Tag: Tax

Is a Limited Liability Company (LLC) good for Canadians buying in the U.S.?

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If you are Canadian, the answer to that question is: it depends.

People purchasing real estate in the U.S. are faced with different challenges depending on whether they plan on using the property personally or renting it. In this article, we will address the latter issue and its different implications.

A Tax Efficient Structure

There are two main issues to be considered when renting property in the U.S.; income tax and liability. Because rental properties generate income, it is necessary to determine the most tax efficient structure in which to hold the property. On the other hand, because a third party (most likely a tenant) will be using the property, it is essential to create a structure that also offers creditor protection to protect against potential civil liability claims from such third party. A limited liability company (LLC) provides both those elements.

In the U.S., an LLC allows a purchaser to benefit from the low individual tax rates and therefore avoid the higher corporate tax rates inherent to owning property in a corporation. A corporation is an independent taxpayer and is taxed at a higher rate. However, an LLC is not an independent taxpayer but rather a “flow through” entity, which means that its revenue is taxed in the hands of its owner. Therefore, if the owner is an individual, the LLC’s revenue is taxed at the low individual rate.

Creditor Protection

Although one of the main goals of tax planning is to minimize tax, the main advantage of the LLC is creditor protection. When owning property in your personal name, you are exposed to liability claims from creditors such as a tenant who may have suffered injuries on your property while renting it. Should a judgement be rendered against you finding you liable for the injuries, the creditor could seek execution of this judgment not only against your U.S. property but also against the rest of your assets. However, when owning property in an LLC, only the assets in your LLC (i.e. your U.S. property) are within reach of the creditor.

The Issue for Canadian Buyers

After reading this, you may be thinking an LLC is the best solution for your U.S. real estate purchase. Unfortunately this structure can be disastrous for Canadian residents due to double taxation. Under the Canada-U.S. Tax Treaty, a Canadian resident is granted foreign tax credits for any tax paid to the Internal Revenue Service (“IRS”). Those credits can be used to offset the tax owed to the Canada Revenue Agency (“CRA”) on the same revenue or capital gain. Although the IRS considers the LLC as a flow through entity and taxes only the owner personally, the CRA does not recognize the flow through nature of the LLC but rather considers it a separate taxpayer, therefore creating a mismatch on said foreign tax credits. In this type of situation, the CRA will tax the owner of the property on the full amount of the revenue or capital gain and will not allow the use of any foreign tax credits for what was paid to the IRS. This is the known and dreaded double taxation. The owner of the property will pay taxes twice on the same revenue or capital gain, once in the U.S. and once in Canada. Depending on the values and amounts involved, Canadian residents can be required to pay in excess of 70% of taxes on their property income or capital gain due to double taxation. In extreme circumstances, this rate can even climb up to 80%.

That being said, even though LLCs should be avoided in the above-described situation, LLCs can be a valuable tool in a carefully planned structure. As general partner of a Limited Partnership for example. When used in such a structure, an LLC can help provide an extra layer of creditor protection to a Canadian resident while creating very limited tax consequences.

As you probably realised by now, the way you own property in the U.S. is crucial and putting your asset(s) in the wrong structure can lead to very unpleasant surprises. Always talk to a cross-border legal advisor before making any decisions in order to make sure you are aware of all the tax implications.

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Could Your Business Qualify for a 179D Green Building Tax Break?

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If your company has built a new facility or upgraded an existing one anytime in the past six years, you might find that you qualify — at least partially — for a tax break of up to $1.80 per square foot under federal tax code section 179D, or the energy efficient commercial buildings deduction. This could be the case even if you had no concrete intention to focus on green building standards at the time.

A couple of great features of this deduction are, first, that you might be able to substantially mitigate your tax burden  as far back as six years and, second, it’s very likely that you will qualify if your facility exceeds 50,000 square feet and it meets current state building codes, according to a business tax writer for Forbes, who spent eight years as the U.S. Senate Finance Committee’s tax counsel.

The 179D tax deduction gives the business an immediate deduction in the current year plus a basis reduction for the value of the facility, which can be anything from a warehouses or parking garage to an office park or a multi-family housing unit. For private-sector projects, the building owner, assuming it paid for the construction or improvements, generally gets the deduction. In public projects, the architect, engineer or contractor can obtain it by seeking a certification letter from the government unit. Nonprofits and native American tribes are not eligible.

The green building deduction was created in recognition of the fact that around 70 percent of all electricity used in the U.S. is consumed by commercial buildings. The deduction, which is up for renewal — and possible expansion — this year, has already proven that efforts to mitigate the tax burden of businesses in a technology-neutral way is an effective way to encourage energy efficiency, according to the Forbes writer.

