23rd Annual Health Sciences Tax Conference Tax accounting methods update: let’s not forget about the basics December 10, 2013
Disclaimer Ź
Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.
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Tax accounting methods update: let’s not forget about the basics
Disclaimer Ź
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EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. For more information about our organization, please visit ey.com. This presentation is © 2013 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are not necessarily those of Ernst & Young LLP.
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Tax accounting methods update: let’s not forget about the basics
Presenters Ź
Glen Mortensen Director, Corporate Tax HCA Healthcare Nashville, Tennessee
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Jack Donovan Ernst & Young LLP 1101 New York Ave., NW Washington, DC +1 202 327 8054
[email protected]
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Craig Pickard Vice President, Corporate Taxation Community Health Systems Franklin, Tennessee
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Alison Jones Ernst & Young LLP 1101 New York Ave., NW Washington, DC +1 202 327 6684
[email protected]
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Dan Penrith Ernst & Young LLP 1101 New York Ave., NW Washington, DC +1 202 327 6606
[email protected]
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Tax accounting methods update: let’s not forget about the basics
Agenda Ź Ź
Update: recovery audit contractor (RAC) audits Refresher — accounting methods and transactions Ź Ź Ź
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Taxable transactions Tax-free transactions Cash method vs. accrual method considerations
Transaction cost analysis (TCA) update Other considerations Ź Ź
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Year-end planning Deductibility of fines and penalties
Tax accounting methods update: let’s not forget about the basics
Update: RAC audits
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RAC audits Ź Ź
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RAC: recovery audit contractor. RAC audit: Center for Medicare & Medicaid Services (CMS) employs RACs to conduct post-payment reviews of claims filed with CMS by taxpayers for reimbursement for services previously provided. If RAC determines reimbursement is made in error, letter is sent to taxpayer demanding repayment of all or a portion of previously reimbursed amount. Ź Appeal process is available to taxpayer. Ź Recoupment by CMS is forced after appeal failure. Ź Taxpayer can still appeal further after recoupment.
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Tax accounting methods update: let’s not forget about the basics
RAC audits Ź
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Opportunity: deduction available to taxpayer during taxable year amount is recouped by CMS. Section 461(f) and Treas. Reg. Section 1.461-2 provide that if: Ź Ź Ź Ź
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Taxpayer contests a liability Taxpayer transfers money or other property to satisfy liability Contest still exists after time of transfer Absent the fact the liability is contested, a deduction would be allowed during the taxable year of transfer Deduction for contested amount allowed in taxable year of transfer
If a refund is received by taxpayer subsequently as a result of success during appeals, amount is includable in gross income in taxable year of receipt.
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Tax accounting methods update: let’s not forget about the basics
RAC audits
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Successful in obtaining Internal Revenue Service (IRS) consent for a taxpayer to deduct RAC audit liabilities in the tax year recouped by CMS Consent received with little resistance from IRS
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Tax accounting methods update: let’s not forget about the basics
Refresher — accounting methods and transactions
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Taxable transactions
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Taxable stock acquisition Ź Ź
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Taxable asset acquisition Ź Ź
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Generally, accounting methods carry over. Generally, tax basis in assets/liabilities carries over. Generally, new accounting methods may be adopted. Generally, acquirer receives a step up in basis to fair market value (FMV) for assets received.
Elections under Section 338 — stock purchases treated as asset acquisitions Ź
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Generally, new accounting methods may be adopted for target and acquirer receives step up to FMV in the basis of the assets.
Tax accounting methods update: let’s not forget about the basics
Tax-free transactions
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Entity formation: i.e., via a Section 351 transaction (transfer of property for controlling stock) or Section 721 transaction (transfer of property for partnership interest) Ź Ź
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Generally, new entity can adopt accounting methods. Some methods may carry over, i.e., fixed assets.
Section 381 transactions, such as reorganizations under Section 368 or liquidations under Section 332 Ź
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Additional analysis needed to determine accounting methods implications (see next slide)
Tax accounting methods update: let’s not forget about the basics
Navigating Section 381(c)(4) and (c)(5) Step 1: Is the transaction one to which §381(a) applies? No
Yes Is the established method (carryover method) permissible? Yes
Use carryover method unless request voluntary change in method.
Yes
Will Acquiring operate the trades or businesses as separate trades or businesses after the transaction? *
No
No Is the Transferor larger than Acquiring? For general methods: Aggregate adjusted basis of assets and aggregate gross receipts for 12 months preceding date of transaction must both be larger than Acquiring’s. For Inventory: FMV of inventory of a type of goods.
Must request consent to change to a permissible method of accounting.
Yes
No
Is Transferor’s method a permissible method of accounting? Yes
Use Transferor’s method unless requesting a voluntary change in method.
The determination of the methods of accounting depends upon the type of transaction. For example, if forming a new corporation in a Section 351 transaction, generally the taxpayer must adopt new methods of accounting. However, dropping assets into an existing corporation in a Section 351 transaction will generally require the taxpayer to continue to use its established methods of accounting.
No
Is Acquiring’s method a permissible method of accounting? No
Must request consent to change to a permissible method of accounting.
Yes
Use Acquiring’s method unless requesting a voluntary change in method.
* Rules apply to both overall methods of accounting and to special methods of accounting. See special rules if Acquiring intends to integrate multiple component trades or businesses. The chart is a summary of §381 guidance and is not a substitute for a detailed reading and application of the pertinent authorities.
