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TAX SHELTERS

TAX SHELTERS. Bob Blum Hanson Bridgett Marcus Vlahos & Rudy LLP San Francisco, CA October, 2007. For Discussion. IRS’ concern Applicable Code sections Shelter defined Excise taxes on managers + entities Details re the tax What you can do for protection. IRS’ CONCERN.

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TAX SHELTERS

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  1. TAX SHELTERS Bob Blum Hanson Bridgett Marcus Vlahos & Rudy LLP San Francisco, CA October, 2007

  2. For Discussion • IRS’ concern • Applicable Code sections • Shelter defined • Excise taxes on managers + entities • Details re the tax • What you can do for protection

  3. IRS’ CONCERN

  4. From the Commissioner “I cannot overstate the seriousness of the involvement of tax-exempt and government entities as accomodation parties to abusive transactions.” Commissioner Everson, 6/22/04, statement before the Senate Finance Committee

  5. Example – Roth IRAs • IRA owner (O) also owns a sole proprietorship business (B) • IRA sets up a wholly owned corp (C) • O sells assets of B to C for less than FMV • IRS: treats as payment to O, a contrib to the IRA and a contrib by IRA to C • Notice 2004 – 9 • A “listed transaction”

  6. Example – SILO • Lender (L) loans $ to X • X uses $ to purchase property from FP which leases it back with optn to purchase • FP transfers $ to L in its capacity as “payment undertaker” • L is obligated to use this $ to make lease payments to X • X instructs L to apply those lease payments to satisfy X’s debt to L

  7. Example – SILO (2) • IRS: X cannot deduct depreciation or interest on the loan • “Treasury Press Release on Abusive ‘SILO’ Arrangements”, 2/11/05 • IRS problem: failure to convey tax ownership and absence of genuine debt. • Circularity of funds • Self cancelling nature of rights and obligations • No substance to transaction

  8. S Corp - Notice 2004-30 • S corp issues nonvoting stock (9:1 nonv to v) • 10:1 warrants to buy nonv also issued • Nonvoting stock is contrib’d to qualified plan; 90% of income is allocated to nonv stock. little income is distributed • Income on nonv is treated as not UBTI • Warrants are exercised; economic benefit to qual plan is much lower than S corp income allocated to it

  9. General Issue • Income is shifted to exempt from taxable; deductions or losses shifted to taxable • Qualified plans have engaged in these transactions, as have other exempts

  10. More Reading • Notice 2001-16 – intermediary transactions • Coordinated Issue – Intermediary Transaction Tax Shelters (12/19/02) UIL 9300.16.00 • Rev. Rul. 2002-69 – LILO transactions • “TE/GE Abusive Tax Shelters”, ACT 5/20/03 • Notice 2005-13 – leasing with defeasance

  11. Section 4965 • Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) • P.L. 109-222, sec. 516(a)(1) • Added new section 4965 imposing excise taxes on tax exempts and on their managers in connection with shelters

  12. CODE SECTIONS

  13. Governing Sections • 4965 + prop 53.4965 [72 Fed Reg No. 129 (7/6/07)] • 6707A • 6011 + 1.6011-4 [72 Fed Reg No. 149 (8/3/07)] + 54.6011-1T • 6011(g) + 301.6011(g)-1 • 6033 + 1.6033-5T • 6071 + 53.6071-1T • 6652(c)(3)

  14. General Scheme • 4965 imposes excise taxes on entities and managers that are parties to shelters • up to 100% of net income or 75% of proceeds • $20,000 per manager per action • 6707A defines the tax shelters targeted • 6707A refers to 6011; definition in regs • 6033 reqs reporting & 6652 sets penalties • 6011(g) reqs disclosure to tx exempts • 6071 sets return requirements

  15. Dual Requirements? • 6011 and 1.6011-4 separately require disclosure and reporting of shelters • 6707A sets high penalties for failure to disclose per 1.6011-4 • as much as $200,000 per transaction • Notice 2004-30 clearly requires that a qualified plan disclose under 6011 • IR 2044-44 (first time IRS has designated an exempt entity as a “participant” for shelter reporting per 6011)

