NewsNotes

Lesli S. Laffie, J.D., LL.M.

Tax Preparer Regulation Comments • Debt Instruments in Reorganizations • New Treaty with Japan (Box) • Tax Freedom Day (Chart)

AICPA Activities

Tax Preparer Regulation Comments

The AICPA has written to Congress to support tax preparer regulation and raise some public policy and drafting concerns about the registration proposal in Section 141 of S 882, which passed the Senate in May 2004.

In its letter, the AICPA noted that the registration proposal is a partial response to (1) the high error rates on earned income tax credit (EITC) claims and (2) consumer protection concerns about refund anticipation loans. The letter stated, “[T]he AICPA believes that direct approaches will better resolve these enforcement and consumer protection issues and result in more tangible increases in compliance levels than a preparer registration process alone might yield. We recommend enacting legislation that directly attacks the fraud, negligence, and abuses committed by some preparers with respect to EITC claims. We also strongly urge Congress to enact legislation that further restricts, or out-right prohibits, the use and availability of refund anticipation loans.”

The AICPA letter also stated the proposal “would place significant budgetary demands on the IRS; and thereby place the Service in the unenviable position of having to allocate its fixed annual budget among a number of competing, but important priorities.”

From the IRS

Debt Instruments in Reorganizations

According to Rev. Rul. 2004-78, debt instruments issued by an acquirer in a reorganization in exchange for target securities can qualify for tax-free treatment under Sec. 354, in certain circumstances.

The IRS stated in the ruling that, even if the debt instruments are held for less than five years, they can still qualify if they represent a continuation of the security holder’s investment in the target in substantially the same form.

Facts: In the ruling, a target issued debt instruments on Jan. 1, 2004, with a stated maturity date of Jan. 1, 2016. On the issue date, the instruments provided for a market rate of interest and were securities under Sec. 354.

The target has one class of common stock outstanding. On Jan. 1, 2014, under state law, the target would merge into the acquirer in an A reorganization. The target’s shareholders would exchange their common stock for that of the acquirer.

Also, the target’s security holders would exchange their securities for acquirer debt instruments with identical terms, including the maturity date. The only difference would be the interest rate (e.g., to reflect differences in creditworthiness between the target and the acquirer). The modification of the interest rate is a significant modification under Regs. Sec. 1.1001-3.

Holding: Under Sec. 354, no gain or loss is recognized if a company that is a party to a reorganization exchanges its securities solely for its own securities or those of another party to the reorganization, as part of a plan.

However, Regs. Sec. 1.368-1(b) sets forth a general rule that, in the ex-change, gain or loss must be recognized if the new property differs materially in kind or extent from the old property. Neither Sec. 354 nor its regulations defines “securities.”

Under case law, an instrument with a term of less than five years generally is not a security; thus, an instrument with a term of two years generally would not qualify as a security. However, the IRS stated that the shorter-term securities described in Rev. Rul. 2004-78 would qualify, because the acquirer’s debt instruments are issued in the reorganization in exchange for target securities and bear the same terms (other than interest rate). Thus, the acquirer’s debt instruments represent a continuation of the security holder’s investment in the target in substantially the same form and are securities under Sec. 354.