What improvements must be made to qualify for the green building credit? Currently, the new or renovated building merely needs to exceed the 2001 energy efficiency standards developed by the American Society of Heating, Refrigerating and Air Conditioning Engineers, or ASHRAE — and most state building codes already require this. That means the vast majority of new and improved buildings already meet this requirement.

It’s also possible to partially qualify for the deduction by meeting the standards only for the building envelope itself, which includes HVAC, the hot water system, and the interior lighting system. A building could qualify based upon only one of these systems, or all three.

Source: Forbes, “179D Tax Break for Energy Efficient Buildings — Update,” Dean Zerbe, Aug. 19, 2013

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Treasury and IRS Postpone the Effective Dates of Several Key Foreign Account Tax Compliance Act (FATCA) Provisions

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On July 12th, the IRS issued Notice 2013-43, which postpones the effective dates of several key FATCA provisions.   This Notice provides: (i) revised timelines for implementation of FATCA; and (ii) additional guidance concerning the treatment of financial institutions located in jurisdictions that have signed intergovernmental agreements (IGAs) for the implementation of FATCA but have not yet brought those IGAs into force.

Overview

FATCA, which will be phased in between 2013 and 2017, subjects many categories of payments made by U.S. persons to “Foreign Financial Institutions” (including most banks, funds, investment entities, depositories and insurance companies, collectively referred to as  “FFIs”) and certain non-financial foreign entities (including multinationals, partnerships and trusts, collectively referred to as “NFFEs”) to a 30% U.S. withholding tax unless the foreign recipient, and each member of its affiliated group, have agreed in advance to provide information to the IRS on their (direct and indirect) U.S. owners, creditors and investors (“U.S. Account Holders”).

FATCA generally (i) requires FFIs to provide information to the IRS regarding their U.S. Account Holders; (ii) requires certain NFFEs to provide information on their “Substantial U.S. Owners” to withholding agents; (iii) requires certain certifications that the FFI or NFFE is compliant with FATCA rules; (iv) enhances certain withholding tax rules and imposes a withholding tax on certain payments (“Withholdable Payments”) to FFIs and NFFEs that fail to comply with their obligations; and (v) imposes increased disclosure obligations on certain NFFEs that present a high risk of U.S. tax avoidance.

The burden of complying with FATCA falls on both the foreign recipients of Withholdable Payments, which have to identify and disclose their U.S. Account Holders in order to be exempt from the FATCA withholding, and on the payors of such payments (as withholding agents), which are required to obtain certification of such exemption from the foreign payees in order not to withhold.  A failure to obtain such certification can subject the payors to personal liability for any taxes not withheld.

Treasury Regulations under FATCA were issued on January 17, 2013.  In addition, the United States has begun the process of signing IGAs with other countries to implement FATCA on a government to government basis. The IGAs currently fall into two categories, Model 1 and Model 2, which contain different terms and requirements.

Notice 2013-43

Notice 2013-43 provides a six-month extension (from January 1 to July 1, 2014) for when FATCA withholding will begin and for implementing new account opening procedures as well as related requirements to comply with FATCA.  Importantly, the definition of “Grandfathered Obligation” (i.e., an obligation not subject to withholding) will be revised to include obligations outstanding on July 1, 2014 (whereas under the current rules, “grandfathered obligations” were obligations issued before January 1, 2014).  Withholding on gross proceeds is still scheduled to begin on January 1, 2017.

The timeline for foreign financial institutions (FFIs) to register as participating foreign financial institutions (PFFIs) is also extended, with the registration portal expected to open on August 19, 2013.  When the FATCA registration website opens, a financial institution will be able to begin the process of registering by creating an account and inputting the required information.  Prior to January 1, 2014, however, any information entered into the system, even if submitted as “final,” will not be regarded as a final submission, but will merely be stored until the information is submitted as final on or after January 1, 2014. Thus, financial institutions can use the remainder of 2013 to get familiar with the registration process, to input preliminary information, and to refine that information. On or after January 1, 2014, each financial institution must finalize its registration information and submit the information as final.  The IRS will electronically post the first IRS FFI List by June 2, 2014, and will update the list on a monthly basis thereafter. Thus, to ensure inclusion in the June 2014 IRS FFI List, FFIs would need to finalize their registration by April 25, 2014.

Finally, a jurisdiction will be treated as having in effect an IGA with the United States if the jurisdiction is listed on the Treasury website as a jurisdiction that is treated as having an IGA in effect. In general, Treasury and the IRS intend to include on this list jurisdictions that have signed but have not yet brought into force an IGA. The list of jurisdictions that are treated as having an IGA in effect is available at the following address: http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx.

