Category: Tax

Is the $5 Million Gift Tax Exempt Amount About to End?

Recently posted in the National Law Review an article by Elyse G. Kirschner and Carlyn S. McCaffrey  of McDermott Will & Emery regarding the The Tax Relief Act of 2010 made significant changes to the gift, estate and generation-skipping, however, not permanent:

 

 

 

The Tax Relief Act of 2010 made significant changes to the gift, estate and generation-skipping transfer tax regimes by increasing the amount each individual can give without incurring tax from $1 million to $5 million.  The increase was not permanent however, and rumor has it that it may be in jeopardy.  To avoid any risk, those who have decided to use their full exemptions should do so no later than December 31, 2011, and, if feasible, November 22.

The Rumors

The Tax Relief Act of 2010 made significant beneficial changes to the gift, estate and generation-skipping transfer tax regimes.  Most important, it increased the amount each individual can give without incurring gift tax and generation-skipping transfer tax to $5 million from $1 million.  For married individuals, the combined exemptions can be as high as $10 million.  The 2010 increase was not a permanent one.  Congress scheduled the exemption to return to $1 million after the end of 2012.

Rumors circulating recently within the financial and estate-planning communities have suggested the $5 million exemptions may be in immediate jeopardy.  Democratic staff on the U.S. House Committee on Ways and Means recently proposed decreasing the $5 million gift, generation-skipping transfer tax and estate tax exemptions to $3.5 million, effective January 1, 2012.  There also are rumors the Joint Select Committee on Deficit Reduction (the Super Committee) may recommend a drop down in the gift tax exemption to $1 million, effective at year end, or possibly as early as November 23, 2011, when its recommendations are scheduled to be released, though there is no confirmation this rumor is true.

What Should You Do?

Although it seems unlikely that Congress will focus on changes to the transfer tax system before year end, congressional action in the transfer tax area has been notoriously difficult to predict.  Congress’ decision in December 2010 to reinstate the estate tax retroactively, to permit the estates of 2010 decedents to opt out of paying estate tax and to reduce the generation-skipping transfer tax rate to zero, was a noteworthy example of congressional action that took the entire estate-planning community by surprise.  A congressional decision to reverse the 2010 transfer tax reductions would be more surprising because it would immediately strip from taxpayers a benefit that was clearly agreed to last December.  However, Congress is unpredictable.

In view of the uncertain availability of the $5 million exemption, those who have decided to use their full exemptions may want to do so quickly, rather than run the risk of losing them.  To avoid any risk, your deadline should be no later than December 31, 2011, and, if feasible, November 22.  The choices to be made include identifying the property to be transferred, selecting the individual recipients and determining the manner in which the recipients should receive their gifts.

Selection of Assets to Give

Assets to be transferred to the trust should be those that are likely to appreciate over time.  The transfer of appreciating assets will help leverage the initial gift.  Investments that are temporarily depressed as a result of recent market conditions, for example, could prove to be successful gifts. Remainder interests in residences in today’s depressed housing markets may also be attractive gifts.  Marketable securities, interests in hedge funds or other investment partnerships and real estate are all good possibilities.  High-basis assets typically are a good choice, but assets that are valued today at less than their basis are not usually the best choice.

If non-marketable assets are given, an appraisal of those assets is needed to properly value and report the gift, but the appraisal can be completed after the gift is made.  In most instances, a formal appraisal of non-marketable assets will take into account certain valuation discounts (for example, lack of marketability and minority interest discounts).  The effect of these valuation discounts will be to further leverage the gift tax credit.

Selecting Recipients

The logical recipients of gifts will be those family members who will receive the estate.  Because tax-free gifts can be made to a spouse and charity, gifts to them do not need to be accelerated to take advantage of the gift tax exemption.  In some cases, clients may plan to use their increased exemptions to forgive debts previously made to friends and family members with financial needs, or to meet the living expenses of adult children.

Making Gifts in Trust

Outright gifts are a simple way to use the gift and generation-skipping transfer tax exemptions, but gifts in trust offer many more advantages.  For example, transferring assets to a trust for the benefit of children can protect those assets from the claims of their creditors or spouses.  In addition, with a trust the trustees of the trust can control the timing and manner of distributions to children.

Furthermore, if portions of the remaining $5 million generation-skipping transfer tax exemption are allocated to the trust, future distributions to grandchildren and more remote issue can be made free of the generation-skipping transfer tax.  Finally, if the trust that is established is a so-called “grantor trust” for income tax purposes, you, and not the trust, will pay the income tax on the income generated inside the trust.  When the gift-giver pays the income tax on the income of the trust, the size of the estate is reduced without having to make additional taxable gifts to the trust.

An Existing Trust or a New Trust?

Once the decision is made to make a gift in trust, the next question is whether to make the gift to an existing trust or to a new one.  Whether an existing trust or a new trust is selected is a function of a number of considerations, such as whether the trusts that are already created have the appropriate beneficiaries, whether a spouse also plans to make a gift in trust and whether certain provisions should be in the trust to address uncertainties at this time.

