SLIT9100TransactionalElectivity2-5-2015-v5 (2)

St. Louis International Tax Group, Inc.

Correction of an Error – 9100 Relief,

Rescission, Transactional Electivity and

Other Fun and Games

Daniel C. White

Philip B. Wright

Bryan Cave LLP

5th February 2015

Transactional Electivity

and Error Correction

I. Overview – Base Case

II. Transactional Electivity

III. Overview of Tax Mistakes

IV. Potential Legal and Equitable Remedies

V. Illustrative Examples

1

Base Case

2

P

FS-2

FS-3

FS-1

For operating efficiencies, P wants to transfer FS-1 to the

FS-2 group. The general counsel has asked for your

recommended structure.

For the form of the transaction, you consider:

• Acquiror: FS-2 or FS-3

• Form: Stock, Assets, or “Hybrid”

• Consideration: Cash, Stock, Other

• Origin of Proceeds: Pre/Post

Dividend/Redemption

FS-2 Group

II. Transactional Electivity

Remedies to Correct

A Tax Mistake

Transactional Electivity:

Explicit and Implicit Elections

“Transactional electivity” means the ability to choose the tax consequences of a business transaction without substantially altering the economic arrangements. These elections are explicit and implicit.

Explicit electivity directly in the Internal Revenue Code or in the Treasury Regulations.

Implicit electivity in three types:

Electivity caused by form of transactions

Electivity arising as a result of conflict among authorities (e.g., IRS vs. courts; conflict between circuits)

Electivity caused in the absence of guidance (e.g., Gottesman & Co. v. Commissioner, 77 T.C. 1149 (1981))

Taxing different economic arrangements “differently” is not transactional electivity

3

Examples of Potential

Transactional Electivity – Base Case

4

P

FS-2

FS-3

FS-1

P

FS-2

FS-3

FS-1

P

FS-2

FS-3

FS-1

1. FS-2 acquires FS-1 stock in

exchange for no consideration.

2. FS-1 converts under local

law to the form of a limited

partnership/disregarded entity.

1

1 1

2 2


exchange for no consideration.

2. FS-1 converts under local

law to the form of a limited

partnership/disregarded entity.


exchange for cash/other

property.

Considerations in Comparing Explicit

Elections with Transactional Elections

5

Explicit Elections Implicit Elections

Ease of application Potential need for expert

advice

Doctrine of Election Reformation/Scriveners

error

Substantial Compliance

doctrine

Danielson/Substance over

form

Section 9100 relief Rescission

Timing - Generally post-

closing but often not beyond

the tax return filing date

Timing – At Closing but

though may be later as a

result of explicit election or

created by conflicts or

absence of law

III. Overview of Mistakes

Remedies to Correct A

Tax Mistake

6

What is a Mistake: A Tax Perspective

Tax Mistake Defined: The tax consequences of the

particular transaction are not as intended or as favorable as

they might have been absent the “mistake”.

Tax Mistake versus Hindsight:

Hindsight is the attempt to alter the tax consequences

of a transaction to achieve a more favorable tax result

where future events turned out other than as expected

and as such the resulting tax consequences are not as

intended.

7

What is a Mistake: A Tax Perspective

Execution Error: The parties understood the facts, law and method by which to achieve the desired tax result but there was a failure to execute the transaction as designed to achieve the desired tax results.

Documentation Errors “Scrivener” Error. There is a mistake in the documents attributable to a communication or drafting error

such that the documents as drafted/executed do not reflect the intent of the parties.

Substantiation/Filing/Election Errors. The intended tax consequences require that the transaction be substantiated in a particular manner or the parties file a particular form or make a particular election within a given time period.

Timing/Sequencing Error The intended tax consequences of the transaction depend on the transaction(s) occurring within a certain

time period or occurring in a particular sequence.

Mistake of Fact:

A mistaken belief as to a material fact that alters the tax consequences of the transaction.

Mistake of Law:

An erroneous application of the law to the known facts (including the lack of knowledge of a particular law) an error in the legal analysis or conclusion.

IV. Legal and Equitable Remedies

Remedies to Correct A

Tax Mistake

8

Fixing Tax Election/Tax Return Mistakes

Election Tax Mistakes

Late Elections

Defective Elections - Taxpayer attempts to make an election but does not substantially

comply with the applicable requirements

Erroneous Elections – Taxpayer makes an election in error and seeks to revoke the election

Doctrine of Election - Pacific National Co. v. Welch, 304 U.S. 191 (1938)

Election Remedies

Section 9100 Relief – Late Elections

Equitable Remedies

Tax Return Reporting Errors

Inaccurate Returns

Failure to include documentation/forms

Tax Return Remedies

Amended Tax Returns

Affirmative Claims on Audit

Equitable Remedies

9

Fixing Non-Election Related Mistakes

Equitable Remedies Rescission

Rev. Rul. 80-158 – IRS Ruling Position Background

Elements of Rescission - Judicial Underpinnings Same Taxable Year – Penn v. Roberson

