NEW YORK NOVEMBER 11, Blank Rome Tax Update

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1 NEW YORK NOVEMBER 11, 2015 Blank Rome Tax Update

2 Tax Update The Accountant s Role in the Mergers and Acquisitions Process 11/11/2015 Blank Rome LLP Joseph T. Gulant Cory G. Jacobs Jeffrey M. Rosenfeld Definitions Taxes Tax or Taxes means (a) any foreign, federal, state or local income, earnings, profits, gross receipts, franchise, capital stock, net worth, sales, use, value added, occupancy, general property, real property, personal property, intangible property, transfer, fuel, excise, escheat, unclaimed property, payroll, withholding (including under Section 409A of the Code), unemployment compensation, social security, retirement, environmental (including any Taxes imposed under Section 59A of the Code) or other tax of any nature; (b) any foreign, federal, state or local organization fee, qualification fee, annual report fee, filing fee, occupation fee, assessment, sewer rent or other fee or charges of any nature; or (c) any deficiency, interest or penalty imposed with respect to any of the foregoing. Tax Returns means all returns and reports, amended returns, information returns, statements, declarations, estimates, schedules, notices, notifications, forms, elections, certificates or other documents required to be filed or submitted to any Government Entity with respect to the determination, assessment, collection or payment of any Tax or in connection with the administration, implementation or enforcement of, or compliance with, any Tax. 3 1

3 Definition Working Capital Net Working Capital means the difference between (a) Current Assets of the Company as of the close of business on the Closing Date, and (b) Current Liabilities of the Company as of the close of business on the Closing Date. Current Assets means, without duplication, the sum of (a) Cash, (b) trade and other accounts receivable, (c) prepaid expenses (including prepaid Taxes), (d) Inventory, and (d) other current assets, but excluding any deferred Tax asset reflected on the Closing Statement to record differences between book and Tax income, all as defined herein or if not defined herein determined in accordance with GAAP. Current Liabilities means, without duplication, the sum of (a) trade and other accounts payable, (b) accrued liabilities (including accrued Taxes), and (c) other current liabilities, but excluding any (x) Indebtedness and Transaction Expenses, (y) deferred Tax liabilities reflected on the Closing Statement to record differences between book and Tax income and (z) any amounts required to be shown as a liability pursuant to ASC 740, all as defined herein or if not defined herein determined in accordance with GAAP. 4 Defining Excluded Liabilities in an Asset Purchase Agreement Excluded Liabilities includes any Liability for (i) Taxes of the Seller (or any Affiliate of the Seller) or relating to the operation of the Business for any pre-closing Tax period (or portion thereof); (ii) any Tax payable by the Seller with respect to the ownership, possession, purchase, lease, sale, disposition or use of any of the Business, Purchased Assets or the Assumed Liabilities for taxable periods (or portions thereof) ending on or before the Closing Date; and (iii) Taxes that (x) arise out of the consummation of the Transactions or (y) are the responsibilities of the Seller pursuant to Section [ ] [Transfer Taxes]; provided, however, any Liabilities for Taxes included as a Current Liability in the calculation of Net Working Capital pursuant to Section [ ][Working Capital Adjustments] shall be an Assumed Liability. (asset purchase) 5 2

4 Purchase Price and Net Working Capital Adjustments Subject to any adjustments set forth in Section [ ] [Net Working Capital Adjustments] herein, the aggregate purchase price for the Purchased Assets shall be $ which shall be comprised of: (a) $ (the Initial Cash Payment ) plus (b) $ (the Escrow Amount ). Within three (3) Business Days prior to the Closing Date, Seller shall prepare and deliver to Buyer a certificate executed by a duly authorized officer of Seller which contains an estimated unaudited closing statement of Seller as of the Closing Date (the Estimated Closing Statement ), which Estimated Closing Statement shall set forth Seller s good faith estimate of the Current Assets, the Current Liabilities and the Net Working Capital (the Estimated Working Capital ). The Estimated Closing Statement shall be prepared in accordance with the Accounting Policies and presented in the same format as the Sample Net Working Capital Calculation. On the Closing Date, the Estimated Working Capital will be compared to the Target Working Capital. If the Target Working Capital (i) is less than the Estimated Working Capital, the Initial Cash Payment shall be increased by an amount equal to the difference between the Estimated Working Capital and the Target Working Capital, or (ii) exceeds the Estimated Working Capital, the Initial Cash Payment shall be decreased by an amount equal to the difference between the Target Working Capital and the Estimated Working Capital. 6 Purchase Price and Net Working Capital Adjustments Within seventy-five (75) days following the Closing Date, Buyer shall prepare and deliver to Seller a certificate executed by a duly authorized officer of Buyer which contains an unaudited statement (the Proposed Closing Statement ), setting forth Buyer s proposed calculation of the Current Assets, the Current Liabilities and the Net Working Capital as of the Closing Date (the Closing Working Capital ), and including reasonable supporting documentation showing the calculation of such amounts reflected in the Proposed Closing Statement and, upon reasonable request, all work sheets, account reconciliations and schedules used in the preparation of the Proposed Closing Statement and other reasonable supporting documentation showing the calculation of such amounts set forth therein. The Proposed Closing Statement shall be prepared in accordance with the Accounting Policies and presented in the same format as the Sample Net Working Capital Calculation. Seller and Seller s accountants shall have reasonable access to the relevant books and records of Seller, the personnel of Buyer (provided that access to Buyer s personnel shall be during normal business hours and with the consent of Buyer, not to be unreasonably withheld) and all other information reasonably requested by Seller upon reasonable notice to Buyer to the extent it relates to the Proposed Closing Statement. 7 3

5 Purchase Price and Net Working Capital Adjustments Buyer s calculation of the Closing Working Capital, as set forth in the Proposed Closing Statement, shall be final, conclusive, binding and non-appealable unless, within forty-five (45) days after delivery to Seller (the Review Period ), Seller gives notice to Buyer of an objection to the calculation of the Closing Working Capital setting forth in reasonable detail the basis for such objection (the Objection Notice ). If the Objection Notice is timely given by Seller, Buyer and Seller shall attempt in good faith to resolve such disputed items therein described. Buyer agrees to provide Seller with a reasonable extension of the Review Period if Seller so requests in good faith. In the event that Buyer and Seller are unable to reach agreement with respect to such disputed items within thirty (30) days after the Objection Notice has been given, Buyer and Seller shall jointly retain and refer their disagreements to the Independent Accountant. Buyer and Seller shall instruct the Independent Accountant promptly to review this Section [ ]and to determine solely with respect to the disputed items and amounts so submitted on the Objection Notice which remain in dispute. Buyer and Seller shall instruct the Independent Accountant to select one of its partners experienced in purchase price adjustment disputes to make a final determination of the Closing Working Capital calculated with reference to the items that are in dispute as set forth in the Objection Notice. The Independent Accountant shall base its determination solely on written submissions by Buyer and Seller and the terms of this Agreement and not on an independent review. Buyer and Seller shall each make available to the Independent Accountant all relevant books and records and other items reasonably requested by the Independent Accountant. 8 Purchase Price and Net Working Capital Adjustments As promptly as practicable, but in no event later than thirty (30) days after its retention, the Independent Accountant shall deliver to Buyer and Seller a written report which sets forth its resolution of the disputed items and whether and to what extent, if any, the Closing Working Capital, as calculated by Buyer, requires adjustment; provided, however, that in no event may the Independent Accountant assign a value to any item in dispute greater than the greatest value assigned by Buyer, on the one hand, or Seller, on the other hand, or less than the smallest value for such item as assigned by Buyer, on the one hand, or Seller, on the other hand. The decision of the Independent Accountant shall be final, conclusive, binding and non-appealable. The fees, costs and expenses of the Independent Accountant shall be borne by the party whose calculation of Closing Working Capital, is furthest from the Independent Accountant s calculation; provided, however, that in the event that the party whose calculation is furthest from the Independent Accountant s is less than ten percent from the Independent Accountant s calculation with respect to Closing Working Capital, the fees, costs and expenses of the Independent Accountant shall be borne one-half by Buyer and one-half by Seller. Otherwise, Seller and Buyer shall each pay their own fees and expenses related to such Independent Accountant s arbitration. 9 4

6 Purchase Price and Net Working Capital Adjustments For purposes of this Agreement, Final Working Capital means Closing Working Capital: (i) as shown in the Proposed Closing Statement delivered by Buyer to Seller pursuant to Section [ ], if no Objection Notice with respect thereto is timely delivered by Seller to Buyer pursuant to Section [ ]; or (ii) if an Objection Notice is so delivered, (a) as agreed by Buyer and Seller pursuant to Section [ ], or (b) in the absence of such agreement, as shown in the Independent Accountant s calculation delivered pursuant to Section [ ]. The Proposed Closing Statement shall be revised, if necessary, to reflect the ultimate determination of the Final Working Capital (the final form of the Proposed Closing Statement, including any revisions which are made thereto pursuant to this Section [ ], is referred to herein as the Final Closing Statement ). 10 Purchase Price and Net Working Capital Adjustments Within three (3) Business Days after the Final Working Capital has been ultimately determined pursuant to this Section [ ], the Purchase Price shall be adjusted in accordance with the following: if the Final Working Capital as reflected on the Final Closing Statement is less than the Estimated Working Capital (the amount of such shortfall, if any, is hereinafter referred to as the Final Working Capital Deficit ), then Buyer shall be entitled to claim from the Escrow Fund an amount equal to such Final Working Capital Deficit; or if the Final Working Capital as reflected on the Final Closing Statement is greater than the Estimated Working Capital (the amount of such excess, if any, is hereinafter referred to as the Final Working Capital Surplus ), Buyer shall pay to Seller an amount equal to the Final Working Capital Surplus, by wire transfer of immediately available funds to an account designated in writing by Seller or its designee at least one (1) Business Day prior to such transfer. 11 5

7 Earnout Payments If, with respect to the FY2015 Earnout Period, the EBITDA of the Company is equal to or greater than the FY2015 EBITDA Target, the FY2015 Earnout Payment shall equal the FY2015 Maximum Earnout. If, with respect to the FY2015 Earnout Period, the EBITDA of the Company is less than the FY2015 EBITDA Target but equal to or greater than the FY2015 EBITDA Minimum, then the FY2015 Earnout Payment shall decrease linearly, such that the FY2015 Earnout Payment shall equal the FY2015 Minimum Earnout, plus (( A B ) / ( E B )) x ( C D ), where A equals the EBITDA of the Company for the FY2015 Earnout Period, B equals the FY2015 EBITDA Minimum, C equals the FY2015 Maximum Earnout, D equals the FY2015 Minimum Earnout, and E equals the FY2015 EBITDA Target. If, with respect to the FY2015 Earnout Period, the EBITDA of the Company is less than the FY2015 EBITDA Minimum, the FY2015 Earnout Payment shall be $0. Note: FY2015 EBITDA Minimum, FY2015 Maximum Earnout, FY2015 Minimum Earnout, the FY2015 EBITDA Target can be any amount agreed to by the Buyer and Seller. 12 Purchase Price Allocation (Asset Purchase Agreement and Stock Purchase Agreement with 338(h)(10) The Purchase Price (which for these purposes shall include the Assumed Liabilities) shall be allocated among the Purchased Assets acquired from Seller and the non-competition covenants set forth in Section [ ]. Buyer shall prepare in good faith consultation with Seller an allocation ( Allocation Statement ) of the Purchase Price among the Purchased Assets acquired from Seller and such noncompetition covenants in accordance with Section 1060 of the Code and the applicable Treasury Regulations promulgated thereunder (and any similar provision of state, local or foreign Law, as appropriate). Notwithstanding the foregoing, the parties acknowledge and agree that the consideration paid for the non-competition covenants set forth in Section [ ] shall be equal to $[ ]. Buyer shall deliver the Allocation Statement to Seller no later than sixty (60) days after the Closing Date. Seller shall notify Buyer of any objections to the Allocation Statement within twenty-five (25) days after Seller receives the Allocation Statement (the Seller Allocation Statement Review Period ). If Seller does not notify Buyer of any objections to the Allocation Statement prior to the expiration of the Seller Allocation Statement Review Period, the Allocation Statement shall be construed as final. If Seller notifies Buyer of an objection to the Allocation Statement by the end of the Seller Allocation Statement Review Period, and Seller and Buyer are unable to resolve their differences, acting in good faith, within fifteen (15) days thereafter, then the disputed items on the Allocation Statement shall be submitted to the Independent Accountant for resolution, with the fees and expenses of the Independent Accountant paid one-half by Buyer and one-half by Seller, and the Independent Accountant shall be instructed to deliver a finalized Allocation Statement as soon as possible. 13 6

