Introduction

In this month's roundup, we scrutinize proposed regulations implementing the stock buyback excise tax, explain the limits of recent estimated payment relief for the corporate alternative minimum tax, evaluate recent dispute resolution initiatives at the IRS Independent Office of Appeals, and dissect case law developments in the areas of federal tax accounting, microcaptive insurance, and conservation easements.

Tax Fact: At end of fiscal year (FY) 2023, the IRS had obligated $3.5 billion in additional funding from the Inflation Reduction Act (IRA). Of that amount, $0.9 billion went to taxpayer services, $0.3 billion to enforcement, $1.5 billion to operations support, and $0.8 billion to business systems modernization. 

"Any tax is a discouragement and therefore a regulation so far as it goes." – Oliver Wendell Holmes, Jr. (Supreme Court Justice, 1902-1932)

Questions Remain on Applicability of Stock Buyback Excise Tax to Foreign-Parented Companies under Newly Proposed Regulations

Layla Asali, Rocco Femia, Caroline Reaves, and Candice James

On April 12, the U.S. Department of the Treasury (Treasury) and the IRS published two sets of proposed regulations addressing the excise tax imposed on repurchases of corporate stock under section 4501. REG-115710-22, 89 FR 25980 offers overall guidance on the operation and applicability of the excise tax and REG-118499-23, 89 FR 25829 addresses the reporting and payment of the stock buyback tax. The proposed regulations expand on the preliminary guidance previously provided in Notice 2023-2. Comments are due May 13, 2024, for the regulations on reporting and procedure, and June 11, 2024, for the substantive regulations.  

As background, section 4501 imposes a one percent excise tax on stock repurchases by publicly traded domestic corporations, and on "economically similar" transactions. For purposes of computing the excise tax, the amount of stock repurchases is reduced by the fair market value of stock issued by the corporation, including stock issued to employees (referred to as the "netting rule"). Section 4501 also provides specific statutory exceptions, including an exception for tax-free reorganizations, and provides regulatory authority to address preferred stock. Finally, section 4501(d) provides that the excise tax may apply to transactions involving the purchase of stock of publicly traded foreign corporations in two circumstances: 

• In the case of a purchase by a U.S. subsidiary of stock of its publicly traded foreign parent
• In the case of stock repurchases by a publicly traded foreign corporation that is a surrogate foreign corporation within the meaning of the anti-inversion rules of section 7874

Much of the guidance in the proposed regulations is consistent with the preliminary guidance in Notice 2023-2, including:

• The term "stock" is defined to include stock or similar instruments, with no exception for "straight preferred stock" or mandatorily redeemable preferred stock (other than a limited exception for "additional tier 1 preferred stock" issued by regulated financial institutions) 
• The proposed regulations provide an exclusive list of transactions that are considered "economically similar" to a stock repurchase
• The proposed regulations provide that the statutory exception for tax-free reorganizations does not apply to the extent an acquisitive reorganization is partially funded by the target corporation (on the basis that such an acquisition is treated as a redemption under general tax principles)
• Guidance on the operation of the netting rule 
• Guidance on the statutory exceptions to the excise tax, including an ordering rule for the de minimis exception for repurchases that do not exceed $1 million annually 

As part of these sweeping regulations, Treasury and the IRS modified, but did not remove, the "funding rule" in Notice 2023-2 that extended the application of section 4501 to stock buybacks by foreign corporations (discussed in our prior coverage) that are deemed to be funded by a U.S. subsidiary. While the proposed regulations drop the "per se" rule introduced in Notice 2023-2, the proposed regulations retain and extend a "principal purpose" rule, under which a U.S. subsidiary of a foreign parent is treated as purchasing its parent's stock to the extent the U.S. subsidiary (1) has funded its parent "by any means" and (2) such funding has "a principal purpose" of funding a stock buyback by the parent. 

The proposed regulations also introduce a rebuttable presumption for "downstream" funding arrangements that applies to the extent (1) a U.S. subsidiary of a foreign publicly traded parent funds its foreign subsidiary and (2) the funded foreign subsidiary purchases stock of the ultimate foreign parent stock within two years of the funding. 

In terms of the general principal purpose test, the proposed regulations "clarify" that a principal purpose to fund, directly or indirectly, a repurchase of stock by the foreign parent is treated as a principal purpose of avoiding the stock buyback excise tax. The proposed regulations do not explain why funding a foreign parent stock buyback should be considered to have the same purpose as avoiding the excise tax in light of the fact that the excise tax does not apply to a stock buyback by a foreign corporation. 

