Tax Watch: Cost of defending IPO suit can’t be expensed

The Internal Revenue Service has concluded that a company’s legal costs for defending a class action stemming from its initial public offering of stock must be capitalized, not deducted as a business expense.

In the situation cited by the IRS in a field service advisory, a subsidiary of an international manufacturing and marketing company launched an IPO that became the subject of a class action.

The suit was subsequently settled, and the subsidiary deducted all its legal costs on its Form 1120, Corporate Tax Return.

The IRS proposed to disallow the deduction because the origin of the claims was the IPO. The subsidiary’s alleged misrepresentations were about the IPO, not the normal reporting, the IRS held.

The settled claims originated in the sale of securities, which is considered disposition of a capital asset. The costs to settle the lawsuit weren’t deductible under Section 162, but had to be capitalized.

Cite: Field Service Advice 200126018

Split decision for expatriate

In a field service advisory, the IRS concluded that one individual’s termination of his U.S. citizenship had U.S. tax avoidance as one of its principal purposes. However, his transfer of a U.S. company’s stock for a foreign company’s stock did qualify as a “non-recognition exchange” under Section 351, “Transfer to Controlled Firm.”

According to the IRS’ facts, the individual was born in the United States, and his business involved managing large international companies. The individual maintained a primary residence in a foreign country but also remained a member of the board in a U.S. company.

He relinquished his U.S. citizenship when he found that the foreign country prohibited dual citizenship.

Before expatriating, the individual owned a domestic grantor trust that owned stock in a U.S. corporation.

After renouncing his U.S. citizenship, the individual formed a foreign corporation, then transferred his entire interest in the U.S. company to it in exchange for all of the outstanding shares of the foreign company’s stock.

The IRS concluded that the individual’s principal purpose in expatriating was to avoid U.S. taxes.

The IRS also determined that there could have been enough non-tax reasons for the individual to contribute U.S. company stock to the foreign company.

The exchange of stock, said the IRS, may not have been a sale or exchange under the Section 877, “Expatriation to Avoid Tax,” rule on the date of the expatriation.

Cite: Field Service Advice 200126016

Comp plane rides’ cost is deductible

The 8th U.S. Circuit Court of Appeals has ruled that a corporation was entitled to deduct the expenses of providing flights on its corporate jet for non-business uses by its corporate officers.

The officers reported the flights as compensation using the standard cents-per-mile rate computed by the IRS.

The IRS standard has no relationship to the cost of the flights.

The IRS disallowed the corporation’s deduction for the non-business flights on the basis that they were Section 274, “Business Expense Substantiation,” entertainment expenses. If that argument didn’t fly, the IRS also sought to restrict the deduction to the amount claimed as compensation by the officers.

The 8th Circuit agreed with the U.S. Tax Court’s reasoning that Section 274 clearly does not apply, as the expenses are compensation to the employee and are not entertainment expenses.

The appeals court rejected the IRS argument that Section 274 requires parity in the reported compensation and the deducted expense.

Cite: Sutherland Lumber-Southwest Inc. v. Commissioner, No. 00-2827 (8th Cir. 7/3)