8 Purchase Price Allocation (cont.) (Asset Purchase Agreement and Stock Purchase Agreement with 338(h)(10) All Tax Returns of Seller and Buyer shall be filed consistently with the information set forth on the Allocation Statement. Moreover, Seller and Buyer further agree to file IRS Form [8594 for APA] or [8883 for SPA] (and any corresponding form required to be filed by a state or local Taxing Authority) in a manner that is consistent with the information on the Allocation Statement. Seller and Buyer agree to promptly provide each other with any information necessary to complete such Tax Returns and IRS Forms [8594 for APA] or [8883 for SPA] (and any corresponding form required to be filed by a state or local Taxing Authority). Seller and Buyer shall not take any position on a Tax Return, Tax Action or audit that is inconsistent with any information set forth on the Allocation Statement except to the extent required otherwise by applicable Law; provided, however, that (i) Buyer s cost for the Purchased Assets may differ from the total amount allocated hereunder to reflect the inclusion in the total cost of items (for example, capitalized acquisition costs) not included in the total amount so allocated and (ii) the amount realized by Seller may differ from the total amount allocated hereunder to reflect transaction costs that reduce the amount realized for federal income Tax purposes. 14 Purchase Price Allocation (cont.) (Asset Purchase Agreement and Stock Purchase Agreement with 338(h)(10) Allocation of Purchase Price. No later than one hundred twenty (120) days after the Closing Date, Buyer and Sellers shall jointly prepare a statement (the Allocation Schedule ) to allocate the sum of the Purchase Price among the assets of the Company, including specifically those assets under Section 751 of the Code. The Parties, based upon the Purchase Price Allocation set forth on the Allocation Schedule, shall prepare and file their respective Tax Returns consistent with Allocation Schedule, unless otherwise prohibited by applicable Law, including any requirements to file any applicable statements required pursuant to Sections 743, 751 and 754 of the Code and the applicable Treasury Regulations thereunder. The Parties shall take no positions contrary thereto in any Tax Return or other Tax filing or proceeding unless otherwise required by applicable Law. Any disputes with respect to the preparation of the Allocation Schedule shall be resolved by the Tax Dispute Accountants. 15 7

9 Tax Representations (General) All Tax Returns of the Company have been timely filed in accordance with applicable Laws, and each such Tax Return is true, correct and complete in all material respects. The Company has timely paid all [material] Taxes due with respect to the taxable periods covered by such Tax Returns (whether or not shown on any Tax Return). The Company has not requested an extension of time within which to file any Tax Return which has not since been filed. Sellers have delivered to Buyer true, correct and complete copies of all Tax Returns of the Company for the prior five (5) Tax years. The Company has complied with the provisions of the Code relating to the withholding and payment of [material] Taxes, including, without limitation, the withholding and reporting requirements under Code Sections 1441 through 1464, 3401 through 3406, and 6041 through 6049, as well as similar provisions under any other Laws, and has, within the time and in the manner prescribed by Law, withheld from employee wages and paid over to the proper Taxing Authorities all amounts required. The Company has accurately classified all service providers as either employees or independent contractors for all Tax purposes. The Company (i) has collected and remitted all applicable sales and/or use Taxes to the appropriate Taxing Authority, or (ii) has obtained, in good faith, any applicable sales and/or use Tax exemption certificates. There are no liens for Taxes related to the Business other than Permitted Liens upon any of the Acquired Assets. Permitted Liens includes (a) Liens for Taxes or assessments and similar charges, which either are (i) not delinquent or (ii) being contested in good faith and by any appropriate Action or Proceeding. 16 Tax Representations (General) (cont.) There is no [written] claim against the Company for any Taxes which are owed by the Company and due under applicable Law, but have not been paid in full, and no assessment, deficiency, or adjustment has been asserted, proposed, or threatened [in writing] with respect to any Tax Return of or with respect to the Company. No [written] claim has ever been received by the Company from any Taxing Authority in a jurisdiction where the Company does not file Tax Returns that it is or may be subject to taxation in the jurisdiction. The Company is not currently, and has never been, subject to a Tax audit by a Taxing Authority or Governmental Authority. All Tax deficiencies that have been claimed, proposed, or asserted against the Company have been fully paid or finally settled, and no issue has been raised in any examination which, by application of similar principles, could be expected to result in the proposal or assertion of a Tax deficiency for any other year not so examined. None of Sellers is a foreign person as such term is defined in Section 1445 of the Code. 17 8

10 Tax Representations (Equity Purchase) The Seller has not waived any statute of limitations in respect of Taxes or agreed to any extension of time with respect to any Tax assessment or deficiency that has continuing effect (equity purchase) The Company is not a party to or bound by any Tax sharing agreement, Tax indemnity obligation or similar Contract or practice with respect to Taxes (including any advance pricing agreement, Tax Closing Agreement or other agreement relating to Taxes with any Governmental Authority). (equity purchase) The Company will not be required to include any material item of income (including income resulting from an adjustment under Section 481(a) of the Code (or any similar provision of applicable state, local or foreign Law)) in, or exclude any material item of deduction from, taxable income for any period (or any portion thereof) ending after the Closing Date as a result of any (i) installment sale or other transaction on or prior to the Closing Date, (ii) Tax Closing Agreement pursuant to Section 7121 of the Code or any corresponding provision of state, local or foreign Tax Law, (iii) accounting method change or agreement with any Taxing Authority, (iv) prepaid amount received on or prior to the Closing Date, or (v) income from discharge of Indebtedness deferred pursuant to Section 108(i) of the Code or any corresponding provision of state, local or foreign Tax Law. (equity purchase) 18 Tax Representations (Equity Purchase) (cont.) The Company has not (i) acquired assets from another corporation in a transaction in which the Company s bases for the acquired assets was determined, in whole or in part, by reference to the tax basis of the acquired assets (or any other property) in the hands of the transferor or (ii) acquired the stock of any corporation that is a qualified subchapter S subsidiary. (equity purchase) The Company has not constituted either a distributing corporation or a controlled corporation in a distribution of stock intended to qualify for tax-free treatment under Section 355 of the Code (i) in the two (2) years prior to the date of this Agreement or (ii) in a distribution which could otherwise constitute part of a plan or series of related transactions (within the meaning of Section 355(e) of the Code) in conjunction with the transactions contemplated by this Agreement. (equity purchase) The Compilation Financial Statements fully accrue all Liabilities for Taxes that are owed but have not been paid to the applicable Taxing Authorities with respect to all periods through the dates thereof. Since the date of the Latest Compilation Balance Sheet, the Company has not incurred any Liabilities for Taxes except in the ordinary course of Business consistent with past practice. (equity purchase) The Company has not participated in a reportable transaction within the meaning of Treasury Regulation Section (b)(1) (other than such transactions that have been properly reported), or transactions that constitute listed transactions as such term is defined in Treasury Regulation Section (b)(2). (equity purchase) 19 9

11 Tax Representations (Equity Purchase) (cont.) The Company has not received any Tax Ruling or entered into a Tax Closing Agreement with any Taxing Authority that would have a continuing effect after the Closing Date. For purposes of this Agreement, the term Tax Ruling shall mean written rulings of a Taxing Authority relating to Taxes, and the term Tax Closing Agreement shall mean a written and legally binding agreement with a Taxing Authority relating to Taxes. No power of attorney currently in force has been granted by the Company concerning any Tax matter. (equity purchase) No position has been taken on any Tax Return with respect to the Business or operations of the Company for a taxable period for which the statute of limitations for the assessment of any Taxes with respect thereto has not expired that is substantially similar to any position which a Taxing Authority has successfully challenged in the course of an examination of a Tax Return of the Company. (equity purchase) The Company has not been a member of an Affiliated Group, other than an Affiliated Group of which the Company is the common parent, and the Company does not have any Liability for Taxes of any other Person under Section of the Treasury Regulations (or any similar provision of Law), as a transferee or successor, by Contract or otherwise. (equity purchase) The Company is and has been a validly electing S Corporation within the meaning of Code Sections 1361 and 1362 (and corresponding provisions of state and local Law) at all times since [date] and will be an S Corporation up to and including the Closing Date. (S corporation only) 20 Preparation of Tax Returns (Target is a Pass-Through Entity) Non-Income Tax Returns. The Buyer shall prepare or cause to be prepared and file or cause to be filed all Tax Returns for the Company for all taxable periods ending on or prior to the Closing Date (the Pre-Closing Tax Period ) that are filed after the Closing Date, other than income and capital stock and franchise Tax Returns for such Pre-Closing Tax Periods. Such Tax Returns shall be prepared consistently with the past practice of the Company, unless otherwise required by applicable Law. The Buyer Parties shall submit any such Tax Return to the Seller for the Seller s review and comment at least thirty (30) days prior to the due date (with applicable extensions) for such Tax Returns. The Seller shall provide any written comments to the Buyer not later than ten (10) days after receiving any such Tax Return and, if the Seller does not provide any written comments within ten (10) days, the Seller shall be deemed to have accepted such Tax Return. [The Seller shall reimburse the Buyer [solely from the Escrow Fund for Taxes of the Company] with respect to such periods within five (5) days of payment by the Buyer or the Company of such Taxes, except to the extent such Taxes are taken into account in the calculation of Net Working Capital. In determining the amount of Taxes that the Sellers shall be required to pay pursuant to this Section [ ], the Sellers shall receive credit for (i) all estimated Tax payments made prior to the Closing Date, (ii) the benefit of the Tax deductions associated with the Transaction Payments and (iii) any Tax losses available to the Company for the Pre-Closing Tax Period. If the amount accrued for such Pre-Closing Tax Period Taxes in the calculation of Net Working Capital exceeds the amount that the Sellers are liable to pay pursuant to this for such period, then the Buyer shall reimburse the Seller for such amount within ten (10) days of the date that the applicable Tax Return representing the over-accrued Taxes is filed with the applicable taxing authority. The cost of preparing such Tax Returns shall be borne by the Company. (equity purchase) Note: For pass-through targets, pre-closing tax return provisions usually divided between income tax returns and non-income tax returns 21 10

