interest

August 9, 2012

By:  Dustin Covello

Earlier this year, my former colleague Jonathan Prokup and I published an article in the Journal of Taxation and Regulation of Financial Institutions.  In the article, we considered the federal tax consequences of Treasury’s capital purchase program – the centerpiece of TARP.  Under the program, Treasury invested several hundred billion dollars into hundreds of our country’s banks to alleviate their perceived liquidity problems, which many believed to be the cause of the unfolding financial crisis.

Our article concluded that, even though most TARP instruments were nominally designated as preferred stock, the instruments actually constituted debt for tax purposes.  We reached this conclusion by applying the debt-equity factors that are classically used to classify hybrid instruments for tax purposes.  Most of these factors strongly support the classification as debt.  As a result, the tens of billions of dollars repaid on TARP investments could have been deducted by the banks as interest on their federal tax returns.

As new details continue to emerge about the October 2008 meeting that gave rise to TARP, our argument appears even more compelling.  In the article, we acknowledged that perhaps the most significant impediment weighing against debt characterization was that the TARP instrument was nominally designated as “preferred stock.”  As a general rule, courts are reluctant to allow taxpayers to determine the tax consequences of a transaction in a manner inconsistent with its papered form.  TARP was not, however, the product of arms-length negotiations.  Rather, Treasury mandated all of the terms of the TARP instrument each bank was pressured to accept, including its nominal form as preferred stock.  Given the duress placed upon the banks to accept the TARP investment, the banks may be able to disclaim the form of the TARP instrument even under the most restrictive interpretation of the general rule.  See Commissioner v. Danielson, 378 F.2d 771 (3rd Cir. 1967) (allowing taxpayer to disclaim the form of a transaction if the transaction would be unenforceable under common law contractual defenses such as duress).

In a speech this past June, former Wells Fargo CEO Richard Kovacevich recounted that fateful October 2008 meeting.  As described in the San Francisco Business Times, Mr. Kovacevich’s description of the meeting confirms the duress experienced by the banks to accept TARP investments.  In speaking to an audience at Stanford University, he said:

“Why didn’t I just say no and not accept the TARP money?”

“As my comments were heading in that direction in the meeting, Hank Paulson turned to Fed Chairman Ben Bernanke sitting next to him and said, ‘Your primary regulator is sitting right here. If you refuse to accept these funds, he will declare you ‘capital deficient’ Monday morning,'” Kovacevich recalled. “‘Is this America?’ I asked myself.”

“This was truly a ‘godfather moment.’ They made us an offer we couldn’t refuse,” Kovacevich said, adding that he might have put up more of a fight if the San Francisco bank … had not been trying to acquire troubled Wachovia at the time.

We are not aware whether any bank that accepted the TARP instrument in its nominal preferred stock form actually deducted “interest” paid on the instrument on its tax return.  Banks that did not originally claim the interest deduction may now pursue the interest deduction by filing a claim for refund.  Pursuing such a claim would incur small costs and create little risk, which would be far outweighed by the potentially hefty rewards.  However, despite the legal merits and potential rewards of such a refund claim, the statute of limitations has nearly expired for many banks to file one; by March 2011, banks had repaid Treasury over ninety-nine percent of invested funds.

Detection Risk Continues To Grow As The IRS Expands Its Offshore Bank Account Investigation Into Liechtenstein

June 12, 2012

By:  Dustin Covello

Late late year, we asked what’s next for foreign bank account holders after OVDI?  Although the answer to this question continues to evolve, it is becoming increasingly clear that the risks of detection have only grown – and will continue to do so.  The latest news on this front comes from Business Week, which reported Sunday that the IRS has requested account holder information from Liechtenstein’s second largest bank, LLB.  Specifically, the IRS has asked for information pertaining to accounts holding $500,000 or more anytime since 2004.  Current and former LLB account holders who continue to hold undisclosed offshore assets now have a rapidly closing window of opportunity to come into compliance before the IRS contacts them for an investigation.  By coming forward voluntarily, an account holder reduces the chance of criminal prosecution and probably qualifies for the miscellaneous 27.5% penalty in lieu of potentially significantly higher tax and FBAR penalties.

LLB’s clients are likely not the only Liechtenstein account holders at significant risk of detection.  Although the IRS’ previous investigation primarily targeted banks, there is anecdotal evidence that the IRS has also begun to pressure Liechtenstein advisors (e.g., lawyers, accountants, trust companies, and the like) to disclose their clients’ identities.  Moreover, if Switzerland is any guide, the IRS will likely expand its Liechtenstein investigation to other banks after establishing a successful precedent with LLB’s likely forthcoming disclosure.

