IRS Wants Companys Tax Return Software
The Eighth Circuit Court has ordered enforcement of the first Internal Revenue Service summons seeking the software a taxpayer used to prepare its consolidated federal income tax return ( United States v. Norwest Corporation [no. 96-2792, CA8- June 26, 1997]). The IRS believes that the softwareparticularly its underlying "code"will provide greater insight into the companys complex computations, such as those used to compute its allocations figures. Norwest, a large bank holding company, licensed Tax Director, a suite of tax preparation programs, from Arthur Andersen & Co.
Responding to the IRS request, Norwest and Andersen went to some lengths to provide the IRS computer with files and software, other than Tax Director, that would allow the IRS to tie the companys tax return to the companys financial data. The IRS was not satisfied and issued a designated summons for preparation programs (a designated summons suspends the statute of limitations). A magistrate ordered enforcement with certain limitations intended to protect Arthur Andersens proprietary interest in Tax Director. With some modifications, the federal district court affirmed the magistrates order.
In their appeal, Norwest and Andersen argued that Tax Director was not the proper subject of a summons because the program was merely a tool, akin to a calculator, that contained no information regarding the taxpayer. Circuit Judge Arlen C. Beam rejected their argument on the basis that the softwares arithmetical processes and ability to organize financial information qualified it as a "record" or "other data" under Internal Revenue Code section 7602. Norwest and Andersen also challenged the summons as failing to meet the relevancy and legitimate purpose standards set forth in United States v. Powell (379 U.S. 48, 1964).
The court found for the IRS saying the software was relevant as "the final step in translating the companys summary book income into the information reported on the returns."
Observation . A number of companies have been put in the uncomfortable position of having the IRS request tax preparation software that their software licenses preclude them from providing. The court said the Copyright Act does not override the IRSs summons authority; however, the court did not address Norwests contractual obligations under the license because Arthur Andersen intervened in the enforcement action. With this success in the Eighth Circuit Court, the IRS is sure to expand its efforts to obtain tax preparation software. Companies should be aware the IRS also wants tax planning software, the relevancy of which may be more difficult to establish.
Tracy Hollingsworth, Esq., staff director of tax councils at Manufacturers Alliance, Arlington, Virginia .
Stiff Late Fee
In technical advice memorandum 9722005 the IRS ruled the wage or salary deduction for alternative minimum tax (AMT) purposes must be reduced by the targeted jobs credit even though the credit is not allowed for AMT purposes. The IRS probably will treat the current work opportunity credit in a similar fashion.
Taxing Pro Pain
How to Fill Out the Form
Losses on Corporate Stock Investments
Losses on stock investments are best classified as ordinary because capital losses can be used only to offset capital gains while ordinary losses can offset any variety of income. However, based on a string of recent court cases, companies may not have the liberty of choosing how stock losses will be classified.
Historically, corporations have been able to attain ordinary loss treatment for stock that was acquired and held for business purposes. Thus, if a corporation acquired stock to ensure a supply source a needed raw material, the so-called Corn Products doctrine ( Corn Products Refining Co. v. Commissioner , 350 US 46, 1955) enabled the corporation to classify the stock as ordinary.
In Arkansas Best v. Commissioner (485 US 212, 1988), however, the U.S. Supreme Court rejected the notion that the Corn Products doctrine created an exception for capital assets acquired for business purposes. Nevertheless, even after Arkansas Best, Circle K v. United States (Court of Federal Claims, 12-86T, 1996) suggested that a "source of supply stock purchase" could qualify as a hedging transaction (the stock would be considered ordinary) if it was an integral part of an inventory purchase system.
However, in the most recent ruling on this issue, Cenex v. Commissioner , the Circle K reasoning is rejected. Why? Cenex stands for the proposition that, except in the case of a securities dealer, corporate stock always is a capital asset and a loss sustained thereon is a capital loss.
Observation: As a result of Cenex, the Arkansas Best decision was reinforcedthe Arkansas Best case intended to create a fixed classification for corporate stock.
Robert Willens, CPA, managing director at Lehman Brothers, New York City .
Tax-Deferred 401 k Distributions
In private letter ruling 9721036, a taxpayer over age 59 1 / 2 qualified for an in-service distribution of cash and employer stock from a qualified 401(k) plan. The taxpayer sought to roll over the cash into an individual retirement account and keep the employer stock. The Internal Revenue Service ruled the rollover did not affect the status of the distribution as a qualified lump-sum distribution. Thus, the taxpayer was not currently taxed on the net unrealized appreciation of the employer stock.
Take, for example, a taxpayer who participates in the company 401(k) plan. The plan invests in several assets, including $20,000 in the employer corporation stock, which the taxpayers company pays for. While in the 401(k) pension trust, the value of the employers securities skyrockets to $100,000. How will the taxpayer be taxed if he or she takes the employer stock out of the plan?
Under Internal Revenue Code section 402(e)(4)(B), if the taxpayer receives the employer stock as part of a lump-sum distribution, then he or she will be taxed currently only on the stocks cost of $20,000 and the net unrealized appreciation of $80,000 can be tax deferred. In order for the distribution to be a lump-sum distribution, the taxpayer must receive the entire account balance within one year after (a) reaching age 59 1 / 2 , (b) death, (c) separation from service or (d) becoming permanently disabled (if self-employed).
Observation: Assume six months later the taxpayer sells the stock for $115,000. The taxpayer must report a long-term capital gain of $80,000 (the net unrealized appreciation) and a short-term capital gain of $15,000. If the stock is held for more than a year before it is sold, the entire gain of $95,000 would be long term.
If the taxpayer had wanted to, he or she could have elected to be taxed on the entire $100,000 in the year of the lump-sum distribution.
Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island .