APPRAISAL RIGHTS DEEMED NOT SOLE REMEDY WHERE PRIOR BAD ACTS OF CORPORATE PRINCIPALS [FLORIDA]

Under Florida corporate law, minority shareholders of corporations are protected from majority shareholders who engage in undesirable merger, sale, or other major corporate transactions by demanding that their minority shares be purchased for fair value ("appraisal rights"). So as to limit litigation and force use of appraisal rights as a dispute resolution mechanism, such rights are made the exclusive remedy for a disgruntled shareholder, unless proper corporate formalities are not followed or the corporate transaction was "procured as a result of fraud or material misrepresentation." Fla.Stats. Section 607.1302(4)(b).

In a recent Florida case, the majority shareholder transferred corporate assets and liabilities to a new entity to which the minority shareholders were not included as shareholders. There was no fraud or material misrepresentation in regard to the transaction itself. Nonetheless, the minority shareholders sued for relief outside of the appraisal statute, claiming that a prior course of bad actions by the majority shareholder (relating to use of corporate funds to pay personal expenses) was enough "fraud" to allow for a remedy other than appraisal rights.

At first review, this would not seem to be the type of fraud that the appraisal rights statute was addressing, since there was no fraud in the transfer transaction itself. However, drawing upon Delaware corporate decisions under a similar statute, the Florida 1st District Court of Appeals has indicated that the statutory term "fraud or material misrepresentation" includes "unfair dealing." It further found that the majority shareholder's prior actions and overall course of conduct, if proved to be true, could constitute "unfair dealing" and thus allowed the minority shareholders to bring a cause of action outside of appraisal rights.

This expansive reading of the statute does allow for a court to do equity in egregious cases. However, it is unclear in the case how appraisal rights would not provide an adequate remedy (if the court could include in the valuation of the corporation an obligation of the majority shareholder to repay any misappropriated funds). It further effectively voids the public policy of using appraisal rights as an exclusive remedy since the standard of "unfair dealing" opens the door to many likely challenges to the required use of the appraisal rights as the exclusive remedy.

PAUL R. WILLIAMS AND JAMES F. WILLIAMS, JR. ON BEHALF OF BROWN & STANFORD COMPANY, INC., A FLORIDA CORPORATION D/B/A J.C. STANFORD & COMPANY, INC., Appellants, v. JOHN C. STANFORD, JR., AN INDIVIDUAL; VICTORIA B. STANFORD, AN INDIVIDUAL; BROWN & STANFORD COMPANY, INC., A FLORIDA CORPORATION D/B/A J.C. STANFORD & COMPANY, INC.; J. C. STANFORD & SON, INC., A FLORIDA CORPORATION; AND HENDERSON KEASLER LAW FIRM, P.A., A FLORIDA PROFESSIONAL CORPORATION, Appellees. 1st District. Case Nos. 1D06-3701 & 1D06-4808. Opinion filed March 25, 2008.

APPLICABLE FEDERAL RATES - APRIL 2008

April 2008 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 1.84% (2.24%/March -- 3.09%/February -- 3.16%/January)

-Mid Term AFR - Semi-annual Compounding - 2.85% (2.95%/March -- 3.48%/February -- 3.55%/January)

-Long Term AFR - Semi-annual Compounding - 4.35% (4.23%/March -- 4.41%/February -- 4.41%/January)


DIRECTION OF RATES: Mixed

IRS CONTINUES TO ASSERT THAT COMPENSATORY STOCK OPTIONS ARE A SHARED EXPENSE UNDER SECTION 482

The qualified cost sharing regulations under Section 482 are an arrow in the IRS' quiver in its attempts to limit the ability of U.S. companies to develop an intangible, deduct the costs in the U.S., but then have a significant portion of the income earned in a non-U.S. entity that does not incur immediate U.S. tax. The regulations require that when a U.S. company and a foreign affiliate jointly develop an intangible, they must share costs in the same proportion that they expect to receive benefits from the intangible.

