PREPAID FORWARD CONTRACT TREATED AS A SALE

Prepaid forward contracts were a popular item in the early 2000’s. Such arrangements would allow the holder of substantially appreciated public stock (such as a founder whose stock had run up substantially in the bull market) to receive a payment of 75%-80% of the value of his or her shares, have an upside if the stock appreciated in value thereafter in the next few years, have no downside risk, and be able to defer income taxes on the funds paid until the transaction closed a few years later. A principal issue regarding such transactions was whether the upfront payment constituted a taxable sale in the initial year, or whether deferral existed until the transaction completely closed in a later year. Something of a sweet deal, Revenue Ruling 2003-7 allowed for nonsale treatment for prepaid forwards, at least under the facts of that ruling.

Taxpayers who participated in those transactions could typically receive a better financial deal if as part of the transaction they also lent the shares that were subject to the transaction so that the investment entity involved could sell those shares short or otherwise hedge their risks. This is what the Anshutz Company did in the prepaid forward contracts it entered into in the early 2000’s.

The Tax Court has now determined that the Anshutz Company was not entitled to defer its gain, but instead had income upon entering the prepaid forward contract. The court noted that the prepaid forward, in combination with the share lending transaction, resulted in almost all incidents of ownership having been given up by the taxpayer, and thus it was appropriate to trigger gain in the year the taxpayer received the cash proceeds.

Since many of these transactions occurred awhile ago, of those older ones only those that are either under audit, in litigation, or for which the taxpayers have extended the applicable statute of limitations, will be affected by the new decision. Presumably, those whose transactions did not include the stock lending element will not be as adversely impacted by the Tax Court’s analysis, but it remains to be seen how the IRS will interpret the precedential value of the case in those situations.

Anschutz Company v. Commissioner, 135 T.C. No. 5 (2010)

APPLICABLE FEDERAL RATES – AUGUST 2010

DOES A TAX FRAUD GUILTY PLEA AUTOMATICALLY RESULT IN AN FBAR PENALTY?

A taxpayer through a company had Swiss bank account. He did not report the income from the accounts on his federal income tax return. The taxpayer also did not file the required FBAR disclosure form for the accounts.

The taxpayer eventually plead guilty to tax fraud, conspiracy to defraud the United States and criminal tax evasion in connection with the Swiss bank accounts. The IRS sought to use his guilty plea as requiring an automatic finding of willful failure to file the required FBARs and sought to automatically impose FBAR penalties.

Not so fast, says the U.S. District Court for the Eastern District of Virginia. In denying the government’s motion for summary judgment, the court noted that there may still be valid defenses available to the FBAR penalty even though the taxpayer admitted guilt on the above tax charges. More particularly, the court noted the following issues still remain and thus allowed the case to proceed to trial:

-The taxpayer contends that U.S. authorities were already on notice of the accounts, and indeed, the assets in the accounts had already been frozen.  Thus, according to the taxpayer, he did not have the requisite intent to “willfully” fail to disclose the accounts by filing the Form TDF 90-22.1 because he believed their existence had already been disclosed.

-The taxpayer contends he had no knowledge that Form TDF 90-22.1 existed, nor had his attorneys advised him as to its existence or significance, and thus could not “willfully” have failed to file the Form.

-Lastly, the taxpayer contends he had no “signatory or other authority over” the accounts as required by 31 C.F.R. § 103.24 because the accounts were frozen.

Whether the taxpayer will prevail remains to be seen, but at least he will have his day in court as to these issues.

U.S. v. Williams, 106 AFTR 2d 2010-XXXX, (DC VA), 03/19/2010