INSIDE SALT
INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
Internal Revenue Code
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SALT Implications of Proposed Section 385 Debt/Equity Regulations

by | May 18, 2016 | , , , , ,

On April 4, 2016, without warning, the US Department of the Treasury proposed a new set of comprehensive regulations under section 385. There had been no advance indication that regulations were even under consideration. Although the Treasury indicated that the proposed regulations were issued in the context of addressing corporate inversions, their application went well beyond the inversion space and they apply to inter-corporate debt regardless of whether it occurs in an international context. The following is a discussion of the state and local tax consequences of the proposed regulations; for a detailed discussion of the proposed regulations themselves, see this previous article.

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NYS Tax Department Relaxes Investment Income Identification Rules

by | Jan 11, 2016 | ,

The New York State Department of Taxation and Finance has announced that it would extend the time for certain taxpayers to identify stocks as being held for investment so that income from those stocks would be tax-exempt [TSB M-15(4.1)C, (5.1)I]. Instead of having to make the identification on the date on which the stock is purchased, many corporations will now have a 90-day grace period to make the identification. This relaxation of the identification rules will come as a major relief to many companies that otherwise may have been ambushed by New York’s new rules, particularly out-of-state corporations that start doing business in New York after acquiring investment securities. The announced change is effective immediately.

Under corporate tax reform legislation enacted in 2015, corporations—to treat income from stock held as an investment as tax-exempt investment income—must identify the stock on the date of purchase as being held for investment and follow certain procedures. This requirement has been widely criticized as being unrealistic since a corporation’s investment people are unlikely to know about arcane tax rules on the date that they make trades. Securities dealers, to qualify for tax-free investment income treatment, must identify the stock as being held for investment pursuant to Section 1236 of the Internal Revenue Code (IRC), which requires the identification to be made on the date of purchase. Non-dealers must still make the identification on the date of purchase under the statute, but they need not make the federal election under Section 1236 since that provision applies only to dealers.

The Department’s new rules significantly relax the requirement for many non-dealer corporations. They do not apply to dealers, which will still be subject to the Section 1236 election requirements.

One criticism that has been made of the identification requirement is that a corporation that had not been doing business in New York and, hence, had not been a New York taxpayer and acquired stock as an investment would not have made the New York identification because it would not have cared about, or known about, New York taxes. If such a corporation later starts doing business in New York and becomes subject to New York taxes, it will be too late to make the identification for previously acquired stock and, hence, the income from that stock will not be exempt investment income. Under the Department’s new announcement, a corporation that first becomes a New York taxpayer on or after October 1, 2015, can make the identification within 90 days after becoming a New York taxpayer or, if it became a New York taxpayer before January 7, 2016, by April 6, 2016. Stock purchased after this extended period must still be identified as being held for investment on the date of purchase.

Ordinarily, a corporation becomes taxable in New York on the first day on which it does business, employs capital, owns or leases property, or maintains an office in New York. Under new economic nexus rules, a corporation also becomes taxable in New York on [...]

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State Revenue Departments Misapplying Federal Tax Law

by | Sep 9, 2014 | , , , , , ,

State income tax laws generally build on federal tax law.  The typical pattern is to begin the calculation of state taxable income with federal taxable income and then to modify it by adding or subtracting items where state tax policies differ from federal tax policies.  As a result, a corporation’s state taxable income can be affected by the application of the federal Internal Revenue Code.  State revenue departments generally do not consider themselves bound by Internal Revenue Service determinations respecting the application of federal tax law and believe that they are free to interpret the Internal Revenue Code as they see fit.  Unfortunately, this has led to problems because state tax auditors often are not well trained in federal tax principles.  We had an instance earlier this year in which an auditor claimed that the merger of a wholly-owned subsidiary into its corporate parent was taxable because there was an increase in the parent’s retained earnings.  The merger was a plain vanilla tax-free liquidation under Sections 332 and 337 of the Internal Revenue Code (there was no intercompany debt and the subsidiary was clearly solvent), but sending copies of these provisions to the auditor left him unmoved.  We finally got him to back down by showing that the parent’s increase in retained earnings was matched by a decrease in the subsidiary’s retained earnings so that there was no overall increase.  As we explained to the client, a win is a win, even if for the wrong reasons.  Nevertheless, if the auditor had been properly versed in the most basic federal corporate tax principles, this exercise would not have been necessary.

