The individual gave no consideration for the option other than his promise to continue managing the company and the S corporation granted the option intending to secure the individual’s continued employment. Moreover, the individual exercised his option through a cashless exercise provision and received shares of the S corporation’s stock. Therefore, the value of the stock was properly based on a per-share value established by the cashless exercise provision and the transaction was arm’s-length between the individual and the S corporation. Since the shares were not valued with reference to listed securities, it was reasonable for the Tax Court to use the parties’ own valuation of the shares on the date of individual exercised the option.

Further, nonrecognition treatment under Code Sec. 1041 did not apply to the individual’s exercise of the option. Although the individual and his wife were not required to recognize any gain or loss when the option was transferred to the individual pursuant to a divorce settlement, Code Sec. 1041 did not apply to the subsequent exercise of the option by the receiving spouse. Moreover, the rights contained in the option, which the individual subsequently exercised by using the cashless exercise provision, were transferred to him by the S corporation and not by his wife or incident to divorce.

Affirming the Tax Court, 102 TCM 575, Dec. 58,831(M) , TC Memo. 2011-286.

A.L. Davis, CA-11, 2013-1 ustc ¶50,330

CCH Comment: The privatization occurred under a Conservative government policy to transfer the companies from government ownership to private investors. The windfall profits tax was enacted by a subsequent Labour government to recapture some of the profits realized by the private investors. The tax was imposed only on companies that were not allowed to raise their prices for a fixed period (generally, four years) after they became private.

Creditable Tax

A foreign tax is creditable if its predominant character is that of an income tax in the U.S. sense. This analysis was based on the normal manner in which the tax applied, regardless of the terms of the statute or how the tax was characterized by the foreign government. A foreign tax’s predominant character is that of a U.S. income tax if the tax is likely to reach net gain. Net gain for this purpose was realized gross receipts reduced by significant costs and expenses attributable to them; in other words, net gain was the same as net income.

The windfall profits tax met this test because it was economically equivalent to a tax on the difference (over a certain threshold) between the profits each company actually earned and the amount the government believed it should have earned based on what the private investors paid for it. Accordingly, a company’s net income was an essential component of the windfall tax formula. It was irrelevant that the windfall tax was formally imposed on value, specifically the difference between a company’s imputed profit-making value and what the investors paid for it. Imputed profit-making value was not a real value; instead, it was an artificial construct based on the profits a company actually realized during the relevant period. Thus, in a substance-over-form analysis, the windfall tax was nothing more than a tax on a company’s actual profits above a certain threshold.

CCH Comment: The fact that the windfall tax was based on a company’s actual, realized net income set it apart from (i) value-based taxes, such as U.S. estate and gift taxes, that consider past income for purposes of estimating future earning potential; and (ii) Reg. §1.901-2(b)(3)(ii) , Example 3, in which a noncreditable tax was based on imputed gross receipts rather than actual net income.

Predominant Character Test

In a concurring opinion, Justice Sotomayor agreed that the majority analysis was correct with respect to the companies that were subject to the tax for roughly four years after they were privatized. In contrast, when affected companies with other tax periods were considered, the windfall tax appeared to operate as a tax on average profits, which was much closer to a tax on value than it was to a tax on income or excess profits. However, since the government failed to make this argument, this was not an appropriate case for deciding whether the determination of a foreign tax’s predominant character should be based on how it applied to all, as opposed to most, affected taxpayers.

CCH Comment: The Court’s opinion resolved a conflict between the Third Circuit’s opinion and Entergy Corp. , CA-5, 2012-1 ustc¶50,386 .

Reversing CA-3, 2012-1 ustc ¶50,115 .

PPL Corp., SCt, 2013-1 ustc ¶50,335

Congress

Small Business Tax Reform. The Small Business and Pass-Through Entity Tax Reform Discussion Draft proposed by House Ways and Means Committee Chairman Dave Camp, R-Mich., won approval from tax experts testifying before the House Subcommittee on Select Revenue Measures on May 15 (TAXDAY, 2013/05/16, C.1 ). Witness suggested changes to the draft, including expanding cash accounting to more small businesses and allowing a safe harbor for inventory tracking. Lawmakers heard opposing views of the proposal to shift to a unified regime for pass-through entities.

IRS Tax-Exempt Controversy. On May 17, Treasury Inspector General for Tax Administration (TIGTA) J. Russell George testified before the Ways and Means Committee regarding the TIGTA report concerning oversight by the IRS of groups that apply for tax-exempt status (TAXDAY, 2013/05/20, C.1 ). The report found that the IRS used inappropriate criteria, based on names and policy positions, to identify specific groups applying for tax-exempt status (Reference No. 2013-10-053 ; TAXDAY, 2013/05/16, T.1 ).

