ABA Tax Section Mid-Year Meeting. Exploring the Intersection of the Federal Consolidated Return Rules and State Tax

Transcription

1 ABA Tax ection Mid-Year Meeting Exploring the Intersection of the Federal Consolidated Return Rules and tate Tax Dave Friedel, Washington National Tax (202) Rob Ozmun, Boston MA (617) January 24, 2014

2 Agenda Topic Contributions Distributions ection 304 Reorganizations Other Considerations Total Time 20 min. 35 min. 15 min. 15 min. 5 min. 90 min. Consolidated / tate Tax Issues 2

3 Overview Examples of rules which override separate return Code / Regs Reg (b) (shutting off ec. 304); -80(d) (shutting off ec. 357(c)); -80(e) (shutting off ec. 163(e)(5)); -80(f) (shutting off ec. 1031); -80(h) (shutting off ec. 362(e)(2)); -32 / -19 (replacing ec. 301(c)(2) and (3)); -13(f)(2) (shutting off ec. 311(a)); -13(f)(3) (shutting off ec. 356). Examples of rules which modify separate return Code / Regs Reg (c) (timing of worthless stock loss under ec. 165); -13(c) (any time the matching rule redetermines any attribute); -13(g) (extending ec. 108(e)(4) to broader universe of debt transactions); -33 (changing the members E& adjustments). 3

4 What s at stake? Only everything Amount Different basis in assets drives different depreciation / amortization etc, as well as different gain or loss on subsequent disposition; consider financial accounting implications (deferred tax assets / liabilities at applicable state tax rates). Different basis in stock drives different gain or loss on subsequent disposition / worthlessness; typically no DTA or DTL on subsidiary stock. Different characterization of transaction consider intercompany sales of stock. Timing Transactions that are deferred for federal purposes but recognized currently for state purposes. Gross gains recognized, gross losses deferred (ec. 267(f))! Attributes Gains and losses changed from capital to ordinary or vice-versa; ource of items changed from domestic to foreign or vice-versa; Etc. 4

5 Contributions 5

6 Contributions: Assets ubject to Liabilities Example 1 Federal eparate Return Rules Asset FMV: $80 Asset Basis(A/B): $10 Liabilities: $50 recognizes $40 gain! tock eparate Return Rules Under section 357(c), recognizes gain to the extent that: Under section 358, s basis in the stock received is equal to: $10 $50 +$40 s basis in s stock $0 Under section 362(d), s basis in the Asset is equal to: $10 +$40 (not limited under sec. 362(d)) $50 = $40 6

7 Contributions: Assets ubject to Liabilities Example 1 Federal Consolidated Return Rules Asset FMV: $80 Asset Basis(A/B): $10 Liabilities: $50 tock Consolidated Return Rules ection 357(c) does not apply. ee Treas. Reg (d). Under section 358, s basis in the stock received is equal to: Under section 362(d), s basis in the Asset is equal to: $10 $50 $40 Excess Loss Account (ELA) $10 $10 7

8 Contributions: Assets ubject to Liabilities Example 1 Comparison eparate Return Rules Consolidated Return Rules s basis in tock FMV: $30 A/B: $0 s Basis in tock FMV: $30 A/B: $40 ELA Assets and Liabilities FMV: $80 A/B: $50 Liabilities: $50 Assets and Liabilities FMV: $80 A/B: $10 Liabilities: $50 8

9 Contributions: Assets ubject to Liabilities Example 1 Considerations Federal Consolidated o s basis in tock = $40 ELA o s basis in Asset = $ 10 tate o Unitary / Consolidated states which adopt Treas. Reg (d) ame as above o Unitary tates that don t follow Treas. Reg (d) and eparate Co. tates s basis in tock =$0 s basis in Asset = $50 Question Does depreciate the additional basis in the asset? steps into s shoes and continues to depreciate s $10 Asset basis; depreciates the $40 step-up as a new asset. ection 168(i)(7). Opportunities and itfalls to Consider Implications if or has tate NOLs Tax rovision Implications on the Asset in the hands of Apportionment Other 9

10 Contributions: Assets ubject to Liabilities Example 2 Deemed Contributions Check closed Asset 1 FMV: $80 A/B: $10 Liabilities: $50 Asset 2 FMV: $130 A/B: $20 Liabilities: $15 s assets Deemed Transaction tock How does section 357(c) apply in the separate/consolidated context? 10

