4.10.13  Certain Technical Issues

Manual Transmittal

March 16, 2015

Purpose

(1) This transmits a revision of IRM 4.10.13, Examination of Returns, Certain Technical Issues.

Material Changes

(1) Minor editorial changes have been made throughout this IRM. Website addresses, legal references, and IRM references were reviewed and updated as necessary.

(2) Significant changes to this IRM are reflected in the table below:

Reference Description
IRM 4.10.13.2 Discussion on the accumulated earnings tax re-emphasizing that the burden of proof is on the Commissioner unless a notification is sent to the taxpayer.
IRM 4.10.13.3 Discussion on the transferee liability as a tool used to collect a taxpayer's tax liability. Includes information based on Transferor-Transferee Liability Cases
IRM 4.10.13.4 Discussion of Related Party transactions and IRC 482 emphasizing examiners understanding that taxpayers must clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions.
IRM 4.10.13.5 Discussion of various adjustments between correlative U.S. taxpayers.
IRM 4.10.13.7 Discussion of Change in Accounting Method
IRM 4.10.13.8 Discussion involving the procedures set by Technical Services on real estate developers: alternative treatment of common improvements under Rev. Proc. 92-29
IRM 4.10.13.10 Discussion on personal holding company deficiency dividends with emphasis on Form 976 Procedures.
Exhibit 4.10.13-6 Court Cases - Change in Accounting Methods removed as unnecessary
Exhibit 4.10.13-7 Personal Holding Company Worksheet removed as unnecessary

Effect on Other Documents

This IRM supersedes IRM 4.10.13, dated March 30, 2005.

Audience

Examination personnel in SBSE, LB&I and Specialty Programs

Effective Date

(03-16-2015)

Joseph L. Wilson
Director, Field-Campus Examination/Automated Under Reporter (AUR) Policy
Small Business/Self-Employed

4.10.13.1  (03-16-2015)
Section Overview

  1. The topics covered and their subsections are listed below:

    IRM Subsection Topic
    IRM 4.10.13.2 Accumulated Earnings Tax (IRC 531)
    IRM 4.10.13.3 Transferor-Transferee Liability Cases
    IRM 4.10.13.4 Related Party Transactions (IRC 482)
    IRM 4.10.13.5 Adjustments Between Correlative Taxpayers (also known as Whipsaw Issues)
    IRM 4.10.13.6 Activities Not Engaged in For Profit - Hobby Loss (IRC 183)
    IRM 4.10.13.7 Change in Accounting Method
    IRM 4.10.13.8 Real Estate Developers: Alternative Treatment of Common Improvements Under Rev. Proc. 92-29
    IRM 4.10.13.9 Self-Rented Property and Renewable Options
    IRM 4.10.13.10 Personal Holding Company Deficiency Dividends
  2. Additional information on certain of the above topics may be found in the following Examining Officers Guide (EOG) IRMs:

    • IRM 4.11.5 , Allocations of Income & Deductions;

    • IRM 4.11.6 , Change in Accounting Method; and

    • IRM 4.11.52 , Transferee Liability Cases;

4.10.13.2  (03-16-2015)
Accumulated Earnings Tax (IRC 531)

  1. The purpose of the accumulated earnings tax is to prevent a corporation from accumulating its earnings and profits beyond the reasonable needs of the business for the purpose of avoiding income taxes on its stockholders.

  2. Liability for the accumulated earnings tax is based on the following two conditions:

    1. The corporation must have retained more earnings and profits than it can justify for the reasonable needs of the business

    2. There must be an intent on the part of the corporation to avoid the income tax on its stockholders by accumulating earnings and profits instead of distributing them

  3. Any corporation within a chain of corporations can be subject to the accumulated earnings tax. A subsidiary corporation can be subject to the accumulated earnings tax even though the parent corporation is not subject to the accumulated earnings tax and vise versa.

  4. The accumulated earnings tax is computed on the corporation's accumulated taxable income for the taxable year or years in question.

  5. The accumulated taxable income is the corporation's taxable income with various adjustments. These adjustments are made primarily for the purpose of arriving at an amount that corresponds more closely to financial reality and thus, measures more accurately the corporation's dividend paying capacity for the year.

  6. The term "earnings and profits" is not defined in any of the revenue acts. The amount of earnings and profits for a taxable year usually is computed by adjusting taxable income in accordance with Treas. Reg. 1.312-6, 26 CFR 1.312-6.

4.10.13.2.1  (03-16-2015)
Considerations in Computing Accumulated Earnings and Profits

  1. In order for the examiner to make a determination of the corporation's accumulated earnings and profits, the following items should be considered:

    1. Book "earned surplus" should be analyzed. The book account may have been reduced by the transfers to capital, or other accounts, in the form of stock dividends or reserves.

    2. Some accounting write-offs of surplus might not qualify as write-downs of earnings and profits for tax purposes.

    3. It is generally helpful to reconcile the surplus shown in the books to earnings and profits available for tax purposes.

    4. Life insurance proceeds are a part of earnings and profits and are available for dividend distribution.

    5. Excess of percentage depletion over cost depletion constitutes a part of earnings and profits.

    6. At some time during the history of the corporation, surplus may have been reduced by writing down purchased goodwill or other intangible assets. For this reason, the examiner should prepare a careful analysis of the earned surplus account for the year under examination and at least the five preceding years, and the amount and date of any cash dividends paid shortly after the close of the year under examination. If any distribution of dividends in reorganization was made, full details of such distribution should be stated.

4.10.13.2.2  (03-16-2015)
Indicators of Intent

  1. A prerequisite to imposition of the IRC 531 tax has been that the corporation be formed or availed of for the purpose of avoiding the income tax on its shareholders. As purpose involves a state of mind or intent, it is necessary to look at the surrounding facts and circumstances in each individual case to determine whether the purpose of the accumulated earnings was to allow the shareholders to avoid the income tax or for some other purpose.

  2. The following factors should be considered in determining whether the tax avoidance purpose was present:

    1. Dealings between the corporation and its shareholders, including loans to shareholders and expenditures of corporate funds for the personal benefit of the shareholders:

      • Corporate loans to or expenditures on behalf of shareholders tend to show that the corporation has the capacity to distribute these funds as dividends, particularly if there is a pattern of these transactions

      • The loans or expenditures are substitutes for dividends and show that corporate earnings are diverted

      • The examiner should include an analysis of amounts, if any, withdrawn by the stockholders in the form of loans or advances and reflected in the asset accounts at the close of the year under examination

    2. Investments of undistributed earnings in assets having no reasonable connection with the corporation's business:

      • An inference may arise if the corporation has invested its funds for purposes which are not reasonably related to the business

      • Such unrelated investments evidence the liquidity and dividend-paying capacity of the corporation, as well as an inference that the failure to distribute such funds as dividends was for the purpose of avoiding shareholder taxes

    3. The corporation's dividend history:

      • A failure to distribute dividends or minimal payments indicates that earnings may have been accumulated to avoid shareholder taxes

      • The examiner should include a statement showing the amount of taxes actually avoided by the principal stockholders through the failure of the corporation to distribute all of its earnings for the year under consideration

      • Even if the corporation has a good dividend record and pays liberal officer-stockholder salaries, this does not in itself serve to rebut the tax avoidance factor

  3. IRM 4.8.8.2(1), Accumulated Earnings Tax, discusses that the burden of proof is on the Commissioner unless a notification is sent to the taxpayer under IRC 534 (b), Burden of Proof, prior to the issuance of a notice of deficiency. Letter 572, Proposal to Issue a Notice of Deficiency for Excess Accumulated Earnings Under IRC Section 531 is used for this notification. see Exhibit 4.10.13-3

  4. IRM 4.8.8.2(2) notes the following important points:

    1. The notification Letter 572 may be sent to the taxpayer prior to issuance of the 30-day letter or concurrently with the 30-day letter (in which case the purge date will allow for 60 days rather than the normal 30 days).

    2. The letter must be sent by certified mail, normally by the examiner using the examiner’s contact information.

    3. Only officials and Technical Services’ reviewers delegated to sign notices of deficiency pursuant to Servicewide Delegation Order 4-8 are authorized to sign notifications under IRC 534 (b) according to Rev. Proc. 56-11, 1956-1 C.B. 1028.

    4. Each case is forwarded to Technical Services to sign Letter 572. Technical Services will return the case to the group for certified mailing and suspense.

4.10.13.2.3  (03-16-2015)
Holding or Investment Company

  1. IRC 532 (a) states that the accumulated earnings tax imposed by IRC 531 shall apply to every corporation (other than those described in subsection IRC 532(b) formed or availed of for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed.

  2. IRC 532(b),Exceptions, states that the accumulated earnings tax imposed by section 531 shall not apply to a personal holding company (as defined in IRC 542,Definition of personal holding company),

  3. However a Personal Holding Company (PHC) tax is a penalty tax which discourages excessive accumulation of passive income. Regulations under IRC 547, Deduction for Deficiency Dividends, provide a method (absent fraud) for a corporation to eliminate its personal holding company tax liability for a prior year by making a distribution of a deficiency dividend. The benefits of IRC 547 are applicable when an examination results in an agreed deficiency in PHC tax. See IRM 4.8.8.4 for additional information.

  4. The examiner should set forth the basis for concluding why a corporation does not qualify as a personal holding company, and why it is a mere holding company or investment company that was formed or availed of for the purpose of sheltering its shareholders from income taxes.

4.10.13.2.4  (03-16-2015)
Reasonable Needs of the Business

  1. Examiners should consider that IRC 543 provides that earnings permitted to accumulate beyond the reasonable needs of the business shall be "determinative" of the purpose to avoid shareholder's income taxes unless the corporation shall prove to the contrary by a preponderance of the evidence. By virtue of this provision, most cases have been won or lost on the battleground of reasonable business needs.

4.10.13.2.4.1  (03-16-2015)
Effect of Prior Accumulations

  1. In determining whether current earnings were accumulated for reasonable business purposes, the examiner must make a determination of whether prior accumulations were, in fact, sufficient to meet the taxpayer’s then current and reasonably anticipated future needs. See Reg. 1.537-1(a).

  2. In making this determination, it is necessary to examine the character of the corporation's assets, since earnings used for the expansion of business plant or equipment, inventories, or accounts receivable cannot be readily distributed to the stockholders no matter how large the corporation's earned surplus may be.

  3. This issue requires a thorough analysis of the corporation's business and financial status for each year, including:

    1. Balance sheet position - meaning the size, character, and relationship of its various asset, liability and surplus accounts

    2. Profit and loss statement

    3. Liquidity and cash flow position

    4. Type of business

    5. Economic conditions prevailing in the taxpayer's business

4.10.13.2.4.2  (03-16-2015)
Factors to be Considered in Determining Reasonable Needs

  1. The term "reasonable needs of the business" includes the reasonably anticipated future needs of the business.

  2. The following items, while not exclusive, may indicate that the earnings and profits are being accumulated for the reasonable needs of the business and should be used as guides:

    1. Bona fide expansion of business or replacement of plant

    2. Acquisition of a business enterprise through purchasing stock or assets

    3. Retirement of bona fide indebtedness created in connection with the trade or business, such as the establishment of a sinking fund for the purpose of retiring bonds issued by the corporation in accordance with obligations incurred on issue

    4. Necessary working capital for the business

    5. Investments or loans to suppliers or customers

  3. Apart from the grounds specifically mentioned above, accumulations may be justified by a range of business needs. Among these are the following:

    1. Redemption of stock held by minority stockholders

    2. Need to meet competition

    3. Reserves for various business risks and contingencies such as self-insurance against casualties, potential liability from litigation, and unsettled business conditions

    4. Need to finance pension or profit sharing plans for the employer

    5. Possible loss of principal customer

    6. The IRC 303 redemption needs of the business. Examiners should thoroughly investigate the facts and circumstances in the case with a view toward determining whether the redemption was for a corporate purpose or was primarily for the benefit of the stockholders in a redemption of the stock of a minority or a majority stockholder

    7. Need to redeem excess business holdings of shareholders under IRC 4943 Taxes on excess business holdings

4.10.13.2.4.3  (03-16-2015)
Contingencies

  1. Accumulations have been justified as a result of various forms of contingencies including the following:

    1. An actual or potential lawsuit

    2. A possible liability arising out of some contractual obligation

    3. A possible business reversal resulting from the loss of a customer

    4. Accumulations to guard against competition has been justified in some cases

    5. An accumulation to provide funds to finance a self-insurance plan. This includes key men/women, as well as the more common types of risk insurance

    6. Accumulations to provide a retirement plan for employees

4.10.13.2.4.4  (03-16-2015)
Financing of Corporate Operations and Debt Retirement

  1. A corporation cannot be required to resort to the borrowing of funds under any circumstances. Therefore, the current operations of the business or planned expansion may be financed fully by retained earnings.

  2. An accumulation to retire a corporate indebtedness has in most cases been determined to be a reasonable need of the business, depending upon the reason the debt was created in the first place.

  3. The examiner should determine if the debt to be retired by the accumulation was bona fide and was incurred in connection with the trade or business.

4.10.13.2.4.5  (03-16-2015)
Effect of Subsequent Events

  1. Events subsequent to the end of the taxable year may not be used to show that retention of earnings and profits was unreasonable at the close of such taxable year if all the events indicated a reasonable accumulation at the close of the taxable year.

  2. Examiners may consider subsequent events to determine the taxpayer actually intended to carry out or has actually carried out the plans for which the earnings and profits were accumulated.

