2012 Corporate Tax Update

1. Minnesota State Bar Association
2012 Tax Institute
Hot Topics In Corporate Taxation
December 5, 2012
By: Kevin Kaiser

2. Agenda
• Report of Organizational Action Affecting Basis of
Securities - IRS Form 8937
• Abandonment Loss and Worthless Assets
• Liquidation – Reincorporation (upstream C Reorgs)
• Purchase Price Allocations
• Reasonable compensation
• Earnings and Profits and Year-end dividends

3. Report of Organizational Actions
IRS Form 8937
• In 2008, Congress enhanced the information reporting on
Form 1099 to include tax basis information
• Congress also added Section 6045B requiring any issuer of a
specified security to file an information return to describe
any organizational action that affects the basis of the
security
3

4. Report of Organizational Actions
IRS Form 8937
• Form 8937 – Report of Organizational Actions Affecting Basis of
Securities
– Designed to allow corporations to comply with Section 6045B
corporation action reporting requirements
– Issued January 6, 2012
– Form must be filed when a corporate action affects basis
• Stock distribution
• Stock split
• Merger
• Acquisition
– Form must be filed by the earlier of (1) the 45th day following the
organizational action; or (2) January 15th of the year following the
calendar year of the organizational action
4

5. Abandonment Loss and Worthless Assets
• Section 165 permits taxable losses for assets, including securities, that
become worthless or abandoned during the current year
• Asset must have no current value and potential future value
• Loss must be claimed in the year the asset became worthless
– Taxpayer must show that asset was not entirely worthless in the
preceding year
• Claiming of the loss must be accompanied by an “identifiable event”
• CCA 201207009 – Taxpayer may claim an abandonment loss with
actually disposing of the asset if it is held solely for salvage value
(reference to PLR 7920002 – permitting abandonment loss)
5

6. 6
Upstream C Reorganization
PLR 201127004
P
S
LLC1
Other
Members
1. S converts from
corp to LLC –
treated as C Reorg
2. S assigns LLC1
interest to P
3. S converts from
LLC to corp –
treated as a
section 351
exchange
Steps

7. 7
Upstream C Reorganization
PLR 201127004
• P, a publicly-traded state X corporation, is the common parent of an affiliated group of corporations
filing a consolidated U.S. federal income tax return. P owns all of the outstanding common and
preferred stock of S. The preferred stock is nonvoting preferred. Through its direct and indirect
subsidiaries, S conducts Business A Operations and Business B Operations. All of S's Business A Ops
are conducted by LLC1, which is classified as a partnership.
• To achieve state income tax savings and to "enhance management focus within S," P has proposed
the following transactions:
• S will convert to a single-member LLC (Sub LLC) that would be disregarded (Conversion)
• Sub LLC would assign and transfer the LLC1 interest to P
• P would assign and transfer the LLC1 interest to new LLC classified as a disregarded entity
(LLC2) in exchange for all membership interests in LLC2.
• Sub LLC would distribute the intercompany debt to P
• Sub LLC would convert to a corporation (New S) , (the Reincorporation)
• The deemed transfers will qualify as a reorganization under section 368(a)(1)(C). The Conversion
will not be disqualified or recharacterized by reason of the reincorporation. Section 368(a)(2)(C)
and Treas. Reg. Sec. 1.368-2(k).

8. 8
Upstream C Reorganization
• Parent and subsidiary affiliated group (consolidated or nonconsolidated)
• Move appreciated asset from subsidiary ("Sub") to parent (P)
1. Sub should be a "checkable entity" i.e., limited liability company classified
as a corporation
2. Check-the-box to liquidate Sub
3. Transfer or assign appreciated asset to P (while Sub is DRE)
4. Check-the-box to reincorporate Sub
• See also 201232033 and 200952032 (similar rulings)

