Monthly Tax Roundup (Volume 2, Issue 1)
Our December tax roundup focuses on a slew of administrative guidance released by the Internal Revenue Service (IRS), including much anticipated guidance regarding the newly enacted corporate alternative minimum tax and the stock buyback excise tax.
"If anyone from the, uh, from the IRS is watching, I forgot to file my 1040 return, and I meant to do it today, but..." – Astronaut Jack Swigert (Kevin Bacon) in Apollo 13
Tax Fact (by Andrew Beaghley): Season 43 of Survivor wrapped in December and the winner, Mike Gabler, promised to give his entire million-dollar prize to charity. Unfortunately for Mr. Gabler, the section 74 exception to including a prize as income if it is donated does not apply to contestants on a game show. Mr. Gabler's charitable deduction will be limited to 30 percent at worst or 60 percent at best of his adjusted gross income in the current year. He might want to hold on to some of those winnings to pay the taxes and avoid the mistakes of Season 1 winner, Richard Hatch, who was convicted of attempted tax evasion after failing to report his winnings.
IRS Releases Final Schedule UTP and Instructions for 2022
The IRS released its final revisions to Schedule UTP and its instructions on December 22, 2022. As we reported last month, there were two main concerns that arose during the comment period following the release of the draft changes to the schedule – the amount to be reported and the contrary guidance to be disclosed – both of which the IRS addressed to some degree in the final revision.
As expected after recent comments from Holly Paz, Acting Commissioner of the IRS Large Business and International Division (LB&I), the IRS has revised the instructions to provide that the amount to be reported on Schedule UTP is the amount reported on the line identified elsewhere on the schedule. Much of the ambiguity in the draft instructions surrounded the phrase "incremental amount," which has been removed from the final instructions. Curiously, the portion of the instructions addressing the amount to be reported on the schedule still refers to the definition of "size," which is determined by the amount recorded in the taxpayer's financial books for the position. However, the description of what is to be entered in column (k) has been clarified and now only requires the amount reported on the form and line number listed in columns (i) and (j).
The IRS also limited the authorities to be disclosed in column (c) to Revenue Rulings, Revenue Procedures, Notices, and court decisions. Removed from the list were Private Letter Rulings (PLRs), Technical Advice Memoranda, Chief Counsel Advice, Field Service Advice, and General Counsel Memoranda. Many comments on the draft schedule and instructions pointed out that they required taxpayers to cite non-precedential rulings that the taxpayer could not rely on to argue its position (other than to avoid penalties). The contrary authorities the IRS chose to keep (other than court decisions) are all published in the Internal Revenue Bulletin and binding on the IRS as an official statement of its position. However, the final schedule and instructions continue to require taxpayers to identify contrary court decisions without any distinction between those court decisions that are binding on the taxpayer and those that are not. Thus, for example, a taxpayer in the Fifth Circuit would still need to identify contrary authority (if any) in the Eleventh Circuit.
In a statement released with the final schedule and instructions, the IRS stated, "The IRS policy of restraint as set forth in Announcement 2010-76 remains in effect." Many commentators had raised concerns that the proposed changes from the earlier draft reflected an erosion of the policy of restraint. While the modifications in the final schedule and instructions help temper any erosion of the policy of restraint, the information required to be included may still pose a threat to the policy. Given the new changes, taxpayers should carefully assess their potential uncertain positions and ensure descriptions do not reveal privileged information.
Treasury Issues Preliminary Guidance on Corporate Alternative Minimum Tax
On December 27, the Treasury Department and the IRS released Notice 2023-7, addressing the corporate alternative minimum tax (CAMT) enacted in the Inflation Reduction Act (IRA). The Notice provides "interim guidance" describing some of the provisions of anticipated proposed regulations, and taxpayers may only rely on the guidance until proposed regulations are issued (for example, to calculate estimated payments). Comments are due 60 days after publication in the Internal Revenue Bulletin (IRB). Taxpayers within scope of the CAMT are strongly encouraged to review and comment on this guidance. Of particular significance, the Notice:
- Confirms that Treasury and the IRS will exercise their authority to align the CAMT treatment of certain liquidations, reorganizations, and contributions with the regular tax treatment of those nonrecognition transactions.
