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The Tax Court has held that payments made by a parent corporation’s wholly owned subsidiaries to another wholly owned subsidiary were deductible as insurance expenses.
The court abandoned its previous position that there could not be risk shifting in brother-sister corporate arrangements (Rent-A-Center and Affiliated Subsidiaries v Commissioner, 142 TC No. 1, Jan. 14, 2014).
Rent-A-Center, Inc. (RAC) is the parent of a group of approximately 15 affiliated subsidiaries. RAC and its subsidiaries rented, sold and delivered home electronics, furniture and appliances. RAC’s wholly owned subsidiary, Legacy Insurance Co., Ltd., is a Bermuda corporation.
Legacy and RAC’s other wholly owned subsidiaries entered into contracts under which each subsidiary paid Legacy an amount – determined by actuarial calculations and an allocation formula – relating to workers’ compensation, automobile and general liability risks. In turn, Legacy reimbursed a portion of each subsidiary’s claims relating to these risks.
On their consolidated returns, RAC’s subsidiaries deducted the payments to Legacy as insurance expenses. On audit, the IRS determined that the payments were not deductible. In its majority opinion, the Tax Court concluded that the payments by RAC’s subsidiaries to Legacy were deductible as insurance expenses.
In making this determination, the court found that RAC presented convincing evidence that:
➤ Legacy was a bona fide insurance company.
➤ RAC faced actual and insurable risk.
➤ Comparable coverage with other insurance companies would have been more expensive.
➤ Some insurance companies would not underwrite the coverage provided by Legacy.
➤ RAC established Legacy for legitimate business reasons, including increasing the accountability and transparency of its insurance operations, accessing new insurance markets and reducing risk management costs.
The court concluded that Legacy was not a sham. It reasoned that, while federal income tax consequences were considered, the formation of Legacy was not a tax-driven transaction.
Legacy entered into bona fide arm’s-length contracts with RAC, charged actuarially determined premiums, was subject to the regulatory control of the Bermuda Monetary Authority and met Bermuda’s minimum statutory requirements. It also paid claims from its separately maintained account and was adequately capitalized.
The court noted that, to be deductible, an arrangement must involve insurance risk and meet commonly accepted notions of insurance. And, there must be risk shifting and risk distribution.
The court then determined that the arrangement in this case satisfied the following requirements:
➤ Insurance risk policies. RAC faced insurable risk relating to all three types of insured risk – workers’ compensation, automobile and general liability. RAC entered into contracts with Legacy and an independent insurance company to address these risks.
➤ Risk shifting. The court repudiated its 1987 Humana Inc. decision with regard to brother-sister arrangements and concluded that a balance sheet and net worth analysis, looking at the arrangement’s economic impact on the insured entities, were the proper analytical framework to determine risk shifting in brother-sister arrangements. It found that the policies shifted risk from RAC’s insured subsidiaries to Legacy, and that Legacy:
❋ Was formed for a valid business purpose
❋ Was a separate, independent and viable entity
❋ Was financially capable of meeting its obligations
❋ Reimbursed RAC’s subsidiaries when they suffered an insurable loss
A payment from Legacy to RAC’s subsidiaries did not reduce the net worth of RAC’s subsidiaries because, unlike RAC, the subsidiaries did not own stock in Legacy.
➤ Distributed risk. RAC’s subsidiaries owned more than 2,500 stores, had more than 14,000 employees and operated more than 7,000 insured vehicles. RAC’s subsidiaries had a sufficient number of statistically independent risks. Thus, by insuring RAC’s subsidiaries, Legacy achieved adequate risk distribution.
➤ Insurance in the commonly accepted sense. Legacy was adequately capitalized, regulated by the Bermuda Monetary Authority, and organized and operated as an insurance company. It issued valid and binding policies, charged and received actuarially determined premiums, and paid claims.
©2014 CPAmerica International
A business that is forced to move does not have to include move-related reimbursements in income, but the business cannot deduct relocation expenses to the extent it is reimbursed, according to a private letter ruling by the IRS.
