Archive for Andrew Mirisis

IRS: Basis Adjustments Apply To CFC Mid-Year Distributions To Prevent Section 961(b)(2) Gain

PLR 202304008: Taxpayer Does Not Have Section 961(b)(2) Gain for Mid-Year Distributions Introduction to Section 961 and Mid-Year Distributions For years, there has been a longstanding question under the subpart F rules on whether a controlled foreign corporation’s (“CFC”) mid-year earnings could be taken into account in determining section 961 basis adjustments with respect to a mid-year distribution of current year earnings to a U.S. shareholder. If a CFC distributed earnings in excess of its U.S. shareholder’s section 961(a) basis in the CFC, the distribution would trigger gain under section 961(b)(2). As a result, U.S. parented groups with CFCs were limited in the amount of current year earnings that could be distributed to avoid triggering non-economic section 961(b)(2) gain as a result of basis adjustments. In PLR 202304008, the IRS confirmed that, at least in the case of the taxpayer that submitted the PLR, mid-year earnings could be taken into account when determining a section 961(b) basis reduction. The ruling is consistent with how many international tax practitioners viewed these rules. Below, we discuss the basics of section 961 as well as the facts and ruling of PLR 202304008. Section 961 Basis Adjustments In a U.S. parented group with CFCs, the rules under sections 951-965 (i.e., subpart F), require each U.S. shareholder of a CFC to currently include in income its pro rata share of the CFC’s subpart F income for the tax year. Thus, when a CFC generates earnings, the U.S. shareholder of that CFC must include its pro rata share of such amounts in income. A related and important component of these rules is that under section 961(a), a U.S. shareholder is required to increase its basis in the stock of the CFC by the amount that the U.S. shareholder is required to include in income under section 951(a) with respect to such CFC stock. Similarly, under section 961(b), if a U.S. shareholder receives an amount which is excluded from gross income under section 959(a) (i.e., previously taxed earnings and profits (“PTEP”)), the U.S. shareholder is required to reduce its adjusted basis in the stock of the CFC. Typically, this involves a distribution of PTEP. Moreover, under section 961(b)(2), if an amount that is excluded under section 959(a) exceeds the adjusted basis of the stock with respect to which it is received, the amount is treated as gain from the sale or exchange of property. In other words, if the U.S. shareholder receives a distribution that is in excess of its section 961(a) basis in the CFC, the U.S. shareholder must recognize gain as if it had sold the stock of the CFC. A common issue interpreting these rules is that they do not specify the timing of when current year earnings should be taken into account for purposes of section 961 basis adjustments. Thus, even if a CFC had current year earnings that were in excess of its basis, if the CFC made a mid-year distribution to its shareholder, it could trigger non-economic section 961(b)(2) gain since those current year earnings had not yet been taken into account. Generally, practitioners believed that current year earnings were only taken into account when the subpart F inclusion accrued at the end of the tax year. In PLR 202304008, the IRS confirmed that current year earnings are taken into account for purposes of determining section 961 basis adjustments for mid-year distributions. PLR 202304008 – Current Year Earnings are Taken Into Account For Section 961 Basis Adjustments Resulting from Mid-Year Distributions On January 27, 2023, the IRS released PLR 202304008. The facts of the PLR were that U.S. parent owns U.S. shareholder, which in turn, owns CFC1. U.S. parent causes CFC1 to distribute cash to U.S. shareholder before the last day of the tax year (Year 2). All of the entities use the calendar year as their taxable year. CFC1 only has one class of stock outstanding, all of which is owned by U.S. shareholder. Additionally, the taxpayer represented that U.S. parent and U.S. shareholder will compute and report its Year 2 consolidated taxable income in accordance with all applicable rules, including keeping, maintaining and making adjustments to its and its affiliate PTEP accounts under Notice 2019-01. The taxpayer also represented that U.S. shareholder will include in its gross income its pro rata share of CFC1’s subpart F income for Year 2 and its GILTI inclusion amount ((within the meaning of Treas. Reg. §§ 1.951A-1(c)(1) and 1.1502-51). Moreover, the taxpayer represented that all or a portion of the distribution will be excluded from U.S. shareholder’s gross income under section 959(a). Other than the distribution, CFC1 will not have any actual or deemed distributions in Year 2 on or before the date of the distribution. Finally, the taxpayer represented that for one or more shares of CFC1 stock, the adjusted basis of the share at the time of the distribution and without regard to the section 961(a) basis increase will be less than the amount by which the adjusted basis of the share would be reduced under section 961(b)(1) as a result of the distribution. Based on those facts and representations, the IRS ruled that for purposes of determining a section 961(b) basis reduction with respect to the mid-year distribution of current year earnings from CFC1 to its U.S. shareholder, the U.S. shareholder can first increase its basis in the CFC1 stock under section 961(a) for current year subpart F and GILTI amounts that the U.S. shareholder will include in gross income at the end of its taxable year. Accordingly, a U.S. shareholder in this position would no longer trigger non-economic section 961(b)(2) gain on the sale or exchange of stock of CFC1. Observations – Will Section 961 Basis Adjustments For Mid-Year Distributions Apply to All Taxpayers? PLR 202304008 is helpful guidance that appears to answer a longstanding question about the timing mismatch between mid-year distributions and when section 961 basis adjustments should occur with respect to CFC income inclusions to avoid section 961(b)(2) gain. As noted above, taxpayers in this position were often stuck limiting the amount of the mid-year distribution to the amount of the section 961(a) basis existing at the start of the tax year (unadjusted by current year subpart F and GILTI amounts) to avoid recognizing section 961(b)(2) gain. It remains to be seen whether the forthcoming PTEP regulations will adopt this ruling for all taxpayers, but it may be a signal of what is to come. The PTEP regulations are expected to be released sometime in 2023 and will likely address this issue.