- Addresses the consequences of cancelled debt and bankruptcy restructuring on Adjusted Financial Statement Income (AFSI).
- Provides guidance relating to the depreciation adjustment rules in section 56A(c)(13) that are intended to substitute tax depreciation in lieu of book depreciation, including providing that:
- Depreciation expense taken into account as cost of goods sold is treated as a depreciation "deduction" for purposes of the depreciation adjustment.
- Depreciation adjustments are made only for section 168 property, and not for expenses deducted as a repair for tax purposes but capitalized for book purposes.
- Depreciation adjustments must be made for section 168 property placed in service in any taxable year, including taxable years prior to the effective date of the CAMT.
- AFSI adjustments must be made to redetermine book gain or loss recognized in a disposition of depreciable section 168 property to account for the depreciation adjustment.
- Announces a simplified method for determining whether a taxpayer is an "applicable corporation," which generally allows groups to rely on consolidated financial statements if their consolidated income is significantly below the relevant threshold ($500M instead of $1,000M; $50M instead of $100M).
- Adjusts AFSI to disregard certain amounts under the elective payment provisions of certain IRA clean energy credits and the Advanced Manufacturing Investment Credit and amounts received from the transfer of eligible credits.
Treasury and the IRS intend to issue additional interim guidance prior to proposing regulations and have requested feedback on 32 specific issues listed in the Notice.
Treasury Issues Preliminary Guidance on Stock Buyback Excise Tax
On December 27, the Treasury Department and the IRS released interim guidance in the form of Notice 2023-2, addressing the stock buyback excise tax enacted in the IRA. As the Notice describes anticipated proposed regulations, taxpayers may only rely on the guidance until proposed regulations are issued. Comments are due 60 days after publication in the IRB. Specifically, the Notice:
- Provides a de minimis exception for annual repurchases that do not exceed $1 million.
- Provides rules regarding the scope of the term "repurchase" and identifies an exclusive list of transactions that are considered "economically similar" transactions and a nonexclusive list of transactions that are not economically similar transactions.
- Provides rules for applying the excise tax to repurchases of foreign corporation stock, including a per se "funding" rule that treats a stock repurchase by a foreign parent as subject to the excise tax if the repurchases was funded by a specified affiliate such as a U.S. subsidiary by any means other than through distributions within two years of the repurchase.
- Describes the method for determining the base on which the excise tax is calculated, including rules for determining the timing and fair market value of repurchased stock.
- Clarifies certain statutory exceptions and offsets, including a netting rule for stock issued to employees or others during the year and rules for contributions to employer-sponsored retirement plans and for security dealers.
The Notice also lists 17 specific questions on which Treasury seeks public comment.
IRS Extends Automatic Method Change Procedures for R&E Expenditures
The IRS recently issued procedural guidance allowing taxpayers to use automatic accounting method change procedures to change their accounting method for specified research or experimental expenditures (R&E) to comply with section 174 as amended by the Tax Cuts and Jobs Act (TCJA). Before the TCJA amendments, section 174 allowed taxpayers to deduct R&E in the year paid or incurred. But for tax years beginning after December 31, 2021, post-TCJA section 174 (new section 174) requires taxpayers to capitalize R&E and amortize it over five years (15 years in the case of foreign research). An uncodified portion of the TCJA made clear that the change from expensing R&E to capitalizing R&E is a change in accounting method that is made on a cut-off basis. However, uncertainty existed as to what procedures (if any) taxpayers had to follow to make this change. The IRS resolved this uncertainty in Revenue Procedure 2023-8, which added a new section 7.02 to Revenue Procedure 2022-14, the most recent consolidated list of automatic accounting method changes. Shortly thereafter the IRS issued Revenue Procedure 2023-11, which modified and superseded Revenue Procedure 2023-8.