In cases where the principal purpose rule applies, the buyback is allocated first to the amount of funding by the U.S. subsidiary rather than other sources, such as dividends from foreign subsidiaries to the foreign parent. The proposed regulations and underlying examples do not address what constitutes a principal purpose to fund a repurchase of foreign parent stock. Because the per se rule has been eliminated, however, routine transactions for value would not appear to be implicated by the funding rule in the proposed regulations. 

Under the proposed regulations, payment for the stock buyback tax for a taxable year is due when the excise tax return (Form 720 plus attachments) for the first quarter of the following taxable year is filed. For taxable years before the regulations are finalized, the first return and payment are due on the due date for the first full calendar quarter after the date the regulations are finalized. For instance, if the regulations are finalized September 16, 2024, the taxpayer would be required to file and pay the tax liability for 2023 on the due date for a fourth-quarter Form 720 (for calendar year taxpayers, January 31, 2025). For taxable years ending after the regulations are finalized, the general due date is the due date of the Form 720 for the first full quarter following the end of the taxable year. For instance, if the regulations are finalized September 16, 2024, for a calendar year taxpayer, the return for the 2024 year (and the tax liability) would be due April 30, 2025.

The proposed regulations generally apply to repurchases and issuances that are made after, and during taxable years ending after, December 31, 2022. However, certain aspects of the proposed regulations apply only to transactions occurring after, and during taxable years ending after, April 12, 2024. In particular, in the case of the funding rule, the proposed regulations apply to repurchases after April 12, 2024, and the rules of Notice 2023-2 apply to repurchases prior to April 13, 2024. In addition, the principal purpose test in the proposed regulations applies to fundings after December 27, 2022. Taxpayers can choose to apply the proposed regulations to repurchases prior to April 13, 2024, provided they do so consistently. 

IRS Provides Further Relief for Estimated Tax Payments Affected by the Corporate Alternative Minimum Tax

Jim Gadwood, Caroline Reaves, and Andrew Beaghley

In eleventh-hour guidance, the IRS waived section 6655 additions to tax for underpaying the installment of corporate estimated tax due on or before April 15, 2024 (May 15, 2024, in the case of a FY taxpayer with a taxable year beginning in February 2024) to the extent such underpayment is attributable to a corporation's liability under the corporate alternative minimum tax (CAMT). Released on April 15, Notice 2024-33 effectively extends for an additional quarter the section 6655 relief the IRS previously provided in Notice 2023-42 for the four estimated tax payments corporations owed in 2023. See here for our prior coverage. To date, the IRS has provided no relief from section 6655 additions to tax for the remaining three installments of corporate estimated tax due during the rest of 2024. 

In addition to being the due date for a calendar-year corporation's first 2024 quarterly estimated tax payment, April 15 was also the deadline for a calendar-year corporation to request a six-month extension of time to file a 2023 tax return. Such an extension request does not extend the time to pay 2023 taxes and so must be accompanied by a payment of estimated 2023 tax liability net of payments and credits to date. Failing to pay the 2023 tax liability — the determination of which could very much depend on a corporation's CAMT liability — by this date could subject a corporation to section 6651 penalties. Significantly, neither Notice 2023-42 (relating to 2023 corporate estimated tax payments) nor Notice 2024-33 (relating to the first corporate quarterly estimated tax payment for 2024) provide relief from these potential section 6651 penalties. Rather, it seems a corporate taxpayer facing a potential section 6651 failure-to-pay penalty relating to 2023 CAMT liability may have to resort to reasonable cause defenses under section 6651(a).

Notice 2024-33 directs affected corporations to file a Form 2220, Underpayment of Estimated Tax by Corporations, with their 2024 federal income tax returns to avoid a penalty notice, even if the corporation owes no estimated tax penalty without regard to the Notice 2024-23 relief. The IRS intends to modify the instructions to Form 2220 to provide specific instructions on how to avoid a penalty notice. 

While the Notice 2024-33 relief is limited, it is nevertheless welcome as taxpayers continue to navigate the CAMT morass.

IRS Creates New ADR Program Management Office

George Hani and Omar Hussein

On April 24, 2024, the IRS Independent Office of Appeals (Appeals) announced the creation of the Alternative Dispute Resolution (ADR) Program Management Office (PMO), aimed at "[revitalizing] existing programs" and developing new programs aimed at allowing taxpayers to resolve tax disputes without the need for litigation. This development represents the IRS's latest effort to revamp its ADR Program and bodes well for taxpayers who are looking for alternative means to resolve tax disputes.

