The Tax Adviser

Irrevocable life insurance trusts.

Unfunded irrevocable life insurance trusts can be used to provide heirs and the surviving spouse with funds for estate costs and can provide estate tax savings if properly structured. A trust is the owner of the life insurance policy, and the grantor contributes to the trust to pay the premiums. The policy is therefore not part of the estate at death because incidents of ownership in the trust have not been retained by the grantor. Estate planners must consider what powers may be retained by ...

Nexus through the presence of intangibles.

The South Carolina Supreme Court ruled in Geoffrey, Inc. v. South Carolina Tax Commission that the physical presence test applied by the US Supreme Court in Quill Corp. v. North Dakota only applied to state sales and use taxes. South Carolina was attempting to tax income of a Toys R Us Corp. subsidiary established solely to license trademarks and collect royalties. The Court in Quill found that a substantial physical presence in the state was required for state corporate taxation, but the Cou...

Maximizing FSC benefits for software companies.

Foreign sales corporations Software companies can take advantage of the tax exemptions available under the foreign sales corporation rules for export products if the sales do not include the right to reproduce. IRS regulations state that software is considered property under the rules, but services that accompany the product do not receive the benefit of tax exemption. Software developers will want to structure a sale that combines property and service so that at least 50% of the gross recei...

LLPs: a new form of organization.

Limited liability partnerships Limited liability partnership (LLP) combines the limited liability of incorporation with the tax advantages of partnership status without the additional administrative burdens required for limited liability companies. Five states have passed LLP legislation that allows the partner in a LLP to avoid liability for the conduct of other partners and employees not under that partner's direct supervision. To receive favorable tax treatment, the LLP must meet the test...

RRA complicates charitable deduction status of travel expenses.

Travel expense deductions under the charitable contribution provisions of IRC section 170 are not deductible unless there is no significant element of pleasure in the travel, as is the case with medical travel expenses. Changes in the charitable contribution rules for 1994 may require the substantiation of the expenses as charitable contributions if aggregate expenses for one trip exceed $250. The deduction for meals during charitable travel will be reduced to 50% for 1994 as well. Hotel expe...

Sec. 29 nonconventional fuels credit: 1993 highlights.

Oil and gas producers that drilled for fuels from nonconventional sources between 1979 and 1993 can claim tax credits on fuels extracted through 2002. The nonconventional sources include oil-shale, tar sands and coal seams. Much of the discussion surrounding the IRC section 29 tax credit has focused on what constitutes the commencement of drilling and what sources were included. In Texaco, Inc. & Subsidiaries, the Tax Court ruled that high viscosity crude was not considered extracted from tar...

Sec. 1202 can benefit investors in an S corporation.

S corporation shareholders may wish to take advantage of the 50% capital gains tax exclusion available on the sale of qualified small business stock under IRC section 1202. To exclude 50% of gain, the stockholder must have held stock in the qualified small business for at least five years, and the stock must have been acquired at the time of issuance. Only individuals and pass-though entities can hold the stock. An existing S corporation can benefit from the section 1202 exclusion by forming ...

Calculating 'in-house' lobbying expenses under IRS safe harbors.

The regulations for the IRC section 162(e) disallowance of the lobbying expense deduction have failed to clarify treatment of in-house lobbying activities but have provided two safe harbors. While direct contact lobbying is clearly not deductible, the treatment of research, office and travel expenses remains unclear. The safe harbors define how to calculate nondeductible expenses based on the percentage of time that employees devote to lobbying activity. Additional regulations have identified...

Corporate downsizing - tax treatment of leased employees.

Employers should be aware that the IRS is scrutinizing independent contractor and leased employee situations more closely and that improper classification of employees as independent contractors may jeopardize the qualified status of benefit plans. Employees are subject to greater withholding and reporting requirements than are independent contractors. If the IRS reclassifies independent contractors as employees, these employees have to be included in minimum participation and nondiscriminati...

Earnings stripping and foreign-owned controlled groups.