The business lessee also does not have basis for acquired replacement property to the extent the cost does not exceed reimbursements, according to the ruling (PLR 201401001).
Title II of the Uniform Relocation Assistance and Real Property Acquisitions Policies Act, 42 USC Sections 4621-4638, was enacted to establish a uniform policy for the fair and equitable treatment of all affected persons displaced as a result of federal and federally assisted programs and projects. Whenever a program or project undertaken by a displacing agency will result in displacing any persons, Section 4622(a) provides that the displaced persons will be paid:
➤ Actual reasonable expenses in moving themselves, their business or other personal property;
➤ Actual direct losses of tangible personal property as a result of moving or discontinuing their business, but not to exceed an amount equal to the reasonable expenses that would have been required to relocate the property, as determined by the head of the agency; and
➤ Actual reasonable expenses in searching for a replacement business.
No payment received under Sections 4621-4638 is treated as income for purposes of the Internal Revenue Code.
The IRS cited Revenue Ruling 78-388 for the proposition that a taxpayer cannot claim a deduction for an expense for which there is a right or expectation of payment. The IRS also concluded that basis cannot be assigned to substitute equipment acquired to replace non-movable equipment and leasehold improvements at the new location, to the extent such costs are reimbursed with the relocation payments and the additional payments. Because these payments reimburse the taxpayer for the cost of such property, the taxpayer does not incur a cost to acquire that property.
©2014 CPAmerica International
If you had work-related education costs during 2013 or expect to incur such costs during 2014, you may be entitled to a tax deduction.
If you are an employee and can itemize your deductions, your deduction will be the amount by which your qualifying work-related education expenses – plus other job and certain miscellaneous expenses – are greater than 2 percent of your adjusted gross income.
If you are self-employed, you deduct your expenses for qualifying work-related education directly from your self-employment income, reducing your income subject to both income tax and self-employment tax.
Your work-related education expenses may also qualify you for other tax benefits, such as the American Opportunity and Lifetime Learning Credits. These credits may be more valuable to you than the deduction.
To qualify for the deduction, your education must meet one of the following tests:
➤ The education is required by your employer or the law to keep your present salary, status or job.
➤ The education maintains or improves skills needed in your present work.
Even if the education meets one or both of the above tests, it is not qualifying work-related education if it:
➤ Is needed to meet the minimum educational requirements of your present trade or business;
➤ Is part of a program of study that will qualify you for a new trade or business; or
➤ Does not serve your employer’s bona fide business purpose.
If your education is not required by your employer or the law, it can still be qualifying work-related education if it maintains or improves skills needed in your present work. However, education that is part of a program of study that will qualify you for a new trade or business is not qualifying work-related education. This is true even if you do not plan to enter that trade or business.
If your education meets the requirements described above, the following education expenses can be deducted:
➤ Tuition, books, supplies, lab fees and similar items
➤ Certain transportation and travel costs
➤ Other education expenses, such as costs of research and typing when writing a paper as part of an educational program
If you use your car for transportation to school, you can deduct your actual expenses or use the standard mileage rate to figure the amount you can deduct. Whichever method you use, you can also deduct parking fees and tolls.
You can deduct expenses for travel, meals (limited to 50 percent of the cost) and lodging if you travel overnight mainly to obtain qualifying work-related education. Travel expenses for education are treated the same as travel expenses for other employee business purposes.
Certain cruises and conventions offer seminars or courses as part of their itinerary. Even if the seminars or courses are work related, your deduction for travel may be limited. This applies to:
➤ Travel by ocean liner, cruise ship or other forms of luxury water transportation
➤ Conventions outside the North American area
©2014 CPAmerica International
Adam Hart may have seen himself as an established pharmaceutical salesman, but the Tax Court didn’t agree.
Hart graduated from college in 2007. In 2009, he enrolled in an M.B.A. program with a concentration in finance.
Hart deducted $18,600 as an unreimbursed employee business expense for his education costs paid during 2009. The IRS denied the deduction.