© 2011 McDermott Will & Emery

2011 Wisconsin Act 49: Wisconsin Tax Law Amended to Conform with Federal Adult Child Coverage Requirements

Posted in the National Law Review an article by Alyssa D. Dowse and Timothy C. McDonald of von Briesen & Roper, S.C.  regarding Wisconsin’s state income tax law for health coverage provided to an employee’s adult child to the exclusion provided for that coverage under federal income tax law.

As expected, Governor Scott Walker has signed legislation to conform the exclusion under Wisconsin state income tax law for health coverage provided to an employee’s adult child to the exclusion provided for that coverage under federal income tax law. If an employer’s health plan extends coverage to an employee’s adult child, then, through the end of the tax year in which the child attains age 26, the employee will not be subject to either federal or Wisconsin state income tax on the value of that coverage. This is the case regardless of whether the child otherwise qualifies as the employee’s tax dependent. This change in Wisconsin law is effective for tax years beginning on or after January 1, 2011.

If employer health plan coverage is provided to an employee’s adult child after the tax year in which the child attains age 26, then, as under current law, the employee will be subject to federal and Wisconsin state income tax on the value of that coverage unless the child qualifies as the employee’s tax dependent for health plan purposes.

Governor Walker signed 2011 Wisconsin Act 49 (the “Act”), which amends Wisconsin tax law to conform the state income tax exclusion for coverage provided to an employee’s adult child to the federal income tax exclusion, on November 4, 2011.

©2011 von Briesen & Roper, s.c

Wisconsin Eliminates Income Tax Disparity on Health Coverage for Adult Children

Posted on November 9, 2011 in the National Law Review an article by attorneys Kelli A. Toronyi, Charles P. Stevens and Kirk A. Pelikan of Michael Best & Friedrich LLP regarding Wis. Act 49.:

On November 4, 2011, Governor Walker signed into law 2011 Senate Bill 203 now known as 2011 Wis. Act 49. The bill, which received large bipartisan support among Wisconsin legislators, exempts from Wisconsin income tax the value of health coverage provided to certain adult children.

Background

Prior to 2010, most employers’ health plans provided coverage for children of employees up to age 19, or up to age 23 if the child was a full time student. Effective January 1, 2010, Wisconsin imposed a new rule requiring insurance carriers and certain self-funded governmental plans to provide eligibility for coverage for children through age 26 (up to the day before the child’s 27th birthday).

On March 23, 2010, the federal Patient Protection and Affordable Care Act (“PPACA”) was enacted. It required employer health plans to cover older children through age 25 (up to the day before the child’s 26th birthday), effective for calendar year health plans on and after January 1, 2011. Under the then current federal Internal Revenue Code, however, this coverage would be considered taxable income to some parents.

Then a week later on March 30, 2010, Congress amended the federal Internal Revenue Code to exclude from taxable income health coverage that a taxpayer receives for a child up to the end of the calendar year in which the child reaches age 26. Thus, the imputed income problem was solved for federal tax purposes.

In June of 2011, Wisconsin modified its insurance eligibility rules to adopt the federal eligibility rules under PPACA, effective January 1, 2012 (or upon expiration, extension, modification or renewal of an applicable collective bargaining agreement, if later). Thus, under both Wisconsin and federal law health coverage must be made available for children up through age 25. However, Wisconsin did not modify its tax rules, which continued to observe the previous version of the federal Internal Revenue Code, so the coverage of an employee’s child subject to Wisconsin income tax in some circumstances. To the extent such coverage has been taxable for Wisconsin income tax purposes, employers have been required to report this coverage as income on the employee’s W-2 form and to withhold the appropriate amount from wages.

Amendment to Wisconsin Tax Code Eliminates Obligation to Impute Income for Adult Child Health Coverage

With the enactment of 2011 Wis. Act 49, the Wisconsin Tax Code and the federal Internal Revenue Code are again consistent. Wisconsin employees are no longer subject to taxation for this coverage and Wisconsin employers are no longer required to impute as income the value of such coverage for tax withholding and W-2 reporting purposes. The new law is effective retroactive to January 1, 2011. This may result in some over withholding for some employees to date, but with a reduction in taxable income, this provides for a somewhat lower Wisconsin tax liability when tax returns are filed next year.

A copy of 2011 Wis. Act 49 can be found here.

© MICHAEL BEST & FRIEDRICH LLP

ABA Conference: Criminal Tax Fraud and Tax Controversy

The National Law Review wanted to bring your attention to the upcoming 28th Annual National Institute on Criminal Tax Fraude and the Fisrt National Institute on Tax Controversy on December 1-2, 2011 in Las Vegas:

  • Program Description

The  National Institute on Criminal Tax Fraud is the annual gathering of the criminal tax defense bar.  This year, it will be combined with the National Institute on Tax Controversy, bringing together high-level Government representatives, judges, corporate counsel, and private practitioners engaged in all aspects of tax controversy, tax litigation, and criminal tax defense.

The two Institutes will meet each morning of the conference in joint plenary sessions, addressing issues concerning international tax enforcement and ethics.  Participants will then chose break- out sessions that will focus on current civil tax controversy or criminal tax defense topics.