The new automatic method change provides different procedures for taxpayers to follow depending on the tax year for which the taxpayer seeks to change to new section 174. First, a taxpayer that changes to new section 174 for the taxpayer's first tax year that begins after December 31, 2021, can make the change by filing a statement with the taxpayer's tax return for that year. A Form 3115, "Application for Change in Accounting Method," is not required. Interestingly, while the introductory portion of Revenue Procedure 2023-11 refers to filing this statement "with the taxpayer's original Federal income tax return," the revisions to Revenue Procedure 2022-14 are silent as to whether the statement must be filed with an original return or can alternatively be filed with an amended return. Additionally, neither the introductory portion of Revenue Procedure 2023-11 nor the revisions to Revenue Procedure 2022-14 explicitly require that the relevant tax return be filed timely.
Second, a taxpayer that changes to new section 174 for a tax year after the taxpayer's first tax year that begins after December 31, 2021, must make the change using IRS Form 3115 and calculate a modified section 481(a) adjustment that accounts for R&E that the taxpayer paid or accrued in tax years beginning after December 31, 2021.
Third, a taxpayer with a short tax year that begins and ends in 2022 and that files a tax return for this short tax year with the IRS on or before January 17, 2023, is deemed to have made the automatic change to new section 174 if the tax return properly reports the R&E for the short tax year on IRS Form 4562, "Depreciation and Amortization," and properly capitalizes and amortizes this R&E as required under new section 174. Revenue Procedure 2023-11 refers to this as a "transition rule."
Audit protection does not apply for R&E that a taxpayer pays or accrues in tax years beginning before January 1, 2022. As compared to Revenue Procedure 2023-8, Revenue Procedure 2023-11 adds that audit protection also does not apply to R&E that a taxpayer pays or accrues in tax years beginning after December 31, 2021, "if an accounting method change is made for the taxable year immediately subsequent to the first taxable year" in which new section 174 becomes effective (emphasis added). An IRS News Release that accompanied Revenue Procedure 2023-8 suggests that this change is "designed to encourage timely compliance with changes made by the [TCJA]." Nevertheless, on its face this additional carveout from audit protection appears not to apply to a taxpayer that changes to New Section 174 after the second tax year for which new section 174 is effective (e.g., for 2024 in the case of a calendar-year taxpayer).
Now that the IRS has issued procedural guidance for changing to new section 174, taxpayers are turning their attention to anticipated proposed regulations providing substantive guidance on new section 174. Among other areas, these proposed regulations are expected to address scoping issues relating to the definition of R&E that is subject to new section 174. Of course, Revenue Procedure 2023-11 and any eventual proposed regulations under new section 174 could be mooted by subsequent legislation that retroactively delays its current effective date.
Government Seeks Dismissal in KYOCERA
In December 2022, the Department of Justice (DOJ) moved to dismiss refund litigation in the District of South Carolina, asserting that the district court lacks subject matter jurisdiction because the taxpayer has not "fully paid" its tax liability before seeking refund. Specifically, the government contends that the taxpayer must prepay installment amounts due in future years, which arise from a section 965 transition tax liability in the year at issue. KYOCERA AVX Components Corporation v. United States, No. 6:22-cv-02440-TMC (D.S.C. Dec. 6, 2022). The government's motion represents an extension of an IRS informal legal position first articulated in 2018 on recovery of estimated payments. The National Taxpayer Advocate previously rebuked the IRS for violating the legislative intent behind the transition tax installment rules, which were designed to ease the liquidity impact of taxing three decades of foreign earnings in a single period.
In KYOCERA, the taxpayer filed a refund suit for its tax year ending March 31, 2018, challenging the validity of regulations issued under section 78. For additional background, see our prior coverage. In moving to dismiss, the government contends that KYOCERA has not satisfied the "full payment" rule established in Flora v. United States, 357 U.S. 63 (1958). The DOJ asserts that "full payment" requires KYOCERA to satisfy the entire transition tax liability identified on its original tax return, including each installment due in the succeeding seven years. The government's motion principally relies on a Federal Circuit decision interpreting the estate tax, Rocovich v. United States, 933 F.2d 991 (Fed. Cir. 1991).