Hart’s employment history during 2009 was as follows:
➜ Jan. 1 to April 30, 2009 – employed by Priority Healthcare Distribution as a cancer pharmaceutical salesman
➜ May 1 to Aug. 10, 2009 – unemployed
➜ Aug. 11 to Oct. 1, 2009 – employed by ADP Totalsource as a cancer pharmaceutical sales account manager
➜ Oct. 2 to Oct. 11, 2009 – unemployed
➜ Oct. 12 to Dec. 31, 2009 – employed as entry-level professional for Walgreen Co.
None of his 2009 employers required Hart to attend M.B.A. courses. Hart contended that he was in the business of selling pharmaceuticals and that the M.B.A. classes he took enabled him to obtain employment in 2009.
The IRS contended that Hart was not established in a trade or business during 2009 and that his employers did not require him to enroll in an M.B.A. program.
Implicit in claiming a business expense deduction for education expenses is the notion that the taxpayer must be established in a trade or business before any expenses are deductible. The IRS contended that Hart was not established in a trade or business before entering the M.B.A. program.
Hart contended that he was engaged in a trade or business because he focused on the selling of cancer pharmaceuticals, which is a specialized field.
The Tax Court sided with the IRS and denied the deduction. The court’s reasoning included the following:
➜ Hart graduated from college only two years before starting his M.B.A. program.
➜ Carrying on a trade or business has been defined as entailing continuous and regular activity.
➜ Hart’s employment in the cancer pharmaceutical sales field was not continuous.
➜ There is no evidence that Hart was carrying on a trade or business before he enrolled in the M.B.A. program.
Because the court ruled that Hart was not engaged in a trade or business, it had no reason to decide whether the M.B.A. program would qualify Hart for a new trade or business (Adam E. Hart et. ux. v. Commissioner, T.C. Memo 2013-289, Dec. 23, 2013).
©2014 CPAmerica International
The Tax Court ruled on a case in December that involved falsified documents, deception and forgery – perpetrated by the wife.
The wife’s tangled web included:
➜ Submitting falsified requests to withdraw funds from her husband’s IRAs
➜ Forging her husband’s signature to endorse the distribution checks
➜ Depositing the funds into a joint account that only she used
➜ Using the proceeds for her personal benefit
The husband did not find out until the next year. The Tax Court said the husband was not required to include the distributions in his gross income and was not liable for the additional tax on early distributions.
Andrew Roberts and his wife, Cristie Smith, maintained two joint checking accounts. Although the accounts were titled in joint name, Roberts exclusively used one account, and Smith exclusively used the other account.
Roberts did not have a checkbook for, write checks on or make withdrawals from Smith’s account, and he didn’t receive or review the bank statements. He didn’t know about, authorize or benefit from any deposits into, or withdrawals from, Smith’s account.
The custodians of Roberts’s two IRAs received requests with his forged signature, faxed from Smith’s workplace, to withdraw approximately $37,000 from his IRAs. Roberts did not make or authorize the requests.
Checks were sent pursuant to the withdrawal request, the endorsement was forged, and the checks were deposited into Smith’s joint account that she maintained separately from Roberts. The court inferred that Smith (or someone on her behalf) forged Roberts’s signature on the distribution requests and endorsements.
Roberts first learned of the unauthorized withdrawals when he received Forms 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., early in the following year. By the time Roberts had determined Smith’s involvement, the couple was already involved in a divorce proceeding.
Roberts advised the trial court of what had happened, and the court’s decree of dissolution took into account that Smith had withdrawn the funds.
Throughout their marriage, Smith prepared and filed a joint income tax return with Roberts. In early 2009, Roberts, although separated from Smith, discussed with her the preparation and filing of a joint income tax return for 2008. He understood from that conversation that he and Smith would still file a joint return.
Roberts gave his tax information to Smith so that she could prepare the 2008 joint return. However, Smith prepared and filed separate returns, using married filing separate filing status for herself and single filing status for Roberts.
On Roberts’s return, Smith made several errors, including not reporting the IRA withdrawals as income. Roberts’s return showed a refund that had been electronically deposited into the joint account controlled by Smith. She did not show Roberts the return or give him a copy, despite his asking for one.
