Michigan Tax Lawyer Fall 2000 by chenmeixiu

VIEWS: 4 PAGES: 38

									                                                                     2


      Business Entities Committee                                    4
      Employee Beneftts Committee                                    4
      Estates and Trusts Committee                                   4
      Practice and Procedure Committee                               5
      State and Local Tax Committee.·                                7


      Business Valuations: Application of Revenue Ruling 59-60
         By: Mark E. Blazevic, CPA
      Computer Software: Finally a Clear Sales and Use Tax Rule ·   13
         By: Brian C. Bernhardt
     The Whittling Away of /NDOPCO: PNC Bancorp and Wells Fargo     21
        By: Jay M. Frucci and Lisa M. Kiner

SHORT SUBJECTS .
    MICHIGAN TAX LAWYER                                                       STATEBAR~OFMICHIGAN
                                                                                       ~

       The Michigan Tax Lawyer is a quarterly publication of the Taxation Section of the State Bar of
    Michigan that is designed to be a practical and useful resource for the tax practitioner. Features
    include concise reports in a uniform format from the Section's committees, practitioner articles
    with the "how to" approach, news of events and of other Section members, and "Short Subjects"
    providing helpful practice information.
       Input from members of the Taxation Section is most welcome. Our publication is aimed toward
    involving you in Section activities and assisting you in your practice. If you have suggestions
    or an article you wish to have considered for publication, please contact Aaron Sherbin, Esq.,
    32300 Northwestern Highway, Suite 200, Farmington Hills, MI 48334-1567, (248) 855-6500.

                      AARON H. SHERBIN                         SHIRLEY A. KAIGLER
                           Editor                                 Assistant Editor
                                        Publication Committee
                              AARON H. SHERBIN and SHIRLEY A. KAIGLER
                       State Bar of Michigan Taxation Section Council
         JAMES H. NOVIS                ERIC T. WEISS             EDWARD M. DERON
           Chairperson                 Vice Chairperson               Treasurer

                                           SHERILL SIEBERT
                                               Secretary
                                        JOSEPH A. BONVENTRE
                                              Ex-Officio
         David B. Deutsch                    Mark C. Larson                    Eric M. Nemeth
         Shirley A. Kaigler                  Charles M. Lax                     Mark E. Rizik
          Jay A. Kennedy                     Michael 0. Love                   Aaron H. Sherbin
                       Editor's Assistant                    Program Facilitator
                       Kyla R. Wisdom                        Jan M. Baggett
                       Beverly A. Landgraf
                                        Subscription Information
      The Michigan Tax Lawyer (ISSN 0899-2460), (USPS 093930) is published quarterly by the
    Taxation Section, State Bar of Michigan, 817 N. Gainsborough, Royal Oak, Michigan 48067.
1   Subscription fee of $5.00 is included in the $30.00 annual Taxation Section membership fee.
    Periodicals postage paid at Royal Oak, Michigan. POSTMASTER: Send address changes to
    Michigan Tax Lawyer, Membership Records, Taxation Section, State Bar of Michigan, 306
    Townsend, Lansing, Michigan 48904.
                                           Change of Address
      Individual subscribers should send notification in writing to: Michigan Tax Lawyer, Member-
    ship Records, Taxation Section, State Bar of Michigan, 306 Townsend, Lansing, Michigan 48904.
                                          Citation Form
      The Michigan Tax Lawyer may be cited as follows: (Vol.)(lssue) MI Tax L. (Page)(Qtr. and Yr.).
                                                 Disclaimer
      The opinions expressed herein are those of the authors exclusively and do not necessarily reflect
    those of the Publication Committee, the Taxation Section Council or the Taxation Section. It is
    the responsibility of the individual lawyer to determine if advice or comments in an article are
    appropriate or relevant in a given situation. The Publication Committee, the Taxation Section
    Council and the Taxation Section disclaim all liability resulting from statements and opinions
    contained in the Michigan Tax Lawyer.
                                                            TAXATION SECTION
                                                                                    F
CHAIRPERSON                                                 STATE BAR /:!•                     OF MICHIGAN
 JAMES H. NOVIS                                                             <              0
   222N. WASHINGTONSO.,I500
    lANSING 48933-1817                                                      •
                                                                            ~
                                                                            •
                                                                                  l935
    {517)377-0008

VICE CHAIRPERSON
  ERIC T. WEISS
                                                                                           November 15, 2000
    1400AMERICAN CENTER
    27TT7 FRANKLIN RD.
    SOUlHFIELD 48034-2379
    (248)355-5000                        Dear Taxation Section Members:
TREASURER
  EDWARD M. DERON
   2500BUHL8LDG.                         It is a pleasure and honor to serve as the Chairperson of the Taxation Section for 2'
    DETROIT 48226
    (313)963-9625                        2001. Welcome to our new committee chairpersons (Estates and Trusts - Henry P.
SECRETARY
  SHERILL SIEBERT
                                         State and Local- Thomas J. Kenny) and new council members (David B. Deutsch
    2290 RRST NATIONAL BLDG.
    660WOODWAROAVE.                      Shirley A. Kaigler).
    DETROIT 48226-3583
    (313)465-7556


COUNCIL
                                         I look forward to meeting as many of you as possible during the coming year at or;
 DAVID B. DEUTSCH
   {248) 489-8600
                                         the following activities of the Taxation Section.
  SHIRLEY A. KAIGLER
   (313}96Hl380
  JAY A. KENNEDY
   {313} 566-2500
                                                 Summer Tax Conference· The Annual Summer Tax Conference wit
  MARK C. LARSON                         returning to Shanty Creek at Cedar River on June 29 and 30, 2001. Charles La
   {313) 568·6790
  CHARLES M. LAX                         putting together an exciting program. In addition to outstanding golf, we are workir
   (248)827·1877
  MICHAEL O. LOVE                        add organized activities for the kids and families of our attendees. Please call Chuc
   (248)901-3979
 ERIC M. NEMETH                          (248) 827-1877 for additional information.
  (248)357-3010
 MARK E. RIZIK
   {616) 831-1700
  AARONS. SHERBIN                                After-Hours Tax Series· From October through May, there will be a presenta
   {248) 855-6500
                                         on various topics of interest. Jay Kennedy is in charge of this educational series. If
EX·OFFICIO
 JOSEPH A. BONVENTRE
                                         have any questions or would like to be a speaker, please contact Jay at (313) 566-2.
   (313)965-8293
                                         A list of presentations can also be reviewed in the seminar room (select taxation pra<
COMMISSIONER LIAISON                     area) of the ICLE website at www.icle.org.
 THOMAS G. PLUNKETT
   {248)642.()333


COMMITTEE CHAIRPERSONS
                                                 Tax Court Luncheon· The Tax Court Luncheons are an opportunity for
BUSINESS ENTITIES
                                        practitioners to meet with the presiding Tax Court Judge and IRS District Con
 ANTHONY J. CAPUTO
   {810) 573-8900
                                        members when the Tax Court is in Detroit. The luncheons are announced in advanc<
EMPLOYEE BENEFITS                       correspondence to taxation section members and in this publication. Mark Larson
 LAWRENCE F. SCHILLER
   (313)394-5101                        Eric Nemeth are sharing responsibilities for the luncheons this year and may be rea(
ESTATES AND TRUSTS                      at (313) 568-6790 or (248) 357-3010, respectively.
  HENRY P. LEE
   (248)646-4200

PRACTICE AND PROCEDURE
 TREVOR T. WETHERINGTON
                                                Commissioner Advisory Groups· Commissioner advisory groups have 1:
   (313)628·7439                        established by the Michigan Department of Treasury to provide it with input from
STATE AND LOCAL
  THOMAS J. KENNY
                                        various practice groups and taxpayer constituencies. Tom Kenny and I are represen
   {248)357-3010
                                        the Section on the advisory groups for individual tax matters and business tax matl
PROGRAM FACILITATOR
 JAN M. BAGGETT                         respectively. We can be reached at (248) 357-3010 or (517) 377-0608, respective!~
   2290 RRST NATIONAL BLDG.
   660WOOOWARDAVE.                      you have any questions about the advisory groups.
   DETROIT 48226-3583
   {313)465-8212