PLR 202304008: Taxpayer Does Not Have Section 961(b)(2) Gain for Mid-Year Distributions

Introduction to Section 961 and Mid-Year Distributions

For years, there has been a longstanding question under the subpart F rules on whether a controlled foreign corporation’s (“CFC”) mid-year earnings could be taken into account in determining section 961 basis adjustments with respect to a mid-year distribution of current year earnings to a U.S. shareholder. If a CFC distributed earnings in excess of its U.S. shareholder’s section 961(a) basis in the CFC, the distribution would trigger gain under section 961(b)(2). As a result, U.S. parented groups with CFCs were limited in the amount of current year earnings that could be distributed to avoid triggering non-economic section 961(b)(2) gain as a result of basis adjustments. In PLR 202304008, the IRS confirmed that, at least in the case of the taxpayer that submitted the PLR, mid-year earnings could be taken into account when determining a section 961(b) basis reduction. The ruling is consistent with how many international tax practitioners viewed these rules. Below, we discuss the basics of section 961 as well as the facts and ruling of PLR 202304008.

Section 961 Basis Adjustments
In a U.S. parented group with CFCs, the rules under sections 951-965 (i.e., subpart F), require each U.S. shareholder of a CFC to currently include in income its pro rata share of the CFC’s subpart F income for the tax year. Thus, when a CFC generates earnings, the U.S. shareholder of that CFC must include its pro rata share of such amounts in income. A related and important component of these rules is that under section 961(a), a U.S. shareholder is required to increase its basis in the stock of the CFC by the amount that the U.S. shareholder is required to include in income under section 951(a) with respect to such CFC stock. Similarly, under section 961(b), if a U.S. shareholder receives an amount which is excluded from gross income under section 959(a) (i.e., previously taxed earnings and profits (“PTEP”)), the U.S. shareholder is required to reduce its adjusted basis in the stock of the CFC. Typically, this involves a distribution of PTEP.
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IRS: Basis Adjustments Apply To CFC Mid-Year Distributions To Prevent Section 961(b)(2) Gain

IRS: Basis Adjustments Apply To CFC Mid-Year Distributions To Prevent Section 961(b)(2) Gain

PLR 202304008: Taxpayer Does Not Have Section 961(b)(2) Gain for Mid-Year Distributions

