Wednesday, September 30, 2015

Will Yahoo take Alibaba For A Spin?

I have – on and off – been following the Yahoo and Alibaba story. 

It has to do with a proposed spin of a corporate subsidiary. Unless someone has reason to be there, corporate reorganizations – such as spins - are not the easiest reading.  

To set it up, Yahoo owns approximately 15% of Alibaba Group, which itself is a Chinese internet giant. Yahoo has proposed spinning its Alibaba shares into a separate publicly traded company. Spinning in a tax context means getting it out of Yahoo itself and into the hands of the shareholders. This in turn has caught the IRS’ eye, mostly because Yahoo wants to do this on a tax-free basis.

There is gigantic money here. Yahoo’s stake in Alibaba may be worth around $35 billion. Albeit Yahoo is not intending to spin all its Alibaba stock, it would spin enough to trigger an $8 to $10 billion tax – if its tax advisors do not get it right.

QUESTION: How would you like to be the tax honcho that gives this thing a green light? No pressure …

We have talked about reorganizations before. It is a complicated area of tax law, but they have gained in importance as a means of mitigating the double taxation of corporations.  Proctor & Gamble, for example, uses several flavors of reorganizations on a routine basis. What is different about Yahoo?

In general, the IRS likes to see at least a couple of historically active businesses inside the corporate shell. Perhaps one business makes soap and the other makes baby lotion, and they have for as many years as Carter has liver pills. For whatever reason, the soap business wants to go one way and the baby lotion business another. The IRS sees two historically active businesses before and two afterwards. Comply with some technicalities and the IRS is willing to accept that there exists a business purpose for the reorganization – that is, a purpose other than avoiding the tax man.

Let’s stir the pot. Say that you stuff one of the companies with a lot of investment assets, such as Alibaba stock. How does the IRS feel now?

Well, I suppose that would vary. If the stock were 15% of total assets, I suspect you would not draw a long, piercing stare from the IRS. What if it climbs to 50%, 60%, 70%? We can both anticipate the IRS getting increasingly cynical as those percentages climb.

And that is where Yahoo is going.

Yahoo CEO Marissa Mayer

Yahoo is proposing to stuff Yahoo Small Business, an existing small line of business, into a subsidiary. Yahoo would then drop the Alibaba stock and spin the resulting subsidiary to its shareholders.  The value of the Alibaba stock would completely dwarf the value of Yahoo Small Business.

But why?

Let’s say the new company will be called Yaboo. Yaboo would be stuffed with so much Alibaba stock that it would essentially be a “tracking” stock for Alibaba. Throw in some market arbitrage and Alibaba may find Yaboo an attractive target for acquisition.

Then again, maybe Yahoo just wants to kick Yahoo Small Business out of the nest so it can learn to fly. On the same plane of reality, I am still available if an NFL team wants to make me an offer.

Generally speaking, tax advisors approach the IRS when they get into these high-stakes situations. They may meet informally in order to gauge IRS sentiment before requesting a private letter ruling, for example. The ruling is “private” in that it is directed to one taxpayer (Yahoo) and its unique facts (Alibaba). Yahoo’s advisors would meet with IRS attorneys to discuss, review and argue. If the IRS agrees with the proposed transaction, then Yahoo would request the ruling. If the IRS disagrees, Yahoo would not. It is unlikely that you or I would do this, as failure to submit a ruling request would be considered invitation to an audit. A company the size of Yahoo is under constant audit, however, so this threat is considerably diminished. 

You know – absolutely know – that Yahoo is going to request a private letter ruling. There is way too much money at stake here.

And then on September 2 the IRS came out with Notice 2015-59, saying that it was stopping its practice of issuing rulings on transactions that are suspiciously similar to the proposed Yahoo spin.


Now what does Yahoo do? Does it rely on an opinion from its law firm without an IRS ruling? Does it retract the spin? Does it adjust the spin so the percentages of the stock and active business are not so skewed?

Remember: just because the IRS says it does not make it so. There is complex law here, and a Court may have to decide.

For a tax geek, this is like the latest installment of Mission Impossible.

Thursday, September 24, 2015

Do You Earn Too Much For An IRA?

I have received several questions about IRAs recently.  They can roughly be divided into two categories:

(1) Do I qualify?
(2) I converted to a Roth and it is worth less than what I paid tax on.

I wondered whether there is some way to blog about this without our eyes glazing over. IRAs are a thicket of seemingly arbitrary rules.

Let’s give it a try by discussing a couple of situations (names and numbers changed, at least a smidge) that came across my desk this year.     