9. 9
Upstream C Reorganization
• Tax developments that support the tax treatment of the upstream C
reorganization
– Regulation 1.368-2(k) transaction first to qualify for recognition should be
respected (issued in 2007) – no recharacterization
 When the elements of the C reorganization are satisfied, the tax
analysis should stop, then begin to evaluate next transaction (in the
example, a valid section 351 capital contribution)
– Section 368(a)(2)(C) transfer of assets to controlled corporation is OK (no
remote continuity or asset alienation problem)
– Repeal of Bausch & Lomb doctrine - pre-existing ownership of target (Sub)
stock will not prevent tax-free reorganization treatment

10. 10
Asset Purchases
Purchase Price Allocation
• Section 1060 prescribes allocation rules for asset acquisition that
constitute an applicable asset acquisition
• Allocation reported on IRS Form 8594 – seven asset classes "I - VII”
• Section 1060 applies the so-called residual allocation method

11. 11
Asset Purchases
Purchase Price Allocation
• Purchase Price Allocation Cannot Be Changed – Post Acquisition
• Peco Foods Inc. v. Comm., T.C. Memo 2012-18 (1/17/12)
– Taxpayer cannot change Section 1060 purchase price allocation
describe in asset purchase agreement (“APA”)
– IRS and Tax Court rejected taxpayer’s attempt to reclassify
assets based on post-acquisition cost-segregation project
– APA was clear and there was no mistake or unknown facts
– Taxpayer bound by the agreement
– Court applied the rule of Danielson to bar a unilateral change

12. 12
Asset Purchases
Purchase Price Allocation – Cost Segregation studies, cont.
• AmeriSouth XXXII, Ltd. v. Comm., T.C. Memo 2012-67 (3/12/12)
– Cost segregation study successfully challenged by the IRS
– Court focused on the purpose of the building in order to determine the
classification of the assets used in the building
– Court stated that the focus of the analysis should take into account the
context in which the assets are used - the buildings in question in
AmeriSouth were apartment buildings
– Court concluded that although certain assets “could be moved”, in the
residential apartment context, assets such as shelves, mirrors and other
fixtures were intended to be “permanent”

13. Reasonable Compensation
• C corporations
– IRS challenges excess compensation
• S corporations
– IRS challenges insufficient compensation
13

14. Reasonable Compensation
• Reasonable Compensation Factors
– Multi-factor Test
• Qualifications and training of employees
• Nature and scope of employees duties
• Size and complexity of business operation
• Compensation rates for competitors
– Hypothetical Independent Investor Test
14

15. Reasonable Compensation
• Hypothetical Independent Investor Test
– Would an independent investor pay the
employee the compensation at issue, and how
the employees services affect the investor's
return
15

16. Reasonable Compensation
Recent cases
• Menard v. Commr., 560 F3d 620 (CA-7, 2009)
– Taxpayer victory in C corporation compensation case
• Mulcahy, Pauritsch, Salvador v. Commr., 680 F.3d 867 (CA-7,
2012)
– Government victory in S corporation compensation case
• David Watson PC v. U.S., 668 F.3d 1008 (CA-8, 2012)
– Government victory in S corporation compensation case
16

17. Reasonable Compensation
• C corporation Excess Compensation
 Corporation losses the compensation deduction
 Recharacterized as corporate distribution
 Dividend to the extent of earnings and profits (E&P)
 Note – Adequate disclosure for penalty protection
 Complete Form 1120, Schedule E (Rev. Proc. 2012-15)
17

18. Earnings and Profits and Year-end Dividends
I. Present overview of federal tax rules governing the tax
treatment of earnings and profits (“E&P”) and Dividend
Distributions
II. Describe the E&P Computation process
18

19. Overview of E&P Concepts
• Tax planning for distributions has always started with a few
basic facts of life:
– Corporate shareholders generally prefer dividends,
because of the dividends received deduction, presently
embodied in Section 243
– Noncorporate shareholders generally prefer capital gain
treatment (or return of capital)
19

20. Overview of E&P Concepts
• The principal Code provisions governing pro rata distributions
are contained in:
– Section 301 Distributions of Property
– Section 311 Taxability of Corporation on Distribution
– Section 312 Effects on Earnings and Profits
– Section 316 Dividend Defined
• In addition, with respect to corporate distributees, Sections
243, 246 and 1059, which contain the principal rules dealing
with the dividends received deduction, are of particular
importance.
20