Conclusions

Six months ago, when the IRS issued the final FATCA Regulations, it intended to provide some clarity and certainty for FFIs and other affected taxpayers intending to comply with FATCA this year.  However, as of today, FFIs still face significant uncertainties pertaining to the implementation of FATCA in accordance with the timeline provided in the Regulations.  In addition, the progress of the IGA program has been much slower than expected.  At the beginning of the year, the Treasury and IRS indicated that active negotiations on IGAs were taking place with dozens of countries.  Nevertheless, as of today, only 10 IGAs have been signed.  FATCA compliance may differ depending on whether the FFI is in an IGA or non-IGA jurisdiction (and if the FFI is from an IGA jurisdiction, there will be a different term; depending on whether the IGA is a Model 1 or Model 2 IGA and whether the IGA is reciprocal or not).  Thus, there is growing concern among FFIs from jurisdictions that have yet to sign an IGA with the IRS with respect to the course of action to comply with FATCA.

Furthermore, last year, the IRS issued a draft version of the IRS Form W-8BEN-E, which foreign persons would use to certify as to their FATCA status.  The proposed W-8BEN-E form is an eight page long complex form containing a list of over 20 types of FATCA categories.  It was expected that the IRS would finalize the W-8BEN-E, and, importantly, would issue guidance on how to prepare it early enough so that all affected taxpayers would be able to comply with it.  Nevertheless, the IRS instead issued another draft in May 2013, and still expects comments from the tax community on the new draft.  As a result, it is not expected that the final W-8BEN-E Form, with the instructions, will be issued before the fall of 2013.

The six-month extension provided in Notice 2013-43, will hopefully allow Treasury and the IRS, on the one hand, to provide more guidance with respect to implementation of FATCA; and affected taxpayers, on the other hand, to get more clarity as to how to comply with FATCA.

Defense of Marriage Act’s Demise (DOMA) – What it Means for Canadian Residents with U.S. Ties

Altro Levy LogoLast week, the US Supreme Court issued an historic and landmark ruling in the case of US v. Windsor. It has been hailed in the media as the demise of the Defense Of Marriage Act (“DOMA”), and celebrated as an extension of more than 1,000 federal benefits to same-sex couples.

In US v. Windsor, Edith Windsor brought suit against the US government after she was ordered to pay $363,000 in US estate tax upon the death of her wife Thea Spyer. Edith and Thea were legally married in Canada in 2007, but the US federal government did not recognize their marriage when Thea passed away in 2009. Under DOMA gay marriage was not recognized, even if it was legal in the jurisdiction where it was performed. This lack of recognition meant that Edith could not take advantage of the marital deduction that would have allowed her to inherit from her wife without paying US estate tax.

In its ruling on June 26th, the US Supreme Court ruled that the US federal government could not discriminate against same-sex married couples in the administration of its federal laws and benefits as previously dictated by DOMA. Same-sex couples, who are legally married in one of the 13 states that recognize gay marriage, or a country like Canada, now have access to the same federal protections and benefits as a heterosexual married couple.

Tax Benefits

The demise of DOMA will bring with it a multitude of changes under US tax law. We will not attempt to enumerate all of them here, though we will provide a brief overview of key changes for our Canadian and American clients.

i. US Estate Tax

The case of US v. Windsor was based on the US estate tax, which is imposed by the US federal government on both US citizens and residents, as well as non-residents who own US assets worth more than $60,000 USD. Currently US citizens and residents with less than $5.25 Million USD in worldwide assets do not owe US estate tax on death. Canadians with worldwide assets of $5.25 Million USD or less receive a unified credit under the Canada-US Tax Treaty that works to eliminate any US estate tax owed on their US property.

Under federal law a US citizen may pass his entire estate to his US citizen spouse tax-free upon death. Up until last week this rollover was unavailable to same-sex couples.

Canadian same-sex couples should now benefit from the Canada-US Tax Treaty provisions that provide a marital credit to the surviving spouse. This allows for a doubling up of credit against any potential US estate tax due on US property. Now a Canadian same-sex spouse can inherit a worldwide estate worth up to $10.5 Million USD and should see little to no tax on US assets due upon the death of the first spouse.

ii. Gift Tax

The US imposes a tax on gifts if they exceed $14,000 USD per recipient per year. There is an exemption for gifts between spouses, which are generally not taxable.

Gifts made in the US between non-US citizen non-resident spouses are taxable, but the annual exemption is $139,000 USD instead of $14,000 USD. Canadian spouses who gift each other US property, US corporate stocks, etc. may gift up to $139,000 USD per year without incurring US gift tax.

