Leveraged Forward Contract Disregarded Under Economic Substance Doctrine
In Chief Counsel Advice 201515020, the IRS used the economic substance doctrine to disregard a leveraged forward contract transaction, thereby disallowing deductions with respect to items attributable to the transaction. The taxpayers, a married couple filing jointly, purchased an interest in the transaction, which was marketed and sold as a "leveraged forward contract." The transaction consisted of two legs – a loan obligation and prepaid derivative contracts. The loan and the derivative contracts were designed to create offsetting rights and obligations over a period of 20 years. The derivative contracts were designed so that they would make periodic "bond delivery face amount payments" that were tied to a guaranteed "protected rate," so that payments from the derivative contracts were certain to offset payments due on the loan. The derivative contracts also provided for potential "additional payments" if the "market rate" were to exceed the "protected rate" during the term of the contracts.
The IRS disregarded the taxpayers' participation in the transaction under the common law economic substance doctrine. The IRS found that the transaction lacked economic substance because: (1) the transaction did not change the taxpayers' objective economic position apart from tax benefits; and (2) the taxpayers did not have a subjective nontax purpose for entering into the transaction. The IRS acknowledged that although the transaction had a remote possibility for earning a profit, that factor was outweighed by the transaction's expected tax benefits relative to the profit potential, and by the inflated cost that the taxpayers paid for the potentially profitable component of the transaction. The taxpayers entered into the transaction to generate cash flow through expected tax benefits, rather than through the expectation of a profit.
IRS Issues Ruling on Taxable Annuity
The IRS released Private Letter Ruling 201515001 on April 10, involving a deferred annuity contract supported, in part, by subaccounts, each of which invested in a single publicly available mutual fund. The ruling holds that: (a) the policyholder and not the life insurance company issuer of a nonqualified deferred annuity contract is treated as owning mutual fund shares under the contract; (b) the contract is an annuity contract; (c) the contract is not part of a straddle with the mutual fund shares that the policyholder is treated as owning for federal income tax purposes; and (d) dividends that the policyholder receives from the mutual fund will be treated as qualified dividend income. The impact of taxing the policyholder as the owner of the underlying mutual fund shares is that the policyholder can claim capital gains and losses on the policyholder's investment. If, instead, the policyholder was viewed as owning a nondiversified variable annuity contract, the policyholder would be required to include annual increases in the cash value of the contract in income as ordinary income on a current basis without any deductions.
IRS Finds That Interest in Nonprofit Mobile Home Cooperative Homeowners Association Is an Interest in Real Property
In Private Letter Ruling 201515009 issued on April 10, the IRS held that a REIT's acquisition of an interest in a nonprofit mobile home cooperative homeowners association, which was organized to acquire and manage an existing manufactured home community, constituted an interest in real property under Section 856(c) (section references are to the Internal Revenue Code of 1986, as amended). The association was organized as a homeowners association under Section 528 rather than as a cooperative housing corporation under Section 216, but the IRS found that the REIT's interest in the association conferred rights similar to those held by tenant-stockholders in a cooperative housing corporation.
IRS Issues Ruling Applying Look-Through Rules to U.S. Source Income of Foreign Corporation
The IRS issued Private Letter Ruling 201515006 addressing the interaction of "look-through" rules in Sections 1297(c) and 1298(b)(7), which apply when determining whether a foreign corporation should be treated as a passive foreign investment corporation where the foreign corporation owns an interest in a chain of U.S. domestic corporations.
District Court Case Addresses Novel FBAR Questions
In Moore v. United States, No. 2:13-cv-02063 (W.D. Wash. 2015), the taxpayer had a foreign account subject to the Report of Foreign Bank and Financial Accounts (FBAR) requirements, on which the taxpayer failed to report. The IRS assessed a penalty relating to the unreported account. The court found that the taxpayer engaged in nonwillful violations of FBAR reporting. The court disagreed with the taxpayer's reasonable cause argument, which, if successful, would have relieved the taxpayer from FBAR penalty liability. The court cited with favor the Code and United States v. Boyle, 469 U.S. 241 (1985), to define reasonable cause as the exercise of "ordinary business care and prudence" for purposes of FBARs and the Bank Secrecy Act. The case appears to be the first instance of a court analyzing the requirements for imposition of the nonwillful FBAR penalty. The court noted that the taxpayer's lack of knowledge about a question on the tax return (asking whether the taxpayer had an interest in or authority over a foreign financial account), in addition to his negative answers in the beginning of 2006 to a tax return preparer's questions regarding interests in foreign accounts, could not be viewed as the exercise of ordinary business care or prudence.
Maryland Tax Amnesty Program to Commence Soon
Maryland enacted legislation on April 14, a summary of which can be found here, establishing a tax amnesty program for certain civil and criminal penalties and interest relating to state and local income, withholding, sales and use, and admissions and amusement taxes. The amnesty program, which applies to businesses and individuals, commences Sept. 1, 2015, and ends Oct. 30, 2015. It provides for the waiver of penalties and interest relating to the nonreporting, underreporting and nonpayment of Maryland tax liabilities.
Joint Committee on Taxation Releases Report on Choice of Business Entity
The Joint Committee on Taxation released a report, which can be found here, providing information about present law and data relating to C corporations, partnerships (including LLCs) and S corporations. The report provides background information on the choice of business entity in the U.S.; describes sole proprietorships and their federal tax treatment; summarizes present law governing the federal tax treatment of C corporations, partnerships and S corporations; and presents a table of the principal differences in the tax treatment of the three types of business entities. The report also presents data on the distribution of business entities by number, size, industry and net income.