As in past years, these Institutes will offer the most knowledgeable panelists from the government, the judiciary, and the private bar.  Attendees will include attorneys and accountants just beginning to practice in tax controversy and tax fraud defense, as well as highly experienced practitioners.  The break-out sessions will encourage an open discussion of hot topics.  The program will provides valuable updates on new developments and strategies, along with the opportunity to meet colleagues, renew acquaintances and exchange ideas.

The IRS has focused on international enforcement, from its reorganization of its Large Business and International Division to its focus on global high wealth taxpayers and offshore activities, and both Institutes will focus on these issues, in a combined plenary session and in break-out sessions.  The break-out sessions will also include roundtable discussions with senior representatives from the IRS, and the Treasury and Justice Departments, and panels will focus on topics ranging from the nuts-and-bolts of representing clients in examination, at Appeals, at trial and in criminal investigations, to the hottest areas of civil and criminal enforcement.  It promises to be a program that no tax litigator should miss.

  • CLE Information

ABA programs ordinarily receive Continuing Legal Education (CLE) credit in AK, AL, AR, AZ, CA, CO, DE, FL, GA, GU, HI, IA, ID, IL, IN, KS, KY, LA, ME, MN, MS, MO, MT, NH, NM, NV, NY, NC, ND, OH, OK, OR, PA, RI, SC, TN, TX, UT, VT, VA, VI, WA, WI, WV, and WY. These states sometimes do not approve a program for credit before the program occurs. This course is expected to qualify for TBD CLE credit hours (including TBD ethics hours) in 60-minute-hour states, and TBD credit hours (including TBD ethics hours) in 50-minute-hour states. This transitional program is approved for both newly admitted and experienced attorneys in NY. Click here for more details on CLE credit for this program.

IRS Announces Retirement Plan Limitations for 2012 Tax Year – Most Limits Increased

Recently posted in the National Law Review an article written by Alyssa D. Dowse of von Briesen & Roper, S.C. regarding the cost of living adjustments for the 2012 tax year:

The Internal Revenue Service (“IRS”) has announced the cost of living adjustments for the 2012 tax year, which affect various dollar limitations for retirement plans. The IRS increased many of these limitations for the first time since 2009. Some limitations remain unchanged. The following chart highlights many of the noteworthy limitations for the 2012 tax year.

Plan Limit

2011

2012
Social Security Taxable Wage Base $106,800 $110,100
Annual Compensation (Code Section 401(a)(17)) $245,000 $250,000
Elective Deferral (Contribution) Limit for Employees who Participate in 401(k), 403(b) and most 457(b) Plans (Code Sections 402(g), 457(e)(15)) $16,500 $17,000
Age 50 Catch-Up Contribution Limit (Code Section 414(v)(2)(B)(i)) $5,500 $5,500
Highly Compensated Employee Threshold (Code Section 414(q)(1)(B)) $110,000 $115,000
Defined Contribution Plan Limitation on Annual Additions (Code Section 415(c)(1)(A)) $49,000 $50,000
Defined Benefit Plan Limitation on Annual Benefit (Code Section 415(b)(1)(A)) $195,000 $200,000
ESOP Distribution Period Rules—Payouts in Excess of Five Years (Code Section 409(o)(1)(C)) $985,000

$195,000

 $1,015,000

$200,000
Key Employee Compensation Threshold for Officers (Code Section (416(i)(1)(A)(i)) $160,000 $165,000

Plan sponsors should review employee communications and update such communications as appropriate based on the 2012 cost of living adjustments. Other cost of living adjustments can be found on the IRS  website: http://www.irs.gov/retirement/article/0,,id=96461,00.html.

©2011 von Briesen & Roper, s.c

 

 

Office of Foreign Assets Control: Understanding the Federal Agency

Recently posted in the National Law Review an article by Simi Z. Botic and D. Michael Crites of Dinsmore & Shohl LLP regarding  the climate surrounding our nation’s safety has drastically changed since 9/11: 

Since September 11, 2001, the climate surrounding our nation’s safety has drastically changed. In an effort to promote United States foreign policy and national security goals, the Office of Foreign Assets Control (“OFAC”) has responded to the changing political environment. Although OFAC is not a recent development, the agency certainly operates with the present security sensitivities in mind.

OFAC operates within the U.S. Department of the Treasury, administering and enforcing economic and trade sanctions. Blocking necessary assets exemplifies one trade sanction often imposed by OFAC. In particular, sanctions are enforced against targeted foreign countries, terrorist regimes, drug traffickers, distributers of weapons of mass destruction, and other individuals, organizations, government entities, and companies that threaten the security or economy of the United States.

By enforcing the necessary economic and trade sanctions, OFAC restricts prohibited transactions. OFAC defines a prohibited transaction as a “trade or financial transaction and other dealing in which U.S. persons may not engage unless authorized by OFAC or expressly exempted by statute.” OFAC is largely responsible for investigating the “prohibited transactions” of individuals, organizations, and companies who operate in foreign nations. OFAC also has the ability to grant exemptions for prohibited transactions on a case-by-case basis.

Administrative subpoenas, vital OFAC investigation tools, allow OFAC to order individuals or entities to keep full and complete records regarding any transaction engaged in, and to furnish these records at any time requested. Both the Trading with the Enemy Act of 1917, 5 U.S.C. § 5, and the International Emergency Economic Powers Act, 50 U.S.C. § 1702(a)(2), grant OFAC the authority to issue administrative subpoenas.