Our first example:

Matt is single and makes around $200,000 annually. He is over age 50 and maxes-out his 401(k). He heard that he can put away an additional $1,000 in an IRA for being over age 50. He puts $6,500 into a Roth, and then he calls his tax advisor to be sure he was OK.

He is not.

His 401(k) is fine. There generally are no problems with a 401(k), unless you are one of the highly-compensated and the plan administrator sends money back to you because the plan went “top heavy.” 

It is the IRA that is causing headaches.

He has a plan at work (the 401(k)) AND he made an IRA contribution. The tax rules can get wonky with this combination.

You see, having a plan at work can impact his ability to make an IRA contribution. If there is enough impact, He cannot make either a traditional (which means “deductible”) or Roth IRA contribution.

 Is it fair? It’s debatable, but those are the rules.

What is too much?

(1) A single person cannot make a traditional IRA contribution if his/her income exceeds $71,000. 

CONCLUSION: He makes $200,000. He does not qualify for a traditional (that is, deductible) IRA.

(2) A single person cannot make a Roth contribution if his/her income is over $131,000.

CONCLUSION: He makes too much money to make a Roth contribution. 

Did you notice the two different income limits for a regular and Roth IRA? It is an example of the landmines that are scattered in this area.

What should Matt do?

Let’s go through example (2) and come back to that question.

Sam and Diane are married. They are both in their 50s and make approximately $180,000 combined. They did well in the stock market this past year, picking up another $15,000 from capital gains as well as dividends, mostly from their mutual funds. Diane and Sam were a bit surprised about this at tax time.

Diane has a 401(k) at work. Sam does not. Diane contributes $6,500 to her traditional (i.e., deductible) IRA, and Sam contributes $6,500 to his Roth.

There is a problem.

The 401(k) is fine. The 401(k) is almost always fine.

Again it is those IRAs. The income limits this time are different, because we are talking about a married couple and not a single person. The limits are also different because Sam does not have a retirement plan at work.

A reasonable person would think that Sam should be allowed to fully fund an IRA. To require otherwise appears to penalize him as he has no other retirement plan. Many would agree with you, but Congress saw things differently. Congress said that there was a retirement plan at work for one of the two spouses, and that was enough to impose income limits on both spouses. Seems inane to me and more appropriate for the Gilligan’s Island era, but – again – those are the rules.

(1) Since Diane has a plan at work, neither can make a traditional/deductible) IRA contribution if their combined income exceeds $193,000. 

Note that she would have had a deductible IRA (at least partially deductible) except for the dividends and capital gains. Their combined income is $195,000 ($180,000 + $15,000), which is too high. No traditional/deductible IRA for Diane.

(2) Roth contributions are not allowed for marrieds with income over $193,000.

OBSERVATION: Hey, that is the same limit as for a traditional/deductible IRA. Single people had different income limits for a traditional/deductible and Roth IRA. 

Q: Why is that? 

A: Who knows. 

Q: How does a tax person remember this stuff?

A: We look it up.

They went over $193,000. Sam cannot make a Roth contribution. 

Diane and Sam did their tax planning off their salaries of $180,000, which was below the income limit. They did not anticipate the mutual funds. What should Diane and Sam (and Matt) do now?

First, you have to do something, otherwise a penalty will apply for over-funding an IRA. Granted the penalty is only 6%, but it will be 6% every year until you resolve the problem.

Second, you can contact the IRA custodian and have them send the money back to you. They will also send back whatever earnings it made while in the IRA, so there will be a little bit of tax on the earnings. Not a worst case scenario.

Third, you can have the IRA custodian apply the contributions to the following year. Maybe they will, maybe they won’t.  It would be a waste of time, however, if your income situation is expected to remain the same.

Fourth, you can move the money to a nondeductible IRA.


Bet you did not realize that there are THREE types of IRAs. We know about the traditional IRA, which means that contributions are deductible. We also know about Roth IRAs, meaning that contributions are not deductible. But there is a third - and much less common – IRA.

The nondeductible IRA. 

You hardly hear about them, as the Roth does a much better job. No one would fund a nondeductible if they also qualified for a Roth. 

There is no deduction for money going into a Roth IRA, but likewise there is no tax on monies distributed from a Roth. Let that money compound for 30 or 35 years, and a Roth is a serious tax-advantaged machine.

There is no deduction for money going into a nondeductible IRA, but monies distributed will be partially taxed. You will get your contributions back tax-free, but the IRS will want tax on the earnings.  The nondeductible IRA requires a schedule to your tax return to keep track of the math. 

The Roth is always better: 0% being taxed is always better than some-% being taxed. 

Until you cannot contribute to a Roth.

You point out that Matt, Diane and Sam are over the income limits. Won’t the nondeductible IRA run into the same wall?