Upon examination, the IRS argued that Roberts should have reported the withdrawals as taxable distributions because he was the owner of the IRAs and the person entitled to receive distributions, the distributions were deposited into a joint account, and they went toward “family living expenses.” The IRS also found it significant that Roberts never attempted to return the funds to the IRAs or contest the distributions once he discovered the payments.
Roberts claimed that he was not a payee or distributee of the funds because the IRA withdrawals were made pursuant to forged requests, the checks were stolen, the endorsement signatures were forged, and he had received no economic benefit.
The Tax Court concluded, based on common sense as well as its finding of fact and analysis, that Roberts was not a payee or distributee of the funds. The court noted that, although it has held that the distributee or payee of an IRA distribution is “generally” the participant or beneficiary entitled to receive the distribution, it has rejected the claim that the recipient is “automatically” the distributee.
The court also found that Roberts’s failure to timely pursue a state law remedy did not necessarily mean that he had received a taxable distribution from his IRA accounts. Thus, on the basis of the overall facts, the court concluded that Roberts did not fail to report any income attributable to the IRA distributions. Because the withdrawals were not distributions taxable to Roberts, he was not liable for the additional tax on early withdrawals.
However, the court ruled against Roberts on the issue of filing status. It reasoned that, because Roberts and Smith were still married on Dec. 31, 2008, and were not separated for the last six months of the year, the proper filing status was married filing separately.
The court also held that, to the extent that the final computations showed that his understatement of tax exceeded the greater of 10 percent of the tax required to be shown on the return or $5,000, Roberts would be liable for a substantial underpayment penalty (Andrew W. Roberts v. Commissioner, 141 TC No. 19, Dec. 30, 2013).
©2014 CPAmerica International
Smaller organizations that lost their exempt status for failure to file the required annual returns for three consecutive years can now retroactively reinstate the tax-exempt status.
Over the past few years, the IRS has attempted to inform organizations of their filing responsibilities and the consequence of failing to file.
Nonetheless, many organizations have failed to comply and have had their tax-exempt status automatically revoked.
Administrators and board members of an organization that has lost its tax-exempt status for failure to file the required returns should be aware of three new procedures outlined in Revenue Procedure 2014-11:
1. An organization that was eligible to file either Form 990-EZ, Short Form Return of Organization Exempt from Income Tax, or Form 990-N (e-Postcard) for each of the three consecutive years it failed to file – and that has not previously had its tax-exempt status automatically revoked – may use the following streamlined retroactive reinstatement process:
➜ Submit an application for reinstatement with the appropriate fee no later than 15 months after the later of the date of the IRS’s Revocation Letter or the date on which the IRS posted the organization’s name on the Revocation List – the list of organizations that have had their tax-exempt status revoked for failure to file returns.
➜ If approved, the organization will be deemed to have reasonable cause for its failures to file Forms 990-EZ or 990-N for three consecutive years, and it will be reinstated retroactively to the date of revocation.
➜ The IRS will not impose a penalty for failure to file the annual returns for the three consecutive tax years if the organization files properly completed and executed paper Forms 990-EZ for all such tax years. For any year that it was eligible to file a Form 990-N, the organization is not required to file a prior-year Form 990-N or Form 990-EZ for that year.
2. An organization that is not eligible to use the process described above may use the following:
➜ Submit a reinstatement application with the applicable fee no later than 15 months after the later of the date of the Revocation Letter or the date the IRS posted the organization’s name on the Revocation List.
➜ File properly completed and executed paper returns for:
◆ All tax years in the consecutive three-year period for which the organization was required to file annual returns but failed to do so, and
◆ Any other tax years after the consecutive three-year period for which required returns were due and not filed.
➜ Also include:
◆ A statement confirming that the paper returns have been filed, and
◆ A Reasonable Cause Statement, described in Section 8.01 of Rev. Proc. 2014-11, showing reasonable cause for its failure to file a required annual return or notice for at least one of the three consecutive years.