21. Overview of E&P Concepts
• Earnings and profits ("E&P") are taxed at the corporate level
when earned, and again when the corporation distributes
them to the owners of the company, the shareholders.
• E&P forms the foundation of the double tax system and
applies to non-corporate shareholders and, to a limited extent
(depending on ownership), to corporate shareholders.
21

22. Earnings and Profits
• Dividend distribution to extent of “earnings and
profits”
• Current E&P
• Accumulated E&P
22

23. Consolidated E&P
• Treat consolidated group as a single entity by
reflecting the E&P of lower-tier members in E&P of
higher-tier members
• Consolidate the group’s E&P in the common parent
23

24. Consolidated E&P
• Parent’s E&P are adjusted for Sub’s E&P
• Unused losses reduce E&P currently
• Intercompany transactions affect E&P when taken
into account
24

25. Deconsolidation
• Sub’s E&P eliminated immediately before it becomes a
nonmember to the extent taken into account by any member
• Exceptions
– Acquisition of group
– Certain corporate separations and reorganizations
• This is an important consideration when acquiring companies
or selling a subsidiary
25

26. E&P Calculation
• START - Taxable income
• Plus additions
– Tax exempt income, excess LIFO, DRD excess accumulated
depreciation, etc.
• Depreciation Adjustment
• Less subtractions
– E.g., federal income tax, penalties, 50% meals and entertainment,
§267 deductions, etc.
• Less Distributions to the extent of E&P
• FINISH = E&P
26

27. E&P Determination (process)
• Taxable income reconciliation
– Each year since inception
 Reconcile originally filed return to final taxable income (audit
adjustments, amendments, etc.)
• Transaction Analysis - analyze E&P effects of every corporate transaction
• E&P Adjustments - analyze E&P adjustments for each year
• E&P Depreciation - apply E&P depreciation rules (usually separate project)
• Final E&P Determination
27

28. Example of a Summary of Estimated
Consolidated Earnings & Profits
December 31, 2004 to December 31, 2011
Year
Beginning
of Year
E&P
Total Adjusted
Consolidated
Taxable
Income
Adjusted
Federal
Income Tax
Merger
and
Liquidation
Adjustments
Tax Exempt
& N/D Expense
Adjustments Distributions
End of
Year
E&P
12/31/04 0 10,000 (3,000) (150) (1,300) 5,550
12/31/05 5,550 7,500 (2,250) (100) (1,400) 9,300
12/31/06 9,300 2,500 (750) 100 (80) (1,560) 9,510
12/31/07 9,510 (100) 0 (75) (100) 0 9,235
12/31/08 9,235 3,000 (1,000) (200) (1,200) 9,835
12/31/09 9,835 4,000 (1,200) 120 (150) (1,750) 10,855
12/31/10 10,855 5,000 (1,500) (100) (1,500) 12,755
12/31/11 12,755 7,500 (2,250) (300) (1,555) 16,150
Totals 0 39,400 (11,950) 145 (1,180) (10,265) 16,150
Subtotal Accumulated E&P Before E&P Depreciation 16,150
Estimated Section 312(k) E&P Depreciation (cumulative) 500
Estimated Accumulated E&P (with depreciation adjustment) 16,650

29. Thank You
Hot Topics in Corporate Taxation

30. Contact Information
Kevin W. Kaiser
Lindquist & Vennum PLLP
4200 IDS Center
80 South Seventh Street
Minneapolis, MN 55402
Phone: (612) 371-2467
E-mail: kkaiser@lindquist.com

31. ANY TAX ADVICE CONTAINED IN THIS COMMUNICATION IS NOT INTENDED OR
WRITTEN TO BE USED, AND CANNOT BE USED FOR THE PURPOSE OF (i)
AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii)
PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY
MATTERS ADDRESSED HEREIN.
The information contained herein is general in nature and based on authorities
that are subject to change. Applicability to specific situations is to be determined
through consultation with your tax advisor.
Hot Topics in Corporate Taxation