In sharing costs, the IRS regulations provide that compensatory stock options and other stock-based compensation should be included as a cost that must be borne proportionately between the companies engaged in a qualified cost sharing arrangement. The potential problem with this is that the Tax Court, in Xilinx v. Commissioner, 125 T.C. 37 (2005), albeit under a prior version of the Regulations, held that requiring such stock-based compensation to be a shared cost was improper, since arms-length arrangements between unrelated parties for the joint development of an intangible might not share such a cost.

The IRS has appealed the case to the 9th Circuit Court of Appeals. In a Coordinated Issue Paper, entitled "Cost Sharing Stock Based Compensation," LMSB-04-0208-005, UIL 482.11-13, the IRS has indicated it will continue to apply the Regulations as written. Further, it announced that even if it loses its appeal in Xilinx, it will continue to apply the Regulations except in the 9th Circuit. Further, since the 2003 cost sharing Regulations were issued after the tax years at issue in Xilinx, it appears that the IRS may still apply them in the 9th Circuit for tax years after the issuance of the 2003 Regulations regardless of the final outcome of Xilinx.

LATE CONVERSION TO LIFETIME PAYOUT FROM INHERITED IRA ALLOWED

When an IRA owner dies before the required beginning date of required IRA distributions, a nonspouse beneficiary of the IRA can either take the IRA out over the beneficiary's remaining life expectancy, or take the entire IRA out within 5 years of the IRA owner's death (by December 31st of the 5th year after such death). Since IRA distributions are generally taxable to the recipient, taking the IRA out over the beneficiary's life expectancy typically results in two benefits. First, the payouts will be spread over many years, continuing the tax deferral aspects of the IRA and deferring taxes to the recipient. Second, it avoids bunching of the payouts which could result in even higher income taxes by pushing the recipient into a higher income tax bracket.

To avoid the 5 year payout rule and use the life expectancy rule, life expectancy distributions to the beneficiary must begin on or before the end of the calendar year immediately following the calendar year in which the employee died. Therefore, beneficiaries need to act in a timely manner to secure this tax benefit.

In a recent private letter ruling, the IRS did allow a beneficiary to use the life expectancy rule, even though the first distribution was not made within the above time limit. In the ruling, the beneficiary made up the missed annual distributions in later years, but prior to the expiration of the 5 year period.

The IRS' generosity was not unlimited, however. The beneficiary had to pay the usual penalty on late IRA distributions for the late payments - 50% of the required distribution. The taxpayer may also have incurred higher taxes than would have been the case if the payments had been made timely, since the bunching of makeup payments and the required payment in one tax year may have pushed the taxpayer into a higher bracket for the years of the makeup payments. The taxpayer is also out the fees for applying for the ruling, including professional fees which were likely incurred.

Since this relief was granted in a private letter ruling, it is not automatically available to everyone in the same situation. Instead, similarly situated taxpayers will have to apply for a ruling to get the relief. Per the language of the ruling, if the IRA documentation provides that a 5 year payout is the default payout method, then a ruling may not be available in those circumstances.

PLR 200811028

THEFT LOSS VS. WORTHLESS SECURITY LOSS

A taxpayer will often prefer a theft loss deduction to a deduction for a worthless investment security. One advantage of theft loss treatment is that the loss is not a capital loss, unlike the worthless security loss. The timing of the loss may also be more advantageous for a theft loss, since the loss for a worthless security cannot be used until the security is entirely worthless (or the security is otherwise sold).

The subprime mess has given rise to an IRS pronouncement that deals with a potential overlap area between these two types of losses. The taxpayers here were lenders, who lent money to an established company that wrote sub-prime mortgage loans. While the company was at one time a legitimate business, as its subprime losses mounted it provided false and fraudulent information to its investors to encourage them to continue to lend money to the company. Eventually, several insiders of the company were convicted of or plead guilty to securities laws violations based on their misrepresentations to their investors.

The investors did not get repaid on their investments. The issue was whether their losses had to be treated as worthless securities losses, or whether they could qualify for theft loss treatment.

