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IRS Updates Ruling Policy on Corporate Business Purpose and Device Requirements under Section 355

The U.S. Internal Revenue Service (“IRS”) released Revenue Procedure 2016-45 (the “Revenue Procedure”) on August 26, 2016, permitting taxpayers once again to seek private letter rulings on issues of “corporate business purpose” and “device” under Section 355 of the U.S. Internal Revenue Code of 1986, as amended (dealing with tax-free spin-offs and related transactions). The corporate business purpose and device requirements under Section 355 have long been matters on which the IRS has preemptively declined to issue letter rulings or determination letters (these are commonly referred to as “no-rule” areas, the full list of which is reissued annually; see, e.g., Rev. Proc. 2016-3). The Revenue Procedure states that the IRS has determined that there are a number of unresolved legal issues relating to the corporate business purpose and device requirements that may be germane to determining the tax consequences of a transaction. As a result, the IRS will consider ruling requests, dated on or after August 26, 2016, related to the corporate business purpose and device requirements, subject to the overall standard requiring that the request present a “significant issue” and the general latitude of the IRS not to rule if, in their view, the facts and circumstances so warrant.

By removing these issues from the no-rule list, the IRS offers corporations considering a tax-free spin-off the possibility of significantly greater comfort on the U.S. federal income tax treatment of the transaction. The change in position may also reflect recognition by the IRS that while existing published and non-published guidance on corporate business purpose and device addresses many open issues in respect of these requirements of Section 355, significant issues remain that may merit seeking an IRS determination before a transaction proceeds.

The removal of corporate business purpose and device from the no-rule list follows on the heels of the July issuance of proposed regulations under Section 355 addressing the “device” and “active trade or business” requirements of Section 355. Notably, the Revenue Procedure does not specifically discuss whether questions about the application or interpretation of the new proposed regulations relating to device are amenable to ruling requests (indeed, the Revenue Procedure does not mention these proposed regulations at all). Click here for our client alert on the proposed regulations on “device” and “active trade or business”.

A brief background on private letter rulings and no-rule areas under Section 355 follows.

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IRS Eliminates Requirement to Submit Copy of Section 83(b) Elections with Tax Return

The IRS adopted final regulations that no longer require taxpayers who have made Internal Revenue Code §83(b) elections to attach a copy of the election to their annual federal income tax return.

Under §83, restricted stock granted in connection with the performance of services generally becomes taxable as ordinary income compensation when it is no longer subject to a substantial risk of forfeiture and is freely transferable. Section 83(b) and Treasury Regulation §1.83-2(a) permit a taxpayer who has received compensatory restricted stock or other property subject to a substantial risk of forfeiture to make a special election to include in gross income in the year of receipt, any excess of the fair market value of the property at the time of transfer over the amount (if any) paid for the property. Making such an election “closes” the compensation element of the grant, and therefore, future vesting would not be taxable and future sale or transfer generally would generate capital gains and not ordinary income.

In accordance with Treas. Reg. §1.83-2(c), the taxpayer must file a written statement of the election with the IRS no later than 30 days after the date of transfer. In the past, the taxpayer was also required to attach and submit a copy of the §83(b) election with the taxpayer’s income tax return for the year in which the property was granted.

In late July, the IRS released final regulations to amend Treas. Regs. §1.83-2(c) to no longer require taxpayers to submit a copy of the written statement of election with their income tax return covering the year of transfer. In the preamble to the proposed regulations, the IRS explained that the submission of the copy of the election was no longer necessary, given that IRS personnel electronically scan the first filing of the election statement, and acknowledged that most commercial tax preparation software does not permit electronic submission of a copy of an §83(b) election.

The final regulations apply to property transferred on or after January 1, 2016. For property transferred on or after January 1, 2015, taxpayers are permitted to rely on the proposed regulations, which were adopted without change.

Taxpayers remain subject to general recordkeeping obligations when making §83(b) elections, and should continue to use certified mail, return receipt requested, to have proof of timely filing, and to keep copies of their elections and receipts in a safe place for the duration of the statute of limitations.

Proposed Regulations Under Section 355 Clarify Device and Active Trade or Business Requirements for Spin-offs

The U.S. Internal Revenue Service (IRS) and the Department of the Treasury (“Treasury”) have published proposed regulations that would modify the device and active trade or business requirements for tax-free spin-offs under section 355 of the Code in three important respects.

