EXPANSIVE DEFINITION OF GOODWILL IN LIKE-KIND EXCHANGES

Under Code Section 1031, taxpayers can exchange property of like-kind without incurring current gain - that is, they can defer gain recognition by rolling over their tax basis into the replacement property. While most often applied to real property, such exchanges can include exchanges of trade or business property.

The goodwill or going concern value of a business is per se not property that can be like-kind and thus cannot qualify for Section 1031 nonrecognition. Therefore, in the exchange of a business property, the taxpayer needs to identify what portion of the business assets are in the nature of goodwill.

A recent article in the publication Business Entities discusses the IRS treatment of intangibles in Section 1031 exchanges. Determining which intangible assets are part of goodwill and which are not is a difficult task. The term “goodwill” has generally been defined as the expectancy of continued patronage. This expectancy may be due to the name or reputation of a trade or business or any other factor. The term “going concern value” has generally been described as the additional value that attaches to property because of its existence as an integral part of an ongoing business activity.

Prior to the enactment of Code Section 197 relating to the amortization of goodwill and other intangibles, there was frequent litigation about which intangible assets were part of goodwill. In Newark Morning Ledger, 507 US 546 , 123 L Ed 2d 288 (1993) the Supreme Court noted that the value of every intangible asset is related, to a greater or lesser degree, to the expectation that customers will continue their patronage (i.e., goodwill). Nevertheless, for purposes of amortization, the Supreme Court held that a taxpayer who is able to prove that a particular asset can be valued and has a limited useful life that can be ascertained with reasonable accuracy may still depreciate the asset's value over its useful life.

Code Section 197 ended the debate about which intangible assets were separate enough from goodwill to be amortizable. However, the issue of separateness remains for purposes of Section 1031, and the IRS continues to be expansive in categorizing intangible assets as part of related to goodwill, so as not to qualify for like-kind exchange treatment.

For example, in TAM 200602034, the IRS held that a taxpayer's trademarks and trade names were a component of goodwill or going concern value, and thus their exchange could not qualify for like-kind exchange treatment. In Memorandum 20074401F, the IRS determined that a taxpayer's advertiser accounts and subscriber accounts were closely related to goodwill and could not be distinguished from the taxpayer's trademarks and trade names, and thus were ineligible for like-kind exchange treatment.

Therefore, taxpayers engaged in Section 1031 exchanges with trade or business property can expect IRS resistance to like-kind treatment for many of the intangible assets of the business. Whether the IRS' broad sweep up of intangible assets into goodwill is legally appropriate remains to be seen.

Source: IRS Applies Expansive Definition of Goodwill for Section 1031 Purposes, Authored by Holly Belanger, Business Entities (WG&L)

IRS REMINDS TAXPAYERS OF A FIRPTA WITHHOLDING TRAP

Internal Revenue Code Section 897 subjects foreign taxpayers to U.S. income tax on their gains from sales and dispositions of U.S. real property interests. Code Section 1445 imposes a 10% withholding tax, to be collected by purchasers, when a foreign taxpayer sells a U.S. real property interest. This tax is credited against the actual tax liability of the seller, with any excess withholding being refunded.

Because the purchaser must withhold the 10%, the purchaser must determine whether a seller of U.S. real property is a foreign taxpayer. Many purchasers will assume that if the seller is a U.S. entity, then there is no foreign seller and withholding is not required.

In Chief Counsel Advice 200836029, the IRS reminds taxpayers that if the seller of U.S. real property is a disregarded entity, and the owner of the disregarded entity is a foreign person, the purchaser is obligated to withhold on the transaction. How is a purchaser supposed to know if a selling entity is a disregarded entity, so as to determine if it is obligated to withhold?

One approved mechanism is to obtain a certification from the entity that it is not foreign and is not a disregarded entity. The Treasury Regulations provide suggested language for such a certification. If the entity is a disregarded entity, then additional certification will be needed to show that the owner is not a foreign person and is itself not a disregarded entity. If the appropriate certifications cannot be obtained, then the purchaser should withhold and pay over to the IRS the required 10% withholding.

For sure, many taxpayers (and their real estate counsel) believe that if the seller is a U.S. entity, they do not need to inquire further and do not have to withhold. To avoid being responsible for the withholding and potential interest and penalties out of their own pockets, taxpayers and their counsel should seek and obtain a nonforeign certificate (with the appropriate "nondisregarded entity" language) from all domestic entity sellers.

Presumably this applies even when the seller is a U.S. corporation, since such a seller can be a disregarded entity by reason of being a qualified Subchapter S subsidiary. In such case there is probably no withholding anyway because the parent S corporation would have to be domestic, but the certificate should still be sought because to get a valid domestic certification in this case, the certification needs to be issued by a non-disregarded parent owner of the disregarded Subchapter S affiliate instead of the disregarded affiliate itself.

APPLICABLE FEDERAL RATES - NOVEMBER 2008

IRS TWISTING ARMS TO REMOVE ELECTRONIC FILING FEES

If you are one of the brave ones that prepares and files your own federal income tax return, you probably use one of the commercial tax preparation software programs to assist you. When you are ready to file your tax return, the programs typically prompt you to file your tax return electronically. This is tempting because it avoids the need for printing out the return and mailing it to the IRS (including saving the postage), and for last minute filers it avoids waiting in line at the post office.

