Principal’s $291 million loss struck down in Claims Court. Des Moines’ largest employer had a bad day at the U.S. Court of Federal Claims Friday when the court ruled against a $291 million loss taken on tax returns in 2000 and 2001. That was a time when many big companies took up the search for the Tax Fairy, the mythical sprite who can make millions in taxes go away with incantations and fancy wandwork.
The Principal deductions were from a “strip” transaction, where Principal Life Insurance Company purchased money-market funds, and then split them between the right to income and the, er, principal. The company retained the right to earnings for 16 to 18 years (there were multiple transactions), and sold the remaining value of the securities. It allocated all of its basis in split securities to the part it sold, generating the losses.
The IRS had a number of objections to the deduction, may of which can be found in a memo discussing similar transactions — perhaps these transactions. The Claims Court judge honed in on one: Treasury Regulations that seem to require basis to be allocated between the components of stripped securities (Reg. Sec. 1.61-6(a)):
[w]hen a part of a larger property is sold, the cost or other basis of the entire property shall be equitably apportioned among the several parts, and the gain realized or loss sustained on the part of the entire property sold is the difference between the selling price and the cost or other basis allocated to such part.
The judge didn’t care for Principal’s arguments that it properly allocated all basis to the sold piece of the securities (my emphasis):
It asserts, in effect, that the regulation has a tacit exception, that is, it does not address situations in which an income interest is carved out from a financial instrument. In that situation, PLIC claims, the proper tax treatment is governed not by the Treasury Regulations, but by “80 years of common law, which Congress and the Treasury have knowingly left in place.” PLIC cites, as evidence of this, a line of authority that it claims demonstrates not only the existence of carve-out interests, but also the fact that the normal basis allocation rules do not apply to them. It contends that this lineament well-illustrates that the basis allocation performed by PLIC here — in which all of its cost in acquiring the Perpetuals was allocated to the residual equity interest — was quite appropriate. But, as will be seen, PLIC’s invocation of these cases — and the supposed “common law” rules they embody — turns out to be something of a clupeidae roseus (or perhaps a school of them).
Clupeidae roseus must be what judges call “red herrings” when they talk to each other. In this case, the judge found the PFG arguments wanting and ruled for the IRS. It deferred its decision on whether penalties would apply pending further proceedings.
While this transaction looks like something that might have been marketed to Principal by a big law or accounting firm, the opinion doesn’t say so. The case also involved income items where IRS challenged Principal’s exclusion of $21 million from other stripped securities — a part of the case the company also lost.
The moral? I think the judge put it well: “Only in a parallel universe, where the ‘too good to be true’ rule of taxation reigns not, should the result be different.” Or as I might put it, there is no Tax Fairy.
William Perez, Tips for Starting a Business
Jason Dinesen, Taxpayer Identity Theft — Part 19. Jason links to a summary of his client’s battle with ID theft, including the 10-thumbed IRS treatment she received.
Russ Fox, When Two Intelligent Individuals Reach the Opposite Conclusion… “Welcome to the brave new world of signature documents.”
Robert D. Flach, MORE CLIENTS SCREWED BY THE TAX CODE. I’d say pretty much all of them.
Stephen Dunn, Foreign Accounts? Don’t Rush Into OVDP.
William McBride, How Best to Prevent the Corporations from Leaving? (Tax Policy Blog):
Most industrialized countries largely exclude foreign earnings from the corporate tax base. Most industrialized countries let businesses write-off investments faster than they can in the U.S. These are not “loopholes” but broad-based ways in which these countries compete for business investment and jobs.
TaxProf, The IRS Scandal, Day 368
The “Brewster’s Millions” tax strategy. IMDB has the plot summary from this 1985 Richard Pryor vehicle:
Brewster is challenged to either take $1 million upfront or spend $30 million within 30 days to inherit $300 million. If he chooses the former, the law firm becomes executor of the estate and divides the money among charities (after taking a sizable fee). In the latter case, after 30 days, he must spend the entire $30 million within one month…
Brewster gets the idea to join the race for Mayor of New York and throws most of his money at a protest campaign urging a vote for “None of the Above”.
India’s Economic Times reports that on the Subcontinent, Brewster’s Millions is apparently a prophecy:
Made a huge profit selling your property and wondering how to avoid paying tax? Form a political party and “donate” your sale proceeds to it. And if you were worried the taxman will come knocking, just relax, it is perfectly legit. You and your party can claim 100% tax exemption too. “Many political parties are fronts for income tax fraud,” says former chief election commissioner N Gopalaswami . That explains the burgeoning political party registrations. There are about 1,600 political parties in India, but only 100-150 actually contest elections.
It doesn’t work that way in the States. Here, politics is just a way to blow money. Unless, of course, you are a humble career public servant from Iowa.