Adam J. Szubin is the current director of OFAC. In his capacity as director, Mr. Szubin is authorized by 31 CFR § 501.602 to hold hearings, administer oaths, examine witnesses, take depositions, require testimony, and demand the production of any books, documents, or relevant papers relating to the matter of investigation. Once OFAC has issued an administrative subpoena, the addressee is required to respond in writing within thirty calendar days from the date of issuance. The response should be directed to the named Enforcement Investigations Officer, located at the U.S. Department of the Treasury, Office of Foreign Assets Control, Office of Enforcement, 1500 Pennsylvania Ave., N.W., Washington, D.C.

Should an addressee fail to respond to an administrative subpoena, civil penalties may be imposed. If information is falsified or withheld, the addressees could receive criminal fines and imprisonment. OFAC is authorized to penalize a party up to $50,000 for failure to maintain records. Therefore, should you find yourself the recipient of an OFAC administrative subpoena, it is imperative that you do not delay in responding. Typically, OFAC requests detailed information about payments or transactions, along with documentation to support such information. The subpoena response should be drafted by your attorney. The addressee of the letter should not have direct communication with OFAC. Counsel for the addressee should also follow up with the individual OFAC officer to make sure that all necessary paperwork was received.

Lastly, entities are encouraged to make voluntary disclosures when there has been an OFAC violation. Once a subpoena has been issued, disclosures are no longer considered voluntary. If information is turned over in response to an administrative subpoena, it may then be referred to other law enforcement agencies for possible criminal investigation and prosecution. Therefore, if there is a possible violation of OFAC, it is in your best interest to consult with counsel about the proper steps to take moving forward.

© 2011 Dinsmore & Shohl LLP. All rights reserved.

The Top Five Tax Traps in M&A Transactions

Recently posted  in the National Law Review an article by Jeffrey C. Wagner  and Daniel N. Zucker of McDermott Will & Emery regarding tax consequences of acquisition and disposition transactions:

The tax consequences of acquisition and disposition transactions can dramatically impact deal value. Often the potential tax issues can be resolved in a manner that is consistent with the intention of the parties without changing the economics of the deal. If some of these tax issues are not addressed, however, the parties may not obtain the benefit they had bargained for even though it may have otherwise been possible. This puts a premium on the involvement of tax advisors from the outset of a transaction. Although one rarely wants to see tax be the “tail that wags the dog” in a deal, tax issues can present significant economic opportunities or costs that may often warrant tweaking or changing the deal structure to accommodate these issues.

1. Failure to Solicit Tax Advice at the Letter of Intent Stage

Although not binding, the terms of the letter of intent entered into by the parties in the early stages of the acquisition process can put one of the parties in a superior bargaining position as it relates to which party bears the burden or reaps the benefits of the tax costs and benefits associated with a transaction. Too often, a client does not engage its outside advisors (or significantly limits the involvement of its outside advisors) until after a letter of intent is signed. The failure to include the tax advisor at this early stage can mean lost dollars to the seller or additional cost to the buyers.

For example, if the target is an S corporation, in most cases the buyer should be able to secure the benefit of a tax basis step-up for federal income tax purposes without a material increase in the taxes payable by the seller with respect to the sale. However, if the buyer is not well-advised, the letter of intent may simply indicate that the buyer will acquire the stock of the target for the agreed-upon consideration. If, after the letter of intent is executed, the buyer recognizes that a tax basis step-up can be achieved with little or no tax cost to the seller, the buyer may request that the transaction be converted to an asset purchase or that a Section 338(h)(10) election be made by the parties. At this point, the seller has the leverage and can demand additional consideration from the buyer in exchange for the tax benefits that such a structure would provide.

2. Section 197 Anti-Churning Rules

When the acquisition of a business is structured for income tax purposes as an asset purchase (i.e., an asset purchase in form or a stock purchase coupled with a Section 338(h)(10) election), the buyer usually has bargained for the tax benefits that accompany such a transaction—namely, the ability to tax effect the purchase price by depreciating or amortizing the premium paid for the assets, which premium is usually attributable to the goodwill and going concern value of the acquired business. If the business being acquired was in existence on or before August 10, 1993 and, before or after the transaction, the seller or a related party owns, directly or indirectly, greater than twenty percent of the equity of the buyer – which may be the case, for example, if the deal calls for the seller to receive “rollover equity”—the goodwill and going concern value of the target (as well as other Section 197 intangibles) may not be amortizable by the buyer. As a result, the buyer will not obtain the tax benefits that it anticipated and paid for as part of the acquisition. The economic benefit that is lost can amount to as much as 20-25 percent of the purchase price depending on the discount rate used to calculate tax benefits and other factors.

Moreover, if the acquirer is a limited liability company or the corporate acquirer is owned by a limited liability company, and the seller will have an interest in the limited liability company following the acquisition, the anti-churning rules can be an issue even where the seller owns less than twenty percent of the limited liability company. It is therefore critical that any transaction that calls for the seller or a party related to the seller to obtain (or retain) an equity interest in the buyer in connection with the acquisition, the buyer should closely study whether the anti-churning rules could be applicable. A failure to do so can result in a significant – and perhaps needless—reduction in the buyer’s after-tax cash flow and adversely affect the purchase price payable by a subsequent buyer of the business.

