Steve Hamilton is a Tampa native and a graduate of the University of South Florida and the University of Missouri. He now lives in northern Kentucky. A career CPA, Steve has extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.
representing in a difficult tax audit, and the IRS revenue agent has requested
that the client extend the statute of limitations by six months. The statute
has already been extended to February, 2016, so this extension is the IRS’ second
time to the well. The client was not that thrilled about the first extension,
so the conversation about a second should be entertaining.
gives us a chance to talk about the statute of limitations.
Did you know
that there are two statutes of limitations?
with the one commonly known: the 3-year statute on assessment.
your personal return on April 15, 2015. The IRS has three years from the date
they receive the return to assess you. Assess means they formally record a
receivable from you, much like a used-car lot would. Normally – and for most of
us – the IRS recording receipt by them of our tax return is the same as being
assessed. You file, you pay whatever taxes are due, the IRS records all of the
above and the matter is done.
introduce some flutter into the system: you are selected for audit.
you in March, 2017. What should have been an uneventful audit turns
complicated, and the audit drags on and on. The IRS knows that they have until
April, 2018 on the original statute (that is, April 15, 2015 plus 3 years), so
they ask you to extend the statute.
you extend for six months. The IRS now has until October 15, 2018 to assess (April
15 plus six months). It buys them (and you) time to finish the audit with some
concludes and you owe them $10 thousand. They will send you a notice of the
audit adjustment and taxes due. If you ignore the first notice, the IRS will
keep sending notices of increasing urgency. If you ignore those, the IRS will
eventually send a Statutory Notice of Deficiency, also known as a SNOD or
means the IRS is getting ready to assess. You have 90 days to appeal to the Tax
Court. If you do not appeal, the IRS formally assesses you the $10 thousand.
And there is
the launch for the second statute of limitations: the statute on collections. The
IRS will have 10 years from the date of assessment to collect the $10 thousand
So you have two
statutes of limitation: one to assess and another to collect. If they both go
to the limit, the IRS can be chasing you for longer than your kid will be in
grade and high school.
What was I discussing
with my CPA friend?
if his client does not (further) extend the statute?
observe the obvious: his client would provoke the bear. The bear will want to
strike back. The way it is done – normally – is for the bear to bill you
immediately for the maximum tax and penalty under audit. They will spot you no
issues, cut you no slack. They will go through the notice sequence as quickly
as possible, as they want to get to that SNOD. Remember that the SNOD allows 90
days to appeal to the Tax Court, so the bear will want to send you that SNOD at
least 91 days out, allowing that last day to record it (that is, assess you).
The bear will not cut it that close, but you get the idea.
has extended the statute until February. Working backward 90 days, the IRS
would have to wrap up the audit, go through its notices and send the SNOD no
later than some day in November. It is late August as I write this. The bear
would have approximately 3 months to react if the client refuses to extend the
What are the
odds the IRS machinery, especially in 2015, will work in such a constrained
you have a conversation between two CPAs.
would not provoke the bear, especially in a case where more than one tax year
is involved. I view it as climbing a tree to get away from a bear. It appears brilliant
until the bear begins climbing after you.
I suspect my friend’s client has a
different temperament. I am looking forward to see how this story turns out.
remember when the Washington Redskins and the Miami Dolphins went to the Super
Bowl? It was 1983, and I was living in Florida at the time. I am pretty sure I
was rooting for the Florida team. The Redskins had a hard-charging fullback
named John Riggins. His nickname was “Diesel” and he scored a touchdown on a
forty-something yard run. Blocking for
him was (among others) George Starke, an offensive tackle. The Washington offensive linemen, the ones who block for the quarterback and running back, were known as The Hogs.
