TaxProf Blog

Wednesday, April 21, 2004

Non-TaxProfer Gordon Smith (Wisconsin) blogs How Much Tax Do Large Corporations Pay? Estimating the Effective Tax Rates of the Fortune 500, 89 Va. L. Rev. 1793 (2003), by George Yin (on leave at Virginia while serving as Chief of Staff, U.S. Joint Committee on Taxation). Here is the abstract:

Three recent phenomena – the corporate governance scandals, continuing concern about corporate tax shelters, and the Bush Administration’s proposal to exempt dividends from income – have generated renewed interest in the amount of taxes paid by public corporations on the profits they report to their investors. This paper estimates the effective tax rates (ETRs) from 1995 to 2000 of the corporations included in the S&P 500 based on a comparison of their worldwide current income tax expense to their worldwide pre-tax book income. It finds that after controlling for the disparate tax and accounting treatment of stock options, the ETR of the sampled corporations declined slightly, from 30.11% in 1995 to 27.98% in 2000. Potentially more revealing is the fact that there is an important reduction in the 1999 ETR relative to the 1995-98 period (during which the ETR was virtually unchanged), and the 2000 ETR remains below the 1995-98 average. The paper is unable to relate these remaining changes in ETR to trends in foreign investment of the companies involved.

The paper also estimates that the six-year ETRs (after stock option conformity) of ten industry groups varied from a low for the energy sector (25.72%) and industrials (25.84%) to a high for the information technology sector (32.48%) and utilities (32.43%). Both the level of taxation (compared to the statutory tax rate of 35 percent) and relative uniformity of tax treatment of the industries is to be contrasted with the much greater variations experienced by industries during the early 1980’s.

Wednesday, April 21, 2004

Paul Asofsky (Weil Gotshal & Manges) has posted A Guide to Common Tax Issues Incident to Filing Business Bankruptcy on SSRN. Here is the abstract:

Any company considering bankruptcy should be aware of certain routine tax procedural items, and this article addresses a number of those issues. The bankruptcy claims resolution process and the requirements of return filing are discussed. Additionally, the effects of bankruptcy on tax audits are touched on.

There is a distinction between liabilities that arise prior to the filing of the bankruptcy petition and those that come forward after the filing of the petition. This distinction of whether a tax liability is pre-petition or post-petition as well as the payment and refund consequences of each is discussed in length.

The most controversial issue within this area deals with the status of tax liabilities for the taxable year in which the bankruptcy petition is filed. Tax authorities adhere to the position that such a liability is a post-petition liability because the tax must not be paid until the last day of the taxable year which is a date following the filing of the bankruptcy petition. However, debtors take the opposing position that the liability should be considered pre-petition, and three Courts of Appeals have adopted their argument and instituted a bifurcation rule in their jurisdictions. The effects of these decisions as well as the determination and payment of pre-petition liabilities are addressed, and a discussion of post-petition interest on tax claims concludes the article.

Tuesday, April 20, 2004

Karen Burke (San Diego) has posted Exculpatory Liabilities and Nonrecourse Partnership Allocations on SSRN. Here is the abstract:

The rise of limited liability companies (LLCs) classified as partnerships for federal income tax purposes challenges traditional assumptions concerning the treatment of recourse and nonrecourse liabilities under Subchapter K. The complex rules of sections 704(b) and 752 give little attention to liabilities that are recourse to the entity under section 1001 but for which no member bears the economic risk of loss under section 752. In comparison to traditional general or limited partnerships, however, LLCs are much more likely to incur such “exculpatory” liabilities because of the limited liability shield under state law. Under the existing regulations for section 704(b) and 752 (the “section 704(b)/752 regulations”), the classification of liabilities as either recourse or nonrecourse is essential for purposes of allocating basis and deductions attributable to such liabilities. Although exculpatory liabilities are functionally quite similar to traditional nonrecourse liabilities secured by all of an LLC’s assets, literal application of the section 704(b)/752 regulations with respect to such liabilities is fraught with difficulties.

Under these regulations, the allocation of tax items attributable to nonrecourse liabilities is extraordinarily permissive: since no partner bears the economic risk of loss attributable to such liabilities, the corresponding deductions may be allocated in virtually any manner the parties desire. Upon disposition of the underlying property, however, the partners who received such deductions must be allocated offsetting gain and income to restore any capital account deficits, thereby vindicating the earlier loss allocations. The underlying premise of the nonrecourse allocation rules is that it is possible to identify the partnership’s nonrecourse liabilities and track the deductions generated by such liabilities for purposes of allocating the corresponding basis and losses. Because of their hybrid nature as recourse liabilities for purposes of section 1001 and nonrecourse liabilities for purposes of section 752, exculpatory liabilities challenge the basic premises of this somewhat oversimplified description of the nonrecourse allocation rules. Indeed, as two recent articles demonstrate, the uncertainty and lack of consensus concerning the treatment of exculpatory liabilities within the framework of the section 704(b)/752 regulations is quite remarkable.

This article seeks to disentangle the treatment of exculpatory liabilities under the nonrecourse allocation rules and suggests several needed reforms. Part II concludes that an exculpatory liability should be treated similarly to a traditional nonrecourse liability for purposes of determining economic risk of loss upon a constructive liquidation. Part III argues that the mechanical provisions of the nonrecourse allocation rules can be properly applied to exculpatory liabilities once it is clearly understood that the nonrecourse standard of sections 704(b) and 752 diverges fundamentally from the nonrecourse standard of section 1001. Part IV discusses related problems that arise because exculpatory liabilities are secured not by particular assets but rather by all of an LLC’s assets. Finally, Part V suggests that the section 704(b) regulations should be amended to harmonize the treatment of guaranteed recourse liabilities of an LLC (or recourse loans from an LLC member) and functionally similar guaranteed nonrecourse liabilities of an LLC (or nonrecourse loans from an LLC member).

While clarifying these issues is necessary to provide certainty in the tax treatment of exculpatory liabilities, this article also suggests the need to rethink the nonrecourse definition under sections 704(b), 752, and 1001. Upon a disposition of property encumbered by liabilities in excess of fair market value, the section 1001 regulations draw a distinction between recourse and nonrecourse liabilities; the latter generate section 1001 gain through relief from the underlying liability, while the former generate a combination of section 1001 gain (or loss) and ordinary income from discharge of indebtedness.10 Although the conceptual model underlying the section 704(b)/752 regulations is derived from section 1001 and Tufts v. Commissioner, the drafters failed to clearly articulate and rationalize the manner in which the nonrecourse allocation rules deviate from the section 1001 standard. Consequently, uncertainty persists concerning the precise boundaries between the nonrecourse definitions of sections 704(b), 752, and 1001. Ultimately, such uncertainty can be dispelled only if the section 704(b)/752 regulations construct a theory of nonrecourse allocations that is explicitly independent of the section 1001 standard.