                                                                      PAST COUNCIL CHAIRPERSONS
JOSEPH A. BONVENTRE              OSCAR H. FELDMAN             CAROL J. KARR                JERRY D. LUPTAK       REGINALD J. NIZOL    BENJAMIN 0. SCHWENDE~
 ALLAN J. CLAYPOOL              STEPHEN M. FELDMAN         LOUIS W. KASISCHKE               JOHNW.McNEIL         ROBERT B. PIERCE           JOHN N. SEAMAN
   STEPHEN H. CLINK            EUGENE A. GARGARO, JR.          JOHN L. KING                JACK E. MITCHELL    B. COURTNEY RANKIN          PETERS. SHELDON
 JOHN J. COLLINS, JR.               ERNESTGETZ              DONALD M. LANSKY               DENNIS M. MITZEL    JOHN J. RAYMOND, SR.       WILLIAM J. SIKKENG
     ROGER COOK                  GEORGEW. GREGORY           JEFFREY A. LEVINE               J. LEE MURPHY     DAVID M. ROSENBERGER          I. JOHN SNIDER, II
 CLIFFORD H. DOMKE               JOSEPH D. HARTWIG      ARNOLD W. LUNGERSHAUSEN          LAWRENCE J. MURPHY      ANDREW M. SAVEL          LAWRENCE R. VAN T
J. BRUCE DONALDSON                STEPHEN I. JURMU


@Printed on Recycled Paper
       Internet· The Taxation Section has a web page that is accessed through the State
Bar web site at www.michbar.org. Select Member Resources/Committees, Sections &
Task Forces/Taxation Section. If you have any questions or comments about our web
page, please contact Mark Rizik at (616) 831-1700.

        Annual Dinner with Past Chairpersons· If you are a past chairperson of the
Taxation Section, please mark May 10, 2000 on your calendar for the annual dinner at the
University Club in East Lansing. This is a great opportunity to share your knowledge and
experience with the current Council Members and Committee Chairpersons and to see
old friends.

        Committee Meetings· Each of the five Taxation Section Committees listed below
conducts informative meetings during the year to address practice area issues. Taxation
Section members can be placed on a Committee's mailing list by contacting the
Committee's chairperson. Notices of Committee meetings are also placed on the e-
Journal, The State Bar's daily web publication. If you need information about a
Committee or would like to write an article for the Michigan Tax Lawyer in your area of
specialty, please contact me or the appropriate Committee chairperson as follows:

               BUSINESS ENTITIES- Tony Caputo (810) 573-8900
              EMPLOYEE BENEFITS- Larry Schiller (313) 394-5101
              ESTATES AND TRUSTS- Henry P. Lee (248) 646-4200
         PRACTICE AND PROCEDURE- Trevor Wetherington (313) 628-7439
              STATE AND LOCAL- Thomas J. Kenny (248) 357-3010

       Annual Meeting· The annual meeting is scheduled for September 12, 13, and 14,
2000 in Lansing. David B. Deutsch is organizing the program for the annual meeting. If
you have any ideas or comments, please contact David at (248) 489-8600.

       As I begin my year as Chairperson, I want to thank my predecessor, Joseph
Bonventre, for his leadership of the Taxation Section. I also look forward to working
with the new officers of the Section: Vice Chairperson - Eric T. Weiss, Treasurer -
Edward M. Deron, and Secretary - Sherill Siebert. The Section's Officers, Council
Members and Committee Chairs look forward to meeting you soon.

Very truly yours,




L
JAMES H. NOVIS, Chairperson
    Reports
    from the
    Committees                                                      Michigan Tax Lawyer-4th Quarter 2000



                  Report of the Business                      ners with an opportunity to voice
                                                              their concerns regarding benefits tax
                  Entities Committee                          policy in order to assist Mr. I wry's
                  Anthony J. Caputo, Chairperson              office in resolving problems in the
                  Caputo Brosnan, P.C.                        establishment, operation and admin-
                  29199 Ryan Road                             istration of employee benefit plans,
                  Warren, Michigan 48092-4243                 both at the legislative and regulatory
                  {81 0) 573-8900 Office                      levels. (For example, through similar
                  (81 0) 573-7695 Fax                         forums, the regulations under IRC
                  cabrpc@ aol.com                             Section 411(d)(6), permitting the
                                                              elimination of many optional forms
                  Recent Activities                           of benefit, were conceived and devel-
                  A meeting was held on Thursday,             oped.) The forum was designed to be
                  November 2, 2000. The topic was             a non-technical discussion of policy
                  "Choice of Entity for Entrepreneurs         issues, rather than to answer specific
                  in the Twenty First Century'' which         transactional problems or technical
                  coincidentally is the title of an article   questions.
                  written by David B. Deutsch for a              The forum was co-sponsored by the
                  future issue of the Michigan Tax            Michigan Employee Benefits Confer-
                  Lawyer. David hosted this meeting           ence, and approximately 60 members
                  at the offices of Couzens, Lansky,          of the Committee and the MEBC
                  Fealk, Ellis, Roeder & Lazar, P.C.          attended. Discussions dealt with,
                                                              among other things, plan loan and
                                                              refinancing issues, minimum required
                  Report of the Employee                      distributions, fringe benefit guidance,
                  Benefits Committee                          leased employee matters, and general
                                                              plan administrative issues.
                  Lawrence F. Schiller, Chairperson
                  Deloitte & Touche, L.L.P.
                  600 Renaissance Center                      Future Meetings
                  Suite 900                                   Our next meeting will be on February
                  Detroit, Michigan 48243                     13, 2001, followed by a joint meeting
                  (313) 394-5101 Office                       with the Estates and Trusts Commit-
                  (313) 566-0242 Fax                          tee on May 15.
                  lschiller@ ditus.com

                   Recent Activities                          Report of Estates
                   At a meeting held on November 16,          and Trusts Committee
                   2000, at the Renaissance Club in
                 · Detroit, Committee members had the         Henry P. Lee, Chairperson
                   opportunity to hear J. Mark Iwry,          Lee, Gregory & Sternberg, P.C.
                   Benefits Tax Counsel of the Office of      300 Wabeek Building
                   Tax Policy of the Department of            280 West Maple Road
                   Treasury (Washington, D.C.). Mr.           Birmingham, Ml 48009
                                                              (248) 646-4200 PhoneNoice Mail
                   Iwry is the principal legal advisor to     (800) 433-8776 PhoneNoice Mail
                   the Secretary of Treasury and the          (248) 642-0625 Fax
                   Assistant Secretary of Tax Policy          lgs@voyager.net
                   with regard to all aspects of employee
                   benefits taxation and related mat-         Recent Activities
                   ters, including pensions, health care      The Estates and Trusts Committee
                   and executive compensation. Mr.            had a special presentation regarding
                   Iwry hosted an open forum to discuss       Multi-Disciplinary Practices at our
                   benefits tax policy, intended to           committee's presentation at the State
4                  provide plan sponsors and practitio-       Bar Convention Conference on Sep-
i
!
II

(                                                                                            Reports
                                                                                            from the
'i Michigan Tax Lawyer-4th Quarter 2000                                                   Committees
I
~    tember 20, 2000. The speakers were         Report of the Practice
li Richard E. Rassel, Esq., Chairperson
!  ofthe State Bar MDP Committee, as            and Procedure
 ; well as Marsha Procter, Esq., who            Committee
   also sits on that committee. They are        Trevor Wetherington, Chairperson
1  both affiliated with Butzel Long,            Ernst & Young
j where Dick is the Managing Partner            500 Woodward Avenue
I, and Marcia is the General Counsel to         Suite 1700
1 the firm. They discussed the MDP              Detroit, Michigan 48226
   Committee's Executive Summary of             (313) 596-7100
   the July 2000 Report and Recommen-
   dation Regarding Modifications to the        Recent Developments
   Michigan Rules of Professional Con-          A. Pre-Filing Agreement Program.
   duct that would clarifY the obligations      Earlier this year, the IRS Large and
   of a lawyer when offering law and            Mid-Size Business Division estab-
   non-law services to a client, either         lished a pre-filing agreement pilot
   t~rough an ancillary service or jointly
                                                program. The purpose of this program
   With other non-law service profession-       is to advance the resolution of factual
   als. Their presentation was well             issues that would otherwise likely be
   received.                                    disputed in post-filing audits by
                                                applying settled legal principles to
     Future Activities                          those facts. The IRS selected twelve
     The Committee anticipates holding          corporate taxpayers to participate in
     quarterly sessions. The first session      the test-run of this program. The
     will be held on Wednesday, November        issues considered during the test-run
     29 at 3 p.m. in the second floor confer-   included: (1) valuation of assets; (2)
     ence room of National City Bank in         expense v. capitalization; (3) change
     Birmingham, Michigan. At that              of method; (4) capitalization; (5)
     meeting, Sebastian V. Grassi, Esq.         reorganization; (6) start-up costs;
     will be discussing "Twenty-One Key         and (7) research and experimentation.
     Issues to Consider when Drafting an        IRS Commissioner Charles 0.
     Irrevocable Insurance Trust," includ-      Rossotti, speaking at the recent Tax
1    ing sample language. At subsequent         Executives Institute (TEl) meeting,
     quarterly meetings we anticipate           stated that the pre-filing agreement
     having other speakers pertaining to        process to date has led to closing
     topics of current interest. In May         agreements for seven of those
     2~01 we contemplate a joint meeting
                                                corporations.
     With the Employee Benefits Commit-
     tee. It is likely that we may see some     B. New Ex Parte Communications
     legislative changes in the next Con-       Guidance for Appeals.
     gress and we will attempt to deal          The Service has issued guidance (Rev.
     with some of those issues at future        Proc. 2000-43; IR-2000-70), 2000 TNT
     meetings.                                  197-5 that finalizes the rules on the
                                                prohibition of some ex parte communi-
     Thank you, Michael                         cations between IRS appeals officers
     We extended our gratitude to Michael       and other IRS employees. Section
     0. Love, Esq., Vice-President of           1001(a)(4) of the IRS Restructuring
     National City Bank, for his past two       and Reform Act of 1998 prohibits ex
     years of hard and most effective work      parte communications between IRS
     on behalf of this committee. He will       appeals officers and other IRS employ-
     now sit on the Tax Council of the          ees to the extent that the communica-
     Taxation Section. Therefore, he has        tions would appear to compromise the
     assured us of his continued support.       independence of the appeals officers.              5
    Reports
    from the
    Committees                                                    Michigan Tax Lawyer-4th Quarter 2000