  3. The fact that the corporation did not, in fact, use the accumulated funds as originally planned does not necessarily mean that the accumulation was not reasonable when made.

  4. If the earnings are not used to accomplish the purpose for which they were to be used, this may indicate that the earnings were not to be used for the indicated purpose in the first place and will make any future accumulations more difficult to justify.

4.10.13.2.4.6  (03-16-2015)
Working Capital

  1. Working capital is defined as current assets minus current liabilities. Working capital is the liquidity of a business that is used in its day-to day operations.

  2. The working capital needs of a business are justification of accumulating earnings and profits.

4.10.13.2.5  (03-16-2015)
Operating Cycle Approach

  1. The formula for calculating the working capital needs of a manufacturing concern or similar business is set forth in the Bardahl Manufacturing Corp. v. Commissioner, T.C. Memo. 1965-200. In that case, the Tax Court permitted the corporation to accumulate enough working capital to cover the normal expenses of one operating cycle plus any anticipated extraordinary operating expenses. This is known as the operating cycle approach, which uses a mathematical formula to compute working capital needs.

  2. A normal operating cycle is the period of time required to convert cash into raw materials, raw materials into inventory of finished goods, finished goods inventory into sales and accounts receivable, and accounts receivable into cash.

4.10.13.2.5.1  (03-16-2015)
Selection of Appropriate Working Capital Formula

  1. Inasmuch as the need for working capital has long been recognized as the main reason for accumulating earnings and profits, the examiner should compute the Bardahl formula as modified by the Empire Steel Casting decision, on a preliminary basis by using the figures shown on the return to calculate reasonable working capital needs. If the taxpayer's net working capital exceeds the calculated reasonable working needs, then further analysis should be made following the procedures set forth in Exhibit 4.10.13-1

  2. In an expanding business, the examiner should obtain the necessary financial information to compute the corporation's working capital needs in the years immediately preceding the year or years under examination and the years immediately succeeding the year or years under exam.

  3. For seasonal business, the Bardahl International formula is considered more appropriate for peak inventory and receivable months. For service business, the formulas should be modified to consider the average length of time required to perform on a contract rather than use the operating inventory turnover concept. The Apollo formula may have application to non-manufacturing businesses.Exhibit 4.10.13-2

  4. As noted above, the Bardahl formula is" one test" and is not necessarily applicable to every IRC 531 case. Examiners who are considering IRC 531 should analyze each case with respect to specific facts before determining the type of operating cycle approach most appropriate.

  5. The latest criteria relied on in current court decisions should be considered.

4.10.13.2.6  (03-16-2015)
Relationship to Other IRC Sections

  1. Consideration should be given to the relationship between IRC 531, Imposition of accumulated earnings tax , IRC 541, Imposition of Personal Holding Company Tax and IRC 545, Undistributed Personal Holding Company Income, since these sections consider the problem of tax avoidance through undistributed earnings. An examiner may find that a potential IRC 541 case is actually a good IRC 531 case because the taxpayer does not qualify as a personal holding company.

4.10.13.2.7  (03-16-2015)
Data to be Furnished When Application of IRC 531 is Recommended

  1. The examiner should weigh all available evidence before proposing to apply IRC 531. When it is determined that IRC 531 should not be applied, the examiner will make a clear, concise statement in his/her report transmittal or workpapers supporting the recommendation.

  2. If an examiner recommends application of IRC 531, he/she will include the data, specified in (3) below, in the workpapers or in the report transmittal. Since disclosure of certain information specified below might violate the disclosure provisions, the report will only include information considered vital to the taxpayer's understanding of the case.

  3. The examiner will include in the report transmittal or workpapers the following data:

    1. A history of the corporation from the date of its incorporation, fully setting forth the purpose for which it was formed. Plus comments, if applicable, regarding the following:
      assets transferred thereto,
      capital stock issued in exchange for such assets,
      actual paid-in capital,
      whether represented by par or no par stock, and if no par stock, the stated value, if any, ascribed thereto and kind of business in which engaged.

    2. Names and addresses of the principal or controlling stockholders and number of shares held by each at the close of the year involved.

    3. Names and titles of the officers of the corporation, stock ownership (if any) and amount of compensation received, if such information is not contained in the corporate return.

    4. A statement of substantial amounts, if any, withdrawn by the stockholders in the form of loans or advances and reflected in the asset accounts at the close of the year under examination.

    5. An analysis of the earned surplus account for the year under examination and at least the five preceding years, which will show in particular both taxable and nontaxable income, the amount of cash dividends paid during each of the respective years, and the amount and date of any cash dividends paid shortly after the close of the year under examination. If any distribution of dividends in reorganization was made, full details of such distribution should be stated.

    6. A statement showing the amount of taxes actually avoided by the principal stockholders through the failure of the corporation to distribute all of its earnings for the year under consideration.

    7. Review of corporate minutes for a discussion on why the funds are being accumulated (e.g. plans for plant expansion, debt retirement, inventory increases, etc.).

    8. Comparative balance sheets at the beginning and end of the year or years under examination, and five prior years.

    9. Whether or not, in the opinion of the examiner, the corporation is a mere holding or investment company and the basis for such conclusion and why it does not qualify as a personal holding company under the applicable revenue law.

    10. Any other facts and circumstances deemed pertinent by the examiner, including a summary of the material facts upon which the IRC 531 recommendation is based.

4.10.13.2.8  (03-16-2015)
Notification of Unreasonable Accumulation of Earnings

  1. In any proceeding before the Tax Court involving the allegation that a corporation has permitted its earnings and profits to accumulate beyond reasonable business needs, the burden of proof is on the Commissioner unless a notification is sent to the taxpayer under IRC 534(b) However, if such a notification is sent to the taxpayer and he/she timely submits the statement described in IRC 534(c), the burden of proof will be on the Commissioner as to the grounds given in the statement.

  2. Operating officials who hold delegations or redelegations of authority to sign notices of deficiency pursuant to Delegation Order 4-8 (formerly No. 77) are also empowered to sign notifications under IRC 534(b). See IRM 4.8.8.2, Accumulated Earnings Tax, regarding coordination with Technical Services.

  3. IRC 534(b) requires that taxpayers be notified if a proposed notice of deficiency includes an amount with respect to the accumulated earnings tax imposed by IRC 531 so that the burden of proof initially will be on a taxpayer.

    1. Exam is responsible for notifying the taxpayer.

    2. Letter 572 is used for this notification.

    3. If notification is sent to the taxpayer and (1) the taxpayer timely submits the statement of the grounds on which the taxpayer relies to establish that there has been no accumulation of earnings and profits beyond the reasonable needs of the business and, (2) such grounds are supported by facts contained in the statement, then the burden of proof will be on the Commissioner as to the grounds given in the statement. See Treas. Reg. 1.534-2(a) (2).

    4. Letter 572 should be mailed concurrently with the 30-day Letter in cases with any unagreed cases including with those having less than one year remaining on the statute of limitations.

    5. Officials and reviewers delegated to sign notices of deficiency pursuant to Servicewide Delegation Order 4-8 (formerly 77, Rev. 28) are also empowered to sign Letter 572.

  4. A notice of deficiency will not be issued before expiration of the period of time granted for filing the statement except when expiration of the period of limitation is imminent or other compelling circumstances require earlier issuance.

  5. If a jeopardy assessment is made under IRC 6861(a) , a separate notification need not be sent before a notice of deficiency is issued. In such instances the notice of deficiency, which must be mailed within 60 days after the date of assessment, constitutes the notification providing it informs the taxpayer that the deficiency includes the tax imposed by IRC 531. The taxpayer's statement then may be included in the petition to the Tax Court.

  6. Notification under IRC 534(b) will be issued on Letter 572 , which must be manually signed, and sent by certified mail (by registered mail if the taxpayer's address is outside the United States). The number and disposition of copies of Letter 572 usually will be the same as for a notice of deficiency. The records concerning the issuance of Letter 572 by certified mail will be maintained under IRM. U.S. Postal Service Form 3877 should be noted: "Notification under IRC 534(b)."

4.10.13.2.9  (03-16-2015)
Rebuttal Statement by Taxpayer

  1. Treas. Reg. 1.534-2(d) allows a taxpayer 60 days after a notification is mailed in which to file a statement to justify the alleged unreasonable accumulation.

  2. If the taxpayer, for good cause, cannot submit the statement within the 60-day period, he/she may be granted an extension, not to exceed 30 days. He/she must request the extension before expiration of the 60-day period. SB/SE Delegation Order 4.3, Extension of Time for Filing Statement of Grounds for Earnings and Profits Accumulation, states Compliance Section Chiefs, Group Managers in Technical Services and RA Reviewers are delegated authority to grant an extension of time not to exceed 30 additional days.

  3. Letter 572 requires the taxpayer to submit an original and two copies of the statement. Upon receipt, the original should be attached to the return of the earliest year in which the issue is raised. One copy should be placed in the administrative file and the other copy should accompany the administrative file for further association with the Area Counsel's legal file.

  4. After consideration of the taxpayer's rebuttal, the issue will be dropped if it is concluded that earnings and profits have not been accumulated beyond reasonable business needs.

4.10.13.3  (03-16-2015)
Transferor-Transferee Liability

  1. Transferee liability is a situation where a third party can be held liable for the tax liability of another. The government may seek to collect a taxpayer’s unpaid tax, penalty or interest by asserting transferee liability when a taxpayer (transferor) has transferred property to another person or entity (transferee) and a substantive provision of the law provides the ability to assert liability against the recipient based on the transfer.

  2. Under IRC 6901, “transferee liability” is a tool used:

    • to collect a transferor-taxpayer’s tax liability from the transferee who received the transferor-taxpayer’s assets for less than adequate consideration or

    • to collect the liability from the transferee that is legally responsible for paying the transferor-taxpayer’s liability

  3. “Transferee” is defined in IRC 6901(h), and includes a donee, heir, legatee, devisee, and distributee and the person or entity whose tax liability the Service is seeking to collect is known as the "transferor" .

  4. Transferee liability does not create a new liability. Instead, it provides a secondary method to collect the transferor’s tax liability. Thus the Service has the same right of action against a transferee that it has against the transferor.

  5. IRC 6901 is strictly a procedural statute that does not by itself create any liability. It provides the IRS with a method to enforce and collect the liability of a transferee. The substantive elements establishing the existence or extent of a transferee’s liability are determined by applicable state or federal law.

  6. The substantive basis of law for transferee cases is:

    1. The applicable State fraudulent conveyance statute;

    2. The Federal fraudulent conveyance statute, effective for transfers made on or after May 29, 1991, subpart D of the Federal Debt Collection Procedures (FDCPA) Act of 1990 (codified at 28 U.S.C. 3301 to 3308), which can be asserted instead of or in the alternative to the applicable State fraudulent conveyance statute

    3. An express or an implied contract

    4. A state statute other then the state fraudulent conveyance statute; and

    5. A federal statute (FDCPA, 28 U.S.C. 3001 et seq.)

  7. IRC 6901 applies to income, estate, and gift taxes incurred by the transferor. It also applies to all other taxes (e.g., employment taxes) incurred by the transferor if the transferee’s liability arises as a result of the liquidation of a partnership or corporation, or a reorganization under IRC 368 (a).

  8. The Area Director having jurisdiction in the initial determination of the income, estate, and gift tax liability of the transferor is responsible for proceeding, under IRC 6901, against transferees or fiduciaries regardless of their location, and is responsible for all administrative action required in management and control of the case.

  9. IRM 4.8.9.17.5.1Transferor-Transferee Liability Cases discusses the notice of deficiency issued to a transferee and the three parts to the transferee notice of deficiency.

  10. See the recently revised IRM 5.17.14, Fraudulent Transfers and Transferee and Other Third Party Liability.

4.10.13.3.1  (03-16-2015)
Origination of Transferee Cases

  1. Two sources from which a transferee case can be generated are:

    1. As a referral from the Collection function, see IRM 5.17.14 , Legal Reference Guide for Revenue Officer - Fraudulent Transfers and Transferee and Other Third Party Liability for additional information and

    2. As a related pick-up during an examination, see IRM 4.11.52, EOG Transferee Liability Cases

4.10.13.3.1.1  (03-16-2015)
Referral From Collection Function

  1. In an attempt to collect a tax liability, the Collection function may refer transferee cases to the Examination function for assistance.

  2. Collection prepares Form 3031 , Report of Investigation of Transferee Liability, to recommend a transferee assessment. The Advisory Section reviews the report to ensure that pertinent factual data and adequate evidence is obtained to sustain assertion of the transferee liability. Once approved, the original report is forwarded to Planning and Special Procedures (PSP) to establish the transferee case on AIMS non-master file and to forward the case to an examination group.

4.10.13.3.1.2  (03-16-2015)
Transferee Case Initiated During a Related Examination

  1. Examiners are required to consider collectibility in every examination. IRM 4.20.1, Examination Collectibility, General Collectibility Procedures provides instructions and guidance to examiners for considering collectibility during the examination process and for soliciting payment at the conclusion of the examination.

  2. As such, they must be able to identify situations in which the taxpayer has intentionally or inadvertently placed assets out of the legal reach of the IRS. Additionally, they must be able to identify situations in which asset transfers may not be conducted in a normal" business manner" because of the close relationship of the parties involved.

