Florida Tax Attorney Blog

As a general rule, where a parent corporation elects to change a subsidiary's tax classification from corporation status to disregarded entity status (e.g., conversion of a corporate subsidiary into a single-member LLC), the election is treated as a constructive liquidation. This means that I.R.C. § 332 will generally preclude the parent corporation from recognizing gain or loss as a result of the liquidation.

But what if the subsidiary which is deemed to liquidate into the parent corporation is insolvent at the time of this deemed liquidation? Does Section 332's non-recognition rule preclude the parent corporation from claiming a worthless stock deduction under I.R.C. § 165(g) insofar as such a deduction is essentially in the nature of a loss?

It shouldn't, and here's why:

The non-recognition rules contained in Section 332 are only implicated if the transaction satisfies the three-prong test set forth in I.R.C. § 332(b). Under the first prong of Section 332(b), the recipient corporation must own at least eighty percent of the total vote and value of the liquidating corporation's stock, on the date of adoption of the plan of liquidation, and at all times until receipt of the liquidating corporation's property.

Under the second prong of Section 332(b) the distribution must be either: (1) in complete cancellation of all of the stock of the liquidating corporation, and within the taxable year ; or (2) one of a series of distributions in complete cancellation of the stock of the subsidiary in accordance with a plan under which all the liquidating distributions will be completed within three years from the close of the taxable year during which the first of the series of distributions occurred under the plan.

Under the third prong of Section 332(b), the distribution must be pursuant to a plan of liquidation that has been adopted by each of the corporate parties to the transaction. To be clear, the statute does not explicitly state that a plan of liquidation is a necessary prerequisite to non-recognition treatment under Section 332. However, the requirement is explicit in the definition of "complete liquidation" as defined in the treasury regulations. Specifically, the regulations state: "[t]o constitute a distribution in complete liquidation within the meaning of Section 332, the distribution must be (1) made by the liquidating corporation in complete cancellation or redemption of all of its stock in accordance with a plan of liquidation; or (2) one of a series of distributions in complete cancellation or redemption of all its stock in accordance with a plan of liquidation." See Treas. Reg. § 1.332-2(a) & § 1.332-2(c). It should be noted, however, that a formal plan of liquidation is not required. See e.g., Fowler Hosiery Co. v. Commissioner, 301 F.2d 394 (7th Cir. 1962) (holding that there was no need for liquidating subsidiary to adopt a formal plan of liquidation; it was sufficient that the distribution was in fact part of a plan of complete liquidation); McCarthey v. Conley, 229 F. Supp 517 (D.C. Conn. 1964) (stating that the Court must consider whether or not any informal plan did exist as a matter of fact, notwithstanding the absence of a formal plan).

In addition to the three-prong analysis set forth in the statute, Treasury Regulation § 1.332-2(b) provides that Section 332 only applies to cases in which the recipient corporation receives at least partial payment for the stock which it owns in the liquidating corporation. A transfer of assets is first applicable to discharge any indebtedness to the transferee. Houston Natural Gas Corp. v. Commissioner, 9 TC 570, 574 (U.S. Tax Ct. 1947). Consequently, when the fair market value of a subsidiary's assets, (including intangible assets such as goodwill and going concern value) is less than the sum of its liabilities, no part of the transfer is attributable to the parent's stock ownership, and the payment -for-stock requirement is not satisfied. See Rev.Rul. 2003-125, 2003-2 CB 1243. And of course, if the payment-for-stock requirement is not satisfied, the Section 332 non-recognition rules are inapplicable.

As a result, if the subsidiary is insolvent in the sense that the fair market value of its assets (including goodwill and going concern value) do not exceed the sum of its liabilities, Section 332 will not apply to preclude recognition of a loss by the parent corporation. And in that case, Section 332 would not disallow a Section 165(g) worthless stock deduction. This is true even though the liquidation resulting from a check-the-box election to be disregarded is constructive rather than actual. See Private Letter Ruling 201115001.