  16. SHELTERS

  17. 4965 And Shelters • 4965 imposes an excise tax on tax shelter transactions to which tax exempt entities are parties • “Prohibited tax shelter transactions” • A subset of all tax shelter transactions • 4965(e) and 53.4965-3

  18. Prohibited Tax Shelters4965(e) • Listed transactions • including substantially similar transactions • including subsequently listed transactions • this tax picks up transactions after they occur • Confidential transactions • Transactions with contractual protection • If 6011 applies, the shelter universe is larger, for reporting & not for the excise tax

  19. Listed Transactions4965(e) • 4965(e)(1)(A) to 6707A to 6011 to 1.6011-4(b)(2) and prop 53.4965-3 • See Notice 2004-67 (10/12/04) (which is not up to date, however) • http://www.irs.gov/retirement/article/0,,id=118821,00.html for EP abusive transactions

  20. EP Listed Transactions • 401(k) accelerated deductions • S corp ESOP abuse of delayed eff date • Coll bargd welfare funds – 419A(f)(5) • Trusts that do not qualify for 419 exemptn • Abusive Roth IRA transactions • Deductions for excess life insur’ce – 412(i) • Segregation of ESOP-owned S corp profits to cut out rank&file • Plus “business” transactions that use qual plan as an intermediary to shift deductions or income

  21. “Substantially Similar” • “[A]ny transaction that is expected to obtain the same or similar types of tax consequences and that is either factually similar or based on the same or similar tax strategy.” 1.6011-4(c)(4) • An opinion from counsel on the tax effects is irrelevant. Id. • Substantially similar “must be broadly construed in favor of disclosure”. Id.

  22. “Substantially Similar” Examples • Transaction based on offsetting options transferred to partnership can be “SS” to • use of short sales, futures, derivatives, or any other offsetting obligations to inflate basis in a partnership. 1.6011-4(c)(4) • Use of intermediary to buy stock to facilitate an asset sale can be “SS” to • any transaction that uses intermediaries to prevent recognition of gain. Id.

  23. Subsequently Listed • 4965 applies to transactions “entered into before, on or after” the effective date. • Prop 53.4965-9(a) • Prop 53.4965-6(d) re subsequently listed transactions • There is relief from the “knows or should know” tax for pre-enactment deals

  24. Confidential Transactions1.6011-4(b)(3) • Tax advisor limits disclosure of • tax treatment of transaction • tax structure of transaction • AND the limit protects the confidentiality of that advisor’s tax strategies • Irrelevant whether limit is legally binding • OK to say it is proprietary if advisor “confirms” that there is no disclosure limit • Plus minimum fee paid to advisor who limits disclosure

  25. Confidential Transactions (2) • Minimum fee is • $250,000 per transaction for corp txprs • $50,000 for all other transactions • Combine all fees for a tax strategy • strategy, advice, implementation, returns • in cash or in kind including services • indirect fees as referral fees or fee sharing • Qstn: fee to own lawyer if “confidential attorney client privilege”?

  26. Confidential Transactions (3) • Is it a confidential transaction if the transaction is patented, it can be disclosed, but anyone who uses it must pay royalties? • Is it a confidential transaction if the transaction can be disclosed but the party who discloses must pay, e.g., $250,000 to the advisor for each disclosure?

  27. Contractual Protection1.6011-4(b)(4) • Taxpayer has right to refund (all or part) of fees paid if all or part of intended tax effects not achieved • Or, fees are contingent on realizing the tax effects intended • Only re fees paid to a person who “makes or provides a statement” to the txpr “as to the potential tax consequences”

  28. Contractual Protection (2) • Exceptions • OK to have right to terminate “upon the happening of an event affecting the taxation” of a party. [Qstn: like a deficiency notice?] • OK if the statement re tax effect is after transaction is entered into and reported on a return and the person has not previously received fees re the transaction

  29. Contractual Protection (3) • Questions • If the taxpayer gets an indemnification re the taxes, is it contractual protection if the indemnification is not tied to the fees paid? • Is it worse for the taxpayer to get an indemnification or should it just rely on common law for damages if the transaction fails? • What if the indemnification is for more than fees?