3. Qualified Stock Purchase Failure

As an alternative to structuring an acquisition as an asset purchase in form, a buyer can realize the tax benefits of an asset purchase by structuring the acquisition as a stock purchase and making a Section 338 or Section 338(h)(10) election in connection with the transaction (the latter requiring the consent of the seller and being limited to target corporations that are S corporations or subsidiaries of a consolidated group). In order to be eligible to make a Section 338 or 338(h)(10) election, the acquisition must constitute a “qualified stock purchase”, one of the requirements of which is that 80 percent or more of the target corporation’s stock be acquired in a twelve-month period by “purchase”. For this purpose, “purchase” excludes transactions on which gain or loss is not recognized, including exchanges that qualify for tax-free treatment under Section 351. Frequently, when a new corporation is being organized to acquire the stock of the target corporation, one or more of the sellers may “roll over” a portion his or her target corporation stock for stock of the new corporation. When less than 20 percent of the stock of the new corporation is received by the seller(s) in the exchange such that greater than 80 percent of the stock is acquired for cash, it would appear that the requirement that 80 percent or more of the stock of target be acquired by purchase would be satisfied. However, if any seller receives any stock of the new corporation (even one percent) in a transaction that qualifies as a Section 351 exchange, the acquisition will not constitute a qualified stock purchase and will be ineligible for a Section 338 or 338(h)(10) election.

The solution here is to structure the transaction so as to intentionally not qualify as an exchange under Section 351. Although this will undoubtedly have ramifications to the sellers (who may otherwise have been expecting to not have to recognize gain currently with respect to their rollover equity), the failure to obtain a step-up in basis in the assets of target corporation and consequently, the inability to tax-effect the purchase price (through depreciation and amortization deductions) may have an even larger negative impact on the buyer.

4. Acquisition of Shares of “Loss Stock” from Consolidated Group

A recent overhaul of the so-called “loss disallowance rules” changed the rules that apply when a buyer acquires the stock of a target company out of a U.S. federal consolidated group in a transaction in which the seller recognizes a loss. Prior to the change in the law, any limitation on the recognition of that loss for tax purposes would impact only the seller; the buyer was unaffected. However, under the new rules, if the buyer acquires shares of stock from a consolidated group that constitute “loss stock” (i.e., the consideration paid for the stock is lower than the selling consolidated group’s tax basis of the stock), absent a special election made by the seller, the tax basis in the assets of the target corporation (as well as other target corporation tax attributes) may be subject to reduction in an amount equal to some or all of the seller’s loss.

As a result, in all stock purchase agreements where the seller is a member of a U.S. federal consolidated group, the buyer should insist on a representation that none of the acquired shares are “loss shares” and, to the extent any of the shares are “loss shares”, the buyer should insist on a covenant that would require the seller to make the election that would, in lieu of reducing the target corporation’s tax basis in its assets and other tax attributes, cause the loss recognized by the seller to be reduced. In situations where the tax benefit to the seller from the loss is greater than the tax cost associated with the reduction in tax attributes, the seller should compensate the buyer for this tax cost.

5. Phantom Income/AHYDO Rules

Whenever an acquisition is financed, in part, through borrowing, and interest on the loan is not required to be paid at least annually (or there are warrants or other equity instruments issued to the lender in connection with the loan), the parties should consider the potential application of the original issue discount (OID) rules. Generally, subject to certain de minimis rules, if interest on a debt instrument is not required to be paid at least annually—i.e., the interest simply accrues automatically or accrues at the option of the borrower—the interest income and interest expense will be recognized for tax purposes notwithstanding that the interest is not actually paid on a current basis. This means that the holder of the debt instrument will recognize taxable income without receiving any cash—i.e., the holder recognizes so-called “dry income” or “phantom income.” Although the phantom income resulting from the characterization of a debt instrument as an instrument issued with OID is generally manageable (either because the holders are tax-exempt or that portion of the interest needed to cover taxes can be paid on a current basis), in certain circumstances, there are special rules that may result in the borrower’s tax deduction for the interest/OID being deferred or disallowed.

Specifically, the tax rules defer and, in some circumstances, permanently disallow deductions for OID on certain applicable high yield discount obligations (AHYDOs). An AHYDO is defined as a corporate debt instrument that meets three requirements. First, the debt instrument must have “significant OID.” Second, it must have a term exceeding five years. Third, it must have a yield to maturity that is at least five percentage points above the applicable federal rate (AFR) in effect for the calendar month during which the debt instrument is issued. A debt instrument is treated as having significant OID if, at the end of the first accrual period following the fifth anniversary of the issuance of the debt instrument (and at the end of each subsequent accrual period), an amount greater than one year’s worth of OID (the yield to maturity multiplied by the issue price of the debt instrument) can remain unpaid.