George Starke is second from the left.
very much on the backside of his career at that point. He shortly thereafter left
football and opened a car dealership in Maryland. He couldn’t help but notice
that the dealership had difficulty recruiting service technicians. He helped
establish a technical school to educate and train technicians. He also hoped
that - by providing a realistic hope for a better life – the school would also
help with the poverty and violence in the area.
eventually sold the dealership and cofounded the Excel Institute, a nonprofit program
that provided a two-year reading, writing, arithmetic and technical skills
curriculum. The program was free of charge, but one had to commit.
a salary and housing allowance, as well as a credit card. He would charge
business and personal expenses on the card. The personal charges were segregated
on the books and records. George discontinued any personal charges in 2006, and
from 2007 onward the only activity relating to the credit card was a payroll
deduction to repay the balance.
There was a change
in the Board, and Starke did not like the new direction of things. He stopped fundraising.
He left the Excel Institute altogether in 2010.
Excel put the
remaining balance due from George of $83,698 on a Form 1099, sent a copy to
George, a second to the IRS and figured that was that.
not include the $83 grand on his individual tax return, however.
noticed and insisted that George do so. George said no.
And off to Tax
Court they went.
tell me: do you think George has a prayer?
As you know, forgiveness of a loan triggers income. The tax issue
is whether these monies were ever a loan.
thought is: of course they were! Heck, he was paying it back, wasn’t he?
someone gives you money does not mean that there exists a loan. A loan implies
that both sides anticipate the monies will be repaid. It would also be swell if
there were some attention to the basic formalities, like perhaps a loan
agreement and repayment terms.
And – just to
dream – maybe interest could be charged on the whole affair.
There was no
loan agreement. Excel itself gave mixed messages to the Court on whether it
thought the monies were a loan. George told the Court that he never had any intention
of paying back the money, and that he thought the payroll deductions were for
health insurance or something like that.
If not a
loan, then what were the monies to George?
advances, akin to nonrecoverable draws.
more easily understood in a draw-against-commission environment. Draws are intended to
provide some predictable cash flow to the salesperson. Say that a salesperson
receives commissions, and against the commissions is a $5,000 monthly draw. There are two types of draws - recoverable and nonrecoverable. A nonrecoverable draw does not have to be paid back should a saleperson fail to meet quota. A recoverable draw does have to be paid back. Granted, a salesperson who fails on a continuous basis to meet quota would soon be unemployed, but that is a different conversation. For our purposes, the key is that a nonrecoverable draw represents income upon receipt.
Back to our
pulled his 2010 tax year.
no advances in the 2010 tax year.
received advances in 2006.
nothing to tax in 2010 because George received no monies in 2010.
should have pursued his 2006 tax year. They did not, nor could they under the statute
dismissed the case. George won. The IRS
I am curious
why the IRS even bothered. The only thing I can figure is that they were hoping
for a miracle play. Maybe like John Riggins running that football for a
touchdown in Super Bowl XVII with George Starke blocking for him.
You may know
that P&G is streamlining, selling off non-core lines of business. It just
concluded a deal to sell 43 beauty brands, including Clairol and Max Factor, to
Coty, Inc. The deal appears to be good for Coty, as it will double sales and
transform Coty into one of the largest cosmetic companies in the world. P&G
in turn receives $12.5 billion.
it interesting to the tax planners is the structure of the deal: P&G is
using a “reverse-Morris” structure. It combines a carve-out of unwanted assets
(unwanted, in this case, by P&G) with a prearranged merger. The carve-out is
nontaxable, but if you err with the merger the carve-out becomes taxable. This
is a high stakes game, and woe unto you if the IRS determines that the merger
was prearranged. The reverse Morris is designed to directly address a
is a “regular” Morris?
that you own a successful and publicly-traded company (say Jeb). You have a line
of business, which we shall call Lindsey. Someone (“Donald”) wants to buy
Lindsey. Jeb could flat-out sell Lindsey, but the corporate taxes might be
outrageous. Jeb could alternatively spinoff Lindsey to you, and you in turn could
sell to Donald. That would probably be preferable.
center is the classic tax issue with C corporations: double taxation. If Jeb
sells, then Jeb would have corporate taxes. Granted, Jeb would distribute the
after-tax proceeds to you, but then you would have individual taxes. The
government might wind up being the biggest winner on the deal.