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Tax accounting methods update: let’s not forget about the basics
Cash method vs. accrual method
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Section 448 prohibits the use of the overall cash method in the case of a: Ź Ź
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C corporation Partnership which has a C Corporation as a partner Or Tax shelter
Certain exceptions, such as entities with gross receipts of not more than $5,000,000 Ź
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Aggregation rules must be considered for gross receipts test.
Tax accounting methods update: let’s not forget about the basics
Cash method vs. accrual method
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Common situations in which a cash method taxpayer is required to change its overall method of accounting to an accrual method: Ź Ź
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S Corporation status terminates because of C Corporation owner. Stand-alone C Corporation with average annual gross receipts of less than $5m is acquired by the parent of a consolidated group (aggregate gross receipts greater than $5m).
Situations also can arise in which a voluntary cash to accrual method change is beneficial. Ź
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Ability to deduct certain incurred but not reported (IBNR) “reserves” Use of the nonaccrual experience method
Tax accounting methods update: let’s not forget about the basics
TCA update
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Rev. Proc. 2011-29 Ź
Safe harbor election Ź Ź
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70% of the fees are non-facilitative costs 30% of the fees are facilitative costs
Application Ź Ź Ź
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Applies only to “covered transactions” Applies only to the transaction for which the election is made Applies to all the taxpayer’s success-based fees for that transaction Election is irrevocable, made with statement attached to return
Tax accounting methods update: let’s not forget about the basics
Rev. Proc. 2011-29 Open issues Ź
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Must still determine whether 70% is deductible business expansion cost or amortizable start-up expenditures under Section 195 Does not address: Ź Ź
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Recovery, if any, of 30% capitalized Other types of fees, such as retainers and milestone payments Which party to the transaction is entitled to deduct the fees
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Transactions that are not “covered transactions” (multi-step or overlap transactions)
Not a method of accounting Not clear how to treat single success-based fee that includes facilitating financing the transaction
Tax accounting methods update: let’s not forget about the basics
Rev. Proc. 2011-29 Other considerations Ź
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Safe harbor applies to all success-based fees incurred by a taxpayer in a transaction (analysis should be done in total to determine best answer). Opportunities Ź
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Taxpayers with large success-based fees may want to forgo the election if documentation supports a greater deduction. Identify opportunities to determine treatment of non-success-based fee. Bright line date is still relevant for non-success-based and noninherently-facilitative costs (e.g., due diligence costs).
Tax accounting methods update: let’s not forget about the basics
LB&I directives Ź
July 2011 Large Business and International (LB&I) Division directive Ź
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Examiners not to challenge 70% or less deductions for pre-Rev. Proc. 2011-29 years
April 2013 LB&I directive Ź
If a taxpayer: Ź Ź
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Elects safe harbor Has not deducted more than 70% of any “eligible milestone payment” Is not contesting its liability for the eligible milestone payment
Examiners will not challenge eligible milestone payment.
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A non-refundable payment paid for investment banking services, creditable against a success-based fee, payable in the course of a covered transaction upon: (i) the execution of a letter of intent or exclusivity agreement, (ii) board approval or (iii) an event occurring after (i) and (ii)
LB&I directives are non-reliance guidance.
Tax accounting methods update: let’s not forget about the basics
Non-covered transactions: could be significant TCA opportunity Ź
Types of transactions Ź Ź Ź Ź Ź Ź Ź Ź Ź Ź Ź
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Asset sales Spin-offs Initial public offerings Debt restructuring/refinancings Supply chain projects Internal restructurings Sections 351 and 721 transfers Recapitalizations Divestitures Bankruptcies Liquidations/incorporations
Tax accounting methods update: let’s not forget about the basics
Other considerations
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Year-end planning: top accounting methods opportunities 1. 2. 3. 4. 5.
Self-insured IBNR expenditures Accounts receivable and payable analysis Prepaid expenditures Deferral of advance payments of income Software expenditures
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Tax accounting methods update: let’s not forget about the basics
Year-end planning: top compliance method opportunities 1. Section 263A (UNICAP) for self-constructed assets 2. Compliance with Tangible Property Regulations (TPR) for implementation in 2012 tax year 3. Compliance and implementation with TPR for 2013 or 2014 tax year 4. Implementation of method changes after Section 381(a) transaction 5. Retroactive 2012 tax act provisions 6. Accounting method changes for taxpayers under IRS exam 7. Cost segregation/fixed asset study 8. “Reverse” accounting methods planning Page 24
Tax accounting methods update: let’s not forget about the basics
Fines and penalties: deductible? Ź
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Generally, Section 162(f) provides, “no deduction shall be allowed … for any fine or similar penalty paid to a government for the violation of any law.” This includes civil penalties when the purpose for such penalties imposed is for enforcing the law in question or is for punishment for violation of the law.
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Tax accounting methods update: let’s not forget about the basics
Fines and penalties: deductible? Ź
Upon analysis of the origin and characteristics of the amounts paid, certain amounts may be deductible under Section 162 as an ordinary and necessary business expense. For example: Ź
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Amounts paid shown to be compensatory/remedial in nature may be deductible. Legal fees and expenses incurred in defense of prosecution arising from violation of the law may be deductible. For civil penalties, analysis of the statutory purpose of the penalty could result in the amount paid being deductible (i.e., imposed as compensation for damages arising from its violation).
Tax accounting methods update: let’s not forget about the basics
Questions?
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