11 Contributions: Assets ubject to Liabilities Example 2 Considerations Federal Consolidated o s basis in tock = $35 ELA o s basis in Asset #1 = $ 10 o s basis in Asset #2 = $ 20 tate o Unitary / Consolidated states which adopt Treas. Reg (d) ame as above o Unitary tates that don t follow Treas. Reg (d) and eparate Co. tates s basis in tock =$ 0; recognize $35 gain Next step is unclear we ll assume allocates the additional basis ratably by FMV. s basis in Asset #1 = $23 s basis in Asset #2 = $42 Opportunities and itfalls to Consider Implications if or has tate NOLs Tax rovision Implications on the Asset in the hands of Other 11

12 Contributions: Built-in Gain Assets Example 3 Asset FMV: $70 A/B: $60 tock A/B: $200 +$60 $260 Asset FMV: $70 A/B: $60 ince the asset transfer has a built in gain IRC 362(e) does not apply 12

13 Contributions: Built-in Gain Assets Example 3 Comparison eparate Return Rules Consolidated Return Rules s basis in tock A/B: $260 s Basis in tock A/B: $ 260 Assets FMV: $70 A/B: $60 Assets FMV: $70 A/B: $60 13

14 Contributions: Built-in Gain Assets Example 3 Considerations Federal Consolidated o s basis in tock = $260 o s basis in Asset = $ 60 tate o s basis in tock =$260 o s basis in Asset = $60 14

15 Contributions: Built-in Loss Assets Example 4 Asset FMV: $30 A/B: $50 tock A/B: $200 A/B: $250 Default Rule A/B: $230 Election eparate Return: ection 362(e)(2) applies. Asset FMV: $30 A/B: $30 Default Rule A/B: $50 Election Default Rule: increases basis in stock; takes stepped-down basis in Asset. Election: takes fair market value basis in stock; carryover basis in Asset. In addition to election, and must enter into separate legal agreement. Consequences for failed election: Tax, financial accounting. Consolidated Return: ection 362(e)(2) turned off. Treas. Reg (h). 15

16 Contributions: Built-in Loss Assets Example 4 Comparison Default Rule With Election Consolidated Rules A/B: $250 A/B: $230 A/B: $ 250 Assets FMV: $30 A/B: $30 Assets FMV: $30 A/B: $50 Assets FMV: $30 A/B: $50 16

17 Contributions: Built in Loss Asset Example 4 Considerations Federal Consolidated o s Basis in s tock = $250 o s Basis in Asset = $ 50 tate o Unitary / Consolidated states which adopt Treas. Reg (h). ame as above o Unitary tates that don t follow Treas. Reg (h) and eparate Co. tates Default Rule s Basis in s tock =$250 s Basis in Asset = $30 With Election s Basis in s tock =$230 s Basis in Asset = $50 Question How does treat the built-in loss for depreciation purposes? calculates depreciation using its $30 basis does not deduct the $20 basis step-down since doing so would double count the loss already appropriately reflected in s basis in shares Opportunities and itfalls to Consider 17

18 Contributions: Built-in Gain and Loss Assets Example 5 Asset 1 Asset 2 FMV: $70 FMV: $30 A/B: $60 A/B: $50 tock A/B: $200 Check closed Asset 1 FMV: $70 A/B: $60 A/B: $60 A/B: $310 Default Rule A/B: $300 Election Asset 2 FMV: $30 A/B: $40 Default Rule A/B: $50 Election ection 362(e)(2) applies. Test looks at aggregate FMV and aggregate basis. Default Rule: increases basis in stock; takes stepped-down basis in Asset. Election: takes fair market value basis in stock; carryover basis in Asset. Financial accounting risks. Consider filing protective election. 18

19 Contributions: Built-in Gain and Loss Assets Example 5 Comparison Default Rule With Election Consolidated A/B: $310 A/B: $300 A/B: $ 310 Assets Asset #1 FMV: $70 Asset #1 A/B: $60 Asset #2 FMV: $30 Asset #2 A/B: $40 Assets Asset #1 FMV: $70 Asset #1 A/B: $60 Asset #2 FMV: $30 Asset #2 A/B: $50 Assets Asset #1 FMV: $70 Asset #1 A/B: $60 Asset #2 FMV: $30 Asset #2 A/B: $50 19