These exemptions have now been extended to same-sex couples, expanding their ability to use gifting for tax and estate planning.

iii. US Income Tax

Many Canadians move to the US each year, in part because of the lower personal tax rates. In the US spouses are allowed to engage in a form of income splitting by filing a joint income tax return. By filing jointly, married couples are also generally able to take advantage of further credits and deductions not afforded to individual or single filers. Being able to file jointly can be highly tax advantageous.

Previously, same-sex couples had to file either separately or as head of household. Now they have the option of filing jointly as spouses, and gaining access to the aforementioned income splitting, credits and deductions.

Couples may file up to three years of amended US Income Tax returns if they believe that they would have been entitled to a larger tax return by filing jointly in those years.

iv. Other Tax Benefits

In the US most individuals receive health insurance through their employer at least up until they qualify for US Medicare at age 65. Previously, if the employer sponsored health insurance plan covered the same-sex spouse as well, then it was considered a taxable benefit. Such coverage will now also be tax-free for same-sex couples.

Retirement Benefits

Among the many benefits now extended to same-sex couples are a variety of “Retirement Benefits.”

i. Social Security and Medicare Benefits

With the end of DOMA, same-sex couples may now qualify for retirement, death, and disability Social Security benefits based on their spouse’s qualifying US employment history. For example, same-sex couples that do not have the required US employment history to qualify for US Social Security benefits on their own may now qualify for spousal Social Security benefits based on their spouse’s qualifying employment history. These spousal Social Security benefits are typically equal to 50% of the Social Security benefits received by the spouse with the qualifying employment history.

Additionally, spouses can qualify for US Medicare based on only one spouse’s qualifying US employment. This allows access to premium-free, or reduced-premium, health coverage in retirement.

Previously these important retirement benefits were not available to same-sex spouses.

ii. Individual Retirement Accounts

Important changes to the rights and recognition of spouses under US retirement savings plans result from the end of DOMA. Same-sex couples will now be recognized under 401(k), 403(b), IRA, Roth IRA, and similar plans. Spouses will be required to give their consent for any non-spouse beneficiary designations for these accounts. They will be treated as spouses for purposes of determining required distributions. For example, an inheriting same-sex spouse will not have to begin IRA distributions until age 70 ½, whereas previously he would have had to begin required distributions immediately as would any non-spouse beneficiary.

Immigration

One of the biggest questions after the US Supreme Court’s ruling on DOMA was whether there would be immediate changes to US immigration policy. Previously the US government did not recognize same-sex couples for immigration purposes. This meant that a US citizen spouse could not sponsor his husband for immigration to the US as a permanent resident (a.k.a. green card holder).

Last week, shortly after the ruling on DOMA, Alejandro Mayorkas, the director of US Citizenship and Immigration Services (“USCIS”) announced at the American Immigration Lawyers Association annual conference that the USCIS would begin issuing green cards to qualifying same-sex couples.

As of Friday, June 29, 2013, USCIS began issuing green cards to same-sex spouses. USCIS has stated that it has been keeping a record of spousal green card petitions denied only due to a same-sex marriage for the past two years. It is expected to reopen and reconsider these spousal sponsorship petitions that were previously denied due to same-sex marriage.

Conclusion

The demise of DOMA is exciting news for Americans, and Canadians with US ties. It provides same sex couples a wealth of new tax and estate planning opportunities, not to mention new opportunities for retirement and immigration planning. It is not too early to review your current planning, and take advantage of these changes.

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Financial Innovation for Clean Energy Deployment: Congress Considers Expanding Master Limited Partnerships for Clean Energy

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Technological innovation is driving renewable energy towards a future where it is cost competitive without subsidies and provides a growing share of America’s energy. But for all the technical progress made by the clean energy industry, financial innovation is not keeping pace: access to low-cost capital continues to be fleeting, and the industry has yet to tap institutional and retail investors through the capital markets. This is why a bipartisan group in Congress has proposed extending master limited partnerships (MLPs), a financial mechanism that has long driven investment in traditional energy projects, to the clean energy industry.

Last month Senators Chris Coons (D-DE) and Jerry Moran (R-KS) introduced the Master Limited Parity Act (S. 795); Representatives Ted Poe (R-TX), Mike Thompson (D-CA), and Peter Welch (D-VT) introduced companion legislation (H.R. 1696) in the House of Representatives. The bills would allow MLP treatment for renewable energy projects currently eligible for the Sec. 45 production tax credit (PTC) or 48 investment tax credit (ITC) (solar, wind, geothermal, biomass, hydropower, combined heat and power, fuel cells) as well as biofuels, renewable chemicals, energy efficient buildings, electricity storage, carbon capture and storage, and waste-heat-to-power projects. The bill would not change the eligibility of projects that currently qualify as MLPs such as upstream oil and gas activities related to exploration and processing or midstream oil and gas infrastructure investments.