As a final note, it should be emphasized that the parent corporation would receive an ordinary loss deduction instead of a capital loss deduction under the affiliation exception. See I.R.C. §165(g)(3). This is significant for two reasons. First, the loss deduction is not subject to the capital loss limitations. Moreover, the loss is first applied as an offset to ordinary income. Thus, the corporation may currently deduct the entire loss notwithstanding whether it has any capital gains for the year.

In general, a shareholder purpose does not satisfy the business purpose requirement imposed in the corporate reorganization context, at least not in the 355 context. Treas. Reg. § 1.355-2(b)(2). However, in some cases, a shareholder purpose may be "so nearly coextensive" with a corporate business purpose as to preclude any distinction between them. In this spirit, enhancement of shareholder value is often a valid business purpose insofar as the corporation benefits by reason of the enhanced shareholder value. Namely, enhanced shareholder value provides a more valuable currency to the corporation for purposes of post-spin acquisitions and equity compensation programs. Increased share value means that less shares are needed to fund equity compensation programs and potential future acquisitions.

Significantly, all of this and more was acknowledged by the IRS in Revenue Ruling 2004-23. Spin-offs more often than not result in enhanced share value because the market for the shares becomes much larger when a controlling corporate shareholder is eliminated. Thus, this ruling opens the flood gates for satisfying the corporate business purpose requirement with a shareholder purpose. Thus, after Revenue Ruling 2004-23, the business purpose requirement can almost always be satisfied.

One word of caution: while Revenue Ruling 2004-23 provides substantial leeway in the business purpose department, it is not carte blanche. For instance, the logic and theory of the revenue ruling is really only relevant in the public company context. Private companies typically do not diversify equity ownership or provide equity-based employee compensation. As a result, citing a more valuable currency for use in equity compensation programs and future acquisitions would probably be an impermissible shareholder purpose. Even in the public company context, a company with no substantial equity compensation program and/or no history of acquisitions and no legitimate plans of acquisition would probably be a poor candidate for a 2004-23 type business purpose.

On April 3, 29 year old Daniel Adkins, Jr. was shot and killed as he and his yellow lab walked past an Arizona fast food drive-thru about two miles from Adkins' home. Apparently, the shooter nearly hit Adkins with his SUV as the shooter and his pregnant fiance pulled up to the drive-through window to pick up their order. Adkins allegedly swung his hands in the direction of the SUV in response to the near-collision. According to the shooter, it was this gesture which prompted the shooter to draw a .40-calibur handgun from his pants and fatally shoot Adkins. The shooter claims that Adkins was carrying a 3-foot metal pipe or bat, but no weapon was found on or near Adkins' person.

Arizona law recognizes a "stand your ground" right similar to the Florida law at the center of the controversy surrounding the Trayvon Martin case. As a result, the Arizona shooter has not been charged with any crime in the shooting death of Daniel Adkins, Jr.

Significantly, the shooter has told police that he did not believe that Adkins would have killed him or his fiance.

With that being said, this case clearly falls outside the intended scope of any state's stand your ground law. Stand your ground laws confer a right to meet force with force. Under the authority of these laws, a person is permitted to meet a punch with a punch ... a slap with a slap. And yes, worst case scenario, a person is permitted to meet deadly force with deadly force. The stand your ground law does not permit a person to meet an ambiguous gesture with a bullet. . Yet, as previously mentioned, no charges have been filed against the shooter in connection with the death of 29-year-old Daniel Adkins, Jr.

In any event, the Trayvon Martin and Daniel Adkins, Jr. shooting cases raise substantial concerns about the wisdom of stand your ground laws. To be clear, every person possesses a right of self-defense under our law. But stand your ground laws arguably provide too much discretion. They encourage a shoot first, think later kind of mentality which unreasonably infringes upon one of the most fundamental rights: the right to life.