Introduction to Section 961 and Mid-Year Distributions

For years, there has been a longstanding question under the subpart F rules on whether a controlled foreign corporation’s (“CFC”) mid-year earnings could be taken into account in determining section 961 basis adjustments with respect to a mid-year distribution of current year earnings to a U.S. shareholder. If a CFC distributed earnings in excess of its U.S. shareholder’s section 961(a) basis in the CFC, the distribution would trigger gain under section 961(b)(2). As a result, U.S. parented groups with CFCs were limited in the amount of current year earnings that could be distributed to avoid triggering non-economic section 961(b)(2) gain as a result of basis adjustments. In PLR 202304008, the IRS confirmed that, at least in the case of the taxpayer that submitted the PLR, mid-year earnings could be taken into account when determining a section 961(b) basis reduction. The ruling is consistent with how many international tax practitioners viewed these rules. Below, we discuss the basics of section 961 as well as the facts and ruling of PLR 202304008.

Section 961 Basis Adjustments
In a U.S. parented group with CFCs, the rules under sections 951-965 (i.e., subpart F), require each U.S. shareholder of a CFC to currently include in income its pro rata share of the CFC’s subpart F income for the tax year. Thus, when a CFC generates earnings, the U.S. shareholder of that CFC must include its pro rata share of such amounts in income. A related and important component of these rules is that under section 961(a), a U.S. shareholder is required to increase its basis in the stock of the CFC by the amount that the U.S. shareholder is required to include in income under section 951(a) with respect to such CFC stock. Similarly, under section 961(b), if a U.S. shareholder receives an amount which is excluded from gross income under section 959(a) (i.e., previously taxed earnings and profits (“PTEP”)), the U.S. shareholder is required to reduce its adjusted basis in the stock of the CFC. Typically, this involves a distribution of PTEP.
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Written by | Posted in Controlled Foreign Corporation • Section 961 • Section 961(b)(2) Gain • Subpart F

Monetized Installment Sales Make The IRS’s “Dirty Dozen” List for the Second Straight Year

Monetized Installment Sales Make The IRS’s “Dirty Dozen” List for the Second Straight Year

Introduction
The IRS has for the second time in as many years included monetized installment sales on its annual “Dirty Dozen” tax schemes list. As we discussed in a prior post, the “Dirty Dozen” list alerts taxpayers and practitioners to certain transactions or arrangements that the IRS considers potentially abusive tax arrangements that taxpayers should avoid.[1] Generally, the “Dirty Dozen” list includes transactions that are heavily promoted and that will likely attract IRS enforcement and compliance efforts in the future. The IRS warned taxpayers to beware of, and avoid, advertised schemes, many of which are promoted online, that promise tax savings that are “too good to be true” and that will likely put taxpayers in jeopardy. The purported tax benefits that promoters offer from a monetized installment sale have clearly drawn the IRS’s attention. Generally, these tax arrangements allow taxpayers to sell appreciated property but defer the corresponding tax (typically many years later) when seller receives one or more payments, relying, in part, on the installment sale rules in section 453.

The inclusion of monetized installment sales on the “Dirty Dozen” tax list follows on the heels of CCA 2021180016[2] where the IRS explained six reasons why these transactions are problematic. The CCA also explained why the promoters’ basis for how the transactions purportedly achieve the desired tax consequences, is flawed. Promoters of monetized installment sales often rely on a 2012 IRS Memorandum[3] as support for their position that monetized installment sales have been blessed by the IRS and are legitimate. As discussed below, the 2012 IRS Memorandum was issued in a different factual context and should not be viewed as support for the typical monetized installment sale structure. Taxpayers that are considering, or have engaged in, monetized installment sales, deferred sales trusts, or similar transactions, should consult with an independent tax professional to carefully review the underlying legal requirements and technical analysis on which such arrangements are based.

The Generic Monetized Installment Sale
Promoters market monetized installment sales as a strategy to receive all of the proceeds from the sale of a highly appreciated asset in the year of the sale but defer paying the corresponding tax well into the future. In some cases, promoters are marketing a thirty-year deferral of the tax. If that sounds too good to be true, you are on the right path. If the transaction works as marketed, the promoter is selling an arrangement that takes advantage of the time-value of money. Investing pre-tax dollars received from the sale and allowing that investment to grow over a period of time will yield a larger return than if the same sales proceeds were used to pay the tax at the time of the sale and then the remainder invested post-tax.