Given the ever-expanding scope of the IRS’ investigation (not to mention FACTA’s new financial-institution withholding and individual-reporting requirements),  any person who previously chose not to disclose his or her offshore accounts should consider reexamining whether risking detection remains prudent.  As of now, OVDI and other methods of coming into compliance — including quiet disclosures and prospective compliance — may still be reasonable choices.  However, all of these options fall off the table if the IRS contacts a taxpayer before disclosure.  Taxpayers in this position should strongly consider contacting an experienced tax advisor to discuss their options.

The Tax Story Behind The Big Story: The Taxation Of Carried Interests In ‘Buyout Profits Keep Flowing To Romney’

December 20, 2011

By Dustin Covello

Editors’ note.  This is the first of a new periodic series on the Tax Blawg.  Mainstream press articles often implicate complex, technical tax issues.  Admirably, the press attempts to simplify the tax issues to make them more interesting and digestible for the general public, but sometimes simplification can leave readers with an incomplete or misleading understanding of the big tax picture.  For that portion of the audience who wants a little more background than the mainstream press can realistically provide, this series will unwind the tax issues discussed in prominent news articles.   

Yesterday, the New York Times published a thorough investigative report about the compensation that Mitt Romney continues to receive thirteen years after he left Bain Capital.  The report suggests that the tax law provides private equity managers like Mr. Romney favorable tax treatment not available to the rest of us:

But since Mr. Romney’s payouts from Bain have come partly from the firm’s share of profits on its customers’ investments, that income probably qualifies for the 15 percent tax rate reserved for capital gains, rather than the 35 percent that wealthy taxpayers pay on ordinary income. The Internal Revenue Service allows investment managers to pay the lower rate on the share of profits, known in the industry as “carried interest,” that they receive for running funds for investors.

“These are options that are not available to the ordinary taxpayer,” said Victor Fleischer, a law professor at the University of Colorado who studies financial firms. “You continue to take your carried interest — a return on labor, not capital invested — and you’re paying 15 percent on it instead of high marginal income rates.”

In a vacuum, the Times’ assertion appears scandalous.  Is it true that private equity managers receive preferential tax treatment on their labor income compared to the middle class?  Well, yes and no. (more…)

If MF Global Lost My Money, Do I At Least Get A Tax Deduction?

December 14, 2011

By:  Jonathan Prokup & Dustin Covello

After MF Global filed for bankruptcy protection just over a month ago, investigators discovered that approximately $1.2 billion of assets in customers’ accounts had somehow disappeared.  Although no one at the firm has confirmed where the money went, news reports have suggested that the money may have been used to cover bad trades and debts to other financial institutions.  For example, the New York Times recently reported that investigators believe MF Global, in a frantic attempt to remain solvent, may have paid at least $200 million in customer funds to JPMorgan Chase.  Also, late yesterday afternoon on Capitol Hill, after the firm’s top executives repeatedly and unequivocally denied knowing where the money went, murky allegations arose that the executives knew that the firm was loaning customer money to related parties.

It remains to be seen whether and to what extent MF Global’s customers will receive a return of their accounts.  Although only a full recovery of the missing $1.2 billion would make the customers whole, tax planning may help ameliorate their financial losses.  Section 165 of the Internal Revenue Code provides taxpayers relief to deduct casualty or theft losses that are not compensated by insurance.  Revenue Ruling 2009-9, issued to clarify section 165 issues related to the Bernie Madoff Ponzi scheme, offers useful guidance regarding the timing and character of deductions for losses that are due to theft or fraudulent investments (should MF Global’s actions turn out to meet either of those conditions).  The Ruling, however, reflects a trap for the unwary buried in section 165:  in which year does the deduction arise?     (more…)

Publication Alert: BNAI Transfer Pricing Forum

September 9, 2011

By:  Dustin Covello

In the September 2011 issue of BNA International’s Transfer Pricing Forum, Jonathan and I summarized the dispute resolution process for transfer pricing controversies against the IRS.   Transfer Pricing Forum provides an overview of selected transfer pricing issues under the tax laws of twenty-five countries.   For U.S. tax professionals, the publication provides a succinct resource for addressing transfer pricing problems in foreign countries.

Our U.S. summary is available here.   The entire September issue of Transfer Pricing Forum is available here through BNA International’s website.

Tax Court May Be The Forum Of Choice For Taxpayers Seeking To Challenge Treasury Regulations

June 23, 2011

By Dustin Covello & Phil Karter

As Tax Blawg readers know, after the Supreme Court’s Mayo decision adopted the deferential Chevron standard for determining the validity of Treasury regulations (instead of the less deferential National Muffler standard that taxpayers preferred), taxpayers and practitioners have speculated that seeking to invalidate a regulation may be a fool’s errand.   Since Mayo, many of the U.S. Circuit Court of Appeals (but not all) have shown a proclivity towards deference.  Extrapolating from these precedents, on the heels of the Mayo decision, it appears that the pendulum has swung heavily toward courts routinely deferring to Treasury regulations.  The question thus arises: is there a litigating forum where a challenge to regulatory deference might be more favorably received?  Surprisingly, the answer may be the U.S. Tax Court.

