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Dahlia Ali focuses her practice on US and international tax matters. Read Dahlia Ali's full bio.

As we previously discussed, the US Department of the Treasury (Treasury) announced a plan in October 2017 to repeal more than 200 regulations. The plan appears is moving forward based on remarks by Acting Chief Counsel William M. Paul earlier this week at the New York State Bar Association Section meeting that the Internal Revenue Service will soon propose 200 – 300 tax regulations (including longstanding temporary and proposed regulations) for withdrawal as part of President Donald Trump’s 2017 executive order creating a Treasury Regulatory Reform Task Force. Practitioners will have the opportunity to comment before the regulations are withdrawn.

Practice Point: Comments from taxpayers and practitioners will be instrumental in ensuring that seemingly obsolete regulations do not still have effect in other areas or negatively impact tax reporting positions. We will continue to monitor Treasury’s plan and provide more information once the proposal is released.

In two recent cases, the United States Tax Court (Tax Court) has explored the bounds of the anonymity protection afforded to potential whistleblowers under the court’s rules and other authorities. Tax Court Rule 345 relates to privacy protections for filings in whistleblower actions.  Under paragraph (a), a whistleblower may move the court for permission to proceed anonymously.  In order to proceed anonymously, the whistleblower must provide a sufficient, fact-specific basis for anonymity.  Specifically, the Tax Court has held that “[a] whistleblower is permitted to proceed anonymously if the whistleblower presents a sufficient showing of harm that outweighs counterbalancing societal interest in knowing the whistleblower’s identity.”  (Whistleblower 10949-13W v. Commissioner, T.C. Memo 2014-94, at 5).  However, the balance of harm to societal interest may shift as the case progresses, thereby justifying disclosure after anonymity has been granted.  See Tax Court Rule 345(b). Continue Reading Tax Court Requires Specific Factual Showing of Harm for Whistleblower Anonymity

A frequently disputed tax issue is the proper treatment of costs incurred by taxpayers and whether they are currently deductible or must be capitalized. Internal Revenue Code (Code) Section 162 generally provides a deduction for ordinary and necessary business expenses paid or incurred during the taxable year in carrying on any trade or business. However, Code Section 263 provides no deduction for any amount paid for permanent improvements made to increase the value of any property. Code Section 263 requires capitalization of, amongst other things, costs paid or incurred to facilitate the acquisition of a trade or business. The capitalization rules of Code Section 263 trump the deductibility rules of Code Section 162. Continue Reading IRS Provides New Guidance on Ordinary Versus Capital Issue

Two petitions for certiorari pending before the Supreme Court of the United States ask the Court to resolve the question of whether a tax return filed after an assessment by the Internal Revenue Service (IRS) is a “return” for purposes of the Bankruptcy Code (BC). The answer to this question will determine whether a bankrupt taxpayer’s tax debts can be discharged or are permanently barred from discharge. According to these petitions, the courts of appeal are divided as to the answer.

BC § 523(a) generally allows a debtor to discharge unsecured debt, except for, inter alia, tax debts of debtors who: (1) failed to file tax returns; (2) filed fraudulent tax returns; or (3) filed late tax returns, where a bankruptcy petition is filed within two years of the date the late return was filed. See BC § 523(a)(1)(B)(i), (B)(ii), (C).

Continue Reading IRS Opposes Granting of Certiorari in Cases Addressing Definition of Return

Termination fee clauses are commonly incorporated in merger agreements to compensate a party for time and expenses incurred in the event that the deal is not consummated. Where the merger is terminated by one party, the clause generally requires either the target to pay the acquirer a termination fee (if the target terminates), or the acquirer to pay the target a reverse termination fee (if the acquirer terminates). Typically, termination fees range from 1–3 percent of the transaction value, which may result in a cash payment in the billions of dollars depending on the size of the transaction. The tax treatment of termination fees, both in terms of deductibility or income inclusion and the character of the fee as either ordinary or capital, has been the subject of past litigation, Internal Revenue Service (IRS) regulatory action, and informal IRS advice.

Internal Revenue Code (Code) Section 165 allows a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 162 provides deductions for ordinary and necessary business expenses paid or incurred during the taxable year. In contrast, Code Section 263 provides generally that a deduction is not allowed for new buildings or for permanent improvements or betterments made to increase the value of any property of estate. Prior to the promulgation of the INDOPCO regulations, litigation ensued over whether the payor of a termination fee could deduct such payment under Code Sections 162 or 165 or had to capitalize the payment under Code Section 263. In 2003, the IRS promulgated the INDOPCO regulations and specifically addressed the situations under which termination fees could be deducted immediately. For more background on this subject, see here.

The above-referenced litigation and the INDOPCO regulations focused on the deductible versus capital issue and did not address the character a termination fee (either paid or received). However, informal IRS guidance treated termination fees as liquidated damages, and thus ordinary income, arguably because the taxpayer had not sold, exchanged or transferred any capital asset. See, e.g., Private Letter Ruling 200823012 (June 6, 2008), available here and Tech. Adv. Memo. 200438038 (Sept. 17, 2004), available here. In the Private Letter Ruling, the IRS held that Code Section 1234A, which provides that gain or loss attributable to the cancellation, lapse, expiration or other termination of a right or obligation with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer is treated as gain or loss from the sale of a capital asset, did not apply. However, in, recent guidance released in September and October of this year available here and here the IRS reversed course and provided that Code Section 1234A applies to termination fees pursuant to merger agreements. The IRS’s new position is that a target’s stock to which the termination fee relates would have been a capital asset in the hands of an acquirer, had the deal been completed, and that the acquisition agreement provides rights and imposed obligations on both parties as to the target’s stock, therefore making section 1234A applicable and requiring capital treatment.

The tax treatment of termination fees, both from a standpoint of current deductibility versus capitalization and the nature of the fees, is a significant issue for affected taxpayers. It remains to be seen whether taxpayers will challenge either the INDOPCO regulations, which overrule prior judicial precedent, or the recent IRS guidance applying Code Section 1234A. Taxpayers facing either of these situations need to carefully consider how best to report transactions involving termination fees and be prepared to argue their position during audit if the IRS believes such position is contrary to the agency’s current positions. Taxpayers may also want to consider whether to formally disclose their positions, such as on Form 8725 or Form 8275-R, to protect against any potential penalties that the IRS may assert.