Some Perspective (from an Unexpected Source) In Defense of the IRS’ Notice 2016-66
IRS Notice 2016-66 requiring dealers to file Forms 8886 to disclose Producer Owned Reinsurance Company (PORC-like activities) has created considerable uncertainty over what should be filed and by whom.
Over a decade ago, when the IRS specifically was looking at dealership PORCs, after a series of audit challenges and Technical Advice, the Service concluded that PORC arrangements were not, per se, tax shelters so long as they were operated as legitimate business activities.
It is my belief that most legitimate dealer PORCs should eventually obtain favorable interpretation/acceptance by the IRS on this point, and eventually, dealers and related parties will be excused from these onerous Form 8886 filing requirements.
In the meantime, I would suggest patience and understanding on the part of dealers and CPAs who have to put up with this uncertainty and the compliance work it engenders.
To appreciate the full magnitude of the outlandish arrangements which the IRS is faced with auditing, and to understand why Notice 2016-66 was issued, it is eye-opening to read two recently reported cases.
One case is “Owensboro Dermatology Associates PSC et al. v. Unites States; No. 4:16mc-00005” which involved the creation of multiple PORC entities.
The second case is “Crithfield, Duane et al. v. United States; No. 8:13-cr-00237.” This case did not involve the creation of a PORC entity, but it does fall within the ambit of being an arrangement substantially similar to what the IRS describes in Notice 2016-66. This case includes a list of 22 different potential risks against the happening of which individuals would purchase insurance and claim deductions in their tax returns. Here’s just a few to show you the imagination (and gullibility?): international communicable disease medical expense reimbursement … international kidnap/random investigation expense … key supplier loss expense reimbursement … market/CPGS fluctuation loss expense reimbursement … research and development expense overrun reimbursement, etc.
When one of the promoters was asked by a potential investor for a claim form, the promoter said, “There’s no claim form. No one has ever filed a claim. The whole idea is not to file a claim. But don’t worry, 85% of your premium will go into your trust account.”
(http://www.taxnotes.com/tax-notes-today/criminal-violations/court-finds-shelter-promoters-are-guilty-tax-fraud-conspiracy/2017/07/19/1vwpp?highlight=Crithfield)
In light of these and other situations where promoters and taxpayers try to take advantage, many advisors may feel that the Service is clearly not overreaching in casting a wide net initially to sort out the illegitimate from the legitimate insurance arrangements.
READ MOREAre PORCs on the IRS’ Endangered Species List?
Just wondering if anyone has heard anything within the last few weeks about the IRS Notices regarding the status of PORCs as “abusive” tax shelters and the related filing requirements with OTSA.
After digging into the changes made by the PATH Act affecting PORCs, it appears many will no longer be eligible for favorable tax treatment under Section 831(b) notwithstanding the impact – if any – of Notice 2016-66.
READ MOREHead’s-Up … A Significant Filing Date for Forms 8886 Is Approaching
Almost a decade has passed since IRS activities involving PORCs (that’s Producer-Owned Reinsurance Companies) rose to a level of general awareness of automobile dealers’ CPAs.
It appears the IRS is now in an intensive “information-gathering mode” driven by its suspicion that many auto dealers’ captive insurance arrangements under Sections 953(d) or 831(b) involve abusive tax shelter activities. It’s suspected to be so bad that “captive insurance” arrangements made it to the IRS’ Dirty Dozen List of Tax Scams for the 2017 filing season. (See IRS News Release IR-2017-31.)
CPAs for dealerships that have these micro-captive transaction structures should be alert to IRS Notices 2016-66 and 2017-08.
What stands out (where these structures and arrangements are in use) is the necessity that Form 8886 – Reportable Transaction Disclosure Statement requirements must be immediately addressed. May 1, 2017 is a key filing date we all should be aware of.
We are talking about filings with the IRS OTSA (Office of Tax Shelter Analysis), and possibly – depending on IRS interpretations – with some income tax returns filed for 2016.
Nowadays, the box to check for these arrangements is the Box (e) “Transaction of interest.” When I last wrote about these in the “Dealer Tax Watch” in Dec. 2003, the box to be checked on Form 8886 would have been for a “Listed Transaction.”
The real problems involve trying to interpret how many people who are involved (or related to others who are involved) need to file Form 8886. Further complications relate to whether or not information relating to all transactions dating as far back as November 2, 2006 needs to be reported on Form 8886.
Other complications arise depending on whether (1) C Corps or S Corps or other entity arrangements are involved, (2) an intermediary entity is involved between the dealership and the captive, and (3) rules of stock ownership attribution apply under Section 267(b), 267(c) and/or Section 707. This is heady stuff.
After discussion of interpretations with NADA, the IRS and some of the larger CPA firms whose practices include several hundred captive arrangements, I think it is possible that some general guidance for dealing with these requirements will be made available in the near future by NADA.
However, I will be surprised if the IRS publishes any clarification or guidance before the filing deadline.