In Chief Counsel Advise 200811016, the IRS held, surprisingly enough, that the losses qualified as theft losses. The Advisement noted that to qualify as a theft loss, a taxpayer needs only to prove that his loss resulted from a taking of property that is illegal under the law of the state where it occurred and that the taking was done with criminal intent. It also noted that in Rev.Rul. 71-381, a corporation provided fraudulent financial statements to obtain a loan, and the president of the corporation was convicted of violating state securities laws in issuing those statements. That ruling allowed the lender to take a theft loss deduction for the amounts that were lent and not repaid.

Thus, a theft accomplished through a purported borrowing or offer to sell a security does not get converted to a worthless security loss, but can qualify as a theft loss.

INTEREST RATES FOR TAX OVERPAYMENTS AND UNDERPAYMENTS (APRIL 2008 QUARTER)

The IRS has announced the interest rates for tax overpayments and underpayments for the calendar quarter beginning April 1, 2008.

For noncorporate taxpayers, the rate for both underpayments and overpayments will be 6%.

For corporations, the overpayment rate will be 5%. Corporations will receive 3.5% for overpayments exceeding $10,000. The underpayment rate for corporations will be 6%, but will be 8% for large corporate underpayments.

Rev. Rul. 2008-10

TEST YOUR FLORIDA HOMESTEAD LAW KNOWLEDGE [FLORIDA]

An interesting homestead case gives us the opportunity to test our knowledge of Florida law. Here are the facts. Husband owns the homestead. He executes a valid deed that transfers the homestead to create a life estate interest in himself and his wife as tenants by the entireties, and a remainder interest after their deaths to one of his children. The wife does not join in the deed. The husband then dies, without a Last Will.

Remember that Article X of Florida's Constitution provides in part that "[t]he owner of homestead real estate, joined by the spouse if married, may alienate the homestead by mortgage, sale or gift and, if married, may by deed transfer the title to an estate by the entirety with the spouse. " Further Fla.Stats. Section 689.11 provides in pertinent part that "[a] conveyance of real estate, including homestead, made by one spouse to the other shall convey the legal title to the grantee spouse in all cases in which it would be effectual if the parties were not married, and the grantee need not execute the conveyance. An estate by the entirety may be created by the action of the spouse holding title: (a) Conveying to the other by a deed in which the purpose to create the estate is stated; or (b) Conveying to both spouses."

So what legal interests are created under Florida law? See if you can arrive at the proper answer.

In Clemons and Gilpin, Jr. v. Thorton, 1st District Court of Appeal (Case No. 1D07-1664) held that:

a. A valid life estate, to be held as tenants by the entireties was created between the husband and wife. A grantee spouse is not required to join in to a conveyance to herself by the other spouse.

b. The conveyance of the remainder was invalid, since the grantee spouse would have needed to join in that conveyance.

c. The fact that the conveyance of the remainder was void did not impact the validity of the life estate conveyance.

d. Since the conveyance of the remainder interest was void, the husband continued as the owner of the remainder interest at his death.

e. At the husband's death, since he died intestate (without a Last Will), the remainder interest (effective at the death of the wife) passed to his then surviving lineal descendants per stirpes.

So, how did you do?

By the way, remember you can consult a summary table of Florida's homestead restrictions on transfers.

EARNINGS AND PROFITS NEEDED FOR CRIMINAL TAX EVASION RELATING TO DIVIDEND DISTRIBUTION

A shareholder of a corporation wrote checks from the corporation to his wife and girlfriend. He did not report any income from such transfers. The government asserted that this was tax evasion and obtained a criminal conviction. The shareholder appealed, claiming that he should have been able to present evidence that the corporation had no earnings and profits and that the distributions were thus not taxable up to the shareholder's basis in his shares, applying the general rules of Sections 301 and 316 (relating to corporate nonliquidating distributions). Under those rules, the recipient of a distribution from a corporation that has no current or accumulated earnings and profits will not be taxed as having received a taxable dividend.

The government had been able to exclude such evidence based on the precedent of United States v. Miller, 545 F2d 1204 (9th Cir. 1976). There, the court held that in a criminal tax evasion case, a diversion of funds may be deemed a return of capital only if there is some evidence that the distribution was intended by the corporation or shareholder as a return of capital. Since the defendant in the current case could not show such evidence, it ended up that the defendant was convicted of tax evasion when there was no evidence presented that any tax was actually due.

