Back in the era of beepers, being “on call” evoked imagery of importance.  Indeed, those people required by their job to carry a beeper, along with those who did so voluntary, displayed the devices with a noticeable degree of smugness.  The positive aspects of this status symbol aside, anyone who has been obligated to carry a beeper or its modern equivalent (e.g., BlackBerry, iPhone, PalmPilot, etc.) understands that being constantly reachable is often more of a curse than a blessing.

Many jobs mandate that a person respond to messages within a certain period of time, minimize travel so that one can be at the office quickly if necessary, avoid alcohol at all times to ensure constant preparedness to work, etc.  Given this reality, it is understandable that many people who are perpetually “on call” feel that they are always working, continuously performing.

This concept is at the core of a recent Tax Court case, Moss v. Commissioner, 135 T.C. No. 18 (Sept. 20, 2010), where the taxpayer claimed that all the time he spent “on call” with respect to his rental real estate business should be counted in determining whether he met the necessary participation standards.  The attached article, called “If You’re On Call, You’re Out of Luck in Passive Activity Cases,” analyzes Moss v. Commissioner and the three important rulings this case contains:  (i) in determining whether a taxpayer “materially participates” in an activity, only time the taxpayer actually spends performing services can be counted; (ii) the fact that a taxpayer is “on call” and thus available to field inquiries, take actions, etc. does not constitute performing services; and (iii)  the regulations permit a taxpayer to establish participation by “any reasonable means,” but simply allocating an arbitrary portion of the total “on call” time is not reasonable.  The article was published in Practical Tax Strategies.

The Supreme Court’s decision in Mayo Foundation for Medical Education and Research v. United States means that tax practitioners must be more sensitive to administrative law and judicial deference to administrative rules.  This includes gaining some familiarity with the Administrative Procedure Act (APA) and the major cases that deal with judicial deference to administrative action, starting with Chevron USA Inc. v. Natural Resources Defense Council Inc.  While the Supreme Court spends a lot more time considering issues of administrative law rather than tax law, the many decisions don’t result in a clear set of rules as to how courts are to treat administrative pronouncements.

In “Who’s Afraid of the APA?,” I identify the important issues in the application of general rules of administrative law to tax regulations.  The discussion should help tax practitioners identify the issues that are raised when the validity of an IRS pronouncement is open to question.  Further guidance may be available when the Supreme Court hands down its decision in Home Concrete & Supply LLC v. United States, which was argued before the Supreme Court in January.  This article appeared in 134 Tax Notes 825 (Feb. 13, 2012).

The tax code is best known for its strict rules, but it also features hundreds of taxpayer-favorable elections.  The first step to evaluating and possibly taking advantage of these elections is being aware of their existence.  Unfortunately, taxpayers and/or their advisors sometimes overlook an election or fail to follow the related procedures.  A classic example is the so-called “aggregation election,” under which taxpayers who qualify as real estate professionals can choose to combine all their interests in real estate endeavors for purposes of the passive activity rules in Section 469.  If taxpayers make a timely aggregation election, they often meet the “material participation” test and are thus able to claim their real estate losses in the year that they actually occur.  If not, the losses are largely suspended.

Taxpayers who neglect to follow the aggregation-election procedures have historically had two main options:  (i) seek a private letter ruling from the IRS granting permission to file a retroactive election, or (ii) litigate the case on grounds that they made a “deemed election” or “substantially complied” with the election procedures.  Both options have significant downsides for taxpayers.  Times have changed, though.  The IRS recently issued Rev. Proc. 2011-34, which sets forth special procedures allowing certain taxpayers to make an expedited, inexpensive, late aggregation election.  My article, titled “Better Late than Never:  IRS Radically Changes Aggregation Election Procedures in Passive Activity Cases,” analyzes passive loss limitation rules, material participation standards, aggregation elections, and the pros and cons of various methods for rectifying non-election situations, including reliance on Revenue Procedure 2011-34.  The article was published in the most recent issue of Journal of Tax Practice & Procedure.

Nearly all taxpayers will face penalties by the IRS at some point, regardless of their sophistication level and size.  Accordingly, tax practitioners, even those who claim not to get involved in traditional “collection” activities, must understand key aspects of abatement and collection procedures in order to effectively advise their clients.  This is particularly true given that the IRS persists in taking extreme positions in the Tax Court, such as the always-say-never approach, that are contrary to the majority of existing legal authorities.  A recent example is Custom Stairs & Trim, Ltd., Inc. v. Commissioner, T.C. Memo 2011-155, a case in which the IRS unsuccessfully argued that financial distress caused by events beyond the taxpayer’s control can “never” constitute reasonable cause for abating late payment and federal tax deposit penalties.  The attached article, called “Always Say Never:  Tax Court Rejects IRS’s Extreme Litigation Position in Penalty Cases,” analyzes Custom Stairs and the valuable lessons that it contains for taxpayers and their advisors.  The article was published in the most recent issue of Journal of Tax Practice & Procedure.