The earnings-stripping rules of IRC section 163(j) require affiliated subsidiary corporations to aggregate tax calculations for purposes of calculating interest expense deductions when stock ownership requirements are met. Aggregation of tax calculation can reduce the benefit of the interest expense deduction for subsidiaries with low debt-to-equity ratios. IRS regulations state that section 163(j) can apply to subsidiaries affiliated via a foreign parent corporation even though the foreign p...

Transfer pricing penalty pitfalls.

Misstatement of transfer pricing valuation can subject taxpayers engaging in transnational related-party transactions to penalties under IRC section 6662 of up to 40% of the underpayment of tax. The penalty percentage is based on the percent that the related-party valuation deviates from arms-length valuation or on the percentage of gross receipts that the error is. The tax penalty can be avoided by establishing arms-length valuation methods or by establishing a reasonable method and assertin...

Settling pending intangibles disputes - IRS guidance.

The IRS has developed an internal handbook for IRS agents examining and attempting to settle disputes regarding intangible property amortization. Though IRC section 197 establishes a 15-year amortization period for all intangible property, disputes still exist regarding treatment under prior law. The IRS handbook addresses market-based and customer-based intangibles, existing workforce and training costs as intangible assets. It also identifies going concern value as nonamortizable and stress...

Tax strategies available under income forecast method.

Depreciation deductions for taxpayers using the income forecast method are calculated by multiplying the capitalized costs by the ratio of current year gross income to total estimated gross income for the project. This method is typically used by television, film and recording production companies to depreciate expenses incurred on specific productions. Distribution costs need not be capitalized though they are capitalized for book purposes. These costs, including marketing costs, are subtrac...

Charitable contribution deductions - an alternative to capitalization of demolition costs.

Owners wishing to tear down a building but not wanting demolition costs to be added to their basis in the land under IRC section 280B should consider making a charitable donation of the building. Fire departments can use the building for training exercises and will demolish the building in the process. The taxpayer will receive a current deduction for the fair market value of the building at the time of the donation. The Tax Court has supported this arrangement, stating that the community ben...

IRS releases favorable sec. 263A accounting method change guidance.

Notice 88-78 has been revoked by the final regulations promulgated under IRC section 263A, leaving taxpayers with little guidance on how to file for accounting method changes due to failure to apply section 263A properly. For tax years beginning with 1994, taxpayers will have to use more restrictive accounting method change guidelines. Some taxpayers will be allowed to apply positive adjustments made pursuant to the accounting method change to their net operating losses.

Avoiding potential disallowance of foreign branch losses.

Many US corporations deducting foreign branch losses may be unaware of the certification requirements enacted under IRC section 1503(d) to restrict the use of losses in other tax jurisdictions. Companies have formed dual resident corporations to take interest expense deductions in two nations to be used to offset affiliate income on consolidation. The dual consolidated loss rules of section 1503(d) were enacted in 1986 to combat this practice. If branch losses could be used in another jurisdi...

Final OID regulations provide guidance on debt instruments.

Original issue discount Final IRS regulations governing the tax and accounting treatment of imputed interest on land contract deferred payments and of original issue discount (OID) for debt instruments were released in 1992. The regulations identify how to compute OID, what expenses are considered OID and when to deduct OID. Issuers of debt may elect to deduct OID using their existing accounting method or by using a straight-line method for de minimis OID. Homeowners can elect to deduct loan...

Sec. 351: an alternative to taxable asset acquisitions.

Corporations wishing to engage in the transfer of assets may be able to use the provisions of IRC section 351 instead of traditional asset sales. The two corporations could form a new corporation or use an existing one to issue stock. The stock would be transferred to the purchaser for its cash, and the cash and preferred stock would go to the seller of the assets. The treatment of contingent liabilities varies under the two methods of asset transfer, and taxable asset acquisition may be pref...

Spousal rollover rights when trust is qualified plan beneficiary.