Return of the Parties to the Status Quo Ante

Contractual – Transaction giving rise to rescission must arise out of a “contract”

Reformation

General Judicial nunc pro tunc orders (now for then)

Rev. Rul. 93-79 (Reformation of trust to meet S shareholder eligibility was not given retroactive tax effect)

Same American Nurseryman Publishing Company v. Commissioner 75 T.C. 271 (1980), aff'd without opinion, 673 F.2d 1333 (7th Cir. 1982)

Non Judicial Reformation - Contract Modification

Mistake in Fact or Law to Reform or Abrogate the Agreement

Scrivener’s Error – Rev. Rul. 71- 416

Void and Voidable Transactions

10

Section 9100 Relief – Failure to Elect

General

Treas. Reg. Section 301.9100 – 1 through – 3 provides the

standards the Commissioner will use to grant taxpayers

extensions of time for making certain elections.

Relief is provided to taxpayers who reasonably and in good faith

fail to make a timely election when relief will not prejudice the

interests of the government.

Regulatory versus Statutory Elections

Regulatory Election – Deadline for making election is prescribed by

regulation, revenue ruling, revenue procedure, notice or announcement

Statutory Election – Deadline for making the election is prescribed by

statute

Accounting Method Elections

Standard

Reasonable action and good faith

A taxpayer is deemed to have acted reasonably and in good faith if: (1) the taxpayer applies for relief

before the failure to make the regulator election is discovered by the IRS; (2) the taxpayer inadvertently

failed to make the election because of intervening events beyond its control; (3) the taxpayer failed to make

the election because after exercising reasonable diligence the taxpayer was unaware of the necessity for the

election; (4) the taxpayer reasonably relied on the written advice of the IRS; or (5) the taxpayer relied on a

qualified tax professional, including a professional employed by the taxpayer, and the professional failed to

make or advise the taxpayer to make the election.

A taxpayer is deemed to have not acted reasonably and in good faith if: (1) the taxpayer is requesting relief

for an election to alter a return position for which an accuracy related penalty could have been imposed

under section 6662; (2) the taxpayer was fully informed of the required election and related tax

consequences and chose not to file the election; or (3) the taxpayer uses hindsight in requesting relief.

Interests of Government Prejudiced

The interests of the government are deemed to be prejudiced if granting relief would result in a taxpayer

having a lower tax liability than the taxpayer would have had if the regulatory election had been timely

made. In addition, the interests of the government are ordinarily deemed to be prejudiced if the tax year in

which the election should have been made or any affected tax years are closed by the statute of limitations.

11

Remedies to Correct A Tax Mistake

Section 9100 Relief – Failure to Elect

12


Equitable Remedies - Rescission

Rescission

A transaction may be disregarded for federal tax purposes if the parties to the

transaction, during the same taxable year in which they undertake the transaction,

rescind the transaction and restore themselves to the same position they would have

occupied had they not undertaken the transaction

Elements

The Status Quo Ante Requirement – The parties to the transaction must return to

the status quo ante

The Same Taxable Year Requirement – The restoration must be achieved within

the taxable year of the transaction

Underlying transaction in the nature of contract

Actions necessary to affect a rescission

Relevance of State/Foreign Law that define the parties property rights

Rescission versus Modification

13



Rescission Legal Precedent

Penn v. Robertson 115 F.2d 167 (4th Cir. 1940)

IRS Ruling Position

Rev. Rul. 80-58, 1980-1 C.B. 181

Selected PLRs PLR 201113023 (Dec. 15, 2010) (Upstream Merger Rescinded)

PLR 201016048 (Dec. 22, 2009) (Debt Cancellation Rescinded)

PLR 201008033 (Nov. 20, 2009) (Sale Rescinded)

PLR 200923010 (Dec. 26, 2008) (Distribution and Redemption Rescinded)

PLR 200915031 (Dec. 22, 2008) (Share Issuance Rescinded)

PLR 200908016 (Nov. 13, 2008) (Amalgamation Rescinded)

PLR 200843001 (July 2, 2008) (Sale Rescinded)

PLR 200752035 (Sept. 26, 2007) (Stock Issuance Rescinded)

PLR 200716024 (Dec. 22, 2005) (Redemption and Share Issuance Rescinded)

PLR 200701019 (Oct. 5, 2006) (Merger Rescinded)

Business Plan Reconsideration (2012-2013)

Current No Rule Position

Penn v. Robertson 115 F.2d 167 (4th Cir. 1940)

Taxpayer was a participant in an employees stock benefit fund created by the

directors of the company without the approval of the shareholders. Under the

plan the taxpayer was credited with earnings from the fund for the years 1930

and 1931.

In 1931, as a result of suits filed by a shareholder, the directors of the company

passed a resolution whereby the plan would be rescinded as to all participants in

the plan who agreed to relinquish their credits and rights.

