Florida Tax Attorney Blog

Under the continuity of proprietary interest doctrine, a substantial part of the proprietary interest in the target corporation must be preserved in the reorganization. As to what constitutes a "substantial part," the treasury regulations indicate that 40% is sufficient. See Treas. Reg. § 1.368-1T(e)(2)(v), Example (1). That is, the requisite level of continuity is preserved if at least 40% of the value received for the target stock is in the form of stock in the acquiring company. While there are cases out there finding the requisite level of continuity where stock of the acquiring company constitutes less than 40% of the total merger consideration, taxpayers are well-advised to structure the transaction to satisfy the 40% threshold.

But even then, the transaction may be subject to fluctuations in value. Historically, where the merger consideration consisted of a fixed number of shares, the risk was that the stock would decline in value between the signing of the merger agreement and the closing date and, thereby, cause the merger consideration to consist of less than 40% of the total merger consideration. These types of valuation issues have been largely mitigated by the signing date rule under which valuation occurs at the close of the day before the signing of the merger agreement in cases where it applies. However, valuation concerns have not been eliminated, especially in the private company environment.

Unlike public company stock for which an active market exists, there is no established market for stock of privately held companies. As a result, valuation of the shares is a subjective determination to which the IRS is not bound. Thus, even in cases where the signing date rule applies, the actual value of the shares on the day before signing is susceptible to challenge by the IRS. Consequently, valuation risks continue to persist in the private restructuring environment.

Although valuation risks cannot be eliminated in the private restructuring environment, restructuring transactions can be proactively structured so that a successful valuation challenge by the IRS doesn't turn into a double-level tax disaster. In this respect, the reverse forward merger structure is one of the soundest forms of protection. Here's how it works:

Step 1: acquiring company sets up two subsidiaries, Sub1 and Sub2.

Step 2: reverse merger of Sub1 into target company.

Step 3: forward merger of target company with and into Sub2.

Under this structure, if the share valuations are respected, the separate steps would, more likely than not, be integrated, and the steps would, collectively, qualify as a tax-free reorganization. Obviously, this is the desired result. However, if the share valuations are successfully challenged, the reverse merger would constitute a qualified stock purchase of the target shares, while the forward merger would constitute a good (A) reorganization. The result? A single layer of tax at the shareholder level. Thus, while the transaction is not tax-free in its entirety, the reverse forward structure avoids the double layer of taxation (i.e. at both the shareholder and corporate levels) that would otherwise be triggered by a successful valuation challenge.

Effective 2008, Florida residents voted to amend the Florida Constitution to protect commercial property owners against substantial increases in annual property assessment values. Specifically, the constitutional amendment operates to preclude increases in the assessed value in excess of ten percent from one year to the next.

All Commercial Properties Are Not Created Equal

While the protection of the ten percent cap extends to most types of commercial property, certain types of properties are unprotected. Among these unprotected properties are agricultural and conservation properties. The theory is that these types of properties already receive favorable tax treatment under Florida law and do not require additional protection in the form of the ten percent cap.

10% Cap Is Not Absolute

The protection against increases in assessed value in excess of ten percent is forfeited by a change in ownership or control. This means that sale or other disposition of the property will result in loss of the protection. To be clear, the new owner of the property is entitled to the protection going forward. However, the assessed value for the new owner's first year of ownership may be more than ten percent of the prior owner's assessment for the year preceding the property transfer.

Key Takeaway

If your Florida commercial property assessment has increased by more than ten percent this year, your commercial property may be overassessed for Florida property tax purposes. If your property is of a type entitled to protection under the ten percent can and there has been no transfer of ownership or control that would trigger loss of that protection, you can and should appeal the assessment.

Yesterday, KPMG announced that it will offer tax offsets to its same-sex employees for the additional federal and state tax costs incurred when they pay for medical benefits for their same-sex domestic partners.

Here's how it works: Basically, KPMG employees who pay for medical and dental benefits for same-sex partners who do not qualify as a spouse or dependent under federal law will receive a credit at the end of the year funded by KPMG.

KPMG is the second major public accounting firm to implement this type of program (Ernst & Young was the first last month).

Back in October, I wrote an article entitled, Separate is Not Equal: Same-Sex Couples Should Be Entitled to Federal Tax Benefits. That article summarizes the disparate tax treatment afforded to same-sex couples and briefly explains why I believe this disparate treatment violates the First Amendment (among other provisions of the U.S. Constitution - e.g., Equal Protection Clause, Due Process Clause).

The recent initiatives by KPMG and Ernst & Young demonstrate that the accounting industry recognizes the injustice of subjecting same-sex couples to increased tax burdens on the basis of their sexual orientation. When will the government recognize this?

I've said it before, and I'll say it again, the opposition to same-sex marriage is a predominantly religious one. As such, it has no place in the law or politics. To the contrary, this type of religious entanglement is inconsistent with some of the core values upon which this Nation was founded (namely, anti-establishment of religion and free exercise of religion).