                 Under the new ex parte rules, a                provided advice on that issue in
                 taxpayer or representative must be             the case to the IRS employees
                 given the opportunity to participate           who made the determination
                 in communications between appeals              Appeals is reviewing. Counsel
                 officers and other IRS personnel that          will assign a different attorney
                 deal with matters that are not en-             to provide assistance to Ap-
                 tirely ministerial, administrative, or         peals. If an Appeals employee.
                 procedural in nature. For example,           . believes it is necessary to seek
                 under the new ex parte procedure:              advice from any Counsel field
                     Appeals may continue to have               attorney who previously pro-
                     ongoing communication with                 vided advice to the originating
                     the originating function during            function regarding that issue
                     the course of an appeal, but               in the case, the taxpayer/
                     Appeals must give the taxpayer/            representative will be provided
                     representative the opportunity             an opportunity to participate
                     to participate in any discussions        · in any such communications.
                     that concern matters that                 Appeals' requests for legal
                     are not entirely ministerial,
                     administrative or procedural              advice that raise questions that
                     in nature. >r                             cannot be answered with a high
                                                               degree of certainty by applica-
                    Outside consultants or experts             tion of established principles of
                    under contract to the IRS (other           law to particular facts will be
                    than those employed directly               referred to the Chief Counsel
                    by Appeals) will be treated as             National Office and will be
                    "other IRS employees" subject              handled as requests for field
                    to the ex parte communication              service advice or technical
                    prohibition.                               advice, as appropriate, in
                                                               accordance with applicable
                    The prohibition on ex parte                procedures. The response of the
                    communications also applies
                                                               National Office to Appeals will
                    to pre-conference meetings                 be disclosed to the taxpayer in
                    between Appeals and Exami-                 accordance with section 6110.
                    nation. Accordingly, pre-
                    conference meetings should                 Appeals employees are cautioned
                    not be held unless the taxpayer/        that, while they may obtain legal
                    representative is given the             advice from the Office of Chief
                    opportunity to participate.             Counsel, they remain responsible
                                                            for independently evaluating the
                 C. Chief Counsel's Position on Ex          strengths and weaknesses of the
                 Parte Communication with Appeals.          specific issues presented by the cases
                 On October 10, 2000, the IRS issued        assigned to them, and for making
                 Rev. Pro c. 2000-43 finalizing the rules   independent judgments concerning
                 on prohibited ex parte communica-          the overall strengths and weaknesses
                 tions. Chief Counsel Notice N(35)270-      of the cases and the hazards oflitiga-
                 001 (October 25, 2000) elaborates on       tion. Consistent with this assignment
                 Counsel's role in these matters:           of responsibility, Counsel attorneys
                     Appeals employees should not           will not provide advice that includes
                     communicate ex parte regard-           recommendations of settlement
                     ing an issue in a case pending         ranges for an issue in a case pending
                     before them with Counsel field         before Appeals or for the case as
                     attorneys who have previously          a whole.
6
                                                                                           Reports
                                                                                          from the
1
 '     Michigan Tax Lawyer-4th Quarter 2000                                             Committees
r,~
  ..
I, D. IRS Position on Obtaining                 to focus predominately on internal
1
       Valid Consents to Extend                 use software.
i' Limitations Period.
!
1 Section 6501(c)(4)(B), added to the           Next Meeting
f  Code by the IRS Restructuring and            Committee Members will be
   Reform Act of 1998, requires the             contacted shortly about the next
   Service to notify taxpayers of their         meeting. If you are not a member of
   right to (1) refuse to extend the            the Practice & Procedure Committee,
   limitations period; (2) limit the exten-     but are interested in attending the
1' sion to particular issues; and (3) limit     next meeting, contact Trevor
   the extension to a particular period         Wetherington, (313) 628-7439 or
   of time. Although IRS personnel              Trevor.Wetherington@ey.com.
   received instructions on how to
   inform taxpayers of their Section
   6501(c) (4)(B) rights, some consents         Report of the State and
   to extend the limitations period may         Local Tax Committee
   have been obtained without following         Thomas J. Kenny, Chairperson
   proper procedure. In a memorandum            Raymond & Prokop, P.C.
   dated March 30, 2000, and released           26300 Northwestern Highway, 4th Floor
   August 18, 2000, Deborah Butler,             Southfield, M I 48086-5058
   Assistant Chief Counsel (Field Ser-          (248) 357-301 0
   vice), noted it is possible that the
   courts may not sustain the validity          Recent Activities
   of extensions obtained where there           The last meeting of the State and
   was not strict compliance with the           Local Tax Committee was held at the
   provisions of Section 6501(c)(4)(B).         State Bar's Annual Meeting on Sep-
      Accordingly, IRS personnel were           tember 20, 2000. Attorney Art Rosen
   instructed to check their inventories        of McDermott, Will & Emery in New
   for cases where extensions were              York, Jack Van Coevering, Acting
   requested after December 31, 1999.           Director of Legal and Hearings Divi-
   I{ Service personnel did not follow          sion of the Michigan Department of
   Section 6501(c)(4)(B), and the period        Treasury, and Thomas Halic spoke
) oflimitations would remain open               relative to e-commerce issues.
   on those cases absent the extension,            The Commissioner's Advisory
   Service personnel are to request             Group for business taxes is in the
   new extensions following the proper          process of drafting Revenue Admin-
   procedures.                                  istrative Bulletins on the following
                                                topics:
       E. IRS Increases Staff of National         • SET Consolidation
       Research Credit Issue Specialist.          • Innocent Spouse
       The IRS has added technical exper-         • Income Tax Nexus
       tise to its National Research Credit       • Financial Institutions
       Issue Specialist staff in an unan-         • Statute of Limitations/Claims
       nounced employment action. An                 for Refund
       experienced IRS Engineer, Hugh             • SET ITC Rates
       Whitledge, will assist the Research        • Franchise Fees
       Credit Issue Specialist on an as           • Exemption Certificates
       needed basis for government contract       • Real Estate Transfer Tax
       issues and a software consultant, Don       Any member who would like to
       Singer, has been employed as a full-     review or comment on the draft
       time assistant to the issue specialist   bulletins may contact the Chairperson

                                                                                                 7
    Reports
    from the
                                                         Michigan Tax Lawyer-4th Quarter 2000
    Committees



                 or the Revenue Commissioner's Office
                 for a copy of the bulletins.

                 Future Meetings
                 The next meeting of the State and
                 Local Tax Committee will be held on
                 November 29,2000, at the offices of
                 Raymond & Prokop, P.C., at 12:00
                 p.m. Dale Vettel, Administrator of
                 the Sales Tax Division of the Michi-
                 gan Department of Treasury, will be
                 speaking relative to the Streamlined
                 Sales Tax Project.
                    Please contact Thomas Kenny's
                 secretary, Kathleen Cronin, by e-mail
                 at kcronin@raypro.com, or by phone:
                 (248) 357-3010, to confirm your
                 attendance at the November 29, 2000
                 meeting.




