Thursday, July 31, 2008


Internal Revenue Code Section 212(1) allows a deduction to individual taxpayers for expenses relating to the production or collection of income. Therefore, if one attended a seminar to learn investment trading techniques, that should be deductible, right?

That's what Carl Jones thought, when he deducted the expenses of a day-trading seminar that he attended to improve his day trading skills. Unfortunately, both the IRS and the Tax Court disagreed, based on an obscure, but directly on point, provision of the Internal Revenue Code Section 274(h)(7).

This provision provides in plain and simple language that "[n]o deduction shall be allowed under section 212 for expenses allocable to a convention, seminar, or similar meeting." This provision is hard to locate, in large part because the title of Section 274 gives only the faintest warning of the existence of the prohibition - "Disallowance of certain entertainment, etc., expenses."

Carl Jones' case is not that interesting, but I mention it here as a public service because I am sure that Carl Jones is not the only one out there that is unaware of the deduction prohibition for seminar attendance. As a tax matter, note that Section 274(h)(7) only applies for Section 212 expenses. If attendance at a seminar qualifies as a Section 162 "trade or business" expense, the provision does not apply.

Carl H. Jones, 131 TC No. 3 (2008)

Saturday, July 26, 2008


Since U.S. transfer taxes (estate and gift taxes) are calculated on the value of the property transferred, taxpayers seek low values while the IRS seeks high values. When the asset in question is an interest in a business entity (e.g., stock in a corporation), valuation experts recognize that the stock of an entity may be worth less than the value of the assets owned. Valuation adjustments (commonly referred to as "discounts") are typically applied for lack of control, and for lack of marketability.
Sometimes the interests of the taxpayer and the IRS are reversed - the IRS seeks a low value for an asset and the taxpayer seeks a high value. For example, a taxpayer seeks a high value for shares of stock when they are being contributed to charity, so as to maximize his or her charitable income tax deduction. Here, the IRS has to be mindful since the arguments it makes for a low value may be used against it in a later transfer tax case when it is seeking a high value for the same type of asset.
In a recent case, the IRS did not seem too concerned about that, when it argued for (and indeed prevailed in court) for a 35% lack of control discount and a 45% lack of marketabilty discount relating to shares of stock in a corporation. If a taxpayer sought those levels of discount in a transfer tax case, the IRS would clearly have vigorously objected. But here, such levels were acceptable since it the IRS was looking to reduce value.
It is only a matter of time before taxpayers try and use these discount levels in transfer tax cases. Will what was good for the goose, also be good for the gander?
Bradley J. Bergquist, et al. v. Commissioner, 131 T.C. No. 2 (2008).

Wednesday, July 23, 2008


A restricted management account (RMA) is an account under which the owner of cash and/or securities places those items in the hands of an investment manager to manage for an extended period of time. The account agreement usually provides that the items will be kept under such management for a fixed number of years. This allows the account manager to make long term investment decisions, and thus to put less focus on short term profits to retain client business.

Some assert that an ownership interest in an RMA is worth less for gift and estate tax purposes than the assets held in the RMA, by reason of the obligation to keep management with the investment manager for a fixed period of time. The IRS has now issued a Revenue Ruling that such valuation adjustments are inappropriate.

One leg of the IRS position is that a willing buyer would not reduce what they would pay for the underlying assets by reason of them being bound by this management restriction, and thus the willing buyer/willing seller test for value does not justify a reduction. However, if you ask yourself the question, would you pay the same for $1 million dollars in securities that are under such a restriction and as you would pay for $1 million dollars that are not under such a restriction, it seems obvious that you (or any other willing buyer) would pay less in the first circumstance. It doesn''t take a professional appraiser to question the validity of the IRS' conclusion.

The other argument of the IRS is that no reduction is allowed per Code §2703(a)(2). This provision provides that for federal estate, gift, and generation-skipping transfer tax purposes, the value of any property shall be determined without regard to any restriction on the right to sell or use such property, and thus the account management agreement should not give rise to a valuation adjustment.  However, under Code §2703(b), Code §2703(a)(2) will not apply if to a restriction (1) that is a bona fide business arrangement; (2) that is not a device to transfer property to members of the decedent's family for less than full and adequate consideration in money or money's worth; and (3) whose terms are comparable to similar arrangements entered into by persons in an arm's length transaction. The Ruling concludes that this exception does not apply, but provides no convincing argument or precedent why the exception could not be valid in many circumstances.