12 Preparation of Tax Returns, continued Income and Franchise Tax Returns. The Seller shall prepare or cause to be prepared all income and capital stock and franchise Tax Returns for the Company for all Pre-Closing Tax Periods. Such income and capital stock and franchise Tax Returns shall be prepared consistently with the past practice of the Company, unless otherwise required by applicable Law. The Seller shall submit any such Tax Return to the Buyer for the Buyer s review and comment at least thirty (30) days prior to the due date (with applicable extensions) for such Tax Returns. The Buyer shall provide any written comments to the Seller not later than ten (10) days after receiving any such Tax Return and, if the Buyer Parties do not provide any written comments with ten (10) days, the Buyer shall be deemed to have accepted such Tax Return. The Sellers shall reimburse the Buyer [solely from the Escrow Fund] for Taxes of the Companies with respect to such periods within five (5) days of payment by the Buyer Parties or the Companies of such Taxes, except to the extent such Taxes are taken into account in the calculation of Net Working Capital. In determining the amount of Taxes that the Sellers shall be required to pay pursuant to this Section [ ], the Sellers shall receive credit for (i) all estimated Tax payments made prior to the Closing Date, (ii) the benefit of the Tax deductions associated with the Transaction Payments and (iii) any Tax losses available to the Company for the Pre-Closing Tax Period. If the amount accrued for such Pre-Closing Tax Period Taxes in the calculation of Net Working Capital exceeds the amount that the Sellers are liable to pay pursuant to this Section [ ] for such period, then the Buyer shall reimburse the Seller for such amount within ten (10) days of the date that the applicable Tax Return representing the over-accrued Taxes is filed with the applicable taxing authority. The cost of preparing such Tax Returns shall be borne by the Company. (equity purchase) 22 Preparation of Tax Returns (cont.) Tax Periods Beginning Before and Ending After the Closing Date. The Buyer shall prepare or cause to be prepared and file or cause to be filed any Tax Returns of the Company for Tax periods that begin on or before the Closing Date and end after the Closing Date (a Straddle Tax Period ). Such Tax Returns shall be prepared consistently with the past practice of the Company, unless otherwise required by applicable Law. The Buyer shall submit any such Tax Return to the Seller for the Seller s review and comment at least thirty (30) days prior to the due date (with applicable extensions) for such Tax Returns. The Seller shall provide any written comments to the Buyer Parties not later than ten (10) days after receiving any such Tax Return and, if the Seller does not provide any written comments within ten (10) days, the Seller shall be deemed to have accepted such Tax Return. The Sellers shall reimburse the Buyer [solely from the Escrow Fund] within five (5) days of the date on which Taxes are paid with respect to such periods an amount equal to the portion of such Taxes which relates to the portion of such taxable period ending on the Closing Date, except to the extent such Taxes are taken into account in the calculation of Net Working Capital. In determining the amount of Taxes that the Seller shall be required to pay pursuant to this Section [ ], the Seller shall receive credit for (i) all estimated Tax payments made prior to the Closing Date, (ii) the benefit of the Tax deductions associated with the Transaction Payments and (iii) any Tax losses available to the Company for the portion of the Straddle Tax Period ending on the Closing Date. (equity purchase) 23 11

13 Preparation of Tax Returns (cont.) For purposes of this Agreement, in the case of any Taxes that are imposed on the Company for any Straddle Tax Period, the Tax that is attributable to the portion of such Straddle Tax Period ending on the Closing Date (the Pre-Closing Straddle Period ) shall (A) in the case of any Taxes other than the Taxes based on or measured by income, receipts or profits earned during a Straddle Tax Period, be deemed to be the amount of such Tax for the entire taxable period multiplied by a fraction the numerator of which is the number of days in the taxable period ending on the Closing Date and the denominator of which is the number of days in the entire taxable period, and (B) in the case of Taxes based on or measured by income, receipts or profits earned during a Straddle Tax Period, be deemed equal to the amount which would be payable if the relevant taxable period ended on and included the Closing Date. For purposes of this Agreement, in the case of any Tax credit relating to a Straddle Tax Period, the portion of such Tax credit which relates to the portion of such taxable period ending on the Closing Date shall be the amount which bears the same relationship to the total amount of such Tax credit as the amount of Taxes described in (B) above bears to the total amount of Taxes for such taxable period. (equity purchase) In the case of Tax Returns filed by Buyer under this Section and as to which Buyer expects payment from Sellers, Buyer shall inform Sellers of any amounts due from Sellers at least ten (10) days prior to the due date of the pertinent Tax Return, and Sellers will pay such amounts to Buyer in immediately available funds at least five (5) days prior to the due date of the Tax Return. In the case of any Tax Returns filed by Sellers, Sellers will pay the amount of Taxes due with respect to such Tax Returns. (equity purchase) 24 Tax Benefits The parties hereby agree and acknowledge that the Tax deductions associated with the Transaction Payments shall be for the sole benefit of the Sellers and shall be allocated to (and deemed to have been incurred in) the applicable Pre-Closing Tax Periods ending on the day before the Closing Date or portions of the applicable Straddle Tax Periods ending on the Closing Date, in each case to the extent permitted by applicable Law and that notwithstanding anything to the contrary in this Agreement, the Sellers shall be entitled to any tax benefits of each such Tax deduction. (equity purchase) Transaction Payments means all fees and expenses incurred by any Acquired Company or the Seller in connection with the Transactions or in connection with the proposed sale of the Acquired Companies, such as (but not limited to) (i) the fees and expenses of any investment bankers, lawyers, accountants, consultants and other outside financial and other advisors, (ii) the fees and expenses of the electronic data room, (iii) any cancellation payment to holders of Options and any Phantom Equity Payments, (iv) bonuses, retention awards, change in control payments, severance or other similar amounts triggered by, or payable by any Acquired Company in connection with, the consummation of the Transactions, and (v) any payroll, employment or similar Taxes payable by any Acquired Company in connection with the foregoing. (equity purchase) Revenue Ruling provides a safe harbor whereby the taxpayer can treat 70% of success-based transaction fees as non-facilitative costs that are fully deductible for tax purposes

14 Cooperation on Tax Matters Buyer, the Company and Sellers shall cooperate fully, as and to the extent reasonably requested by the other Party, in connection with the filing of Tax Returns and any Income Tax Proceedings or Tax Proceeding. Such cooperation shall include the retention and (upon the other Party s request) the provision of records and information reasonably relevant to any such audit, litigation, or other Proceeding and making employees available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder. The Company, Sellers and Buyer agree (i) to retain all Books and Records with respect to Tax matters pertinent to the Business relating to any taxable period beginning before the Closing Date until expiration of the statute of limitations (and, to the extent notified by Buyer or Sellers, any extensions thereof) of the respective taxable periods, and to abide by all record retention agreements entered into with any Taxing Authority, and (ii) to give the other Party reasonable written notice prior to transferring, destroying, or discarding any such books and records and, if the other Party so requests, Buyer, the Company or Sellers, as the case may be, shall allow the other Party to take possession of such books and records. Buyer and Sellers further agree, upon request, to use commercially reasonable efforts to obtain any certificate or other document from any Governmental Authority or any other Person as may be necessary to mitigate, reduce, or eliminate any Tax that could be imposed (including with respect to the transactions contemplated hereby). Seller shall cooperate with the Buyer Parties to cause an election under Section 754 of the Code to be made for OpCo for the tax year ending on the Closing Date. (purchase of less than 100% of partnership/llc) 26 Amended Tax Returns Any amended Tax Return of the Company or claim for refund of Taxes on behalf of the Company for any Pre-Closing Tax Period shall be prepared, or caused to be prepared only by the Seller. The Seller shall not, without the prior written consent of the Buyer (which consent shall not be unreasonably conditioned, withheld or delayed), make or cause to be made, any such filing, to the extent such filing, if accepted, reasonably might change the Tax Liability of the Buyer for any period ending after the Closing Date. (equity purchase) Any amended Tax Return of the Company or claim for Tax refund on behalf of the Company for any Straddle Tax Period shall be filed, or caused to be filed, pursuant to the procedures set forth Section [ ] only by the Buyer. The Buyer shall not, without the prior written consent of the Seller (which consent shall not be unreasonably conditioned, withheld or delayed), make or cause to be made, any such filing, to the extent such filing, if accepted, reasonably might change the Tax Liability of the Seller for any Pre-Closing Tax Period or Pre-Closing Straddle Period. (equity purchase) The Buyer shall not, and shall cause the Company not to, make any Tax election that has retroactive effect to any Pre-Closing Tax Period or portion of a Straddle Period ending on the Closing Date without the consent of the Seller (which consent shall not be unreasonably withheld or delayed). (equity purchase) 27 13

15 Audits and Claims The Buyer shall promptly provide the Seller with written notice of any inquiries, audits, examinations or proposed adjustments by a Taxing Authority, which relate to any income or franchise Tax Returns for Pre-Closing Tax Periods within ten (10) days of the receipt of such notice. The Seller shall have the sole right to represent the interests of the Company in any Tax audit or other Proceeding relating to any Tax Return for a Pre-Closing Tax Period, to employ counsel of its choice at its own expense, and to settle any issues and to take any other actions in connection with such proceedings relating to such taxable periods; provided that the Seller shall inform the Buyer of the status of any such Proceedings, shall provide the Buyer (at the Buyer s cost and expense) with copies of any pleadings, correspondence, and other documents as the Buyer may reasonably request and shall consult with the Buyer prior to the settlement of any such Proceedings and shall obtain the prior written consent of the Buyer prior to the settlement of any such Proceedings that could reasonably be expected to adversely affect the Buyer in a material manner in any taxable period ending after the Closing Date, which consent shall not be unreasonably conditioned, withheld or delayed; provided further that the Buyer and counsel of their own choosing shall have the right to participate in, but not direct, the prosecution or defense of such proceedings at the Buyer s sole expense. (equity purchase) The Buyer and the Seller shall promptly provide each other with notice of any inquiries, audits, examinations or proposed adjustments by the IRS or any other taxing authority that relate to any Straddle Tax Period. The Buyer and the Seller shall jointly control the conduct of any Tax audits or other action or proceeding relating to Taxes for a Straddle Tax Period, and neither party shall settle any such Tax audit or other action or proceeding without the written consent of the other party (which consent shall not be unreasonably withheld, conditioned or delayed). The Buyer shall have the right to control all other Tax audits or Proceedings of the Company. The Buyer shall obtain the prior written consent of the Sellers prior to the settlement of any such Proceedings that could reasonably be expected to increase the Sellers Tax Liability for a Pre-Closing Period, which consent shall not be unreasonably conditioned, withheld or delayed. (equity purchase) 28 Transfer Taxes All transfer, documentary, sales, use, stamp, registration and other such Taxes and fees (including any penalties and interest) incurred in connection with this Agreement shall be paid fifty percent (50%) by the Buyer and fifty percent (50%) by the Seller when due, and the Buyer or the Company will file all necessary Tax Returns and other documentation with respect to all such transfer, documentary, sales, use, stamp, registration and other taxes and fees, and, if required by applicable Law, the Seller will join in the execution of any such Tax Returns and other documentation

16 Bulk Sale Provisions It may not be practicable to comply or attempt to comply with the procedures of the Bulk Sales Law or similar law of any or all of the states in which the Purchased Assets are situated or of any other jurisdiction which may be asserted to be applicable to the Transactions. Accordingly, to induce Buyer to waive any requirements for compliance with any or all of such Laws, Seller hereby agrees that the indemnity provisions of Section [ ]hereof shall apply to any Losses of Buyer and any of its Affiliates arising out of or resulting from the failure of Seller or Buyer to comply with any such Laws. (Note that bulk sale provisions are generally applicable only for asset purchases) 30 Intended Tax Treatment Sellers, Parent and Buyer covenant and agree to characterize and report for United States federal income tax purposes, each Seller s sale to Buyer, and Buyer's purchase from each Seller, of such Seller s share of the Purchased Interests in accordance with the analysis and holding applicable to Situation 1 of Revenue Ruling 99-6, CB 432. The parties agree that each Seller s sale to Buyer, and Buyer's purchase from each Seller, of such Seller s share of the Purchased Interests is intended to be a fully taxable transaction to Sellers (treated as a sale of the Purchased Interests) and that under the principles of Revenue Ruling 99-6, CB 432, such is intended to be treated (from Buyer s perspective) as a taxable acquisition of assets by Buyer. The parties further agree that any income, gains, losses, deductions, credits and other Tax items of the Company though the Closing shall be allocated to Sellers and not to Buyer. Buyer and Seller agree that all deductions attributable to the Transaction Bonuses and Transaction Expenses shall be allocated to Seller and not to Buyer; provided that such treatment is not contrary to applicable law. Each of Seller and Buyer shall file all Tax Returns consistent with the income Tax treatment as set forth in this Section [ ] and shall not take voluntarily any position inconsistent therewith upon examination of any relevant Tax Return in any audit, proceeding or otherwise with respect to such Tax Returns (except to the extent required by a final taxing authority determination and except that this provision shall not require any party to appeal a final taxing authority determination or enter into litigation). (example of lateral partner buyout) 31 15

