1. St. Louis International Tax Group, Inc.
Correction of an Error – 9100 Relief,
Rescission, Transactional Electivity and
Other Fun and Games
Daniel C. White
Philip B. Wright
Bryan Cave LLP
5th February 2015
2. Transactional Electivity
and Error Correction
I. Overview – Base Case
II. Transactional Electivity
III. Overview of Tax Mistakes
IV. Potential Legal and Equitable Remedies
V. Illustrative Examples
1
3. Base Case
2
P
FS-2
FS-3
FS-1
For operating efficiencies, P wants to transfer FS-1 to the
FS-2 group. The general counsel has asked for your
recommended structure.
For the form of the transaction, you consider:
• Acquiror: FS-2 or FS-3
• Form: Stock, Assets, or “Hybrid”
• Consideration: Cash, Stock, Other
• Origin of Proceeds: Pre/Post
Dividend/Redemption
FS-2 Group
5. Transactional Electivity:
Explicit and Implicit Elections
“Transactional electivity” means the ability to choose the tax consequences of a business
transaction without substantially altering the economic arrangements. These elections are
explicit and implicit.
Explicit electivity directly in the Internal Revenue Code or in the Treasury Regulations.
Implicit electivity in three types:
Electivity caused by form of transactions
Electivity arising as a result of conflict among authorities (e.g., IRS vs. courts; conflict
between circuits)
Electivity caused in the absence of guidance (e.g., Gottesman & Co. v. Commissioner, 77
T.C. 1149 (1981))
Taxing different economic arrangements “differently” is not transactional electivity
3
6. Examples of Potential
Transactional Electivity – Base Case
4
P
FS-2
FS-3
FS-1
P
FS-2
FS-3
FS-1
P
FS-2
FS-3
FS-1
1. FS-2 acquires FS-1 stock in
exchange for no consideration.
2. FS-1 converts under local
law to the form of a limited
partnership/disregarded entity.
1
1 1
2 2
1. FS-3 acquires FS-1 stock in
exchange for no consideration.
2. FS-1 converts under local
law to the form of a limited
partnership/disregarded entity.
1. FS-3 acquires FS-1 stock in
exchange for cash/other
property.
7. Considerations in Comparing Explicit
Elections with Transactional Elections
5
Explicit Elections Implicit Elections
Ease of application Potential need for expert
advice
Doctrine of Election Reformation/Scriveners
error
Substantial Compliance
doctrine
Danielson/Substance over
form
Section 9100 relief Rescission
Timing - Generally post-
closing but often not beyond
the tax return filing date
Timing – At Closing but
though may be later as a
result of explicit election or
created by conflicts or
absence of law
9. 6
What is a Mistake: A Tax Perspective
Tax Mistake Defined: The tax consequences of the
particular transaction are not as intended or as favorable as
they might have been absent the “mistake”.
Tax Mistake versus Hindsight:
Hindsight is the attempt to alter the tax consequences
of a transaction to achieve a more favorable tax result
where future events turned out other than as expected
and as such the resulting tax consequences are not as
intended.
10. 7
What is a Mistake: A Tax Perspective
Execution Error: The parties understood the facts, law and method by which to
achieve the desired tax result but there was a failure to execute the transaction as
designed to achieve the desired tax results.
Documentation Errors
“Scrivener” Error. There is a mistake in the documents attributable to a communication or drafting error
such that the documents as drafted/executed do not reflect the intent of the parties.
Substantiation/Filing/Election Errors. The intended tax consequences require that the transaction be
substantiated in a particular manner or the parties file a particular form or make a particular election
within a given time period.
Timing/Sequencing Error
The intended tax consequences of the transaction depend on the transaction(s) occurring within a certain
time period or occurring in a particular sequence.
Mistake of Fact:
A mistaken belief as to a material fact that alters the tax consequences of the
transaction.
Mistake of Law:
An erroneous application of the law to the known facts (including the lack of
knowledge of a particular law) an error in the legal analysis or conclusion.