Therefore, while the Ruling will result in challenges to valuation adjustments taken for RMA's, whether the IRS is correct on this issue is probably still an open question.

Revenue Ruling 2008-35, 2008-29 IRB 116.

Monday, July 21, 2008


On July 10, I commented on recent IRS guidance relating to interest expense deductions of partners in securities trading partnerships. A more detailed analysis of that guidance was published on pages 98 & 99 of the July 14, 2008 edition of Tax Notes. The article makes good reading, and you can read it by clicking here. The most interesting part, in my opinion, is the highlighted commentary at the end of the second page - but that's probably because the commentator was me!

Tuesday, July 15, 2008


In 1992, several Shell Oil affiliates transferred various properties to Shell Frontier Oil & Gas Inc. in a Section 351 transaction. As a Section 351 transfer, the shareholders of Shell Frontier received a basis in their Shell Frontier stock equal to the basis of the property transferred to Shell Frontier.

Shell Western E&P Inc. was one of the companies contributing properties to Shell Frontier. As it turned out, the basis of much of the property transferred by Shell Western far exceeded its value. Due to this disparity, when Shell Western later sold some of its shares in Shell Frontier, it realized substantial losses (in the hundreds of millions of dollars) since it received proceeds for that stock in excess of its basis in the stock..

The IRS was not too pleased with these losses, and challenged them on various grounds. The first line of attack was that the assets contributed to Shell Frontier (oil shale rights and offshore leases) were not “property” for Section 351 purposes because they had no value (and thus no tax basis for them should be given to Shell Western). The appellate court made short shrift of this argument, noting that just because the properties were not income producing did not mean they had no value. Further, the court acknowledged that there is no requirement under Section 351 that a positive value is required for an item to be "property" for Section 351 purposes. The court also rejected the IRS attempt to categorize the properties as equivalent to stock in a wholly insolvent corporation that is in receivership (which stock had been previously held not to be "property" under Section 351).

The IRS also attempted to characterize the transfer of the loss properties as a sham transaction. The appellate court found too much substance and non-tax purpose for the transfer for a sham argument to succeed. An interesting aspect of the case was that the structuring plan came from the Shell Oil tax department. However, the department specifically held back from management the tax benefits of the transaction, so that management would base its decision solely on nontax reasons. This worked well to eliminate the punch from the IRS' argument that the purpose of the tax transaction was entirely or substantially tax motivated.

Lastly, the IRS attempted to use Section 482 to deny loss treatment to the taxpayer. However, insufficient evidence to invoke Section 482 was provided at trial. The appellate court also noted that even if Section 482 evidence had been provided, there was insufficient evidence of an improper purpose to evade taxes to allow for a Section 482 adjustment that would override the Congressional purposes of Section 351 transactions.

Thus, in the end, the IRS lost and Shell's losses were respected.

SHELL PETROLEUM INC. v. U.S., 102 AFTR 2d 2008-XXXX, (DC TX), 07/03/2008

Saturday, July 12, 2008


Contracts often contain release or exculpatory language that seek to protect a party from liability for future activities. Such clauses are disfavored in the law because they relieve one party of the obligation to use due care and shift the risk of injury to the party who is probably least equipped to take the necessary precautions to avoid injury and bear the risk of loss. Nevertheless, because of the countervailing policy that favors the enforcement of contracts as a general proposition, unambiguous exculpatory provisions are enforceable.

While  such clauses will be enforceable, there are limits. A recent Florida case points out two of those limitations. In the case, a builder of a residence included a very broad clause that released the builder from any liability for faulty construction whether based on negligence, gross negligence, strict liability or intentional conduct. The 5th District Court of Appeals noted at least two problems with the release language.

First, it noted that the release clause is unenforceable to the extent it seeks to release the builder for an intentional tort. Second, it noted that a party may not contract away its responsibility to comply with a building code when the person with whom the contract is made is one of those whom the code is designed to protect. Consequently, to the extent that the builder's release language sought to protect it against liability from such sources, it was unenforceable.

SUE A. LOEWE AND WARREN LOEWE, Appellant, v. SEAGATE HOMES, INC., Appellee. 5th District. Case No. 5D07-1683. Opinion filed July 11, 2008.