Let’s spinoff Lindsey tax-free to you, and you sell to Donald. There would be
one tax hit (yours), which is a big improvement over where we were a moment
cannot do that.
under regular corporate tax rules a tax-free merger with Donald within two
years of a spinoff would trigger BAD tax consequences. We are talking about the
spinoff being retroactively taxable to Jeb. Jeb will have to amend its tax return
and write a big check. That is BAD.
you could tell Donald to take a hike for a couple of years while you reset the
clock. Good luck with that.
You talk to
your accountant (“Hillary”). She recommends that you have Jeb borrow a lot of
money. You then drop Lindsey into a new subsidiary and spinoff new Lindsey to
you. You leave the debt in Jeb. You then sell Jeb to Donald. Donald takes over
the debt. He doesn’t care. Donald just offsets whatever he was going to pay you
by that debt.
This is a
Morris deal and Congress did not like it. It looked very much like a payday.
cash is in Lindsey
debt is in Jeb
keep the money that is in Lindsey
government doesn’t get any money from anybody
was not getting its vig. Congress in response wrote a new section into the tax
Code (Section 355(e)) which triggers gain if more than 50% control of either
the parent or subsidiary changes hands.
pretty much will shut down a Morris deal. Donald wants more than 50% control.
Donald is like that.
355(e) presented a challenge to the tax attorneys and CPAs. Think of it as an epic
confrontation between a chromatic Great Wyrm and your 28th level paladin at the
weekly Saturday night D&D game. The players were not backing down. No way.
said “the deal will work if the buyer will accept less than 50% control.”
our example above and introduce a different buyer (let’s call him Bernie).
Bernie wants to buy Lindsey. Bernie is willing to accept less than 50%, as
contrasted to that meanie Donald. Same as before, let’s drop Lindsey into a new
subsidiary. New Lindsey borrows a lot of money and ships it to Jeb. New Lindsey,
now laden with debt, is sold to Bernie. Bernie takes over the debt as part of
the deal. When the dust settles, Bernie will own less than 50% of new Lindsey,
which gets us out of the Section 355(e) dilemma.
You in turn keep
Jeb and the cash.
And that is
the reverse Morris. We sidestep Section 355(e) by not allowing more than 50% of
either Jeb or Lindsey to change hands.
Why do we
not see reverse Morris deals more often? There are three key reasons:
It requires a buyer that is smaller
than the target, but not so small that it cannot do the deal.
There will be new debt, likely
significant. This raises the business risk associated with the deal, as the
bank is going to want its money back.
The new company’s management and
board may be an issue. After all, the buyer BOUGHT the company. It is not
unreasonable that Bernie wants to control what he just bought. I would want to
drive the new car I just bought and paid for.
family of Germany owns approximately two-thirds of Coty. Even though Coty is
acquiring less than 50% of the P&G subsidiary, the Reimann’s will own a
large enough block of stock to have effective control. That must have helped
make the reverse Morris attractive to Coty.
deals are not unicorns, but there have been less than 40 of them to-date. That
makes them rare enough that the tax specialists look up from their shoes when
one trots out. P&G by itself has had three of them over the last ten or so
years. Someone at P&G likes this technique.
Late on a
dark and stormy Saturday night, the Congressional Spartans - urged on by Poppa John's
and the National Tomato Growers Association – passed a sweeping vegetable care
bill by a vote of 220-215.