As we all know by now, six-year-old Isabel Celis disappeared from her bedroom either late last Friday night or early last Saturday morning.

Last week, surveillance video footage from a neighboring business was released. This footage shows a group of five people passing through a parking lot after leaving a nearby nightclub. There has been a lot of talk about this group, and it is hoped that they might have seen or heard something that can help police locate Isabel Celis.

What surprises me about the release of this surveillance video is not what the police and media are talking about, but rather what they are not talking about. Take a look at this surveillance footage released last week by the Tucson police department. If you watch closely, there appears to be a person moving about the curtilage of the building after the group from the nightclub has passed through the parking lot. The activity of this unidentified sixth person can be seen for approximately five seconds beginning about 49-50 seconds into the footage shown here.

Who is this unidentified person seen walking near the building?

We are learning this morning that George Zimmerman possessed a substantial amount of money at the time of his bond hearing which was not disclosed to the court. Zimmerman's attorney plans to disclose this information to the court at a hearing today. In light of this development, many are wondering whether the court will remand Zimmerman back into custody.

Under Florida law, "good cause" must be shown in order to modify a criminal defendant's bond. Fla. R. Crim. Pro. 3.131(d). In this respect, the prosecution must prove "a change in circumstances or additional evidence not made known" at the initial bond hearing. E.g., Burton v. Felton, 625 So. 2d 1334 (Fla. 3d DCA 1993). To this end, Florida courts have tended to focus on changed circumstances or additional evidence that demonstrates an increased financial ability to post bond. Sikes v. McMillian, 564 So.2d 1206 (Fla. 1st DCA 1990) (holding that bond modification based on subsequent information alleging drug charges was improper because there were no profits which defendant might have used to post bond).

With that being said, this is a big deal. Knowledge of this money could very well have made a difference to the judge who presided over George Zimmerman's bond hearing. Moreover, the judge is unlikely to take kindly to the fact that this information emerged first via national news sources rather than in the courtroom.

This development has also led the Martin family attorney and others to attack George Zimmerman's character on grounds of dishonesty. Although character evidence is generally inadmissible in a criminal trial, a testifying witness's character for veracity is always at issue. With that being said, this incident could cast a long shadow if Zimmerman testifies at his murder trial. Will be interesting to see how this unfolds today.

In the wake of the high-profile shooting death of 17-year old Trayvon Martin, there is substantial public unrest surrounding Florida's "Stand Your Ground" law. In response, much of the Nation seems to be placing reliance on the Florida court system to redress the perceived shortcomings of this controversial statute. However, this reliance is misplaced.

Common Law Duty to Retreat

While the common law uniformly recognizes a person's right of self-defense, it also requires retreat to avoid killing whenever possible. Accordingly, under the common law, a person may not resort to the use of deadly force in self-defense unless and until he or she has exhausted every reasonable means for avoiding the threatened danger in a non-deadly manner. As far as the law is concerned, all lives are equal. Thus, the use of deadly force in self-defense must be a last resort.

Florida's "Stand Your Ground" Law

In 2005, the Florida legislature enacted the "Stand Your Ground" law that is the source of much of the controversy surrounding the Trayvon Martin case. Pursuant to that statute, a person who is not engaged in an unlawful activity and who is attacked in any place where he or she has a right to be has no duty to retreat and has the right to stand his or her ground and meet force with force, including deadly force. Fla. Stat. § 776.013. Thus, Florida's Stand Your Ground law explicitly abrogates the common law duty to retreat and expressly provides for a legal right to employ force against an assailant.

Any Change to "Stand Your Ground" Law Must Be Done Legislatively, Not Judicially

Obviously, reasonable people could disagree as to the wisdom of Florida's "Stand Your Ground" policy. And I agree that this tragic case is cause for Florida to reevaluate the proprietary of this law. But the public reliance on the court system to do this is misplaced. Any amendment or repeal of the "Stand Your Ground" law must be done in a legislative capacity. A judicial ruling on the wisdom of this statute would constitute judicial activism which would be in sharp contravention of well-established separation of powers principles. Moreover, any legislative change to the law must be prospective rather than retroactive. Thus, the court cannot allow the perceived shortcomings of this "stand your ground" policy to change the law for purposes of adjudicating this case.

