IRS Publishes Guidelines for Domestic Partners and Same-Sex Spouses

The IRS has published guidelines for domestic partners in community property states and same-sex spouses in California.

Each year, many LGBT couples must complete two separate and completely different tax returns. For states recognizing same-sex marriage or allowing the registration of domestic partners, the couple may be able to file jointly for their state tax return. Then, due to the provisions of the federal Defense of Marriage Act, the couple must individually complete separate federal tax returns.

The IRS guidelines help with couples in which an individual may be eligible for head of household status and clarify that each member of the couple must file a separate tax return.

For more information, click here: “Questions and Answers for Registered Domestic Partners in Community Property States and Same-Sex Spouses in California.”

ROBS Transactions as a Financial Investment Tool: Legal Traps for the Unwary

Over the last few years, ROBS transactions have dramatically increased which means that the funds being used to capitalize these transactions has significantly increased too. I wrote about ROBS transactions last June in a post called “ROBS transactions: the Department of Labor and IRS Regulation.”

Recently, Mr. Alan Lavine interviewed me for an article in Financial Advisor Magazine about ROBS transactions with regard how they are being used as financial investment tools and whether investors should participate in this type of transaction. The article, “Rolling Over, Starting Up,” appears in the in the December 2010 issue. The article’s subtitle is: Clients can tap into retirement savings to start new businesses, but there are legal traps for the unwary.

It was an honor to be quoted by Mr. Lavine who is an accomplished author and syndicated columnist. Mr. Lavine and his wife, Gail Liberman, wrote Rags to Riches which was featured on Oprah and hit two best seller lists.

ROBS transactions: the Department of Labor and IRS Regulation

Recently, the Department of Labor advised that they are in the process of developing information to provide direction for Rollovers as Business Start-ups known by the IRS as ROBS transactions.

The IRS issued a memorandum on October 1, 2008 warning about potential pitfalls for ROBS transactions particularly related to prohibited transactions. Moreover, the Department of Labor and the IRS have indicated that a large percentage of ROBS transactions do not comply with federal rules and regulations with regard to tax-deferred retirement plans such as qualified 401k plans and IRAs.

According to Louis Campagna, Chief of the Fiduciary Interpretations Division for the Department of Labor’s Employee Benefits Security Administration, the direction being produced by his department shall address the Department of Labor’s apprehension with regard to ROBS transactions initiated with rollovers from employer sponsored qualified plans and individual retirement accounts, such as 401k plans and IRAs, in order to allow a professional to assess whether the ROBS transaction could be a prohibited transaction.

The Department of Labor is concerned with the employer’s intent when the ROBS transaction is initiated.

Specifically, the Department of Labor needs to determine whether the ROBS transaction was initiated to implement a lawful way for employees to save money for retirement or is the ROBS transaction being used to shelter income for taxpayers who want to start a business or capitalize an existing business. The latter would allow for the taxpayer to withdraw funds from the C-corporation with the 401k plan for reasons unrelated to the business. If so, the taxpayer could withdraw funds, which where designated as tax-deferred, before they are allowed to be withdrawn tax free.

The IRS has their own concerns with ROBS transactions such as the valuation of the transaction and their compliance with other rules for qualified retirement plans which invest in employer stock, therefore the IRS may publish their own memorandum with respect to the issues they have concerning ROBS transactions.

Besides the complex rules and regulations governing prohibited transactions, another major concern for the IRS is the ability to “unwind” ROBS transactions which have violated IRS rules and regulations for qualified retirement plans. If a 401k plan participates in a prohibited transaction, the entire 401k plan loses its tax deferred status. Therefore, the entire 401k becomes taxable. Another major issue is deterioration of the initial ROBS valuation. Many small to medium size business holders remove cash from the entity for reasons unrelated to the business. This type of action can cause a decrease in the initial value of the ROBS transaction and violate prohibited transaction rules and regulations.

Time is of the essence with respect to hiring a professional to review your ROBS transaction in order to determine if there have been any violations of federal rules and regulations, such as prohibited transactions. The IRS has a self-correction program for 401ks which taxpayers can take advantage of before an IRS examination.

Missouri Historic Tax Credit

Currently, the Missouri legislature is debating on whether to restructure the state’s historic tax credit program given the state’s budget crisis. Governor Nixon apparently believes that the state’s historic tax credit programs are large and have been usurping state funds that could go public schools, colleges and universities. Therefore, his administration believes that these programs need to be reformed to free up cash flow for other state programs. Governor Nixon’s administration has proposed creating new statutes for six separate state historic tax credit programs with discretion on the amount awarded, whether to award any amount at all, whether to award any or all of a particular year’s credits allocation and whether to cap certain tax credits at $314 million a year. No rules or regulations have been set in place for the Missouri Department of Economic Development to even make these types of determinations which will only serve to complicate the process even though the current process has been recognized as a national model.

In 1999, The Wall Street Journal published an article entitled “In St. Louis Developers Bank on Tax Credits” wherein the author called the Missouri Historic Tax Credit program “a national model.” The article explains “the Missouri program provides state income tax credits for 25% of eligible rehabilitation costs of approved historic structures. The credit which has no cap applies to both residential and commercial buildings and can be used in conjunction with the 20% federal historic tax credit. In addition, the state tax credit is transferable: Mercantile Bank (now US Bank) has set up the Missouri Tax Credit Clearinghouse to buy and sell credits.” Rehabilitation construction projects such as Cupples Station, the Chase Park Plaza and projects on Washington Avenue and surrounding areas in downtown St. Louis would not have taken place without these tax credits. Without these tax credits, these properties would most likely continue to be an eye sore for the community and definitely not creating new jobs nor increasing state and local government revenue.