11. IV. Legal and Equitable Remedies
Remedies to Correct A
Tax Mistake
12. 8
Fixing Tax Election/Tax Return Mistakes
Election Tax Mistakes
Late Elections
Defective Elections - Taxpayer attempts to make an election but does not substantially
comply with the applicable requirements
Erroneous Elections – Taxpayer makes an election in error and seeks to revoke the election
Doctrine of Election - Pacific National Co. v. Welch, 304 U.S. 191 (1938)
Election Remedies
Section 9100 Relief – Late Elections
Equitable Remedies
Tax Return Reporting Errors
Inaccurate Returns
Failure to include documentation/forms
Tax Return Remedies
Amended Tax Returns
Affirmative Claims on Audit
Equitable Remedies
13. 9
Fixing Non-Election Related Mistakes
Equitable Remedies
Rescission
Rev. Rul. 80-158 – IRS Ruling Position
Background
Elements of Rescission - Judicial Underpinnings
Same Taxable Year – Penn v. Roberson
Return of the Parties to the Status Quo Ante
Contractual – Transaction giving rise to rescission must arise out of a “contract”
Reformation
General
Judicial nunc pro tunc orders (now for then)
Rev. Rul. 93-79 (Reformation of trust to meet S shareholder eligibility was not given
retroactive tax effect)
Same American Nurseryman Publishing Company v. Commissioner 75 T.C. 271 (1980), aff'd without
opinion, 673 F.2d 1333 (7th Cir. 1982)
Non Judicial Reformation - Contract Modification
Mistake in Fact or Law to Reform or Abrogate the Agreement
Scrivener’s Error – Rev. Rul. 71- 416
Void and Voidable Transactions
14. 10
Section 9100 Relief – Failure to Elect
General
Treas. Reg. Section 301.9100 – 1 through – 3 provides the
standards the Commissioner will use to grant taxpayers
extensions of time for making certain elections.
Relief is provided to taxpayers who reasonably and in good faith
fail to make a timely election when relief will not prejudice the
interests of the government.
Regulatory versus Statutory Elections
Regulatory Election – Deadline for making election is prescribed by
regulation, revenue ruling, revenue procedure, notice or announcement
Statutory Election – Deadline for making the election is prescribed by
statute
Accounting Method Elections
15. Standard
Reasonable action and good faith
A taxpayer is deemed to have acted reasonably and in good faith if: (1) the taxpayer applies for relief
before the failure to make the regulator election is discovered by the IRS; (2) the taxpayer inadvertently
failed to make the election because of intervening events beyond its control; (3) the taxpayer failed to make
the election because after exercising reasonable diligence the taxpayer was unaware of the necessity for the
election; (4) the taxpayer reasonably relied on the written advice of the IRS; or (5) the taxpayer relied on a
qualified tax professional, including a professional employed by the taxpayer, and the professional failed to
make or advise the taxpayer to make the election.
A taxpayer is deemed to have not acted reasonably and in good faith if: (1) the taxpayer is requesting relief
for an election to alter a return position for which an accuracy related penalty could have been imposed
under section 6662; (2) the taxpayer was fully informed of the required election and related tax
consequences and chose not to file the election; or (3) the taxpayer uses hindsight in requesting relief.
Interests of Government Prejudiced
The interests of the government are deemed to be prejudiced if granting relief would result in a taxpayer
having a lower tax liability than the taxpayer would have had if the regulatory election had been timely
made. In addition, the interests of the government are ordinarily deemed to be prejudiced if the tax year in
which the election should have been made or any affected tax years are closed by the statute of limitations.
11
Remedies to Correct A Tax Mistake
Section 9100 Relief – Failure to Elect
16. 12
Remedies to Correct A Tax Mistake
Equitable Remedies - Rescission
Rescission
A transaction may be disregarded for federal tax purposes if the parties to the
transaction, during the same taxable year in which they undertake the transaction,
rescind the transaction and restore themselves to the same position they would have
occupied had they not undertaken the transaction
Elements
The Status Quo Ante Requirement – The parties to the transaction must return to
the status quo ante
The Same Taxable Year Requirement – The restoration must be achieved within
the taxable year of the transaction
Underlying transaction in the nature of contract
Actions necessary to affect a rescission
Relevance of State/Foreign Law that define the parties property rights
Rescission versus Modification
18. Penn v. Robertson 115 F.2d 167 (4th Cir. 1940)
Taxpayer was a participant in an employees stock benefit fund created by the
directors of the company without the approval of the shareholders. Under the
plan the taxpayer was credited with earnings from the fund for the years 1930
and 1931.
In 1931, as a result of suits filed by a shareholder, the directors of the company
passed a resolution whereby the plan would be rescinded as to all participants in
the plan who agreed to relinquish their credits and rights.
Court of Appeals affirmed lower court decision that with respect to amounts
credited to shareholder in 1930, the annual accounting period principle required
the determination of income at the close of the taxable year without regard to
subsequent events. Thus the rescission was disregarded for purposes of
determining 1930 taxable income.