Two recent decisions illustrate misapplications of federal tax law by state revenue departments.

The Idaho Tax Commission recently held that a subsidiary’s net operating loss (NOL) carryovers did not pass to its parent in a merger of the subsidiary into the parent.  The parent did not continue to operate the business of the merged subsidiary and the Commission held that “based on IRC §382, the Petitioner cannot carry the loss forward after the merger.”  Idaho State Tax Commission Ruling No. 25749 (Apr. 17, 2014).  The Commission’s statement of federal tax law is incorrect.  Section 382 of the Internal Revenue Code does not apply to a merger of a wholly-owned subsidiary into its parent.  Because of constructive ownership rules, no change in ownership is deemed to occur.  Moreover, Section 382 does not prevent an NOL from passing to the surviving company in a merger; it simply limits the extent to which the NOL can be used.  Although it is true that the limitation is zero for years in which the merged company’s business is discontinued, the NOL is not destroyed.  If the parent later sells assets received from the subsidiary that had built-in gain at the time of the merger, the loss can be used to offset the gain.

Discussions that we have had with the Commission after the decision came out indicate that the Commission had [...]

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How to Negotiate a Settlement Agreement

by | May 22, 2014 | ,

Settlements of tax audits are typically memorialized in closing agreements between the department of revenue and the taxpayer.  Negotiating these agreements can be an important part of any settlement.

The department of revenue may have standard printed form closing agreements, and the taxpayer should determine the extent, if any, to which the standard form can and should be changed.  If department representatives are reluctant to change the printed form, one possibility would be to add an appendix that elaborates on—and even contradicts—the provisions of the form.

The agreement should indicate whether it is effective with respect to similar issues in future years.  Part of the settlement may be an agreement as to how certain items will be treated in future years; if so, this should be explicitly stated.  On the other hand, if the intent is that the agreement will not govern the treatment of settled items in future years, this too should be explicitly stated.  We have had cases in which this was not made clear, and, when the taxpayer in future years departed from the agreed treatment of certain items, the auditors said that the taxpayer was reneging on a deal.  When the taxpayer pointed out that the agreement specifically said that the settlement was not to apply to future years and did not necessarily reflect the opinions of the parties as to the proper tax treatment of any item, the auditors backed down, but they were still somewhat resentful.  The best approach is to pin down precisely the effect, if any, of the agreement on future years.

The department of revenue may want to provide that it can reopen the audit years if it discovers tax avoidance transactions.  While the auditors are thinking about abusive tax shelters, their suggested language is often broad and can apply to routine business transactions where tax considerations have been taken into account.  One government draft closing agreement that recently crossed our desks would have allowed the department to reopen the audit in the case of any “scheme, product, or transaction structured with the intent of evading or avoiding federal or state taxes.”  This language could apply to the most routine business transactions where taxes were taken into account, such as a decision to sell a business in a tax-free reorganization as permitted by section 368 of the Internal Revenue Code (the Code) rather than in a taxable sale. Taxpayers should try to limit any such provisions to objectively determinable tax shelters such as “listed transactions” within the meaning of the Code or comparable state law.  While the desire of state tax officials to be able to challenge abusive transactions is understandable, the typical closing agreement occurs only after an audit has gone on for some time and the taxpayer’s books have been carefully checked, so there is no reason why any significant transaction should not have come to light.  The department should not be allowed to reopen an audit or address routine business transactions just because they [...]

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