The Missouri Growth Association (MGA) and St. Louis University performed a ten year study with regard to Missouri’s historic tax credit programs. In March 2010, they released their conclusions which revealed that the Missouri historic tax credit program contributed to the creation of over 43,000 Missouri jobs with average salaries of $42,732, $669 million in newsales, use and income tax revenues which directly benefited the state and local governments as well as $2.9 billion in private investment in Missouri. According to the Missouri Department for Economic Development, Missouri Historic Tax Credit projects created 4,900 Missouri jobs in 2007, which according to David Listokin of Rutgers University Center for Urban Policy Research, equals 38 jobs per $1 million invested or more jobs than highway or new construction projects. Moreover, the Missouri Department of Economic Development noted that from 1998 – 2008 over $4 billion of investment had been leveraged throughout Missouri as a result of the Missouri Historic tax Credit Program as well as $858 million being invested in 2008. In addition, the Missouri Department of Economic Development has concluded that over 66 communities in Missouri have taken advantage of these historic tax credit programs.

According to the Downtown Community Improvement District (2009), St. Louis City alone has 5,000 new residents as a direct result of Missouri’s Historic Tax Credit programs which caused the city to have its first population increase in fifty years. All of these new residents as well as visitors are paying new local taxes to the state and St. Louis City.

The discussion of removing or capping Missouri’s Historic Tax Program would have zero effect on the 2010 budget since historic tax credits have already been approved for this year. Any change to the Missouri Historic Tax Credits programs would only affect future state budgets. If the state historic tax programs are changed, developers would then analyze the cost to renovate a historic building with the potential revenue. In addition, changes to the programs or uncertainty in the programs will cause more problems for developers in terms of financing a project. At this time, developers are having a hard time financing projects as a result of new internal lending policies and procedures. Many lenders are requiring anywhere from 40% percent equity to 100% collateralization in order to obtain a loan. If the state has a stable historic tax credits program, a developer can leverage those funds to aid in financing a project.

While Missouri is debating whether to institute significant changes to the Missouri Historic Tax Credits programs which was deemed “a national model”, Kansas removed its historic tax credits cap. Further, Iowa increased their historic tax credits cap and Illinois is organizing a historic tax credit program. If Missouri wants to continue to grow jobs, grow revenue for state and local governments as well as increase private investment; particularly, when the country and the state are hopefully coming out of a significant economic recession, the Governor and state legislators need to think long and hard about altering a extremely successful state historic tax credit program which is not only the envy of many other states but has been recognized on a national level.

U.S. Energy Policy, Intangible Drilling Costs (IDCs) and Income Tax Deductions

Since 1913, the intangible drilling costs (IDC) tax deduction has allowed oil and gas companies to obtain capital for the huge risk of exploring and developing new locations of oil and gas. This tax deduction is critical when it comes to providing an incentive for oil and natural gas companies to continue to explore and develop new sites for oil and gas. For tax purposes, IDCs get special treatment. Usually, costs that benefit periods in the future must be capitalized and recovered over those periods as opposed to being expensed in the period they are realized.

Under the special rules, an operator or working owner can either expense or capitalize these costs if they pay for or incur IDCs in association with the exploration and development of gas or oil on property located in the U.S. IDCs include all payments made by an operator or working owner for wages, fuel, repairs, hauling, supplies, drilling or development work done by contractors under any contract which is necessary for the drilling of a well including drilling, shooting, cleaning, clearing, roads, surveying, geological work, and in the construction of tanks, pipelines, and any other physical structure necessary for the drilling and preparation of the well which are incidental and necessary to the drilling and preparation of a well for oil and gas.

If elected to expense these items, the owner or working operator deducts the amounts of the IDCs as an expense in the taxable year the cost is paid or incurred. If IDCs are not expensed but capitalized, they can be recovered via depreciation. If the well is dry, the IDCs can be deducted.

The ability to expense IDCs is critical for the exploration and development of new sources of oil and gas. Natural gas and oil is a key component with respect to U.S. demand for sources of energy. Currently the Obama Administration wants to repeal the expensing of IDCs.

This could crush the domestic U.S. oil and gas industry.

There would no longer be any incentive for small to medium sized oil and gas companies in the U.S. to explore and develop new wells. Moreover, the repeal would essentially wipe out millions U.S. jobs associated with this industry at a time when many state governments are bankrupt, unemployment levels are high and revenues for state governments and the federal government are declining.

In addition, some estimates have indicated that a repeal of IDCs could wipe out $3 billion of U.S. business investments in oil and gas development and exploration at a time when the U.S. needs these types of investments. Moreover, a repeal of IDCs would destroy corporate financial value which would directly impact securities such as mutual funds as well as 401(k) plans or other retirement plans.

There is no doubt that America must develop alternative sources of energy including renewable sources but oil and gas remains a key ingredient for the U.S. energy policy including national security. Repealing the tax benefit for IDCs would put a significant dent in America’s security and ability to compete in a global economy during a severe economic downturn which does not appear to be showing any signs of quick recovery.