First, the proposed regulations clarify the “device” test and its relationship to the “business purpose” requirement. Second, the proposed regulations would prohibit a tax-free spin-off if (1) two-thirds or more of the assets of the distributing corporation or the controlled corporation consist of nonbusiness assets and (2) the percentage of the distributing corporation’s nonbusiness assets differs significantly from those of controlled, under three specified tests. Third, the proposed regulations would require that the assets constituting an active trade or business must represent at least 5% of the total assets of the distributing corporation and the distributed corporation in order for the spin-off to be tax-free. Thus, the proposed regulations would effectively repeal the so-called “hot dog stand” rule, under which a de minimis active trade or business could support a spin-off of a relatively much larger collection of passive assets.

If promulgated as proposed, the proposed regulations will affect distributing corporations and their shareholders and security holders in spin-offs, split-offs, and split-ups that occur on or after final regulations are published.

For more on this topic, please see our client alert here.

IRS Proposes Modifications to Proposed Income Inclusion Regulations under Section 409A

In general, proposed rulemaking issued in December 2008 with respect to income inclusion under Section 409A of the Internal Revenue Code of 1986, as amended (available here) provides that if there is a Section 409A violation in a taxable year, all compensation deferred under the applicable nonqualified deferred compensation arrangement for that taxable year and all preceding years is includible in the service provider’s gross income to the extent not subject to a substantial risk of forfeiture (i.e., vested) and not previously included in gross income in a prior taxable year. Although the proposed income inclusion regulations appear to permit the correction of certain plan provisions that do not comply with Section 409A without penalty as long as the underlying amounts are unvested, they include certain anti-abuse provisions intended to prevent impermissible changes in the time or form of payment. Continue Reading

Proposed Section 409A Regulations Would Clarify Separation from Service Analysis in Connection with Change in Status From Employee to Independent Contractor

Pursuant to the final regulations under Section 409A of the Internal Revenue Code of 1986, as amended, a termination of employment generally occurs at such time as the employer and employee reasonably anticipate that the level of services to be performed after such time, whether as an employee or an independent contractor, would permanently decrease to no more than 20% of the average level of services performed over the immediately preceding 36-month period (or, if services were performed for less than 36 months, over the full period of services). Further, an independent contractor has a separation from service when there is a good faith and complete termination of the underlying contractual relationship. Continue Reading

IRS Releases Proposed Regulations To Clarify Section 409A Provisions

The Internal Revenue Service (IRS) recently issued proposed Treasury Regulations (available here) that would clarify certain provisions of the final regulations under Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). The proposed regulations also would expand the anti-abuse provisions of proposed rulemaking issued in December 2008 with respect to income inclusion under Code Section 409A (available here). The IRS simultaneously released new proposed Treasury Regulations under Code Section 457, which you can read about in our Client Alert available here.

The proposed regulations under Section 409A are subject to a 90-day comment period ending September 20, 2016, and would become applicable on or after the date of publication in the Federal Register as final rules. While not effective until adopted in final form, proposed regulations may be relied on immediately.

The proposed regulations touch upon a variety of distinct issues under Section 409A. In general, the guidance from the proposed regulations is consistent with how we have interpreted and analyzed the underlying Section 409A requirements. We will be posting a series of blog entries on the proposed rules over the upcoming weeks, with specific analysis and explanations of their individual components.

SEC Approves New Nasdaq Rule 5250(b): Disclosure of “Golden Leash” Arrangements

The SEC recently released an order (available here) approving new Nasdaq listing standard 5250(b)(3), which will require a public issuer to disclose cash and non-cash remuneration (e.g., health insurance, indemnification) that a third party has agreed to pay a director on (or director nominee for) the issuer’s board of directors. These are often referred to as “golden leash” arrangements. The new disclosure requirement includes an exception for pre-existing compensation arrangements. Thus, if a fund manager, consultant, or other “friend of the fund” serves on the board of a public portfolio company, the company need only disclose any incremental additional compensation promised by the fund that is directly related to that board service. With some exceptions, the disclosure must be made on the company’s website or in its next proxy statement prepared for a shareholders meeting at which directors are elected. The disclosure must be repeated annually until the director’s departure from the board, or until one year after the termination of the arrangements. Public issuers will need to establish processes for collecting relevant information from its directors. The new listing standard will be effective 30 days after its publication in the Federal Register – thus it should be effective in August of 2016.

Please feel free to contact the author of this post or your regular Proskauer contact if you have any questions on this topic.