  30. PARTY TO A TRANSACTION

  31. Only A Problem If Is A “Party”4965(a); Prop 53.4965-4 • Exempt facilitates a prohibited tax shelter transaction bec of its tax status • Party: Notice 2004-30 re S Corp • Non-Party: partnership investment; status of exempt investor is irrelevant to other partners • Enters into a listed transaction AND there is a reduction of liability for employment, excise, or UBTI taxes

  32. Examples • Roth IRA “abuse” • 401(k) accelerated deductions • Excess deductions using 412(i) • And others • In each case, the transaction was “facilitated” by the benefit plan/IRA • So IRS has a new weapon – an excise tax

  33. EXCISE TAX

  34. 2 Taxes: Entity + ManagerProp 53.4965-5, -7 • NO entity tax for benefit plans except for • VEBAs • 115 trusts (?) • “Integral part” trusts (?) • Manager tax • Tax is $20,000 per relevant manager • Not split among managers; not joint and several • Self directed – participant can be “manager”

  35. Manager TaxProp53.4965-7(b) • $20,000 if • approved or caused the exempt entity to become a party to a prohibited shelter and • knew or had reason to know it was prohibited

  36. ManagerProp53.4965-5(b) • A benefit plan manager is the person “who approves or otherwise causes” the entity to be a part to the shelter • For self directed plans, the participant is the manager • If there are limited choices, the person who selects the choices is a manager and the participant is not

  37. Manager Who “Approves” • Has the authority to commit the plan • individually or as part of a collective body • everyone who votes for has exercised authority; who abstains or votes against has not

  38. Knows or Has Reason to KnowProp53.4965-6(b) • Has knowledge of enough facts that “would lead a reasonable person” to conclude. . . • A “reasonable person . . . would conclude” that was a prohibited shelter • Facts include: prior disclosure, extraordinary transaction, exceptional return, significant size for the entity; good faith reliance on written opinion; transaction later listed

  39. Manager Tax - Questions • More work for the lawyers? • Will “substantially similar” be a key issue? • Can the employer or plan indemnify the manager against this tax? • No tax at the entity level even if the transaction was intentional?

  40. Entity Tax – VEBAProp53.4965-7(a) • Rate, in general • Highest UBTI rate on net income from deal, or • 75% of proceeds from the deal • If knew or had reason to know • 100% of net income from deal, or • 75% of proceeds • Annual tax • Applies to pre-enactment deals • Applies to later listed transactions

  41. Transition Due Date • Form 4720 for 4965 entity tax due on or before 10/4/07 will be timely if filed and tax paid by that date • 53.60781-1T • Form 5330 for 4965 plan manager tax due on or before 10/4/07 will be timely if filed and tax paid by that date • 54.6011-1T

  42. NEW REPORTING

  43. Form 88861.6033-5T • Every tax exempt entity including plans • Report • Is a party to a prohibited tax shelter transactn • Identity of every other party to the transactn that is known to the exempt entity • Single disclosure for each transaction • Due 5/15 of year after listed or affects taxes • November 5, 2007 due date if entered into after 5/17/06 and before 1/1/07

  44. PROTECTION

  45. Possible Actions • Contract limits on investment managers • Investment policy limits • Rep & warranties re shelter status • Ability to terminate investment • Guaranteed buyout price? Liq. damages? • Plan lawyer’s legal opinion • Regular watch of “listed transactions”

  46. Important Uncertainties • Double jeopardy – 6011 and 6707A + 4965? • Any contractual protection • “Substantially similar” • Constant flow of new “listed” transactions • Patent protection

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