Internal Revenue Code Section Research Articles

Intangible assets, corporate tax credits and pharmaceutical establishments

Starting in the 1970s, the US government offered tax credits to US corporations doing business in Puerto Rico under Internal Revenue Code (IRC) Section 936. Firms in the pharmaceutical industry accounted for 50% of tax credits and 20% of employment. The tax credit program was eliminated in 2006, creating a natural experiment on the impact of eliminating corporate tax credits on establishments with high levels of intangible assets such as pharmaceuticals and medical devices. We use panel data on establishments 1990–2017 and a difference in difference methodology to measure the impact of the elimination of the tax credit program. Probability of survival of all manufacturing establishments declined from 90% three years before the elimination of IRC Section 936 to close to 50% three years after. Survival rates of all manufacturing establishments declined during the phaseout and elimination of the tax credit program. Pharmaceutical and medical devices establishments experienced an additional 3.5 to 6.2% decline. Approximately two thirds of the 33% decline in pharmaceutical and medical devices establishments in Puerto Rico can be attributed to the elimination of the tax credit program.

July 2023

July 2023

Murphy and the Sixteenth Amendment in Relation to the Taxation of Non-Excludable Personal Injury Awards

A recent panel decision of the U. S. Court of Appeals for the District of Columbia, Murphy v. Internal Revenue Service, shocked the tax community by holding that Internal Revenue Code section 104(a)(2) was unconstitutional by failing to exclude from gross income revenue (damages for emotional distress and injury to professional reputation) that is not “income” under the Sixteenth Amendment to the U.S. Constitution.A petition for rehearing en banc was filed, but, in a highly unusual move, the D.C. Circuit panel that decided the case, on its own motion, vacated its judgment and set the case for re-argument.Before 1996, section 104(a)(2) had excluded from gross income compensatory damages on account of personal injuries, including non-physical personal injuries of the type suffered by plaintiff Murphy. In 1996, Congress narrowed the exclusion so that it only applied to damages on account of physical personal injuries, thereby removing the exclusion for non-physical injuries. The panel stated its constitutional holding as follows:Insofar as § 104(a)(2) permits the taxation of compensation for a personal injury, which compensation is unrelated to lost wages or earnings, that provision is unconstitutional.Part I contains a brief description of the federal constitutional provisions concerning taxation and how they are related to each other. Part II discusses the issue of how to interpret the Sixteenth Amendment. Part III considers the on-the-merits exclusionary theories offered by the Murphy panel.

Extinguishing and Amending the Tax-Deductible Conversation Easements: Protecting the Federal Investment after Carpenter, Simmons, and Kaufman

The Internal Revenue Service‘s victory in Carpenter v. Commissioner represented an important step in the agency‘s ongoing efforts to both address abuses and establish precedent consistent with congressional intent in the conservation easement donation context. While Congress has clearly favored providing a charitable income tax deduction under Internal Revenue Code section 170(h) to encourage the donation of conservation easements, Congress also has been willing to do so only if the easements are "granted in perpetuity" to government and nonprofit holders "exclusively for conservation purposes" and the conservation purposes of such easements are "protected in perpetuity."

OPEN ACCESS, THE HUMANITIES, AND CONTEMPLATION THROUGH SCIENCE

OPEN ACCESS, THE HUMANITIES, AND CONTEMPLATION THROUGH SCIENCE

What's good for you is good for me: The effect of CEO inside debt on the cost of equity

We find an overall negative relation between CEO inside debt holdings and the cost of equity capital. Such a negative relation holds in an instrumental-variable analysis, a test using changes in variables due to CEO turnover events, a test using seasoned equity offering (SEO) underpricing as an alternate cost of equity measure, and a difference-in-differences test based on the implementation of Internal Revenue Code Section 409A Final Regulations. Additionally, the negative relation between inside debt and the cost of equity capital is nonlinear, suggesting the existence of optimal inside debt compensation that can minimize cost of capital. The negative relation is less pronounced in firms with pre-funded executive pension plans and in firms that provide executives with the pension lump-sum option. We also provide evidence that inside debt lowers the cost of equity more for excessively levered firms. Collectively, these findings suggest that shareholders value the beneficial role of CEO debt-like compensation in constraining excessive managerial risk taking.