Pennsylvania may soon join the other states that have challenged the use of the so-called Delaware Loophole, according to our colleagues at the State and Local Tax Blawg.  The legislation, contained in Pa. House Bill 2150, would disallow deductions that a parent operating corporation claims for royalty payments made to a “Delaware Holding Company.”

The new limitation would not apply where the transaction is related to “a valid business purpose.”  In this regard, the legislation defines a valid business purpose as, “[a] purpose, other than the avoidance or reduction of taxation, which alone or in combination with other purposes constitute the primary motivation for a business activity or transaction which changes in a meaningful way, apart from a reduction of taxation, the economic position of the taxpayer.”

Our readers will recognize that the legislation defines “business purpose” in a manner that is remarkably similar to the codified “economic substance” doctrine of section 7701(o) of the Internal Revenue Code.  For example, compare the language of the Pennsylvania legislation, which requires that a transaction “change[] in a meaningful way, apart from a reduction of taxation, the economic position of the taxpayer,” with the language of section 7701(o)(1), which requires that a transaction “change[] in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position.”

Notwithstanding this similarity, the Pennsylvania legislation diverges from the Federal doctrine in two key respects.  First, the legislation’s business purpose test is a permissive rule that applies only in defined circumstances.  It serves as an exception to the limitation on royalty payments to a Delaware Holding Company.  In this regard, the legislation is much narrower than the Federal economic substance doctrine, which can apply to a indefinite number of transactions to which the doctrine may be considered “relevant.”  Second, the legislation applies a stricter business purpose test than Federal doctrine, requiring that purposes “other than the avoidance or reduction of taxation” be the “primary motivation for a business activity or transaction.”  Section 7701(o)(1) requires only that a taxpayer’s business purpose be “substantial.”

Over more than a decade, Congress took many attempts at codifying the economic substance doctrine before finally succeeding in 2010.  Given the increasing pressure on state legislators to find revenue, it is unlikely that Pennsylvania will take nearly as long to enact this provision.

Four years have passed since Congress enacted the Troubled Assets Relief Program, better known as TARP.  After Treasury determined that frozen credit markets were threatening the U.S. financial industry and even the entire economy, it asked Congress to authorize the purchase of illiquid mortgages from banks.  Congress obliged, authorizing Treasury to purchase up to $700 billion of these so-called “toxic assets.”

Soon after the enactment of TARP, Treasury Secretary Henry Paulson changed course and decided that investing directly in the banks would better serve TARP’s goals than would buying illiquid mortgages.  Readers may remember Paulson’s next extraordinary and unprecedented move: summoning the CEOs of our country’s nine largest banks to Washington, the Secretary informed each of them that they must accept $25 billion worth of TARP investments—no questions asked.  As one observer told the New York Times, Paulson’s “was a take it or take it offer. . . . Everyone knew there was only one answer.”

Paulson’s historic meeting concludes Andrew Ross Sorkin’s influential book Too Big To Fail, which chronicles the turmoil in the markets that eventually led to TARP’s enactment.  It also begins an article that we published in the latest issue of the Journal of Taxation and Regulation of Financial Institutions.  Our article considers the tax consequences of the Treasury’s TARP investment.

The article is bookended by two sections that assume the nominal form of the TARP investments – i.e., preferred stock – would be respected for tax purposes.  The first part chronicles the tax treatment of the TARP investments under guidance issued by Treasury.  The third part explains why Dodd-Frank, legislation ostensibly enacted to limit taxpayer-funded investments in financial institutions, would not prevent Treasury from making similar investments in the future.

In the heart of the article, we question the nominal form of the TARP investments and demonstrate why, for tax purposes, they should be characterized as debt instead of stock.  The implicit and explicit terms of Treasury’s investment more closely resembled a borrowing relationship and, for tax purposes, should have been treated as such.  Several tax consequences flow from this conclusion, the most important of which is the banks’ ability to treat the “dividends” paid to Treasury as interest and claim corresponding deductions (amounting to many billions of dollars) under Section 163.