In May of 2023, the Government Accountability Office (GAO) issued a report which found that between 2013 and 2022, less than 0.5 percent of all Appeals cases utilized ADR and the use of ADR fell by 65 percent. The GAO recommended, among other things, that the IRS develop a more robust data collection program and link the strategic program goals of the ADR program with those of the IRS generally. On July 27, 2023, the IRS invited public comments on ways to improve its ADR programs. The request for comments focused on four ADR programs: fast-track settlement, fast-track mediation collection, the rapid appeals process, and post-appeals mediation. The IRS also sought comments on how the program could be expanded or improved. For additional information on this request for comments and ADR programs generally, see our prior coverage. On December 8, 2023, Appeals released their FY 2024 Focus Guide, which lists ADR as one of four key focus areas. 

Following these developments, the creation of the ADR PMO represents a natural next step in Appeals' efforts to revamp their ADR program. The office will be headed by Michael Bailiff, previously a senior advisor at Appeals. As stated in the April 2024 announcement, the ADR PMO will "pilot changes to Fast Track Settlement," "remove barriers to participating in Post-Appeals Mediation," test new programs, update existing guidance, and enable easier access to ADR programs overall. Through these changes, "the IRS hopes to make its ADR programs… more attractive and accessible for all eligible parties." 

ADR programs serve as a valuable tool for both tax planning and controversy resolution and the establishment of the ADR PMO represents a positive development for taxpayers interested in participating in these programs. 

Tax Court Asked to Invalidate Regulations Applying Economic Performance Requirement to Cost of Goods Sold

Jim Gadwood and George Hani

The 1984 enactment of the economic performance requirement was a seismic event in the world of federal tax accounting. As Treasury and the IRS turned to issuing related regulations, a debate arose over whether this new requirement applies only to amounts allowable as deductions (subtractions from gross income in calculating taxable income) or also extend to amounts recoverable as cost of goods sold (subtractions from gross receipts in calculating gross income). Proposed regulations took the more expansive view and, despite vociferous pushback in the ensuing comment letters, final regulations followed suit, applying the economic performance requirement to deductions and cost of goods sold. See T.D. 8408. Courts have since parroted these regulations, Dieker v. Comm'r, T.C. Memo. 2005-225 (2005); Pennzoil-Quaker State Co. v. United States, 62 Fed. Cl. 689, 695 (Fed. Cl. 2004), but have not been forced to evaluate them on their merits. A recent court order shows that a pending case gives the Tax Court an opportunity to do exactly that.

The tax matters partners of BRC Operating Company, LLC and Bluescape Resources Company, LLC (collectively, the Petitioners) filed petitions in Tax Court in 2016 to challenge notices of final partnership adjustment that disallowed cost of goods sold in years where the Petitioners had no gross receipts from the sale of goods. In 2021, the Tax Court granted an IRS motion for partial summary judgment, holding that a taxpayer generally must have some gross receipts from the sale of goods to recover cost of goods sold. BRC Operating Co. v. Comm'r, T.C. Memo. 2021-59. Subsequent motion practice led to an April 2024 order that, from a procedural perspective, merely deferred resolution of the remaining legal and factual issues until after trial. BRC Operating Co. v. Comm'r (No. 12922-16, Apr. 11, 2024). While this disposition is not noteworthy on its own, the court's discussion of the parties' arguments is particularly interesting for taxpayers and tax practitioners interested in federal tax accounting.

Following its 2021 opinion, the Tax Court allowed the Petitioners to amend their petitions to plead that the disputed cost of goods sold are, in the alternative, deductible as trade or business expenses under section 162. The IRS has responded by arguing that the Petitioners can neither claim section 162 deductions nor capitalize the disputed amounts under section 263(a) because economic performance had not yet occurred and, in any event, the Petitioners did not obtain the IRS's consent to change their method of accounting from recovering the disputed amounts as cost of goods sold to deducting the disputed amounts under section 162 or capitalizing them under section 263(a). Unsurprisingly, the Petitioners argue that economic performance has occurred. More interestingly, however, the Petitioners also challenge the extent to which the economic performance requirement is even relevant.

First, the Petitioners "argue in the alternative that if the reported... costs instead are capital expenditures under section 263(a) the economic performance requirement does not apply." This appears to be a challenge to Treas. Reg. § 1.263(a)-1(c)(1), which provides that an accrual method taxpayer may not take a liability into account under section 263(a) before the taxable year during which the liability is incurred (requiring, among other things, economic performance to occur). Second, the Petitioners ask the Tax Court to "hold invalid Treas. Reg. §§ 1.61-3(a), 1.446-1(c)(1)(ii)(A), and 1.446-1(c)(1)(ii)(B) to the extent those regulations extend the economic performance requirement of section 461(h) to the computation of offsets under section 451." The reference to "offsets" appears to be a reference to the cost of goods sold that are subtracted from gross receipts in calculating gross income.