Where warrants or other equity-type instruments are issued along with the debt instrument (i.e., as part of an investment unit), there is a greater potential for OID and classification of the debt instrument as an AHYDO because the issue price of the debt instrument will be reduced by any value attributable to this equity thereby reducing the issue price and creating a greater spread between the instrument’s stated redemption price at maturity and its issue price—thus creating more OID.

Advance planning can often neutralize the effect of these rules without significantly changing the business deal. By simply adding a provision to the debt instrument that requires (i) all accrued but unpaid OID (in excess of one year’s worth) to be paid on the first interest payment date following the five year anniversary of the issuance of the debt instrument and (ii) all interest thereafter to be paid on a current basis, the debt instrument can escape classification as an AHYDO. Of course, this change has the potential for real, economic consequences which should not be minimized. However, where, as is frequently the case, the deal contemplates this debt being refinanced before the five-year anniversary (or the borrower is comfortable that a refinancing can be negotiated at that time), the borrower can avoid having its interest/OID deductions deferred or disallowed. In this regard, it should be noted that a debt instrument is tested for AHYDO classification at the time it is issued and is based on when payments on the debt instrument are unconditionally obligated to be paid. If a debt instrument is characterized as an AHYDO, the borrower’s interest/OID deductions are subject to the rules regarding deferral or disallowance even where the borrower actually pays the interest on a current basis.

Conclusion

The foregoing are just a few of the many tax issues that can arise in any deal. If they are spotted early enough, most tax issues can be addressed with relatively inconsequential structural changes to the deal and/or creative planning without changing the underlying business deal. However, if the opportunity to address the tax issues is missed, there are often material economic consequences to one or more of the parties. To the extent that there are tax costs inherent in the deal that cannot be ameliorated through creative planning, the parties need to address how such costs will be shared among the parties; otherwise, the burden of these tax costs may be borne by the wrong party. 

© 2011 McDermott Will & Emery

Protesting at ODRA?: Learning the Lay of the Land

Recently posted in the National Law Review an article by Marko W. Kipa and Ryan E. Roberts of Sheppard Mullin Richter & Hampton LLP regarding filing with the Office of Dispute Resolution for Acquisition when the FAA makes an award.

 

Your company submitted a proposal to the Federal Aviation Administration (“FAA”) to provide widgets and related services. The opportunity had corporate visibility and was critical to your sector’s bottom line. After several agonizing months of waiting for an award decision, you learn that the FAA made an award to your competitor. You immediately accept the first debriefing date offered by the Agency. As that date approaches, you begin to strategize and weigh your options – should you file the bid protest at the Government Accountability Office (“GAO”) or the Court of Federal Claims? The answer – neither. When the FAA makes an award, any protest must be filed with the Office of Dispute Resolution for Acquisition – otherwise known as ODRA. There are several similarities and differences between, on the one hand, the GAO and the Court of Federal Claims, and, on the other hand, ODRA.

First, you are entitled to an automatic stay of performance if you timely file your protest at the GAO (unless the stay is overridden by the Agency).  To obtain a stay of performance at the Court of Federal Claims, you will most likely need to prevail on a motion for a temporary restraining order or a preliminary injunction. It is very difficult, however, to obtain a stay of performance at the ODRA. ODRA presumes that performance will continue pending resolution of the protest, and a protestor must separately brief the issue of whether a stay should be granted.  Unless the protester can demonstrate “a compelling reason to suspend or delay all or part of the procurement activities,” ODRA will allow performance to continue. 14 C.F.R. § 17.13(g); 14 C.F.R. § 17.15(d).  A review of ODRA’s suspension decisions shows that stays of performance are rarely granted. In other words, you should expect that ODRA will not grant a stay of performance.

Second, FAA procurements are not governed by the Federal Acquisition Regulation (“FAR”). Rather, the FAA is subject to the Acquisition Management System (“AMS”), which “establishes the policies, guiding principles, and internal procedures for the FAA’s acquisition system.” 14 C.F.R. § 17.3(c). While the FAR and the AMS share some overlapping concepts, there are notable differences between the two. For example, the AMS does not recognize the FAR’s distinction between “discussions” and “clarifications,” and instead categorizes all exchanges as “communications.” Furthermore, the AMS encourages communications with potential offerors, including one-on-one communications, stating that they “should take place throughout the source selection process” to “ensure that there are mutual understandings between the FAA and the offerors about all aspects of the procurement, including the offerors’ submittals/proposals.”   AMS § 3.2.2.3.1.2.2. ODRA has routinely denied protests where a disappointed offeror has claimed to have been the subject of unfair treatment when the FAA only communicated with one offeror. See, e.g., Consolidated Protests of Consecutive Weather, Eye Weather Windsor Enterprises, and IBEX Group, Inc., 02-ODRA-00254.

Third, ODRA has a robust alternative dispute resolution (“ADR”) program that is central to its resolution of bid protests. ODRA makes a variety of ADR techniques available to the parties, including mediation, neutral evaluation and mini-trials. 14 C.F.R. § 17.31(b). Additionally, ODRA’s rules were amended recently to place an even greater emphasis on ADR. The new rule officially instructs parties to use ADR as the primary means for settling protests and disputes, and allows parties to file “predisputes” so that they may engage in nonbinding, confidential discussions. 76 Fed. Reg. 55217 (Sept. 7, 2011) (to be codified at 14 C.F.R. Part 17). Although you can decline to participate in ODRA’s ADR program, it is well-worth your time and resources to consider pursuing this option.