Court of Appeals affirmed lower court that amounts credited to the shareholder
in 1931 were not income as the rescission in 1931 in the same taxable year
extinguished what otherwise would have been taxable income for that year. 14
Remedies to Correct A Tax Mistake
Equitable Remedies - Rescission
19. Rev. Rul. 80-58, 1980-1 C.B. 181
Legal concept of rescission refers to the abrogation, canceling, or voiding of a contract
that has the effect of releasing the contracting parties from further obligations to each
other and restoring the parties to the relative positions that they would have occupied had
no contract been made.
A rescission may be in effect by mutual agreement of the parties, by one of the parties
declaring a rescission of the contract without the consent of the other if sufficient
grounds exist, or by applying to the court for a decree of rescission.
Situation 1
In February 1978, A sold property to B for cash. Contract provided that if zoning were not
obtained at B’s option A would return cash to B and B would reconvey property to A.
In October 1978, the zoning was not obtained and B reconveyed property to A and A returned
purchase price to B.
Ruling concluded no income as sale is disregarded. Rescission extinguished any taxable income.
Situation 2
Same facts as Situation 1 except property reconveyed in February 1979.
Ruling concluded income because A and B were not in the same position at the end of the
taxable year.
15
Remedies to Correct A Tax Mistake
Equitable Remedies - Rescission
20. 16
Remedies to Correct A Tax Mistake
Equitable Remedies – Reformation and Other
Reformation
Judicial Nunc pro tunc Orders (Now for then)
Rev. Rul. 93-79, 1993-2 C.B. 269
State court order retroactively reforming a trust does not have retroactive effect for purposes of S
Corporation shareholder eligibility.
Non judicial
Mistakes that Abrogate the Agreement of the Parties
Mistake of Fact
Mistake of Law
Void/Voidable Transactions
Documents declare certain prohibited transactions as void ab initio
Void ab initio (from the outset) – the transaction confers no enforceable rights on the parties to the
transaction.
Voidable – the transaction is valid, but may be annulled by one of the parties to the transaction.
Example(s)
Shareholder Restrictions
NOL Preservation – 5% shareholder
Non CFC Restrictions – 10% shareholder
Claw back Provisions
Employee agrees to return funds in certain circumstances “excessive compensation”.
Document Correction
Scrivener's Error
Other
22. Transaction
Step 1: P Contributes all of the interests in FS-1 to FS-2.
Step 2: A classification election is filed to treat FS-1 as a disregarded entity.
Alt. Step 2: FS-1 changes its classification under local law to a limited partnership/disregarded entity.
Intended Tax Consequences – Sections 351, 368(a)(1)(B), 368(a)(1)(D). Compare Rev. Rul. 67-274 (stock acquisition
followed by liquidation tested as asset reorganization) with Rev. Rul. 69-617 (liquidation of Target into Parent followed by
transfer by Parent of substantial assets of Target to Sub tested as upstream reorganization).
Example 1: Transfer to FS-2 for no consideration
17
P
FS-1 FS-2
P
FS-2
FS-1
FS-1
Election
Step 1 Step 2
FS-3
FS-3
1
2
23. Transaction
Step 1: P sells all of the interests in FS-1 to FS-2.
Step 2: A classification election is filed to treat FS-1 as a disregarded entity.
Alt. Step 2: FS-1 changes its form of organization under local law to a limited partnership/disregarded entity.
Intended Tax Consequences – Compare Section 304 with Section 368(a)(1)(D) reorganization. See Rev. Rul. 70-240 (cash D
reorganization); Treas. Reg. 1.301-1(l) (deemed dividend in certain transactions between corporation and its shareholder).
Example 2: Transfer to FS-2 for Cash
18
P
FS-1 FS-2
P
FS-2
FS-1
FS-1
Election
Step 1 Step 2
Cash
FS-3
1
2
FS-3
24. Transaction
Step 1: P sells all of the interests in FS-1 to FS-3. Alternative consideration: nothing; FS-2 stock; FS-3
stock; cash.
Step 2: A classification election is filed to treat FS-1 as a disregarded entity.
Alt. Step 2: FS-1 changes its form of organization under local law to a limited partnership/disregarded entity.
Compare Sections 304, 368(a)(1)(B), 368(a)(1)(C), 1001, 1248. 19
Example 3: Transfer to FS-3 for Alternate Consideration
P
FS-2
FS-3
P
FS-2
FS-1
Step 1 Step 2
FS-3
FS-1
FS-1
Election
25. Example 4: Dividend and “unrelated” Stock Transfer
20
P
FS-1
Transaction
Step 1: FS-2 declares and pays a dividend to P.
Step 2: P contributes all of the interests in FS-1 to FS-2.
FS-2
P
FS-2
FS-1
Step 1 Step 2
Cash
FS-3
2
FS-3
1
FS-1