  3. If the taxpayer gives an indication of insolvency, the examiner should try to learn about the disposition of the taxpayer's assets and/or the transferee's legal responsibility for payment of the transferor's tax liability. The examiner must consider whether the elements of a transferee examination, as described below, have been met.

  4. A transferee case will be initiated once the examiner determines:

    1. The taxpayer has, or will have, a tax liability that cannot be collected directly

    2. The elements of a transferee case have been met (See IRM 4.10.13.3.2.1, Transferee in Equity and IRM 4.10.13.3.2.2, Transferee at Law), and

    3. All or part of the tax liability could be collected from the transferee

  5. Examiners are responsible for the identification and development of potential transferee cases that arise during their examinations. For identification purposes the examiners should fill out Form 2045Transferee Agreement. Examiners should not assume that Collection will develop a transferee case after the transferor's examination is concluded. By the time a case is routed to a Revenue Officer (RO) for collection, the transferee statute of limitations may prevent adequate consideration.

    Note:

    Filling out a Form 2045 does not conclusively establish transferee liability under IRC section 6901.

4.10.13.3.2  (03-16-2015)
Types of Transferee Liability and Burden of Proof

  1. There are two basic types of transferee liability. Both can be asserted under IRC 6901; however, the extent of the liability depends on the law underlying the two types of transferee liability, the value of the equity in the transferred assets, and the amount of taxes due from the transferor. The type types of transferee liability are:

    1. Transferee in Equity, and

    2. Transferee at Law

4.10.13.3.2.1  (03-16-2015)
Transferee In Equity

  1. Transferee liability in equity is the most common form of transferee liability and is based on equity or fairness principles. A Transferee in equity is a person or entity who receives the transferor's assets for less than adequate consideration, leaving the transferor insolvent and unable to pay the tax liability. Transferee in equity cases are predicated on state or federal fraudulent conveyance statutes. See e.g. Hagaman v. Commissioner, 100 T.C. 180 (1993) indicates the specific state statutes must be consulted to determine liability in equity for each particular case.

  2. The liability of a transferee in equity is generally limited to the value of the property transferred. However where transferee liability is based on state law, state law determines the extent of the liability, which may also include penalties or interest. Commissioner v. Stern, 37 U.S. 39, 44-45 (1940).

  3. The Government must prove the value of the assets transferred. Where the assets transferred are subject to existing liabilities or assumed by the transferee, the value of the property received should be reduced by the associated liability in determining the limit of transferee liability.

  4. It should be noted that the mere fact that the transferee uses assets which he receives to pay debts of the transferor will not relieve him of transferee liability. He/she must also show that the debts paid had priority over the tax liability. A transferee does not cease to be a transferee merely by selling the transferred property. Additionally, the price at which the transferee sells the property is not an accurate measure of the transferee liability. Rather, the liability is measured by the value of the property that was transferred on the date of transfer.

  5. Even though a taxpayer admits that he is a transferee of assets of a dissolved corporation, unless he admits the extent of his liability, the Government must still prove the value of the assets so received in order that the Court can determine the amount due from him.

  6. Although specific elements will vary depending on the substantive law relied upon, the Service generally must prove the following:

    1. A transfer of assets from the transferor to the transferee for less than adequate consideration. In this regard, the Government must establish by evidence the value of the assets transferred in order to show that the transfer was for less than full and adequate consideration. Documentation must show:

      1. The transferor transferred property to the transferee (i.e., deeds, balance sheets, cancelled checks, title transfers, etc.)

      2. The value of the transferred property at the date of transfer

      3. The transfer was for less than adequate consideration, and

      4. Who received the assets. The documentation must show the current legal title. A transferee is rarely a joint entity

        Example:

        If a corporation made one check payable to the shareholder husband and one check to the shareholder wife, there would be two separate transferee cases - one for the husband and one for the wife. One transferee case in the joint names would not exist since the checks were not made out in joint names. If land was transferred to them jointly (i.e., joint ownership, such as tenancy by the entireties) there would be only one transferee - the husband and wife as joint tenants.

    2. The transfer of assets must have been made after the liability for taxes accrued. Transferee liability was developed based on the principle that debtors may not transfer assets for less than adequate consideration if they are left unable to pay their liabilities. The chance to satisfy the debt out of the asset(s) transferred never existed where the transfer was made prior to the taxable period involved. Therefore, no transferee liability can ordinarily arise when the transfer is made before the period in which the tax liability is created. However, the tax liability need not have been asserted prior to the transfer. In this connection, the tax liability need only accrue. The examiner should consult with Technical Services and/or Area Counsel in unusual circumstances. Documentation must show:

      1. The date the tax liability accrued. The tax liability accrues at least by the last day of the tax period, not the due date of the return. In some cases (such as lottery winnings), a transfer during the tax year may be argued to include a contingent tax liability since the income was earned prior to the year end and the transfer was obviously fraudulent. There is no requirement that the tax liability be assessed at the time of the transfer.

      2. The date the transfer took place.

    3. The transferor is liable for the tax at the time of the transfer, or the transfer occurred in the year of liability, and the transferor remains liable for the tax.

      1. It would appear to be self-evident that unless the transferor is liable for the tax, there could be no liability asserted against the transferee.

      2. IRC 6902(a) states, in part, that the Government does not have the burden of proof "to show that the taxpayer was liable for the tax" . There is a presumption of correctness in the Commissioner's determination, and unless the transferee offers evidence as to the transferor's tax liability, the amount established by the Commissioner will be sustained. If the transferee contends that the transferor owes no tax, the burden of proving this rests on the transferee. If there has previously been a decision on the merits, the transferee is collaterally estopped from raising the issue of the transferor's tax liability. Documentation must show the tax liability (i.e., transcript of account, Revenue Agent's Report (RAR), Notice of Deficiency, etc.).

    4. All reasonable efforts have been made to collect the tax liability from the transferor-taxpayer.

      1. (1) Courts generally consider a transferee’s liability to be secondary to the primary liability of the transferor. Secondary liability means the transferee derives its liability from the transferor’s liability based on the receipt of property under circumstances that subject the transferee to the liabilities of the transferor.

      2. (2) Before pursuing a transferee, the Service must generally exhaust all legal remedies it may have against the transferor for collection of the tax. The general rule is that the Service must show that collection remedies against the transferor have been exhausted or would be futile. See Gumm v. Commissioner, 93 T.C. 475, 480 (1989). The extent to which the Service must proceed against the transferor depends on the facts and circumstances. For example, the Service need not pursue a corporate taxpayer that has been stripped of its assets or a trust that has distributed its property to a beneficiary and terminated.

      3. Documentation should show that the transferor is in bankruptcy, has dissolved, or has distributed all of the assets and collection is not possible or that collection was pursued but could not be secured. A TXMOD will show the action taken by the Collection function.

    5. The transferor was insolvent when the transfer was made or the transfer of assets left the transferor insolvent.

      1. As stated earlier, the mere fact that there has been a transfer of assets does not establish transferee liability. Any individual may transfer property for little or no consideration, without causing any liability to the transferee, provided the transferor was solvent at the time he/she transferred the property. In cases involving constructive fraud (transfers made without actual intent to hinder, delay or defraud the government’s collection efforts, but efforts to collect the transferor’s tax liability were hindered) the Government must also prove that the transferor was insolvent when the transfer was made or the transfer of assets left the transferor insolvent. Insolvency need not be present in cases involving actual fraud (i.e. transfers made with specific intent to hinder, delay or defraud the government from collecting the transferor’s tax liability). The transferor's insolvency is an essential element of constructive fraud, but it does not need to be established when actual fraud exists. The examiner will need to look to the applicable state fraudulent conveyance statute and/or Subpart D of the Federal Debt Collection Procedures Act (28 U.S.C. 3301-3308) for the basis on which actual fraud could be found. It was previously mentioned that the test for determining insolvency is the comparison of the fair market value of the transferor's assets with his/her liabilities at the time the transfer occurred. If his/her liabilities exceeded his/her assets, the transferor was insolvent.

      2. The liabilities should include liability for taxes, penalties and interest to date of transfer. It should also include additional liabilities as a result of an examination (i.e., when it is found that the transferor embezzled money, the legal duty to repay the embezzled money would be included as an additional liability). However, in calculating the value of the transferor's assets, only those assets which could be reached by the Government to satisfy the tax debts are considered. This means that assets exempt from levy would not be considered as assets in determining insolvency of the transferor.

      3. The fact that the transferor was insolvent at one time during the year does not establish proof of insolvency at the time he/she made the transfer and if several transfers were made, the Government must make a separate determination of insolvency for each of the transfers involved.

      4. In many instances, the Government's transferee suit occurs several years after the transfer took place. It goes without saying that the greater the span of time between the transfer date and the institution of the suit, the more difficult it becomes for the Government to prove insolvency.

      5. Documentation should show that the transferor's tax liabilities and other liabilities (mortgages, debts payable, etc.) exceeded the transferor's assets at the time of transfer. For example, a copy of the transferor's balance sheet at time of insolvency, documents showing bankruptcy, documents showing dissolution of a corporation (contact Secretary of State), documents showing how the assets in a decedent's estate were distributed, etc., should be obtained to support this.

      6. Where a transferee transfers assets to a third person without consideration, the third person, who now becomes a transferee of the transferee, may be liable for the tax liability of the original transferor. This liability is limited to the extent that the second transferee received assets identified as originally belonging to the transferor. However, the transferee liability can only be asserted against the "transferee of the transferee" if:

        1. The first transferee was liable as such, and

        2. The second transferee received the assets under circumstances making him/her liable at law or in equity for the liabilities of the first transferee

      7. If the assets of one corporation are transferred to another corporation without consideration, the second corporation is certainly a transferee and is liable, to the extent of assets received, for any tax impost upon the first corporation. If all of the assets of the second corporation transferred without consideration to a third corporation, the third corporation is liable to the extent of the value of the assets which belonged originally to the first corporation.

      8. Where a transferee transfers to a third person for full and valuable consideration the assets previously received from the transferor, he/she does not thereby cease to be a transferee, nor is the price at which he/she sold the property the measure of his/her liability.

4.10.13.3.2.2  (03-16-2015)
Transferee At Law

  1. See IRM 5.17.14, Legal Reference Guide for Revenue Officers, Fraudulent Transfers and Transferee and Other Third Party Liability. particularly IRM 5.17.14 .3.1 Fiduciary Liability

    1. Pursuant to 31 USC § 3713(b), a representative of a person or an estate (except a trustee acting under the Bankruptcy Code, Title 11) paying any part of a debt of the person or estate before paying a debt due to the United States is personally liable to the extent of the payment for unpaid claims of the United States. See IRM 5.17.13.5, Elements of 31 USC § 3713(a), for additional discussion.

  2. In determining the extent of the transferee's liability at law, the value of the assets received by the transferee is immaterial since the extent of such liability is determined by reference to the amount of tax liability of the transferor that the transferee has agreed to pay (determined by contract or statute). Where transferee liability is based on estoppel, the liability is limited to the value of the assets received. Some state statutes may also limit liability to the value of assets received.

  3. Documentation required for transferees at law must show:

    1. The assets that were transferred and the fair market value at the date of transfer;

    2. A transcript of account showing the tax liability of the transferor for a period which accrued prior to the transfer and remained unpaid at the time of the assertion of transferee liability; and

    3. At the time of transfer of the assets, the transferee assumed the tax liability of the transferor by contract or statute. A copy of the contract and/or statute should be obtained.

  4. Statutory mergers where the surviving corporation is primarily liable for the debts of the merged corporation do not result in a transferee situation. The resulting surviving corporation is not a transferee, but is liable the same as the prior transferor corporation. Consult the contracts and agreements affecting the merger to see what type of transaction occurred.

4.10.13.3.3  (03-16-2015)
Statutory Period and Consents

  1. A transferee is considered a separate entity. The statute of limitations for the transferee is separate and distinct from the transferor's statute of limitations.

  2. The period of limitation for the assessment of the liability of a transferee is as follows:

    1. The initial transferee - one year after the expiration of the period of limitations for assessment against the transferor, as shown by the filing date of the original return or as extended by Form 872 or other statute extension form.

      Note:

      When the transferor's statute has been extended using Form 872-A and the transferor's tax liability has been assessed, Form 872-A is terminated. The computation of the transferee's statute of limitation will be one year from the assessment of the transferor's liability.

    2. A transferee of a transferee - one year after the expiration of the period of limitation for assessment against the preceding transferee, but not more than three years after the expiration of the period of limitations for assessment against the initial transferor.

    3. A fiduciary - not later than one year after the liability arises or not later than the expiration of the period for collection of such tax, whichever is later.

    4. Fraud - IRC 6501(c)(1) provides that, where the transferor files a false or fraudulent return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at anytime. In such cases, the statute of limitations on the transferee would also be indefinite, since the transferee's statute is open for one year after the transferor's statute expires. However, unless the transferor's fraud penalty has been definitively established by judicial decision or otherwise, such as by agreement Form 870), the transferee's statute of limitations should be protected by a consent form. Where the transferor's fraud penalty has not been definitively established, do NOT rely on fraud to keep the transferee's statute of limitations open. Securing a statute extension by consent from the transferor will protect the Government's interest in the event that the fraud issue against the transferor is lost.