The transition tax installment rules differ significantly from the estate tax installment rules on which the government relies. In contrast to the estate tax, section 965(h)(3) identifies an exclusive list of events that accelerate the date on which transition tax liability is "due," and no interest is charged on transition tax installments. Even if the estate tax were relevant, for more than 15 years before Rocovich, the IRS position was that any argument that installments must be prepaid would not be sustained, because it would "negate the relief" provided by the estate tax installment rules for closely held businesses. Gen. Couns. Mem. 35,696 (Feb. 27, 1974). Even after Rocovich, the IRS adopted a "case-by-case analysis" of whether a Flora defense was appropriate. Gen. Couns. Mem. 39,854 (July 8, 1991). In 1998, Congress settled the issue by amending the Code to confirm that federal courts retained refund jurisdiction over estate taxpayers that had not yet satisfied all installments.
The government's position in KYOCERA has significant implications for the 15,000-30,000 businesses estimated to have been subject to the transition tax. Under section 6511, taxpayers must file administrative refund claims within three years from the date an original return is filed or two years from the date on which tax was paid, whichever is later. If the government's position were correct, taxpayers that elected to pay the transition tax in installments would be forced to wait until the end of the eight-year installment schedule (with the amount of the refund arguably limited to the tax paid in the two years preceding the claim) or to prepay installments before filing a valid claim for a refund.
Major Changes for Syndicated Conservation Easements
The end of the year brought two significant developments regarding the treatment of syndicated conservation easement (SCE) transactions. First, on December 6, 2022, Treasury and the IRS issued proposed regulations designating SCE transactions as listed transactions in response to mounting procedural challenges to the validity of Notice 2017-10, which contains the same designation. Second, Congress enacted new provisions to significantly limit the availability of charitable contribution deductions for SCE transactions in future years. Together, these developments are likely to have a significant chilling effect on future SCE activities (in an already frigid environment).
The proposed regulations issued on December 6, 2022, are intended to formalize Notice 2017-10, in which the IRS previously designated SCE transactions as listed transactions. This move is in direct response to the flurry of recent litigation under the Administrative Procedure Act (APA), including challenges to Notice 2017-10. In Green Valley Investors, LLC, v. Commissioner, 159 T.C. No. 5 (Nov. 9, 2022), the Tax Court recently held that Notice 2017-10 is invalid for failure to follow the notice and comment procedures set forth in the APA. We discuss this case and its effects in more detail here. The Tax Court's analysis in Green Valley Investors mirrored the analysis in Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022), where the appellate court invalidated a similar IRS notice. And the validity of Notice 2017-10 is also at issue in another case currently pending in the Northern District of Alabama. See Green Rock, LLC v. IRS, 2:21-cv-01320 (filed June 13, 2022). The proposed regulations would apply beginning on the date when the final regulations are published in the Federal Register. Any taxpayer that has filed a tax return that reflects its participation in an SCE transaction and has not made a disclosure pursuant to Notice 2017-10 by that date will be required to disclose the transaction, provided that the statute of limitations on assessment with respect to that return remains open.
In addition, just before the end of the year, Congress enacted significant changes to the rules allowing a charitable contribution deduction for SCE transactions as part of the Consolidated Appropriations Act, 2023, P.L. 117-328, § 605 (Dec. 29, 2022) (the Act). Most notable, the Act added a new section 170(h)(7) to the Code, which generally disallows the entire deduction for a conservation easement donation by a partnership if the reported value of the easement is more than 2.5 times the partners' aggregate "relevant basis" in their interests in the partnership. The section provides rules for determining "relevant basis" for this purpose. Limited exceptions to the new restriction apply for partnerships that wait at least three years from the later of the date on which the partnership acquired any part of the real property on which the easement was donated or the date on which the last partner in the partnership acquired its partnership interest. There are also exceptions for donations by family partnerships and donations involving contributions to preserve certified historic structures.