20 Contributions: Built-in Gain and Loss Assets Example 5 Considerations Federal Consolidated o s basis in tock = $310 o s basis in Asset #1 = $ 60 o s basis in Asset #2 = $ 50 tate o Unitary / Consolidated states which adopt Treas. Reg (h). ame as above o Unitary tates that don t follow Treas. Reg (h) and eparate Co. tates Default Rule s basis in tock =$310 s basis in Asset #1 = $60 s basis in Asset #2 = $40 With Election s basis in tock =$300 s basis in Asset #1 = $60 s basis in Asset #2 = $50 Opportunities and itfalls to Consider 20

21 Taxable Distributions 21

22 Distributions eparate Return Rules Cash/Note Review DRD rules under ec. 243: 70% 80% for 20% corporate shareholder 100% for affiliated group paid out of E& generated in taxable years when and were affiliated for every day. 22

23 Distributions eparate Return Rules Cash/Note ection 301(c): Distribution treated as: Dividend to the extent of s E&, then Return of basis, and then Gain from the sale/exchange of property. ection 301(e) must recompute its E& when making distribution to 20% shareholder. MACR; many E& addbacks turned off. ection 1059 must reduce basis in recently acquired stock on which extraordinary dividends are paid. 2-year holding period. tate Tax Considerations Consider state tax basis and state E&. 23

24 Distributions Consolidated Return Rules Cash/Note Treas. Reg (f), -32 s E& is irrelevant. Full amount of the distribution is eliminated from s income. s basis in is reduced by full amount of distribution. Can create an excess loss account. tate Tax Considerations Consider unitary vs non-unitary implications. For example California, Massachusetts, Wisconsin states where pre-unitary E& can impact the elimination / DRD Illinois, Minnesota states where pre-unitary does not typically impact the elimination / DRD Consider nexus consolidated filings (e.g Indiana, Iowa,) Consider post-apportioned consolidated filings (e.g Connecticut, Georgia, etc) 24

25 Distributions: Built-in Gain Asset eparate Return Rules Asset FMV: $400 A/B: $300 E& Accum.: $900 Current: $100 +$100 $200 Consequences to recognizes gain on the distribution of appreciated property. ection 311(b). Consider regular tax basis vs. E& basis. s E& is increased by the gain. ection 312(b)(1). = $100 s E& (to the extent thereof) is then reduced by the FMV of Asset. ection 312(a)(3) and (b). Consequences to ection 301 applies. Consider timing rules with respect to E&. s gain can fund the dividend. takes a fair market value basis in Asset. Consider impact on depreciation life of Asset. Note that the FMV is the full distribution to and as such should be what is considered when determining the state DRD rules 25

26 Distributions: Built-in Loss Asset eparate Return Rules Asset FMV: $400 A/B: $650 E& Accum.: $900 Current: $100 Consequences to does not recognize a loss on the distribution of built-in loss property. ection 311(a). s E& (to the extent thereof) is reduced by the adjusted basis of Asset (not FMV). ection 312(a)(3). Consequences to ection 301 applies. Consider timing rules with respect to E&. takes a fair market value basis in Asset. Consider impact on depreciation life of Asset. 26

27 Distributions: Built-in Gain and Loss Assets eparate Return Rules ection 311(b) applies on a gross basis. Each built-in gain and built-in loss property must be considered separately. Asset 1 FMV: $70 A/B: $60 E& Accum.: $900 Current: $100 Asset 2 FMV: $30 A/B: $50 27

28 Distributions: Built-in Gain or Loss Assets Consolidated Return Rules BIG Asset Asset FMV: $400 A/B: $300 Consequences to Consequences to recognizes gain, which is deferred subject to the matching and acceleration rules. Full amount of the distribution is eliminated from s income. s basis in is reduced by full amount of distribution. Can create an excess loss account. takes a fair market value basis in Asset. BIL Asset Consequences to ection 311(a) turned off. recognizes loss, which is deferred subject to the matching and acceleration rules. Asset Losses triggered via FMV: $400 depreciation. A/B: $650 Consequences to Full amount of the distribution is eliminated from s income. s basis in is reduced by full amount of distribution. Can create an excess loss account. takes a fair market value basis in Asset. 28

29 Distributions: Built-in Gain and Loss Assets Consolidated Return Rules Mixed Assets Asset 1 FMV: $70 A/B: $60 Asset 2 FMV: $30 A/B: $50 Consequences to ection 311(a) is turned off. recognizes gains and losses. Gains and losses are deferred subject to the matching and acceleration rules. Gains and losses triggered via depreciation. Consequences to Full amount of the distribution is eliminated from s income. s basis in is reduced by full amount of distribution. Can create an excess loss account. takes a fair market value basis in Asset. 29

