Tax Article - Recent Tax Highlights

Backdated and Mispriced Stock Options:

The IRS announced an initiative intended to provide relief for rank-and-file employees affected by their companies’ issuance of backdated and other mispriced stock options. The initiative will not be available for backdated options exercised by most corporate executives or other insiders. The initiative allows employers to step forward and pay the Section 409A 20% tax and any interest tax that employees owe. Employers must notify the IRS of their intent to participate by 2/28/07, must provide specific details about the options, and will be required to contact affected employees by 3/15/07 to inform them that the employer has applied to participate in the program. The taxes the companies pay to relieve employee tax bills will be treated as additional 2007 compensation income for those employees in the 2007 tax year. IRS Ann. 2007-18, 2007-9 IRB.

Estimated Tax Penalty for Persons Working Abroad:

Because the changes made by the Tax Increase Prevention and Reconciliation Act of 2005 to the foreign earned income and housing cost exclusion applied to tax years beginning after 12/31/05, persons relying on the pre-TIPRA law may have underpaid their estimated tax liability for 2006. Fortunately, the IRS will waive additions to tax to the extent the underpayment resulted from the changes made by TIPRA. This waiver is only available to qualified individuals who file Form 2555 (Foreign Earned Income) or Form 2555-EZ (Foreign Earned Income Exclusion) with their timely filed Form 1040 or Form 1040X. Notice 2007-16, 2007-8 IRB.

Rescinding Reportable Transaction Penalty:

IRC Sec. 6707 authorizes a penalty for failing to file a return or filing false or incomplete information for a reportable transaction, while IRC Sec. 6707A imposes a penalty for failing to include information about a reportable or listed transaction on any return or statement. In either case, the IRS can rescind the penalty if the violation does not relate to a listed transaction and doing so would promote compliance with the Code and effective tax administration. A new revenue procedure describes the (1) procedures (including the deadline) for requesting rescission, (2) information the person must provide in the rescission request, (3) factors that weigh for or against rescission, and (4) rules governing IRS requests for additional information. Rev. Proc. 2007-21, 2007-9 IRB.

Rollovers to Health Savings Accounts:

The IRS announced guidance on rollovers from health flexible spending arrangements (FSAs) and health reimbursement arrangements (HRAs) to health savings accounts (HSAs) following amendments to IRC Sec. 223 by the Tax Relief and Health Care Act of 2006, including special transition relief for rollovers completed before 3/15/07. The guidance clarifies the requirements for making these rollovers, which must be made directly to the custodian or trustee of the HSA. Generally, all of the following conditions must be satisfied for the rollover to receive favorable tax treatment. By plan year-end, the (1) plan must be amended, (2) employee must elect the rollover, (3) year-end balance must be frozen, and (4) funds must be transferred by the employer within 2½ months after the end of the plan year and result in a zero balance in the health FSA or HRA. Notice 2007-22, 2007-10 IRB.

Treasury Explains Administration’s 2008 Revenue Proposals:

On 2/5/07, the Treasury Dept. released its “General Explanation of the Administration’s Fiscal Year (FY) 2008 Revenue Proposals,” commonly known as the Blue Book. The fiscal year 2008 budget includes measures to permanently extend the tax relief enacted in 2001 and 2003, the President’s proposal for a new standard deduction for health insurance, and initiatives to improve compliance. The budget also proposes a one-year extension (through 2007) of the so-called AMT patch, but urges Congress to “create a longer term solution to the problems associated with the individual AMT.” For further discussion, see www.ustreas.gov/press/releases/hp247.htm.

Day Trading Losses Are Capital Losses:

Taxpayer was a physician who also engaged in the day trading of securities, buying and selling securities on his own account on the same day or within a few days to profit from short-term fluctuations in the market price. After noting that taxpayer and the IRS had stipulated that taxpayer was a trader and not a dealer with regard to this activity, the Tax Court stated that the “courts have consistently held, in keeping with the definition of a capital asset under [IRC Sec. 1221], that the character of gains or losses from a taxpayer’s buying and selling securities on his own account is capital and not ordinary, even though the taxpayer may be engaged in a trade or business with regard to such trading activity.” Therefore, taxpayer’s losses were capital losses, not ordinary losses. Shahrooz Jamie, TC Memo 2007-22 (Tax Ct.).

Deducting Payroll Taxes on Deferred Compensation:

A new revenue ruling involves an accrual method corporation that has adopted the recurring item exception. At the end of Year 1, all events have occurred to establish liability for payroll taxes for deferred compensation and the amount of the liability can be determined with reasonable accuracy. The corporation pays the taxes either in Year 1, or before the earlier of 9/15 of Year 2 or the date it files a timely tax return for Year 1. Therefore, under IRC Sec. 461, the payroll taxes would be treated as incurred in Year 1. But under IRC Sec. 404, the deferred compensation itself would be properly deductible in Year 2 (i.e., in the tax year that includes the end of the tax year in which the employees recognize income). According to the IRS, IRC Sec. 404 applies to deferred compensation but not to the payroll taxes related to that compensation. IRC Sec. 404 does not affect the accrual of the corporation’s payroll tax liability. Rev. Rul. 2007-12, 2007-11 IRB

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Like-kind Exchange Followed by Sale:

Under IRC Sec. 1031(f)(1), if a taxpayer exchanges like-kind property with a related person and either of them disposes of the property within two years, gain or loss is recognized. This private letter ruling involved a trust and a group of siblings who decided to sell their land holdings, including Parcels #1, #2, and #3. Taxpayer didn’t want to divest her ownership of real estate, so the parties agreed that she would exchange her undivided 25% interest in Parcel #1 for a 100% fee simple interest of equal value in Parcel #3. Following the exchange, the trust and the siblings sold Parcels #1 and #2 to an unrelated third party. The IRS noted that dispositions that do not involve the shifting of basis between properties are not taken into account under IRC Sec. 1031(f)(1). Since the respective per acre basis in Parcels #1 and #3 were the same due to the step-up in basis that occurred when taxpayer’s father died owning the parcels, the disposition did not involve basis shifting and did not disqualify the like-kind exchange. Ltr. Rul. 200706001.

Patent Cross-licensing Arrangements:

A patent cross-licensing arrangement is a contract between two parties that own intellectual property, typically patents, under which each party grants the other a license for specified property on a nonexclusive and nontransferable basis. In response to a request for comments in Notice 2006-34 (2006-14 IRB 705), the IRS issued a new revenue procedure permitting taxpayers to change to, or continue to use, the net consideration method of accounting for a qualified patent cross-licensing arrangement (QPCLA). Under this method, only the net consideration transferred between the parties to a QPCLA during a tax year is taken into account for withholding purposes as well as for capitalization purposes under IRC Secs. 263(a) or 263A. Rev. Proc. 2007-23, 2007-10 IRB.

Tax-exempt Organizations—Tax Shelter Transactions:

The 2005 Tax Increase Prevention and Reconciliation Act designated certain transactions as prohibited tax shelter transactions and authorized new entity-level and manager-level excise taxes and disclosure rules for such transactions involving tax-exempt entities. The IRS has now clarified the definition of the phrase party to a prohibited tax shelter transaction for Section 4965 purposes as well as the appropriate treatment of net income or proceeds received prior to the effective date of the Section 4965(a) tax. Future proposed regulations will define party to include a tax-exempt entity that enters into a prohibited tax shelter transaction that reduces such entity’s liability for employment taxes, excise taxes, and in appropriate cases unrelated business income tax. Notice 2007-18, 2007-9 IRB.