As reported in Tax Notes yesterday (subscription required), Judge Holmes of the Tax Court recently shared with practitioners a list of rarely utilized strategies for challenging the validity of Treasury regulations.   While the content of the Judge’s speech is useful information regardless of the litigating forum, the speech also reinforces a pattern that has emerged this year.  Despite the decision in Mayo, the Tax Court has exhibited a stubborn streak in resisting the routine deference towards Treasury Regulations that other courts now seem to prefer.

The Tax Court’s resistance to regulatory deference has been demonstrated in at least two opinions issued this year since Mayo.   In April, the Tax Court stuck to its guns in Carpenter Family Investments, LLC v. Commissioner by striking down for the second time Treasury regulations promulgated under section 6501(e), even though two Circuit Courts that deferred to the regulations did so while criticizing the Tax Court’s first opinion in Intermountain Insurance Services v. Commissioner.   Likewise, last month, in Pullins v. Commissioner, the Tax Court struck down regulations imposing an uncodified, two-year statute of limitations on innocent spouse cases under section 6015(f), even though the Seventh Circuit had reversed a 2009 opinion in which the Tax Court reached the same result.

Moreover, further reflecting the Tax Court’s general reluctance to defer to the IRS, Judge Holmes’ remarks were not limited solely to challenging the validity of Treasury Regulations.   In his speech, he also criticized so-called Auer deference, under which courts will generally defer to an agency’s interpretation of its own rules.   Although Auer has historically been accepted as well-settled, Judge Holmes cited a recent concurring opinion by Justice Scalia in Talk America, Inc. v. Michigan Bell Telephone Co., in which the Justice wrote that he would consider overturning Auer on separation-of-power grounds.

Challenging the validity of Treasury regulations has always been an uphill battle.   Nonetheless, Judge Holmes’ comments, coming on the heels of these recent decisions, demonstrates the Tax Court’s apparent reluctance to follow the trend of regulatory deference, which is important information to consider when choosing a litigating forum involving a regulatory challenge.

A final word of caution is that taxpayers would be well-advised to consider the law of the circuit to which an appeal of a favorable Tax Court result may lie, as reversals in cases such as Intermountain demonstrate.   Despite these concerns, the recent Tax Court developments suggest that, like any pendulum that has swung too far in one direction, the deference pendulum may eventually  swing back the other way.   Perhaps the Tax Court is where it is swinging back first.

In Burks v. United States, Did The Fifth Circuit’s Footnote Nine Revive National Muffler?

February 21, 2011

By:  Dustin Covello

On February 9, 2011, the third appellate court in as many weeks issued an opinion addressing whether an overstatement of basis extends the statute of limitations for assessment to six years under section 6501(e)(1)(A).  In Burks v. United States, No. 09-11061 (Feb. 9, 2011) (opinion here), the Fifth Circuit joined the majority of circuit courts that have addressed the issue (including the Fourth, Ninth, and Federal Circuits, as well as the Tax Court) by holding that an overstatement of basis does not trigger the extended statute.  At this point, only the Seventh Circuit has held to the contrary, and the Seventh Circuit’s recent precedent lies on a broad and now-questionable reading of Fifth Circuit precedent, Phinney v. Chambers 392 F.2d 680 (5th Cir. 1968), which the Fifth Circuit confined to its narrow facts.

(more…)

Even After Mayo, Fourth Circuit’s Home Concrete Opinion May Have Paved The Way For Invalidating The 6501(e) Regs

February 10, 2011

By Dustin Covello

Yet another appellate court has weighed in on whether an overstatement of basis constitutes an omission of gross income subject to the six-year statute of limitations under Code section 6501(e)(1)(A).  Home Concrete v. United States, No. 09-2353 (4th Cir. Feb. 7, 2011). This time, the Fourth Circuit Court of Appeals sided with the Ninth (Bakersfield Energy Partners LP v. Comm’r, 568 F.3d 767 (9th Cir. 2009)) and Federal Circuits (Salman Ranch Ltd. v. United States, 573 F.3d 1362 (Fed. Cir. 2009)), as well as the Tax Court (Intermountain Insurance Services v. Comm’r, T.C. Memo 2009-195), holding that an overstatement of basis is not an omission of income that would trigger the six-year statute.  The Fourth Circuit’s decision comes less than two weeks after the Seventh Circuit reached the opposite conclusion in Beard v. Comm’r, No. 09-3741 (7th Cir. Jan. 26, 2011).  For our prior discussion of Beard, see here.  Finally, just yesterday, the Fifth Circuit held for the taxpayer in Burks v. United States, No. 09-60827 (5th Cir. Feb. 9, 2011).  (If we find that Burks adds anything new to the discussion, we’ll post our commentary in the next few days.)

(more…)


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