IRS

Oversight Board. The IRS Oversight Board issued a statement in response to the TIGTA report (TAXDAY, 2013/05/17, I.3 ). ”The use of inappropriate criteria to identify organizations applying for tax-exempt status indicates, in the Board’s opinion, a breakdown in the business processing system of the IRS,” the Oversight Board said. In related news, President Obama also called for accountability in the IRS (TAXDAY, 2013/05/14, I.1 ).

New Acting IRS Commissioner. President Obama announced on May 16 the appointment of Werfel as IRS acting commissioner, effective Wednesday, May 22 (TAXDAY, 2013/05/17, W.1 ). The appointment follows Miller’s resignation in the wake of intense pressure focused on the Service’s improper targeting of conservative political groups that were seeking nonprofit status (TAXDAY, 2013/05/15, I.5 ).

IRS Furlough Days. The IRS will be closed on May 24, June 14, July 5, July 22 and August 30, 2013. On those days, no IRS offices will be operating, IRS employees will be furloughed without pay, no tax returns will be processed and no compliance-related activities will take place (IR-2013-51 ; TAXDAY, 2013/05/16, I.4 ). However, taxpayers should continue to file their returns and pay any taxes due, and the Electronic Federal Tax Payment System (EFTPS) will operate as usual.

June 2013 AFRs. The IRS has provided various prescribed applicable federal rates (AFRs) for federal income tax purposes for June 2013 (Rev. Rul. 2013-12 ; TAXDAY, 2013/05/20, I.1).

RTRP Test Fees. Fee amounts collected for scheduled registered tax return preparer (RTRP) test appointments that were canceled due to the court-ordered injunction are being refunded (TAXDAY, 2013/05/17, I.4 ). Also being refunded are fees collected from return preparers who tested on or after January 18, 2013, the date the test was enjoined.

RTRP Regulations. Karen Hawkins, director of the IRS Office of Professional Responsibility (OPR), spoke in favor of the IRS’s authority to regulate unenrolled tax return preparers, which the IRS has designated as RTRPs (TAXDAY, 2013/05/15, I.5 ). Hawkins believes that the U.S. district court’s decision in S. Loving, DC D.C., 2013-1 ustc ¶50,156 (TAXDAY, 2013/01/22, J.3 ) is incorrect.

Illinois Disaster Relief. Victims of severe storms, straight-line winds and flooding that began on April 16 , in parts of Illinois may qualify for filing relief from the IRS (IL-2013-28 ; TAXDAY, 2013/05/16, I.3 ). The president has declared the counties of Cook, DeKalb, DuPage, Fulton, Grundy, Kane, Kendall, Lake, LaSalle, McHenry and Will as federal disaster areas.

Carbon Dioxide Capture Credit. The IRS has released the 2013 inflation adjustment factor for the carbon dioxide (CO2) capture credit (Notice 2013-34 ; TAXDAY, 2013/05/15, I.1 ). The 2013 inflation-adjusted credit applies to the amount of qualified CO2 captured by a taxpayer at a qualified facility and disposed of in secure geological storage.

Medical Loss Ratio Rules. The IRS has issued proposed regulations that provide guidance to Blue Cross and Blue Shield organizations, and certain other health care organizations, on computing and applying the medical loss ratio added to tax code by the Patient Protection and Affordable Care Act (P.L. 111-148 ) (NPRM REG-126633-12 ; TAXDAY, 2013/05/13, I.1). The regulations are proposed to apply to tax years beginning after December 31, 2013.

Criminal Investigations 2012 Report. IRS Criminal Investigations (CI) has released its annual report for fiscal year 2012, highlighting gains in enforcement actions and penalties imposed on convicted tax criminals (IR-2013-50 ; TAXDAY, 2013/05/13, I.4 ). The 28-page report summarizes a wide variety of CI activity on a range of tax related issues during the year ending September 30, 2012.

Schedules M-1 and M-3. The IRS has announced on its website that corporations and partnerships with $10 million to $50 million in total assets at the end of the tax year will be permitted to file Schedule M-1 for tax years ending after December 31, 2014, rather than Schedule M-3, Parts II and III. Part I, lines 1-12 will continue to be required of these taxpayers (TAXDAY, 2013/05/13, I.5 ).

Code Sec. 336(e) Regulations. The IRS released final regulations allowing an election to treat the sale, exchange or distribution of at least 80 percent of the voting power and value of the stock of a target corporation as a sale of all of the target’s underlying assets (T.D. 9619 ;TAXDAY, 2013/05/13, I.6 ). The regulations provide the terms and conditions for making such an election and the consequences of the election.

