MARCH 7, 2010 UPDATE
Gutter Chaves Josepher Rubin Forman Fleisher Law Firm
An Electronic Newsletter of Gutter Chaves Josepher Rubin Forman
Fleisher P.A.
Charles (Chuck) Rubin, Editor/Author (except as otherwise noted) ©
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CONTENTS OF THIS NEWSLETTER:
1. 2009 FBAR REPORTING RELIEF
2. INTEREST RATES FOR TAX OVERPAYMENTS AND UNDERPAYMENTS (APRIL 2010
QUARTER)
3. GUARANTIES ARE MORE AKIN TO SERVICES THAN INTEREST
4. SPRINGING INSURANCE COMES UNSPRUNG
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1. 2009 FBAR REPORTING RELIEF
Treasury Form TD F 90-22.1 (commonly known as the “FBAR”) is used by
taxpayers to report financial interests in, or signature authority
over, foreign accounts. Several official announcements have come out
recently that address some of the filing requirements. The form for
2009 filings is due by June 30, 2010.
A. DEFINITION OF U.S. FILERS. The definitions of U.S. person in the
2008 form instructions will not apply for 2009 filings. Instead, the
2000 form instructions will apply. Under the prior version of the
form, a U.S. person is defined as a (1) citizen or resident of the
U.S., (2) a domestic partnership, (3) a domestic corporation, or (4) a
domestic estate or trust.
B. FILINGS BY NON-U.S. PERSONS. The filing obligations for non-U.S.
persons are suspended for 2009.
C. SIGNATURE AUTHORITY ONLY. Persons with signature authority over,
but no financial interest in, a foreign financial account for which a
FBAR would otherwise have been due on June 30, 2010, will now have
until June 30, 2011, to report those foreign financial accounts.
D. COMMINGLED FUNDS. the IRS will not apply its enforcement authority
adversely to persons with a financial interest in, or signature
authority over, any foreign commingled fund other than mutual funds
with respect to that account for calendar year 2009 and earlier
calendar years.
E. COORDINATION WITH INCOME TAX RETURN DISCLOSURES. Taxpayers who are
exempt from filing an FBAR pursuant to the above rule modifications
are likewise permitted to not disclose those accounts on the foreign
account disclosures on their individual income tax return forms.
In addition to the above, the Treasury Department's Financial Crimes
Enforcement Network (FinCEN) has issued proposed regulations that will
revise the reporting rules. If finalized, the new rules will be
reflected in revised FBAR instructions. The new rules will revise the
definition of U.S. person, provide for various filing exemptions, and
provide expanded definitions of other statutory terms.
Announcement 2010-16; Notice 2010-23; DEPARTMENT OF THE TREASURY, 31
CFR Part 103, RIN 1506–AB08, Financial Crimes Enforcement Network;
Amendment to the Bank Secrecy Act Regulations—Reports of Foreign
Financial Accounts
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2. INTEREST RATES FOR TAX OVERPAYMENTS AND UNDERPAYMENTS (APRIL 2010
QUARTER)
The IRS has announced the interest rates for tax overpayments and
underpayments for the calendar quarter beginning April 1, 2010.
For noncorporate taxpayers, the rate for both underpayments and
overpayments will be 4% (unchanged).
For corporations, the overpayment rate will be 3% (unchanged).
Corporations will receive 1.5% (unchanged) for overpayments exceeding
$10,000. The underpayment rate for corporations will be 4%
(unchanged), but will be 6% (unchanged) for large corporate
underpayments.
Rev. Rul. 2010-9
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3. GUARANTIES ARE MORE AKIN TO SERVICES THAN INTEREST
Code Section 881(a) imposes a 30% withholding tax on non-U.S.
corporations receiving fixed or determinable, annual or periodic
(FDAP) income from U.S. sources (subject to reduction under applicable
treaties). Does this tax apply to a guaranty fee paid by a U.S.
corporation to a Mexico corporation? The Tax Court recently struggled
with this issue in a decision that plumbed the depths of the concepts
relating to FDAP taxation.
To be taxable, the guaranty fees would need to be (a) FDAP income, and
(b) U.S. source. The parties conceded that the fees were FDAP, so the
real issue was U.S. vs. foreign source.
The IRS argued that the fees are akin to the payment of interest,
which are sourced to the location of the payor (here, the U.S.). The
court noted that “interest” is compensation for the use or forbearance
of money. It found that a guaranty is not a loan, and thus the
interest sourcing rules do not apply.
The taxpayer argued that the Mexico corporation was performing a
service. Services are sourced where they are performed, which the
taxpayer further asserted occurred where the corporation is located –
here, Mexico.
