Individual

Property Settlements

I n private letter ruling (PLR) 9644053, the Internal Revenue Service said a divorcing couple could use an annuity to equalize the division of their property without selling their principal asset.

A husband and wife, residents of a community property state, proposed a marital property settlement in anticipation of their divorce. Their primary asset was an interest in the A&B corporation, the husbands employer. Both husband and wife believed selling the A&B stock would have a substantial disruptive effect on A&Bs operations, so they agreed the husband would resign from A&B and the wife would receive all the companys stock and a portion of other community property. The husband would receive the majority of the other community property.

The couple also agreed to use a trust as an annuity to equalize the distribution of the property because a significant portion of the value of all community property was the A&B stock. According to the trust agreement, all of the property transferred to the trust would become the husbands separate property. During the husbands life, the trustee would distribute as much of the trust income and principal as the trustee deemed appropriate for the husbands happiness, enjoyment, comfort, travel, living expenses, support, maintenance, education and health. IRS temporary regulations said no gain or loss would be recognized if the transfer of property took place within six years of the divorce and any transfer occurring after six years would be presumed to be unrelated to the divorce.

In PLR 9644053, the IRS said that because the husband and wife did not anticipate that the A&B stock would generate enough cash to enable the wife to pay the annuity to the husband within six years, a valid business reason existed to spread the payments out over the husbands lifetime. Thus, the transfers of property and cash between the husband and wife would be tax-free under IRC section 1041.

Observation: Even though the husband and wife resided in a community property state, divorcing couples in other states also can take advantage of the annuity method in equalizing their marital assets.

—Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island.

BUSINESS/INDUSTRY

ISO 9000 Costs

A ccording to an Internal Revenue Service audit position paper, all internal and external costs of ISO 9000 certification should be capitalized because ISO certification confers benefits that last beyond the year in which the costs are incurred.

ISO 9000 certification signifies that a companys processes conform to a series of quality system standards developed by the International Organization for Standardization (ISO), based in Geneva, Switzerland. Many businesses, both foreign and domestic, and governments require their suppliers to be ISO 9000 certified.

The IRS position paper likens ISO certification to an initial entry into a new market or business. It cites court cases dealing with obtaining a seat on a stock exchange, admission to the bar or acquiring hospital privileges. The IRS does not analyze certification in the context of maintaining existing customers and markets, which motivates many if not most certifications. The position paper also cites the U.S. Supreme Courts holding in Indopco v. Commissioner (503 U.S., 112 S.Ct. 1039, 1992) that certain legal and professional fees incurred by a target company to facilitate a friendly merger created significant long-term benefits and thus should be capitalized. The IRS has used Indopco to support capitalization for a broad range of expenses, such as environmental cleanup costs.

Observation: Interestingly, the paper does not address amortization of capitalized costs. A taxpayer faced with an IRS proposed adjustment seeking capitalization of ISO certification costs may want to negotiate a short amortization term. Also, the IRS decision to capitalize ISO 9000 costs could impose significant administrative burdens on some businesses and have the effect of increasing the cost of certification—a competitive disadvantage not faced by non-U.S. companies.

—Tracy Hollingsworth, Esq., staff director of tax councils at Manufacturers Alliance, Arlington, Virginia.

CORPORATE

Reporting Commissions

F or the first time, the Tax Court, in Charles Schwab v. Commissioner, said that an accrual method brokerage firm must accrue commission income on the trade date rather than on the settlement date.

The key issue was to identify the date a commission should be accrued. The IRS said the execution of an order on behalf of a customer was the essential service the taxpayer performed and, thus, was the right time to receive the commission. Although many actions were performed after the trade date, they were regarded as administrative and so did not preclude the commission from accruing. By branding these actions as administrative, they were relegated to the category of conditions subsequent, meaning they were not important elements of the earning process. Although conditions subsequent may terminate an existing right to income, the commission can still be accrued.

Observation: Schwab made an interesting, albeit unsuccessful, argument. It said that, unlike a full-service broker, these administrative actions (following the trade date) should preclude trade date accrual because they represented such a substantial proportion of Schwabs overall activities. The court rejected this argument—Schwabs unique method of conducting business did not change the condition-subsequent status of these post-trade date actions.

—Robert Willens, CPA, managing director at Lehman Brothers, New York City.

FYI

In revenue ruling 96-51 (1996-43, IRB 5), the IRS announced that an employer may properly deduct yearend wages and employment taxes that are accrued in one year and not paid until the following year. Previously, the IRS had said that although the wage accrual was proper, the employment tax accrual was not because the all-events test of treasury regulations section 1.461-1 (a)(2) was not satisfied in the year the wages were earned. In an action on decision (1996-013), the IRS said it no longer would litigate the issue of whether an overstatement in cost of goods sold was considered an omission from gross income for purposes of the "grossly erroneous" requirement under IRC section 6013(e). In private letter ruling 9645002, the IRS said a retail chain did not have to capitalize the preopening costs of opening new stores as part of an expansion program. According to the IRS, not every expenditure that produces a future benefit must be capitalized. Preopening costs can be deducted currently if the new stores are part of an expansion plan, the new stores are similar to the existing stores and an opening takes a few weeks. Starting in 1997, IRS officials must give taxpayers written notice of the relief available under IRC section 530 of the Revenue Act of 1978 before beginning an audit involving worker classification issues. According to informational release 96-44, the IRS will fulfill this requirement by issuing Publication no. 1976, Independent Contractor or Employee ? to the taxpayer. In private letter ruling 9643003, the IRS said a self-employed musician hired a band, rented a studio and prepared a demo tape in order to sell his music. He sought to deduct his expenses under section 263A(h), which allows writers to avoid the uniform capitalization rules of section 263A. The IRS said the demo tape was a sound recording and not a writing and, thus, must be capitalized. IRC section 513(f) said that a not-for-profit organization was not subject to the unrelated business income tax (UBIT) on income from bingo games. According to the Fifth Circuit Court, however, instant bingo does not qualify for this exception. The court determined that instant bingo was similar to a lottery where winners—by scratching a card—were predetermined. Therefore, an instant bingo game was subject to the UBIT ( Julius M. Israel Lodge of Bnai Brith no. 2113 v. Commissioner , no. 96-60087, 5th Cir. Oct. 25, 1996). Close to 100,000 taxpayers have not yet received their 1995 refund checks. According to IRS informational release 96-49, these checks, in excess of $62 million, were returned by the post office because they were undeliverable. Those who are still waiting for their refunds can call the IRS toll-free assistance line listed in the local telephone directory or 800-829-1040. Taxpayers can eliminate the possibility of lost, stolen or undeliverable refunds by electing direct deposit. According to Commissioner Margaret Milner Richardson, This year direct deposit is easier than ever—just two extra lines to complete on the tax form. Also, taxpayers who have moved this year can avoid delays in getting their refunds simply by mailing in Form 8822, Change of Address , when they move. In notice 96-53, the IRS answered many commonly asked questions concerning the new medical savings accounts. The notice explains what they are and who can use them, how they can be established, how contributions and distributions will be treated and the information trustees and custodians must report. —Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island.