To be clear, there are potential paths for the Tax Court to resolve the parties' dispute without having to tackle the extent to which the economic performance requirement applies beyond amounts allowable as deductions.The Tax Court took this approach in its 2021 opinion. BRC Operating Co., T.C. Memo. 2021-59 ("We do not reach the parties' dispute over whether the economic performance requirement in section 461(h)(1) applies...."). Nevertheless, taxpayers and tax accounting professionals will be watching this case closely to see whether the Tax Court will take on an issue that has been lurking ever since Treasury and the IRS issued final regulations applying the economic performance requirement to cost of goods sold more than 30 years ago.

Microcaptive Organizers Not Subject to Section 6700 Tax Shelter Penalties

Maria Jones and Candice James

On April 4, 2024, the U.S. District Court for the Middle District of Florida, by jury verdict, held in favor of an insurance professional and three of his related entities (collectively, Ankner) and found that the section 6700 penalties assessed by the government did not apply. See Ankner v. United States, Dkt. Nos. 2:21-cv-330, 2:21-cv-331, 2:21-cv-333, and 2:21-cv-334 (M.D. Fla., Apr. 4, 2024). Section 6700 imposes significant penalties on any person who organizes or assists in the organization of any plan or arrangement, or participates in the sale of any plan or arrangement, and makes a false or fraudulent statement regarding the availability of tax benefits if the person knows or has reason to know that the statement was false or fraudulent as to any material matter. In April 2021, Ankner sued for refund after being assessed penalties under section 6700 for the tax years 2010 through 2016. In February 2024, the district court denied summary judgment motions filed by Ankner and the government based on its finding that there was a factual dispute about whether the statements at issue were false or fraudulent and whether Ankner could be found to "know or have reason to know" that the statements were false or fraudulent. Ultimately, the jury found that the government had failed to prove by a preponderance of the evidence that each of the elements of section 6700 were satisfied and concluded that Ankner was not liable for the section 6700 penalties for promoting a tax shelter. 

This decision is noteworthy because it is the first litigated case involving section 6700 penalties assessed against parties involved in a microcaptive program. Interestingly, just before this case went to trial, another section 6700 case docketed in the U.S. District Court for the Southern District of Florida was settled for Celia Clark, who was involved in the Avrahami and Swift cases. In Avrahami v. Commissioner, 149 T.C.M. 144 (2017) (see our prior coverage) and Swift v. Commissioner, T.C. Memo 2024-13 (see our prior coverage), the Tax Court concluded that the captive did not qualify as insurance. Based on court filings, it appears that Ms. Clark agreed to pay approximately 45 percent of the assessed penalties. See Celia Clark v. U.S., Dkt. No. 9:21-cv-82056 (S.D. Fla., Apr. 15, 2024).

These tax shelter penalty cases represent another phase in the IRS's unrelenting attack on the section 831(b) microcaptive insurance industry. The cases are interesting because they flip the burden – the government must prove by a preponderance of the evidence that the elements of the section 6700 penalty are satisfied. Among other elements, this requires a showing that the insurance program did not qualify under the tax rules, so that statements regarding the tax benefits were indeed false or fraudulent. Another key issue is whether the parties "should have known" that statements regarding the tax benefits of the program were false or fraudulent. This could be challenging to demonstrate in these cases, since there was no specific guidance provided by the IRS, the issue of qualification as insurance is heavily fact-dependent, and the first Tax Court decision was not issued until 2017. Under these circumstances, we expect that it will be difficult for the government to prove all of the required elements by a preponderance of the evidence. 

U.S. Tax Court Vacates the "Proceeds Regulation," Reverses Previous Decision

Maria Jones, Kevin Kenworthy, and Sam Lapin

In an about-face, the U.S. Tax Court in Valley Park Ranch, LLC v. Commissioner, 162 T.C. No. 6, Docket No. 12384-20, vacated the so-called "proceeds regulation" in a reviewed opinion, finding that the regulation was not promulgated in compliance with the Administrative Procedure Act (APA). The Tax Court previously upheld the very same regulation in Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. 180 (2020), aff'd, 28 F.4th 700 (6th Cir. 2022), against a similar APA challenge just four years ago. The opinion presents the Tax Court's current analytical framework for assessing whether Treasury and the IRS responded to comments in compliance with the APA. It also paints an interesting picture of the Tax Court in a moment of transition. Read our full alert here.

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