30 Distributions: Built-in Gain and Loss Asset Example 6 Comparison eparate Return Rules Mixed Assets Asset 1 FMV: $70 A/B: $70 Asset 2 FMV: $30 A/B: $30 Consolidated Return Rules Mixed Assets Asset 1 FMV: $70 A/B: $70 Asset 2 FMV: $30 A/B: $30 Consequences to Asset 1: recognizes $10 gain Asset 2: $20 loss disallowed Consequences to Asset 1: $10 gain recognized and deferred Asset 2: $20 loss recognized and deferred Consequences to receives section 301 distribution Asset 1 Basis = $70 Asset 2 Basis = $30 Consequences to No income or gain stock Basis = reduced by $100 Asset 1 Basis = $70 Asset 2 Basis = $30 30

31 ection

32 ection 304: Built-in Gain eparate Return Rules FMV: $1,450 A/B: $500 T tock A $600 Note FMV: $600 A/B: $200 T E&: $300 E&: $150 ection 304(a)(1) applies Deemed transactions s basis in hypothetical A stock determined under section 358. A s basis in T stock determined under section 362. Amount receives treated as a dividend to the extent of A s E& then T s E&. Deemed Transaction #1 Contribution T tock A A tock T Deemed Transaction #2 Redemption Deemed A tock A T Note 32

33 ection 304: Built-in Gain eparate Return Rules FMV: $1,450 A/B: $500 T tock A $600 Note FMV: $600 A/B: $200 T E&: $300 E&: $150 ection 304(a)(1) applies Deemed transactions s basis in hypothetical A stock determined under section 358. A s basis in T stock determined under section 362. Amount receives treated as a dividend to the extent of A s E& then T s E&. Deemed Transaction #1 Contribution REMEMBER: 1. Re-compute A s and T s E& under sec. T tock 301(e) ( is a 20% corporate shareholder ) A 2. Every dividend A tock arising under ec. 304 is extraordinary (1059) T Deemed Transaction #2 Redemption Deemed A tock A T Note 33

34 ection 304: Built-in Loss eparate Return Rules T tock FMV: $1,450 A/B: $500 A Note FMV: $600 A/B: $800 T E&: $300 E&: $150 Deemed Transaction #1 Contribution T tock A A tock T Deemed Transaction #2 Redemption Deemed A tock A T Note 34

35 ection 304 Consolidated Return Rules ection 304(a)(1) turned off by Treas. Reg (b) T tock A Note FMV: $600 A/B: $200 T Treated as a taxable stock sale. Gain or loss on the transaction is deferred subject to the matching and acceleration rules. 35

36 ection 304: Built-in Gain or Loss Considerations Federal Consolidated o Gain o recognizes a $400 gain on the sale. The gain is deferred. o s basis in T shares = $500 o A s basis in T shares = $600 o Loss o recognizes a $200 loss on the sale. The loss is deferred. o s basis in T shares = $500 o A s basis in T shares = $600 tate o Unitary / Consolidated states which adopt Treas. Reg (b) ame as above o eparate Co. tates Gain s dividend income = $450 s basis in A shares = $550 (?!) A s basis in T shares = $200 Opportunities and itfalls to Consider o eparate Co. tates Loss Default Rule s dividend income = $450 s basis in A shares = $1,150 (?!) A s basis in T shares = $600 With section 362(e)(2) election s dividend income = $450 s basis in A shares = $950 (?!) A s basis in T shares = $800 36

37 Reorganizations 37

38 Brother-sister Merger with Boot eparate Return Rules T is an historic subsidiary in the group A T Merger w/$300 of boot FMV: $600 A/B: $200 T s E& = $250 Consequences to T T does not recognize gain on receipt of boot to the extent it distributes it to. ection 361(b)(1). T does not recognize loss on the receipt of boot. ection 361(b)(2). T recognizes gain (but not loss) on distribution of appreciated boot to. ection 361(c)(2). ee Rev. Rul Consequences to recognizes gain on exchange but not in excess of boot received. ection 356(a)(1). $300 To the extent of applicable E&, such gain may be treated as a dividend if the receipt of boot has the effect of a dividend. ection 356(a)(2). $250 s basis in the A stock received is the same as the T stock surrendered decreased by the boot received and increased by the amount of gain recognized and the amount treated as a dividend. $200 - $300 + $50 + $250 = $200 38

