I n letter ruling 9721002, a buyer terminated a number of employees two days after it had acquired a company. The employees were entitled to severance payments, and the company deducted those payments. In an earlier ruling (revenue ruling 94-77), the Internal Revenue Service had said severance payments were deductible but had not determined whether they were deductible in connection with an acquisition.
Although a buyer that assumes liabilities generally must capitalize (not deduct) the ensuing payments, the severance payments in letter ruling 9721001 were not considered a liability because the employees were terminated after the acquisition.
Costs "incident to" an acquisition also must be capitalized, but the methods of determining such costs are not based solely on when the costs are incurred. Instead, the nature of a cost can be determined under the "origin of the claim" doctrine. In this case, the severance payments originated with the termination of the employees after the acquisition. Thus, the payments were deductible.
According to Informational Release 97-29, the Internal Revenue Service will include lists on its Web site of all the organizations that qualify as recipients of charitable contributions. The list will be updated quarterly and can be accessed at http://www.irs.ustreas.gov .
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A Taxing Flight
Observation : The severance payments did not have their origin in the acquisition because (1) the severance agreements were in place before the acquisition and (2) the agreements were not mentioned in the stock purchase documents.
Robert Willens, CPA, managing director at Lehman Brothers, New York City.
New Definitions for Long-Term Care
T he Health Insurance Portability and Accountability Act of 1996 allows employees to exclude from income benefits received under an employer-provided long-term care (LTC) insurance contract. The act also allows employees to deduct medical expense amounts paid for qualified LTC services, including a limited deduction for LTC insurance premiums.
Under Internal Revenue Code section 7702B, the Internal Revenue Service defined qualified LTC services and the qualifications of a chronically ill individual. According to 7702B, a chronically ill person is one who has been certified by a licensed health care practitioner within the previous 12 months as (1) unable to perform without substantial assistance from another individual at least two of six activities of daily living for a period of at least 90 days due to a loss of functional capacity, (2) having a similar level of disability as determined under forthcoming regulations or (3) requiring substantial supervision to protect ones self from threats to health and safety due to severe cognitive impairment.
Because individuals, employers and insurance companies were having trouble interpreting these definitions, the IRS issued notice 97-31 (1997-21 IRB) to provide more guidance about whom the IRS considers chronically ill. According to the notice, taxpayers can now rely on the following safe-harbor definitions:
- Substantial assistance means hands-on and standby assistance.
- Hands-on assistance means the physical assistance of another person without which the individual would be unable to perform the activities of daily living.
- Standby assistance means the presence of another person within arms reach to prevent injury while the individual is performing the activities of daily living.
- Severe cognitive impairment means a loss or deterioration in intellectual capacity that is (a) comparable to and includes Alzheimers disease and similar forms of irreversible dementia and (b) measured by clinical evidence and standardized tests that reliably measure impairments in the individuals memory, orientation and reasoning.
- Substantial supervision means continual supervision necessary for the individuals health or safety (such as to prevent wandering).
Observation : CPAs should advise their clients that LTC insurance is now an important aspect of retirement planning. If money is tight, premiums can be paid by using funds in an individual retirement account or 401(k). Although such withdrawals will be included in income, they will not be subject to the 10% penalty for early withdrawals. Premiums also can be paid by using a medical savings account.
Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island .