17 Intended Tax Treatment The Parties agree that, for all United States federal and applicable state and local income tax purposes, the purchase by the Buyer of the Units from Sellers is intended to constitute a transaction described in Situation 1 of Revenue Ruling 99-5, CB 434. The parties agree that Seller s sale to Buyer, and Buyer s purchase from Seller, of the Purchased Interests is intended to be a fully taxable transaction to Seller and that under the principles of Revenue Ruling 99-5, CB 434, such is intended to be treated as a taxable acquisition of a portion of the Acquired Companies assets by the Buyer. The Parties shall report on their respective Tax Returns the Buyer s acquisition of the Purchased Units in a manner consistent with the foregoing, and shall not take a position in any administrative or judicial proceeding with respect to any such Tax Return inconsistent with the foregoing, unless otherwise required by applicable Law. (example of partial sale of single LLC to single buyer) The parties agree that, for all U.S. federal and applicable state income Tax purposes, the Purchaser s acquisition of the Company shall be treated by the Sellers as the sale of the Membership Interests in the Company and by the Purchaser as a purchase of the Company s assets, in a manner consistent with Situation 2 of Revenue Ruling 99-6, and the parties shall report the Purchaser s acquisition of the Company in a manner consistent with the foregoing unless prohibited by applicable Law. (example of sale of multi-member LLC to single buyer) 32 Dispute Resolution Any dispute among the Parties involving Taxes arising under this Agreement shall be resolved as follows: (i) the Parties will in good faith attempt to negotiate a prompt resolution of the dispute; (ii) if the Parties are unable to negotiate a resolution of the dispute within thirty (30) days, the dispute will be submitted to an Tax Dispute Accountant; (iii) the Tax Dispute Accountant shall resolve the dispute, in a fair and equitable manner and in accordance with applicable Tax Law and the provisions of this Agreement, within thirty (30) days after the Parties have submitted the dispute to the Tax Dispute Accountant, whose decision shall be final, conclusive and binding on the Parties, absent fraud or manifest error; (iv) any payment to be made as a result of the resolution of a dispute shall be made, and any other action taken as a result of the resolution of a dispute shall be taken, on or before the fifth day following the date on which the dispute is resolved (except that if the resolution requires the filing of an amended Tax Return, such amended Tax Return shall be filed within thirty (30) days following the date on which the dispute is resolved); and (v) the fees and expenses of the Accounting Arbitrator shall be paid 50% by Buyer and 50% by Sellers. (equity purchase) Tax Dispute Accountant means an independent accounting firm of nationally or regionally recognized standing mutually agreed upon by Buyer and Sellers. (equity purchase) 33 16

18 Tax Indemnification Indemnified Taxes means, without duplication, any of the following Taxes (in each case, whether imposed, assessed, due or otherwise payable directly, as a successor or transferee, jointly and/or severally, pursuant to a contract or other agreement entered into (or assumed) by the Company on or prior to the Closing Date, or for any other reason and whether disputed or not): (a) any Tax in respect of the Company for any Pre-Closing Period (as determined under Section [ ]) to the extent not included in the Net Working Capital Calculation (as finally determined pursuant to Section [ ]); (b) any Tax that the Company is liable for (including under Section of the Treasury Regulations or any similar provision of state, local, or foreign applicable Laws) as a result of being a member of (or leaving) an Affiliated Group on or before the Closing Date; (c) any Tax resulting from a breach of a representation or warranty in Section [ ] (Absence of Certain Changes), Section [ ] (Tax Matters) or Section [ ] (Employee Benefits) (determined without regard to any material, knowledge or similar qualifying language) or a breach of a covenant of Sellers in Section [ ]; (d) any Transfer Taxes that are the responsibility of Sellers pursuant to Section [ ]; and (e) the Company s portion of any payroll Taxes related to any bonuses or other compensation paid to employees or independent contractors related to the transactions that are the subject of this Agreement. (equity purchase) 34 Tax Indemnification (cont.) Survival. All representations and warranties, and all covenants and agreements to be performed prior to or at the Closing shall survive the execution and delivery hereof and the Closing hereunder until the close of business on the [twelve (12) month anniversary] of the date hereof; provided, that (i) the Fundamental Representations shall survive indefinitely, (ii) the Special Representations shall survive until sixty (60) days after the expiration of the applicable statute of limitations for the applicable underlying claim, including any extensions or waivers thereof, and (iii) the covenants of the Parties to be performed after the Closing Date shall survive indefinitely or for such length of time as are indicated by their respective terms. Any claims for Losses arising out of, or caused by or relating to (i) the matters set forth in Sections [ ], [ ], [ ] and [ ] and (ii) fraud, willful misconduct or intentional misrepresentation shall survive indefinitely Special Representations means those representations and warranties set forth in Sections [ ] (Absence of Certain Changes), [ ] (Legal Compliance), [ ] (Tax Matters), [ ] (Employees and Independent Contractors), [ ] (Litigation), [ ] (Employee Benefits) and [ ] (Environmental, Health and Safety Matters)

19 Tax Indemnification (cont.) Indemnity should include following provision for asset purchase: any Liability that may be imposed upon Buyer or its Affiliates as a result of (i) the failure by the Seller to comply with any bulk sales, bulk transfer, fraudulent conveyance or similar Law of any jurisdiction that may be applicable to some or all of the Transactions or (ii) any Law under which Buyer or any of its Affiliates may have successor liability for any Tax or other Liabilities of Seller or the Company Employee Benefit Plans 36 Tax Indemnification (cont.) Any payment or indemnity required to be made pursuant to Section [ ] or Section [ ] herein shall be adjusted to take into account any reduction in Taxes that may be realized at any time by the Indemnified Person (which term shall, for purposes of this paragraph, include the ultimate payer(s) of Taxes in the case of an Indemnified Person that is a branch or a disregarded entity or other pass-through entity for any Tax purpose) as a result of the Loss giving rise to the payment or indemnity. In determining the amount necessary to be added to any payment or indemnity in order to accomplish the foregoing, the Parties hereto agree to treat all Taxes required to be paid by, and all reductions in Tax realized by any Indemnified Person, as if such Indemnified Person were subject to Tax at the highest marginal Tax rates (for both federal and state, as determined on a combined basis) applicable to such Indemnified Person. (pro-seller; sale of C corporation stock) 37 18

20 Tax Indemnification (cont.) Tax Treatment of Indemnification Payments. Any indemnification payments made to the Buyer pursuant to this Agreement shall be treated as an adjustment to the consideration paid by the Buyer hereunder, unless a Final Determination with respect to the Indemnified Person causes any such payment not to be treated as an adjustment thereto. For purposes of this agreement, Final Determination means (i) with respect to federal income Taxes, a determination as defined in Section 1313(a) of the Code or execution of an IRS Form 870-AD, and (ii) with respect to Taxes other than federal income Taxes, any final determination of Liability in respect of a Tax that, under applicable Law, is not subject to further appeal, review or modification through proceedings or otherwise (including the expiration of a statute of limitations or a period for the filing of claims for refunds, amended returns or appeals from adverse determinations). 38 Section 338(h)(10) Election (if applicable to stock purchase) Each Seller shall join, in an appropriate and timely manner, with the Buyer in making an election under Section 338(h)(10) of the Code any corresponding election permitted under the applicable Laws of any local, state or foreign jurisdiction (collectively, the Section 338(h)(10) Election ) with respect to the Buyer s stock acquisition. Each Seller shall cooperate with the Buyer to take all actions necessary or appropriate to effect and preserve a timely Section 338(h)(10) Election with respect to the Buyer s stock acquisition, as applicable, including participating in the timely filing of IRS Form 8023 and related or comparable forms for state, local, or foreign Law purposes (collectively, the Section 338(h)(10) Forms ). The Buyer shall prepare all Section 338(h)(10) Forms and shall provide them to the Sellers for the Sellers completion and execution thereof. Within sixty (60) days of the final determination of the Final Closing Adjustment pursuant to Section [ ] the Buyer shall provide to the Sellers a schedule allocating the adjusted gross-up basis (as defined in Treasury Regulation section ) among the assets (the Purchase Price Allocation Schedule ). The Purchase Price Allocation Schedule shall be prepared in accordance with the applicable provisions of the Code and consistent with the methodologies set forth in Schedule [ ]. The Buyer and the Sellers shall make appropriate adjustments to the Purchase Price Allocation Schedule to reflect changes in the Final Closing Adjustment

21 Section 338(h)(10) Election (if applicable to stock purchase) (cont.) The Buyer and each Seller shall file all Tax Returns consistently with the Section 338(h)(10) Election, the Section 338(h)(10) Forms and the Purchase Price Allocation Schedule (as appropriately adjusted) and to not take any position during the course of any audit or other Action that is inconsistent with such election, forms or schedule, unless required to do so by applicable Law; provided, however, that (i) the cost basis of assets may differ from the total amount allocated hereunder to reflect the inclusion in the total cost of items (for example, capitalized acquisition costs) not included in the total amount so allocated and (ii) the amount realized by the Seller may differ from the total amount allocated hereunder to reflect transaction costs that reduce the amount realized for federal income Tax purposes. Gross-up payment for sellers for participating in a section 338(h)(10) election

22 Tax Update State Tax Aspects of Mergers and Acquisitions 11/11/2015 Blank Rome LLP David M. Kuchinos NEXUS Issues Acquiror may become subject to additional state tax requirements Asset Acquisition now have assets in new states Stock Acquisition combined returns may be required Has Seller filed all required state tax returns? Economic Nexus or Factor Presence Nexus can be established through volume of sales in a state 42 21

23 Tax Update Income Tax Issues A. Is gain to Target business income or nonbusiness income? sellers frequently prefer nonbusiness income treatment, which is allocated to one state only, not apportioned business income usually defined to mean income from the sale of property if the acquisition, management, and disposition of the property constitute integral parts of the tax payer s regular trade or business B. Impact of IRC 338(h)(10) Election will states follow federal treatment gain from deemed sale of Target s assets is taxable to Target and stock sale is ignored? answer can impact purchase price if Parent and Target file separate state returns, Target has the tax gain and buyer can have the burden of seller s tax need price adjustment or other equalizing provision in agreement of sale 43 Income Tax Issues (cont.) 1. New York recognizes IRC 338(h)(10) election if Target C corporation files combined NY return with selling parent corporation does not follow 338(h)(10) for Target S corporation effective 2007, nonresident shareholder of NY S corporation making 338(h)(10) election is taxed by NY on sale gain 2. New Jersey recognizes 338(h)(10) on sale of corporate subsidiary does not recognize 338(h)(10) on sale of S corporation stock 3. Pennsylvania recognizes 338(h)(10) for corporate net income tax purposes does not recognize it for personal income tax purposes C. Net Operating Losses some states adopt IRC 381 and 382 rules limiting NOLs, either specifically (PA), or by adopting federal taxable income as the tax base some states have shorter carryforward periods than the federal 20-year period do not assume federal NOL rules apply for state purposes 44 22

24 Sales and Use Taxes (SUT) Stock Sales generally, no SUT on stock sales NY stock sale follow by pre-arranged liquidation within 30 days not treated as asset sale transfer of assets to subsidiary followed by sale of subsidiary stock and 338(h)(10) election (i.e., deemed asset sale) not subject to SUT. TTX Companies, Inc., DTA (1995) Asset Sales examine each asset category inventory generally exempt as sale for resale furniture, fixtures & equipment does state have a casual, isolated or occasional sale exemption? if so, cars, aircraft and boats may not be covered some states have limits on the number of sales per year that qualify for exemption some states have broad exemptions for sale of any property that seller is not engaged in the business of selling some states exempt the sale of the entire operating assets of a business 45 Sales and Use Taxes (SUT) (cont.) some exempt sales made in liquidation of a business some have specific exemptions for assets transferred in a statutory merger NY does, but not for buyer s parent s stock some exempt any transfers made in a tax-free reorganization consider other exemptions, e.g., manufacturing, production Asset Tranfers in IRC 351 Transactions property transferred in exchange for controlling interest in corporation some states exempt such transfers made at any time some limit the exemption to transfers made on the the organization of the corporation, but not later NY transfer of trucks 10 months after organization not exempt. Noar Trucking Co. Inc., 139 A.D.2d 869 (N.Y. Sup. Ct. 1988) use of a dormant entity may create sales tax liability New Jersey follows New York, but IRC 721 transfers are exempt in both states, even if made after organization 46 23