Clearly, a conviction of criminal tax evasion when no tax is due is an absurd result. However, the 9th Circuit Court of Appeals affirmed the conviction. Thankfully for the defendant, the U.S. Supreme Court disagreed, and reversed the conviction so as to allow in evidence of earnings and profits to determine if the distribution was in fact taxable as a dividend. The Court noted that Miller inserted an intent test into dividend treatment that is nowhere present in the statute or law - Sections 301 and 316 are mechanical rules based on the presence or absence of earnings and profits. Likewise, it had big problems with a tax fraud conviction when there may have been no taxes evaded.

Boulware v. U.S., 552 U.S. ___ (2008)

IRS REJECTS KOHLER DECISION

In 2006, the Tax Court held that post-death changes in the character of stock owned by a decedent pursuant to a tax-free reorganization would be allowed to affect the alternative valuation date value of the stock for estate tax purposes. Herbert V. Kohler, Jr., et al., TC Memo 2006-152. Under Code Section 2032, an estate can elect to value its assets for estate tax purposes on a date that is six months after the death of the decedent, instead of on the date of death. Thus, an estate can reduce its estate taxes if the overall value of those assets has declined in that six month period.

In Kohler, during the six month period restrictions on transfer were placed on the stock of the company, including shares owned by the decedent's estate. Such restrictions reduced the value of the shares, and thus use of the alternate date value saved estate taxes for the estate.

Taxpayers need to be wary upon relying on Kohler for precedent. The IRS has issued an Action on Decision announcing that it does not acquiesce to the Kohler case. This means that the IRS does not accept the legal conclusions of that case, and on similar facts will argue that no valuation adjustment for post-death voluntary changes in the character of corporate stock is allowable.

The rationale of the IRS is that the purpose of Section 2032 is to provide relief for estates when the MARKET causes a substantial dimunition in value of an estate asset - that is, if unfavorable market conditions (as distinguished from voluntary acts changing the character of the property) result in a lessening of its fair market value. In this case, the value change did not relate to changes in market conditions, but came from the affirmative and voluntary act of the corporation and its shareholders changing the character of its outstanding stock.

While the position of the IRS sounds reasonable, one has to wonder that if such an exception to the use of Section 2032 is allowed to stand how many cases will be litigated over the question whether a change in value is due to changes in market conditions vs. a voluntary act?

Action on Decision 2008-001, 3/4/2008

IRS STRICTLY CONSTRUES EXCESS COMPENSATION LIMITS

Code Section 162(m)(1) denies an income tax deduction to publicly traded corporations to the extent compensation paid to certain key employees ("covered employees") exceeds $1 million. However, compensation that is contingent on performance goals being met will not be counted as compensation subject to this limitation. To use this exception, the goals have to be set by a committee of the board of directors which is comprised only of outside directors, and the payment arrangement must be approved by the shareholders.

To qualify, the payments can be made ONLY upon fulfillment of the goals. However, the plan may allow for payment without fulfillment of the goals upon the death, disability, or change of ownership or control of the company. Such a payment will be subject to the $1 million limit because the goals were not met - however, the presence of provisions in the plan allowing such payments will not act to disqualify payments made when the goals are otherwise met.

What happens if under the compensation plan an employee can be paid the performance compensation without reaching the goals, not just for death, disability or change in ownership, but also or instead upon termination by the company without cause or for good reason? The IRS has ruled that any payment under the plan will be subject to the $1 million limit (even if the employee is not terminated and actually satisfies the performance goals). Similarly, if the plan allows for payment due to a voluntary resignation from employment without regard to whether the performance goals are reached, all payments under the plan will also be subject to the $1 million limit regardless of whether the goals are reached.

This is a change from prior private letter rulings issued by the IRS. The IRS indicates that exceptions for termination without cause or voluntary resignation defeat the policy of the performance based pay exceptions to the $1 million limit by allowing payment without the requisite performance - indeed, in circumstances where there is a very good chance the goals will not be or have not been met. Therefore, to discourage such exceptions, it will disqualify all payments under such plans from the performance pay exception, even when the performance goals are met.

Rev.Rul. 2008-13