  3. When it is necessary to extend the statute of limitations of transferees who are not primarily liable, the consent form used is Form 977, Consent to Extend the Time to Assess Liability at Law or in Equity for Income, Gift, and Estate Tax Against a Transferee or Fiduciary, or Form 4016, Consent Fixing Period of Limitation Upon Assessment of Employment or Miscellaneous Excise Taxes Against a Transferee. The extended date on Form 977 or Form 4016 may not be equal to or shorter than the statutory period prescribed by IRC 6901 (c). The consent will be secured in duplicate.

  4. When a Form 977 or Form 4016 is executed and no Form 2045, Transferee Agreement, has been secured, the transferee may subsequently raise the defense that the transferor is liable (by claiming that he/she is not a transferee). In this situation, the Service may only be able to proceed against the transferor if a Form 872 has been secured. To be safe, it is wise to secure consents from both the transferee (Form 977 or Form 4016) and the transferor (Form 872) until it has been determined who is liable for the tax.

    Note:

    Filling out a Form 2045 does not conclusively establish transferee liability under IRC 6901.

4.10.13.3.3.1  (03-16-2015)
Trust Fund Doctrine

  1. If the period of limitations for assessment against a transferee has expired, action against the transferee under the trust fund doctrine for the collection of the unpaid tax assessed against the transferor should be considered.

  2. The trust fund doctrine is most commonly used to impose transferee liability on a shareholder for taxes incurred by a corporation when the shareholder receives assets from a corporation prior to its dissolution. See Benoit v. Commissioner, 238 F.2d 485, 491 (1st Cir. 1956). Recovery under the doctrine is limited to the value of the property transferred. Many states have also enacted statutes to permit creditors of a corporation to sue shareholders. See IRM 5.17.14.2.3.3Trust Fund Doctrine.

  3. If timely assessments have been made against the transferor and the period for instituting suit for collection provided in IRC 6502(a) has not expired, but the time for transferee proceeding has expired, the case, accompanied by a report containing facts in support of the transferee's liability, should be forwarded to Area Counsel through Technical Services.

4.10.13.3.3.2  (03-16-2015)
Protecting the Transferor's Statute of Limitations

  1. In attempting to collect the transferor's tax liability through a transferee case, the transferor's tax liability should always be assessed or a statutory Notice of Deficiency issued prior to the expiration of the transferor's statute of limitations unless one of the exceptions below has been met:

    1. A valid consent (Form 872, Form 872-A, etc.) to extend the transferor's statute of limitations has been obtained;

    2. A validly executed Form 2045 ,Transferee Agreement, has been secured in duplicate from all transferees. Managerial involvement in this determination should be documented both on Form 4318 and on the Form 895, Notice of Statute Expiration. If not secured from all identified transferees, action should be taken to prevent the statute from expiring, such as issuing a notice of deficiency to the transferor. Should there be doubt in a particular case as to whether it would be advisable to accept an agreement from the transferee as a basis for not proceeding against a dissolved corporation, advice should be requested from Area Counsel. Form 2045 does not extend the transferor's statute of limitations, but:

      1. Is an agreement between the transferee and the Commissioner, that the Commissioner agrees to discontinue action against the transferor in return for an admission by the recipient of the assets that he/she is the transferee,

      2. The transferee assumes and agrees to pay the amount of any and all Federal income taxes finally determined or adjudged as due and payable by the transferor, to the extent of such transferee's liability at law or in equity,

      3. The transferee will not, in the absence of the prior written consent of the Commissioner, sell, transfer, or assign without adequate consideration all or any substantial portion of their assets, and

      4. In the event of a corporate transferee, the agreement will be accompanied by a copy of the minutes of the corporate board of directors evidencing authorization of such agreement.

        Note:

        Filling out a Form 2045 does not conclusively establish transferee liability under IRC 6901.

    3. The transferor has an indefinite statute of limitations (i.e., judicially determined fraud - IRC 6501 (c), no returns filed by the transferor etc.).

  2. If a deficiency in tax is determined in the case of the transferor and the statute of limitations has expired, the deficiency should be asserted against the transferee(s) within the period of limitations applicable to him or her.

  3. Although it may appear unlikely that the Service will be able to collect from the transferor, the Tax Court indicates that the Service should attempt to exhaust its reasonable collection efforts before attempting to collect from a transferee, or otherwise show that collection from the transferor would be futile. Issuing a notice to the transferor helps establish this effort.

4.10.13.3.3.3  (03-16-2015)
How State Corporate Dissolution Law Affects an Examination

  1. Transferee situations are very prevalent with dissolved corporations. If the corporation has been dissolved, there may be no assets against which to collect any proposed assessments. In that event, it may be necessary to utilize transferee liability provisions of IRC 6901 to collect the corporate liability. A transferee case will be developed concurrently with the corporate examination if the elements needed to establish a transferee case are present. Otherwise, the examiner may consider limiting the scope of the examination. See IRM 5.17.14., Legal Reference Guide for Revenue Officer - Fraudulent Transfers and Transferee and Other Third Party Liability for additional information.

  2. Federal law, not state law, sets the statute of limitations on assessment and collection of federal taxes for transferee liability cases. State corporate dissolution law does not shorten the assessment limitations period provided by IRC 6501. State law may, however, adversely affect the capacity of a dissolved corporation or its last board of directors to represent the dissolved corporation or to act on its behalf. This will affect the corporation's ability to extend the statute of limitations, to agree to tax liabilities or to litigate corporate liabilities.

  3. State corporate dissolution law governs how a corporation may dissolve. The state law may provide a specific time period for a dissolved corporation to wind up its affairs. Some states have a specific period in which to wind up affairs, while others do not. Only the individuals named in the applicable state law are authorized to act for the dissolved corporation and only during the winding up period. Such appointment may divest others (the officers prior to dissolution) of authority to act on behalf of the corporation. A consent must be executed by the authorized officer of a dissolved corporation on or before the last date of the winding up period in order to be valid and to hold the period of limitations open after the end of the winding up period.

  4. Caution should be exercised in obtaining waivers of restriction on assessment and extensions of the statutes of limitations in dissolved corporation and transferee cases. Examiners should not rely on any such agreements without the approval of Area Counsel.

  5. The state law which governs the corporate dissolution is the law of the state in which the corporation was incorporated.

    Example:

    If a corporation has its offices in Florida, does business entirely in Florida, was examined by the IRS in Florida, but was incorporated under Delaware law, authority to execute a consent should be tested under Delaware law, not Florida law.

  6. Examiners should consult the applicable state corporate dissolution law and identify which individuals (corporate officers, board of directors, etc.) are legally authorized to act for the dissolved corporate entity. Area Counsel may be contacted to request an opinion on who is authorized to act for the corporation.

  7. The examiner will also ensure that the individuals authorized to represent the dissolved corporation have been appointed to these duties by the corporation. Documentation will be obtained to satisfy this requirement and will be attached to any consent or waiver that the authorized individuals sign. A provision should be added below the signatures of the appointed individuals stating their title

    Example:

    Trustee of X corporation, a dissolved corporation. Also a provision should also be added that the corporation has dissolved, but is continuing as a corporate body under (name the section of state law).

  8. The corporation and its authorized officers/directors may perform the following acts up to the end of the winding up period:

    1. Execute a valid extension of the statute of limitations (i.e., Form 872, Form 872-A, etc.);

    2. Execute a valid assessment agreement (i.e., Form 4549, Form 870, etc.). Otherwise the corporation will be unable to agree to the adjustments; and

    3. Institute litigation on behalf of the corporation.

  9. Precautions that should be taken in obtaining waivers of restriction on assessment and extensions of the statute of limitation in transferee and dissolved corporation cases.

    1. Obtain the transferee's agreement to the liability prior to the expiration of the transferor's limitation period, if at all possible;

    2. Clearly explain (and document) the effect of executing a Form 2045, Transferee Agreement; and

    3. Clearly explain (and document) the extent of a transferee's monetary liability.

      Note:

      Filling out a Form 2045 does not conclusively establish transferee liability under IRC 6901.

  10. Some state corporate dissolution law provides that the dissolution of a corporation may be revoked within stated periods. If this occurs, this may affect the authority of the corporation or its directors. Examiners should always inquire if a revocation of dissolution has occurred.

  11. IRC 6901 is only applicable to income, estate, and gift taxes. Transferee liability procedures are not available to employment, excise, and other types of taxes in the Code unless they are involved in the liquidation of a corporation, partnership, or upon the reorganization of a corporation pursuant to IRC 368 (a). See also Treas. Reg. 1.507-1(b)(8) regarding transferee liability for chapter 42 excise taxes in the case of reorganizations and transfers between private foundations described in IRC 507(b)(2). A liquidation is deemed to have occurred if the business entity has ceased to do business and the assets of the entity have been distributed to the owners.

4.10.13.3.3.4  (03-16-2015)
Consents to be Used in Mergers and Consolidations

  1. Many state corporate merger and consolidation statutes provide that when a corporation is dissolved, the successor corporation is not a transferee. In states with such laws, the new or surviving corporation assumes primary liability for the debts of the merged or consolidated corporation. Action to assess the primary liability against the new/surviving corporation should be taken within the statutory period of limitations for assessment against the merged or consolidated corporation. If the period of limitations needs to be extended in order to make this assessment, Form 872 or Form 872-A must be executed by the new/surviving corporation before the expiration of the period of limitations for assessment against the merged or consolidated corporation. The corporate name on Form 872 or Form 872-A will be completed and signed as: "B Corporation, Inc., Successor in interest to A, Inc." .

  2. The examiner should ensure that the successor corporation is solely responsible for the liabilities of the dissolved entity. Many merger and consolidation agreements allocate some or all of the liabilities to other parties, including the sellers, with respect to the dissolved entity. Documents verifying the terms of sale should be scrutinized where possible to resolve any discrepancies.

4.10.13.3.4  (03-16-2015)
Administrative Procedures

  1. If the transferee case is originated through a related examination, the examiner will initiate control of the transferee examination. The transferee will be controlled using a "dummy" TIN on non-master file. See IRM 4.4.23AIMS Procedures and Processing Instructions – Opening, for more detail information on master file and non-master file procedures.

  2. Form 5354, Examination Request Non-Master File, will be completed.

  3. PSP will initiate non-master file controls on all transferee cases referred from the Collection function.

  4. IRM 8.7.5.9 (1)Issuing a Notice of Liability on an Unagreed Transferee Case says Tax Computation Specialists (TCS) are generally responsible for the preparation of Notices of Liability in transferee/transferor cases.

  5. Each individual or entity that is a transferee will have a separate case file. A Form 895, Notice of Statute Expiration, will be attached to the transferee case file for each tax period. Form 895 will be completed with the transferee's name as transferee and taxpayer identification number. The return form and taxable year or period will be that of the transferor. If the transferee case was originated as referral from Collection function, the transferee statute of limitations will be computed by reference to an Individual Master File On-Line (IMFOL) with definer code -T (Tax Module) or M on the transferor, as no returns will be contained in the file from Collection. See IRM 2.3.51.1General Information about CC IMFOL for more information.

4.10.13.3.4.1  (03-16-2015)
Developing the Elements of a Transferee Case

  1. If the transferee case was received from Collection, the examiner will satisfy his/herself that all of the elements required in a transferee case have been documented by the Revenue Officer (RO) on Form 3031Report of Investigation of Transferee Liability. If the elements required, as outlined earlier, have not been documented, the examiner will contact the transferee (and if needed, the transferor), to interview and obtain additional documentation to support the elements required in the transferee case.

  2. If a transferee case is initiated during the examination of a transferor, the examiner will develop the elements required in a transferee case and obtain documentation to support each of the elements. The transferee will be advised that they are under examination as a transferee. An interview with the transferee may need to be scheduled and conducted in order to develop all elements and to obtain supporting documentation.

  3. The examiner will charge his/her time to activity code (AC) 812 - detail to the Collection function.

4.10.13.3.4.2  (03-16-2015)
Transferee Waivers

  1. When all of the elements have been fully developed and documented, the examiner will prepare the following waivers, solicit an agreement and payment from the transferees, and hold a closing conference:

    1. Form 870-T , Waiver of Restrictions on Assessment and Collection of Transferee or Fiduciary Liability and Acceptance of Overassessment (for income tax cases), or Form 2504, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment (for employment or excise tax), modified with special language, should be used to solicit an agreement from the transferee for the amount of the transferor's tax, penalties and interest. The waiver will be completed as follows:

      1. The name and address block will be completed with the name of the transferee as transferee;

        Example:

        Joe Smith, Transferee

      2. The social security or employee identification number will be that of the transferee;

      3. The tax period ended, tax, and penalties blocks will be completed with the tax period and unpaid balance of the transferor's tax and penalties. For transferee cases originated from an examination, the amounts will be taken from the examination report net of any payments. For transferee cases referred from Collection, a transcript of account will be obtained using command code IMFOL-T and will be analyzed by summarizing the total amount of tax (net of any payments) and each penalty for each tax period. These totals will be inserted on the waiver (these amounts plus interest should reconcile to the modified balance per the IMFOL-T). An index of all tax modules available will be obtained using command code IMFOL-I to ensure that all tax periods with an outstanding tax are included on the waiver; and

      4. A special paragraph will be added to the remarks section of Form 870-T or to the reverse side of Form 2504. See all of sectionIRM 4.10.13.6. If the value of the assets transferred is less than the transferor's unpaid liability, the transferee's liability is limited to the value of the assets transferred. A special paragraph with language for the limited liability will be used. In this case, Form 870-T will reflect the total transferor's tax and penalty liability, but the paragraph will state the amount to which the liability is limited.