➜ If the organization’s application is approved, the IRS will not impose the penalty for the failure to file annual returns for the three consecutive tax years.
3. If it has been more than 15 months from the later of the date of the Revocation Letter or the date on which the IRS posted the organization’s name on the Revocation List:
➜ Follow the steps in the previous section, using instead the required Reasonable Cause Statement described in Section 8.02 of Rev. Proc. 2014-11, showing reasonable cause for its failure to file a required annual return or notice for all three years that it failed to file.
➜ If the organization’s application is approved, the IRS will not impose the penalty for the failure to file annual returns for the three consecutive tax years. ■
©2014 CPAmerica International
If you’re holding money in a traditional IRA, maybe it’s time for you to take another look at a Roth conversion.
Since the $100,000 income limitation was removed in 2010, you have no restriction on your ability to transfer funds from a traditional IRA to a Roth IRA – and no limit on the amount you can transfer.
You will have to pay tax currently on the amount of the transfer that would have been treated as a taxable distribution, if you had actually received the money. But the future benefits can be significant.
Future distributions, including profits, from the Roth account will escape tax entirely, provided you have had a Roth account in place for at least five years. Moreover, there is no required minimum distribution when you reach age 70½.
Statistics recently released by the IRS for 2010 – the latest year for which information is available – show that wealthier people are taking advantage of the Roth conversion opportunity in record numbers. Conversions increased more than nine times in 2010, rising to $64.8 billion from $6.8 billion in 2009, according to IRS data. That was the first year in which Roth conversions exceeded contributions.
The wealthiest Americans – those with estates large enough to be subject to the estate tax – receive an additional benefit. Any income taxes paid as a result of the conversion reduce future estate taxes. Without the conversion, the heirs will eventually pay the income taxes anyway, so the estate tax savings is a net benefit to the family.
A Roth conversion may not be for everyone, but you may wish to take a second look. If you convert in early 2014, you may not have to pay the resulting income taxes until April 15, 2015. That gives you more than a year to continue to use those tax dollars to enhance your retirement savings.
With the IRS relaxing the rules on in-plan Roth conversions, your 401(k) plan should also be considered as a conversion candidate if it offers a Roth account feature.
A foreign disregarded entity is treated as a foreign branch of a U.S. corporation for U.S. tax purposes.
The IRS defines a foreign disregarded entity (DE) as an “entity that is not created or organized in the United States and that is disregarded as an entity separate from its owner for U.S. income tax purposes.”
The IRS has issued a Chief Counsel Advice (CCA 201349015) providing guidance on the proper reporting of U.S. taxable income and the proper standard for calculating creditable foreign taxes imposed in transactions between a U.S. corporation and:
• Its DE or unincorporated branch; and
• An affiliated U.S. corporation’s foreign branch or disregarded entity.
All of the income of a foreign branch is included in the taxable income of its owner regardless of whether any of the income is actually distributed to the owner.
Transactions between a foreign branch or disregarded entity and its owner are generally disregarded for U.S. tax purposes, although a payment from the foreign branch or DE to its owner may be treated as a branch remittance requiring recognition of currency gain or loss.
The CCA concludes that, because a foreign branch or disregarded entity and its owner are treated as a single entity, transactions conducted between them do not give rise to income or expenses for U.S. tax purposes.
However, U.S. transfer pricing principles could be relevant to determining whether non-arm’s-length transfer pricing has occurred in transactions between a foreign branch or disregarded entity and its U.S. owner that has resulted in a noncompulsory payment of foreign tax that may not be eligible for a U.S. tax credit.
Transactions that are disregarded for U.S. tax purposes may nevertheless impact foreign taxes.
According to the CCA, a primary concern of a non-arm’s-length price between a U.S. taxpayer and its foreign branch or disregarded entity is that it may report too much income in the foreign country, resulting in the overpayment of foreign income tax.
The foreign tax credit regulations include a noncompulsory payment rule, which provides that a foreign tax is not creditable to the extent that the amount paid exceeds the amount that should have been owed under the applicable foreign law.