Thursday, July 10, 2008


Earlier this year, in Revenue Ruling 2008-12, the IRS ruled that the interest expense of a partnership engaged in trading activities for the account of its owners is characterized as investment interest expense of limited partners for those who do not materially participate in the business. While most expenses of partners in limited partnerships that conduct business activities are treated as "passive" if the partner does not materially participate, Regs. Section 1.469-1T(e)(6) provides that an activity of trading personal property for the account of owners of interests in the activity is NOT a passive activity (without regard to whether such activity is a trade or business activity), and thus passive loss treatment is not appropriate.

In Revenue Ruling 2008-38, the IRS has followed up on the earlier ruling and has indicated that the investment interest expense is business expense under Code Section 62(a)(1), and is not an itemized deduction. An accompanying Notice indicated that the expense is reported on Schedule E.  The IRS guidance is useful for taxpayers. By characterizing the interest expense relating to the trading activities of the partnership as not being an itemized deduction under Section 63(d), it is effectively deductible for individual taxpayers even if they do not itemize their deductions. However, since investment interest deductions are not subject to the phase-out of itemized deductions under Code Sections 67 and 68 (unlike many other itemized deductions), the characterization of the deductions as itemized deductions will often not be a big deal to many taxpayers who otherwise itemize.

The IRS also indicated that any investment interest expense of the trading partnership that relates not to its trading activities but to its investment property is an itemized deduction. If a partnership has both types of interest expense, the taxpayer must allocate the individual's net investment income between the two categories of investment interest expense using a reasonable method of allocation. The Ruling provides an example of a reasonable method - allocate to each category based on the relative amounts of interest expense directly attributable to the two types of activities. Since this may unduly skew the bulk of the interest expense to investment activities (and thus making the deduction an itemized deduction to that extent) when the bulk of the indebtedness relates to investment activity and not trading activity, another reasonable method of allocation may be desired. While the Ruling provides no further guidance on what is reasonable, perhaps allocations based on relative amounts of gross income derived by the two types of activities, or the relative amounts of gross assets involved in each of the activities, may also pass muster as reasonable methods of allocation, and should be considered by taxpayers if they provide more favorable results.

Sunday, July 06, 2008


The IRS has issued Proposed Regulations under §6694, to assist tax return preparers in avoiding penalties under that provision. So long as tax return preparer has a "reasonable basis" for a return position, the penalty can be avoided through proper disclosure if the position later turns out to be wrong. The Proposed Regulations provide significant detail as to what will constitute proper disclosure. Notably, "boilerplate" language to clients to meet the disclosure requirements will not be acceptable.

A quick summary of the Proposed Regulations as to preparers who sign the return, based on how an erroneous reporting issue is characterized, is as follows:

a. There was no "reasonable basis" for the filing position. In this situation, the penalty will almost always apply.

b. There was a "reasonable basis," but not "substantial authority" for the filing position. To avoid a penalty, the preparer must meet disclosure requirements. This will either mean full disclosure to the IRS in accordance with its disclosure rules, or in the case of an income tax return, the preparer delivers the prepared return with proper disclosures to the taxpayer.

c. There was "substantial authority," but no reasonable belief by the preparer that the position was more likely than not reported correctly. Again to avoid a penalty, the preparer must meet disclosure requirements. In this situation for an income tax return, the preparer can meet the disclosure requirements by advising the taxpayer of the applicable penalties and penalty standards.

d. The preparer had a reasonable belief that the reported position was more likely than not reported correctly. In this case, no penalty will apply (with or without disclosure).

Different rules apply for preparers who do not sign the return. Further, the above general rules are subject to various particular refinements in the Proposed Regulations. A more detailed outline of the new provisions can be read here (or click on the .docstock icon below).

Summary of Proposed Regulation Regarding Tax Return Preparer Penalties - Get more Legal Forms

Wednesday, July 02, 2008


Effective this past June 17, the U.S. undertook a wholesale revision as to how it will tax its expatriates – persons giving up their U.S. citizenship or long-term permanent residency. In lieu of the special 10 year sourcing rules that previously applied, the U.S. will subject an expatriate to immediate U.S. income tax as if the expatriate had immediately sold all of his or her assets for their fair market value. Further, any future gifts or bequests of property to a U.S. citizen or resident will be subject to U.S. transfer taxes. Of course, both of these general rules are subject to various statutory exceptions and refinements, including the general income and asset thresholds that must be met before these rules will apply to an expatriate.

To assist in the rapid digestion of the new rules by those who are interested, I have prepared the following summary of the new statutory provisions. Click on the .docstoc logo below to open the summary, or you can also get to it here.