No, it won’t. A nondeductible IRA has no income limit. 

And that gives the tax advisor something to work with when one makes too much money for either a traditional/deductible or Roth IRA.

Let’s advise Matt, Diane and Sam to move their contributions to a nondeductible IRA.  That way, they still make a contribution for the year, and they preserve their ability to make a contribution for the following year. Some retirement contribution is better than no retirement contribution.

BTW, what we have described – moving one “type” of IRA to another “type” – is sometimes called “recharacterization.” More commonly, it refers to moving monies from a Roth IRA to a traditional/deductible IRA. 

For example, if you made a Roth “conversion” (meaning that you transferred from a traditional/deductible IRA to a Roth) in 2014, you might be dismayed to see the stock market tanking in 2015. After all, you paid tax when you moved the money into a Roth, and the account is now worth less. You paid tax on that money!

There is an option: you can “recharacterize” the Roth back to a traditional IRA in 2015. You would then amend your 2014 tax return and get a tax refund. You have to recharacterize by October 15, 2015, however, as that is the extended due date for your 2014 tax return.  Does it matter that you did not extend your 2014 return? No, not for this purpose. The tax Code just assumes that you extended. 

You can recharacterize some or all of the Roth, and there are some rules on when you can move the monies back into a Roth.

The nondeductible IRA is also involved in a technique sometimes called a “backdoor” Roth. This is used when one makes too much money for a Roth contribution but nonetheless really wants to fund a Roth. The idea is to fund a nondeductible IRA and then convert it to a Roth. This works best with an IRA contribution made after December 31st but before the tax return is due.

EXAMPLE:  You make a $5,500 nondeductible IRA contribution on February 21, 2016 for your 2015 tax year. You convert it to a Roth the next day. Think about the dates for a moment. You made a 2015 IRA contribution (albeit in 2016). You converted in 2016. Even though this happened over two days, the two parts of the transaction are reported in different tax years.

BTW, converting to a Roth means that you literally move the money from one account to a different account. It is not enough to just change the name of the account. Formality matters in this area. 

There are rules that make the backdoor all-but-impossible if you have other IRA accounts. It is one of those eye-glazing moments in this area, so we won’t go into the details. Just be aware that there may be an issue if you are thinking about a backdoor Roth.

Thursday, September 17, 2015

Amos And Rodman

Do you remember Dennis Rodman?

He is more recently associated with traveling to North Korea and functioning as an off-the-record ambassador with Kim Jong-un, the dictator of that country. In the 1990s he was better known for playing with Michael Jordan and Scottie Pippen on the Chicago Bulls.

Early in 1997 the Bulls were playing the Minnesota Timberwolves. Rodman went after a loose ball, falling into a group of photographers on the sidelines. Rodman twisted his ankle. While getting back on his feet he kicked one of the photographers in the groin.

The photographer’s name was Eugene Amos. He went to a hospital, where he had difficulty walking and was in noticeable pain. The doctors offered pain medication but he refused, explaining that he was already taking medications for a preexisting back injury. Some dispute arose, and Amos left the hospital without being discharged.

He hired an attorney immediately upon leaving. 

The next day Amos went to another hospital. He complained about his groin, but the doctors did not notice anything other than the expected swelling. They were concerned about his back, though, and took a round of X-rays.

Before the lawsuit was filed, Rodman paid him $200,000 to go away.

Oh, and Amos had to sign a confidentiality provision to not discuss the matter. Standard stuff, but given that we are talking about it the agreement did not hold up as expected.

There is a Code section that addresses physical injuries:
          § 104 Compensation for injuries or sickness.
(a)  In general.
Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include-
(1)   amounts received under workmen's compensation acts as compensation for personal injuries or sickness;
(2)  the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

Relying upon Section 104(a)(2), Amos excluded the $200,000 from his 1997 tax return.

Wouldn’t you know the IRS pulled his return for audit?

And they disagreed with his exclusion of the $200,000 from taxable income. Why? As far as they were concerned, Rodman paid Amos all but $1 of the $200,000 to keep his mouth shut. The IRS was, however, willing to exclude the $1 from income.

Amos disagreed. He took one in the orchestra, after all.

Off to Tax Court they went.

The IRS argued that Amos had not proven his physical injuries, and that Mr. Rodman himself was skeptical that Amos sustained any injuries to speak of. The IRS further argued that Amos was required to pay $200,000 in damages to Rodman should he violate the confidentiality agreement, clearly indicating that Rodman did not intend to pay anything for alleged physical injuries.

The Court immediately dismissed the first argument, noting that if an action has its origin in a physical injury, then damages therefrom are treated as payments received on account of the injury.

