Tax Indemnity Payments

February 18, 2015

General Matters:

Are payments or reimbursements by third parties for tax payments included in gross income for federal tax purposes?  The basic principle of tax law is that a payment by a third party of a taxpayer’s income tax constitutes additional taxable income for the taxpayer.  Old Colony Trust v. Commissioner, 279 U.S. 716 (1929); Treas. Reg. § 1.61-14(a).  There are exceptions to this rule.  In some cases, courts will follow the “relation-back” approach and look to the nature of the transaction for the tax treatment of any tax indemnity payments.  See Arrowsmith v. Commissioner, 344 U.S. 6 (1952).


James F. Hayden, The Taxation of Tax Indemnity Payments from Clark to Consentino, White & Case LLP, November 19, 2014.

Rehabilitation Credit (I.R.C. 47)

February 17, 2015

General Matters:

I.R.C. § 38(a) generally allows as a credit against tax in a given taxable year the sum of the business credit carryforwards carried to that taxable year (I.R.C. § 38(a)(1)), the current year business credit (I.R.C. § 38(a)(2)), and the business credit carrybacks carried to that year (I.R.C. § 38(a)(3)).  I.R.C. § 38(b)(1) provides that the business credit includes the investment credit determined under I.R.C. § 46, which in turn provides that the investment credit includes the rehabilitation credit under I.R.C. § 47.

The rehabilitation credit for any given taxable year is the sum of (a) 10 percent of the qualified rehabilitation expenditure for any qualified rehabilitated building other than a certified historic building, and (b) 20 percent of the qualified rehabilitation expenditure for any certified historic building.

A qualified rehabilitation expenditure is taken into account generally once the qualified rehabilitated building is placed in service.


Chief Counsel Advice 201507020 (January 8, 2015):  IRS provided correct computation of increase in tax imposed by IRC Sec(s). 50(a)(1) where taxpayer carried over its unused IRC Sec(s). 47(a) credit with respect to qualified rehabilitated building/certified historic structure but subsequently disposed of that property more than 2, but less than 3, years after it was placed in service.

Facilities for the Furnishing of Water (I.R.C. 142(e))

February 17, 2015

General Matters:

PLR 201507002 (October 28, 2014):  Private business use of proceeds to be used for 1st water supply improvements, services allocable to improvements, and equipment allocable to 1st water supply doesn’t exceed 10 percent; and 2nd water supply improvements, including services allocable to improvements, and equipment allocable to 2nd water supply constitute facilities for furnishing of water under Code Sec. 142(a)(4) and 142(e).  The ruling illustrates how to determine whether output sold pursuant to an output contract is treated as output from a bond-financed facility.  The ruling also describes what a facility for the furnishing of water is.  Most water facilities are financed with normal governmental bonds.

What is a “Security”

February 14, 2015

Reves v. Ernst & Young

In Reves v. Ernst & Young, 494 U.S. 1092, 110 S.Ct. 1840, the Court considers whether certain demand notes issued by the Farmers Cooperative of Arkansas and Oklahoma are “securities” within the meaning of Section 3(a)(10) of the Securities Exchange Act of 1934.  The Court determines that they are.

The case is important for understanding whether “notes” are investments and therefore considered “securities” or whether notes are not securities because they are issued merely in a commercial or consumer context.

The Court finds that the “family resemblance” test is to be applied to distinguish between a note that is and is not a security.  Under this test, a note is presumed to be a “security.”  The presumption can be rebutted only by showing that the note bears a strong resemblance (determined by examining four specified factors) to one of a judicially crafted list of categories of instruments that are not securities.  If the instrument is not sufficiently similar to a listed item, the court must decide whether another category should be added by examining certain common factors.

The judicially crafted list of categories includes the following types of instruments:

  1. Note delivered in consumer financing;
  2. Note secured by a mortgage on a home;
  3. Short-term note secured by a lien on a small business or some of its assets;
  4. Note evidencing a “character” loan to a bank customer;
  5. Short-term notes secured by an assignment of accounts receivable;
  6. Note which simply formalizes an open-account debt incurred in the ordinary course of business (particularly if, as in the case of the customer of a broker, it is collateralized).

If a note is to be added to this list, courts should consider the following factors:

  1. Examine the transaction to assess the motivations that would prompt a reasonable seller and buyer to enter into the transaction.  If the seller’s purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit the note is expected to generate, the instrument is likely to be a “security.”  If the note is exchanged to facilitate the purchase and sale of a minor asset or consumer good, to correct for the seller’s cash flow difficulties or to advance some other commercial or consumer purpose, on the other hand, the note is less sensibly described as a “security.”
  2. Examine the plan of distribution of the instrument to determined whether there is “common trading for speculation or investment.”
  3. Examine the reasonable expectations of the investing public.  The Court will consider instruments to be “securities” on the basis of public expectations even where an economic analysis of the particular transaction may suggest that the notes are not securities in that transaction.
  4. Examine whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument thereby rendering application of the Securities Act unnecessary.