Visiting the Committees

Commentary and Updates by the Committees

The Compensation and Benefits Committee provides a forum for members of the Taxation Section to learn and discuss issues relating to executive compensation, tax-qualified retirement plans, and health and welfare benefit arrangements. Membership in the Committee is open to employee benefit practitioners and Taxation Section members, and the participation of members of the Labor and Employment Law Section is encouraged. The Committee strives to include in discussions high level members of the Internal Revenue Service, U.S. Department of Labor Employee Benefit Security Administration, and California Franchise Tax Board.

The Compensation and Benefits Committee schedules quarterly conference calls for all members interested in the topics that affect compensation and benefits. Members interested in participating, providing comments, or for more information regarding upcoming meetings and events should contact the Committee Chair, Alison Fay, at alisonfay@boutwellfay.com or Immediate Past Chair, Jeremy M. Pelphrey, at jpelphrey@foxrothschild.com.

IRS Announces Voluntary Closing Agreements for Retirement Plans

The popular Employee Plans Compliance Resolution System ("EPCRS") covers a wide variety of retirement plans and failures. Rev. Proc. 2013-12, 2013-4 I.R.B. 313. EPCRS does not cover every plan or every failure. For failures that do not fit neatly into EPCRS, the Internal Revenue Service ("IRS") has now formally announced an option that it has been informally using for some time now — the "Voluntary Closing Agreement". See, Employee Plans Closing Agreements, 2013-10 Employee Plan News, Dec. 19, 2013, http://www.irs.gov/pub/irs-tege/epn_2013_10.pdf.

Consideration for voluntary closing agreements is completely within the discretion of the IRS. For this reason, the application will need to be reasonable and demonstrate that any violation or tax deficiency was unintentional (i.e., in good faith). Requests will not be considered if the failure is eligible for EPCRS or if the plan, the plan sponsor (or other entity responsible for signing the closing agreement) is under an IRS examination at the time the request is submitted or has any matters on appeal with the IRS or before the Tax Court (a much broader standard than the "Under Examination" standard that precludes a VCP application under EPCRS). Unlike EPCRS, the issues submitted may still be subject to examination. In the event an exam is commenced after a submission, the taxpayer must inform the IRS agent of the submission. The IRS may or may not treat that issue as off limits in the examination depending on the facts and circumstances. Even after a submission is made, if the IRS determines that there was a willful or intentional plan to avoid or evade paying or reporting taxes, the IRS may convert the request into an examination. 457(b) plans, 457(f) plans and any type of plan involving an abusive tax avoidance transaction or a willful or intentional plan to avoid or evade paying or reporting taxes are not eligible for the new policy.

To request a voluntary closing agreement, submit a detailed letter to the address specified in the notice, including: an explanation of the problem, a proposed correction, a calculation of the tax, interest and penalties, a calculation of the correction cost and a proposed sanction amount. No fee is submitted with the actual application — it is paid later once a sanction amount has been agreed to by the IRS and the taxpayer. As under EPCRS, John Doe submissions may be made. Corrections must be completed by the date the taxpayer signs the closing agreement.

- Sherrie M. Boutwell (contributing author), Irvine, CA

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The Corporate and Pass-Through Entities Committee focuses on issues faced by corporate taxpayers and provides opportunities for practitioners and corporate tax counsel to maintain a level of expertise in the field of corporate tax law, expand their professional contacts, and serve the profession, the public and the legal system. Membership in the Committee offers practitioners information on developments with respect to corporate and business tax and a greater voice on developments in such legislation.

Normally, the Committee holds quarterly meetings via teleconference. If you are interested in speaking at an event, or for more information regarding upcoming meetings and events, please contact Committee Chair, Stephen Turanchik, at stephenturanchik@paulhastings.com.

Tax Court determines that payments to a wholly-owned subsidiary qualify as deductible insurance payments.

In the recent Tax Court case of Rent-A-Center, Inc. v. Commissioner, 142 T.C. 1 (2014), the Court found a parent corporation and its affiliated subsidiaries eligible for an insurance deduction where the parent and subsidiaries paid an amount — in accord with actuarial calculations and an allocation formula —to a captive subsidiary for worker's compensation, auto and general liability insurance. In return for the payments, the captive reimbursed the parent and subsidiaries for a portion of their claims relating to these risks.