    2. Form 2045, Transferee Agreement, will be solicited. By signing this form, the transferee admits liability as a transferee of assets received from the transferor, and assumes and agrees to pay the tax liability of the transferor. The government is then relieved of the burden of proof regarding the transferee liability. To protect the government's interest, solicit Form 2045 from each transferee. Form 2045 may be obtained from only one transferee provided that the assets received by the transferee are sufficient in amount to cover the total transferor's liability. If the transferee is a corporation, a copy of the minutes of the board of directors authorizing an officer to enter into this agreement should be attached to this form.

      Note:

      Filling out a Form 2045 does not conclusively establish transferee liability under IRC 6901.

4.10.13.3.4.3  (03-16-2015)
Transferee Case File and Report

  1. Each transferee should be a separate case file, as it is separate and distinct from the transferor examination. Whenever the transferee's name is written in the file, it should have the title "Transferee" after it to distinguish it from an income tax examination of the same entity.

  2. Form 4665, Report Transmittal, should set forth all necessary facts of a confidential nature. This will include a clear statement of the present ability of the transferor and each transferee to pay, with names, addresses, amounts and nature of property held by each that may be subjected to use in payment of the tax.

  3. Each transferee file will contain a transferee report, which is prepared in memorandum form. The memorandum will be very detailed if the case is unagreed. It will list the name, address, and Taxpayer Identification Number (TIN) of the transferee and the transferor. The memorandum will contain the following:

    1. A list of all of the transferor's tax periods and the respective unpaid tax liabilities and penalties

    2. How the transferor's unpaid tax liability was determined (i.e., tax returns that were filed but the balance due was unpaid, income tax examination, etc.)

    3. Whether the transferee is a transferee at law or in equity

    4. A complete background containing the facts and reasons for recommending the transferee action, with reference to the documentation used to support the facts

    5. A list of the elements required to support the Government's burden of proof and how they have been met. The documentation that supports each element should be referenced

    6. An analysis that lists all of the transferor's assets prior to insolvency and their disposition. It will include a description of each asset, its fair market value at the date of transfer, the date each asset was disposed of, and who received the assets

    7. How insolvency and the date of insolvency were determined

    8. Information relating to Collection function's involvement in collecting the transferor's unpaid liability; and

    9. Any attempts to conceal assets and evade payment of taxes

  4. Documentation and workpapers will be attached to the memorandum. If it is voluminous, the workpapers and documentation will be attached to a Form 4318-A, Continuation Sheet for Form 4318, Examination Workpapers Index which will be used to index the workpapers.

  5. A Form 5344, Examination Closing Record, will not be completed for the transferee case file.

4.10.13.3.4.4  (03-16-2015)
Corporate Transferor - Information to Include in the Transferee Report

  1. In cases in which the transferor is a corporation, the examiner will include the following information in the transferee report:

    1. Whether or not the corporation is insolvent, has been dissolved, or is in the process of liquidation. If the corporation has been dissolved, information should be furnished showing the date and manner of dissolution.

    2. A description, including the amount and value of the property or assets of the corporation at the time of dissolution or liquidation.

    3. Whether or not any property or assets were retained by the corporation; and, if so, a description, including the amount, present value, and location of such property or assets should be furnished, together with the name and address of the person having custody thereof. A list of the liabilities of the corporation should also be furnished. Mortgages, judgments, and other liabilities which may take priority over tax liens by reason of being recorded prior to the filing of notices of such liens as provided in IRC 6323 should be listed separately.

    4. If subsequent to the taxable year or years being examined, any of the assets of the corporation that have been transferred to another corporation through a sale or a reorganization, consolidation or merger, a description, including the value of the assets transferred, and a statement showing whether the consideration given for such assets was cash, stock or both. If both cash and stock passed as consideration, a statement of the amount of cash paid and the number of shares of stock transferred, both common and preferred, and the value of such stock at the time of transfer. A statement should also be furnished as to the present financial condition of the corporation taking over the assets, together with the address of such corporation. If the reorganization, consolidation or merger was made pursuant to a written agreement or under the provisions of a State statute, a copy of such agreement should be secured and made a part of the report or reference made to the State statute.

    5. Whether the liabilities of the corporation were assumed by any other corporation or person; and if so, a copy of the agreement under which such liabilities were assumed should be furnished.

    6. The full name of each stockholder who received assets of the corporation at the time of liquidation, the present address of each of such stockholders, and the number and par value of the shares of stock held by each at the time of liquidation.

    7. Whether the stockholders of the corporation received both cash and other property in the liquidation of the corporate assets. If so, the amount of cash received by each stockholder and a description, including the amount and value of the property received by each stockholder and the present financial condition of each should be furnished.

    8. Whether any assets of the corporation were transferred without adequate consideration to any other corporation or person. If so, a complete statement of all the facts and circumstances pertaining to such transactions, particularly the name, present address, and financial status of each transferee, should be furnished, together with a description of the assets transferred, the consideration paid therefor, and the value of the assets received by each transferee.

    9. A statement should also be furnished showing the name and present address of each stockholder who has not paid in full the amount of his/her subscription to the capital stock of the corporation and the amount owing thereon.

    10. State specifically the source or sources from which the information was obtained; that is, whether from the books and records of the corporation concerned, from public records, or from statements of former officers, stockholders, employees, etc.

    11. Copies of the records should be obtained if they are not too voluminous.

4.10.13.3.4.5  (03-16-2015)
Deceased Transferor - Information to Include in the Transferee Report

  1. In cases in which the transferor is deceased, the examiner will include the following information in the transferee report:

    1. The correct name, late address, and the date of death of the decedent, the full name and present address of the executor or administrator, and the title or name and the location of the court having jurisdiction of the estate; also whether or not the decedent left a will, and, if so, a copy thereof.

    2. Whether a proof of claim for the tax referred to has been filed and, if so, the date of filing and with whom it was filed.

    3. A copy of the inventory of the property and assets or any similar document filed by the executor or administrator with the court.

    4. Whether complete distribution has been made of all of the property and assets of the estate, and, if so, a copy of the report of the executor or administrator or of the final order or decree of the court showing the distribution in kind or otherwise of the property and assets of the estate. The date of such report, order, or decree should be given.

    5. Unless clearly and fully shown by the information called for above, a description, including the actual amount or value in money, of all of the property and assets received by each distributee, the dates such property and assets were received and whether received as a specific bequest or whether the distributee is an heir at law or a residuary legatee, together with the name and present address and financial status of each distributee.

    6. A description, including the amount or value in money, of the undistributed property and assets, if any, remaining in the hands of the executor or administrator as of the date of the report.

    7. If the executor or administrator has been discharged, or if the estate has been closed, a copy of the final order or decree of the court discharging him/her or closing the estate should be furnished, unless this is contained in or is clearly shown by any other documents called for herein. The exact date of such order or decree should be shown thereon or in the report.

    8. State specifically the source or sources from which such information was obtained; that is, whether from the books and records of the taxpayer, from public records, or from a statement of persons having knowledge of the facts, such books and records being identified and the pages or folio numbers thereof indicated. Copies of the records should be obtained if not too voluminous.

4.10.13.3.4.6  (03-16-2015)
Closing an Unagreed Transferee Case

  1. If the transferee case is unagreed, the examiner will prepare the 30-day letter using Letter 955, 30 Day Letter - Straight Deficiencies of Both Deficiencies and Overpayments modified as necessary.

  2. Special language will be inserted as the opening paragraph to Letter 955, depending on the circumstances of the case. See IRM 4.10.13.6

4.10.13.3.4.7  (03-16-2015)
Closing an Agreed Transferee Case

  1. If the transferee case is agreed, the case will be forwarded to Technical Services for special handling. Technical Services will prepare Form 1296, Assessment Against Transferee or Fiduciary, see IRM 4.8.8, Technical Services, Miscellaneous Responsibilities.

  2. Technical Services will fax Form 1296, with agreement Form 870-T, Form 2504 or Form 906, Closing Agreement On Final Determination Covering Specific Matters, and Form 3198 to Centralized Case Processing (CCP). The case will not be updated to CCP. Technical Services will also complete Form 10904, Request for Record Deletion from AIMS, using disposal code 28 and include the form inside the case file. Technical Services will then forward the case file to their Planning and Special Programs (PSP), Audit information Management System (AIMS)/ Examination Return Control System (ERCS) Analyst for deletion of the AIMS record.

4.10.13.3.4.8  (03-16-2015)
Closing a Transferee Case with less Than Six Months Remaining on the Transferee Statute of Limitations

  1. If the transferee examination is within six months of the statute expiration date or if the transferee failed to file a valid protest to the 30-day letter (Letter 955), the transferee case will be forwarded to Technical Services for issuance of a Statutory Notice of Transferee Liability.

4.10.13.3.5  (03-16-2015)
Liability of Transferee for Interest

  1. Once it is established that the value of the assets transferred exceeds the transferor's tax liability, the courts have generally held the transferee liable for interest in the same manner as the transferor would have been. In a similar situation involving the transferee of a wholly owned corporation, the transferee is liable for interest from the date on which the corporate tax was due.

4.10.13.3.5.1  (03-16-2015)
Limited Liability Where the Value of the Assets Transferred Is Less Than the Transferor's Liability

  1. If the fair market value of the property transferred is less than the amount of the transferor’s unpaid tax liability, the transferee may, if state law so allows, be liable for interest on the use of the property from the date the transferee receives the assets until the notice of transferee liability is issued, but the transferee is not liable for interest or penalties on the tax itself. Interest under state law does not extend beyond the date of the notice of deficiency.

  2. When closing a transferee case in which the assets transferred are less than the transferor's liability, Form 3198 should be annotated: "Transferee Case - Limited Liability" .

4.10.13.3.6  (03-16-2015)
Transferee Letters

  1. The group prepares the preliminary 30-day letter for transferee cases. Technical Services prepares the statutory notices of transferee liability and statutory notices of fiduciary liability in all transferee cases.

  2. The 30-day letter, the statutory notice of transferee liability and the statutory notice of fiduciary liability all have three different parts:

    1. The letter to the transferee, which is modified by a paragraph for transferee/fiduciary liability. The letter to be used as the 30-day letter is Letter 955

    2. The letter to be used as a statutory notice of transferee/fiduciary liability is Letter 902-T. Notice of Deficiency

    3. The attachment to the letter, lists the name, address, TIN, tax, penalty and interest liability of the transferor. It also lists the name, address, and TIN of the transferee followed by statements as to the extent of the transferee's liability and how the transferee's liability arose. See subsectionIRM 4.10.13.6, for the paragraphs to use and how to prepare the attachment to the letter.

    4. The waiver/agreement on assessment and collection of additional tax, modified by a special paragraph for transferee/fiduciary liability. Form 870-T will be used for income tax cases. Form 2504 will be used for employment or excise tax. Form 890-T, Waiver of Restrictions on Assessment and Collection and Acceptance of Overassessment as to Transferee or Fiduciary Liability for Estate, Gift and Generation - Skipping Transfer Tax will be used for estate tax cases. Refer to subsection below for the paragraph to use to modify the waiver. The total transferor's unpaid tax and penalty liability will be inserted in the applicable blanks even if the transferee's liability is limited. If the liability is limited, the paragraphs modifying the waiver will state the amount the liability is limited to.

    5. Exhibits may be attached to the above letter package to aid the transferee in understanding why he/she is a transferee or any supporting computations. Examination reports will not be sent with preliminary (30-day) letters asserting liability against transferees.

  3. All proposed statutory notices of transferee liability will be reviewed by Area Counsel prior to issuance. IRM 4.8.9.9.2.1 Mandatory Area Counsel Review, requires mandatory review by Area Counsel.

  4. No statutory notices of transferee liability will be issued for employment or excise tax. IRC 6901 states that the liability will be assessed, paid, and collected in the same manner as in the case of the taxes with respect to which the liabilities were incurred. Since no notice of deficiency is issued to a taxpayer for employment or excise taxes, no notice of transferee liability will be issued to a transferee for employment or excise taxes.

  5. If the 30-day letter or notice of transferee liability is issued for a transfer, it should be asserted in the first paragraph of the letter that the substantive liability is founded.

  6. If in an estate tax case a preliminary letter or a statutory notice is issued to a transferee, trustee, or beneficiary of property includible in the gross estate under IRC 2035, IRC 2036, IRC 2037, IRC 2038, IRC 2040, IRC 2041, or IRC 2042. It should be issued within the 3-year period provided by IRC 6501. If such property is in trust and is includible under IRC 2035-2038 , inclusive, in lieu of the single term "transferee" in IRM, the designation "transferee and trustee" should be inserted. If such property is insurance includible under IRC 2042, in lieu of the single term "transferee" , the designation "transferee and beneficiary" should be inserted.

  7. If the letter to the transferee covers a deficiency for 1 year and refund due to the transferor for another year, the statutory notice statement paragraph should be revised to read as follows (unless the refund is protected by a claim filed within the statutory period prescribed for filing claims for refund):

    The overassessment shown herein will be made the subject of a certificate for the overassessment which will be applied against the tax liability of the transferor in accordance with IRC 6402 of the Internal Revenue Code provided a proper claim for refund has been filed by the transferor.

  8. If the transferor's liability has been judicially determined, the adjustments to net income, explanations and computations of tax should be omitted and the following type of paragraph inserted:

    The correctness of the amount of the deficiency due from John E. Doe, (address, has been determined by decision of the Tax Court of the United States, Docket No. (number).