25 Bulk Sale and Successor Liability Buyer can become liable for seller taxes if bulk sale rules not followed Some states limit the liability to sales taxes; others apply the rule to all state taxes Issue must be addressed in agreement of sale New York buyer of whole or any part of another s business must file bulk sale notice, Form AU , with Dep t of Taxation & Finance at least 10 days before earlier of asset transfer or payment within 5 days of receipt, Department sends buyer notice of sales tax issues buyer may not pay purchase price to seller to extent of state s claim if state does not meet deadline, no successor liability for buyer excluding filed liens and sales taxes on the asset sale at issue within 90 days of receipt of notice, Department must give buyer notice of actual taxes due by seller and buyer must pay that amount to state if state does not meet 90-day deadline, buyer can proceed with payment to seller without state liability 47 Bulk Sale and Successor Liability (cont.) buyer is liable to state for seller sales taxes up to greater of purchase price or FMV of assets for failure to follow these rules. see sales Tax Bulletin No. TB-ST-70 (June 2013) New Jersey same starting point rules as in New York. Buyer files Form C-9600 NJ Division of Taxation has 10 days to notify buyer of possible claim for any NJ taxes due from seller Division may ask seller to quantify its gain on sale before telling buyer amount it should hold in escrow. Seller completes Asset Transfer tax Declaration ("ATTD" Form) Division will issue escrow release letter to buyer when seller s Tax obligations are cleared failure of Division to notify buyer of its escrow requirements within 10 days, buyer is relieved of seller tax obligations failure of buyer to follow these rules makes buyer liable for all NJ taxes due from seller not limited to purchase price 48 24

26 Bulk Sale and Successor Liability (cont.) Pennsylvania Seller, not buyer, is required to give 10-day notice (REV-181) in case of transfer of 51% or more of any class of seller s assets located in PA Notice must be sent to both Department of Revenue and Department of Labor & Industry applies to all taxes due from corporations' sales and use taxes, employer income tax withholding and unemployment compensation contributions Seller is required to file all PA tax reports through date of transaction buyer must demand that seller produce a Tax Clearance certificate Department of Revenue is notoriously slow in responding parties frequently rely on escrow and indemnification buyer is liable for Seller taxes for failure to comply not limited to purchase price Bulk Sales Unit of Department now taking a different approach to 10-day Notice requirement 49 Realty Transfer Taxes Generally apply to deed transfer of real estate, but many states tax controlling interests in real estate owning entities Real estate transferred by merger is subject to tax unless an exemption applies Tax may apply even if transfer is to entity with same ownership as transferor Tax may apply when individual transfers real estate to wholly-owned entity and when entity transfers real estate to its owner Controlling Interest Transferers New York taxes the acquisition of a controlling interest of an entity having an interest in real estate 50% or more of beneficial interests, capital or profits interest includes fee title and ownership of an interest in an entity that owns fee title directly or indirectly transfers of interests within 3 years of one another are deemed related and aggregated 50 25

27 Realty Transfer Taxes (cont.) tax is on the consideration paid for the controlling interest FMV of the real estate multiplied by percentage acquired NYC has similar rule, but tax is on actual consideration if entity owns nothing other than NYC real estate New Jersey imposes a controlling interest transfer tax on a transfer of more than 50% in an entity owning classified real property if consideration is more than $1 million classified means Class 4A commercial property controlling interest can be held directly or indirectly transfers within 6 months of one another are presumed to be related and are aggregated if entity owns only real estate in Class 4A, tax is on amount paid for controlling interest if entity owns other property, tax is based on equalized assessed value of more than $1 million 51 Realty Transfer Taxes (cont.) Pennsylvania tax imposed on an acquired real estate company primarily engaged in the business of holding, selling or leasing real estate and 60% or more of its receipts are from owning or disposing of real estate or its real estate makes up 90% or more in value of its tangible assets generally, real estate company is acquired if 90% or more of the total interests in the company are transferred within any 3-year period if option or legally binding commitment to acquire is in place, it can count in determining whether 90% has been transferred tax is due on computed value of the real estate multiplied by the percentage acquired 52 26

28 Tax Update: Hot Topics in Tax Controversy: The Latest Developments in Audits, Investigations, and Tax Litigation 11/16/2015 Blank Rome LLP Matthew D. Lee Jeffrey M. Rosenfeld Jed M. Silversmith Offshore Enforcement Update 55 11/11/2015 Tax Update - New York 27

29 Obligation to Report Worldwide Income United States law has always obligated U.S. citizens (including dual citizens) and U.S. residents to declare and pay taxes on all of their worldwide income, regardless of where those earnings have been derived. Historically, some U.S. taxpayers have attempted to avoid or evade reporting income earned outside of the U.S. because of the U.S. government s inability to identify those earnings from overseas banks and other financial institutions /11/2015 Tax Update - New York Foreign Bank Accounting Reporting Required as part of Bank Secrecy Act since 1970s U.S. taxpayers with foreign accounts have two obligations Answer question yes on Form 1040, Schedule B, Part III (due April 15 or due date of extended return) or other applicable tax return Electronically File FinCEN 114, Report of Foreign Bank and Financial Accounts ( FBAR ) (due June 30) 57 28

30 FBAR Penalties for Non-Compliance Criminal penalties for willful violations: Up to 5 years imprisonment and $250,000 fine Civil penalties Non-willful violation: Up to $10,000 for each violation Willful violation: Greater of $100,000 or 50 percent of the balance in the account at the time of the violation Both civil and criminal penalties can be imposed together. 58 Overview of Section 6038D New Internal Revenue Code provision enacted as part of 2010 HIRE Act Requires reporting of specified foreign financial assets if aggregate value exceeds certain thresholds Applies to tax years beginning after March 18, 2010 Requires that new information return Form 8938 be attached to a taxpayer s U.S. income tax return 59 29

31 Penalties for Non-Filing of Form 8938 Failure to file Form 8938 may result in a $10,000 civil penalty as well as an additional $10,000 continuation penalty for each 30 day period after the taxpayer is notified by the IRS of the failure to file (not to exceed $50,000) Exception if failure to file is due to reasonable cause and not due to willful neglect The fact that a foreign jurisdiction would impose a civil or criminal penalty for disclosing the required information is NOT reasonable cause Criminal penalties may also apply Failure to file Form 8938 or certain assets on Form 8938 may keep the statute of limitations open for ALL items on a return until 3 years after Form 8938 is filed. 60 Options for U.S. Taxpayers with Undisclosed Foreign Assets 61 30

32 Option 1 Streamlined Domestic Offshore Procedures Penalty of 5%. Look back period of three years for amended returns and six years for FBARs. Penalty is on assets which are reportable on FBAR or Form 8938 during the relevant lookback period. Includes value of foreign bank accounts, foreign securities accounts, foreign stock, etc. Does not include signature authority accounts or assets not reportable on FBAR or 8938 (e.g., income producing real estate). Best Option For: U.S. residents for last three years; and Filed U.S. income tax returns last three years; and Need to pick up taxable income on an amended return from a foreign asset; and Needs to file an FBAR, 8938 or other information return; and Acted non-willfully. 62 How to Determine Willfulness Unreported income in the offshore account; Use of structure/entity to hold offshore account; Use of non-u.s. identification to open account; Checking the box no on Schedule B; Failing to advise return preparer of existence of offshore account; Transferring offshore funds to another institution or safe deposit box to avoid detection; Sophistication of taxpayer; Hold mail instruction; Willful blindness to tax/fbar reporting obligations /11/2015 Tax Update - New York 31

33 Required Certification of Non-Willfulness My failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct. I understand that non-wilful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law. I recognize that if the Internal Revenue Service receives or discovers evidence of wilfulness, fraud, or criminal conduct, it may open an examination or investigation that could lead to civil fraud penalties, FBAR penalties, information return penalties, or even referral to Criminal Investigation. Under penalties of perjury, I declare that I have examined this certification and all accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete. 64 Option 2 Streamlined Foreign Offshore Procedures No Penalty. Look back period of three years for amended returns and six years for FBARs. Best Option For: U.S. taxpayer who was a non-resident for one of the last three years; and Needs to pick up taxable income on an amended return from a foreign asset; and Needs to file an FBAR, 8938 or other information return; and Acted non-willfully

34 OPTION 3 Offshore Voluntary Disclosure Program Penalty between 27.5% and 50% - depends on where the taxpayer banked and whether the taxpayer acted willfully. Look back period of 8 years. Penalty is on non-compliant assets (e.g., foreign accounts, income producing real estate, artwork purchased with funds escaping U.S. taxation, foreign businesses, etc.) Best Option for: Willful taxpayers with bad facts. FBARs and information returns not filed. Significant taxable income to pick up. 66 OVDP 50% Penalty 50% penalty in OVDP if foreign financial institution is: (1) under investigation by the IRS or Department of Justice, (2) cooperating with the IRS or Department of Justice in connection with accounts beneficially owned by a U.S. person, or (3) has been identified in a court-approved issuance of a summons seeking information about U.S. taxpayers who may hold financial accounts (a John Doe summons ) at the foreign financial institution 67 33

35 Foreign Banks/Facilitators Under Investigation UBS AG Credit Suisse AG, Credit Suisse Fides, and Clariden Leu Ltd. Wegelin & Co. Liechtensteinische Landesbank AG Zurcher Kantonalbank swisspartners Investment Network AG, swisspartners Wealth Management AG, swisspartners Insurance Company SPC Ltd., and swisspartners Versicherung AG CIBC FirstCaribbean International Bank Limited, its predecessors, subsidiaries, and affiliates Stanford International Bank, Ltd., Stanford Group Company, and Stanford Trust Company, Ltd. The Hong Kong and Shanghai Banking Corporation Limited in India (HSBC India) The Bank of N.T. Butterfield & Son Limited (also known as Butterfield Bank and Bank of Butterfield), its predecessors, subsidiaries, and affiliates 68 11/11/2015 Tax Update - New York Foreign Banks/Facilitators Under Investigation Sovereign Management & Legal, Ltd., its predecessors, subsidiaries, and affiliates (effective 12/19/14) Bank Leumi le-israel B.M., The Bank Leumi le-israel Trust Company Ltd, Bank Leumi (Luxembourg) S.A., Leumi Private Bank S.A., and Bank Leumi USA (effective 12/22/14) BSI SA (effective 3/30/15) Vadian Bank AG (effective 5/8/15) Finter Bank Zurich AG (effective 5/15/15) Societe Generale Private Banking (Lugano-Svizzera) SA (effective 5/28/15) MediBank AG (effective 5/28/15) LBBW (Schweiz) AG (effective 5/28/15) Scobag Privatbank AG (effective 5/28/15) 69 34

36 Foreign Banks/Facilitators Under Investigation Rothschild Bank AG (effective 6/3/15) Banca Credinvest SA (effective 6/3/15) Societe Generale Private Banking (Suisse) SA (effective 6/9/15) Berner Kantonalbank AG (effective 6/9/15) Bank Linth LLB AG (effective 6/19/15) Bank Sparhafen Zurich AG (effective 6/19/15) Ersparniskasse Schaffhausen AG (effective 6/26/15) Privatbank Von Graffenried AG (effective 7/2/15) Banque Pasche SA (effective 7/9/15) ARVEST Privatbank AG (effective 7/9/15) Mercantil Bank (Schweiz) AG (effective 7/16/15) Banque Cantonale Neuchateloise (effective 7/16/15) 70 Foreign Banks/Facilitators Under Investigation Nidwaldner Kantonalbank (effective 7/16/15) SB Saanen Bank AG (effective 7/23/15) Privatbank Bellerive AG (effective 7/23/15) PKB Privatbank AG (effective 7/30/15) Falcon Private Bank AG (effective 7/30/15) Credito Privato Commerciale in liquidazione SA (effective 7/30/15) Bank EKI Genossenschaft (effective 8/3/15) Privatbank Reichmuth & Co. (effective 8/6/15) Banque Cantonale du Jura SA (effective 8/6/15) Banca Intermobiliare di Investimenti e Gestioni (Suisse) SA (effective 8/6/15) bank zweiplus ag (effective 8/20/15) Banca dello Stato del Cantone Ticino (effective 8/20/15) 71 35