Continuity as the Key to Reform of Section 355

There can be little doubt that Internal Revenue Code (Code) section 355 is overly complex; the piecemeal adjustments spanning multiple decades could serve as exemplars of the potential pitfalls of incremental reform. Revisions to section 355 have tended to be under- or over-inclusive because they are reactive to particular deals, yet they leave largely intact older structures that dealt with different deals. The result is a jumble of provisions that fail to implement a coherent, principled approach to the tax treatment of corporate divisions. In Reform of Section 355, Bret Wells urges changing Code section 355 to focus on the continuity of historic shareholders and historic assets. The proposals Wells suggests are grounded in congressional intent, specifically the rise and fall of the General Utilities doctrine and its role in the taxation of corporate divisions. This Response to Reform of Section 355 explores the continuity concept and considers the extent to which, if there were conflicting readings of congressional intent or changes to congressional intent, the use of the continuity concept to guide section 355 reform would remain a principled choice.

Crisis-Driven Tax Law: The Case of Section 382

At the peak of the 2008 financial crisis, the Internal Revenue Service (IRS) issued Notice 2008–83 (the Notice), administrative guidance that limited Internal Revenue Code (the Code) section 382, an important tax rule designed to discourage tax-motivated acquisitions. Although styled as a mere interpretation of existing law, the Notice has been widely viewed as an improper exercise of the IRS’s authority that undermined its legitimacy. But did the Notice work? There were many extraordinary interventions during the financial crisis that raised questions about eroding the rule of law and the long-term destabilizing effects of bail­outs. In a financial crisis, regulators must weigh these real, but distant and uncertain, costs against the immediate benefits of the intervention. Toward that end, we report the first evidence of the effects of limiting Code section 382 during the 2008 financial crisis. Although we find lit­tle evidence that the Notice affected bank merger activity, those merg­ers that occurred while the Notice was in effect produced lower post-merger income growth. The results suggest that Code section 382 may have some benefits in terms of discouraging tax-motivated acqui­sitions. We use the Notice to illustrate the concerns that should guide lawmakers’ decisions about if and how to make law during a crisis.

Save the Gold Watch Receipt: An Analysis of the Gift Tax on Athlete Retirement Gifts

The retirement of professional athletes is an emotional and complex decision for competitors who dedicate their lives to a particular sport. It is common for professional teams, leagues, and other athletes to celebrate the careers of stellar professional athletes with charitable gestures and gifts. However, these gifts can create a financial burden when one is required to pay the gift tax on the item’s value. The purpose of this study is to detail the rules, history, and application of Internal Revenue Code (IRC) Section (§) 102, which could tax athletes who give and receive gifts. Athletes should be cautious when giving gifts, as amounts exceeding the annual and lifetime exclusion limits can trigger the gift tax, causing future complications for decedents with the estate tax. Teams should also explicitly state their lack of a detached and disinterested generosity when honoring an athlete, as the gifts provided are considered taxable compensation.

Exploring the Taxation of New York's New Paid Family Medical Leave Benefit

This article examines the taxation of benefits received under New York’s new Paid Family Leave Act. The article argues that New York’s Paid Family Leave Act is unique when compared to similar provisions enacted in other states to date and that benefits paid under the tax are excluded from federal gross income by operation of Internal Revenue Code Sections 104 and 105. Additionally, the article contends that New York’s Department of Taxation and Finance’s Notice N-17-12 errs in concluding that amounts paid under the Act are includible in federal gross income. The article contends that insurance policies issued in compliance with the Act are “health insurance” and that income replacement benefits paid under the Act are paid for “sickness” as described in Code Sections 104 and 105.