8
(
'
I
¥
{                                                                                                Feature
'J   Michigan Tax Lawyer-4th Quarter 2000                                                        Articles
'
I Business Valuations: Application of Revenue Ruling 59-60
l
l
     By: Mark E. Blazevic, CPA
                                             or a similarly worded, definition of
'' The purpose of Revenue Ruling 59-60       fair market value.
   is to outline and review the ap-             Revenue Ruling 59-60 discusses
   proaches, methods and factors to be       eight specific factors that are to be
   considered in valuing shares of the       considered in any valuation of a
   capital stock of closely held corpora-    closely held company, and a compre-
   tions for estate and gift tax purposes.   hensive valuation report will give
   Valuation experts will also refer to      adequate consideration to each:
   Revenue Ruling 59-60 in engage-             • The nature of the business and
   ments where income taxes are not of            the history of the enterprise
   primary importance (divorce, share-            from its inception.
   holder disputes, lost profits, etc.) to     • The economic outlook in
   assist in defining the term "fair              general and the condition and
   market value." In addition, while              outlook of the specific industry       Revenue
   Revenue Ruling 59-60 specifically              in particular.                         Ruling 59-60
   addresses closely held corporations,        • The book value of the stock             discusses
   its guidance is useful in the valuation        and the financial condition            eight specific
   of a broad spectrum of entities includ-        of the business.                       factors that
   ing partnerships, limited liability         • The earning capacity of the
   companies, and trusts.                         company.                               are to be
      A well researched and written            • The dividend-paying capacity.           considered in
   business valuation report will refer-       • Whether or not the enterprise           any valuation of
   ence Revenue Ruling 59-60 and                  has goodwill or other intangible       a closely held
   address the fundamental factors it             value.                                 company ...
   sets forth to determine "fair market        • Sales of the stock and the size
   value." Attorneys that utilize the             of the block of stock to be valued.
   services of valuation professionals         • The market price of stock of
   should be familiar with the principles         corporations engaged in the
   articulated in Revenue Ruling 59-60            same or a similar line of business
   to assess the quality of the reports           having their stocks actively
   prepared for the benefit of their              traded in a free and open market,
   clients.                                       either on an exchange or over-
      Revenue Ruling 59-60 defines fair           the-counter.
   market value as:                             The following is a brief discussion
       the price at which the property       of each of the foregoing factors:
      would change hands between a           Nature and History
      willing buyer and a willing            of the Business
      seller when the former is not
      under any compulsion to buy            The history of a business will show its
      and the latter is not under any        past stability or instability, its growth
      compulsion to sell, both parties       or lack of growth, the diversity or lack
      having reasonable knowledge of         of diversity of its operations, and
      relevant facts.                        other facts needed to form an opinion
      The American Institute of Certified    of the degree of risk involved in the
   Public Accountants, Institute of          business. The detail to be considered
   Business Appraisers, National             should increase with proximity to the
   Association of Certified Valuation        required date of appraisal, since
   Analysts, American Society of             recent events are of greatest help in
   Appraisers, and The Appraisal             predicting the future; but a study of
   Foundation have all embraced this,        gross and net income and of dividends
                                                                                                        9
 Feature
 Articles                                                           Michigan Tax Lawyer-4th Quarter 2000


                   covering a long prior period is highly     years immediately preceding the date
                   desirable. The history to be studied       of appraisal, together with a balance
                   should include, but need not be            sheet at the end of the month preced-
                   limited to, the nature of the business,    ing that date. These statements
                   its products or services, its operating    usually will disclose to the appraiser
                   and investment assets, capital struc-      (1) liquid position (ratio of current
                   ture, plant facilities, sales records      assets to current liabilities); (2) gross
                   and management, all of which should        and net book value of principal classes
                   be considered as of the date of the        of fixed assets; (3) working capital; (4)
                   appraisal, with due regard for recent     long-term indebtedness; (5) capital
                   significant changes. Events of the         structure; and (6) net worth. Consid-
                   past that are unlikely to recur in the    eration also should be given to any
                   future should be discounted, since        assets not essential to the operation of
... significance   value has a close relation to future       the business, such as investments in
maybe              expectancy.                               securities, real estate, etc. In general,
                                                             such nonoperating assets will com-
attached to the     Industry and General                     mand a lower rate of return than do
ability of the      Economic Outlook                         the operating assets, although in
industry with       A sound appraisal of closely held        exceptional cases the reverse may be
which the           stock must consider current and          true. In computing the book value
company is          prospective economic conditions as       per share of stock, assets of the in-
allied to          of the date of appraisal, both in the     vestment type should be revalued on
                    national economy and in the industry     the basis of their market price and
compete with       or industries with which the corpora-     the book value adjusted accordingly.
other              tion is allied. It is important to know   Comparison of the company's balance
industries.        whether the company is more or less       sheets over several years may reveal,
Prospective        successful than its competitors, or       among other facts, such developments
competition ...    that it is maintaining a stable posi-     as the acquisition of additional
should be          tion with respect to competitors.         production facilities or subsidiary
                   Equal or even greater significance        companies, improvement in financial
given careful      may be attached to the ability of the     position, and details as to recapital-
attention.         industry with which the company is        izations and other changes in the
                   allied to compete with other indus-       capital structure of the corporation.
                   tries. Prospective competition, which
                   has not been a factor in prior years,   Earning Capacity
                   should be given careful attention.      Detailed income statements should be
                   For example, high profits due to the    reviewed for a representative period
                   novelty of its product and the lack of  immediately prior to the appraisal
                   competition often give rise to oppor-   date, preferably for a period of five
                   tunities for others to enter the mar-   years or a complete business cycle, if
                   ket niche creating competition. The     longer. Income statements should
                   public's appraisal of the future pros-  show (1) gross income by principal
                   pects of competitive industries or of   items; (2) principal deductions from
                   competitors within an industry may      gross income including major prior
                   be indicated by price trends in the     items of operating expenses, interest
                   markets for commodities and for         and other expense on each item of
                   securities.                             long-term debt, depreciation and
                                                           depletion if such deductions are made;
                   Book Value and Financial                (3) net income available for dividends;
                   Condition                               (4) rates and amounts of dividends
                   Balance sheets should be obtained,      paid on each class of stock; (5) re-
                   preferably in the form of comparative maining amount carried to surplus;
10                 annual statements for two or more       and (6) adjustments to, and reconcili-
                                                                                            Feature
 Michigan Tax Lawyer-4th Quarter 2000                                                       Articles

ation with, surplus as stated on the      on the net tangible assets. While
balance sheet. The appraiser should       the element of goodwill may be based
be able to separate recurring from        primarily on earnings, such factors
nonrecurring items of income and          as the prestige and reputation of the
expense, to distinguish between           business, the ownership of a trade or
operating income and investment           brand name, and a record of success-
income, and to ascertain whether or       ful operation over a prolonged period
not any line of business in which the     in a particular locality also may
company is engaged is consistently        furnish support for the inclusion
operating at a loss and might be          of intangible value.
abandoned with benefit to the
company.                                  Prior Sales and Size of the Block
                                           Sales of stock of a closely held corpo-   Dividend-
Dividend-Paying Capacity                  ration should be carefully investi-        paying capacity
 Primary consideration should be          gated to determine whether they
given to the dividend-paying capacity     represent transactions at arm's            is a factor that
of the company rather than to divi-       length. Forced sales do not ordinarily     must be
dends actually paid in the past.          reflect fair market value nor do           considered in
Recognition must be given to the          isolated sales in small amounts            an appraisal,
necessity of retaining a reasonable       necessarily control as the measure         but dividends
portion of profits to meet future         of value. This is especially true in       actually paid in
business needs. Dividend-paying           the valuation of a controlling interest
capacity is a factor that must be         in a corporation. Since, in the case       the past may
considered in an appraisal, but           of closely held stocks, no prevailing      not have any
dividends actually paid in the past       market prices are available, there is      relation to
may not have any relation to divi-        no basis for making an adjustment for      dividend·
dend-paying capacity. Specifically,       blockage. It follows, therefore, that      paying
the dividends paid by a closely held      such stocks should be valued upon          capacity.
family company may be measured by         a consideration of all the evidence
the income needs of the stockholders      affecting the fair market value. The
or by their desire to avoid taxes on      size of the block of stock itself is a
div1dend receipts, instead of by the      relevant factor to be considered.
ability of the company to pay divi-       Although it is true that a minority
dends. Where an actual or effective       interest in an unlisted corporation's
controlling interest in a corporation     stock is more difficult to sell than a
is to be valued, the dividend factor      similar block oflisted stock, it is
is not a material element, since the      equally true that control of a corpora-
payment of such dividends is discre-      tion, either actual or in effect, repre-
tionary with the controlling stock-       senting as it does an added element
holders. The individual or group in       of value, may justify a higher value
control may substitute salaries and       for a specific block of stock.
bonuses for dividends, thus reducing
net income and understating the           Comparisons to Similar
dividend-paying capacity of the           Publicly Traded Companies
company.                                  When valuing unlisted securities the
                                          value of stock or securities of corpora-
Existence of Goodwill                     tions engaged in the same or a similar
or Other Intangible Value                 line of business which are listed on an
In the final analysis, goodwill is        exchange should be taken into consid-
based upon earning capacity. The          eration. An important consideration
presence of goodwill and its value,       is that the corporations to be used
therefore, rests upon the excess of net   for comparisons have capital stocks
earnings over and above a fair return     which are actively traded by the                         11
Feature
Articles                                                          Michigan Tax Lawyer-4th Quarter 2000


