An IRS shocker: it has a heart

Nation's Business, Sept, 1988 by Gerald W. Padwe

An IRS Shocker: It Has A Heart The Internal Revenue Code sets some deadlines for taxpayer action: when a return must be filed, when tax must be paid and so on. But many deadlines are set not by law but by the Internal Revenue Service, through its regulations. This is true of many of the elections that taxpayers are eligible to make.

What happens if a taxpayer misses a deadline? If the deadline is set by the code, the taxpayer is generally out of luck and must take the consequences (a penalty, for example) provided by law, unless the code also authorizes forgiveness based on a standard like "reasonable cause."

When a deadline is set by regulation, the Internal Revenue Service can, under a somewhat restrictive procedure, extend that deadline if the taxpayer can show that he or she was not to blame for missing it.

The most common reason offered for seeking a deadline extension is that the taxpayer relied on an outside adviser. In that situation, if the adviser agrees that the taxpayer is not responsible for missing the deadline, the IRS often will grant an extension.

Extensions are also possible when circumstances are truly outside the taxpayer's control.

Recently, in what may be record time for granting that kind of relief, the IRS not only extended the deadline to elect the filing of a consolidated tax return by a group of corporations, but it also granted the extension within 40 days of being asked.

In this case, the parent corporation was based in the Aleutian Islands, in Alaska. The outside return preparer, based in Anchorage, included the consolidated-return election as part of the corporate return mailed to the taxpayer on March 8, presumably in plenty of time for the taxpayer to file the return by the March 15 due date.

A snowstorm prevented any U.S. Postal Service planes from landing on the taxpayer's island for nearly a week, and when the taxpayer received his return from the preparer, for execution and filing, it was March 17--two days too late for timely election of consolidated-return status.

The IRS concluded there was good cause for the late filing of the election and allowed the taxpayer the consolidated-return election that was due March 15.

Congress Fires A Cannon

To Kill A Gnat

One little-noticed 1986 tax-law change is in the treatment of stock-redemption expenses. A stock redemption is generally a capital transaction that does not give rise to a tax deduction. While that may seem obvious for the actual cost of repurchasing shares, what about expenses incurred in connection with the redemption?

While the IRS has usually disallowed expenses incident to a redemption, such as legal, brokerage and accounting fees, some authorities (most notably the Fifth Circuit Court of Appeals, in a 1966 decision) have held that in certain circumstances such related payments could be immediately deducted.

Some corporate managements relied on those authorities in deducting expenses incurred while resisting takeovers--particularly when a raider's shares were redeemed in a "greenmail" buyout. Congress' response, in the 1986 act, was a new provision denying a deduction for any amount paid or incurred by a corporation "in connection with" the redemption of its stock.

Not only is the new rule a broad restriction on deducting expenditures necessary or incident to a redemption, but the prohibition extends to all redemptions, even when they do not occur in response to an attempted hostile takeover. The law allows an exception for payments that represent interest. All other expenditures are nondeductible.

Consider the problems that can arise in interpreting such a wide-open phrase as "in connection with." For example, the legal expenses incurred to carry out the stock redemption would obviously not be deductible, just as they usually were not under prior law. But expenses like commitment fees and loan-origination fees, when associated with the financing a corporation received to acquire the stock, would generally have been amortized over the life of the loan. Now it is uncertain whether such loan expenses will be treated as nondeductible because they are incurred "in connection with" stock redemption.

Many normal redemption transactions, including family-business restructurings, may now carry a higher after-tax cost.