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TAX MATTERS

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july 2008

COURTS ON BOARD WITH CSX CASE

At least one other court has ruled that supplemental unemployment compensation benefits (SUCBS or SUBs) paid by employers to laid-off employees are subject to FICA taxes, after the Federal Circuit so ruled in the long-running case CSX Corp. v. U.S., 101 AFTR2d 2008-1120 (see also “Tax Matters,” JofA, June 08, page 97, and Dec. 06, page 80). The U.S. District Court for South Carolina ruled in a similar case, U.S. v. JPS Composite Materials Corp. (101 AFTR2d 2008-1488), after deferring its decision from a hearing in June 2007 to await the Federal Circuit’s ruling in CSX in March this year.

JPS initially paid FICA on SUBs it paid laid-off employees in 2000. After the Court of Federal Claims in CSX ruled in favor of the railroad on the same issue, JPS obtained a refund of $70,738 for most of the tax paid. The government, however, sued to recover the refund, claiming it was wrongly paid. Meanwhile, the Federal Circuit overturned the relevant portion of CSX. The district court in South Carolina then granted summary judgment to the government in JPS.

Other companies also may have been emboldened by CSX’s example after the Court of Federal Claims’ favorable rulings in 2003, some 13 years after the railroad first challenged the government on the issue (see “In the Money?JofA, Nov. 03, page 73).

IRC § 3402(o) states that a SUB “shall be treated as if it were a payment of wages for a payroll period” for purposes of income tax withholding. CSX Corp. pointed to revenue rulings 90-72 and 56-249, which specify conditions under which some SUBs are not wages. It also argued that section 3402(o)’s phrase “treated as if” means that SUBs are not in fact wages and hence not subject to FICA. The Court of Federal Claims agreed with this latter proposition, but the Federal Circuit likened it to what it said was another fallacy: “For example, to say that for some purposes all men shall be treated as if they were six feet tall does not imply that no men are six feet tall.”

SINGLE-MEMBER LLC IS S CORP SHAREHOLDER

Under IRC § 1361, shareholders of S corporations are generally limited to individuals, estates, certain trusts, certain exempt organizations, or another S corporation that wholly owns the S corporation as a qualified subsidiary. Recently, however, the IRS said in three nearly identical private letter rulings (PLRs) that an individual holding stock in an S corporation could contribute that stock to a domestic limited liability company of which the individual was the sole member, in exchange for a 100% membership interest in the LLC. The Service concluded that the contribution of stock to the LLC did not terminate the S corporation’s election because the LLC was disregarded as an entity separate from its owner. PLRs 200816002, 200816003 and 200816004, dated Jan. 14, 2008, were released April 18.

MEALS ON WHEELS

In Revenue Ruling 2008-23, the Service acquiesced to the Eighth Circuit’s holding in Transport Labor Contract/Leasing Inc. (98 AFTR2d 2006-6143; “Tax Matters: Full Deduction on Meal Reimbursements,” JofA, March 07, page 74) that, under certain circumstances, a company leasing employees to another company is not subject to the section 274(n) deduction limit of half the reimbursements of employees’ meals and incidental expenses but can deduct the full amount. Specifically, the reimbursements must be covered by the exception of section 274(e)(3) (employee performing services to another person to whom the employee accounts for expenses paid or incurred under a reimbursement or other expense allowance arrangement).

Furthermore, the leasing company must provide the client company substantiation required by section 274(d), including documentation of amounts, dates, times and business purposes of the employee expenses. In such situations, the client company is subject to the deduction limit, regardless of which company is considered the employer under common-law principles. The revenue ruling provides examples and analysis involving, as did Transport Labor Contract/Leasing, truck drivers.

CAPITAL ASSET REGS WITHDRAWN

Taking into account critical comments it received in writing and in two public hearings, the Service withdrew proposed regulations that would have tightened the characterization of certain accounts or notes receivable as ordinary, rather than capital assets. REG-109367-06, issued in August 2006, sought to clarify the exception from capital asset treatment in IRC § 1221(a)(4) of accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of stock in trade or inventory. The phrase “acquired … for services rendered” reflects Congress’ intent to apply the exception to situations where a taxpayer counts the value of a receivable as ordinary income but recognizes its later sale as a capital gain or loss. It prevents the mismatch by excepting such receivables from capital asset treatment altogether.

But starting in 1963 with Burbank Liquidating Corp. v. Commissioner (39 TC 999), the exception has been applied where “services rendered” were connected only with the lending transaction or secondary market for the debt instrument itself, the IRS said. The proposed regulations would have amended definitions in Treas. Reg. § 1.1221-1 to bar such treatment, except for reasonable fees connected with the lending transaction, billed in a separate invoice and account or note receivable. A public hearing in November 2006 and written comments prompted the IRS to hold a second public hearing in August 2007, at which representatives of mortgage lenders and automobile financing companies spoke against the proposed regulations.

A QUESTION OF FUND BALANCE

In a round of proposed regulations issued April 11, the IRS further explicated minimum required contribution rules for single-employer defined-benefit plans. The guidance is intended to help employers comply with funding requirements of the Pension Protection Act of 2006 (PPA). It supplements three previous sets of proposed regulations under new IRC § 430, which generally applies to plan years beginning in 2008 and following. Among other things, the proposed regulations prescribe a seven-year period for amortizing installments to correct a shortfall of plan assets as compared with the plan’s funding target for a plan year, using interest rates that apply for the plan year in which the shortfall amortization base is established. REG-108508-08 contains Prop. Treas. Reg. §§ 1.430(a)-1, 1.430(j)-1 and 54.4971(c)-1. It requests comments by July 15 and sets a public hearing for Aug. 4, 2008

IRS FLUSHES KOHLER

Proposed regulations (REG-112196- 07) provided the rationale behind the IRS’s nonacquiescence to the Tax Court’s decision in Herbert V. Kohler Jr. (TC Memo 2006-152; “Tax Matters: IRS Will Not Acquiesce in Kohler,” JofA, June 08, page 94). In general, the regulations restrict to “market conditions” post-death events that cause a reduction in estate value for estates that elect the alternate valuation method of IRC § 2032. In Kohler, the Tax Court allowed an estate valuation reduced during the alternate valuation period by stock transfer restrictions in a post-death tax-free reorganization of closely held Kohler Corp., the manufacturer of plumbing fixtures and small engines. In the proposed regulations, the Service recounted section 2032’s origins in the Great Depression as a remedy for estates whose assets lose significant market value between death of the decedent and payment of estate tax. In 1972, the Service noted, a district court in Flanders v. U.S. (30 AFTR2d 72-5872) disregarded restrictions that reduced real property’s value, acknowledging Congress’ intent in section 2032 to allow for “unfavorable market conditions (as distinguished from voluntary acts changing the character of the property).” The Tax Court rejected Flanders as controlling in Kohler, discussing it only within the narrower issue of a reorganization as a sale, exchange or other disposition of property under section 2032(a)(2).

Consequently, the proposed regulations would amend Treas. Reg. § 20.2032-1(f) to allow a change in property value under the alternate valuation method only to the extent that it is caused by market conditions, defined as events outside the control of the decedent (or executor or trustee) or other person whose property is being valued. That provision would be applicable for decedents dying on or after April 25, 2008, the day after the proposed regulations were issued.

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