The penalty for tripping over the 2.5 times basis limitation is harsh. Not only is the entire deduction disallowed, but the Act also includes a new 40 percent accuracy-related penalty under section 6662, by treating the disallowed deduction as a gross valuation misstatement. The reasonable cause exception does not apply. Moreover, the IRS is not subject to the written supervisory approval requirement in section 6751(b) with respect to this new accuracy-related penalty.
The Act also makes several other changes. It provides that any contribution disallowed under new section 170(h)(7) is a tax avoidance transaction for purposes of section 6011 of the Code. It also directs the Secretary generally to prescribe regulations to require reporting under section 170(h)(7) and specifically requires reporting under new section 170(f)(19) for deductions relating to certified historic structures. Failure to comply with the new reporting requirements for historic structures will result in a full disallowance of the reported deduction.
There is, however, one bit of good news in the Act for taxpayers with certain technical deficiencies in their deeds. The Act instructs Treasury and the IRS to publish safe harbor model easement language relating to extinguishment clauses and boundary adjustment provisions within 120 days of the enactment of the Act. Taxpayers will have 90 days from the issuance of the model language to correct any errors in the deed, provided that (1) the amended deed is signed by the donor and the donee and recorded within that 90-day window and (2) the date the amended deed is recorded is treated as the effective date of the deed. Unfortunately, however, this safe harbor does not apply to any transaction described in Notice 2017-10 or new section 170(h)(7) (i.e., if the donation amount is more than 2.5 times the basis). It also does not apply to docketed cases, and certain other cases involving penalties.
With these recent developments and changes in the law, the IRS is poised to take an even more aggressive stance on SCE transactions going forward. The proposed regulations, which are likely to be finalized in 2023, will designate SCE transactions as listed transactions and subject taxpayers and advisors to accuracy-related penalties and disclosure requirements, which carry additional penalties if not satisfied. The Act imposes a bright line limitation on deductions from SCE transactions without regard to the fair market value of the donated easements and increases the applicability of the 40 percent penalty. It is important to note that both the proposed regulations and the Act will apply prospectively. Taxpayers that have already reported deductions from SCE transactions are not subject to the Act's limitation and the penalty exposure that comes along with it.
Treasury Proposes Rules Addressing Section 959(b) Distributions in the Consolidated Group Context
This month, Treasury and the IRS proposed rules that would treat a consolidated group as a single taxpayer for purposes of determining pro rata share ownership of a controlled foreign corporation (CFC) in a distribution of previously taxed earnings and profits (PTEP) to an upper-tier CFC under section 959(b). The proposed regulations do not apply to distributions of non-PTEP earnings. Comments are due by January 18, 2023. The regulations are currently proposed to apply to taxable years for which the original consolidated return is due (without extensions) once they are finalized. As such, for calendar year taxpayers, if the proposed regulations are finalized by April 18, 2023, they will be applicable to the 2022 tax year.
Generally, under section 951(a)(2)(b), if a CFC was acquired by a U.S. shareholder during its taxable year, the U.S. shareholder reduces its pro rata share of subpart F income or global intangible low-taxed income (GILTI) by the lesser of (1) the amount of actual distributions received by another person with respect to the stock or (2) the amount of subpart F income allocable to the portion of the taxable year that the stock was owned by the previous owner. The reduction is calculated in part based of the number of days the U.S. shareholder held the CFC stock over the number of days in the taxable year.
The preamble states that the proposed regulations are in response to the position taken by some consolidated groups that a midyear transfer of a CFC between members of the consolidated group should reduce the amount of subpart F income or GILTI included by a U.S. shareholder. In the scenario noted in the preamble, a lower-tier CFC would make a section 959(b) distribution to its upper-tier CFC owner, and then be transferred to another member of the U.S. consolidated group. The proposed regulations treat members of a consolidated group as a single U.S. shareholder for purposes of applying the pro rata rule in the context of section 959(b) distributions. Treasury also noted that common law doctrines or other law may apply to recast the transaction outside of the proposed regulations.
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