The Court decided that the “dominant” reason for the settlement was to compensate Amos for his claimed injuries. However, the settlement also indicated that Rodman was paying some portion for Amos not to:

(1)   Defame Rodman
(2)   Disclose either the existence or amount of the settlement
(3)   Publicize facts relating to the incident, and
(4)   Assist in criminal prosecution against Rodman

Problem is, the agreement did not separate how much was paid for what.

The Court did what it had done many times before: it came up with a number.

The Court decided that $120,000 was payable for physical injuries and $80,000 was paid for confidentiality terms. Therefore $120,000 could be excluded under Section 104(a)(2). The $80,000 could not.

The Amos decision changed how personal injury attorneys draft documents. It is now expected that the injured party will not want to sign any confidentiality agreement. If there is one, anticipate the injured party to stipulate a nominal amount to the agreement and to request indemnification for any resulting taxes, penalties, interest, attorney fees and court costs.

And that is how Dennis Rodman contributed to the tax literature.

Thursday, September 10, 2015

Taxing A Corvette

I came across an old case recently. It made me smile, as it reminded me of earlier – and skinnier – times.

Let’s set this up.

There are, broadly speaking, two accounting methods when deciding whether you have reportable income for a period: the cash method and the accrual method. There are a variety of sub, sorta- and who-actually-understands-this methods, but cash and accrual are enough for right now.

The cash method is easy: if you can deposit it at the bank you have income.  Maybe you decide not to deposit at the bank until next week, but it is still income today. Why? Because you can deposit it. The definition is “can” not “did.”

Accrual is trickier. Generally it means that you sent an invoice to someone. The act of invoicing means you have income, as someone owes you. What if you delay invoicing for a week or two? Well, then you have a variation on the above cash-basis reasoning: you could have but didn’t. Again, it is the “could,” not the “did,” that drives the test.

What if you are on the cash method and somebody pays you with property instead of cash? You have income. It makes sense when you remember that cash is a form of property. We have just gotten so used to it that we don’t think of cash that way. For tax purposes, though, someone paying you in asiago cheese and gluten-free crackers still represents income. Granted, we have to translate cheese-and-crackers into dollars, but income it is.

Let’s say that you played football. Not just any football, however. You were Vince Lombardi’s running back. It is December 31, and you and Lombardi and the Green Bay Packers are playing the New York Giants in the National Football League Championship.

COMMENT: NFL historians will immediately recognize that this was before the Super Bowl era. There was no game called the Super Bowl until the two leagues – the National Football League and the American Football League – merged in 1966. The first two Super Bowls were won tidily by Lombardi and the Packers. In Super Bowl 3 Joe Namath famously led the New York Jets over the Baltimore Colts.

So it is the championship game. You are the running back. It is December 31 and you are playing outside in Green Bay. I presume you are freezing. You run wild and score 19 points, establishing a league record. You are selected after the game by Sport Magazine as the most valuable player, which comes with the prize of a new Corvette. 


By the way, your Corvette is waiting for you in New York. It is now the evening of December 31, 1961.

Tax issue: Do you have income (the value of that Corvette) in 1961?

The IRS said you did.

But you throw the IRS a loop: the car is not income. No, siree. It was a gift. Alternatively, it is nontaxable to you as a prize or award.

I give you kudos, but the concept of a gift requires the presence of detached and disinterested generosity. While a creative argument, it could not be reasonably argued that a for-profit magazine was awarding an expensive car to the most valuable player of a televised sporting event out of a detached and disinterested generosity. It was much more likely that both Sport Magazine and General Motors were expecting publicity, advertising and social buzz from the award.

You still have your second argument, though.

Problem is, the prize or award exception requires you to receive it for an educational, artistic, scientific or civic achievement.

You argue your point: being a star football player “calls for a degree of artistry” requiring techniques based on “scientific” principles.


The Court decides:

We believe that petitioner should be caught behind the line of scrimmage on this particular offensive maneuver.”

You have income. And the Court gave us a great quote.

But when do you have income: 1961 or 1962?

The Court reasons through the obvious. You are in Green Bay. The car is in New York. You cannot get to that car - much less title it - unless you had Star Trek technology. However, it is 1961 and Star Trek is not on television yet. You have income in 1962, the following day.

Your tax case is seminal in developing the tax doctrine of constructive receipt. Normally constructive receipt accelerates when you have income, but it did not in your case.You could not have made it to the bank even if you wanted to.

So why did the IRS push the issue of 1961 versus 1962? They didn’t. Remember that you were arguing that the Corvette wasn’t taxable. The IRS had to fight back on that issue. The 1961 thing was a sidebar, albeit that is what the case is remembered for all these years later.

By the way, do you know which football player we have been talking about?