4.10.13.3.6.1  (03-16-2015)
Opening Paragraphs in Preliminary Letters to Transferees

  1. When Letter 950 is sent to transferees, the following opening pattern paragraphs will be used in straight deficiency cases (if employment tax is involved, the words "income tax" will be changed to "employment tax" and "years" will be changed to "periods" ).

    1. Income tax case pattern paragraph P-30:

      We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon as provided by law, constituting your ability as a transferee of the property of (Name, Transferor), (address), for income taxes due for the taxable year(s) ended (date of year end), as shown in the attachment to the letter.

    2. Estate tax case pattern paragraph P-31:

      We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon as provided by law, constituting your ability as a transferee of the property of the estate of (Name), (address) for estate tax, penalties and interest thereon, as shown in the attachment to the letter.

    3. Gift tax case pattern paragraph P-32:

      We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon as provided by law, constituting your liability as a transferee of property of (Name, Transferor), (address), for gift tax, penalties and interest thereon, for the calendar year(s) (year), as shown in the attachment to the letter.

    4. When Letter 955 is sent to a fiduciary regarding his/her liability under IRC 6901 and Title 31 of the United States Code, IRC 3713, because he/she paid debts or distributed assets without first satisfying the tax due to the United States from the estate, one of the following opening paragraphs will be used:

      1. Income Tax Case pattern paragraph P-33:

        We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon as provided by law, constituting your personal liability as a fiduciary of the estate of (name), (address), for income taxes, penalties and interest thereon due from (Decedent name) or (Estate), (address) for the tax year(s) ended (year end), as shown in the attachment to the letter.

      2. Estate Tax Case pattern paragraph P-34:

        We have proposed an assessment against you in the amount of ($amount) plus penalties and interest thereon provided by law, constituting your personal liability as a fiduciary for estate tax due from the estate of (name), (address), as shown in the attachment to the letter.

      3. Gift Tax Case pattern paragraph P-35:

        We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon as provided by law, constituting your personal liability as a fiduciary for gift tax due from (name), deceased, for the calendar year(s) (year), as shown in the attachment to the letter.

  2. In mixed deficiency and overassessment cases involving transferee or fiduciary liability, the opening paragraphs inserted in Letter 955 will be suitable revisions of pattern paragraphs P-30 to P-35 as shown above.

  3. If the value of the assets received by a transferee is less than the unpaid tax liability of the transferor, the opening paragraphs P-30 to P-32 will be used, but modified by the following phrase

    ($amount) of the unpaid liability plus interest thereon provided by law constitutes your liability as a transferee of the assets of (transferor name).

4.10.13.3.6.2  (03-16-2015)
Opening Paragraphs for Statutory Notices of Transferee Liability

  1. The opening paragraph of the statutory notice of transferee liability is dependent upon the circumstances of the case. The language for the various opening paragraphs is contained in IRM 4.8.9.17.5.2 Transferee Letter Opening Paragraphs.

4.10.13.3.6.3  (03-16-2015)
Attachment to the Letter for Statutory Notices of Transferee Liability

  1. The attachment to the letter is an explanation to the transferee as to where the proposed assessment originated. The attachment to the letter is divided into two parts:

    1. First is the transferor's section, which lists the name, address, and TIN of the transferor. The unpaid income tax liability and penalties for each tax period subject to transferee liability will also be listed. If the transferor has made payments to reduce the liability, the payments will be netted against the tax, penalties and interest for the earliest tax periods first. The payments will be allocated to the tax, penalties and interest previously assessed against the transferor on the basis of the ratio of the separate amounts of tax, penalties and interest to the aggregate amount assessed. The net figures will be reflected on the attachment to the letter and on the waiver. If the transferee's liability is limited, the list of the transferor's unpaid liability will reflect the transferor's total unpaid liability and will not be adjusted because of the transferee's limitation. The following statement will be placed below the listing of the unpaid liability; "Interest thereon as provided by law will be charged on the unpaid liability until it is paid in full" .

    2. Second is the transferee's section, which lists the name, address, and TIN of the transferee.

  2. The attachment to the letter will be prepared in the format, with the language, shown in IRM 4.8.9, Statutory Notices of Deficiency.

4.10.13.3.7  (03-16-2015)
Assessments

  1. Form 1296, Assessment Against Transferee or Fiduciary, will be prepared by Technical Services when an assessment is to be made against a transferee. A separate Form 1296 is prepared for each transferee for each taxable year/period of the transferor. If the value of the assets received by the transferee is less than the unpaid liability of the transferor and more than one year is involved, the transferee's liability should not be allocated to the various years. Instead, the liability should be shown as one amount on the Form 1296 for the earliest year of the transferor without identifying it with any particular year of the transferee. In limited liability cases such as these, instructions should be included on Form 1296 for computation of interest. The interest starting date and the interest rate will be annotated on Form 1296. An appropriate cross-reference should be made on the other Form 1296, if any.

  2. If a statutory notice is issued to the transferor prior to completion of the action against the transferee(s), the return of the transferor will be forwarded at the expiration of the 90-day period for assessment if no appeal is filed, or earlier if an agreement is received. After assessment, the case file of the transferor will be sent back to the appropriate examination group to complete and associate with the transferee case.

  3. If a waiver of restrictions on assessment and collection for the entire deficiency is filed by the transferor, and no preliminary action has been taken with respect to the transferees, the case will be forwarded for assessment of the tax. After assessment, the case is returned to Examination function for appropriate action with respect to the transferee liability if the tax has not been paid by the transferor.

  4. When a preliminary action 30-day letter has been taken against the transferor and/or transferee(s), and a waiver of restrictions on assessment for all or any part of the unpaid liability is filed by one but not all of the transferees, the agreement, together with Form 1296, will be forwarded for assessment. The assessment will be made, the agreement and Form 1296 will be transmitted to the appropriate group. Subsequent closing action on the case, including advice to the remaining transferees of discontinuance of transferee action, will depend on whether the transferor's tax liability has been discharged by payment.

  5. If statutory notices are issued concurrently to the transferor and transferee(s) and no petitions are filed within the 90-day period, the entire file will be sent for assessment and subsequent action to clear the accounts if the transferor's tax is paid.

  6. Technical Services will prepare Form 1296 and forward them for assessment when a transferor's case is before the Tax Court, and the transferees fail to file petitions within 90 days after Examination issued statutory notices of liability to them. Appeals office will be informed of any payments made by the transferees.

  7. Examination function's consideration of a transferor-transferee case will not be concluded until the record shows that either the tax due from the transferor has been paid or closing action has been taken with respect to the transferor and transferees.

  8. Form 3198 should be prepared in all transferor-transferee cases, and remarks noted where applicable: "Transferee case Agreed/Unagreed, route to Technical Services." Technical Services will make the decision as to whether a transferee assessment will be made. If so, Technical Services will prepare Form 1296 with proper instructions and will send it along with the case file to Case Processing.

4.10.13.4  (03-16-2015)
Related Party Transactions (IRC 482)

  1. The purpose of IRC 482 is to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent tax avoidance with respect to such transactions. IRC 482 places a controlled taxpayer on a tax parity with an uncontrolled taxpayer by determining the true taxable income of the controlled taxpayer

  2. IRC 482 also applies to cases involving transactions with foreign related parties or domestic related parties . The original purpose of IRC 482 and its predecessor statutes was to prevent arbitrary shifting of profits, making of fictitious sales, and other methods for “milking” among related parties, particularly when a foreign party was involved. While the principal target of IRC 482 appears to have been U.S. income shifted to commonly controlled foreign entities, IRC 482 also applies to prevent tax avoidance and to correct income distortion arising from transactions between domestic entities.

  3. The actual text of IRC 482 is very short and concise. The Treasury Regulations under IRC 482 and case law interpreting IRC 482 provide guidance on its application. In addition to this IRM section on IRC 482 please refer to IRM 4.11.5Allocation of Income and Deductions.

4.10.13.4.1  (03-16-2015)
Purpose and Scope of IRC 482

  1. Under Treas. Reg. 1.482-1(a)(1), "the purpose of IRC 482 is to ensure that taxpayers clearly reflect income attributable to controlled transactions" . Further, IRC 482 places a controlled taxpayer on tax parity with an uncontrolled taxpayer.

  2. Under Treas. Reg. 1.482-1(a)(2), the Service has the authority to make allocations “between and among the members of a controlled group if a controlled taxpayer has not reported its true taxable income.” The Service may allocate all income, deductions, credits, allowances, basis, or any other item affecting taxable income of a controlled taxpayer to prevent the evasion of taxes or to clearly reflect income. The Service may allocate income even if the intent to evade or avoid tax is not present if such allocation will more clearly reflect the income of the controlled taxpayer. Treas. Reg. 1.482-1(f)(1)(i).

  3. The focus of IRC 482 is economic reality, not the taxpayer’s motivation and purpose..

  4. Under IRC 482, the Service's deficiency determinations are presumptively correct. The taxpayer bears the burden of proving that the Service’s deficiency determinations are arbitrary, capricious, and unreasonable.

4.10.13.4.2  (03-16-2015)
Two or More Organizations, Trades or Businesses

  1. To justify a reallocation under IRC 482, the Service must find:

    1. that there are two or more trades, business, or organizations;

    2. that such enterprises are owned or controlled by the same interests; and

    3. that the reallocation is necessary in order to prevent the evasion of taxes or to reflect properly each enterprise's income.

  2. The phrase "two or more organizations, trades or businesses" has caused some concern in determining the applicability of IRC 482. "Organization includes an organization of any kind, whether a sole proprietorship, a partnership, a trust, an estate, an association, or a corporation." Treas. Reg. 1.482-1(i)(1). "Trade or business includes a trade or business activity of any kind, regardless of whether or where organized, whether owned individually or otherwise, and regardless of the place of operation. " Treas. Reg. 1.482-1(i)(2).

  3. A shareholder's transactions with his controlled corporation may be subject to IRC 482. In Fegan v. Commissioner, 71 TC 791, 804 (1979), the taxpayer argued the Service's allocation of additional rental income to him from his controlled corporation was improper because he was an individual and not an organization, trade, or business as referred to in IRC 482. The Service argued that the taxpayer was within the meaning of IRC 482 because that provision permits an allocation of income from a related organization to an individual who is in a trade or business. The Tax Court held that the taxpayer’s lease of real property, equipment, and furnishings to a corporation that the taxpayer owned was a trade or business within the meaning of IRC 482.

  4. It is the Service's position that a shareholder/employee who receives a salary for services rendered is engaged in a trade or business for purposes of IRC 482. Rev. Rul. 88-38, 1988-1 C.B. 246.

4.10.13.4.3  (03-16-2015)
Specific Situations in Which IRC 482 Could Be Applied

  1. The following is a summary of various situations in which an IRC 482 issue could be raised. Neither this summary nor the citations furnished are meant to be all inclusive.

4.10.13.4.3.1  (03-16-2015)
Loans or Advances - Treas. Reg. 1.482-2(a)

  1. IRC 482 may apply to intercompany loans or advances. Treas. Reg. 1.482-2(a) states as follows: "Where one member of a group of controlled entities makes a loan or advance directly or indirectly to, or otherwise becomes a creditor of, another member of such group and either charges no interest, or charges interest at a rate which is not equal to an arm's length rate of interest (as defined in paragraph (a)(2) of this section) with respect to such loan or advance, the district (now Area) director may make appropriate allocations to reflect an arm's length rate of interest for the use of such loan or advance."

  2. IRC 482 only applies to bona fide indebtedness between members of a controlled group of entities. Examples of such indebtedness include: (1) loans or advances of money or other consideration (whether or not evidenced by a written instrument); and (2) indebtedness arising in the ordinary course of business from sales, leases, or rendition of services by or between members of the group or any other similar extension of credit. Treas. Reg. 1.482-2(a)(1)(ii)(A). IRC 482 does not apply to indebtedness that is not bona fide such as contributions to capital or leases of property. Treas. Reg. 1.482-2(a)(1)(ii)(B).

  3. Is an arm's length interest rate charged? An arm’s length rate of interest is the rate of interest that was charged, or would have been charged, at the time the indebtedness arose in independent transactions with or between unrelated parties under similar circumstances. To determine whether an interest rate is arm’s length, consider all relevant factors including the principal amount and duration of the loan, the security involved, the credit standing of the borrower, and the interest rate prevailing at the situs of the lender or creditor for comparable loans between unrelated parties. Treas. Reg. 1.482-2(a)(2)(i).

  4. Treas. Reg. 1.482-2(a)(2)(iii) provides safe harbor interest rates for intercompany loans and advances made after May 8, 1986. The rate of interest actually charged is considered arm’s length if it is between 100 percent and 130 percent of the applicable federal rate (“AFR”). Treas. Reg. 1.482-2(a)(2)(iii)(B)(1). If no interest is charged or if the interest charged is less than 100 percent of the AFR, then 100 percent of the AFR (compounded semi-annually) will be considered an arm’s length rate. Treas. Reg. 1.482-2(a)(iii)(B)(2). If the interest rate charged is higher than 130 percent of the AFR, then 130 percent of the AFR (compounded semi-annually) will be considered an arm’s length rate unless the taxpayer establishes a more appropriate rate of interest. Treas. Reg. 1.482-2(a)(2)(iii)(B)(3). Two exceptions to these safe harbor interest rate rules exist. First, the safe harbor rules do not apply if the lender is regularly engaged in the business of making loans to unrelated parties. Treas. Reg. 1.482-2(a)(2)(iii)(D). Second, the safe harbor rules do not apply to loans or advances when their principal or interest is expressed in a currency other than U.S. dollars. Treas. Reg. 1.482-2(a)(2)(iii)(E).