©2014 CPAmerica International
A federal district court has held that a transaction in which a corporation disposed of equipment and received like-kind property – but its parent company received cash and an obligation to pay the cash six months later – did not qualify for like-kind exchange treatment.
North Central Rental & Leasing is a wholly owned subsidiary of Butler Machinery Company. Butler is a dealer for Caterpillar. North Central is in the business of renting and leasing Caterpillar equipment.
North Central and Butler conducted almost 400 transactions that were structured similar to the following: North Central had old, low-basis equipment that it wanted to sell and replace with new equipment. North Central conveyed that equipment to a qualified intermediary (QI). The QI sold the equipment to an unrelated third party.
Butler purchased replacement equipment from Caterpillar. The replacement equipment was worth approximately the same amount as the old equipment. The QI used the money it received from the sale of the old equipment to purchase new equipment from Butler. The QI then transferred the new equipment to North Central.
As a result of this series of transactions, North Central gave up its old equipment and received new equipment. Butler received the cash proceeds from the sale of the old equipment. Under the terms of its dealer financing arrangement with Caterpillar, Butler was not required to pay over the cash for the new equipment for a period of six months.
The IRS argued that North Central and Butler collectively cashed in their investment in low-basis property. Although North Central continued to hold investment property after the exchange, Butler held only cash for up to six months until the due date of the Caterpillar invoice for the replacement property. North Central argued that Butler was eventually required to pay Caterpillar, so a cashing-out of its investment in like-kind equipment did not occur.
The court found that Butler’s receipt of cash in exchange for equipment, together with its unfettered access to the cash proceeds for a period of several months, rendered the gain on the like-kind exchange transactions recognizable by North Central. The court said that Butler used the cash in the normal course of business (North Central Rental & Leasing v. United States, DC ND, 112 AFTR 2d Paragraph 2013-5544, Sept. 3, 2013).
Essentially, the economic consequences of the exchanges between North Central and Butler provided Butler with cash for a period of up to six months, during which it was free to use the cash for any purpose it deemed necessary.
©2014 CPAmerica International
The IRS has provided new guidance on rollovers within a retirement plan to designated Roth accounts in the same plan – in-plan Roth rollovers.
For a Roth IRA, all contributions are after tax. No deduction is allowed. But amounts held in a Roth IRA that are withdrawn as a qualified distribution are not includable in income or subject to the 10-percent early withdrawal tax.
A qualified distribution is a distribution that is made:
Distributions from a Roth IRA that are not qualified distributions are includable in income to the extent attributable to earnings. They may also be subject to the 10-percent early withdrawal tax.
The 2012 Taxpayer Relief Act allows certain retirement plans to permit participants to elect in-plan Roth rollovers. The new Notice 2013-74 generally expands rules originally published in Notice 2010-84 to apply to all in-plan Roth rollovers, with some modifications.
For example, to be eligible for an in-plan Roth rollover, an amount must be vested. However, the rule that provides that an amount is not eligible for an in-plan Roth rollover unless it satisfies the rules for distribution under the tax code no longer applies.
The new notice provides that the following contributions and related earnings may now be rolled over to a designated Roth account in the same plan without regard to whether the amounts satisfy the conditions for distribution:
No withholding applies to an in-plan Roth rollover of an otherwise nondistributable amount. Further, no part of the rollover may be withheld for voluntary withholding. But an employee making an in-plan Roth rollover may need to increase his withholding or make estimated tax payments to avoid an underpayment penalty.
A plan amendment that provides for in-plan Roth rollovers of otherwise nondistributable amounts is a discretionary amendment. It must be adopted no later than the last day of the first plan year in which the amendment is effective.
However, to give plan sponsors sufficient time to adopt such an amendment and enable plan participants to make in-plan Roth rollovers of otherwise nondistributable amounts before the end of the 2013 plan year, the IRS is extending the deadline. Provided the amendment is effective as of the date the plan first operates in accordance with the amendment, the deadline is now the later of either:
©2014 CPAmerica International