                  public. Stocks listed on an exchange     challenged assumption. Valuation
                  should be considered first. However,     professionals must synthesize these
                  if sufficient comparable companies       discounts from actual transactions
                  whose stocks are listed on an ex-        in similar interests and/or studies of
                  change cannot be found, other compa-     comparable securities. The courts
                  rable companies which have stocks        have increasingly given emphasis to
                  actively traded in the over-the-         the specific valuation experience and
                  counter market also may be used.         professional credentials ofthe expert
                  The essential factor is that whether     when considering this evidence.
                  the stocks are sold on an exchange or
The appraiser's   over-the-counter there is evidence of
opinion with      an active, free public market for the       MARK E. BLAZEVIC, CPA is an associate
                  stock as of the valuation date. In          at the certified public accounting firm of
respect to the    selecting corporations for compara-         Plante & Moran, L.L.P, who specializes in
                                                              the areas of business valua1ion and litigation
discounts         tive purposes, care should be taken         support. Mr. Blazevic has been designated
that must be      to use only comparable companies.           by the American Institute of Certified Public
considered .•.    Although the only restrictive require-      Accountants as an accredited valuation
                  ment as to comparable corporations          professional.
is the most
frequently        specified in the statute is that their
                  lines of business be the same or
challenged        similar, it is obvious that consider-
assumption.       ation must be given to other relevant
                  factors in order that the most valid
                  comparison possible will be obtained.

                  Conclusion
                  As discussed above, there are numer-
                  ous factors that must be considered
                  in preparing a comprehensive valua-
                  tion report. The valuation of a
                  business requires a thorough under-
                  standing of the principles contained
                  in Revenue Ruling 59-60, as well as
                  the broader areas of valuation theory
                  and practice. An accredited valua-
                  tion professional can assist in defin-
                  ing the engagement and will prepare
                  a report that addresses the unique
                  facets of the engagement and is
                  consistent with Revenue Ruling
                  59-60.
                     The most common differences
                  of opinion that arise pursuant to a
                  valuation prepared for tax purposes
                  are not explicitly addressed in Rev-
                  enue Ruling 59-60. The appraiser's
                  opinion with respect to the discounts
                  that must be considered to reflect the
                  lack of marketability of an interest
                  in a closely held business when
                  compared to a publicly traded
                  company is the most frequently
12
                                                                                                 Feature
~   Michigan Tax Lawyer-4th Quarter 2000                                                         Articles
'
I   Computer Software:
    Finally a Clear Sales and Use Tax Rule
    By: Brian C. Bernhardt,                   ness of making sales at retail is 6%
    Raymond & Prokop, P.C.                    of the gross proceeds of the business,
                                              less those deductions allowed under
    For almost twenty years, the State of     the Sales Tax Act." "Gross proceeds"
    Michigan has not been able to deter-      means
    mine how to properly apply the sales          the amount received in money ...
    and use tax to computer software.             in consideration of a sale at retail
    Through numerous cases, administra-           within [Michigan], without a
    tive pronouncements, and statutory            deduction for the cost of the
    amendments, the Department of                 property sold, the cost of material
    Treasury, until recently, has never           used, the cost oflabor or service
    been able to enunciate a firm policy.         purchased, an amount paid for
    Recently, however, the Department of          interest or a discount ... 6           Although the
    Treasury released Revenue Adminis-            The Michigan Use Tax Act (the          Department
    trative Bulletin 1999-5, which served     "Use Tax Act")" imposes a specific
    as its latest attempt to clearly state                                               of Treasury
                                              tax on all persons for the privilege of
    the applicable rules. Although the        using, storing, or consuming tangible      succeeded in
    Department of Treasury succeeded          personal property in Michigan.• A          large part ...
    in large part, a review of Michigan's     "use" is defined to mean                   its recent ruling
    previous attempts at taxation reveal           the exercise of a right or power      left a number
    that its recent ruling left a number           over tangible personal property       of holes ...
    of holes which will likely result in           incident to the ownership of
    future litigation and a need for               that property including transfer
    future guidance from the State.                of the property in a transaction
                                                   where possession is given. 9
    I. General Rules for Michigan                The use tax is not levied on the use
    Sales and Use Taxation:                   of property sold in Michigan on which
    The Michigan General Sales Tax            transaction a tax is due and paid
    Act (the "Sales Tax Act")' imposes        under the Sales Tax Act. 10 In addi-
    a tax on all persons engaged in the       tion, the use tax is not levied on the
    business of making sales at retail        use of property previously subjected
    for the privilege of engaging in that     to a sales or use tax by another state
    business. 2 A "sale at retail" is         if the amount of the tax due and paid
    defined to mean                           was equal or greater than that im-
        a transaction by which the            posed by Michigan. 11 The use tax is
        ownership of tangible personal        imposed at a rate equal to 6% of the
        property is transferred for con-      price of the property upon which the
        sideration, if the transfer is made   tax is imposed. 12 "Price" means
        in the ordinary course of the              the aggregate value in money
        transferor's business and is made          of anything paid or delivered ...
        to the transferee for consumption          in the consummation and
        or use, or for any purpose other           complete performance of the
        than for resale . . .3                     transaction by which tangible
       A sale at retail specifically does          personal property or services
    not include an isolated transaction            are purchased or rented for
    by a person who is not required to             storage, use, or other consump-
    be licensed under the Sales Tax Act.•          tion in [Michigan], without a
    The amount of annual sales tax levied          deduction for the cost of the
    on all persons engaged in the busi-            property sold, cost of materials
                                                                                                        13
 Feature
 Articles                                                      Michigan Tax Lawyer-4th Quarter 2000