The court looked at Section 482 precedents. It looked at case law
under Section 83. It could not find any precedent that clearly
answered the question whether fees should be sourced as interest or
services.
Thus, since there was no direct conclusion that the fees were either
interest or services, the court was left with the task of analogizing
to one or the other, to find the closest match.
The court examined other situations where it had applied the sourcing
rules “by analogy,” including past efforts to source alimony, and
commissions for issuing letters of credit. These areas were not
helpful The court ultimately framed the goal of sourcing by analogy as
“find[ing] the location of the business activities generating the
income or *** the place where the income was produced.” The business
activities supporting the guaranty were the Mexico assets and Mexico
management of the guarantor. This led the court to conclude that the
fees were more akin to services than interest, and that the fees were
foreign source income not subject to the 30% tax.
Clearly, the court could have gone either way on this issue. The
court’s detailed and principled analysis of the issue makes for
interesting reading.
Container Corporation v. Commissioner, 134 T.C. No. 5 (2010)
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4. SPRINGING INSURANCE COMES UNSPRUNG
For awhile, “springing” insurance was a popular method of avoiding tax
on IRA and qualified retirement plan assets. A recent case hammered
the taxpayer who entered into such an arrangement.
While there are variations, the typical arrangement involved the
creation of a pension plan in a closely-held entity, which received a
roll-over distribution from the taxpayer’s IRA. The plan would then
purchase a substantial life insurance policy. A feature of the policy
would be that the insurance company would receive a substantial
surrender charge if the policy was surrendered. The policy would then
be sold to an insurance trust established by the taxpayer, removing
the policy from the pension plan. The insurance trust would be buying
the policy at a substantial discount in price – getting the insurance
out of the pension plan at a reduced cost, and thus moving assets out
of the plan without incurring an income tax. The insurance trust would
often then convert the policy to one that did not have the surrender
charge feature.
The taxpayer justified the sale of the policy at a reduced price by
reducing the value of the policy by the potential surrender charge.
For example, if the policy was purchased for $1.3 million and had a
cash surrender value of $1.3 million and a $1 million surrender charge
applied, the policy would be sold for the net $300,000 value. The
“springing” part of the plan comes about when the policy is converted
by the insurance trust to one that allows more direct access to the
$1.3 million value without the surrender charge – thus springing the
value back up.
The planning makes sense in theory. However, as one would expect, the
IRS was not pleased with the technique. The Tax Court has now accepted
the IRS’ theory that the value of the policy should be determined
without reduction for the surrender value. Thus, the taxpayer in the
case was deemed to have received about $1 million in taxable income
attributable to the discount taken on the insurance policy that was
sold that was attributable to the surrender charge on the policy.
Subsequent to the time that the above transaction was entered into,
the IRS issued Rev.Proc. 2005-25, which provided guidance on how to
value life insurance policies for these and other purposes. The
Revenue Procedure allowed for safe-harbor reductions in value due to
surrender charges, but capped the aggregate reduction at 30% of the
value. However, the Procedure did not bless springing values, per
several restrictions included in the Procedure, including:
a. Allowing a reduction for surrender charges, “but only if those
charges are actually charged on or before the valuation date and those
charges are not expected to be refunded, rebated, or otherwise
reversed at a later date;”
b. Not allowing a reduction for charges, “if a mortality charge or
other amount charged under a contract can be expected to be directly
or indirectly returned to the contractholder (whether through the
contract, a supplemental agreement, or under a verbal understanding
and regardless of whether there is a guarantee);”
c. Allowing for a challenge in other potentially abusive situations,
including situations where the contract is sold if not in force “for
some time” (whatever that means). In particular, the Procedure reads:
“In addition, a surrender charge cannot be taken into account in
determining an average surrender factor if it may be waived or
otherwise avoided or was created for purposes of the transfer or
distribution. Furthermore, at no time are these rules to be
interpreted in a manner that allows the use of these formulas to
understate the fair market value of the life insurance contracts and
associated distributions or transfers. For example, if the insurance
contract has not been in force for some time, the value of the
contract is best established through the sale of the particular
insurance contract by the insurance company (i.e., as the premiums
paid for that contract).”
The IRS also issued new Regulations in 2005 that provide valuation
methodologies that the IRS can attempt to use to challenge springing
value arrangements.
I don’t know how many other similar cases are pending with the
Service, but the Tax Court’s determination, does not bode well for the
taxpayers in those cases.
Karl L. Matthies, et ux. v. Commissioner, 134 T.C. No. 6 (2010)
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