ALI-ABA Course of Study Representing the Growing Business: Tax, Corporate, Securities, and Accounting Issues

Transcription

1 233 ALI-ABA Course of Study Representing the Growing Business: Tax, Corporate, Securities, and Accounting Issues February 22-24, 2007 Coral Gables, Florida Federal Tax Update By Stephen L. Kadish Matthew F. Kadish Kadish, Hinkel & Weibel Cleveland, Ohio IRS Circular 230 Disclosure This is a study outline. It's not tax advice. Sorry, but you can't rely on the outline, or the cartoons, especially to avoid penalties. It might help suggest when you should go get advice, though. That part is up to you. This has been your Circular 230 warning.

2 234 2

3 Federal Tax Update Stephen L. Kadish Matthew F. Kadish 1 Kadish, Hinkel & Weibel 1717 E.9 th Street, Suite 2112 Cleveland, Ohio (216) I. Accounting Methods A. Ten years of consistent miscalculations of inventory value is too long became an accounting method. Huffman v. Commissioner, 126 T.C. (No. 17). 1. Facts: Taxpayer had misvalued inventories under LIFO for ten years. 2. Taxpayer argued that under Reg (e)(2)(ii)(b), this was a correction of a mathematical error, thus excluded from being a change in accounting. 3. Held: the attempted change was a change of accounting method, requiring the IRS consent. B. Warranty program liabilities did not immediately accrue under all events test. Chrysler Corporation v. Commissioner, 436 F.3d 644 (6th Cir. 2006). No amount was irrevocably set aside to meet the warranty claims during the year in question, and as an accrual taxpayer. Chrysler therefore could not deduct the claims until the all events test was met. 1 Our thanks to Ellen Kawashima, Esq., of Torkildson Katz Fonseca Moore & Hetherington (Honolulu, Hawaii) for her assistance in parts of this outline relating to the Pension Protection Act of

4 236 C. Heavy Equipment Dealers Can Continue to Use Replacement Cost Method to Value Cost of Inventory. Rev. Proc , I.R.B Background. Taxpayers using LIFO accounting must use the actual cost when determining the cost of inventory. Mountain State Ford Truck Sales, Inc. v. Commissioner, 112 T.C. 58 (1999). IRS learned that many heavy equipment dealers currently use the replacement cost method as a standard practice for valuing the inventory, and that it is nearly the same as actual cost in the heavy equipment industry. 2. Rev. Proc provides additional details on restrictions for permissible use of the replacement cost method. 3. Taxpayers currently using the replacement cost valuation method are given audit protection, and can continue to use the method without filing a Form Any current audits on that issue will be settled. 4. Qualifying taxpayers who want to switch should file Form 3115 for tax years ending on or after April 30, 2005, and follow the automatic change of accounting method procedures in Rev. Proc II. Corporations A. Reorganizations 1. TIPRA Changes to Tax Free Divisive Reorganizations ( Spin Offs ) a. Disqualified investment companies no tax-free spin-off allowed (effective for distributions after May 17, 2006). i. Background. Pre-TIPRA, there was no specific limit to the amount of investment assets a corporation could own - 3 -

5 237 before or after a spin-off, so long as both the spinner and spun-off corporation meet the active conduct of business requirement. A higher level of passive investment assets could be viewed as a factor in whether the spin-off is a device to siphon off earnings and profits, but there was no set rule. i Code 355(g) now denies tax-free spin-off treatment where either the distributing or distributed corporation is a disqualified investment corporation. Disqualified investment corporation is: A. Generally any corporation if two-thirds or more of its assets are investment assets. B. Transition (first year) rule for distributions after May 17, 2006 and before May 17, 2007, the threshold is higher a corporation is a disqualified investment corporation only if three-quarters of its assets are investment assets. iv. Investment assets A. Generally include cash, stock or securities, partnership interests, debt instruments, options forwards or futures contracts, notional principal contracts or derivatives, foreign currencies, or similar assets. B. Generally excludes assets held for use in an active and regularly conducted lending, financing or banking business, or in a regulated, licensed insurance business, or securities held by a dealer subject to the mark-to-market rules. C. Also excludes stock, securities, debt, options forward or future contracts in a 20% controlled entity. D. Also excludes partnership interests or debt from a partnership if a trade or business of the partnership is taken into account under 355 in determining whether the corporation meets the active trade or business rules

6 238 b. Simplified active business test for 355 spin-offs (effective for distributions made after May 17, 2006, and pre- January 1, 2010). i. A corporation satisfies the active trade or business requirement for a tax-free divisive reorganization only if it is engaged in the active conduct of a trade or business. i For testing purposes, all members of the corporation s separate affiliated group are treated as one corporation (see Code 1504(a), without applying 1504(b) exclusions). Net effect benefits controlled corporate groups makes it easier for a subsidiary in a controlled group to be spun off. 2. Basis of Stock and Securities Received in Corporate Reorganization. T.D. 9244, I.R.B changes to Regs , and - 2. a. Background. i. Prop. Regs. (2004) considered using either an averaging or tracing method for determining the basis of stock and securities received in 368 and 355 reorganizations. Under the tracing method, the basis of each share or stock or security is traced to the basis of each surrendered share of stock or security. b. Final Regulations i. To the extent the terms of the exchange agreement specify which shares are exchanged for which, those terms will control, so long as they are commercially reasonable. i Otherwise, a pro rata portion of shares of each class received is treated as being received for each share of stock and securities surrendered, based on the fair market value of the surrendered shares. Other issues addressed in Final Regs.: A. Boot allocation - 5 -