The IRS has generally accepted that surviving spouses have the right to rollover funds paid out of decedent spouses' qualified benefit plan into an individual retirement account, even when the surviving spouse is not the named beneficiary. Because of the popularity of living trusts, some individuals have named the trust as the beneficiary of their qualified plan. IRC section 402(c)(9) appears to require that the surviving spouse receive the funds directly to make a tax-free rollover. The IRS ...

IRS positions threaten RTC under fixed-price contracts.

Research tax credit, Fairchild Industries decision Taxpayers engaged in funded research cannot claim the research tax credit (RTC) for those expenses because compensation for such research and development is likely and expected. In Fairchild Industries, the US Court of Federal Claims ruled that a government contractor enlisted to develop aircraft prototypes was not engaged in RTC-type research. The contractor argued that the amounts payable were contingent on the success of the project. The ...

Sec. 304: IRS reconsiders 'foreign subsidiary stock transfer' rulings.

The IRS is reconsidering its position on granting foreign tax credits for IRC section 304 transfers of stock in a foreign subsidiary between US and foreign subsidiaries of the same foreign parent corporation. Section 304 was intended to restrict the use of related-party stock transfers to convert ordinary income into capital gain, but it has turned into a planning vehicle for corporations wishing to receive deemed dividend treatment. Under section 301, stock transfers are characterized as a d...

Using S losses to generate future capital gains - planning opportunities available for shareholders with capital losses.

S corporation shareholders with zero stock basis may wish to consider structuring a loan to the S corporation and exchanging capital losses for accelerated S losses. The S corporation losses can be used currently, but use of the losses will result in reduced-basis debt that will require the taxpayer to incur capital gain in a subsequent year. For some taxpayers, this arrangement may be a effective means of using losses that would otherwise be unused. Careful analysis is required to determine ...

Cash method taxpayer must realize gain/loss on sale of stock in year of trade.

Taxpayers selling publicly traded stock cannot use the installment method and must realize gain or loss on the sale in the year that the trade is executed. The installment method is generally available to taxpayers when at least one payment is made in a year after the year of the sale. Under IRC section 453(a), sale of securities is not eligible for this method. The IRS has ruled that payments made in subsequent years must be treated as received in the year that the stock trade was made, not ...

Contested liabilities - when is a deduction allowed?

Taxpayers wishing to take contested liabilities deductions under IRC section 461(f) will need to show that the liability is being actively contested, that the liability would result in a deduction if not contested and that the funds to cover the liability have been transferred beyond the taxpayer's control. Placing funds with a court or in an escrow account constitute relinquishment of control, while use of trusts may not. Courts are divided on whether a written agreement with the claimant is...

Prohibited transactions for qualified employee benefits plans.

Excise taxes Qualified employee benefit plan administrators must be aware that certain transactions, including loans, sales and exchanges of property and leases, can subject the plan to prohibited transactions excise taxes if the plan enters into these transactions with disqualified persons. Disqualified persons include employers, owners and fiduciaries. The excise taxes are particularly burdensome, totalling as much as 100% of the value of the property involved. Correction of the prohibited...

Computer usage and tax software in a tax practice: AICPA tax division survey results.

American Institute of Certified Public Accountants ProSystem fx by CCH Computax Inc. leads all tax preparation software in usage among CPAs according to a 1993 survey by the American Institute of CPAs, though products by Lacerte Software Inc. and ChipSoft Inc. are also widely used. Usage of computer software to prepare tax returns and to perform tax research has increased steadily since 1985, the first year the survey was taken. Tax software firms appear to divide into major companies whose ...

Minimizing gain recognition on the sale of a residence when two homeowners marry.

Two homeowners planning to get married and move into one house should consider filing consent to treat the two taxpayers as one for the purposes of purchasing a subsequent residence. Such consent will help defer gain that one spouse would recognize on the sale of that spouse's property. If one spouse has unrealized losses in that spouse's house, that property should be sold first to take advantage of the losses.