MLPs have been successfully utilized for traditional fossil-fuel projects because they offer an efficient means to raise inexpensive capital. The current total market capitalization of all energy-related MLPs exceeds $400 billion, on par with the market value of the world’s largest publicly traded companies. Ownership interests for MLPs are traded like corporate stock on a market. In exchange for restrictions on the kinds of income it can generate and a requirement to distribute almost all earnings to shareholders (called unitholders), MLPs are taxed like a partnership, meaning that income from MLPs is taxed only at the unitholder level. The absence of corporate-level taxation means that the MLP has more money to distribute to unitholders, thus making the shares more valuable. The asset classes in which MLPs currently invest lend themselves to stable, dividend-oriented performance for a tax-deferred investment; renewable energy projects with long-term off-take agreements could also offer similar stability to investors. And since MLPs are publicly traded, the universe of potential investors in renewable projects would be opened to retail investors.

The paperwork for MLP investors can be complicated, however. Also, investors are subject to rules which limit their ability to offset active income or other passive investments with the tax benefits of an MLP investment. Despite the inherent restrictions on some aspects of MLPs, the opportunities afforded by the business structure are generating increasing interest and support for the MLP Parity Act.

Proponents of the MLP Parity Act envision the bill as a way to help renewable energy companies access lower cost capital and overcome some of the limitations of the current regime of tax credits. Federal tax incentives for renewable energy consist primarily of two limited tools: tax credits and accelerated depreciation rates. Unless they have sizeable revenue streams, the tax credits are difficult for renewable project developers to directly use. The reality is only large, profitable companies can utilize these credits as a means to offset their income. For a developer who must secure financing though a complicated, expensive financing structure, including tax equity investors can be an expensive means to an end with a cost of capital sometimes approaching 30%. Tax credits are a known commodity, and developers are now familiar with structuring tax equity deals, but the structure is far from ideal. And as renewable energy advocates know all too well, the current suite of tax credits need to be extended every year. MLP treatment, on the other hand, does not expire.

Some supporters have noted that clean energy MLPs would “democratize” the industry because private retail investors today have no means to invest in to any meaningful degree in clean energy projects. Having the American populace take a personal, financial interest in the success of the clean energy industry is not trivial. The initial success of ‘crowd-funded” solar projects also provides some indication that there is an appetite for investment in clean energy projects which provide both economic and environmental benefits.

Sen. Coons has assembled a broad bipartisan coalition, including Senate Finance Energy Subcommittee Chair Debbie Stabenow (D-MI) and Senate Energy and Natural Resources Ranking Member Lisa Murkowski (R-AK). Republican and Democratic cosponsors agree that this legislation would help accomplish the now-familiar “all-of-the-above” approach to energy policy.

However, some renewable energy companies that depend on tax credits and accelerated depreciation are concerned that Republican supporters of the legislation will support the bill as an immediate replacement for the existing (but expiring) suite of renewable energy tax credits. Sen. Coons does not envision MLP parity as a replacement for the current production tax credits and investment tax credits but rather as additional policy tool that can address, to some degree, the persistent shortcomings of current financing arrangements. In this way, MLPs could provide a landing pad for mature renewable projects as the existing regime of credits is phased out over time, perhaps as part of tax reform.

So would the clean energy industry utilize MLP structures if Congress enacts the MLP Parity Act? The immediate impact may be hard to predict, and some in renewable energy finance fear MLP status will be less valuable than the current tax provisions. This is in part because the average retail investor would not be able to use the full share of accompanying PTCs, ITCs, or depreciation unless Congress were also to change what are known as the “at-risk” and “passive activity loss and tax credit” rules. These rules were imposed to crack down on perceived abuse of partnership tax shelters and have tax implications beyond the energy industry. Modifying these rules is highly unlikely and would jeopardize the bipartisan support the bill has attracted so far. But other renewable energy companies believe they can make the structure work for them now, and industries without tax credits — like renewable chemicals, for instance — would not have the same concerns with “at-risk” and “passive activity loss” rules. Furthermore, over the long term, industry seems increasingly confident the structure would be worthwhile. Existing renewable projects that have fully realized their tax benefits and have cleared the recapture period could be rolled up into existing MLPs. Existing MLP infrastructure projects could deploy renewable energy assets to help support the actual infrastructure. Supporters of the legislation see the change as a starting point, and the ingenuity of the market will find ways to work within the rules to deliver the maximum benefit.

