TAX GEOGRAPHY 101: ANTARCTICA IS NOT A COUNTRY

Internal Revenue Code Section 911 allows U.S. taxpayers to exclude some or all of their wage income for services performed in a foreign country when they spend most of the tax year in that country. In 1991, Dave Arnett tried to exclude wages earned while he was working in Antarctica.

The U.S. Tax Court has denied the exclusion to Mr. Arnett, based on the conclusion that Antarctica is not a foreign country since it has no government. The Tax Court relied on The Antarctic Treaty of December 1, 1959 which provides that all questions of sovereignty over Antarctica to be held in abeyance.

Interestingly, the U.S. Supreme Court has held that Antarctica is a foreign country for purposes of the Federal Tort Claims Act, and another U.S. federal court has held that is a foreign country for purposes of the Fair Labor Standards Act. Nonetheless, the Tax Court found that the definition of a foreign country is different under those laws than under the Internal Revenue Code.

Arnett v. Comm., 126 T.C. No. 4 (1/25/06)

TAX COURT INVALIDATES FOREIGN TAX RETURN FILING REGULATION

In the 1990's, the Treasury Department enacted regulations that provide if a foreign corporation did not timely file a U.S. income tax return (with some extension for the time to file over traditional filing deadlines), it can not later take income tax deductions for the applicable tax year. The effect of this regulation is that if a foreign corporation fails to timely file, if it ever does file (including by reason of an audit), its income tax liability will likely be higher by reason of the lost deductions than if it timely filed. Indeed, if the corporation had deductions that completely offset its income, it could find itself owing substantial tax when it really had no net income. This is strong medicine, designed to encourage foreign corporations to file their tax returns.

There is only one problem - there is no authority under the Internal Revenue Code to support it and indeed there is old case law that confirms that filing a timely return is not a prerequisite for obtaining deductions. In a decision favorable to taxpayers, the Tax Court has invalidated the regulations. The Tax Court concluded that it was simply wrong for the Treasury Department to attempt to resurrect a failed litigating position through the issuance of interpretative regulations that are contrary to the Internal Revenue Code.

Swallows Holding, LTD., 126 TC No. 6 (2006)

TAXPAYER'S INTENT ALLOWED TO TRUMP FORM

Generally, while the IRS has the ability to argue "substance over form," in determining the tax consequences of a situation taxpayers are generally bound by the legal form of the transaction or situation. In regard to issues involving life insurance policies, this means that taxpayers are generally bound by the "policy facts" - the objective facts of who has ownership and other rights over the policy. This further means that contrary "intent facts" will be disregarded - even if the taxpayer intended something different from what actually occurred.

In the world of insurance and insurance trusts, who owns an insurance policy, whether or when a policy is transferred, and beneficiary designations can have substantial tax consequences, especially in regard to estate and gift taxes. What happens if the parties intended one thing, but they did the paper work wrong and what they intended is not legally what occurred? Under the "policy facts" principle, they are generally stuck with the legal effect of what actually occurred.

In a recent Private Letter Ruling, the IRS provided an exception to this. In the ruling, the taxpayers had given instructions to their insurance agent to exchange a life insurance policy and then transfer the new policy into an insurance trust. Years later, they discover that the transfer to the trust was never made. The taxpayers requested a ruling that if they transfer the policy to the trust now, there will not be a current gift, and the three year rule of Code Section 2035 (which provides that a life insurance policy transferred by an owner/insured to an irrevocable trust will be taxable in the estate of the owner/insured if he or she dies within 3 years of the transfer) will not apply.

In finding an exception to the application of "policy facts," the IRS ruled favorably that there would be no current transfer and Code Section 2035 would not apply. The IRS extrapolated from existing case law and provided that where the insurance contract does not reflect the instructions of the parties, the IRS will respect the intent of the parties and characterize the tax consequences based on that intent as manifested by their instructions.

PLR 200603002