The future of Florida's "stand your ground" law may be unclear, but one thing remains clear: George Zimmerman must be given the benefit of the law which was in effect at the time of the event.

There are 2 basic elements to every crime: (1) criminal act; and (2) criminal intent. In the murder context, there is also a third element of causation. Thus, in a case like this, the defendant's criminal act and intent must cause the victim's death.

Clearly we have a voluntary act on the part of Zimmerman (i.e. the shooting). But whether we have criminal intent is unclear. With that being said, my concern is that this case might be overcharged. The facts of this case are muddled. Depending on who tells the tale, either Zimmerman followed Trayvon and fatally shot him without any real provocation or Zimmerman stood his ground and acted in self-defense after telling the 911 dispatcher that Trayvon was "coming to check [him] out." But the witness recounts thus far have been contradictory and unsatisfactory. This is certainly not the fault of the witnesses. Critically, however, it seems that no one can testify as to exactly what transpired in the moments preceding the fatal shooting of Trayvon Martin. As a result, it is unclear to me whether George Zimmerman possessed the criminal intent to support a murder charge.

Let me be clear: I think that something terrible has happened here, and I think that George Zimmerman should be held accountable for what he did. But we cannot let our compassion for the victim and his family change the legal definition of murder. That's why I am terrified at the notion that the prosecution might be overcharging. It's Casey Anthony all over again ... the prosecution is putting all of its eggs in the murder basket and neglecting the manslaughter argument.

Of course, the prosecution could have evidence at its disposal that has not been made public information. I certainly hope that that's the case. But if Zimmerman walks - talk about miscarriage of justice. At the same time, if George Zimmerman lacked malice aforethought, which is the required level of criminal intent for murder, then a murder conviction would also be a miscarriage of justice.

In the wake of major budget cuts at the hands of pro-life lawmakers, three Texas Planned Parenthood branches have consolidated into a single entity: Planned Parenthood of Greater Texas. This is according to an article published this week by Emily Ramshaw of the Texas Tribune and reprinted in the New York Times. As is the case with most business combinations, the motivating purpose of this transaction was to create a leaner and more efficient organization. In this respect, the integration of the formerly separate businesses will likely result in a net cost savings attributable to non-economic factors such as functional integration, centralization or management, and economies of scale. The organization hopes that these cost savings will counter the lost financing.

So the seemingly age-old abortion debate is still very much alive and well. But this is a debate that never should have been. A woman's constitutional right to abortion cannot be disputed.

Let me be clear: as a Catholic, I am personally opposed to abortion. I believe that life begins at conception. But I believe that life begins at conception because I am Catholic. Science, on the other hand, seems to indicate that "life," as that term is scientifically defined, begins at viability (i.e. the point at which a fetus is able to survive outside the womb - about 24-28 weeks). And herein lies the problem. The opposition to abortion is a religious-based opposition.

With that being said, it becomes clear that the abortion debate is, at bottom, a religious debate. As such, it has no place in our political or legal system. To the contrary, the presence of this debate represents in impermissible entanglement of government and religion and a fundamental misunderstanding of the principles upon which this Nation was founded. Consequently, despite my personal beliefs as a Catholic, my professional opinion as a lawyer is that women must be afforded the right to choose as a matter of constitutional law. Some have called this inconsistent. But as a lawyer (and more importantly, as an American), I cannot allow my personal beliefs to undermine the clear intention of the United States Constitution.

Corporate officers and directors are denominated under the law as fiduciaries. As a result, they must always place the company's interests before their own. To this end, the law imposes two specific duties upon corporate officers and directors: (1) a duty of care; and (2) a duty of loyalty.

