"’UNIFIED BUSINESS ENTERPRISE” THEORY

Under Code §183, individuals and S corporations desiring deductions for their business activities must be engaged in the activity “for profit.” Activities which consistently generate losses may be presumed to be not for profit.

A recent case illustrates a seldom-discussed theory or concept, known as the “unified business enterprise” theory. Under this theory, a taxpayer conducting activities in isolation which generate losses and thus may be considered not to be “for profit” under Code §183, may be able to aggregate that activity with other activities conducted either individually or through other commonly controlled entities to come up with a profit motive for an aggregate, or “unified business” enterprise that will avoid the limits of Code §183.

The cases tend to arise where property, such as an airplane or land, is owned and leased to a related business venture, with losses arising in the owning entity.  In the current case, the taxpayer was a principal in the Hard Rock Café chain. The taxpayer owned several aircraft in one or more entities, which aircraft were used by the taxpayer and/or other entities. The IRS asserted that deductions relating to the aircraft should be disallowed because the owning entities were not operated for profit. The taxpayer countered with the unified business enterprise theory.

The Court of Claims sustained the application of the unified business enterprise theory to the taxpayer’s situation, and ruled against the IRS (although IRS issues of substantiation of expenses were allowed to go forward). The IRS raised the cases of Deputy v. du Pont, 308 U.S. 488 (1940) and Moline Properties, Inc. v. Comm., 319 U.S. 436 (1943) to show that corporations and their shareholders should be treated as separate and distinct for tax purposes.  However, the court noted that in those older cases, S corporations were not involved, and did not involve overlapping businesses that essentially treated the S corporations as alter-egos for the taxpayer owner.

Thus, the unified business enterprise theory is alive and well, at least for pass-through entity situations such as S corporation and partnerships. Situations involving C corporations should expect greater resistance, if not outright rejection, of the theory by the IRS and courts.

Morton v. U.S., 107 AFTGR 2d 2011-xxxx (Ct Fed Cl), April 27, 2011

WHERE IS MY REFUND?

If you have an iPhone or an iPad, there is a new way to check on when to expect your income tax refund. By using the IRS2Go app, you can get this information on i-device. The app is available at the Apple app store.

Haven’t tried it myself, so I can’t vouch for its accuracy or effectiveness.

SECTION 332 LIQUIDATION OF INSOLVENT SUBSIDIARY VIA CONVERSION TO DISREGARDED ENTITY

A corporation converted its wholly owned subsidiary to a disregarded entity via a check-the-box election. At the time, the subsidiary was insolvent. The parent corporation sought a worthless stock loss under Code §165(g)(1).

At issue is Code §332 which will not allow a parent corporation shareholder to recognize gain or loss on liquidating distributions of an 80%-or-more owned subsidiary. The corporation sought a private letter ruling to the effect that Code §332 did not apply.

A necessary requirement for Code §332 to apply is that the parent must receive at least partial payment for the stock it owns. Since a check-the-box election to be treated as a disregarded entity treats the electing corporation as liquidating, at least in normal circumstances it would appear that this constructive liquidation would result in the requisite partial payment for the stock and Code §332 would apply to disallow the loss.

However, in this case the subsidiary was insolvent. The taxpayer sought to apply Rev.Rul. 2003-125 in context of this constructive liquidation. In that Ruling, the  IRS concluded that when the fair market value of the subsidiary's assets, including intangible assets such as goodwill and going concern value, is less than the sum of the subsidiary's liabilities, including bona fide liabilities owed to the parent, no part of the transfer is attributable to the parent's stock ownership and the above payment -for-stock requirement isn't satisfied. Accordingly, the Code Sec. 332 nonrecognition rules didn’t apply.

On a constructive liquidation of an insolvent subsidiary, the same effect should occur, even though no physical movement of assets occurs. Thus, in theory, Rev.Rul. 2003-125 should apply.

Theory does not always apply when dealing with the IRS. However, in this situation, it did, and the IRS acknowledged that Rev.Rul. 3002-125 could apply to a constructive liquidation under a check-the-box election. Thus, the parent corporation obtained the worthless stock deduction.

As an aside, note that the parent corporation was able to receive an ordinary loss instead of a capital loss, by reason of the application of the affiliation exception under Code §165(g)(3).

PLR 201115001

APPLICABLE FEDERAL RATES–MAY 2011

DING, DONG, THE WITCH IS DEAD

President Obama on Thursday signed into law a bill repealing the health care reform law's 1099 tax reporting requirement. Demands for repeal surfaced soon after the health care law was enacted, as the costly and time-consuming new reporting requirement was understood. Given the politics of Washington D.C., it took quite a while to kill off the reporting, even though the repeal was widely supported by Democrats and Republicans. The reporting requirement would have required business and real estate owners to file a 1099 form with the IRS for every vendor to whom they paid more than $600 in a year.

SUSPECT EXPERT APPRAISAL RISKS TOTAL TAXPAYER LOSS

Numerous tax consequences flow from the value of property. Principal examples include charitable contribution deductions, estate taxes, and gift taxes. Absent a contemporaneous sale of the subject property to unrelated persons, an appraisal will usually be needed to compute the relevant tax. If the IRS disputes the value and the matter ends up in court, an expert will be needed to sustain the taxpayer’s valuation. The government will often offer up its own competing appraisal, although it may instead be content with only attacking the taxpayer’s expert and report.