                     used, labor or service cost,            at retail, need no documentation,
                     interest or discount paid, or           training or expert engineering
                     any other expense ...13                 support, and can be used instan-
                    The net effect of the Sales Tax Act      taneously; they are, in essence,
                 and the Use Tax Act is to provide a         an end product in and of them-
                 tax on either the retail sale in Michi-     selves. On the other hand, the
                 gan of tangible personal property or        Court found that other types of
                 the use in Michigan of tangible per-        software, "custom" software, are
                 sonal property. By doing so, the Sales      customized application programs,
                 Tax Act and the Use Tax Act provide         need pre-lease consulting and
                 a complementary framework for               continuing on-site updating,
                 taxing the ultimate end use of tan-         and must be customized to fit the
                 gible personal property in Michigan.        purchaser's particular computer
... the Court                                                configurations; they are not, in
held that the    II. Previous State of the Law               essence, an end product in them-
focus of a       Prior to August 12, 1987, Michigan          selves. Relying on the adminis-
transaction      provided no guidance, whether by            trative definition of tangible
involving        statute, administrative rule, or other-     personal property, the Court held
"custom"         wise, concerning the application of         that the focus of a transaction
                 the Sales Tax Act and the Use Tax           involving "custom" software, as
software, as     Act to computer software. As a              opposed to "canned" software,
opposed to       result, the courts were left to apply       was on the personalized service
"canned"         the broad definitions of "sale at retail"   of the software vendors, making
software,        and "use" without any specific frame-       such a transaction an intangibles
was on the       work upon which to base their analy-        transaction, not subject to either
personalized     sis. In doing so, the courts faced the      the Sales Tax Act or the Use
                 question of whether computer soft-          Tax Act.
service of the   ware qualified as tangible personal
software         property, a term defined administra-        Soon thereafter, in Detroit Auto-
vendors ...      tively, though not statutorily, as          Inter Insurance Exchange v
                     all goods, wares, merchandise,          Department of Treasury, 16 the
                     products, and commodities, all          Court of Appeals expanded on
                     tangible things, and substances         its analysis in Maccabees Life
                     which are dealt in, capable of          ITJsurance Company. The Court
                     being processed and exchanged. 14       rejected the Department's argu-
                                                             ment that the purchase of all
                  A. Application of "Intangible              software, whether custom or
                     Personal Property'' to                  canned, is no different than
                     Computer Software                       buying a tape or record at a
                     In Maccabees Life Insurance             record store for use in a home
                     Company v Department of Trea-           or office, a transaction routinely
                     sury, 15 the Court of Appeals first     subject to the sales tax; instead,
                     examined whether computer               the Court found that such pur-
                     software qualified as tangible          chases of canned software were
                     personal property subject to the        distinguishable from customized
                     Sales Tax Act and the Use Tax           programs which required the
                     Act, ultimately creating a distinc-     personalized services of engineer-
                     tion between what it termed             ing skills, expertise, and expen-
                     "custom" software and "canned"          sive services in their specific
                     software. The Court found               development for the customer.
                     that certain types of software,         The Court found that the
                     "canned" software, can be bought        extrinsic value of tangible custom
14                                                           software was nominal compared
i
I                                                                                             Feature
        Michigan Tax Lawyer-4th Quarter 2000                                                  Articles
    J
I
I
            to the organization, creation,
            knowledge, and skill of the
                                                     functions. Modifications must
                                                     be made to the actual program
"
1           information furnished within the         code. Modification includes
f;          software. Therefore, the Court           changes to source code or
            followed its previous decision in        programming languages that
            Maccabees Life Insurance Com-            are necessary to make the
l
~
            pany, holding custom computer
            software not subject to the Sales
                                                     software fulfill its intended
                                                     function. Selection of program
i
            Tax Act or Use Tax Act.                  alternatives through menu-
                                                     driven interrogatory is not
         B. Revenue Administrative                   considered modification of
            Bulletin 1987-7: Defining                program code. Modification for
            Canned and Custom Software               license protection is not con-
            In response to Maccabees Life            sidered custom programming.
            Insurance Company and Detroit            Also, training and implemen-
           Auto-Interinsurance Exchange,             tation assistance are not
            the Department of Treasury               considered modification of        The Depart-
            released Revenue Administrative          the software.                     menta/so
            Bulletin 1987-7, which followed                                            ruled that
            the Court's decisions in those          The modifications to prewritten
                                                    programs may be made by the        customized
            cases and established specific                                             software was
            guidelines to distinguish between       seller or the purchaser. Docu-
            custom and canned software.             mentation of required modifi-      not considered
                                                    cations to the program must        a sale of
            Ruling that the sale of canned          be retained to verify and sub-     tangible
            software constituted the sale           stantiate any exemption claim,
            of tangible personal property           regardless of who performs         personal
            subject to sales or use tax, the        the modification. Acceptable       property
            Department defined canned               documentation includes:            andwasnot
            software as any program or set of       1. Listing of original program     subject to sales
            programs that can be purchased             code and listing of modifica-   or use tax.
            and used without modifications.            tions made to program code
            The Department noted that               2. Invoice(s) showing services
            canned software may be sold on
            computer cards, disks, tapes, or           rendered for modification.
            other data processing storage           In addition, RAB 87-7 applied
            media as printed material or            similar principals to license
            transmitted via communication           agreements for computer soft-
            devices.                                ware and enhancements and
                                                    upgrading of computer software,
            The Department also ruled that          ruling that such agreements,
            customized software was not             enhancements, and upgrading
            considered a sale of tangible           for canned software were subject
            personal property and was not           to tax while such agreements,
            subject to sales or use tax. Cus-       enhancements, and upgrading
            tom software was defined as             for custom software were not
             any program or set of pro-             subject to taxation.
             grams designed and written
             specifically for a particular      III. Changes to the Law
                                                As a result of Maccabees Life
             user. It also includes any
                                                Insurance Company and Detroit
             prewritten programs that
                                                Auto-Interinsurance Exchange, the
             must be modified before they
                                                Michigan Legislature determined
             can perform their intended                                                              15
                                                that the Sales Tax Act and Use Tax
Feature
Articles                                              Michigan Tax Lawyer-4th Quarter 2000


           Act required revisions to take into           or adaptation. 19
           account the rapid technological            2. "Sale at retail" was defined
           changes for which the law was at              to specifically exclude spe-
           that time unprepared to handle.               cific charges for technical
           Following the Legislature's lead,             support or for adapting or
           the Department of Treasury there-             modifying prewritten, stan-
           after revised its regulatory scheme.          dard, or canned computer
             A. Revisions to the Sales Tax Act           software programs to a
                and Use Tax Act                          purchaser's needs or equip-
                Effective December 31, 1987, the         ment if, and only if, those
                State of Michigan amended the            charges are separately
                Sales Tax Act and Use Tax Act to         stated and identified?"
                provide for the definitive taxation
                of certain types of computer          3. "Sale at retail" was also
                softwareY The new provisions             defined to specifically ex-
                accepted the judicially created          clude computer software
                distinction between computer             originally designed for the
                software 18 as an "end product"          exclusive use and special
                and computer software which              needs of the purchaser. 21
                required personalized service for
                the specific and special needs of     The Use Tax Act provided
                the purchaser. Thus, although         the following:
                the Legislature appeared to           1. "Tangible personal property"
                create an automatic bright line          was defined to specifically
                between canned and custom                include (1) computer soft-
                software, it actually drew a more        ware offered for general use
                hazy line between that computer          by the public or (2) software
                software which was an end                modified or adapted to the
                product and that which was not.          user's needs or equipment
                This distinction allowed the             by the seller, only if the
                taxation of certain noncanned            software is available from a
                modified computer software so            seller of software on an as is
                long as it was also available as         basis or as an end product
                an end product, and excluded             without modification or
                from taxation technical service          adaptation.ZZ
                assistance so long as it could be     2. "Tangible personal property"
                separated from the sale of the           was defined to specifically
                actual software itself.                  exclude computer software
                   The amended Sales Tax Act             originally designed for the
                   provided the following:               exclusive use and special
                   1. "Sale at retail" was defined       needs of the purchaser.za
                      to specifically include (1)     3. "Price" was defined to spe-
                      computer software offered for      cifically exclude specific
                      general sale to the public or      charges for technical support
                      (2) computer software modi-        or for adapting or modifYing
                      fied or adapted to the user's      prewritten, standard, or
                      needs or equipment by the          canned computer software
                      seller, but only if the soft-      programs to a purchaser's
                      ware is available for sale         needs or equipment if the
                      from a seller of software on       charges are separately
                      an as is basis or as an end        stated and identified. 24
16                    product without modification
                                                                                     Feature
t   Michigan Tax Lawyer-4th Quarter 2000                                             Articles

       Notably; the Legislature did not             new legislation subjects a
    provide definitions for many of the             much wider range of computer
    terms - for example: as is basis, end           software to taxation under the
    product, modification or adaption,              sales and use taxes than did
    originally designed, exclusive use,             prior law.26
    or special needs - upon which the          Notably, although RAB 88-41
    statute now relied.                      provides examples of certain canned
     B. Revenue Administrative Bulletin      computer software, it provides no
        1988-41: Application of Statutory    specific examples of custom computer
        Amendments                           software or modified and/or adapted
        The Department of Treasury           computer software available as an
        repealed Revenue Administrative      end product without modification or
        Bulletin 1987-7 and issued Rev-      adaptation.
        enue Administrative Bulletin
                                              C. Subsequent Department of
        1988-41 in order to state the
                                                 Treasury Pronouncements
        Department's position regarding
        the new amendments to the                  Subsequent to the statutory
        Sales Tax Act and Use Tax Act.25           changes to the Sales Tax Act
        Rather than setting forth a                and Use Tax Act and the
        detailed analysis of the Depart-           release ofRAB 88-41, the
        ment's planned application of the          Department of Treasury at-
        statutory amendments or provid-            tempted to resolve additional
        ing a clear explanation of the key         issues as they arose, rather
        differences between taxable and            than through the promulgation
        nontaxable computer software,              of an explicit and detailed
        RAB 88-41 merely restated the              administrative ruling. Al-
        new statute provisions, indicating         though each announcement
        that "purely" canned computer              dealt with issues of impor-
        software was taxable, certain              tance, the informal manner in
        modified and/or adapted com-               which they were made resulted
        puter software was taxable, and            in a patchwork of law that
        the "very few [custom] computer            failed to form a coherent
        software programs" were exempt             framework.
       'from taxation:                             1. Separately Stated
          Under the current law, purely              Computer Software
          canned software remains                     Maintenance Contracts
          taxable as before. However,                 Not Subject to Taxation
          custom software is redefined                On November 4, 1988, the
          as software that is developed               Department released an
          by the seller specifically for             informal letter which, in
          the purchaser or user. This is a            addition to repeating many
          very narrow definition leaving              of the same pronouncements
          few computer software pro-                 set forth in RAB 88-41,
          grams exempt from tax under                provided new guidance
          the sales or use taxes. The new            regarding computer software
          legislation defines software               maintenance service con-
          that is basically formatted, but           tracts.27 In this informal
          for modifications or adapta-               letter, the Department
          tions to suit the specific needs           indicated that it would treat
          of the user or purchaser or                the sale and purchase of
          equipment of the user or                   computer software mainte-
          purchaser, as taxable. The                 nance service contracts in a          17
 Feature
 Articles                                                  Michigan Tax Lawyer-4th Quarter 2000