Rent-A-Center (RAC) was the parent corporation of 15 subsidiaries which constituted the largest rent-to-own business in the country, with stores in all 50 states. After its insurer, AIG — in response to a claim against RAC — withdrew its offer to insure RAC's directors & officers, RAC engaged Aon to assist it with two tasks — 1) finding a new insurer, and 2) analyzing its risk management practices.

Aon initially engaged Travelers to provide a bundled policy to RAC. When the bill for their services topped $3.0 million, RAC decided to purchase (with Aon's help, and from multiple providers) unbundled coverage.

Aon also suggested that RAC form a captive insurance company. Aon argued that a captive could manage certain risks more cost effectively than a third-party provider. With RAC's approval, Aon engaged KPMG to conduct a feasibility study. The study determined that any captive should be capitalized with no less than $8.8 million. After further analysis, RAC determined that the ideal headquarters for the captive would be Bermuda. The captive, called Legacy, was formed in Bermuda, electing to be treated as a U.S. corporation for tax purposes. A management company was hired to insure compliance with Bermuda laws as well as U.S. law. Legacy opened for business with $9.9 million in capital, and determined its rates actuarially based on Aon's loss forecasts, allocating the premiums among RAC's stores.

Because Legacy's policy years began on December 30^th, a significant deferred tax asset (DTA) eventually developed. Initially, RAC guaranteed the DTA, so that Legacy could meet its minimum capitalization requirements under Bermuda law. Once Legacy could meet its minimum requirements without RAC's guarantee, RAC canceled the guarantee. For the years 2002-2006, Legacy exceeded Bermuda's solvency guidelines.

From 2004-2006, Legacy purchased treasury shares of RAC stock with the approval of the Bermuda government, and used the value of the stock as an asset in calculating its liquidity (also with the Bermuda government's approval). It was able to meet its liquidity requirements every year.

In 2008, the IRS issued a notice of deficiency, arguing that Legacy was not a valid insurance company, and therefore the premiums did not meet the requirements of Section 162 of the Internal Revenue Code.

The Court rejected the IRS' claims and found that the arrangement constituted insurance in the commonly accepted sense, noting that Legacy was formed for a legitimate business purpose, there was no impermissible circular flow of funds, the policies involved insurable risk, and that risk had been adequately shifted from RAC and its subsidiaries to Legacy. The Court noted the level of effort made by RAC to insure Legacy's solvency, the fact that other insurers indicated they could not cost-effectively provide the insurance that Legacy did, and Legacy's record of exceeding Bermuda's minimum requirements were indicators of a legitimate business, and not a tax avoidance scheme. Finally, the Court noted that significant precedent existed for finding that a subsidiary could insure a parent's risks.

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-Gregory A. Zbylut, Pasadena, CA

District Court Rejects Florida Bankers Association Challenge to Nonresident Reporting Regulations

In Florida Bankers Association v. U.S. Department of Treasury, 113 AFTR 2D 2014-358, a United State District Court denied a motion for summary judgment holding that U.S. banks must report interest earned by accountholders who reside abroad. Judge James Boasberg ruled against two banking associations that challenged the Internal Revenue Service's ("IRS") Regulations, 26 U.S.C. § 871(i)(2)(A), requiring U.S. banks to report to the IRS the amount of interest paid to certain nonresident aliens ("NRA"). The Regulations are part of a global web of bank information-sharing agreements spun by the United States and other countries in an effort to combat tax evasion.

The Florida Bankers Association and the Texas Bankers Association (the "Associations") sued U.S. Treasury in the District of Columbia seeking a pre-enforcement court ruling to block the regulations. The Associations claimed that banks would be hurt by the requirement since accountholders from countries such as Mexico, Venezuela, the Russian Federation, and Egypt would withdraw their deposits because of concern information about their personal assets would be leaked in those countries.

The challenged IRS regulations include income- reporting requirements aimed at "detecting and deterring tax cheats at home and abroad." It requires the reporting of interest paid to NRA individual residents of countries with which the U.S. has in effect an information exchange agreement under which the U.S...