On April 14, President Barack Obama sealed the fate of 1099 requirements. Taxpayers say good riddance to what was generally seen an over-burdensome reporting requirements. Thursday’s law, the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, repeals both the expanded Form 1099 information reporting requirements mandated by last year’s health care legislation and the 1099 reporting requirements imposed on taxpayers who receive rental income, which was enacted as part of last year’s Small Business Jobs Act. For more on the repeal, see the Journal of Accountancy, http://www.journalofaccountancy.com/Web/20114071.htm or the Feb. 16, 2011, blog entitled, “Rolling Back te ObamaCare 1099 Documentation Burden.”

The Internal Revenue Service is eying executive pay in their ever expanding efforts to raise more revenue from corporate taxpayers. Experts warn that areas such as deferred compensation, restricted stock, and severance packages are expected to come under closer IRS scrutiny. For more, go to CFOZone.com (http://www.cfozone.com/index.php/Newsflash/IRS-audits-of-executive-compensation-Infractions-to-avoid.html).

TaxOps Offers 10-Tax Considerations for Growing Businesses

The Internal Revenue Service has posted a series of questions and answers (FAQs) about the new requirement for large corporations to report their uncertain tax positions. The FAQs address both reporting requirements for Schedule UTP, Uncertain Tax Position Statement, and the IRS’ policy of restraint. IRS FAQs can be found at http://www.taxops.com/asc-740.

On Apr. 8, 2011, the IRS adopted a safe-harbor election (Revenue Procedure 2011-29) that allows taxpayers to deduct 70% of the success-based fees (success fees) incurred in connection with certain capital restructurings and acquisitions or reorganizations. The remaining 30% is treated as going to activities that facilitate the transaction and must be capitalized. The election is available to taxpayers for success fees paid or incurred in tax years ending on or after Apr. 8, 2011.

A success fee is the amount paid a taxpayer pays that is contingent on the successful closing of a transaction. Under current regulations, success fees are not deductible for any amount paid for property that has a useful life substantially beyond the taxable year. In the case of an acquisition or reorganization of a business entity, acquisition costs that produce significant long-term benefits must be capitalized (Code Sec. 263(a)(1)). Reg. Sec. 1.263(a)-5 further requires that any amounts paid to facilitate a business acquisition or reorganization must be capitalized, including due diligence and other work conducted in pursuing the transaction.

Success fees are presumed to be paid to facilitate a transaction. However, taxpayers with sufficient documentation can isolate the portion of the fee that is allocable to activities that do not facilitate the transaction (Code Sec. 446) and therefore do not have to be capitalized. However, the IRS and taxpayers have disagreed over the documentation requirements necessary to establish the capitalized portion of the success fee.

Under Rev Proc 2011-29, the IRS provides a safe harbor election that can be used by a taxpayer that pays or incurs a success fee for services performed in the process of investigating or pursuing a business acquisition. This election is irrevocable, applies only to the transaction for which it is made, and applies to all success fees that the taxpayer paid or incurred in the transaction.

The IRS will not challenge a taxpayer’s allocation of the success fees between activities that do and do not facilitate a business acquisition or reorganization if the taxpayer:

1)  treats 70% of the amount of the success fee as an amount that does not facilitate the transaction;

2)  capitalizes the remaining 30% as an amount that does facilitate the transactions; and

3)  attaches a statement to its original federal income tax return for the tax year in which the success fee is paid or incurred stating that the taxpayer is electing the safe harbor, identifying the transaction, and stating the amounts of the success fee that are deducted and capitalized.

Net operating losses (NOLs) are a very valuable asset that can dramatically reduce, or even eliminate, a corporation’s tax liability. Two recent developments – the rise of poison pill plans and an IRS private ruling – preserve the ability of companies to take full advantage of their NOLs while simultaneously staving off any unsolicited takeovers. An NOL, under Internal Revenue Code sec. 382, is equal to the excess of business deductions over gross income in a particular tax year, resulting in negative taxable income. The loss can be carried back to recover past tax payments or carried forward to reduce future tax payments.

The use of NOL poison pill or “preservation” plans is on the rise as the aftermath of the economic recession gives way to a wave of takeover transactions. These plans are designed to discourage anyone from acquiring 5 percent or more of a company’s shares, thus deterring ownership changes that would deprive the company of otherwise usable NOLs. A number of financial institutions that received bailout funds from the government in the past three years relied on these plans to avert takeovers. The Delaware Supreme Court recently upheld the use of these plans.

After an “ownership change,” the IRS limits the amount by which a loss corporation can offset its taxable income. The purpose of 382 was to prevent the “trafficking” of NOLs—in other words, to limit their benefit when new shareholders who did not bear the actual economic burden of the losses acquire a controlling interest in a loss corporation. An ownership change is defined as a change in the percentage of ownership of the loss corporation’s stock owned by the “5 percent shareholders” of more than 50 percentage points (by value) over a 3-year period. The term “5 percent shareholder” includes any person or public group holding 5 percent or more of the corporation’s stock, directly or indirectly, during the testing period. Ownership shifts trigger an IRS filing, which can be complex and expensive. Some loss corporations may not carefully track their ownership since 382 limitations are only implicated when the corporation becomes profitable.

Poison pill plans vary. One plan could provide that, as of a certain date, existing holders and holders of new shares issued after that date will receive a dividend of one preferred share purchase right for each common share. Any person or entity that acquires 4.99% or more of the shares voids their preferred share purchase rights. The resulting dilution would keep the person’s share under the requisite 5% level—and shareholders are likely to be discouraged from purchasing enough stock to reach that level in the first place. However, this type of plan merely discourages ownership change levels of stock acquisition by making it more expensive but they do not prevent such an acquisition.

Separately, in a private letter ruling, the IRS upheld a loss corporation’s method of determining whether a merger will trigger an ownership change. The private ruling allows for a company to determine through written inquiry whether a transaction will trigger a change in ownership. The subject of the ruling, a loss corporation, solicited information through written inquiry about the stock ownership of a public group that potentially owns “overlapping” stock in both it and the corporation it plans to acquire in a proposed Code Sec. 368(a) merger. The information was collected to determine “actual knowledge” as to whether the merger will result in a change of ownership.

A loss corporation must take certain stock ownership of which it has “actual knowledge” into account to determine whether an ownership change has occurred when the loss corporate either (i) has actual knowledge of stock ownership on any testing date, or (ii) acquires knowledge before the date that the income tax return is filed for the tax year in which the testing date occurs.

 The IRS determined that the additional information the public company will obtain about the stock ownership of the overlapping owners through written inquiry is an acceptable method of determining actual knowledge. This form of written inquiry can greatly simplify the process for determining actual knowledge while still providing businesses with the information they need to satisfy IRS requirements.

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