37 Foreign Banks/Facilitators Under Investigation Hypothekarbank Lenzburg AG (effective 8/27/15) Schroder & Co. Bank AG (effective 9/3/15) Valiant Bank AG (effective 9/10/15) Bank La Roche & Co AG (effective 9/15/15) Belize Bank International Limited, Belize Bank Limited, Belize Corporate Services Limited, their predecessors, subsidiaries, and affiliates (effective 9/16/15) St. Galler Kantonalbank AG (effective 9/17/15) E. Gutzwiller & Cie, Banquiers (effective 9/17/15) Migros Bank AG (effective 9/25/15) Graubundner Katonalbank (effective 9/25/15) BHF-Bank (Schweiz) AG (effective 10/1/15) Finacor SA (effective 10/6/15) Schaffhauser Kantonalbank (effective 10/8/15) BBVA Suiza S.A. (effective 10/16/15) 72 11/11/2015 Tax Update - New York Foreign Banks/Facilitators Under Investigation Piguet Galland & Cie SA (effective 10/23/15) Luzerner Kantonalbank AG (effective 10/29/15) Habib Bank AG Zurich (effective 10/29/15) Banque Heritage SA (effective 10/29/15) Hyposwiss Private Bank Genève S.A. (effective 10/29/15) Banque Bonhôte & Cie SA (effective 11/3/15) 73 11/11/2015 Tax Update - New York 36

38 Other Options Delinquent Information Return Procedures Delinquent FBAR Procedures Quiet Disclosure Do Nothing to Address Past Non-Compliance? 74 FATCA and the End of Tax Havens & Banking Secrecy Anti-tax evasion law passed by Congress in 2010 Became fully effective July 1, 2014 Requires foreign financial institutions (FFIs) to annually disclose account information regarding U.S. customers or face 30% withholding tax/penalty on U.S.-source payments Despite some initial controversy, FATCA has been embraced globally More than 165,000 FFIs have registered with IRS to become FATCA-compliant More than 110 countries have agreed to bi-lateral treaties (IGAs) to fully implement FATCA 75 11/11/2015 Tax Update - New York 37

39 Other Enforcement Priorities 76 11/11/2015 Tax Update - New York IRS Audit Rates Individuals FY 2011 FY 2012 FY2013 FY2014 All returns 1.11% 1.03%.96%.86% No AGI 3.42% 2.67% 6.04% 5.26% AGI $1 to $25, % 1.05% 1.00%.93% AGI $200,000-$500, % 1.96% 2.06% 1.75% AGI $500,000-$1 million 5.38% 3.57% 3.79% 3.62% AGI $1 million-$5 million 11.80% 8.90% 9.02% 6.21% AGI $5 million-$10 million 20.75% 17.94% 15.98% 10.53% AGI over $10 million 29.93% 27.37% 24.16% 16.22% Note: In FY2013, overall audit rate dropped below one percent for the first time since FY /11/2015 Tax Update - New York 38

40 IRS Audit Rates - Overall FY2014 (ending September 30, 2014) Fourth consecutive year of reduced IRS appropriations 1.2 million individual tax returns were audited, a decrease of 12 percent relative to prior year, and lost number since FY2015 FY2015 (ending September 30, 2015) Individual audit rate drops further, to.84% (lowest level since 2004) Revenue from audits declined by 41% (lowest level since 2002) Revenue agent workforce has declined by 22% over past 5 years 78 11/11/2015 Tax Update - New York Renewed Focus on Employment Tax Fraud by DOJ/IRS Justice Department: Holding business owners accountable who willfully evade their employment tax obligations to line their own pockets is among the Tax Division s highest priorities. These offenders, who not only steal from the United States, but also take advantage of honest competitors, will be prosecuted to the fullest extent of the law, and... will face incarceration and substantial financial penalties. Internal Revenue Service: The defendant essentially stole not only from the government but from her own employees. IRS Criminal Investigation realizes the detrimental consequences of employment tax evasion. It results in the loss of tax revenue to the United States government and the loss of future Social Security or Medicare benefits for the employees 79 11/11/2015 Tax Update - New York 39

41 Focus on Employment Tax Fraud Recent Developments Specific training in this area for Revenue Officers, Fraud Technical Advisors, and Special Agents, as well as Justice Department lawyers. Coordinated enforcement both criminal and civil by IRS and DOJ 80 11/11/2015 Tax Update - New York Employment Tax Fraud Penalties Criminal Willful failure to collect or pay over tax: Any person required under this title to collect, account for, and pay over any tax imposed by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined... or imprisoned not more than 5 years, or both, together with the costs of prosecution (IRC 7202) Civil Failure to file/failure to pay penalties for employer Trust Fund Recovery Penalty (IRC 6672) for responsible persons 81 11/11/2015 Tax Update - New York 40

42 Employment Tax Fraud Can Take a Variety of Forms "Pyramiding" -- fraudulent practice where a business withholds taxes from its employees but intentionally fails to remit them to the IRS. Businesses involved in pyramiding frequently file for bankruptcy to discharge the liabilities accrued and then start a new business under a different name and begin a new scheme. Employment Leasing -- Employee leasing is the practice of contracting with outside businesses to handle all administrative, personnel, and payroll concerns for employees. In some instances, employee-leasing companies fail to pay over to the IRS any portion of the collected employment taxes. These taxes are often spent by the owners on business or personal expenses. Often the company dissolves, leaving millions in employment taxes unpaid /11/2015 Tax Update - New York Employment Tax Fraud Can Take a Variety of Forms Paying Employees in Cash -- Paying employees, whole or partially, in cash is a common method of evading income and employment taxes resulting in lost tax revenue to the government and the loss or reduction of future social security or Medicare benefits for the employee. Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns -- Preparing false payroll tax returns understating the amount of wages on which taxes are owed, or failing to file employment tax returns, are methods commonly used to evade employment taxes /11/2015 Tax Update - New York 41

43 Employment Tax Fraud - Examples United States v. Townsend - owner of electrical contracting company in Washington state sentenced to 40 months in prison and ordered to pay $3.3 million in restitution to IRS. For 16 quarters, defendant withheld $3.3 million in employment taxes, but failed to pay over to IRS. Instead, the money was used to pay company s vendors and employees; $200,000 dividend; $300,000 in personal income taxes; $260,000 to family members; $22,000 for a pool; $30,000 for a boat; and $73,000 for luxury cars /11/2015 Tax Update - New York Employment Tax Fraud - Examples United States v. Son husband/wife owners of employee leasing company in Philadelphia indicted by grand jury in September Defendants provided temporary employees to companies. Leasing company remained responsible for withholding employment taxes. Instead of paying over, the defendants cashed checks at check cashing agencies and paid employees in cash. Defendants failed to issue Forms W-2 or Defendants are facing up to 10 years in prison if convicted /11/2015 Tax Update - New York 42

44 Outside Accountants As Responsible Persons? United States v. Buddy Light Accounting & Tax Services (North Carolina 2013) Company hires outside accounting firm to manage payroll and accounts payable, calculate employee withholding, prepare Forms 941, and make federal tax deposits Accountants had access to company bank accounts and wrote company checks to vendors and creditors Company begins to experience financial difficulties, and federal employment taxes are not paid over to IRS, but accountants continue to issue checks to employees, owners, and vendors Are the outside accountants liable for the TFRP? 86 11/11/2015 Tax Update - New York Criminal Tax Update 87 11/11/2015 Tax Update - New York 43

45 IRS Investigations 88 How does this impact Taxpayers? Not many investigations per taxpayer High likelihood of criminal case developing once subject investigation is initiated 93.4% conviction rate Trend towards less criminal cases 89 11/11/2015 Tax Update - New York 44

46 IRS Staffing Levels 90 Key data Over 1,000 Identity Theft prosecutions Over 1,000 questionable refund program (i.e., refund fraud) Over 1,300 money laundering cases Over 300 return preparers Over 225 international investigations Not too many garden variety tax cases 91 45

47 How can the IRS do more with less? Identity Theft, QRP, and Return Preparer cases do not require extensive resources Cases are developed from third parties (local police arrest individual with 5,000 green dot cards and a laptop) Cases are also developed with data mining Money laundering cases are handled with other law enforcement agencies 92 Why the change? Identity theft is a pervasive problem with society IRS not adept at handling refund fraud Wage and Investment Division processes refunds Priority is on getting refunds out IRS is very cautious about disallowing refunds E.g., only recently stopped sending multiple refunds to the same house No real time matching 93 46

48 What does this mean? IRS is shifting focus away from traditional cases Fewer legal source cases Even fewer indirect method cases Lots of tax protestors, collection cases (i.e., easy to prove) 94 Is tax evasion like golfing in a thunderstorm? 400 personal tax evasion cases in 2014 According to NOAA, between 9% and 10% of those struck die, for an average of 40 to 50 deaths per year 95 47

49 Is this going to change? The IRS is now at its lowest level of funding since 2008 Low level of IRS staffing Recent criticism of IRS-CI for purchase of a stingray Congress introduced articles of impeachment on October 30, 2015 for Commissioner Koskinen 96 Swiss Bank Program 48 Swiss banks have entered the program Banks identify U.S. account holders and pay penalty in exchange for a non-prosecution agreement Banks do not furnish clients names Banks do furnish leaver list which include data points to identify clients 97 48

50 Leaner Sentencing Rules 98 What does this mean? Possible uptick in international tax cases Otherwise, very few cases involving personal evasion IRS unlikely to refer civil cases unless egregious conduct (e.g., tax protestor) If you have a problem, get in front of it 99 49

51 QUESTIONS? /11/2015 Tax Update - New York 50

52 Tax Update Washington Update 11/11/2015 Blank Rome LLP Stephen F. Mankowski, CPA NCCPAP/BLANK ROME NEW YORK NOVEMBER 11,

53 AGENDA IP PIN Update Commissioner Security Summit 104 IP PIN Update IP PIN to be required 01/01/2016 TP, spouse or dependent/qualifying individual Form 1040 series Form 2441, Dependent Care EITC Forms

54 COMMISSIONER SECURITY SUMMIT Grew out of Y2K, Intuit and other issues Round 1 started in March 2015 Addressing issues at the front end and stopped 3.3M fraudulent returns Looking to access New Hire reporting and other databases IRS gets 1M+ attacks PER WEEK 106 COMMISSIONER SECURITY SUMMIT Bad guys are reverse engineering system They work to get last years return Tax professionals are also under attack Currently have group working on authentication issues Bank and debit card industry now involved

55 COMMISSIONER SECURITY SUMMIT Submission of returns still issue Working on a hashtag with W2s Tax professionals will be permanent party to the working group. Top 3 theft group front end, middle (filters) and back end Over 100 data elements down to 30 Social Security elimination development 108 THAT S ALL FOLKS!