By Stephen K. Cooper and Jennifer J. Rodibaugh, CCH News Staff

“Was the IRS using inappropriate criteria in its review of organizations applying for tax-exempt status? Yes. Was the IRS delaying their applications? Yes. And finally, did the IRS ask inappropriate and unnecessary questions of applicants? Again, yes,” George told outraged lawmakers. A TIGTA report (TAXDAY, 2013/05/16, T.1 ) on the examination ofCode Sec. 501(c)(4) organizations raised troubling questions about whether the IRS has effective management oversight and control, particularly in the exempt organizations function, he said.

Due to the unfair treatment of conservative groups seeking tax-exempt status, the public needs reassuring that the Service can administer tax laws fairly, lawmakers said. Miller accepted responsibility for the scandal surrounding the Service, and has already tendered his resignation to Treasury Secretary Jacob Lew (TAXDAY, 2013/05/16, I.5 ). Miller will be replaced by Daniel Werfel, White House Office of Management and Budget controller, effective May 22 (TAXDAY, 2013/05/17, W.1) .

“The affected organizations and the American public deserve better,” Miller said.”Partisanship or even the perception of partisanship has no place at the IRS. It cannot even appear to be a consideration in determining the tax exemption of an organization.” In response to questioning by lawmakers, Miller maintained that the IRS would take appropriate steps with the responsible employees, but he was unable to name specific individuals.

Ways and Means Chairman Dave Camp, R-Mich., criticized the Service for its actions and concluded that politically motivated employees represented a breach of American trust and a clear signal that the time for comprehensive tax reform has arrived. He said the problems at the IRS are indicative of problems in the entire tax system. ”It is rotten at the core, and it must be ripped out so we can start fresh. Only then will the American people get a tax system that treats them fairly and honestly, as they deserve,” Camp said.

Lawmakers were also outraged that Miller, former IRS Commissioner Douglas H. Shulman and Lois Lerner, director of the IRS Exempt Organizations Division, did not mention the targeting of conservative groups during testimony at any earlier committee hearings. ”I was the person last week who asked the question of Ms. Lerner as to whether or not the IRS (was) investigating political not-for-profit organizations,” said Rep. Joseph Crowley, D-N.Y.”And at that hearing, we were not given a proper—we were not given an answer.” Learner testified at the hearing on the Service’s Colleges and Universities Project on May 8 (TAXDAY, 2013/05/09, C.1 ).

Oversight Subcommittee Chairman Charles W. Boustany, Jr., R-La., asked why Miller had misled Congress by sending letters acknowledging the committee’s investigation into allegations of improper examinations, but consistently omitting that such discriminatory practices were actually taking place. ”Mr. Chairman, I did not mislead Congress nor the American people. I answered the questions as they were asked,” Miller responded. He told lawmakers’ questions were answered truthfully given what was known at the time, the corrective actions that were underway and the state of ongoing TIGTA investigations.

By Stephen K. Cooper, CCH News Staff

Ways and Means Press Release: Camp Opening Statement

Ways and Means Press Release: Levin Opening Statement

Opening Remarks of Acting Commissioner Steven T. Miller

TIGTA Testimony of J. Russell George

“Throughout his career working in both Democratic and Republican
administrations, Danny has proven an effective leader who serves with
professionalism, integrity and skill,” said Obama. “The American people deserve
to have the utmost confidence and trust in their government and, as we work to
get to the bottom of what happened and restore confidence in the IRS, Danny has
the experience and management ability necessary to lead the agency at this
important time.”

The White House said Werfel was chosen to lead efforts to ensure the IRS
implements new safeguards to restore public trust and administer the tax code
with “fairness and integrity.” He currently serves as Controller of the Office
of Management and Budget (OMB), where he has received praise for improving
federal program integrity, including all areas of financial management,
financial reporting, accounting standards, improper payments and financial
systems, among others, according to a White House statement.

Prior to his current role, Werfel served in multiple career civil service
capacities at the OMB, including as deputy controller, chief of the Financial
Integrity and Analysis Branch, budget examiner in the Education Branch, and
policy analyst in the Office of Information and Regulatory Affairs. He has also
served as a trial attorney in the Department of Justice’s Civil Rights Division.
Werfel has received both national and local awards from the Association of
Government Accountants for his contributions to federal financial management.
During the Bush administration, he was the recipient of the Presidential Rank
Award for Meritorious Service. He also served as a member of the Federal
Accounting Standards Advisory Board from 2006 to 2009.

By Jeff Carlson, CCH News Staff

Treasury Department News Release, TDNR JL-1948