Daily Tax Update - February 03, 2006

Today, the Treasury Department and the Internal Revenue Service issued a notice proposing amendments to Circular 230, which governs practice before the Internal Revenue Service by tax practitioners.

  • The proposed amendments to Circular 230:
    • Expand the definition of "practice before the Internal Revenue Service" to include the rendering of written advice with respect to any entity, transaction plan or arrangement, or other plan or arrangement having a potential for tax avoidance or evasion;
    • Modify the application rules for enrollment agents;
    • Revoke the limited practice rights of unenrolled preparers;
    • Provide that all hearings, reports, evidence and decisions in a disciplinary proceeding be available for public inspection;
    • Authorize the Secretary of the Treasury to impose a monetary penalty on any practitioner (or the practitioner's firm or employer in certain circumstances) who engages in conduct subject to sanctions; and
    • Modify the rules concerning contingent fees, conflicts of interest, standards with respect to tax returns and documents, affidavits and other papers, discovery, and appeals.
  • The proposed regulations do not address the standards for written tax advice that were the subject of final amendments to the regulations issued in December 2004 and modified in May 2005.
  • For additional information contact Arthur L. Bailey via email or Alexis A. MacIvor via email.

In Black & Decker Corp. v. United States, __ F.3d __, 2006 WL 241073 (Feb. 2, 2006), the United States Court of Appeals for the Fourth Circuit reversed the District Court’s grant of summary judgment in favor of the taxpayer and remanded the case to the District Court for further proceedings regarding whether the transaction at issue was a sham. In the transaction, which occurred in 1998, Black & Decker Corporation ("BDC") and subsidiaries (collectively, the "Taxpayer") transferred to Taxpayer’s subsidiary ("BDHMI") $561 million in cash in exchange for preferred stock of BDHMI and BDHMI’s assumption of certain contingent health care liabilities having an estimated net present value of $560 million. Approximately one month later, Taxpayer sold the preferred stock for $1 million to an unrelated third party.

  • In its 1998 tax return, Taxpayer claimed a $560 million capital loss on the sale of the preferred stock. Taxpayer claimed sections 357(c)(3) and 358(d) required that its basis in the preferred stock be $560 million (i.e., unreduced by the transferred liabilities). The IRS claimed that section 357(c)(3) did not apply to the transferred liabilities, and, therefore, section 358(d) required Taxpayer to reduce its basis in the preferred stock by the amount of the transferred liabilities. The IRS also claimed that the transfer of such liabilities was a sham transaction. In response to cross motions for summary judgment, the lower court disagreed with the IRS on both issues.

On appeal, the Fourth Circuit rejected the IRS’s positions with respect to sections 357(c) and 358 but concluded that the District Court had not properly applied the sham transaction doctrine.

  • With respect to section 357(c)(3), the Fourth Circuit rejected the IRS’s argument that some of the legislative history of section 357(c) and tax policy against double deductions precluded the transferred liabilities from being included within section 357(c)(3).
  • The IRS also claimed that the principal purpose of the liability assumption was not a bona fide business purpose and that, pursuant to sections 357(b) and 358, the liability assumption required Taxpayer to reduce its basis in the preferred stock to $1 million, eliminating the capital loss. Although the lower court never evaluated this argument, the Fourth Circuit appeared to conclude that, upon the assumption of a liability, the mere fact that such assumption satisfies section 357(b) alone will not cause the transferor’s basis in the transferee’s stock to be reduced by the amount of the liability assumed.
  • With respect to the sham transaction issue, the Fourth Circuit ruled that the lower court misapplied the objective prong of the two-part sham transaction test applicable in the Fourth Circuit. See Rice’s Toyota World, Inc. v. Comm’r, 752 F.2d 89 (4th Cir. 1985). The court stated: "[T]he district court mischaracterized the Rice’s Toyota test, which focuses not on the general business activities of a corporation, but on the specific transaction whose tax consequences are in dispute. . . . Thus, many of the undisputed facts upon which the district court relied . . . -- including the facts that BDHMI ‘maintained salaried employees’ and paid health claims as they came due with BDHMI assets -- were simply not germane . . . ." The court also noted that the lower court failed to evaluate several experts retained by the IRS. Accordingly, the court remanded the case back to the lower court for trial on the issue of whether Taxpayer’s transactions met the two-part sham transaction test of Rice’s Toyota.
  • For additional information, contact Mark J. Silverman via email or Lisa M. Zarlenga via email.

Last night, the Senate cleared a procedural hurdle in moving one step closer to appointing conferees and passed a substitute version of its tax reconciliation bill. The Constitution requires that all revenue-related bills originate in the House. Therefore, the Senate had to pass the House version, amended with the Senate language. The Senate still has to complete additional procedural steps before conferees can be appointed including debate on a motion to go to conference. The House is expected to approve a motion to go to conference on the tax reconciliation package next week.

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

Steptoe & Johnson LLP has one of the largest and most diverse law firm tax practices in the country. The practice covers the entire spectrum of federal taxation, including representation of businesses before the Congress, Treasury and the national office of the IRS; transactional planning for domestic and multinational corporations; complex audit and controversy work for corporations and other business interests contesting IRS adjustments; litigation before the Tax Court, Court of Federal Claims, district courts, courts of appeals and the Supreme Court. The firm's tax practice also encompasses all aspects of employee benefits (ERISA), executive compensation, tax-exempt organizations and charitable giving.  Steptoe has an extensive state and local tax practice, representing an array of business clients on complex sales and use tax, corporate income tax and property tax matters, both advising those clients and handling audits, administrative appeals, and litigation for them.  Read  more information on Steptoe's tax practice