Most of the common law factors traditionally employed to differentiate debt from equity for tax purposes counsel towards treating the TARP instrument as debt.  Treasury’s own statements indicated that the government never intended TARP to be more than a short-term loan to keep the banks solvent and liquid until the credit markets thawed.  Consistent with this approach, all but one of the banks represented at Secretary Paulson’s October 2008 meeting repaid their TARP investments by the end of 2009.  The last would repay Treasury by the end of 2010.

Although we presume that none of the banks treated the TARP investment as debt on their tax returns, for an enterprising bank, the statute of limitations remains open to seek the refund that they are rightfully owed.

Following the release of Ann and Mitt Romney’s tax returns, the news media and political commentators of all stripes have – to paraphrase Arlo Guthrie – detected, neglected, selected, rejected, and inspected those returns for a variety of commercial and political purposes.  As expected, the return shows substantial income, largely from passive investments.

One of the most interesting aspects of the Romneys’ returns – from a tax practitioner’s perspective – is the geographic location of a significant portion of their investments.  As MSNBC reported:

His 2010 return shows a number of foreign investments, including funds in Ireland, Switzerland, Germany and Luxembourg. Most of Romney’s vast fortune is held in a blind trust that he doesn’t control. A portion is held in a retirement account.

Romney’s advisers acknowledged Tuesday that Romney and his wife, Ann, had a bank account in Switzerland as part of her trust. The account was worth $3 million and was held in the United Bank of Switzerland, said R. Bradford Malt, a Boston lawyer who makes investments for the Romneys and oversees their blind trust, which was set up to avoid any conflicts of interest in investments during his run for the presidency.

For tax practitioners, this excerpt poses the natural question: have the Romneys filed foreign bank account reports (“FBARs”), which have been the subject of much media attention in recent weeks?  The answer might not be as straightforward as it would initially seem.

As the article noted, some of the Romneys’ assets are held in a “blind trust,” which is a trust set up so that its beneficiaries (in this case, Mitt and Ann Romney) have no knowledge of or control over its investments.  Politicians often use such blind trusts to avoid accusations that they are using a public office to affect the value of their private investments – the sort of conflict of interest referenced in the article.

Nevertheless, the Romneys have some general knowledge about their investments.  Schedule B of the 2010 return itself discloses that the Romneys have a bank account in Switzerland for which FBARs presumably have been filed.

However, they also own interests in “passive foreign investment companies” (“PFICs”) in Germany, Switzerland, Ireland, Luxembourg, and the Cayman Islands for which FBAR filings may have been required, but which are not listed on Schedule B.  In Notice 2009-62, Treasury invited comments about whether a PFIC interest should be subject to FBAR reporting; yet, in subsequent guidance and regulations, Treasury declined to address the issue.  Nevertheless, in the Frequently Asked Questions and Answers regarding the Offshore Voluntary Disclosure Initiative, the IRS has clearly contemplated that taxpayers with previously undisclosed PFIC interests should come forward under the Initiative, suggesting that it believes FBARs should have been filed for such interests.

(Although an investment’s tax status as a PFIC does not itself trigger an FBAR filing requirement, a PFIC may be an “account[] in which the assets are held in a commingled fund” and for which an FBAR must be filed.  See Notice 2009-62.)

It is not certain that the Romneys were required to report their foreign investments on FBARs.  Nevertheless, if the IRS concludes that FBAR filings were required, yet the Romneys failed to do so, the penalties that could be asserted against them would be significant.  If the failure were considered “willful,” the penalty could be the greater of $100,000 or 50 percent of the account value at the time of each failure.  In that case, the amount of money the Romneys pay to the government could increase dramatically.

Update: Thanks to Jack Townsend at Federal Tax Crimes for the pointer.

In this morning’s Tax Notes (subscription required), Jeremiah Coder addresses a topic that we at the Tax Blawg have discussed a couple of times over the past two years: the tax consequences of a potential breakup of the euro.  For our prior coverage, see here and here.  As the currency lurches towards and away from a potential dissolution (in part or in whole), the tax fallout of such an event lurks in the background.

The Tax Notes article generally covers the major tax issue (e.g., currency gain/loss recognition) associated with a potential breakup of the euro.  As the article seemed to suggest, though, the uncertainty about how Treasury would respond to a breakup is probably just as great as the uncertainty about whether the currency itself will survive, at least with its current composition.

The inability of Treasury to provide meaningful ex ante guidance about the tax consequences of a euro breakup is probably driven less by technical constraints than by political ones.  In the event of a breakup, Treasury would likely treat the conversion of a euro-denominated instrument into a legacy-denominated instrument as a non-event for tax purposes, thereby avoiding the recognition of gain or loss upon the forced conversion.  This would be the same route Treasury chose at the euro’s inception.   See Treas. Reg. § 1.1001-5.