                   manner similar to how it                  few years ago in State Tax
                   treated sales at retail which             Notes, 30 the Department
                   included charges for technical            again erroneously applied
                   support or for the adaption               the tangible/intangible
                   or modification of computer               distinction that Maccabees
                   software - such services                  Life Insurance Company and
                   were taxable unless they                  Detroit Auto-Interinsurance
                   were separately stated and                Exchange, and thereafter the
                   identified as an optional                 Legislature, transformed into
                   purchase. 28                              the canned/custom di-
                                                             chotomy. In the letter, the
                 2. Electronic Databases                     Department indicated that
                    Not Subject to Taxation                  the sale of software, or other
RAB99-5             In Letter Ruling 90-6, 29 the            types of information, by
provides that       Department examined                      electronic means was not
the deciding        whether sales of a database              subject to the sales or use tax
                    service that provided news               absent the physical transfer
factor, in all                                               of a diskette, tape, or other
cases, for the      and other information to
                    customers through a personal             tangible item. The letter
taxability of       computer with a dial-up                  wholly ignored the canned!
computer            modem. The Department                    custom distinction set forth
software is         noted that the company                   in the Sales Tax Act and
whether the         selling the database service             Use Tax Act.
software is         provided only information,
                    not programs or instructions    IV. Current State of the Law -
canned or                                                Revenue Administrative
                   that allowed or enabled a
custom.            machine to perform particu-           Bulletin 1999-5
                   lar functions. Acknowledging     Last year, in an attempt to clearly
                   that information was not         set forth the applicable sales and use
                   tangible personal property,      taxation of computer software, the
                   the Department ruled that        Department issued Revenue Adminis-
                   sales of the database service    trative Bulletin 1999-5. 31 RAB 99-5
                   were not subject to sales or     provides that the deciding factor,
                   use tax. This ruling, how-       in all cases,"2 for the taxability of
                   ever, failed to take into        computer software is whether the
                   account the distinction be-      software is canned or custom.
                   tween essentially canned            RAB 99-5 defines canned computer
                   computer software and            software as computer software sold
                   custom computer software set     to the general public, and inc! udes
                   forth in the recently amended    license agreements for the sale of
                   Sales Tax Act and Use Tax        such software within its definition.
                   Act, instead referring to the    Such computer software is subject
                   older, and not strictly appli-   to sales and use tax regardless of its
                   cable, distinction between       method of delivery,33 regardless of its
                   tangible and intangible          medium,"• and regardless of whether
                   property.                        it has bee}\ modified for an individual
                                                    customer. Any modifications to
                 3. Electronic Downloads            canned software are also subject to
                    of Computer Software            tax, unless such modifications are
                    Not Subject to Taxation         separately stated on the invoice.
                                                       RAB 99-5 defines custom software
                    In a letter published only a
18
                                                                                                    Feature
     Michigan Tax Lawyer-4th Quarter 2000                                                           Articles
l


I
I
t
     as computer software originally
     designed for the exclusive use and
     needs of a particular customer. Such
                                             and "particular purchaser," as well
                                             as the failure ofRAB 99-5 or the
                                             Department to expand upon the
~'   software is not subject to sales or     type, manner, method, and number
                                                                                            Notably,
     use tax. Notably, however, custom       of sales that will transform custom
     computer software will become           software into canned software,                 however,
     canned software if it is offered for    especially within the context of               custom
     sale; RAB 99-5 pointedly does not       intercompany transactions, will                computer
     provide any de minim us exception       no doubt result in future litigation           software
     to this rule or provide any guidance     in the Michigan courts.                       will become
     on the scope of such sale, creating
     a presumption that any offer to                                                        canned
                                              Brian C. Bernhardt is an associate at the
     sell such custom software to any                                                       software if
                                              law firm of Raymond & Prokop, P.C., 1n
     potential customer other than the        Southfield, Michigan. He graduated from       it is offered
     particular customer for whom it is       Brown University in 1994 and the University   for sale ...
     originally designed will result in it    of Michigan Law School, with honors, in
     being subject to rules for canned        1997.
     software.

     V. Conclusion
     The key for determining whether the
     sale or use of computer software in
     Michigan is subject to taxation is an
     examination of whether the computer
     software is canned or custom. No
     longer does the method of delivery
     to the consumer affect taxation. No
     longer does the media upon or in
     which the computer software is
     delivered to the consumer affect
     taxation. No longer does the inher-
     ent status of the software as system,
     application, or operational software
     affect taxation. No longer is the
     taxpayer or the Department required
     to provide theoretical analyses of
     whether the computer software
     provides a tangible benefit to the
     consumer.
        Of course, the picture is not as
     clear as RAB 99-5 would have tax-
     payers believe. Although the defini-
     tion of canned software appears to
     provide a distinct and easily defined
     world in which most computer soft-
     ware will be subject to taxation, the
     definition of custom software creates
     numerous unresolved issues. The
     Department's continuing failure to
     define terms such as "originally
     designed," "exclusive use and needs,"
                                                                                                            19
 Feature
 Articles                                                                          Michigan Tax Lawyer-4th Quarter 2000


             ---------------------------ENDNOTES---------------------------
            1.   167 P.A. 1933, as amended, codified at MCL 205.51 et. seq.; MSA 7.521, et. seq.
            2.   See MCL 205.52(1), (2); MSA 7._.
            3.   SeeMCL205.51(1)(b); MSA 7._.
            4.   See MCL 205.51 (1 )(g); MSA 7. _ _ .
            5.   See MCL 205.52(1 ); MSA 7. _ _.
            6.   See MCL205.51(1)(i); MSA 7._.
            7.   94 P.A. 1937, as amended, codified at MCL 205.91 et. seq.; MSA 7.555(1), et. seq.
            8.   See MCL 205.93(1); MSA 7. ___ .
            9.   See MCL 205.92(b); MSA 7._.
            10. See MCL 205.94(1 )(a); MSA 7. __ .
            11. See MCL 205.94(1 )(e); MSA 7. __.
            12. See MCL205.93(1); MSA 7. ___ .
            13. See MCL 205.92(!); MSA 7. ___ .
            14. See Mich. Admin. CodeR. 205.7, rescinded 1996 MR 8, effective September 4, 1996.
            15. 12 Mich App 660; 332 NW2d 561 (1983).
            16. 138 Mich App 696; 361 NW2d 373 (1984).
            17. See 259 P.A. 1987; 260 P.A. 260.
            18. "Computer software" was defined to mean a set of statements or instructions that when incorporated in
                a machine usable medium is capable of causing a machine or device having information processing
                capabilities to indicate, perform, or achieve a particular function, task, or result. See MCL 205.51 (1 )(e);
                MSA 7. _ _ . See also MCL 205.92(k); MSA 7. ___.
            19. See MCL205.51(1)(e); MSA 7. ___ .
            20. ld.
            21. ld.
            22. See MCL 205.92(k); MSA 7. ___ .
            23. See MCL 205.92(k); MSA 7. ___.
            24. See MCL       205.92(~;   MSA 7. ___.
            25. See Revenue Administrative Bulletin 1988-41 (June 10, 1988).
            26 ld.
            27. See Michigan Department of Treasury Informal Letter (November 4, 1988).
            28. Id., at~ 4.
            29. LR 90-6 (March 27, 1990).
            30. 14 State Tax Notes 386 (February 2, 1998) (Letter from Dale P. Vette!, Administrator, Sates, Use, and
                Withholding Tax Division, Michigan Department of Treasury).
            31. See Revenue Administrative Bulletin 1999-5 (September 29, 1999).
            32. Thus, by its own terms, RAB 99-5 applies to operating software, application software, and system software
                and, by implication, it also applies to any future developed types of computer software. See RAB 99-5,
                Conclusion § 11.
            33. Regardless of whether a computer program is transferred electronically by a network, Intranet, the Internet,
                or any other electronic method, the computer software is taxable if it otherwise falls within the definition of
                canned computer software. See RAB 99-5, Conclusion § Ill.
            34. Regardless of whether the computer software sold or licensed is created on CDs disks, tapes, or other data
                processing storage media, computer cards, or printed material, computer software is taxable if it otherwise
                falls within the definition of canned computer software. See RAB 99-5, Law and Analysis, p. 2.




