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Monday, December 29, 2008


Section 529 plans are a popular method for savings and investments relating to education expenses. The plans allow investments to grow and be expended for qualified education expenses, free of income taxes. They also allow for contributors to use up to five years of present interest gift tax exclusions in one year, so as to avoid or limit gift taxes on funding of a plan account.

The Internal Revenue Code requires that investment planning and oversight for a plan account cannot be done at the direction of the contributor or beneficiaries of the plan. This requirement has previously been loosened by the IRS in Notice 2001-55, which together with regulations, allows the contributor to select a general investment strategy upon funding, which can be revised once a calendar year and upon a change of designated beneficiary.

As we all know, the investment markets have been wildly turbulent in recent months. To assist taxpayers in preserving value in Section 529 plan accounts in regard to the current state of the markets, the IRS has now announced that the once-per-calendar-year adjustment will be changed to two adjustments for calendar year 2009.

Such relief is beneficial to the plans and their beneficiaries - assuming that taxpayers are astute enough investors to exercise the adjustment powers in a manner that increases overall investment returns. One has to wonder, however, that if twice-per-year adjustments are worthwhile for 2009, then why not allow them for all future years?

Notice 2009-1, 2009-2 IRB, 12/23/2008

Thursday, December 25, 2008


Section 7701(l) of the Code authorizes the Treasury Department to prescribe regulations recharacterizing a multiple-party financing transaction as a transaction directly among any two or more of such parties where the Secretary determines that such recharacterization is appropriate to prevent the avoidance of any tax imposed by the Code. Existing regulations under that provision allows the IRS to disregard the participation of one or more intermediate entities in a financing arrangement where such entities are acting as conduit entities, and to recharacterize the financing arrangement as a transaction directly between the remaining parties to the financing arrangement for purposes of imposing tax under sections 871, 881, 1441 and 1442 of the Code. The regulations are primarily concerned with taxpayers being able to take advantage of advantageous treaty and Code provisions by inserting a qualifying entity or person inbetween an ultimate provider of financing (that would not benefit under the treaty or Code for the favorable benefits) and an ultimate buyer – e.g., “back-to-back” loan arrangements.

New proposed regulations have been issued under Proposed Regulations 1.881-3 that seek to prevent taxpayers from getting around the conduit rules by using a “disregarded entity” as an intermediate entity in a financing arrangement.

The Preamble to the regulations also indicate that separate guidance may be issued in regard to the use of hybrid instruments issued by an intermediate entity that is treated as debt under the laws of the foreign jurisdiction where the intermediate entity is resident and is not treated as debt for U.S. federal tax purposes. The IRS is studying when such arrangements will qualify as conduit arrangements.

Most troubling in the Preamble is a discussion that the IRS is considering issuing rules when equity ownership interests would be recast as financing interests and thus implicate the conduit rules. From the language of the Preamble, the IRS could be limiting this recharacterization to situations in which hybrid instruments are used (as discussed in the preceding paragraph) – that would not be so bad. However, if the discussion portends broad rules that will recast equity arrangements as part of conduit financing arrangements outside of the use of hybrid instruments, this could have a very broad (and chilling effect) on various existing financing arrangements. For example, a loan by a foreign lender to a partner or shareholder of a partnership or corporation, followed by a capital contribution of such loan proceeds to the partnership or corporation, could trigger application of the conduit rules. Hopefully, the guidance, if and when issued, will focus on equity arrangements only in situations where hybrid instruments are used.

Preamble to Prop Regs. 12/22/2008. Fed. Reg. Vol. 73, No. 246 p. 78254

Sunday, December 21, 2008

Tuesday, December 16, 2008


Corporations can often combine or be acquired without any of the parties recognizing gain or loss under the corporate reorganization provisions. One of the requirements for such treatment is that the equity owners of the target corporation continue their equity ownership via acquiring a substantial equity interest in the acquiring corporation (or a parent of the acquiring corporation) – this requirement is known as the continuity of interest requirement.

When a target corporation is insolvent, it may not be possible for the shareholders of the target to receive a substantial equity interest in the acquiring company because the value of the target is substantially held by the creditors of the target corporation. Under newly issued regulations, the IRS will now allow interests of creditors of the target that are exchanged for equity interests in the acquiring corporation to be counted as equity interests in the target corporation for purposes of the continuity of interest requirement, even if the target corporation is not in bankruptcy but is merely insolvent.

When the acquiring corporation issues consideration partly in stock, and partly with cash or other property, the new regulations provide a method of determining how much of a creditor’s interest is considered to be continuing as equity. Different rules apply for senior and junior indebtedness.

The new rules are a welcome method of both allowing for tax-free reorganizations for insolvent entities, and providing mechanical formulas for computing continuing equity for purposes of the continuity of interest test.

Treas.Regs. §1.368-1(e)

Sunday, December 14, 2008


IRA’s and other pension plans allow taxpayers to defer income taxes on contributed amounts and earnings until distribution. The deferral does not last forever – under the required minimum distribution (RMD) rules, taxpayers must make certain prescribed minimum distributions each year after age 70 1/2. The RMD for a given year is computed by multiplying a required distribution table percentage against the value of the account at the end of the preceding year.

With the broad investment market declines, many have seen their IRA and pension accounts lose substantial value. For taxpayers that do not need a full RMD, the RMD rules add insult to injury by (a) requiring annual distributions from the accounts, thus further depleting their balances, and (b) possibly causing account holders to sell investments at distressed values to be able to make the distribution.