The future of the MLP Parity Act will be linked to the larger conversation in Congress regarding tax reform measures. The MLP Parity Act is not expected to pass as a stand-alone bill; if it were to be enacted, it would most likely be included as part of this larger tax-reform package. Congress currently is looking at ways to lower overall tax rates and modify or streamline technology-specific energy provisions. This has many renewable energy advocates on edge: while reform provides an opportunity to enact long-term policies (instead of one-year extensions) that could provide some level of stability, it also represents a chance for opponents of renewable energy to exact tough concessions or eliminate existing incentives. As these discussions continue in earnest this year, the reintroduction of the MLP Parity Act has already begun to generate discussions and mentions in policy white papers at both the House Ways and Means Committee and the Senate Finance Committee. Whether a highly partisan Congress can actually achieve such an ambitious goal as tax reform this year remains uncertain. But because of its bipartisan support, the MLP Parity Act certainly will be one of the many potential reforms Congress will consider seriously.

Senate Finance Committee Leadership Releases Tax Reform Framework

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A major step forward on tax reform occurred today with Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) releasing their tax reform framework.  They are planning a “blank-slate” approach:  stripping the tax code of all current tax deductions, credits, and expenditures in place of a lower individual and corporate tax rate.

In their “Dear Colleague” letter sent out today, Senators Baucus and Hatch announced their plan to hold a markup on a bill after the August recess.  Members of the Senate have been invited to submit by July 26th a “wish list” of which tax provisions they would like to keep alive, and the Senators are encouraging the submission of legislative language.  This approach, requiring Senators to defend the provisions they would like retained, rather than cut breaks they don’t support, is a departure from current practice.  Baucus and Hatch did note that any benefit that ends up in the tax code will reduce the amount of revenue that could go towards reducing the overall rate or reducing the deficit.

Final Section 336(e) Regulations Allow Step-Up in Asset Tax Basis in Certain Stock Acquisitions

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Final regulations were issued last month under IRC Section 336(e). These regulations present beneficial planning opportunities in certain circumstances.

For qualifying transactions occurring on or after May 15, 2013, Section 336(e) allows certain taxpayers to elect to treat the sale, exchange or distribution of corporate stock as an asset sale, much like a Section 338(h)(10) election. An asset sale can be of great benefit to the purchaser of the stock, since the basis of the target corporation’s assets would be stepped up to their fair market value.

To qualify for the Section 336(e) election, the following requirements must be met:

  1. The selling shareholder or shareholders must be a domestic corporation, a consolidated group of corporations, or an S corporation shareholder or shareholders.
  2. The selling shareholder or shareholders must own at least 80% of the total voting power and value of the target corporation’s stock.
  3. Within a 12-month period, the selling shareholder or shareholders must sell, exchange or distribute 80% of the total value and 80% of the voting power of the target stock.

Although the rules of Section 338(h)(10) are generally followed in connection with a Section 336(e) election, there are a few important differences between the two elections:

  1. Section 336(e) does not require the acquirer of the stock to be a corporation. This is probably the most significant difference; and, to take advantage of this rule, purchasers other than corporations may wish to convert the target without tax cost to a pass-through entity (e.g., LLC) after the purchase.
  2. Section 336(e) does not require a single purchasing corporation to acquire the target stock. Instead, multiple purchasers—individuals, pass-through entities and corporations—can be involved.
  3. The Section 336(e) election is unilaterally made by the selling shareholders attaching a statement to their Federal tax return for the year of the acquisition. Purchasers should use the acquisition agreement to make sure the sellers implement the anticipated tax strategy

Section 336(e) offers some nice tax planning opportunities, by allowing a step up in tax basis in the target’s assets where a Section 338(h)(10) election is not allowed.

Example: An S corporation with two shareholders wishes to sell all of its stock to several buyers, all of which are either individuals or pass-through entities with individual owners. A straight stock purchase would not increase the basis of the assets held inside the S corporation, and an LLC or other entity buyer would terminate the pass-through tax treatment of the S corporation status of the target. A Section 338(h)(10) election is not available since the purchaser is not a single corporation. However, a Section 336(e) election may be available, whereby the purchase of the stock would be treated as a purchase of the corporation’s assets (purchased by a “new” corporation owned by the purchasers). The purchasers could then convert the purchased corporation (the “new” corporation with the stepped-up assets basis) into an LLC, without tax, thereby continuing the business in a pass-through entity (single level of tax) with a fully stepped-up tax asset basis.