  5. There are certain coordination rules with respect to interest adjustments required under certain other IRC provisions. Treas. Reg. 1.482-2(a)(3). For example, if IRC 7872 could apply in addition to IRC 482, then IRC 7872 should be used as the primary position. If there is a dispute over whether IRC 7872 applies, or if it is unclear whether it applies, then IRC 482 should be raised as an alternative position. Prop. Reg. 1.7872-2(a)(2)(iii).

  6. When considering loans between two related entities, the Service is not necessarily bound to the position of “imputing” interest income under IRC 482. Under certain circumstances, the Service may use IRC 482 to reallocate interest expense claimed by one entity to its affiliate. In Kahler Corp. v. Commissioner, 486 F.2d 1 (1973), rev’d, 58 TC 496 (1972), the common parent of an affiliated group borrowed funds from third party lenders. Subsequently, the parent reloaned some of its borrowed funds to two of its subsidiaries. The loans from the parent to the subsidiaries were made on an interest-free basis. The affiliated group did not file a consolidated return. The parent was in a higher-tax bracket than its subsidiaries, and thus, received a significant benefit from the interest expense deduction that it claimed. On the other hand, both of the subsidiaries were in much lower-tax brackets and would not have derived as much of a tax benefit from the interest deductions. The Service imputed interest income to the parent and increased the interest expense deductions of the subsidiaries. The Court held that the Service’s allocation was necessary under IRC 482 to clearly reflect the income of the parent and the subsidiaries.

  7. Similarly, in Latham Park Manor, Inc. v. Commissioner, 69 TC 199, 220-221 (1977), in his concurrence, Judge Scott stated:

    In economic reality, MIC was the true borrower. Making a proper allocation of the interest deductions and amortized loan costs (which is the substance of the adjustment made by respondent in the notice of deficiency) fully eliminates the tax avoidance here occasioned by the relationship of the parties....

4.10.13.4.3.2  (03-16-2015)
Performance of Services - Before January 1, 2007 Treas. Reg. 1.482-2(b) (1968)

  1. The Treasury Department issued regulations covering service transactions between controlled entities in 1968. T.D. 6952, 1968-1 C.B. 218; Treas. Reg. 1.482-2(b) (1968). The 1968 controlled services regulations were partly amended in 1994 by T.D. 8552, 1994-2 C.B. 93, but remained relatively unchanged until 2006 when the Service adopted new temporary regulations that covered controlled service transactions. T.D. 9278, 2006-2 C.B. 256; Temp. Treas. Reg. 1.482-9T (August 4, 2006); issued in final form in T.D. 9456, 2009-33 I.R.B. 188; Treas. Reg. 1.482-9 (August 4, 2009).

  2. Prior to its amendment by Treas. Reg. 1.482-9T, Treas. Reg. 1.482-2(b) (referred to hereafter as “Former Treas. Reg. 1.482-2(b)”) required that where one member of a group of controlled entities performs marketing, managerial, administrative, technical, or other services for the benefit of, or on behalf of another member of the group at a charge that is not an arm’s length charge, the Service may make allocations to reflect and arm’s length charge for the services.

  3. Former Treas. Reg. 1.482-2(b)(2)(i) authorized the Service to make allocations to reflect arm’s length charges for services undertaken for the joint benefit of the members of a controlled group, or services performed exclusively for the benefit of one member the controlled group. However, if the benefits to the other members were so indirect or remote that unrelated parties would not have charged for the services, the Service was not authorized to make a section 482 allocation regarding those services.

  4. In determining the amount of the arm’s length charge, Former Treas. Reg. 1.482-2(b)(3) provided that if services are not an “integral part” of the business activity of either the member rendering the services or the member receiving the benefit of the services, then the arm’s length charge shall be equal to costs of the service, unless the taxpayer establishes a more appropriate charge. However, if the services are an “integral part” of the business activity of either the member rendering the service or the member receiving the benefit of the service, then the arm’s length charge is the amount that would have been charged for the same or similar services in independent transactions between unrelated parties under similar circumstances. Former Treas. Reg. 1.482-2(b)(7) provided four separate tests for determining whether a particular service was considered to be an “integral part” of an entity’s business. If any of the four tests were satisfied, then the services at issue were considered to be an “integral part” of the business activity, and an arm’s length charge was not deemed equal to the costs or deductions of those services but instead required a determination of the actual amount that would have been charged between unrelated parties under similar circumstances for those services.

  5. Some cases applying Former Treas. Reg. 1.482-2(b) to controlled service transactions are set forth below. This is not an exhaustive list of cases covering this area.

  6. In Haag v. Commissioner, 88 TC 604, 622 (1987), the United States Tax Court held that IRC 482 may be used to allocate income from a professional service corporation to a shareholder/employee. In Haag, a physician assigned his interest in a medical partnership to his professional corporation. Although the doctor provided medical services to the corporation, he received either no salary or minimal salary for the years at issue. The court stated that “Petitioner would not have agreed to work for no compensation if he had bargained at arm's length with an uncontrolled entity” and upheld the government’s IRC 482 adjustment, which was “the difference between the amount of compensation petitioner would have received in each year absent of incorporation and the amount he actually received.”

  7. In Keller v. Commissioner, 77 TC 1014 (1981), in determining the applicability of IRC 482 to a pathologist's compensation, his total compensation (salary, pension plan contributions, and medical benefits) was compared to what the petitioner would have bargained for in an arm's-length transaction with an unrelated party.

  8. Due to employment tax considerations, it appears when inadequate compensation is paid to a shareholder/employee, consideration should be given to whether loans to the shareholder should be recharacterized as compensation instead of treating them as dividend distributions.

  9. In Haber v. Commissioner, 52 TC 255 (1969), an S corporation made loans to one of its shareholder/employees over several years but reduced the shareholder/employee's salary by the amount of the loans. The loans were recharacterized as compensation for services.

  10. Although raising an IRC 482 issue on compensation from an S corporation will usually have a wash effect on income tax, it should be considered when the shareholder otherwise has no earnings subject to FICA tax.

  11. In Bell v. Commissioner, T.C. Memo 1982-660, three physicians formed a C corporation and a separate S corporation. The S corporation earned income from providing X-ray services to the C corporation. IRC 482 was used to allocate income from the S corporation to the C corporation. The income allocated was then treated as dividend distributions from the C corporation to its shareholders.

  12. If an existing business is transferred to multiple corporations, the examiner, in addition to considering IRC 482, should consider the applicability of IRC 269 and IRC 1551.

  13. In Rubin v. Commissioner, 460 F.2d 1216 (2d Cir. 1972), payments by Corporation A to Corporation B were allocated under IRC 482 to the shareholder of Corporation B who had performed the management services for Corporation A. The taxpayer's services constituted a trade or business separate from his interest in Corporation B and were subject to IRC 482.

  14. In Ach v. Commissioner, 42 TC 114 (1964), the taxpayer sold her successful dress shop to her son's insolvent corporation for less than adequate consideration. Although the taxpayer continued to provide significant managerial services to the business, she was not remunerated for her services. The court upheld the Service's use of IRC 482 to allocate 70% of the profits of the dress shop to the taxpayer. The court held the parties had not dealt at arm's length and the sole purpose for the transfer of the dress shop was for the corporation to utilize net operating losses it would have otherwise lost..

4.10.13.4.3.3  (03-16-2015)
Performance of Services After December 31, 2006 and Before August 1, 2009 - Treas. Reg. 1.482-9T

  1. The Treasury Department issued proposed regulations in 2003 covering controlled service transactions. 68 Fed. Reg. 53448 (Sep. 10, 2003). In response to comments received on issues covered by the 2003 proposed regulations, the Treasury Department issued Temp. Treas. Reg. 1.482-9T. These temporary regulations were later clarified and the effective date modified by Notice 2007-5, 2007-1 C.B. 269. Rev. Proc. 2007-13, 2007-1 C.B. 295, also identified specified covered services within the meaning of Temp. Treas. Reg. 1.482-9T(b).

  2. The 2006 temporary regulations generally apply for tax years beginning after December 31, 2006 through July 31, 2009. On July 31, 2009, the Service adopted the final version of the Treasury Regulations covering controlled service transactions. The final 2009 services regulations generally apply to taxable years beginning after July 31, 2009; however, taxpayers may affirmatively elect to retroactively apply certain provisions of the 2009 services regulations to taxable years beginning after September 10, 2003. See Treas. Reg. 1.482-9(n).

4.10.13.4.3.4  (03-16-2015)
Performance of Services After July 31, 2009 - Treas. Reg. 1.482-9

  1. Treas. Reg. 1.482-9 provides methods to determine taxable income from a controlled services transaction. A controlled services transaction includes any activity by one member of a group of controlled taxpayers that results in a benefit to one or more other members of the controlled group. Treas. Reg. 1.482-9(l)(1). An activity includes: (1) the performance of functions; (2) assumptions of risks; (3) use by a renderer of tangible or intangible property or other resources, capabilities, or knowledge, such as knowledge of and ability to take advantage of particularly advantageous situations or circumstances; and (4) making available to the recipient any property or other resources of the renderer. Treas. Reg. 1.482-9(l)(2).

  2. For an activity rendered by one member of a group of controlled taxpayers to be considered a controlled services transaction, the activity must result in a benefit to one or more other members of the controlled group. An activity is considered to provide a benefit to the recipient if the activity directly results in a reasonably identifiable increment of economic or commercial value that enhances the recipient’s commercial position, or that may reasonably be anticipated to do so. Further, an activity is generally considered to confer a benefit if an uncontrolled taxpayer in circumstances comparable to those of the recipient would be willing to pay an uncontrolled party to perform the same or similar activity. Treas. Reg. 1.482-9(l)(3)(i).

  3. Rules on activities that may not confer a benefit.

    1. (Indirect or remote benefit) An activity is not considered to provide a benefit to the recipient if, at the time the activity is performed, the present or reasonably anticipated benefit from that activity is so indirect or remote that the recipient would not be willing to pay an uncontrolled party to perform a similar activity, and would not be willing to perform such an activity itself. Treas. Reg. 1.482-9(l)(3)(ii). Examples 2 and 3 of Treas. Reg. 1.482-9(l)(5) illustrate the indirect or remote benefit concept.

    2. (Duplicative activities) If an activity performed by a controlled taxpayer duplicates an activity that is performed or reasonably anticipated to be performed, by another controlled taxpayer for its own account, the activity is generally not considered to provide a benefit to the recipient, unless the duplicative activity itself provides an additional benefit to the recipient. Treas. Reg. 1.482-9(l)(3)(iii). Examples 4, 5, and 6 of Treas. Reg. 1.482-9(l)(5) illustrate the duplicative activities concept.

    3. (Shareholder activities) An activity is not considered to provide a benefit to a related party if the sole effect of that activity is to protect the render’s capital investment in the recipient or other members of the controlled group, or to facilitate compliance by the renderer with reporting, legal, or regulatory requirement applicable specifically to the renderer. Treas. Reg. 1.482-9(l)(3)(iv). Examples 7 through 14 of Treas. Reg. 1.482-9(l)(5) illustrate the shareholder activities concept.

    4. (Passive association) A controlled taxpayer will generally not be considered to obtain a benefit resulting from the controlled taxpayer’s status as a member of a controlled group. Treas. Reg. 1. 482-9(l)(3)(v). Examples 15 through 19 of Treas. Reg. 1.482-9(l)(5) illustrate the passive association concept.

  4. The 2009 services regulations require that the amount charged in a controlled services transaction be determined under one of the following methods:

    1. The services cost method, as described in Treas. Reg. 1.482-9(b)

    2. The comparable uncontrolled services price method, as described in Treas. Reg. 1.482-9(c)

    3. The gross services margin method, as described in Treas. Reg. 1.482-9(d)

    4. The cost of services plus method, as described in Treas. Reg. 1.482-9(e)

    5. The comparable profits method, as described in Treas. Reg. 1.482-5 and Treas. Reg. 1.482-9(f)

    6. The profit split method, as described in Treas. Reg. 1.482-6 and Treas. Reg. 1.482-9(g); and

    7. Unspecified methods, as described in Treas. Reg. 1.482-9(h).

  5. Each method must be applied in accordance with the best method rule of Treas. Reg. 1.482-1(c), the comparability analysis of Treas. Reg. 1.482-1(d), and the arm’s length range of Treas. Reg. 1.482-1(e). See Treas. Reg. 1.482-9(a).

  6. A central part of Former Treas. Reg. 1.482-2(b) was that an arm’s length charge for services that were not “integral” were deemed equal to costs or deductions of rendering the services. Treas. Reg. 1.482-9 preserves aspects of this “deemed equal to the costs or deductions” treatment through the services cost method. The services cost method is designed to minimize compliance burdens for intragroup back office services common across many industries. The services cost method as set forth in the 2009 services regulations may be applied if a taxpayer satisfies four conditions.

    1. First, the service must be a “covered service” within the meaning of Treas. Reg. 1.482-9(b)(3). “Covered services” consist of (1) specified covered services or (2) low-margin covered services. A list of specified covered services is provided in Rev. Proc. 2007-13. Low-margin covered services are controlled services transactions for which the median comparable markup on total services costs is less than or equal to seven percent. Treas. Reg. 1.482-9(b)(3)(ii).