Court of Appeals affirmed lower court decision that with respect to amounts

credited to shareholder in 1930, the annual accounting period principle required

the determination of income at the close of the taxable year without regard to

subsequent events. Thus the rescission was disregarded for purposes of

determining 1930 taxable income.

Court of Appeals affirmed lower court that amounts credited to the shareholder

in 1931 were not income as the rescission in 1931 in the same taxable year

extinguished what otherwise would have been taxable income for that year.

14



Rev. Rul. 80-58, 1980-1 C.B. 181 Legal concept of rescission refers to the abrogation, canceling, or voiding of a contract

that has the effect of releasing the contracting parties from further obligations to each other and restoring the parties to the relative positions that they would have occupied had no contract been made.

A rescission may be in effect by mutual agreement of the parties, by one of the parties declaring a rescission of the contract without the consent of the other if sufficient grounds exist, or by applying to the court for a decree of rescission.

Situation 1 In February 1978, A sold property to B for cash. Contract provided that if zoning were not

obtained at B’s option A would return cash to B and B would reconvey property to A.

In October 1978, the zoning was not obtained and B reconveyed property to A and A returned purchase price to B.

Ruling concluded no income as sale is disregarded. Rescission extinguished any taxable income.

Situation 2 Same facts as Situation 1 except property reconveyed in February 1979.

Ruling concluded income because A and B were not in the same position at the end of the taxable year.

15



16


Equitable Remedies – Reformation and Other

Reformation Judicial Nunc pro tunc Orders (Now for then)

Rev. Rul. 93-79, 1993-2 C.B. 269 State court order retroactively reforming a trust does not have retroactive effect for purposes of S

Corporation shareholder eligibility.

Non judicial Mistakes that Abrogate the Agreement of the Parties

Mistake of Fact Mistake of Law

Void/Voidable Transactions Documents declare certain prohibited transactions as void ab initio

Void ab initio (from the outset) – the transaction confers no enforceable rights on the parties to the transaction.

Voidable – the transaction is valid, but may be annulled by one of the parties to the transaction. Example(s)

Shareholder Restrictions NOL Preservation – 5% shareholder Non CFC Restrictions – 10% shareholder

Claw back Provisions Employee agrees to return funds in certain circumstances “excessive compensation”.

Document Correction Scrivener's Error Other

Remedies to Correct A Tax

Mistake

V. Illustrative Examples

Transaction

Step 1: P Contributes all of the interests in FS-1 to FS-2.

Step 2: A classification election is filed to treat FS-1 as a disregarded entity.

Alt. Step 2: FS-1 changes its classification under local law to a limited partnership/disregarded entity.

Intended Tax Consequences – Sections 351, 368(a)(1)(B), 368(a)(1)(D). Compare Rev. Rul. 67-274 (stock acquisition

followed by liquidation tested as asset reorganization) with Rev. Rul. 69-617 (liquidation of Target into Parent followed by

transfer by Parent of substantial assets of Target to Sub tested as upstream reorganization).

Example 1: Transfer to FS-2 for no consideration

17

P

FS-1 FS-2

P

FS-2

FS-1

FS-1

Election

Step 1 Step 2

FS-3 FS-3

1

2

Transaction

Step 1: P sells all of the interests in FS-1 to FS-2.


Alt. Step 2: FS-1 changes its form of organization under local law to a limited partnership/disregarded entity.

Intended Tax Consequences – Compare Section 304 with Section 368(a)(1)(D) reorganization. See Rev. Rul. 70-240 (cash D

reorganization); Treas. Reg. 1.301-1(l) (deemed dividend in certain transactions between corporation and its shareholder).

Example 2: Transfer to FS-2 for Cash

18

P

FS-1 FS-2

P

FS-2

FS-1

FS-1

Election

Step 1 Step 2

Cash

FS-3

1

2

FS-3

Transaction

Step 1: P sells all of the interests in FS-1 to FS-3. Alternative consideration: nothing; FS-2 stock; FS-3

stock; cash.


Alt. Step 2: FS-1 changes its form of organization under local law to a limited partnership/disregarded entity.

Compare Sections 304, 368(a)(1)(B), 368(a)(1)(C), 1001, 1248. 19

Example 3: Transfer to FS-3 for Alternate Consideration

P

FS-2

FS-3

P

FS-2

FS-1

Step 1 Step 2

FS-3

FS-1

FS-1

Election

Example 4: Dividend and “unrelated” Stock Transfer

20

P

FS-1

Transaction

Step 1: FS-2 declares and pays a dividend to P.

Step 2: P contributes all of the interests in FS-1 to FS-2.

FS-2

P

FS-2

FS-1

Step 1 Step 2

Cash

FS-3

2

FS-3

1

FS-1

SLIT9100TransactionalElectivity2-5-2015-v5 (2)

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