The duty of care generally requires that corporate officers and directors act on an informed basis in good faith and in honest belief that their action is in the best interests of the company. Brane v. Roth, 590 N.E. 2d 587 (In. Ct. App. 1993). The duty of loyalty requires that corporate officers and directors place the best interests of the corporation before his or her own interests. E.g., State Ex Rel. Hayes Oyster Co. v. Keypoint Oyster Co., 64 Wash. 2d 375 (Wa. 1964).

Notwithstanding these duties, a fundamental tension exists in the sense that a corporate officer or director may arguably act unlawfully without breaching the duties of care and loyalty. That is, a corporate officer or director may act with due care and in the best (economic) interests of the company, but in a manner which contravenes the law.

As a result of the foregoing, criminality in the corporate context has, in essence, become a business decision. In this respect, the decision-making criteria can be summarized in three words: does crime pay? For instance, in some cases, the fine associated with violation may be less costly than compliance. This is often true in the environmental context where it is often cheaper to pay the fine than to comply with environmental regulations. This may also be true with respect to corporate operations abroad. In many nations, official bribery is an accepted part of doing business. In this respect, the U.S. consequences of engaging in this bribery may be less costly than the loss of revenue from foreign operations that would result in the absence of the bribe.

Thus, the current state of the law appears to be this: if crime pays, then the criminal act is committed, and the corporate actors have complied with their duties of care and loyalty insofar as they have acted on an informed basis and in the best economic interests of the company. On this basis, U.S. companies are increasingly electing to knowingly violate the law. This is confirmed by a recent survey conducted by Deloitte which reveals that one in five executives fear management override of compliance systems. According to the survey, it appears that this increasing trend of corporate criminality can be largely attributed to unrealistic revenue goals and a lack of defined roles and accountability.

Pursuant to the treasury regulations under I.R.C. § 355, a spin-off must be undertaken for a purpose that is "germane" to the business of either the distributing corporation, the controlled corporation, or the affiliated group of which the distributing corporation and the controlled corporation are a part. In this respect, the IRS has long taken the position that a shareholder purpose is not a valid business purpose. But is this correct? Arguably, no.

Significantly, this issue has not been addressed by a court. That is, this position does not necessarily have any basis in the law (or in logic for that matter). My personal opinion is that a court would, more likely than not, squarely disagree with the IRS on this issue because I believe this general disallowance of shareholder purpose as a valid business purpose to be inconsistent with fundamental principles of corporate governance. The most basic theory of corporate governance is that a corporation exists for its shareholders. E.g., Dodge v. Ford Motor Co., 170 N.W. 668 (N.J. 1919). Indeed, a corporation is organized and carried on primarily for the profit of its shareholders. Id. Thus, any purpose which enhances shareholder value is consistent with the corporation's existence for its shareholders. Why, then, is a shareholder purpose insufficient by itself to support a 355 transaction?

To be clear, I would never recommend supporting a 355 transaction solely with a shareholder purpose. The IRS has clearly stated its position with respect to this issue, and the stakes are simply too high in this type of transaction to challenge the IRS. However, I do think that this is an issue to watch. Eventually, this issue will make its way into the court system, and when it does, I predict that the IRS' position will be invalidated.

Brokerage Firms Use Advance Commission Loans as Part of Compensation

Brokerage firms often use advance commissions incentives to stockbrokers, financial advisors, and other financial professionals as an employee recruitment tool. The intent of this type of industry-standard compensation package is generally three-fold. First, and most significantly, the advance on future commissions functions as a financial subsidy for the broker during the transition from the former employer to the new employer. Because of the regulated nature of the securities industry, it often takes months for a broker's license to clear and transfer to a new firm. Similarly, it takes time for the broker's clients' account paperwork to be completed and returned to the new firm. Even once these documents are received by the new firm, the transferred accounts are subject to the firm's internal account approval process. It is only after completion of this internal approval process that the asset transfer process between financial institutions can be completed. And only after the transfer of the clients' assets from the old firm to the new firm can the revenue streams associated with the client accounts commence with the new employer.