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Reviewing A Foreign Legal Structure

Reviewing A Foreign Legal Structure

Why You Should Hire A Tax Professional To Review Your Foreign Legal Structure

U.S. parented corporations that have foreign operations conducted through a foreign legal structure have significant U.S. tax filing and reporting obligations. The U.S. international tax rules and regulations that apply to U.S. parented structures are voluminous and complicated. Whether the parent corporation is a start-up company establishing offshore operations for the first time or a mature business with pre-existing offshore operations that is considering certain international tax planning, the parent corporation’s foreign legal structure may be able to be optimized for tax efficiency. In addition to the abundance of sticks in the tax code, it also contains many tax benefits that uncounseled taxpayers may not be fully utilizing. A thorough review and analysis of a parent corporation’s organizational structure may uncover unutilized tax benefits that coupled with international tax planning could increase the foreign legal structure’s tax efficiency.

Additionally, reviewing the organizational structure ensures that the parent corporation and each of the entities in its foreign legal structure are complying with U.S. tax reporting obligations and are filing required information returns. Failing to comply with these U.S. tax reporting obligations and information returns may result in significant tax penalties, keeping the statute of limitations open indefinitely, and even criminal tax penalties in extreme cases. Early identification of any deficiencies in the parent corporation’s U.S. tax reporting obligations or information returns is critical to mitigating issues and limiting any tax and penalty exposure. Thus, reviewing a parent corporation’s organizational structure serves dual purposes: (1) it can ensure that the parent corporation and its foreign legal structure are benefiting from the available tax benefit provisions of the Code and (2) it can identify any deficiencies in its tax reporting to avoid costly and significant tax penalties.

As a corporation grows and evolves, a tax professional should be consulted prior to executing an international tax planning transaction to identify and consider any unforeseen tax impacts. However, at the very least, a tax professional should be consulted to periodically review its organizational structure and tax reporting with these dual purposes in mind. Below, are some of the benefits to having a tax professional review a parent corporation’s organizational structure and offshore operations as well as some of the commonly overlooked U.S. tax reporting obligations and filings.

Tax Benefits Under The Code And U.S. Tax Treaties

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Written by | Posted in ANDREW MIRISiS - Reviewing A Foreign Legal Structure

IRS CCMs On Crypto Donations And Crypto Losses

IRS CCMs On Crypto Donations And Crypto Losses

IRS Chief Counsel Memoranda: Cryptocurrency Donations Above $5,000 Need Qualified Appraisal and No Unrealized Cryptocurrency Loss Without Disposition

Introduction

The IRS recently released two chief counsel memoranda addressing cryptocurrency donations and cryptocurrency tax losses. In CCM 202302012[1], the IRS stated that a taxpayer that donates cryptocurrency and seeks a charitable contribution deduction of more than $5,000, must obtain a qualified appraisal under section 170(f)(11)(C) to qualify for the deduction under section 170(a). In the second, CCM 202302011[2], the IRS stated that a taxpayer that owns cryptocurrency that has substantially declined in value has not sustained a cryptocurrency loss under section 165 due to worthlessness or abandonment of the cryptocurrency. While these conclusions may not be surprising, these written determinations provide a glimpse into the IRS’s thinking on the issues. The IRS likely issued these written determinations in advance of the kickoff of the individual tax filing season to inform similarly situated taxpayers how to treated unrealized cryptocurrency losses and substantiating cryptocurrency donations where the taxpayer intends to claim a deduction greater than $5,000.