39 pin-offs 2007 Congress amended sec. 355 to liberalize the active trade or business requirements inside affiliated groups IR/Treasury revised the intercompany obligation rules. As revised, Reg. ec (g)(3)(i)(B)(7) makes it clear groups don t recognize gain under the deemed satisfaction rules where an intercompany debt is created and then promptly distributed to a non-member under sec. 361(c). The IR has issued private rulings applying this rule. ee LTRs (Ruling #22), (Ruling #7), (Ruling #7), and (Ruling #7). Immediate gain recognition was arguably required under the former regulations, although the IR liberally ruled no gain was triggered. ee LTRs (Ruling 18), (Ruling 22), (Ruling 9), (Ruling 8), (Internal Debt ayment Ruling 1), (Ruling 17), (Ruling 17), (Ruling 12), (Rulings 10 and 11), (Ruling 3). 39

40 pin-offs California conforms to the consolidated return intercompany transaction rules. Reg (a). That regulation applies to intercompany transactions occurring on or after January 1, ee Reg (k)(1). rior to its recent amendment, that rule incorporated Reg as amended through March 17, April, 2010 California adopted the IRC as of 2009 (.B. 401). November, 2010 California voters passed rop. 26, amending CA constitution to require 2/3 approval for any bills that raise taxes. January, 2011 FTB announced it will follow the 09 Code until.b. 401 is superseded by future legislation or invalidated by an appellate court. Legal Division Guidance January, 2014 California revised its conformity regulation. As revised, California now conforms to Reg as amended through April 1, This regulation is still retroactively effective (to intercompany transactions on or after Jan 1, 2001) but taxpayers may elect to apply certain amendments prospectively. ee Reg (k)(2). 40

41 Brother-sister Merger with Boot Consolidated Return Rules A T Merger w/$300 of boot FMV: $600 A/B: $200 Treas. Reg (f)(3) ection 356 and 361 turned off with respect to boot. Treat merger as an all-stock transaction followed by A redeeming any deemed stock for the actual boot in a separate (post-reorg) redemption transaction. Generally qualifies as a section 301 distribution. Merger Consequences Consequences to T T does not recognize gain or loss on the receipt of A stock. ection 361(a). T does not recognize gain or loss on transfer of A stock to. ection 361(c). Consequences to does not recognize gain or loss on the receipt of A stock. ection 354. s basis in A stock received is same as in T stock. Consequences to A A does not recognize gain or loss on the issuance of its stock. ection Redemption Consequences Consequences to A If A distributes property (rather than cash) A recognizes and defers gain or loss on the redemption. ection 311; Treas. Reg (f). Consequences to The full amount of the distribution is eliminated from s gross income. takes a fair market value basis in the boot. s basis in A stock is reduced by the full amount of the distribution. Can create an excess loss account. $200 - $300 = $100 ELA 41

42 Brother-sister Merger with Boot Comparison / Considerations Federal Consolidated o recognizes no gain or loss. o has a $100 ELA in a new block of A stock. o A recognizes and defers any gain or loss on the distribution of boot. tate o Unitary / Consolidated states which adopt Treas. Reg (f)(3) ame as above o Unitary tates that don t follow Treas. Reg (f)(3) and eparate Co. tates has $250 of dividend income and $50 of gain. s basis in its A stock remains $200. T recognizes gain, but not loss, on the distribution of boot. Opportunities and itfalls to Consider Consolidated / tate Tax Issues November

43 Other Considerations 43

44 What else should trigger a conversation? Distributions ay attention where item will be reported differently for federal and state purposes $100 cash A/B: $60 E&: $0 Federal: No gain; basis reduction. tate: Gain under section 301(c)(3). 44

45 What else should trigger a conversation? Character Differences Investor Land $$$ Land B Dealer Land $$$ Land X Land ay attention where item will be reported differently for federal and state purposes Federal: Character of eller s items may be changed to ensure matching. tate: What if states don t follow? 45

46 ection 1031 Like-kind Exchanges eparate Return Intercompany Transaction Whiteacre Blackacre B Whiteacre Blackacre B No gain or loss recognized on exchange if: property held for investment or use in a trade or business is exchange solely for property of like kind to be held for investment or use in a trade or business ection 1031 turned off. Treas. Reg (f). Exchange taxable under section