In a relief measure, Congress has included in the recently enacted Worker, Retiree and Employer Recovery Act (which is expected to be signed into law by President Bush) a provision that waives the requirement for taxpayers to make an RMD in 2009. Therefore, taxpayers who do not need a full RMD distribution in 2009 do not have to make one.

The provisions apply to IRA’s, and many (but not all) pension plans. Individuals withdrawing under a five year method may also get an additional year to make withdrawals.

This is only a one year relief provision – RMD’s must recommence in 2010. Unfortunately, the provision does not apply to 2008 RMD’s – these must still be made in full. Of course, taxpayers who need full RMD distributions for living expenses will not benefit from this provision.

Wednesday, December 10, 2008


IRS Commissioner Douglas Shulman recently spoke to the George Washington University International Tax Conference. The Commissioner addressed several areas that the IRS is concerned about in the international arena. With such expressions of concern, taxpayers with interests in these areas should be forewarned that stricter or adverse IRS attention to these areas can be anticipated (although some of these areas are already feeling the heat).

TRANSFER PRICING - COST SHARING. The Commissioner is concerned that taxpayers are abusing existing transfer pricing cost sharing mechanisms to shift taxation of profits from valuable intangibles (e.g., new drugs) to offshore, low-tax jurisdictions. He indicated that the IRS is challenging such arrangements at audit when taxpayers are perceived to be crossing the line, and are also working on temporary regulations in the area.

CONTRACT MANUFACTURING. Subpart F of the Code attempts to tax foreign corporations controlled by U.S. persons on a current basis on profits that relate to sales of products that are involved in certain related party sales, instead of allowing taxes to be deferred offshore. Taxpayers have developed mechanisms of reducing exposure to Subpart F by engaging in contract manufacturing between related foreign companies. IRS attacks in regard to transfer pricing reviews of contract manufacturing pricing, and expansion of Subpart F income definitions and the "branch rule" to include contract manufacturing activities, are likely.

USE OF LOW OR NO TAX JURISDICTIONS BY FINANCIAL INSTITUTIONS. Attempting to book transactions as loans and swaps to shift profit to such jurisdictions, is something the IRS is concerned about.

USE OF HYBRID ENTITIES TO OBTAIN DOUBLE DEDUCTIONS OR CREDITS IN VARIOUS JURISDICTIONS. The IRS is concerned about hybrid entities abusing foreign tax credits - if two different taxpayers are getting the benefit of a credit, watch out.

AVOIDANCE OF WITHHOLDING TAXES. The IRS is concerned about institutional assistance by financial institutions in regard to foreign persons avoid U.S. withholding taxes.

UNDISCLOSED FOREIGN BANK ACCOUNTS OF U.S. PERSONS. Well, I think we all know the IRS is big on this issue (e.g., the recent UBS problems in Switzerland).

Saturday, December 06, 2008


Many taxpayers have funds in IRA accounts. If they want to use the funds for a business venture, a distribution of the funds is needed. Such distributions are generally taxable, and if the owner is not old enough, a 10% penalty tax to boot is imposed.

Some taxpayers have been using a special route to accessing these funds without current income taxes. It generally involves forming a new business corporation, establishing a 401(k) plan for the business that allows for investment in employer securities, rolling over the IRA funds (or other funds from a prior employer qualified plan) to the new 401(k) plan, and then using the funds to acquire stock in the new business. By transferring cash for stock in the new business, the corporation receives capital it can use for its business.

On its face, there is nothing illegitimate about such an arrangement – it makes use of legitimate provisions of the tax laws, including the roll-over rules and the ability of certain plans to own employer securities. In practice, some of those that have used such arrangements may not have been strictly following all required retirement plan rules and regulations, so those taxpayers who have not done so may be vulnerable to attack. From an overall policy standpoint, one can speculate that such use of IRA funds is beneficial, since the funds are being put to use in job creation business development activities.

Of course, since it has the “appearance” of use of IRA funds that circumvents the taxable distribution rules, one would expect the government to be bothered by such use. Such expectations have been borne out – the IRS has issued a Memorandum for the directors  of the Employee Plans Examinations division and the Employee Plans Rulings & Agreements division expressing hostility to these arrangements and areas for attack. Indeed, the IRS has adopted the acronym “ROBS” for these rollover to business start-up arrangements. This acronym speaks volumes about the IRS’ attitude towards them.

Possible lines of attack described in the Memorandum include purported violation of antidiscrimination provisions and prohibited transactions relating to deficient valuation of the stock received in the transaction by the plan and payment of promoter fees. The Memorandum also addresses statute of limitations issues since many of these transactions done in the past are close to the expiration of the applicable limitations periods.

There are several promoters out there that seek to educate and assist taxpayers with these types of transactions. Before undertaking them, taxpayers or their advisors should familiarize themselves with the issues raised by the Memorandum.

Memorandum of Michael D. Julianelle, October 1, 2008 (

Thursday, December 04, 2008


For individuals who are not U.S. citizens, Code Section 7701(b) provides rules for determining whether the U.S. will treat them as resident aliens (and thus generally subject their worldwide income to U.S. income tax). I recently prepared a map of the test for a client – for those who are interested it can be accessed here (

Please note that this is an expandable map and works well with recent versions of Adobe Acrobat or Adobe Reader. It may not work with non-Adobe PDF readers.