56 Tax Update Estate Planning Potpourri 11/11/2016 Blank Rome LLP David M. Warren Susan Peckett Witkin William Finestone John S. Kiely Blank Rome Tax Update 2016 Inflation Adjustments

57 2016 Final Inflation Adjusted Exemptions Rev. Proc Estate/Gift/GST Tax Exemption Amount: $5,450,000 (+ $20,000) Annual Exclusion: $14,000 (no change) Annual Gift Exclusion to Noncitizen spouse: $148,000 (+$1,000) Income Tax Brackets (for 39.6% top rate): Married Filing Jointly: Over $466,950 (+$2,100) Single: Over $415,050 (+ $1,850) Estates/Trusts: Over $12,400 (+ $100) 113 Blank Rome Tax Update Portability

58 Estate Tax Exemption Portability The Law Legislation: Introduced by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 [P.L , December 17, 2010] Made permanent by the American Taxpayer Relief Act of 2012 [P.L , January 3, 2013] Final Regulations T.D. 9725, 80 Fed. Reg Effective for married decedents dying on or after January 1, 2011 and their surviving spouses 115 Estate Tax Exemption Portability What s Actually Portable? Deceased Spousal Unused Exemption Amount (DSUEA) The Lesser of: The basic exclusion amount (for 2015: $5,430,000); and The Applicable Exclusion Amount of the last deceased spouse of the surviving spouse over the amount of the last deceased spouse s taxable estate plus adjusted taxable gifts Applicable Exclusion Amount The Basic Exclusion Amount plus the DSUEA

59 Estate Tax Exemption Portability How Does a DSUEA Become Portable? DSUEA Election: Deceased spouse s executor elects on a timely filed (with extensions) Federal Estate Tax Return (Form 706) Return must be filed even if not otherwise required Return must be complete and properly prepared. Treas. Reg (a)(2) Completely and Properly Prepared: Comply with form 706 Instructions and meet requirements of Treas. Reg , -3 and Estate Tax Exemption Portability How Does a DSUEA Become Portable? DSUEA Election: Completely and Properly Prepared Valuation of Certain Property not Required (Treas. Reg (a)(7)(ii)): Not otherwise required to file form 706 Bequests and devises deductible under the Marital Deduction or Charitable Deduction Report the description, ownership, beneficiary and information to establish the deduction

60 Estate Tax Exemption Portability How Does a DSUEA Become Portable? DSUEA Election: Completely and Properly Prepared Valuation Required If: A value is needed to determine what is passing to someone other than the spouse or charity Value is needed to make other estate tax provisions available (e.g., IRC 2032A, 6166) Less than the entire value of the property is eligible for marital or charitable deduction A partial disclaimer or partial QTIP election is made 119 Estate Tax Exemption Portability How Does a DSUEA Become Portable? DSUEA Election: Who Makes the Election: Appointed Executor If No Executor Appointed: Any person in actual or constructive possession of the decedent s property An appointed executor s election or non-election can supervise a non-appointed executor s election or non-election A contrary election by another non-appointed executor generally cannot supersede the first election

61 Estate Tax Exemption Portability How Does a DSUEA Become Portable? DSUEA Election: Who Makes the Election: Potential Conflict -- Spouse is not the appointed Executor Second marriage, children not also second spouse s children Third party executor Cost of preparing an unnecessary return 121 Estate Tax Exemption Portability When Can the DSUEA Be Used? Used by Surviving Spouse: When Surviving Spouse Dies During Surviving Spouse s Life for Gifts DSUEA applied to Taxable Gifts First Rules for Multiple Deceased Spouses If a DSUEA from one deceased spouse was used by Surviving Spouse and at time of gift Surviving Spouse has a new (later) deceased spouse: The DSUEA amount used for the new gift is The last deceased spouses DSUEA, plus The previous deceased spouses DSUEAs to the extent applied to previous taxable gifts

62 Estate Tax Exemption Portability When a Bypass Trust Still Makes Sense When Should Portability Not Be Used and Traditional Bypass Trust Planning (with Asset Equalization) Used Instead: GSTT planning desired The GSTT Exemption is not portable Spouses combined estates over (or way over ) their combined Basic Exclusion Amounts Borderline Estates Near but not over the combined Basic Exclusion Amounts DSUEA not indexed for inflation, if assets grow more rapidly than inflation rate, survivor s estate could grow into an estate tax 123 Estate Tax Exemption Portability When a Bypass Trust Still Makes Sense When Should Portability Not Be Used and Traditional Bypass Trust Planning (with Asset Equalization) Used Instead: Second marriages, particularly when each spouse has children from a prior marriage Issues with Surviving Spouse Creditor Protection Elder Abuse Professional Management (spouse not capable of or interested in managing the assets)

63 Estate Tax Exemption Portability When a Bypass Trust Still Makes Sense When Should Portability Not Be Used and Traditional Bypass Trust Planning (with Asset Equalization) Used Instead: Surviving spouse likely to remarry and potentially lose the DSUEA of the first deceased spouse 125 Estate Tax Exemption Portability State Death Tax Considerations Decoupled States Without Portability New York Decoupled NY Estate Tax Exclusion < Federal No NY Portability (TSB-M-14(6)M) No NY Separate QTIP Election If QTIP Election made on Federal return, it must be made on the NY Return; If no Federal return is required to be filed, a separate NY QTIP Election may be made (for NY purposes a Federal return is required to be filed even if only to elect portability) (Id.; TSB-M- 11(9)M)

64 Estate Tax Exemption Portability State Death Tax Considerations Decoupled States Without Portability New Jersey Decoupled NJ Estate Tax Exclusion < Federal No NJ Portability No NJ Separate QTIP Election If no federal return filed (NJ QTIP Election Available) (See Practical Drafting, 10462) 127 Blank Rome Tax Update Basis Consistency Rules

65 Basis Issues: Consistency Requirements Highway Bill Requires Basis Consistency and Reporting New IRC Section 1014(f): Basis of property received from a decedent must be consistent with value as finally determined for Federal estate tax purposes, or if value is not yet determined, value reported to beneficiary pursuant to new IRC Section 6035(a) Applies only to assets that increased estate tax liability (marital/charitable deduction assets excluded; not required for portability returns) 129 Basis Issues: Reporting Requirements IRC 6035(a) Statement Requirements: Applies to all estates with Form 706s filed after 7/31/15 Must be sent within 30 days after earlier of (a) 706 due date (including extensions), or (b) date 706 actually filed. NOTE: Notice extended due date for all 6035(a) Statements to 2/29/2016 Must be sent to each beneficiary and the Secretary (IRS), normally by the Personal Representative Must include the basis of each asset distributed to the beneficiary

66 Basis Reporting Requirements: Open Items No form yet released (expected early January, but no proposed regulations) Do requirements apply to cash, items of IRD, tangible personal property or term interests? Personal Representatives duty to beneficiaries, including non-probate and trust beneficiaries (e.g. joint tenants) What if recipient is not determinable at time of reporting? Example: Formula funding in which assets are not transferred until well after Form 706 due date 131 Blank Rome Tax Update What Kind of Trust Am I Dealing With?

67 Simple vs. Complex Trusts Simple Trusts- Three Requirements for a trust to be a simple trust for any tax year (IRS 651(a)): The trust instrument requires that all income must be distributed currently; The trust instrument does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes; and During the year in question, the trust does not distribute amounts allocated to the corpus of the trust Sample Language- The entire net income of the trust shall be distributed in such periodic installments as Trustees shall find convenient, but at least as often as annually, to the beneficiary 133 Simple vs. Complex Trusts Complex Trusts- A trust that does not provide for mandatory income distributions Sample Language- All of the net income of the trust must be accumulated All or any part of the net income of the trust may be accumulated, paid to or applied for the benefit of the beneficiary, at such times and in such proportions, equal or unequal, as Trustees, other than a Trustee who may be a beneficiary hereunder, shall in their discretion determine In addition, a trust will be a complex trust in any year in which: A principal distribution is made A charitable contribution is made, set aside or used for charity

68 Grantor Trusts Common Methods of Creating a Grantor Trust for Federal Income Tax Purposes Power of Substitution- Settlor shall have the sole and absolute power, exercisable in a nonfiduciary capacity and in writing, without the approval or consent of any person in a fiduciary capacity, to reacquire (within the meaning of 675(4)(C) of the Code) trust corpus other than any insurance policy on the life of Settlor, by substituting other property of an equivalent value Power to Add Charitable Beneficiaries- [U]ntil the death of the Settlor, Trustees, other than a Trustee who may be a beneficiary hereunder, may in their discretion add as a beneficiary of the income and/or principal of any trust created hereunder any organization or organizations described in Sections 170(c), 2055(a) and 2522(a) of the Internal Revenue Code Please note that Pennsylvania s income tax law does not recognize grantor trust status. As a result, a grantor trust is a taxable entity for Pennsylvania income tax purposes 135 Blank Rome Tax Update Taxation of Same Sex Marriage

69 Same-Sex Marriage Obergefell v. Hodges, 576 U.S. (2015). Same-sex right to marry guaranteed by Due Process and Equal Protection clauses of the U.S. Constitution, so clients can now legally marry in all 50 states and the District of Columbia This opens all planning opportunities available to any married couple. In light of this change in status, existing plans for same-sex clients should be reviewed 137 Same-Sex Marriage Planning Opportunities After Marriage: Review existing plans to incorporate marital tax planning QTIPs, reverse QTIPs, and other marital tax planning now available (including Portability ); previous plan may have only left Federal exemption amount to surviving same-sex partner Spousal Rollover and Joint and Survivor Annuity rules apply Review life insurance: A single-life policy needed for liquidity may be replaced by a survivorship policy Split gifts on Gift Tax Returns In California and other community property states, transmute property into community property (or vice versa)

70 Same-Sex Marriage Planning Opportunities After Marriage (cont d): International estate planning opportunities, including citizenship Increased health insurance rights Amend prior tax returns Rev. Rul (August 29, 2013) Open returns (later of 3 years of filing date, or 2 years of payment REG (October 21, 2015) IRS proposed regulations providing same-sex marriage recognized by any state will be recognized for Federal tax purposes. Terms husband and wife now include any spouse 139 Blank Rome Tax Update Gift Tax Adequate Disclosure

71 What is Adequate Disclosure? Gift Tax Returns: Statute of Limitations Treas. Reg (c)-1(f)(2) Adequate Disclosure requires: Description of transferred property and any consideration received Identity of, and relationship between, transferor and transferee If to a trust, the trust s taxpayer ID number and either a brief description of the trust, or a copy of the trust instrument Detailed description of the method used to determine FMV Actively Traded Assets: List exchange where traded, CUSIP number, and mean between highest and lowest quoted selling prices on date of transfer 141 What is Adequate Disclosure? Gift Tax Returns: Statute of Limitations Non-Actively Traded Assets Statement providing the FMV of 100% of the entity The pro rata portion of the entity subject to transfer The FMV of the transferred interest in the entity Taxpayer bears burden of demonstrating FMV properly determined by method other than NAV Information is required for each entity in which transferred entity owns an interest

72 What is Adequate Disclosure? Gift Tax Returns: Statute of Limitations Appraisals In lieu of information on previous slide, can use an appraisal if: Appraiser holds itself out as an appraiser or performs appraisals on a regular basis Appraiser qualified to make the appraisal of the type of property being valued based on appraiser s background (education, experience and professional memberships) Appraisal contains ALL of the following: (1) date of transfer, date of appraisal and purpose of appraisal, (2) description of property, (3) description of appraisal process employed, (4) description of assumptions, hypothetical conditions and any limiting conditions and restrictions that affect the analyses, opinions and conclusions, (5) information considered in determining the FMV, (6) procedures followed and reasoning supporting conclusions reached, and (7) specific basis for valuation, such as specific comparable sales, interests, asset-based approaches, M&A information, etc. 143 What is Adequate Disclosure? Gift Tax Returns: Statute of Limitations FAA F Concluded taxpayer failed to provide adequate disclosure under Treas. Reg (c)-1(f)(2) EIN for FLP being transferred missing one digit and FLP name abbreviated Did not include a detailed description of method used to determine FMV of the property transferred (no appraisal) Chief Counsel s Office concluded that, because of items listed above, no adequate disclosure and therefore exception to three-year statute of limitations under IRC 6501(c)(9) applied and the IRS could assess gift tax at any time

73 Blank Rome Tax Update Estate Tax Deferral For Closely Held Business Interests 145 Estate Tax Deferral For Closely Held Business Assets Payment Deadline: Estate tax payment is due 9 months from the decedent s date of death. Option 1. Deferral under IRC 6166 For the Estate Tax on a Closely Held Business Key 6166 Points The closely held business must exceed 35% of the decedent s adjusted gross estate and only the estate tax attributable to it is eligible for deferral. If the estate selects the maximum deferral, the first installment is due on the fifth anniversary of the return s due date. Interest is owed for the entire deferral period. The first $1,470,000 (See Rev. Proc ) of the deferred tax liability bears interest at 2%, and the balance bears interest at 45% of the underpayment rate (presently generates a rate of 1.35%) election must be made on a timely filed estate tax return