Fourth, you should be aware of the various procedural rules at ODRA, as they differ from those of the GAO. Most notably, ODRA spurns the GAO standard of calendar days for business days (thereby excluding weekends and federal holidays). In this regard, a party must file its post-award protest within (i) 7 business days of when it knew or should have known of the basis for its protest, or (ii) not later than 5 business days from the date of the debriefing. 14 C.F.R. § 17.15(a)(3). Once filed, a contractor should be prepared to act – the FAA’s response to the protest is due 10 business days after the initial status conference, and the contractor’s comments on the FAA’s response are due five business days later. 14 C.F.R. § 17.17(e); 14 C.F.R. § 17.37(c). Contractors can also expect ODRA to issue a decision relatively quickly, as the ODRA Dispute Resolution Officer assigned to the case must issue a decision within 30 business days of the FAA’s response to the protest. 14 C.F.R. § 17.37(a),(i).

In conclusion, ODRA differs markedly from the GAO and COFC as a bid protest forum. An understanding of those differences is critical to the preservation and pursuit of your bid protest rights. Since ADR at ODRA has resulted in some form of agency corrective action in roughly 40% of the cases filed at the ODRA from 1997-2007, a failure to appreciate the differences in the rules and the consequent forfeiture of your protest rights can be highly prejudicial. See here.

Copyright © 2011, Sheppard Mullin Richter & Hampton LLP.

Carried Interest Language Narrowed, but Remains Far-Reaching

Recently posted in National Law Review an article by Kevin J. Feeley, Gary C. Karch and Patrick J. McCurry of McDermott Will & Emery regarding Obama administration’s recent carried interest tax provision:

This newsletter summarizes the Obama administration’s recent carried interest tax provision. The provision is not expected to be enacted soon, but the proposal contains drafting changes of interest to those following the discussion.

On September 12, 2011, President Obama submitted to U.S. Congress legislative text for the American Jobs Act, including a revised version of the carried interest tax provision that has been introduced several times since 2007. The latest provision is unlikely to be enacted soon, but gives an indication of the form that ultimately enacted legislation may take. The latest language appears narrower than prior versions, but remains potentially applicable to more taxpayers and transactions than one would expect from the announced purpose to treat the carried interest income of investment fund managers as ordinary income subject to self-employment tax.

General Approach Continues

The latest provision would add a new Section 710 to the Internal Revenue Code. New Section 710 would continue to create a new defined term called anInvestment Services Partnership Interest (ISPI). It also continues to provide thata partner’s income from holding or disposing of an ISPI is ordinary and subject to self-employment tax, even if it would be capital gain and not subject to self-employment tax under general tax rules.

The latest provision also continues to apply to all partnership interests, not just interests received for services or otherwise disproportionate to capital, unless a Qualified Capital Interest (QCI) exception applies. The QCI exception continues to apply only to a class of equity that is held by persons who do not provide any services to the partnership and are not related to the partner holding the ISPI. There is no exception for completely pro rata partnerships, as there was in the most recent prior version.

ISPIs Defined More Narrowly

Prior versions defined an ISPI as any partnership interest where the holder was expected to provide services regarding the acquisition, financing, management and disposition of securities, real estate and partnership interests, referred to as Specified Assets. The latest proposal limits the ISPI definition to partnerships in which “substantially all” of the assets are Specified Assets; the holder owns the partnership interest in connection with a business that “primarily involves” the acquisition, financing, management and disposition of Specified Assets; and more than half the contributed capital of the partnership is contributed by persons who hold their partnership interests for the production of income. The “production of income” requirement appears intended to imply that the interest is not held as part of a business. This change may exclude partnerships that conduct operating businesses, and partnerships in which more than half the owners are involved in the business.

The ISPI definition attributes a business of one member of a corporate group to all others. This provision may be intended to remove most corporate internal partnerships and external joint ventures from becoming subject to the rules.

The limitation of the ISPI definition to partnerships in which substantially all of the assets are Specified Assets may remove the so-called enterprise value of some investment fund managers from ordinary income treatment. The fund manager’s carried interest from funds it operates would be ordinary, but a gain attributable to the enterprise value of the fund manager itself might qualify as capital gain.

No Loss Deferral

Prior versions of the carried interest legislation deferred all losses from an ISPI. This provision is dropped from the most recent legislation.

Disposition Provisions Narrowed Somewhat

The proposed legislation continues to require recognition of ordinary income in normally tax-free transfers. The proposal continues the exception for contributing an ISPI to another partnership if an election is made to treat the resulting partnership interest as an ISPI. The proposal adds an exception for some gifts and charitable contributions. However, other tax-free transactions including corporate contributions and mergers where ISPIs are among the assets would be taxable to the extent of the gain inherent in the ISPIs.

Publicly Traded Partnership Provisions Deferred 10 Years

The proposed legislation provides that publicly traded partnerships with income from ISPIs could continue to be publicly traded pass-through entities for 10 years after enactment.