As a final note, it is interesting to note the similarities between today's ban on same-sex marriage and the historical ban on interracial marriages. Consider the landmark U.S. Supreme Court case of Loving v. Virginia as an example. That case involved the prosecution of a Virginia couple for violation of a Virginia statute which prohibited interracial marriages.

In support of their conviction, the Virginia judge wrote the following: "Almighty God created the races white, black, malay, and red, and he placed them on separate continents. . . . The fact that he separated the races shows that he did not intend for the races to mix."

Right about now, you're probably asking yourself how someone could be so ignorant. I don't understand either. Maybe we should ask the government. After all, current federal law bans same-sex marriage on the same caliber of logic.

In Florida, it is not uncommon for purchasers of real estate to purchase old homes in "up and coming" areas for the underlying land. They purchase the property, knock down the existing home, and rebuild a new more modern home in its place. Some purchasers plan to live in the new home while others plan to flip it for a profit. Whatever the case, one thing is clear - it's expensive to demolish a home.

So why not make a charitable contribution of the home to the local fire department to be burned down in a firefighter training exercise?

That's exactly what Theodore Rolfs and his wife, Julia Gallagher did. See Rolfs v. Commissioner, No. 11-2078 (decided February 8, 2012).

Facts:

Theodore Rolfs and Julia Gallagher purchased a three-acre lakefront property in Chenequa, Wisconsin. Their plan was to demolish the existing home and build another in its place. Pursuant to this plan, they donated the existing home to the local fire department to be burned down in a firefighter training exercise. In connection with this donation, the couple claimed a $76,000 charitable deduction on their 1998 tax return for the value of the house. The IRS challenged the deduction.

Holding:
The couple took their case to the United States Tax Court which ruled in favor of the IRS. The taxpayers appealed the Tax Court decision to the U.S. Seventh Circuit Court of Appeals, which affirmed.

Takeaway:

When a gift is conditional, the conditions must be taken into account in determining fair market value of the donated property. In this case, the value of the benefit received (i.e. demolition) reduced the fair market value of the gift so substantially that no net value was available to support a charitable deduction. In this respect, the Court emphasized that the taxpayers failed to show that the value of their donation exceeded the substantial benefit they received in return.

So remember: if you receive a substantial benefit in connection with a charitable gift, you have the burden as the taxpayer to establish value of the gift in excess of the benefit received to support a charitable deduction.

It is well-established that the Due Process and Commerce Clauses of the U.S. Constitution impose limits on the taxing powers of the several States. E.g., Bellas Hess v. Illinois, 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Under the Due Process Clause, there must be some minimum connection between a state and a corporation before such state may tax that corporation. E.g., Miller Bros. Co. v. Maryland, 347 U.S. 340, 344-45 (1954). Under the Commerce Clause, the corporation must have a "substantial nexus" with the taxing state. See Quill Corp. v. North Dakota, supra (citing Complete Auto v. Brady, 430 U.S. 274 (1977). In addition, the tax must be fairly apportioned, non-discriminatory, and fairly related to the services provided to the corporation by the taxing state. Id.

Of course, a corporation will typically know where its property and employees are located. Thus, to the extent a corporation has property or employees in a given state, it can be said to be on notice of its potential exposure to tax in that state, and the requirements of the Due Process Clause are, therefore, satisfied. In addition, the substantial nexus requirement of the Commerce Clause will likely be satisfied assuming that the tax is fairly apportioned, non-discriminatory, and fairly related to the state services provided to the corporation.

But what about corporations engaged in the leasing business (e.g., rental car businesses, equipment leasing businesses)? Can nexus be established with a state solely by virtue of a lessee's transportation of the leased property into that state?

The current trend suggests that the answer is yes.

Continue reading "STATES MAY BE DEPRIVING LEASING COMPANIES OF DUE PROCESS" »

The issuance of additional stock by an acquiring corporation is often (though not always) a necessary precondition to qualify a merger or acquisition transaction as a tax-free "reorganization" under Section 368 of the Internal Revenue Code. However, the issuance of additional shares could have a dilutive effect in the simple sense that more shares outstanding means lower earnings per share ("EPS"). For privately held companies, this potentially dilutive effect is not much of a concern. But for public companies, this is a big deal. Indeed, EPS is highly correlated with market rate, and the stock of many public companies trades on that basis.

One option is for the acquiring company to go out into the market and buy back the number of shares issued in connection with the reorganization. Keep in mind, however, that continuity of interest is generally a prerequisite to a valid tax-free reorganization. The tax-free treatment of the reorganization transactions described in Section 368 of the Internal Revenue Code are predicated on the theory that the investment in the target corporation has not changed but rather continues in a different form. Stated more simply, the shareholders of the target corporation have not cashed out their investments insofar as they continue to hold stock in the acquiring corporation. Consequently, there has been no realization event which would trigger tax.

Now, if the acquiring corporation goes out into the market where it repurchases the number of shares that it issued in the reorganization it is conceivable that it could acquire shares that were issued to target shareholders in the reorganization.

The question, therefore, becomes whether this destroys the requisite continuity of interest and, thereby, exposes the merger transaction to tax.