New Executive Compensation Rules

The Tax Cuts and Jobs Act (TCJA) made several changes to the rules affecting employee compensation for publicly held corporations and private companies. These changes include both good news and bad news. On the positive side, TCJA added a new provision under Internal Revenue Code (IRC) Section 83(i) allowing employees of private companies to make an election to defer the recognition of income for up to 5 years from certain stock options and restricted stock plans. Unfortunately, this good news is offset by the changes made to IRC Section 162(m) which limits deductibility of compensation in excess of $1 million for publicly traded corporations. The TCJA expanded the definition of employees who are subject to the $1 million limitation and the types of compensation affected, including repealing the performance‐based exception. As a result, the types of strategies that corporations used to avoid this deduction limit in prior years may no longer work. © 2019 Wiley Periodicals, Inc.

Bridging the Red-Blue Divide: A Proposal for U.S. Regional Tax Relief

Bridging the Red-Blue Divide: A Proposal for U.S. Regional Tax Relief

The Influence of Internal Revenue Code Section 162(m) on Pay Sensitivity Estimates: The Case of Section 162(m) Qualifiers and Non-qualifiers and the Value of Subjectivity in Compensation Arrangements

We examine the impact that Internal Revenue Code Section 162(m) had on pay for performance relationships for two sets of firms- those U.S. firms that qualified their CEO’s (Chief Executive Officer’s) annual bonus under Section 162(m) and those that did not take such steps during the years 1992 to 2003. We hypothesize that the link between pay and objective measures of performance would improve more for the Section 162(m) qualifying firms classified as “subjective evaluators” of CEO performance in years prior to Section 162(m). We also hypothesize no change in pay for performance for those firms that did not qualify certain of their CEO’s pay programs under Section 162(m). Our regression results are generally consistent with our hypotheses that states that observed pay for performance improvements associated with Section 162(m)’s passage were largely driven by firms that qualified their pay programs and which based their CEO’s compensation on subjective performance measures prior to the passage of Section 162(m). We also look at the benefits (in terms of tax savings) or the loss (in terms of added tax costs) incurred by companies which qualified and those that did not qualify their CEO’s annual bonus as performance based under Section 162(m). We find that the benefits from qualifying the CEO’s bonus as performance based were the highest for those companies which had used subjective criteria to evaluate a CEO’s annual performance prior to qualifying this compensation as performance based. To us, this suggests that subjective based performance measures have value to a company and that forfeiting the use of such measures requires that a benefit be received for doing so.

Passport Revocation and Denial for Seriously Delinquent Tax Debts: New IRS Procedures Signal More Stringent Enforcement

In January 2018, the IRS published procedures to begin enforcement of Internal Revenue Code (IRC) section 7345, which requires the State Department to deny the application for, or revoke the passport of, any individual whom the IRS certifies as having a “seriously delinquent tax debt.” IRC section 7345 was enacted on December 5, 2015, as part of the Fixing America’s Surface Transportation Act (FAST Act). Prior to January 2018, the IRS had not been enforcing IRC section 7345, and there were many questions about how the passport revocation/denial process would work, such as whether there would be any additional exceptions, how the IRS would exercise its discretion, and how the IRS would interact with the State Department. Recently, the IRS has answered many of these questions through the issuance of Notice 2018-01 (Jan. 16, 2018), new Internal Revenue Manual (IRM) provisions, and updates on its website. Now that the IRS has procedures in place to enforce IRC section 7345, it is important for CPAs to advise individual clients about this new and very serious consequence to being noncompliant with their tax liabilities. Below is a description of the provisions of IRC section 7345 and the IRS guidance, followed by answers to common questions that affected individuals may have.

CRI-Leslie: Musings on Plain Meaning, Absurdity and Capital Gain

CRI-Leslie, LLC v Commissioner is a noteworthy case of first impression involving the interpretation of Internal Revenue Code Section 1234A. In CRI-Leslie the U.S. Tax Court and the Eleventh Circuit U.S. Court of Appeals held against capital gain treatment for proceeds received as a result of the cancellation of a contract involving the sale of property. However, the greater importance of these decisions may be the illustration of the methodology used by the courts to interpret the Internal Revenue Code. Or, more to the point, whether the courts were justified in relying on the plain meaning rule rather than the legislative history in determining what Internal Revenue Code Section 1234A means.

