Many taxpayers overlook the possibility of obtaining a ruling from the IRS Office of Chief Counsel on how to report an anticipated transaction, or a transaction that has occurred but has not yet had to be reported. This is unfortunate, because such rulings frequently can be obtained fairly quickly, at little additional cost to the taxpayer relative to an attorney’s opinion, and will provide iron-clad assurance.
The Subjects of Rulings
The limitation on rulings that is perhaps the most surprising to many taxpayers is that the IRS will not issue hypothetical rulings; that is, you can’t get a ruling on the treatment of a transaction that you might or might not enter into. You pretty much must be committed to the transaction, or the transaction may have already occurred but you have not yet reported it in a tax return.
Also the IRS will not decide issues of fact. Therefore, the facts must be clear and the question must revolve around uncertainty in the law.
In past times, the most common ruling subject in the business area was rulings on corporate mergers and acquisitions, generally referred to as reorganizations. Literally hundreds of cookie cutter rulings were issued in the 1960s and 1970s on largely identical deals that were not problematic. The rulings were relatively cheap insurance and thought to be the reasonable way to go.
Later, the IRS chose to husband its resources by declining to issue what it called “comfort rulings” and, therefore, those reorganization rulings mostly diminished in the business world, except for cases in which the taxpayer could make a showing that the law was really uncertain. That standard has now evolved to the point that, if the taxpayer cannot obtain a “will” opinion from an attorney, the IRS generally will entertain the ruling request. Procedure
The taxpayer must represent the facts under penalties of perjury. The taxpayer must pay a fee to the IRS (currently $11,500). If the issue is in the corporate area, there is reason to hope that it will be issued within a period as short as two to four months after submission. If the issue requires attention from other divisions of Chief Counsel and coordination among multiple divisions, the time period can lengthen.
If the IRS is not inclined to issue the desired ruling, it will not just issue a negative ruling. Rather, it will inform the taxpayer and allow for a withdrawal of the ruling request. Of course, if the transaction has occurred or will occur anyway, it is likely that the Chief Counsel’s negative views on the issue will be communicated within the IRS to the audit division.
Standard of Ruling
A letter ruling is a “will” opinion that the IRS can issue if it reaches a level of comfort satisfactory to itself on the proper treatment of the transaction. That level is usually the same as courts apply, which is “more likely than not.” In other words, as a practical matter, the IRS does not have to reach as high a level of certainty as an attorney would have to reach to render an opinion with a high comfort level, because the IRS binds itself to the result (unless the facts did not turn out as described) and it, to some extent, makes the rules.
By far, the most common sort of corporate ruling issued in recent years has involved rulings on corporate divisions that want tax-free treatment. Of course, many spin-offs proceed upon opinion of counsel, for a variety of reasons, including the need for haste and the uncomplicated nature of the transaction; however, given the fact that rulings on at least some of the issues in spin-offs can be obtained—usually within a couple of months—and given the large potential tax liability at stake, the ruling practice in the area still thrives.
Almost every public company merger or acquisition involves an SEC filing that describes the Federal Income Tax Consequences to the shareholders. An opinion of a professional tax advisor must be supplied to the SEC to back up these disclosures. The SEC reviewers actively investigate these disclosures and can raise a variety of questions.
If there is any significant level of uncertainty in the tax outcome, the SEC reviewers will require the disclosure to explain it. This is why some prospectuses have rather lengthy explanations of multiple possible tax outcomes. That is not the norm and is not desired by the corporations, but sometimes it is necessary. While there is no need to explain a “will” opinion, a “should” opinion or one of lesser level of assurance usually will have to be explained so that the shareholders, at least in theory, can assess their tax risks.
When the taxpayer making the SEC disclosures has obtained an IRS ruling on the tax consequences, that will, of course, be the centerpiece of the disclosure. However, it is almost always necessary to also have a legal opinion ancillary to the IRS ruling to cover issues the ruling does not cover.
Obtaining IRS private letter rulings is a reasonable, prudent and cost-efficient method of obtaining certainty in cases where the tax law relative to a transaction is unclear to the taxpayer’s tax advisors, or the stakes are so high that the taxpayer requires absolute certainty. It can turn out to be cheaper than reliance solely on a legal opinion, and more useful in the long run.