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Comprehensive Immigration Reform Proceeds to Senate Floor, Heated Debate Expected to Follow

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On June 11th, the U.S. Senate voted to move the “Border Security, Economic Opportunity, and Immigration Modernization Act” (S. 744), the comprehensive immigration reform bill drafted by the “Gang of Eight,” to the floor for debate, where it is expected to face dozens of amendments in the coming weeks. The final vote to begin debate on the landmark legislation was 84 in favor and 15 against. Below are some of the key issues that this bill faces on its way to a final vote in the Senate:

Border Security: Senator John Cornyn (R-TX) has signaled support for implementing border security triggers – including a 90% apprehension rate of illegal border crossings – before putting undocumented immigrants on the path to permanent residency. Senator Cornyn’s amendment would also introduce a biometric exit system as well as a nationwide electronic employment eligibility verification program. The measure has already stirred opposition from Democratic senators and immigration advocates, who liken it to a “poison pill” that will indefinitely delay the citizenship prospects of the estimated 11 million undocumented immigrants already in the United States.

Senator Marco Rubio (R-FL), a member of the “Gang of Eight,” has also indicated that he may not be able to support the legislation in its current form without strengthened border security measures. To this end, Senator Rubio and his colleague, Senator Tom Coburn (R-OH) may propose an amendment that would transfer the responsibility for drafting, but not enforcing, a border security plan from the U.S. Department of Homeland Security (DHS) to Congress. Several other drafters of the bill, including Senator Charles Schumer (D-NY), expressed a willingness to include border security triggers so long as they are “both achievable and specific.”

Taking a more expansive approach, Senator Rand Paul (R-KY) plans to offer an amendment that would require Congress to draft and enforce a border security plan, as well as to vote on border security every year for the first five years after the bill takes effect. Democratic senators and immigration advocates oppose this measure, citing unpredictability and partisanship as future hurdles to implementing a path to citizenship.

Taxes: Senator Jeff Sessions (R-AL) plans to re-introduce two amendments that would require families to provide a valid Social Security number to receive a child tax credit and deny the earned-income tax credit to immigrants with temporary legal status, respectively. Both measures previously failed in committee on a party-line vote.

Senator Orrin Hatch (R-UT) is also expected to offer an amendment that would require immigrants to demonstrate that they have paid back taxes and remained current on present obligations as they progress toward citizenship. Senator Hatch may also introduce a measure that would ban immigrants who are legal permanent residents from receiving Affordable Care Act subsidies for five years.

Guns: Senator Richard Blumenthal (D-CT) may offer two amendments restricting access to guns for undocumented immigrants. One of the provisions would eliminate the loophole that allows certain immigrants to purchase firearms, while another would require the Attorney General to alert the Secretary of Homeland Security when an undocumented immigrant or temporary visitor to the U.S. attempts to buy a firearm. Currently, both categories of individuals are legally barred from purchasing firearms.

Same-Sex Benefits: Senator Patrick Leahy (D-VT) is weighing whether to revive an amendment that he reluctantly declined to introduce in committee due to the opposition of his Republican colleagues. The measure would permit U.S. citizens in state-recognized same-sex marriages to apply for permanent residency on behalf of a same-sex spouse, a benefit that is currently afforded to heterosexual couples only.

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Yahoo!/Tumblr Deal and the Tax Cost of Cash Acquisition Payments

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When Yahoo! recently acquired the blogging service Tumblr, the two companies structured the deal so that virtually all of the $1.1 billion price tag for Tumblr will be paid in cash. In the current economy, many companies, particularly tech companies, have a lot of cash available, making the more traditional payment in stock appear less desirable. However, tax planning during mergers or acquisitions can be invaluable because, with proper counsel, the organizations can anticipate and mitigate the tax ramifications for the companies, individuals and shareholders.

Specific information about any tax planning in the Yahoo!/Tumblr deal hasn’t been released, but let’s consider the potential tax consequences of an essentially all-cash deal.

Most of Tumblr’s existing shareholders likely purchased their stock for substantially less than it was valued at the time of Yahoo’s acquisition. Since capital gains taxes are levied on the difference between the purchase price and the sale price, those Tumblr shareholders may be facing a hefty capital gains tax bill that will come due as soon as the transaction is complete.

If the deal had been structured as a stock transaction, on the other hand, it might have been structured to defer the capital gains tax for those shareholders until they actually sell their stock to Yahoo! There are a number of methods, such as 1031 exchanges, Section 368 tax-free reorganizations, and or 338(h)(10) stock purchase elections, that might also be effective in mitigating the tax burden.

An all-cash deal also presents challenges for Yahoo! in that it could affect the incentives for Tumblr’s founder and senior management going forward. In a tax-free reorganization, for example, they would generally be compensated in Yahoo! stock, which automatically creates an incentive for Tumblr’s leadership to build value for Yahoo! Without stock, a different incentive plan is needed.