went to the Senate, where its fate was sadly in doubt. The fearless majority
leader Harry Leonidas negotiated agreements with several recalcitrant senators,
including the slabjacking of New Orleans, an ongoing automatic bid for the
Nebraska Cornhuskers to the college Bowl Championship Series and the relocation
of Vermont to somewhere between North Carolina and Florida. After passage, the
bill was signed by the president while on the back nine at Porcupine Creek in Rancho
consequence of this visionary act, Americans now had access to affordable
tomatoes, thanks to market reforms and consumer protections put into place by
this law. The law had also begun to curb rising tomato prices across the system
by cracking down on waste and fraud and creating powerful incentives for
grocery chains to spend their resources more wisely. Americans were now
protected from some of the worst industry abuses like out-of-season shortages
that could cut off tomato supply when people needed them the most.
and Massachusetts established state exchanges to provide tomato subsidies to individuals
whose household income levels were below the threshold triggering the maximum federal individual income tax rate (presently 39.6 percent).
The remaining states had refused to establish their own exchanges, prompting the
federal government to intervene. The Tax Exempt Organization Division at the
IRS, recognized for their expertise in technology integration, data development
and retention, was tasked to oversee the installation of federal exchanges in those backwater baronies. IRS Commissioner Koskinen stated
that this would require a reallocation of existing budgetary funding and – as a
consequence - the IRS would not be collecting taxes from anyone in the Central
time zone during the forthcoming year.
states that did not establish their own exchanges filed a lawsuit (Bling v Ne’er-Do-Well) challenging a key
part of the TomatoCare law, which read as follows:
The premium assistance amount determined under this
subsection with respect to any vegetable
coverage amount is the amount equal to the lesser of the greater…”
states pointed out that, botanically, a tomato was a fruit. A fruit was defined
as a seed-bearing vessel developed from the ovary of a flowering plant. A
vegetable, on the other hand, was any other part of the plant. By this standard,
seedy growth such as bananas, apples and, yes, tomatoes, were all fruits.
There was great
fear upon the land when the Supreme Court decided to hear the case.
upon how the Supreme Court decided, there might be no tomato subsidies because
tomatoes were not vegetables, a result clearly, unambiguously and irretrievably-beyond-dispute
not the intent of Congress on that dark, hot, stormy, wintery Saturday
night as they debated the merits of quitclaiming California to Mexico.
began under great susurration. The plaintiffs (the 54 moon landings) read into evidence
definitions of the words “fruit” and “vegetables” from Webster’s Dictionary,
Worcester’s Dictionary, the Imperial Dictionary and Snoop Dogg’s album “Paid
tha Cost to Be da Bo$$.”
The Court acknowledged
that the words “fruit” and “vegetable” were indeed words in the English
language. As such, the Court was bound to take judicial notice, as it did in
regard to all words in its own tongue, especially “oocephalus” and “bumfuzzle.”
The Court agreed that a dictionary could be admitted in Court only as an aid to
the memory and understanding of the Court and not as evidence of the meaning of
The Court went
Botanically speaking, tomatoes are the fruit of the vine. But
in the common language of the 202 area code, all these are vegetables which are
grown in kitchen gardens and, whether eaten cooked, steamed, boiled, roasted or
raw, are like potatoes, carrots, turnips and cauliflower, usually served at
dinner with, or after, the soup, fish, fowl or beef which constitutes the principal
part of the repast.”
The Court decided:
But it is not served, like fruits
generally, as a dessert.”
the Court decided that tomatoes were vegetables and not fruit. The challenge to
TomatoCare was courageously halted, and the liberal wing of the Court – in a show
of their fierce independence and tenacity of intellect – posed for a selfie and
went to Georgetown to get matching tattoos.
Thus ends our
There was no
TomatoCare law, of course, but there WAS an actual Supreme Court decision
concerning tomatoes. Oh, you didn’t know?
Back in the
1880s the Port of New York was taxing tomatoes as vegetables. The Nix family,
which imported tons of tomatoes, sued. They thought they had the law – and common
sense – on their side. After all, science said that tomatoes were fruit. The
only party who disagreed was the Collector of the Port of New York, hardly an
The tax law
in question was The Tariff of 1883, a historical curiosity now long gone, and
the case was Nix v Hedden.
And that is
how we came to think of tomatoes as vegetables.