However, when you reach the point in the program to file electronically, if your income exceeds certain thresholds the program will charge you $15 to $30 extra. The IRS believes these fees are dissuading taxpayers from filing electronically. It would like more people to file electronically, since it avoids errors and reduces processing costs. Therefore, the IRS is trying to get the software companies to drop the filing fees.

It is estimated that $1 billion in electronic filing fees are collected each year, so giving up those fees will be costly for the software companies. While they still may do their patriotic duty and reduce or eliminate the filing fees, we shouldn't be surprised if the losses in fees are offset by increases in the prices for the software itself.

IRS CHANGES PUBLIC SUPPORT ADVANCE RULING PROCEDURES FOR SECTION 501(c)(3) ORANIZATIONS

Under the Internal Revenue Code, there are advantages for a Section 501(c)(3) organization to be classified as a "publicly supported" organization. To be "publicly supported," that organization must meet certain mathematical tests demonstrating a broad base of donor support (as compared to a small non-public pool of donors, such as a single family).

Previously, organizations that expect to meet the public support test would file a Form 1023 exemption application and seek a five year advance ruling. With such a ruling, the organization would generally be treated as publicly supported for its first five years. Then, it would need to submit a Form 8734 to show that its fundraising meets the publicly supported requirements, and if it did, the IRS would issue a final ruling establishing publicly supported status (or if it did not meet that status, it would be reclassified as a private foundation).

The IRS has now withdrawn the need to file a Form 8734 after 5 years. Instead, the taxpayer makes its own determination after 5 years, and if it meets the publicly supported requirements (and for so long as it does), it will report as a public charity without the need for a final determination by the IRS. The IRS will police the fulfillment of the public support requirement by new disclosures required on the Form 990 filings of the entity (assuming such a filing is required).

Note that if a public charity does not meet the public charity support requirements for two continuous years, it will lose its public charity status.

The IRS has issued a FAQ in question and answer format that address various transitional rules and other issues relating to the new reporting method.

09082008faq

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

The IRS has announced the interest rates for tax overpayments and underpayments for the calendar quarter beginning October 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. 2008-47

DOC STAMP "SHORT SALE" RULING EXPECTED SOON [FLORIDA]

Florida imposes documentary stamp taxes on the transfer of real property, based on the amount paid for the property. Amounts paid for the property include mortgage indebtedness that encumbers the property.

The declines in real property values has given rise to a substantial increase in real property "short sales." These sales are purchases by third parties of distressed real property from the owners at a sales price less than the current mortgage indebtedness, with the lender typically forgiving the unpaid mortgage amount.

The question arises whether documentary stamp taxes should be computed on the full mortgage amount (before the forgiveness), or on the lower purchase price paid by the buyer. By analogizing to existing rules that impose documentary stamp taxes on the full indebtedness amount when a mortgage holder transfers encumbered real property back to the lender as a deed in lieu of foreclosure, the Florida Department of Revenue has informally advised that it believes documentary stamp taxes in a short sell should likewise be based on the full amount of the mortgage debt.

There are practical difficulties with using the full amount of the mortgage debt. For example, buyers may not be aware of the full amount of the debt when they buy, even though they are responsible for the documentary stamp taxes (along with the seller). Further, since sellers are usually responsible by contract for payment, imposing higher taxes only increases the financial burden and distress of the home seller.

It is expected that the Department of Revenue will be issuing guidance to taxpayers within the next two weeks. If the Department indicates that the higher tax amounts are due, there is a possibility that the Legislature could try to reverse it through legislation, at least in regard to situations involving insolvent sellers.

EXTENSION PERIODS TO SHORTEN FOR PARTNERSHIPS, ESTATES & TRUSTS

Presently, partnerships, estates and trusts are generally obligated to file their income tax return by April 15, and can obtain 6 month extensions to October 15 (such dates are extended to the next business day if they fall on a weekend or federal holiday). These are the same dates that apply to individuals.

If you are an individual taxpayer on extension waiting for a Form K-1 from a partnership, estate or trust to complete your federal income tax return, it might not show up until you have to file the return, since the partnership, estate or trust doesn't have to complete its return until the same day that the individual taxpayer has to file its return.

The IRS has decided to help taxpayers with this problem. One way to resolve the problem would be to extend the individual 6 month extension period to give more time for taxpayers to receive the K-1 and finish their return. Surely, accountants would appreciate that type of relief.

Unfortunately, the IRS went the opposite direction, and SHORTENED the extension period for partnerships, estates and trusts from 6 months to 5 months. While this will help individual taxpayers, it will put more time pressure on tax preparers to complete the partnership, estate and trust returns.

No change is being made for S corporations, another entity that provides Forms K-1's. Since S corporations are required to file their returns on March 15, the existing six month extension already expires on September 15 - one month before the extension expiration for individual taxpayers.

These new rules will be effective for tax returns due in 2009 and thereafter.

IRS News Release IR-2008-84

VACATION!

Hopefully, you have noticed an absence of postings over the last two weeks. I have been on vacation - posts to restart shortly.