Exceptions and Phase-Ins Removed

Unlike some prior versions of the legislation, the latest version would apply to 100 percent of ISPI income beginning January 1, 2013. The legislation does not contain an exception or a reduced rate of recharacterization for the disposition of ISPIs held more than five years.

The proposal does not contain exceptions for pro rata partnerships or family farms. The pro rata partnership exception was thought to exclude family partnerships that could not use the QCI exception because all partners are related. It is unclear whether family partnerships and family farms would avoid the provision due to the narrowing of the ISPI definition described above.

© 2011 McDermott Will & Emery

Coming Home: Service Members Bring Value, Benefits to Workplace

Posted in the National Law Review an article by Drew B. Millar of Dinsmore & Shohl LLP regarding a significant number of returning servicemen and women are out of work:

Among the millions of Americans who are out of work are a significant number of returning servicemen and women. Many employers are distracted by the host of employment issues that can arise in employing these individuals and, to some extent, their families. Among the applicable laws are the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA) and the Family and Medical Leave Act (FMLA).

While an understanding of the rights afforded to servicemembers by these statutes is essential, employing these individuals provides much more than a sense of patriotism for employers. Specific tax incentives exist (and more have been proposed) to get these individuals back to work. Many possess unique skills and abilities that would be an asset to any workforce. This article provides simple guidance about the laws that employers need to be aware of that impact the hiring of veterans and provide incentives for doing so.

USERRA mandates that employees be given a leave of absence to serve in the uniformed services and prohibits discrimination against employees because of their service. USERRA applies to all public and private employers regardless of size. This leave of absence can be as long as five (5) years and there are specific pronouncements on how the leave can be treated and what benefits the employee is entitled to while on qualifying leave. After the employee’s period of service has ended, the employer has an obligation to re-employ the individual in the same or similar position depending on the length of the leave period.

The FMLA also has a leave provision specifically designed to protect injured servicemembers and their families. While employees must have worked at least 1,250 hours during the preceding twelve-month period, under USERRA, an employee returning from fulfilling his or her National Guard or Reserve Military obligation shall be credited with the hours of service that he or she would have performed (based on pre-service work schedule) but for the period of military service to meet this requirement.

Military Caregiver leave or Covered Servicemember leave permits a “spouse, son, daughter, parent, or next of kin” to take up to 26 workweeks of unpaid leave during a rolling twelve-month period to care for a injured member of the Armed Forces, National Guard, or Reserves. A covered servicemember also includes a veteran “who is undergoing medical treatment, recuperation, or therapy for a serious injury or illness” if the veteran was a member of the armed services at any time in the five years preceding the medical treatment. The 12-month period to be used for purposes of tracking this leave entitlement begins when the employee starts using his or her leave. Therefore, it is possible that the 12-month period utilized for tracking other forms of FMLA leave may not be the same as what is being utilized for tracking this entitlement.

Importantly, an employee is not entitled to more than 26 total weeks of FMLA leave including Military Caregiver leave, during the 12-month period that commences with the need for leave. Therefore, an employee is not entitled to 26 weeks of leave to care for a family member under this provision, plus an additional 12 weeks of leave for other FMLA-qualifying reasons. Employees may utilize the 26-week entitlement for each servicemember and for each illness or injury incurred. An employee may take 26 weeks of leave in consecutive 12-month periods for family members covered by this provision.

While these laws may seem to discourage the hiring of our returning servicemembers, employers who wisely elect to recruit such individuals can make a significant dent in their federal taxes. Currently, the Work Opportunity Tax Credit (WOTC) Program provides up to a $2,400 credit if the hired veteran is 1) a member of a family that has received Food Stamps for at least 3 consecutive months in the 15 months prior to the date of hire; or 2) a person with a disability who is participating in a vocational rehabilitation program through US Veteran’s Administration. The aforementioned credit increases to $4800 for disabled veterans who were 1) hired within one year of having been discharged, or released from active duty, or 2) unemployed for any six of the last 12 months. In addition, a majority of states offer partial, or total exclusions, from state-level taxes for combat and/or other military compensation paid to troops/reserves. President Barack Obama also recently proposed a $2,400 tax credit for hiring an unemployed veteran and $4,800 for hiring a veteran who has been unemployed for six months or longer. The existing tax credit for hiring veterans with a service-connected disability would also be raised to $9,600.

Many federal and state programs are also available for these men and women to receive training and be reintegrated into the workforce. Several resources, including Employer Support of the Guard and Reserve (www.esgr.org) and the Department of Labor’s VETS Program (http://www.dol.gov/vets/), provide services to servicemembers and employers to assist in these efforts. The Kentucky Office of Employment and Training also has Veterans Employment Representatives and Disabled Veteran Outreach Specialists specifically assigned to assist veterans with their employment and training needs (http://oet.ky.gov/des/veteran/veteran.asp).

In short, an employer in today’s job market would be wise to actively recruit individuals who have returned from active duty in the military or have the prospect of being called to active duty at some point during their employment. These employees bring valuable skills and hiring them should be a serious consideration of any employer in this economic climate.

© 2011 Dinsmore & Shohl LLP. All rights reserved.