According to the IRS, a market repurchase of shares by an acquiring corporation following reorganization does not destroy continuity. To be sure, it is conceivable (and probably likely) that the acquiring corporation will repurchase shares issued to the target corporation shareholders in the reorganization. However, there is no privity between the buyer and seller in a market transaction. Consequently, a purchase of stock issued to a target shareholder in the reorganization would be purely coincidental.

Note, however, that the holding in Revenue Ruling 99-58 is subject to one mathematical caveat: the acquiring corporation cannot buy back more shares than were outstanding before the reorganization. If you think about it, this makes sense. If the acquiring corporation bought more shares than were outstanding before the reorganization, it would necessarily be purchasing shares issued to target shareholders in the reorganization. And that would destroy continuity.

Structuring a tax-free reorganization is difficult. If you need assistance in this area, please contact me.

The IRS Collection Financial Standards are intended for use in calculating repayment of delinquent taxes. That is, they are used to evaluate a taxpayer's ability to pay delinquent taxes. In essence, the standards estimate a taxpayer's expenses to determine how much of their income is available to allocate towards taxes. In the past, the criteria used by the IRS to evaluate a taxpayer's ability to pay were based on national averages. But of course, costs of living vary from state to state, from county to county, and even from locality to locality. In this respect, the IRS has historically ignored known disparities in costs of living when evaluating ability to pay. For instance, a taxpayer living in New York City would be deemed to have the same living expenses as a taxpayer living in rural Wyoming. In essence, a taxpayer's expenses turned solely on family size with no other variables coming into play. This method for evaluating a taxpayer's ability to pay taxes has troubled me since my first day in the practice of tax law.

When I say that this has troubled me since my first day as a tax practitioner, I mean literally my very first day. The first tax matter that I handled was an innocent spouse petition. The case involved a woman whose former husband failed to report some serious income. Of course, as most married couples do, the couple filed joint tax returns during their marriage. Also, as is the case with many married couples, this woman signed a tax return prepared by her spouse without reviewing or understanding its contents. And no one can blame her for that. After all, marriage is a relationship of reciprocal trust. But as it turned out, her husband failed to adequately disclose income on the tax return. Sounds precisely like the type of situation for which the innocent spouse provisions are designed to provide relief ... unless you're the IRS.

Unfortunately, our innocent spouse petitions weren't well-received by the IRS. The IRS imputed knowledge of the unreported income to this woman by virtue of her signature on the couple's joint income tax return and was unwilling to deviate from this position notwithstanding the circumstances. That led to plan B: offer in compromise. Part of the offer in compromise process involves completing IRS Form 433-A. On this form, the taxpayer provides information regarding his or her income and expenses so that the IRS can evaluate the ability to pay tax. This is where the Collection Financial Standards come in.

Of course, one of the things South Florida is known for is a high cost of living. As a result of the IRS' national standards, however, the maximum expenses that the woman was allowed to report were substantially below her actual expenses. How is this an accurate reflection of a taxpayer's ability to pay delinquent taxes?

The good news is that the IRS recently issued new Collection Financial Standards. Significantly, these new standards take geographic disparities in costs of living into account, at least in part. For instance, under the new standards, the maximum allowable car or lease payment for a taxpayer living in Miami is $346. In this respect, Broward County (e.g., Fort Lauderdale) is included in the Miami region. The remaining counties in the state, however, fall into the broader "South Region" for which the maximum allowable car ownership expense is capped at $244. The propriety of drawing this $102 line at the Broward-Palm Beach County line is questionable, but the line has to be drawn somewhere, and any type of line-drawing will necessarily be arbitrary to some degree. Still, the perceived benefits of a bright-line standard like this typically outweigh any arbitrariness. In any event, these local standards are a significant improvement from the previous one-size fits all national standards. From this perspective, although the $244 maximum allowable car ownership expense for the South Region is $102 less than the $346 allowed for taxpayers in Broward and Miami-Dade Counties, it is, nevertheless, $52 more than that allowed for taxpayers in Seattle, $32 more than that allowed for taxpayers in the Midwest Region, and $28 more than that allowed for taxpayers in the Minneapolis-St. Paul area. Thus, while the new local standards may not be completely accurate in all circumstances, it does reflect disparities in costs of living.

In addition, the newly issued standards include comprehensive local standards for costs of housing and utilities. In this respect, the maximum allowable expense is computed on a county-by-county basis. The maximum allowable expense for housing and utilities for one person in Broward County is $1,719. The maximum allowed in Miami-Dade County is $1,676, and the maximum allowed in Palm Beach County is $1,710.

Note, however, that inaccurate national standards continue to govern the maximum allowable expenses for food, clothing, personal care products (e.g., cosmetics, toothpaste, etc.), and health insurance costs. In this respect, an individual is allowed a maximum of $300/month for food, $86/month for clothing, and $32/month for personal care products. To illustrate the inadequacy of these national standards, consider that a taxpayer living in Broward or Miami-Dade County is allowed to allocate more monthly income to a car lease payment than to food. But hey, no one has ever accused the IRS of being a picture of logic. To be sure, the new local standards represent with respect to transportation and housing expenses represent a significant improvement. But there's still a long way to go.