According to The New York Times’ DealBook blog, Yahoo! may not need to worry about incentivizing Tumblr’s leadership, however, as it plans to continue to run the blog service as a separate company with the same group of executives. That may leave the existing incentives for success in place.

In this particular case, we don’t have enough information to determine why Yahoo! and Tumblr structured the acquisition as an all-cash deal. Well-considered tax planning, however, is essential for any business considering a merger or acquisition, stock sale, or major asset sale. Anticipating and minimizing transactional taxes, including business transfer taxes and business succession taxes, can help ensure that companies garner all potential benefits of the deal.

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Supreme Court Ruling on Defense of Marriage Act (DOMA) Could Lead to Refunds of Federal Taxes

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Employers providing benefits for employees’ same-sex spouses may want to consider the availability of federal payroll tax refunds if the Supreme Court of the United States finds Section 3 of the Defense of Marriage Act (DOMA) unconstitutional.  Employers currently must impute income to an employee for the fair market value of benefit coverage for a non-dependent same-sex spouse.  Such imputed income is subject to federal income and payroll taxes, as well as state income taxes in the majority of states.

The Supreme Court of the United States is expected to rule in late June on the constitutionality of Section 3 of the Defense of Marriage Act (DOMA).  A ruling that DOMA is unconstitutional will favorably reverse the federal tax treatment of employer-provided benefits for non-dependent same-sex spouses.  Such a reversal may lead to refunds of federal payroll taxes paid by employers and federal income taxes paid by employees on income imputed to employees for same-sex spouse benefit coverage.

Current Law

The Supreme Court is considering the constitutionality of Section 3 of DOMA in United States v. Windsor.  Windsor is a surviving spouse who was required to pay $350,000 in federal estate taxes after her same-sex spouse died—taxes she would not have had to pay if her same-sex marriage that was legally recognized in her home state of New York was also recognized under federal law.  Section 3 of DOMA provides that for all purposes of federal law, the word “marriage” means “only a legal union between one man and one woman as husband and wife,” and the word “spouse” refers “only to a person of the opposite-sex who is a husband or wife.”

Employees who enroll a non-dependent same-sex spouse or partner under an employer-sponsored benefit plan currently must pay federal income taxes on the fair market value of such coverage.  While federal law excludes amounts that an employer pays toward medical, dental or vision benefits for an employee and the employee’s opposite-sex spouse and dependents from the employee’s taxable income, employers that provide these same benefits to employees’ same-sex spouses or partners are required to impute the fair market value of the benefits as income to the employee that is subject to federal income tax, unless the same-sex spouse or partner otherwise qualifies as the employee’s “dependent” as defined for federal income tax purposes.  Employers are required to withhold federal payroll taxes from the imputed amount, including income, Social Security and Medicare taxes.  In addition, employers must pay their share of Social Security and Medicare taxes on the imputed amount, as well as Federal Unemployment Tax Act taxes.  The majority of states follow the federal income tax rules approach and also require employers to impute income on the value of such benefits for state income tax purposes.

Consider Filing a Protective Claim Now

Employers that have imputed income on the fair market value of benefits for employees’ same-sex spouses should consider filing protective FICA tax refund claims and should be poised to change their systems to allow for the future exclusion of benefits provided to same-sex spouses.  Although filing a complete refund claim can be burdensome from an administrative perspective, it is relatively easy for an employer to file a protective claim to preserve the statute of limitations on employment tax refund claims for open years and later file a supplementary claim with necessary employee consents and exact calculations. 

In general, the statute of limitations for tax refund claims is three years.  The due date for the protective claim is three years from April 15 of the calendar year following the year in which the income was imputed to the employee.  For example, for employment taxes paid on income imputed in 2010, a protective claim should be filed by April 15, 2014.  If not filed already, a refund claim cannot be filed with respect to employment taxes paid on income imputed before 2010 as the statute has run for that year.

If an employment tax refund had already been filed and the Internal Revenue Service (IRS) issued a notice of claim disallowance, the taxpayer must either bring suit to contest the disallowance within two years after the issuance of the notice or obtain an extension of the time to file such a suit with the IRS—this process can be initiated by filing IRS Form 907, Agreement to Extend the Time to Bring Suit.

Next Steps

Until the Supreme Court rules on Windsor, employers are advised to continue imputing income on the value of benefit coverage for employees’ non-dependent same-sex spouses and partners and to continue withholding and paying federal payroll taxes on the imputed amount.

View “Supreme Court Oral Arguments on DOMA, Proposition 8: Potential Employee Benefit Plan Implications” for more information on the employee benefit plan implications of the Supreme Court’s possible rulings on the constitutionality of DOMA in Windsor and California’s Proposition 8 in Hollingsworth v. Perry.