READ MORETaxation of VW Settlement Payments: Don’t Expect Any Advance IRS Guidance
On February 14, I participated in a follow-up conference call / discussion hosted by Paul Metrey of NADA (Vice President, Regulatory Affairs) involving several CPA firms whose input NADA sought on whether it would be advisable at this time to seek guidance from the IRS on the interpretation of several key income tax issues arising from the payment of settlement awards by Volkswagen to Volkswagen dealers.
Prior to the “fairness hearing” on January 23, NADA had made the decision to wait to see if any changes were made to the settlement terms … and none were made.
As a result of the conference call and other input, NADA has made the decision to not seek guidance from the IRS on any of the tax issues involved. This was also the recommendation by a VW dealership group.
The almost unanimous conclusions from the CPAs involved in the conference call were that (1) guidance should not be sought from the IRS and (2) that payments received for reduction of the VW franchise goodwill would be, or could be, offset against any basis previously capitalized in connection with the VW franchise.
Accordingly, CPAs will have to reach conclusions on their own as to how much to accrue initially, whether payments are ordinary income, whether long-term capital gain or Section 1231 treatment may be involved, whether Section 1253 comes into play, whether Section 197 is operative, whether installment treatment under Section 453 is a possibility … not to mention the potential for the IRS to invoke the penalty provisions of Sections 6662–6664 if it does not agree with what it finds (if it finds it) in the tax returns when they are filed in just a few months from now.
The take-away from all of this is obvious … It seems that most CPAs are willing to wait in the weeds and see what happens to somebody else. Although many dealers will receive millions of dollars, the tax revenue arising from these amounts is a drop in the bucket compared to many of the other issues that the IRS might want to take on.
As a CPA, at this point, how comfortable are you with all of this?
READ MORECourt Approval of VW-Dealer Settlement Still Leaves Taxation Question Unanswered
On January 23, U.S. District Judge Court Breyer gave the Court’s final approval to the Volkswagen settlement, holding that “the settlement is fair, reasonable and adequate.”
The Court evaluated eight factors in considering the fairness and reasonableness of the proposed settlement. Two discussions related to the impact of the emission scandal on VW franchise value.
In discussing the strength of the Class Members’ case, the Court noted that the dealers submitted expert testimony as to the lost profit exposure of Class Members which provided a “reliable estimate for either the present value of lost profit, or alternatively, a diminishment to the earnings capacity of Class Members’ franchises.”
In discussing the “experience and views of counsel” as a factor to be considered, the Court stated – in part – that “Class Counsel ‘strongly support this settlement’ because it ‘provides Franchise Dealer Class Members with genuine and substantial financial support to compensate them for the loss in the value of their dealerships’.”
Based on these statements, some CPAs might accept them as clear support for reducing previously capitalized VW franchise value or goodwill by the amounts of the payments (to be) received.
Let’s inject a note of caution here. Language elsewhere in the Court’s opinion indicates that in evaluating various factors, “Courts need not ‘reach any ultimate conclusions on the contested issues of fact and law which underlie the merits of the dispute, for it is the very uncertainty of outcome in litigation and avoidance of wasteful and expensive litigation that induce consensual settlements’.”
It really comes down to this: Now that we know that the terms of the settlement have been accepted, how should these payments be characterized for income tax purposes? Are they ordinary income? Or, are they basis reductions potentially resulting in long-term capital gain?
Viewing ratification by the Court as a foregone conclusion, Volkswagen paid almost 60% of the dealers in the Class (374 of 644 dealers) the initial 50% of their cash component in December 2016. Another 155 dealers received their initial payment on January 13, 2017, and another 10 dealers received their initial payment a few days later.
Clearly, since almost all of the dealers have already accepted payments from VW, they now need some precedentially binding guidance (i.e., certainty) from the IRS on how these payments should be treated for tax purposes. It’s now time for NADA to push the IRS to provide that guidance to insure uniform treatment across this broad spectrum of taxpayers.
READ MORETax Return Disclosures … Is Form 8275 Indispensable?
A recent article (in Tax Notes, posted today 1/19) by two San Francisco attorneys, entitled “Tax Return Disclosures: What Is Adequate and Why It Matters,” provides a comprehensive discussion emphasizing that it is important to carefully consider the form of making disclosures of aggressive positions taken in tax returns.
Consideration of this article in connection with tax return disclosures involving basis reductions for payments received from manufacturers for Factory image upgrade construction or in the settlement of claims against Volkswagen is recommended for CPAs advising auto dealerships.
One cannot help but think that it may be unwise to try to get by with a simple “white paper” narrative statement describing the position taken – instead of attaching Form 8275 to the tax return.
There are some really good insights and examples in this article, a copy of which can probably be obtained by directly requesting it from either of its authors – Robert W. Wood (Wood@WoodLLP.com) or Milan N. Ball (Ball@WoodLLP.com).
READ MORE