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IRS Issues Proposed Regulations On Section 951(a)(2)(B) Planning

IRS Issues Proposed Regulations On Section 951(a)(2)(B) Planning

IRS Issues Proposed Regulations to Curb Section 951(a)(2)(B) Tax Planning

Introduction: Consolidated Groups and Section 951(a)(2)(B) Tax Planning

On December 9, 2022, Treasury and the IRS released proposed regulations that are intended to stop certain U.S. shareholder tax planning under section 951(a)(2)(B). Proposed Regulation § 1.1502-80(j) modify the consolidated return regulations to treat members of a consolidated group as a single U.S. shareholder in certain cases for purposes of applying section 951(a)(2)(B). The preamble to the proposed regulations states that Treasury and the IRS are aware that some consolidated groups were engaging in tax planning that reduced the consolidated group’s aggregate pro rata share of a lower-tier CFC’s subpart F income or tested income under section 951(a)(2)(B). Additionally, in the proposed regulations, the government once again warned taxpayers that it may assert other authorities or common law doctrines such as economic substance to challenge or recast the tax treatment of a transaction. This is consistent with recent government messaging that it may begin to assert economic substance more frequently than it has in the past.  Below, we discuss the section 951(a)(2)(B) tax planning at issue and the mechanics of Proposed Regulation § 1.1502-80(j)(1) and (2).

Subpart F, Tested Income, and Previously Taxed Earnings and Profits

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Section 6751(b) Penalty Approval Circuit Split

Section 6751(b) Penalty Approval Circuit Split

Eleventh Circuit Sides with Ninth Circuit on Section 6751(b) Circuit Split

Introduction: Section 6751(b) and the Timing of Supervisory Approval of a Penalty

The Eleventh Circuit’s decision in Kroner v. Commissioner[1], is the latest opinion to address section 6751(b) and, specifically, the appropriate timing of the supervisory approval of a penalty.[2] The Eleventh Circuit reversed the Tax Court which held, consistent with its recent section 6751(b) jurisprudence that section 6662 penalties were disallowed because the supervisory approval did not occur before the IRS examiner sent the taxpayer a letter asserting penalties. In reversing the Tax Court, the Kroner court agreed with the Ninth Circuit’s decision in Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner[3]. While the IRS has continued to unsuccessfully litigate the issue before the Tax Court[4] it has gained significant victories in two Circuit Courts whose holdings are in direct conflict with the Second Circuit’s opinion in Chai v. Commissioner[5]. Importantly, the Kroner and Laidlaw’s Harley Davidson Sales, Inc. decisions set up a circuit split on the timing of section 6751(b) supervisory approval and raise the possibility that the United States Supreme Court may resolve the dispute.

Background Facts

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Can I Deduct Cryptocurrency Losses?

Can I Deduct Cryptocurrency Losses?

Claiming Cryptocurrency Losses As Tax Deductions

Introduction: Crypto Bankruptcies, Custodial Accounts, Misappropriation, Hacks, and Theft 

Can digital asset or cryptocurrency investors that were customers or account holders in a failed cryptocurrency business claim a deduction for their digital asset or cryptocurrency loss? So far this year there have been four notable crypto bankruptcies: (i) Celsius Network, (ii) Three Arrows Capital, (iii) Voyager Digital, and (iv) FTX and FTX.US. These crypto bankruptcies left their investors and customers with large economic losses.  The primary reasons for the cryptocurrency losses were because (i) the digital asset the customer held in the account abruptly and significantly dropped in value as a result of events that precipitated the bankruptcy, or (ii) the customer’s custodially held assets disappeared through misappropriation, hacking of the platform, or were simply unaccounted for. Cryptocurrency investors and customers in this unfortunate position may be able to claim a deduction for their digital asset or cryptocurrency loss as a section 165(f) capital loss, a section 165(g)(1) worthless stock loss, or a section 165(e) theft loss.

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Micro-Captive Insurance Arrangements Disclosure: An Area Of Focus For The IRS

Micro-Captive Insurance Arrangements Disclosure

CCA 202244010: What Constitutes Adequate Disclosure of Micro-Captive Insurance Arrangements

Introduction: Micro-captive Insurance Arrangements Disclosure

Micro-captive insurance arrangements are an area of focus for the IRS. As we have discussed in our prior post discussing Avrahami v. Commissioner, 149 T.C. No. 7 (2017), micro-captive insurance arrangements can be abusive if they are used improperly. As a result, the IRS requires disclosure of the material facts for a micro-captive insurance arrangement on certain information reporting forms. This disclosure gives the IRS the opportunity to analyze the underlying micro-captive insurance arrangement to determine whether it satisfies the requirements of section 831(b) and whether the arrangement constitutes “insurance” for federal tax purposes.