Although taxpayers would welcome the announcement of such a rule ahead of any euro breakup, diplomatic considerations probably limit Treasury’s ability to provide that level of comfort.  If Treasury were to issue preemptively any kind of guidance about the tax consequences of a euro breakup, they would likely be accused of hastening the currency’s demise merely by acknowledging the likelihood of such a demise occurring.  Consequently, taxpayers will likely have to wait until a breakup occurs, if at all, to receive any guidance from Treasury about its U.S. income tax consequences.

Related Posts

Businesses Prepare For The End Of The Euro; Will Treasury Do The Same?

It’s April 29th; Do You Know Where Your Euros Are?

Fox Business invited me to appear yesterday on “After The Bell” with Liz Claman and David Asman to discuss (i) the IRS reopening the disclosure initiative for offshore bank accounts and (ii) the ongoing debate about whether Congress should implement a corporate repatriation holiday.  A link to the video is below the fold.

See the video at Fox Business.

The reopening of the 2011 OVDI is good news for taxpayers.  While the initiative presently has no deadline by which taxpayers must come forward, the IRS can change the terms of the initiative at any time.  If the government experiences success in getting a greater number of foreign banks to disclose the names of U.S. account holders, it is likely that the IRS will then set a firm deadline that will represent the last opportunity for taxpayers to come forward voluntarily.

Regarding the repatriation holiday, David asked me to respond to comments by Gene Sperling (director of the National Economic Council), who had previously remarked that such a holiday would not create jobs.  I noted that Mr. Sperling’s negative comments were “speculation.”  Whether a repatriation holiday would “create jobs” requires comparing the number of jobs that would be created without a holiday and the number of jobs that would be created with a holiday.  The problem is that, once a policy is implemented and we can see how many jobs exist following its implementation, we cannot observe how many jobs would have existed had the policy not been implemented.

This problem of such “counterfactuals” is one that pervades much of the discipline of economics: the counterfactual will never occur, leaving only speculation (economists refer to this as “modeling”) about what would or would not have happened under that alternate reality.  That same speculation forms the basis for political claims about the number of jobs that would or would not be created by various policy actions.  (Ironically, this is the same criticism that was leveled at claims about the number of jobs created or saved by the 2009 stimulus package.  See also Greg Mankiw’s take from February 2009.)

The whole debate simply points to the need for Congress to develop a coherent long-term policy regarding the taxation of foreign earnings of U.S. companies.  If Congress wants to create an incentive for companies to repatriate their foreign earnings regularly, that may require a rethinking of how we tax businesses globally, potentially including steps like implementing a lower steady-state tax rate for repatriated earnings or a move towards a territorial tax system.

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The IRS announced yesterday a reopening of its 2011 offshore voluntary disclosure initiative (“OVDI”).  This program will have essentially the same terms as the 2011 OVDI, but with a penalty rate of 27.5 percent (rather than 25 percent) of the highest account balance during the period covered by the initiative.  The program requires filing eight years of amended tax returns and unfiled FBARs and the payment of tax, interest and a possible accuracy-related penalty on unreported income as well as the above-mentioned lump-sum penalty.  In certain cases, a reduced penalty for failure to file FBARs is available.  Unlike the prior initiatives, the reopened OVDI has no deadline; however, the government can always choose to impose a deadline or terminate the program at its discretion.

See the announcement at the IRS website here and “How to Make an Offshore Voluntary Disclosure” here.  The IRS’ Frequently Asked Questions page provides significant guidance to determine whether individuals are eligible for OVDI.

As in the past, yesterday’s move follows a carrot-and-stick approach in which the IRS announces an opportunity for delinquent filers to come clean, but only after the government first announces major enforcement actions.  In this case, the reopening of OVDI follows one week after the Department of Justice announced the indictment of three Swiss bankers for allegedly “conspiring with U.S. taxpayers and others to hide more than $1.2 billion in assets….”  In the same vein, the U.S. government offered a settlement to nearly a dozen Swiss banks on December 16, which could result in the disclosure of more names of U.S. taxpayers with accounts at those banks.  The reopening of OVDI, together with these announcements, suggests that the IRS will continue its push towards enforcement over offshore bank accounts.

Although the relatively small increase in the penalty amount provides good news for taxpayers who are thinking of coming forward, the initiative nevertheless continues the unfortunate pattern of treating all disclosing taxpayers similarly, without regard to willfulness in failing to meet their compliance burdens.  This one-size-fits-all approach seems particularly harsh in situations involving minimal tax liability or otherwise sympathetic facts.

For our prior coverage, see here.