Designing a Federal Tax on Cannabis

Abstract A Federal tax on cannabis requires answers to several questions: 1. What should we tax? What should be the “base” or bases of a cannabis tax? (Possible bases include: price; weight of various product types [like flower, trim, and concentrate]; and THC content.) 2. Given any base, what should the tax rate be? 3. Should medical cannabis bear full tax? 4. Should marijuana advertising and selling expenses become deductible for federal income tax purposes? (That would treat cannabis businesses like other businesses; current Internal Revenue Code section 280E bars such deductions.) Recently introduced federal legislation provides answers, some more aligned with drug policy than others, to those questions.

State-of-the-Art Federal Marijuana Tax Bills

Recent federal marijuana tax bills address these questions: 1. What should we tax? What should be the “base” or bases of a cannabis tax? (Possible bases include: price; weight of various product types [like flower, trim, and concentrate]; and THC content.) 2. Given any base, what should the tax rate be? 3. Should medical cannabis bear full tax? 4. Should marijuana advertising and selling expenses become deductible for federal income tax purposes? (That would treat cannabis businesses like other businesses; current Internal Revenue Code section 280E bars such deductions.) A few of the answers are unsatisfactory for tax policy and drug policy, but some of the answers are forward-looking, going beyond what has been proposed before.

Taking a Knee: An Analysis of the NFL’s Decision to Relinquish Its § 501(c)(6) Federal Tax Exemption

After 50 years as a nonprofit entity, the National Football League (NFL) voluntarily relinquished its favorable tax exemption. The NFL was exempt from paying federal income taxes due to its classification as a nonprofit organization according to Internal Revenue Code (IRC) Section (§) 501(c)(6). This rule provides a tax exemption to organizations performing operations that further the industry or profession they represent. While professional football leagues are explicitly stated in §501(c)(6), the NFL’s exemption only applied to its League Office opposed to the NFL Ventures partnership, which manages the league’s business activities. As such, the NFL may have erred on deciding to forfeit their exemption. The purpose of this study is to review §501(c)(6) to determine if the League Office should maintain its exemption. The analysis shows the League Office cannot be considered an industry association due to the performance of particular activities for the benefit of its individual members.

Insider Trading and IRC Section 6103(e)(1)(D)(iii)

ABSTRACT Tax returns, including corporate returns, are generally confidential and not disclosed to the public. However, in certain circumstances, Internal Revenue Code (IRC) Section 6103(e)(1)(D)(iii) provides that corporate shareholders who meet a 1 percent ownership criterion can request from the Internal Revenue Service (IRS) a copy of the corporate tax return. In this paper, we discuss the legislative history of IRC Section 6103 as it relates to tax return disclosure in general (for individual and corporate returns) and its precursors that provide for disclosure of corporate tax returns to shareholders who own more than 1 percent of the capital stock. We then provide examples of the valuable proprietary information that is included in corporate tax returns. Next, we provide a history and discussion of the insider trading laws and argue that the information content of a corporate tax return is such that it provides material nonpublic information that is not readily available in annual reports or other public documents filed with the Securities and Exchange Commission (SEC). While 1 percent shareholders do not meet the classical definition of an “insider,” we argue that they are similar to other “outsiders” who have been found liable for violating insider trading rules. We conclude by arguing that the actions of a 1 percent shareholder who requests and receives the corporate return and who subsequently makes purchases and/or sales of corporate stock should constitute illegal insider trading.

Assessing the potential impact of abnormal pricing violations on state corporate tax receipts

This paper examines the state corporate tax implications of abnormal transfer-pricing by U.S. companies involved in international trade. The state corporate tax cost of improperly priced imports and exports is estimated through analysis of every import and export transaction for the years 2005 through 2009 using the interquartile range methodology provided in regulations to Internal Revenue Code Section 482. Calculation of the interquartile range using the entire population of international transactions addresses interpretive issues related to abnormal prices that occur with the smaller samples normally used in such analyses. A policy recommendation is made for improving tax compliance through more rigorous state involvement in transfer pricing enforcement and greater formal collaboration with the Internal Revenue Service with respect to transfer pricing.