74 Real Estate: When Is It Used In An Active Trade or Business? Revenue Ruling provides the following nonexclusive list of factors to determine whether real estate is used in an active trade or business: Time devoted to the trade or business; Whether there was an office for conducting business activities with regular hours; Active involvement in finding tenants and entering into leases; Provision of services for areas outside the leased premises, such as landscaping; and Level of involvement in the repair and maintenance of the real estate Ancillary real estate owned in connection with an operating business qualifies as part of a trade or business 147 Security For 6166 Installment Payments General Estate Tax Lien IRC 6324(a) provides that the general federal estate tax lien runs for 10 years from the decedent s death. If the maximum 6166 deferral option is selected, the last four years and nine months are outside the scope of the general estate tax lien

75 Security For 6166 Installment Payments Additional Security Measures Under 6165, the IRS can require a bond of up to twice the extended estate tax liability. In lieu thereof, the executor can grant an extended estate tax lien under 6324A, which runs until the estate tax is paid 149 Security For 6166 Installment Payments Internal Revenue Manual , effective as of June 1, 2010, provides the following nonexclusive list of factors for determining whether a bond or extended estate tax lien are necessary: The nature of the business and its assets, market factors, recent financial history of the business, and management, in order to predict the likelihood of success and survival during the deferred payment period; How the estate expects to make the annual payments of tax and interest, and whether that expectation is realistic; and The tax compliance history of the business, estate, and the decedent At any point during the deferral period, the IRS can require the aforementioned bond or extended lien, even if they previously waived such security provisions. See CCA

76 Acceleration of Installment Payments If the Estate: (i) has distributed, sold, exchanged or otherwise disposed of its interest in a closely held business, or (ii) money and other property attributable to such ownership interest is withdrawn from the closely held business, and the aggregate of the foregoing equals at least 50% of the value of such ownership interest (See IRC 6166(g)(1)(A)); fails to timely pay principal or interest due on installments, and does not remedy its default within six months (See IRC 6166(g)(3)(A) and (B)); or fails to comply with the previously discussed security requirements; the remaining installments are accelerated and the previously deferred estate tax liability is immediately due 151 The Graegin Loan Option 2. The Graegin Loan IRC 2053(a)(2) provides that bona fide administration expenses actually and necessarily incurred can be deducted from the gross estate In Estate of Graegin v. Commissioner of Internal Revenue, T.C. Memo (U.S. Tax Ct. 1988), an illiquid estate consisting of shares in Graegin Industries Inc., borrowed funds to pay the estate tax from Graegin Corporation, a subsidiary of Graegin Industries, Inc. The note had a fifteen year term, prohibited prepayment, and provided for one lump sum payment of principal and interest. The estate deducted the future interest payment as an administration expense The IRS challenged the deductibility of the interest, but the estate prevailed because: (i) The loan was bona fide because the estate intended to make the payment; (ii) The interest expense was calculable with reasonable certainty since the note prohibited prepayment; and (iii) The loan was necessary for the administration of the estate because it avoided potential losses from a forced asset sale

77 The Graegin Loan Requirements of a Graegin Loan: Bona fide The Estate must actually intend to pay the debt, which can be disputed when the lender is a family controlled entity Calculable with Reasonable Certainty The loan must prohibit the prepayment of principal and interest, otherwise, the interest is speculative Necessary Estate of Duncan v. Commissioner of Internal Revenue, T.C. Memo , clarified the court s decision in Black v. Commissioner, 13 T.C. 340 (U.S. Tax Ct. 2009), which found that a Graegin loan was unnecessary. In Black, the estate needed to sell the illiquid asset whether or not there was a Graegin loan. Since the Graegin loan could not prevent a forced sale under those circumstances, it was unnecessary. If the IRS argues that a Graegin loan was unnecessary, the taxpayer must show why alternative approaches would have resulted in a discounted sales price 153 The Graegin Loan Tax Treatment of 6166 Interest v. Graegin Interest IRC 2053(c)(1)(D) prohibits claiming an estate tax deduction, and 163(k) prohibits claiming an income tax deduction, for 6166 interest All future interest payments on a Graegin loan are a valid estate tax deduction. This is a key benefit of the Graegin loan option The IRS s position is that Graegin loan interest is nondeductible personal interest for income tax purposes. The lender, which may be a family controlled entity, will recognize taxable income on the interest payments

78 The Graegin Loan Which Is Better? Graegin loans are more widely available than 6166 deferral, provide estate tax savings, and are simpler to administer. The lender may be a friendly party, as in Duncan, when funds were borrowed from a trust with the same beneficiaries as the estate If the Graegin lender is a bank, the interest rate will undoubtedly be higher than the rate charged by the IRS. The executor would need to determine whether paying a higher amount of interest to a bank, which results in an estate tax deduction, produces a better result than lower, but nondeductible, interest payments to the IRS 155 Blank Rome Tax Update New York Estate Tax Update

79 I. The New York Basic Exclusion Amount New York Tax Law Subsection 952(c)(2)(A) For dates of death: Basic Exclusion Amount On or after April 1, 2014, and on or before March 31, 2015 $2,062,500 On or after April 1, 2015, and on or before March 31, 2016 $3,125,000 On or after April 1, 2016, and on or before March 31, 2017 $4,187,500 On or after April 1, 2017, and on or before December 31, 2018 $5,250,000 Beginning January 1, 2019, the New York basic exclusion amount will equal the federal basic exclusion amount, which is currently $5,430, II. The New York Estate Tax Cliff Computation Section Excerpted from the New York Estate Tax Return

80 II. The New York Estate Tax Cliff New York Estate Tax Computation Section 952(b) of the Tax Law sets forth the rate table for the New York estate tax, which is computed as a percentage of the New York taxable estate. Subsection 952(c)(1) provides that an applicable credit will be allowed against the tax as follows: if the taxable estate is less than or equal to the basic exclusion amount, the applicable credit amount is the amount of tax that would be due under 952(b); if the taxable estate exceeds the basic exclusion amount by 5% or less, a portion of the credit that would be allowed for an estate under the basic exclusion amount is allowed, as computed based on a formula; and if the taxable estate exceeds 105% of the basic exclusion amount, there is no credit 159 The New York Estate Tax Cliff As of April 1, 2015, the New York estate tax exclusion amount is $3,125,000 Example I: John Smith died on May 1, 2015 with a taxable estate of $3,124,000 1 Taxable estate for New York State $3,124,000 2 New York Estate Tax $193,104 3 Applicable Credit $193,104 4 Tax 0 Explanations Per Tax Law Subsection 952(b), the tax is $190,800 on the first $3,100,000, plus 9.6% of the amount in excess of $3,100,000. Since the taxable estate is less than the basic exclusion amount, the credit is equal to the tax calculated under 952(b)

81 The New York Estate Tax Cliff Example II: Sam Brown died on May 1, 2015 with a taxable estate of $3,282,000 1 Taxable estate for New York State $3,282, New York Estate Tax $208, Explanations Per Tax Law Subsection 952(b), the tax is $190,800 on the first $3,100,000, plus 9.6% of the amount in excess of $3,100, Applicable Credit $ Tax $208, Since the taxable estate is greater than 105% of the basic exclusion amount, there is not a credit. The estate tax cliff is triggered at $3,281,250, which is 105% of the exclusion amount of $3,125,000. The $157,000 in excess of the exclusion amount in Mr. Brown s taxable estate produces a New York estate tax of $208,272, a marginal tax rate of 133% 161 III. Gifts Within 3 Years of Death New York Tax Law Subsection 954(a) provides that any gifts in excess of the annual exclusion amount made on or after April 1, 2014 are included in the gross estate of the transferor if he dies within 3 years This clawback provision does not apply to estates of decedents who die on or after January 1,

82 IV. Portability Under Internal Revenue Code section 2010(c)(2), the unused exclusion amount in the estate of a deceased spouse ( DSUE ) may be used in computing the estate tax in the estate of the surviving spouse. This is commonly known as portability There is no portability in the New York estate tax regime 163 Blank Rome Tax Update Estate Tax Closing Letters

83 Federal Estate Tax Closing Letters No longer being issued automatically by IRS for Form 706 filed after May 31, 2015 Must be requested no earlier than 4 months after filing by calling IRS at (866) and providing name of decedent, decedent s social security number and date of death. See Frequently Asked Questions on Estate Taxes at IRS website 165 Blank Rome Tax Update ExPat Transfer Tax

84 Covered Expatriate Transfer Tax IRC 877A and 2801 (2008 HEART Act ) New Proposed Regulations under IRC 2801 (9/10/15) 40% Tax on gifts and bequests received by U.S. Persons from Covered Expatriates Covered Expatriate defined as nonresident alien (based on domicile) who, after 6/16/08, relinquished U.S. citizenship or ceased to be a long-term resident (a U.S. tax resident for 8 of the last 15 years), and who had (1) a net-worth in excess of $2M, (2) an average annual net income over the previous 5 years of $160,000 (indexed for inflation - $161,000 for 2016), OR (3) has failed to certify and substantiate U.S. Tax Compliance for the past 5 years 167 Covered Expatriate Transfer Tax Reported on new Form 708 (not released); due date not until after Final Regulations issued; tax deferred until such time as well Preparers must ask if any gifts/bequests received from Covered Expatriate Excluded transfers: (1) taxable gifts reported on donor s Form 709 (and tax paid), (2) gross estate property (including QDOT distributions) reported on decedent s Form 706 (and tax paid), (3) charitable transfers, (4) marital transfers (including QDOTs and QTIPs), and (5) qualified disclaimers Proposed Regulations permit protective Form 708 filing

85 Blank Rome Tax Update EU Succession Regulation 169 EU Succession Regulation Effective 8/17/15 All EU countries except Denmark, Ireland and the United Kingdom Addresses Conflicts of Laws issues: A given succession is now treated coherently by one Court applying one law Law of succession to apply can be either state of habitual residence (default) or state of nationality (if designated)

86 Blank Rome Tax Update Basis Issues: CRTs and Grantor Trusts 171 Basis Issues: CRT Transactions Effective 8/12/15 and applies to sales of interests in Charitable Remainder Trusts ( CRTs ) occurring on or after 1/16/14 If all CRT beneficiaries transfer all beneficial interests in a sale to an unrelated third party, the basis of those interests is the portion of the adjusted uniform basis allocable to those interests reduced by sum of undistributed (1) ordinary income [664(b)(1)], and (2) capital gain [664(b)(2)]

87 Basis Issues: Grantor Trusts at Death of Grantor IRS places this issue on no-ruling list (Rev. Proc ) Issue is whether assets in a Grantor Trust receive a stepup in basis under IRC 1014 at the Grantor s death when the Grantor Trust is not otherwise includible in the Grantor s estate (an Intentionally Defective Trust ) Some practitioners argue that the Grantor Trust is acquiring the assets for estate tax purposes as of the Grantor s death when the Grantor and the Trust are first recognized as separate entities for income tax purposes and therefore IRC 1014(b)(1) applies 173 Basis Issues: Grantor Trusts at Death of Grantor Related Issue: Sale Transactions If a Grantor sells an asset to a Grantor Trust for a promissory note and dies before the note is repaid, is there gain to the Grantor to the extent the outstanding balance on the note exceeds the Grantor s basis? If so, do the assets in the Trust get a step-up under IRC 1012 for cost basis? No confirmed guidance from the IRS

88 Blank Rome Tax Update Planning For Elderly Clients The Net Net Gift 175 Net Net Gifts: Agreement to Assume Potential Estate Tax Liability Steinberg v. Comm r., 145 T.C. No. 7 (9/16/15) ( Steinberg II ) (Steinberg I rejected IRS motion for summary judgment) Enforceable Net Net Gift Agreement reduced taxable gift Donees agreed to pay (1) gift tax on transfer (first net ) and any estate tax under 2035(b) if donor s death occurred within 3 years (second net ); Agreement reduced FMV based on likelihood of donor surviving the 3 years (need appraisal) Overruled 5 th Circuit McCord case; adopted willing buyer/willing seller test Donor should be elderly (but healthy)

89 88

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