    2. Second, the service must not be an “excluded activity” under Treas. Reg. 1.482-9(b)(4). The following types of activities are excluded activities: (1) manufacturing; (2) production; (3) extraction, exploration, or processing of natural resources; (4) construction; (5) reselling, distribution, acting as a sales or purchasing agent, or acting under a commission or other similar arrangement; (6) research, development, or experimentation; (7) engineering or scientific; (8) financial transactions, including guarantees; and (9) insurance or reinsurance.

    3. Third, the service must meet the business judgment rule. Treas. Reg. 1.482-9(b)(2)(iii). Under this rule, the taxpayer must reasonably conclude in its business judgment that the service does not contribute significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure in one or more trades or businesses of the controlled group. Treas. Reg. 1.482-9(b)(5). The reasonableness of the taxpayer’s conclusion is determined based on all the facts and circumstances.

    4. Fourth, the taxpayer must maintain adequate books and records. Treas. Reg. 1.482-9(b)(2)(iv). The taxpayer’s books and records must be adequate to permit verification by the Service of the total services costs incurred by the renderer, including a description of the services in question, identification of the renderer and the recipient of such services, and sufficient documentation to allow verification of the methods used to allocate and apportion such costs to the services in question. Treas. Reg. 1.482-9(b)(6). In addition, the books and records must include a statement evidencing the taxpayer’s intention to apply the services cost method to evaluate the arm’s length charge of such services.

  7. Under certain conditions, the 2009 services regulations also permit taxpayers to use shared service arrangements to allocate costs within a controlled group. Treas. Reg. 1.482-9(b)(7). A shared services arrangement must: (1) include two or more participants; (2) include as participants all controlled taxpayers that benefit from one or more covered services subject to the shared services agreement; and (3) be structured such that each covered service confers a benefit on at least one participant. Treas. Reg. 1.482-9(b)(7)(ii)(A). Examples illustrating the shared services arrangement rules are set forth in Treas. Reg. 1.482-9(b)(8).

  8. The 2009 services regulations contain coordination rules for service transactions that contain elements of different types of transactions. For example, a transaction structured as a service transaction may also involve the transfer of tangible or intangible property. In evaluating whether to value these integrated transactions as a single transaction or whether to value each component separately, depends on which approach will provide the most reliable measure of an arm’s length result. Treas. Reg. 1.482-9(m).

4.10.13.4.3.5  (03-16-2015)
Use of Tangible Property - Treas. Reg. 1.482-2(c)

  1. Where possession, use, or occupancy of tangible property owned or leased by one member of a group of controlled entities is transferred by lease or other arrangement to another member of such group without charge or at a charge that is not equal to an arm’s length rental charge, the Service may make appropriate allocations to properly reflect an arm’s length charge. Treas. Reg. 1.482-2(c)(1). Generally, an arm’s length charge equals the amount of rent that was charged, or would have been charged, for the use of the same or similar property, during the time it was in use, in independent transactions between unrelated parties under similar conditions. Treas. Reg. 1.482-2(c)(2).

  2. If a taxpayer leases property from an unrelated party and then subleases the property to a related party, an arm’s length rental charge is equal to all the deductions claimed by the taxpayer for the period the property is used unless the taxpayer can establish a more appropriate arm’s length rental charge or the taxpayer or the related party subleasing the property were regularly engaged in the business of renting property of the same general type as the property in question to unrelated parties. Treas. Reg. 1.482-2(c)(2)(iii).

  3. Some cases applying IRC 482 to the use of tangible property by lease are set forth below. This is not an exhaustive list of cases covering this area.

  4. A shareholder's rental of a commercial building to her controlled corporation for a non-arm’s length rent is subject to IRC 482. See Peck v. Commissioner, T.C. Memo 1982-17; Fegan v. Commissioner, 71 TC 791; Thomas v. Commissioner, T.C. Memo. 1983-462.

  5. This may be particularly abusive in situations where the corporation has a net operating loss. To the extent the shareholder has an allowable rental loss after applying IRC 482 and any other relevant provisions of the Code, IRC 469 should be considered to disallow any passive activity loss.

  6. A partnership's rental of a building to a related corporation for a non-arm’s length rent is also subject to IRC 482. Boyer v. Commissioner, 58 TC 316 (1972).

4.10.13.4.3.6  (03-16-2015)
Cost Sharing Arrangements - Treas. Reg. 1.482-7A and Treas. Reg. 1.482-7

  1. The development of intangible assets may be funded by the use of a cost sharing arrangement if all legal requirements are satisfied. Generally under a cost sharing arrangement, two or more cost sharing participants agree to jointly contribute to the costs of developing an intangible asset in proportion to their reasonably anticipated benefits.

  2. Treasury Regulations issued in 1968 first governed cost sharing arrangements without providing detailed guidance. See Treas. Reg. 1.482-2(d)(4) (1968). However, during the early 1990s proposed and temporary Treasury Regulations were issued that provided more detailed guidance on cost sharing arrangements. Final Treasury Regulations covering cost sharing arrangements were issued in December of 1995 and then amended in May of 1996. See T.D. 8632, 1996-1 C.B. 85; T.D. 8670, 1996-1 C.B. 99. These regulations were amended again in 2003 to provide guidance on the treatment of stock-based compensation in cost sharing arrangements. See T.D. 9088, 2003-2 C.B. 841. The 1995 cost sharing regulations, as amended by T.D. 8670 and T.D. 9088, are currently designated as Treas. Reg. 1.482-7A. With the exception of Treas. Reg. 1.482-7A(a)(3), (d)(2), and (j)(2)(i)(F) (addressing the requirement to share stock-based compensation costs), Treas. Reg. 1.482-7A applies to taxable years beginning after December 31, 1995 (Treas. Reg. 1.482-7A(a)(3), (d)(2), and (j)(2)(i)(F) apply for taxable years beginning after August 25, 2003) and remain applicable through January 4, 2009. Temporary Treasury Regulations were issued on January 5, 2009, which made significant changes to the prior 1995 cost sharing regulations. T.D. 9441, 2009-7 I.R.B. 460. The final cost sharing regulations were issued in December 2011 and are designated under Treas. Reg. 1.482-7. T.D. 9568, 2012-12 I.R.B. 499. The final cost sharing regulations are effective December 16, 2011.

  3. Under Treas. Reg. 1.482-7A, “a cost sharing arrangement is an agreement under which the parties agree to share the costs of development of one or more intangibles in proportion to their shares of reasonably anticipated benefits from their individual exploitation of the interests in the intangibles assigned to them under the arrangement.” Treas. Reg. 1.482-7A(a)(1). Taxpayers may utilize cost sharing only for “qualified” cost sharing arrangements. To be “qualified,” a cost sharing arrangement must: (1) include two or more participants; (2) provide a method to calculate each controlled participant’s share of intangible development costs, based on factors that can reasonably be expected to reflect that participant’s share of anticipated benefits; (3) provide for adjustment to the controlled participants’ shares of intangible development costs to account for changes in economic conditions, the business operations and practices of the participants, and the ongoing development of intangibles under the arrangement; and (4) be recorded in a document that is contemporaneous with the formation of the cost sharing arrangement.”

  4. Participants in a cost sharing arrangement may be either controlled participants or uncontrolled participants. A controlled participant’s participation is only recognized if it: (1) reasonably anticipates that it will derive benefits from the use of covered intangibles; and (2) substantially complies with the accounting and administrative requirements of the cost sharing regulations. Treas. Reg. 1.482-7A(c)(1). The accounting requirements are that the controlled participants in a qualified cost sharing arrangement must use a consistent method of accounting to measure costs and benefits, and must translate foreign currencies on a consistent basis. Treas. Reg. 1.482-7A(i). The administrative requirements are that the controlled participant must maintain sufficient documentation as set forth in the cost sharing regulations and also must attach to its U.S. income tax return a statement indicating that it is a participant in a cost sharing arrangement, and listing the other controlled participants in the arrangement. Treas. Reg. 1.482-7A(j).

  5. A qualified cost sharing arrangement must specify each participant’s share of the “intangible development costs.” Treas. Reg. 1.482-7A(b)(2). This share means all of the costs incurred by the participant relating to the intangible development area, plus all of the cost sharing payments it makes to other controlled and uncontrolled participants, minus all of the cost sharing payments it receives from other controlled and uncontrolled participants. Treas. Reg. 1.482-7A(d). Costs incurred related to the intangible development area include operating expenses, other than depreciation and amortization, and arm’s length charges for the use of tangible property that a participant makes available to the qualified cost sharing arrangement. Id.

  6. Intangible development costs must be shared among the controlled participants in proportion to their shares of reasonably anticipated benefits. Treas. Reg. 1.482-7A(a)(1) and (e). A controlled participant’s reasonably anticipated benefits are the aggregate benefits it reasonably anticipates that it will derive from the covered intangibles. Treas. Reg. 1.482-7A(e)(2). For that purpose, benefits are the additional income generated or costs saved by the use of the covered intangibles. Treas. Reg. 1.482-7A(e)(1). A controlled participant’s share of reasonably anticipated benefits is equal to its reasonably anticipated benefits divided by the reasonably anticipated benefits of all controlled participants. Treas. Reg. 1.482-7A(f)(3)(i).

  7. Reasonably anticipated benefits must be determined using the most reliable estimate of reasonably anticipated benefits. In making that determination, the quality of the data and assumptions used in the analysis must be taken into account. Treas. Reg. 1.482-7A(f)(3)(i). Significant divergences between the projected and actual benefits may mean the projections are unreliable. Treas. Reg. 1.482-7A(f)(3)(iv)(B). Projections will not be considered unreliable based on a divergence between a controlled participant’s projected benefit share and actual benefit share if the amount of such divergence for every controlled participant is less than or equal to 20 percent of the participant’s projected benefit share. Id.

  8. If a controlled participant makes pre-existing intangible property in which it owns an interest available to other controlled participants for purposes of the cost sharing arrangement, then each other controlled participant must make a buy-in payment to the owner of the pre-existing intangible property. Treas. Reg. 1.482-7A(g)(2).

  9. Under the 2011 cost sharing regulations, a cost sharing arrangement in existence on January 5, 2009, and satisfying the legal requirements of the 1995 cost sharing regulations, will continue to be regarded as a cost sharing arrangement if certain conforming changes are made to the arrangement. Treas. Reg. 1.482-7(m). The cost sharing arrangement must have been amended by the parties to conform with Treas. Reg. 1.482-7(k) by July 6, 2009. In addition, taxpayers must have filed a cost sharing arrangement statement with the Service no later than September 2, 2009. Treas. Reg. 1.482-7(m)(2)(viii). Cost sharing transactions and platform contributions taking place prior to January 5, 2009 are subject to the 1.482-7A regulations. Treas. Reg. 1.482-7(m)(2)(i).

  10. The 2011 cost sharing regulations were significantly changed from the 1.482-7A regulations. The 2011 cost sharing regulations are set out in Treas. Reg. 1.482-7. Treas. Reg. 1.482-7(g) provides methods to determine an arm’s length result for a platform contribution transaction, including the comparable uncontrolled transaction method, the income method, the acquisition price method, the market capitalization method, the residual profit split method, and unspecified methods. The 2011 cost sharing regulations also provide new rules on determining divisional interests (Treas. Reg. 1.482-7(b)(4)) and reasonably anticipated benefits share (Treas. Reg. 1.482-7(e)), along with many other provisions. Considering the complexity of the cost sharing regulations, consider contacting the Office of Associate Chief Counsel (International) and the Transfer Pricing Practice if you have questions regarding the examination of a taxpayer’s cost sharing arrangement.

4.10.13.4.3.7  (03-16-2015)
Transfers of Intangible Property - Treas. Reg. 1.482-4

  1. . The arm's length amount charged in a controlled transfer of intangible property must be determined under one of the four methods listed in Treas. Reg 1.482-4:

    1. The comparable uncontrolled transaction method, described in Treas. Reg 1.482-4(c);

    2. The comparable profits method, described in Treas. Reg 1.482-5;

    3. The profit split method, described in Treas. Reg 1.482-6; and

    4. Unspecified methods described in Treas. Reg 1.482-4(d).

  2. Each of the methods must be applied in accordance with all of the provisions of Treas. Reg 1.482-1, including:

    1. The best method rule of Treas. Reg 1.482-1(c);

    2. The comparability analysis of Treas. Reg 1.482-1(d); and

    3. The arm's length range of Treas. Reg 1.482-1(e).

    The arm's length consideration for the transfer of an intangible determined under Treas. Reg 1.482-4 must be commensurate with the income attributable to the intangible. See Treas. Reg 1.482-4(f)(2) (Periodic adjustments).

  3. Pursuant to Treas. Reg. 1.482-4(b), intangible property for purposes of IRC 482 is an asset that comprises any of the following items and has substantial value independent of the services of any individual:

    1. Patents, inventions, formulae, processes, designs, patterns or know-how;

    2. Copyrights and literary, musical, or artistic compositions;

    3. Trademarks, trade names, or brand names;

    4. Franchises, licenses, or contracts;

    5. Methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data; and

    6. Other similar items.

  4. Consideration for a transfer of intangible property shall be in the form of a royalty to the transferor where the transferor retains a substantial interest in the property and the transferee pays nominal or no consideration, unless a different form is more appropriate. Treas. Reg. 1.482-4(f)(1)


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