A recent Tax Court case demonstrates the hazards of relying on a suspect expert or appraisal in tax litigation. In Boltar LLC et al v. Comm., the issue was the valuation of a conservation easement for charitable deduction purposes. During trial, the Tax Court noted a host of problems with the valuation opinion of the taxpayer’s expert. The government moved to exclude the expert’s report and testimony as neither reliable nor relevant, under the authority of the Federal Rules of Evidence and Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 (1993). The expert’s report and opinion was so problematic that the Court granted the motion.

A typical result in a case such as this will be a finding of value at or close to the value presented by the government, since there will be little or no admissible evidence to the contrary. Opportunities to shift the burden of proof on value to the government may also be lost. Thus, a taxpayer relying on a weak appraisal report or expert risks a total loss on the valuation issue.

Results such as this demonstrate that relying on an aggressive value during litigation enhances the risk of total loss. It also demonstrates the importance of properly vetting the expert and his appraisal to determine its credibility and correctness. Lastly, it suggests that using more than one expert or report may be an appropriate litigation strategy in the proper circumstances (although having differing values under those reports may create other litigation issues, and will also include litigation costs).

The taxpayer argued that the Daubert analysis should only apply in a jury trial (Boltar involved a non-jury trial). The Tax Court did not buy into that, holding that a Daubert-type exclusion can apply in a bench trial.

Boltar, LLC et al v. Comm., 136 TC No. 14 (4/5/2011)

RECOVERING ATTORNEY FEES FROM THE IRS WHEN SOMEONE ELSE PAYS YOUR FEES

Under Code §7430 , a taxpayer who prevails against the IRS in court (or at the administrative level) can recover his fees and costs. Restrictions on recovery exist, however. The taxpayer must have exhausted administrative remedies before going to court, the taxpayer must not unreasonably protract the proceedings, and the taxpayer must meet financial eligibility requirements. Further, no fees will be allowed when the IRS proves its position in the proceeding was substantially justified. Thus, taxpayers can only recover fees if the IRS was acting unreasonably in seeking to impose taxes.

Oftentimes, a taxpayer’s employer or a related person or entity may pay his attorneys fees. The procedural history of a recent case has established that recovery of fees by the taxpayer are still available in this circumstance, but only under two limited circumstances.

Under the first of these, the taxpayer must have an absolute obligation to repay the fees to the person or entity that paid them initially, regardless of whether he successfully recovers an award of fees from the IRS. Under the second, the taxpayer must have a contingent obligation to pay the fees if he recovers an award of fees from the IRS.

This new law established in the taxpayer’s case unfortunately did not help the taxpayer. The Tax Court, on remand from the appellate court to apply these rules, did not find either of the two limited circumstances to apply. While the taxpayer did assert that he had a contingent obligation to repay any fees he recovered by the IRS, there was no written evidence of such an obligation – essentially, the Court did not find sufficient evidence to find that there really was such an agreement.

The taxpayer also argued that he was obligated to pay the attorneys if the corporation that undertook to pay them could not. However, the court indicated that this does not meet the first circumstance – the test there is only whether the taxpayer had on obligation to repay the entity paying his fees.

“In other words, the relevant inquiry is whether petitioner is indebted to Caspian for the amounts Caspian paid to counsel on his behalf. Petitioner's argument focuses incorrectly on his supposed obligation to pay the fees to counsel directly ‘if Caspian failed to pay for such services’, rather than on an obligation to repay Caspian.”

Taxpayers seeking to be able to recover fees from the IRS in these circumstances would be well served to establish in a contemporaneous writing an agreement to repay the paying entity or person, either in all circumstances or in the event of recovery from the IRS (assuming that to be the actual agreement of the parties).

Morrison, TC Memo 2011-76 

FORM 8939 AND ELECTION OUT OF ESTATE TAX FOR 2010–CONTINUING EXTENSION

As April 18 approaches, there have been continuing concerns whether the election out of estate tax for those estates that desire to do so for 2010 decedents, and the filing of Form 8939 to report basis adjustments for those decedents, will be required to be filed by that date. This is because previously the Form 8939 reporting was to have been completed and submitted by the due date of the decedent’s 2010 income tax return.

We have previously discussed earlier guidance on when those items will be due here. On March 31, the IRS issued further unambiguous guidance that such items will not be due on April 18.

The due dates (and applicable forms) will be released by the IRS in the future.

IR-2011-33, March 31, 2011

SUMMARY TABLE OF TRANSFER TAX EXEMPTIONS, RATES, KEY CREDITS & BASIS ADJUSTMENTS

Trying to keep track of the various changes in the federal transfer tax exemptions, credits, rates, and basis adjustments that have occurred since 2001 and the enactment of EGTRA is becoming a difficult task. Below is a summary table I have created. If anyone sees any necessary corrections, please leave a comment and I will update it.

The table is too large to read well here. A downloadable PDF version of this table is located here, or at http://www.box.net/shared/ndsso2kmsd.