The 40 percent accuracy-related penalty under section 6662(i) may apply for a taxpayer’s nondisclosed noneconomic substance transactions, which includes micro-captive insurance transactions. Chief Counsel Advice 202244010 addressed whether the taxpayers adequately disclosed a micro-captive insurance arrangement where they disclosed the material facts of the transactions as reportable transactions on Forms 8886, “Reportable Transaction Disclosure Statement” but did not separately disclose the transactions on Forms 8275, “Disclosure Statement” as required by Notice 2010-62.

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Risk Of Holding Digital Assets Through Custodial Wallets

Holding Digital Assets Through Custodial Wallets

Non-Custodial Wallets v. Custodial Wallets: Considerations for Holding Digital Assets

Introduction: The FTX Collapse, Custodial Wallets, and Bankruptcy Concerns

The recent headlines regarding cryptocurrency exchange FTX’s collapse, and subsequent bankruptcy filing have put renewed focus on whether customers of a cryptocurrency exchange should hold digital assets through a custodial wallet. When a customer holds digital assets through a custodial wallet the service provider holds both the public key and the private key and effectively has control over the assets. The issue for cryptocurrency exchange customers is if a cryptocurrency exchange files for bankruptcy protection are the customers’ digital assets property of the exchange’s bankruptcy estate and available to be used to satisfy debts of other creditors? Bankruptcies involving cryptocurrency exchanges or cryptocurrency lending platforms is a developing area of the law and presents issues of first impression. Recent cryptocurrency bankruptcies include Voyager Digital LLC, Celsius Network LLC, and most recently FTX Trading Ltd. If customers of a cryptocurrency exchange or cryptocurrency lending platform hold their digital assets in a custodial wallet, rather than a non-custodial wallet (i.e., a private wallet), it may increase the risk that such assets are treated as corporate assets of the exchange or lending platform.

Risks of Holding Digital Assets in a Custodial Wallet

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Conservation Easements And Retained Mineral Interests: An Area Of IRS Focus And Litigation

Conservation Easements And Retained Mineral Interests: An Area Of IRS Focus And Litigation

Retained Surface Mining Rights in Conservation Easement Deeds: CCA 202236010

Introduction: Separating the Surface Estate from the Retained Mineral Interest

As we have discussed in prior posts, conservation easements remain an area of focus for the IRS. The Service has spent significant effort challenging and litigating conservation easements to ensure that only donations that meet the strict standards of section 170(h) of the Code are permitted. In a recent Chief Counsel Advice, CCA 202236010[1] the IRS addressed whether a conservation easement satisfies the requirements of section 170(h) where (i) the easement donor retains a qualified mineral interest, (ii) the ownership of the surface estate and the mineral interest has never been separated, and (iii) under the terms of the deed the donor can use a surface mining method to extract the subsurface materials with the donee’s approval.

As discussed below, the IRS concluded that the conservation easement did not meet the requirements of section 170(h), and in particular, the requirement that the conservation easement was contributed “exclusively for a conservation purpose” because the qualified mineral interest was never separated from the surface estate and the deed retained the possibility of surface mining to extract the subsurface materials. Donors seeking to claim a charitable contribution deduction for a conservation easement should be sure to separate the qualified mineral interest from the surface estate and that the deed to the property permits the owner of the qualified mineral interest to extract or remove the minerals by a surface-mining method.

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Conservation Easements And Retained Mineral Interests

Conservation Easements And Retained Mineral Interests

Retained Surface Mining Rights in Conservation Easement Deeds: CCA 202236010

Introduction: Separating the Surface Estate from the Retained Mineral Interest

As we have discussed in prior posts, conservation easements remain an area of focus for the IRS. The Service has spent significant effort challenging and litigating conservation easements to ensure that only donations that meet the strict standards of section 170(h) of the Code are permitted. In a recent Chief Counsel Advice, CCA 202236010[1] the IRS addressed whether a conservation easement satisfies the requirements of section 170(h) where (i) the easement donor retains a qualified mineral interest, (ii) the ownership of the surface estate and the mineral interest has never been separated, and (iii) under the terms of the deed the donor can use a surface mining method to extract the subsurface materials with the donee’s approval.

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