The second purpose of these compensation arrangements is to acknowledge and compensate for the reality that brokers often lose clients when transitioning from one firm to another. For instance, some clients may decide to remain with the broker's former firm. This might happen for a variety of reasons. In many cases, the extended re-licensing process allows another professional at the former firm to establish a relationship with the client during the lengthy license-transfer process. In other cases, the client may have a pre-existing relationship with the new firm or may have previously had a bad experience with the new firm that left a sour taste.

The third and final purpose of these types of compensation arrangements is to provide proceeds which the broker may use for business development. For instance, a portion of the proceeds are typically used to pay for additional sales help (e.g., assistant), to purchase leads for potential clients, and to pay other costs of marketing and general business expenses. More importantly, however, the proceeds can be used to fund a platform of investments which the broker can then showcase to existing and potential clients as evidence of the broker's investment and money management skills. In this way, the broker is able to create a performance track record which conveys the broker's competence and qualification to existing and prospective clients.

Forgiveness of Debt In Connection With Termination of Employment

These arrangements are generally evidenced by a promissory note to be repaid over a period of several years through paycheck deductions. If the broker leaves the employ of the firm prior to full repayment, the notes are often due and payable on demand. In the vast majority of cases, however, the outstanding principal amount will be forgiven in part or full.

Subject to some exceptions, cancellation of debt generally constitutes taxable income insofar as the debtor receives an economic benefit as a result of the debt forgiveness. The effect of a debt cancellation is to reduce the debtor's liabilities and, thereby, increase the debtor's overall net worth. Thus, the amount of debt forgiven is generally treated as taxable income received. Generally, brokerage firms and financial institutions report this income to the IRS as non-employee compensation on Form 1099-MISC. As a result, brokers who leave the employ of a firm prior to repayment of the employment-related loan end up not only with income tax liability, but also self-employment tax liability (about 14% for Social Security, Medicare, FICA, etc). However, since most brokers and financial professionals are W-2 employees, use of a 1099-MISC is often an improper method of reporting the income.

Cancelled Debt as W-2 Wages

The use of a 1099-MISC to report the cancellation of debt as non-employee compensation is, in essence, an explicit statement by the brokerage house that the recipient employee is not an employee. So then why would the employer report this employment-related income as non-employee compensation rather than as W-2 wages?

Maybe to avoid the employer-portion of payroll tax (e.g., FICA, Social Security, Medicare). Maybe due to other non-tax commercial considerations. Whatever the case may be, both the Internal Revenue Service and the United States Tax Court have found stockbrokers and financial advisors to be employees for federal tax purposes. E.g., Gierek v. Commissioner, T.C. Memo 1993-642; Rev. Rul. 76-138, 1976-1 C.B. 315. Most brokers and financial advisors are provided with an office, equipment, and other benefits. In addition, commissions are usually reported on a Form W-2. Finally, and most significantly, stockbrokers and financial advisors are subject to the firm's control with respect to trading and other business activities. Moreover, the promissory notes are issued in connection with the employment. In these respects, the loan proceeds are in the nature of employee compensation. Consequently, the forgiveness of debt is properly reportable on Form W-2 rather than on a 1099-MISC. See Chief Counsel Advice 200130038. In this respect, it should be of no moment whether the cancellation occurs prior to or subsequent to the broker's resignation or termination from the firm. Under relevant United States Supreme Court jurisprudence, an amount constitutes W-2 wages if it arises in connection with the employment relationship. This is true even where the employment relationship no longer exists at the time taxable income is realized to the former employee as a result of the debt forgiveness.

Takeaway

If you or someone you know has incurred a tax liability in connection with the cancellation or forgiveness of an employment-related loan, you might be paying too much in tax.