Dilemma for IRS: How big can a hedge be?

To qualify as a hedging transaction, must a hedge be proportionate in size to the volume of the commodity hedged?

That question is on the table at the Internal Revenue Service, according to Michael S. Novey, a lawyer/adviser in the Department of the Treasury’s office of legislative counsel.

In recent comments to the District of Columbia Bar Association’s financial instruments and products committee, he said that when the Treasury issued proposed regulations on hedging, it believed that it had properly followed Congress’ directions to broaden the standard for qualifying hedging transactions.

One the practical issues the department is concerned about, according to Mr. Novey, is whether expansion of those rules is workable.

He said the Treasury Department believes that if the hedge doesn’t get substantially bigger than the hedged item, it has a workable rule. But there’s concern when the hedge gets a whole lot bigger.

Congress ratified the hedging treatment that the Clinton administration had already granted taxpayers in lenient hedging regulations. In so doing, Congress endorsed the concept of risk management but not speculation. Congress gave the Treasury Department and IRS broad regulatory authority.

Forums set for tax professionals

The IRS says it will host six nationwide forums for tax professionals. The three-day programs include a variety of seminars with information on IRS programs, practices and policies. Tax professionals can earn up to 18 continuing-professional-education credits for a forum. The dates and locations are as follows:

July 10-12: Philadelphia

July 24-26: Fort Lauderdale, Fla.

Aug. 14-16: Dallas

Aug. 21-23: Atlanta

Sept. 4-6: Cleveland

Sept. 18-20: Las Vegas

Cite: IRS News Release: IR-2001-53

French contributions not deductible

Persons who live in the United States and make contributions to the French social security system may not deduct or exclude those amounts from their taxable income in the United States. That is true whether those payments were voluntary or mandatory.

If, however, U.S. residents receive payments from French social security, only France has the authority to tax them. The two nations have agreed on the treatment for French social security payments under their tax treaty.

The IRS explained that taxpayers who exclude French social security distributions from their U.S. taxable income do not need to disclose that on their tax returns. The agreement applies to the years starting with 1996.

American residents who paid U.S. income tax on French social security distributions after Dec. 31, 1995, may claim a refund during the next three years. However, residents who took a deduction for their contributions should file amended returns for any open tax years to include those amounts in U.S. taxable income.

Cite: IRS News Release: IR-2001-54

A complex merger clears tax hurdle

The IRS has provided further guideance on the control-for-voting-stock requirement for a reverse triangular merger.

In the case in question, the parent corporation tendered for a target’s voting stock and acquired 51% of the target’s stock in exchange for the parent’s voting stock. Both the acquiring parent and the target were manufacturing companies. The parent formed a subsidiary that merged into the target under state law.

In the merger, the parent’s subsidiary stock was converted to target stock, and the target’s other shareholders exchanged the remaining 49% of the target voting stock for the parent’s voting stock and cash. The tender offer and the statutory merger were treated as an integrated acquisition by the parent of all the target’s stock.

In a second scenario, the subsidiary initiated the tender offer for target stock, and in that offer, it acquired 51% of the target’s stock for the parent’s stock.

The IRS determined that in both situations, the control-for-voting-stock requirement was satisfied because the target shareholders exchanged more than 80% of the target’s voting stock for the parent’s.

Cite: Revenue Ruling 2001-26

New tables issued for withholding

New federal withholding tables, effective for wages paid after June 30, have been released by the IRS as Publication 15-T, “New Withholding Tables for 2001.” The publication contains revised withholding tables that reflect changes made by the Economic Growth and Tax Relief Reconciliation Act of 2001.

The publication also includes revised 2001 percentage-method withholding tables, wage-bracket-method tables and the alternative-method tables.

The new tables replace those currently reproduced in Publication 15, Circular E, “Employer’s Tax Guide for 2001,” and the 2001 Publication 15-A, “Employer’s Supplemental Tax Guide.”

Partners lose again on their tax bases

The U.S. Tax Court has refused to reconsider its earlier ruling that if a partnership had no debt for two years that would allow the partners to increase their bases in the partnership. Apparently the partnership failed to show any reason for departing from the general rules.

Four individuals and their S corporation formed a partnership, Dynadeck Rotary Systems Ltd. The corporation was used to secure funding to pay Dynadeck’s expenses. In 1990, the Laurel Assets Group advanced funds to the corporation for a promissory note.

In a 1994 agreement between Laurel, the S corporation and Dynadeck, the Dynadeck group agreed to pay Laurel a 5% royalty because of the funds advanced. Dynadeck filed its 1991 and 1992 returns but didn’t report any partnership liabilities.

The IRS determined that the partners could not increase their bases in Dynadeck, because the partnership had no debt during 1991 and 1992. Dynadeck argued that the corporation was acting as an agent in receiving the Laurel funds.

The Tax Court rejected that argument for lack of supporting evidence. After Dynadeck moved for “reconsideration,” Tax Court Judge David Laro noted that reconsideration was available only to correct errors or to allow the introduction of new evidence, and said the partnership’s case didn’t qualify.

Cite: Dynadeck Rotary Systems Ltd., et al., v. Commissioner, T.C. Memo 2001-113

A split decision on excess pay

The U.S. Tax Court has ruled that a corporation was entitled to deduct a limited amount of an officer’s compensation above the amount determined by the IRS.

But the same court found the corporation guilty of accumulating income, a strategy that allowed its shareholders to avoid taxes.

George Valente owned all the stock in Metro Leasing and Development Corp., an auto leasing and real estate development company. When Mr. Valente became ill, he and his wife operated the business under a cooperative arrangement.

Metro Leasing deducted $240,000 in 1995 and $460,000 in 1996 as compensation to the Valentes.

The IRS determined that the company was entitled to deduct $77,000 for each year as reasonable compensation. The IRS also determined that Metro let its earnings accumulate beyond the reasonable needs of the business and was subject to the accumulated-earnings tax.

Tax Court Judge Joel Gerber, sustaining in part the IRS’ determination, concluded that an independent investor wouldn’t be satisfied with little or no return.

However, the court found that increases in Metro Leasing’s income due to the sale of assets during 1995 and 1996 were attributable to the Valentes’ efforts. The court concluded that reasonable compensation for the Valentes’ services for those years was $90,000 and $163,000, respectively.

On the accumulated-income issue, the court ruled that Metro Leasing could accumulate, without the imposition of the accumulated-earnings tax, no more than $250,000. The court declined to impose accuracy-related penalties.

Cite: Metro Leasing and Development Corp., et al., v. Commissioner, T.C. Memo 2001-119

Gennifer Flowers is suing the IRS

Gennifer Flowers has filed a lawsuit against the IRS, seeking disclosure of documents and files arising from allegedly retaliatory audits to which she was subjected between Jan. 20, 1993, and Jan. 19, 2001.

Ms. Flowers, with whom former President Bill Clinton admits having had a sexual liaison, says she had sought, under the Freedom of Information Act, internal IRS documents that would show the political nature of actions by the agency, but received no substantive response from the IRS.

Ms. Flowers has now asked the court to rule that the IRS’ refusal to disclose the requested documents is unlawful, and to order the IRS to make available the requested documents.

Cite: Gennifer Flowers v. IRS, U.S. District Court for the District of Columbia, filed 4/10