20
                                                                                               Feature
Michigan Tax Lawyer-4th Quarter 2000                                                           Articles

The Whittling Away of INDOPCO:
PNC Bancorp and Wells Fargo1
By: Jay M. FrucCi and Lisa M. Kiner        sponse. The following discussion
                                           illustrates that while these recent
 The IRS, emboldened since 1992 by         cases whittle away atiNDOPCO, by
 the Supreme Court's landmark              limiting the broad reach of §263, the
 INDOPCO decision, 2 has required the      extent to which individual taxpayers
 capitalization of many expenditures       may be affected remains uncertain.
 which would appear to be beyond the
 reach of §263." The Service's expan-       Deductibility under Section 162
 sive interpretation of the INDOPCO         Section 162(a) of the Internal
 opinion has been virtually unchecked       Revenue Code allows the current
 by subsequent Tax Court decisions,                                                    Whether an
                                            deduction of "ordinary and necessary
 further providing aid and comfort to                                                  expense is
                                            expenses paid or incurred during the
 the IRS in the pursuit of the capitali-    taxable year in carrying on a trade or     ordinary and
 zation of otherwise deductible ex-         business." However, under §263, no         necessary for
 penses. More recently, however,           current deduction is permitted for          purposes of
the Third Circuit, in PNC Bancorp          capital expenditures.< Capital expen-
v. Comm'r, 212 F.3d 822, (3rd Cir..                                                    §162(a)
                                           ditures must be depreciated over the        depends on
2000)· revisited the INDOPCO deci-         life of the asset or useful life of the
sion discovering that INDOPCO is                                                       the facts and
                                           asset with which the expenditure is
not ~early as broad, or as anti-tax-        associated, or, where no specific .        circumstances
payer, as the Service would like us to                                       . asset   of each
                                           or useful life is ascertainable, It IS
believe. Furthermore, on August 29,        deducted upon dissolution of the            particular case.
2000 the Eighth Circuit determined         enterprise. 5
in W~lls Fargo v. Comm'r, 2000 US               To qualify for a deduction under
App. Lexis 22201 (8th Cir. 2000); that     §162(a), the taxpayer generally must
INDOPCO requires courts to engage          prove that an item ~atisfies five       .
in further examination beyond              criteria.• First, the Item must be pmd
whether the expenditure is related         or incurred during the taxable year.
to the creation of a future benefit.       Second the item must be incurred in
These two cases, while not fully in        the taxrayer's trade or business.
accord force taxpayers and their           Although the term "trade or business"
advoc~tes, if not the IRS, to revisit      is not specifically defined in either
their prior understanding of the           the Code or regulations, the term
INDOPCO doctrine. At a minimum,            is considered to mean an activity
these developments raise the bar for       regularly engaged in for the primary
forcing capitalization. Some readers       purpose of generating income or
of these opinions, especially PNC          profit. Third, the item must be c?n-
Bancorp, would assert that these           sidered an expense. Fourth, the Item
cases establish a new bright-line test     must be ordinary. Finally, the expen-
which is far removed from the IRS'         diture must be necessary. Whether
current position on capitalization of      an expense is ordinary and necessary
expenses.                                  for purposes of§ 162(a) depends on
   Although the Service requested          the facts and circumstances of each
and received an extension of time to       particular case. Because of the
file a request for a writ of certiori to   inherently factual nature in deter-
the Supreme Court in the PNC               mining whether a cost is "ordinary"
Bancorp case, the extended deadline        and "necessary," these terms
expired without action on September        have been the subject of extensive
18, 2000, presumably b~ca~se the           litigation.
Service is still formulatmg Its re-                                                                  21
 Feature
 Articles                                                          Michigan Tax Lawyer-4th Quarter 2000


                     The most widely quoted definition     or estate. In addition, Treas. Reg.
                  of"ordinary" appears in Welch v.       · §1.263(a)-l(b) provides that a deduc-
                  Helvering, 8 where the Supreme Court tion is specifically denied for any
                  determined that an expense need not      "amounts paid or incurred (1) to add
                  be incurred habitually or normally to    to the value, or substantially prolong
                  be considered ordinary for purposes      the useful life of, property owned by
                  of§162. The Supreme Court has also       the taxpayer, such as plant or equip-
 ... the courts   interpreted the term "ordinary'' to      ment, or (2) to adapt property to a
                  mean that which is "normal, usual,       new or different use." Once costs
 and the Service or customary. . . [T]he transaction       have been capitalized, the regulations
 frequently have which gives rise to [the expense] must provide that these costs are recovered
 difficulty       be of common or frequent occurrence      through depreciation, amortization,
 distinguishing   in the type of business involved."       or cost of goods sold, as adjustments
 between             The requirement that an expense       to basis. 12
 deductible       be "necessary" has been broadly             Although the regulations provide
                  interpreted to mean that an expense      guidance regarding capital expendi-
 expenses         be consistent with actions that would    tures, the courts and the Service
 and capital      be taken by "a reasonably prudent        frequently have difficulty distinguish-
 expenditures.    man" under similar circumstances.       ing between deductible expenses and
                      The Supreme Court has also           capital expenditures. Unlike deduc-
                  noted "our decisions have consistently tions, capital expenditures are not
                  construed the term 'necessary' as        specifically enumerated in the Code.
                  imposing only the minimal require-      Thus, §263 "serves as a general
                  ment that the expense be 'appropriate means of distinguishing capital
                  and helpful' for 'the development of    expenditures from current expenses."
                  the [taxpayer's] business."'"           For this reason, several criteria have
                                                          been established to differentiate
                  Expenditures That Must Be               capital expenditures from deductible
                 Capitalized Under Section 263            expenses.
                 The term "capital expenditure" is not        For example, when a taxpayer
                 specifically defined in the statute,     purchases land, equipment, or a new
                 although §263(a)(l) provides that no     building, the expenditure serves to
                 deduction is allowed for any amount      "create or enhance ... what is essen-
                 paid for new buildings or for perma-     tially a separate and distinct addi-
                 nent improvements or betterments         tional asset" whose value is obviously
                 made to increase the value of any        not properly allocable to the current
                 property or estate. Thus, capital        taxable year and a nondeductible
                 expenditures that result in the cre-     capital expenditure is identifiable. 13
                 ation, prolongation, or improvement      Another test employed to identify
                 of a capital asset are not deductible.   capital expenditures determines
                    AB interpreted by the regulations,    whether an expense results in the
                 §263 prohibits any deduction for         creation of an asset with a "useful life
                 amounts paid or incurred that add        beyond the current taxable year." 14
                 value to, or substantially prolong the       Both of these tests, if strictly
                 useful life of, a taxpayer's property,   applied to all fact patterns, result
                 or to adapt property to a new or         in the characterization of minor
                 different use. In particular, Treas.     expenses as capital expenditures. As
                 Reg. §1.263(a)-l(a) provides that no     noted by the Seventh Circuit, "[I]f one
                 deduction is allowed for any amount      really takes seriously the concept of
                 paid for new buildings or permanent      a capital expenditure as anything
                 improvements or betterments to           that yields income, actual or imputed,
                 increase the value of any property       beyond the period in which the expen-
22
                                                                                            Feature
Michigan Tax Lawyer-4th Quarter 2000                                                        Articles

 diture is made, the result will be to      PNC Bancorp -Treatment
 force the capitalization of virtually      of Loan Origination Costs
 every business expense."15 Many            The Third Circuit Court of Appeals
 expenses that are otherwise clearly        reversed the Tax Court decision in
 deductible have prospective effect         PNC Bancorp 20 on May 19, 2000. In
 beyond the taxable year. Thus, if          1998, the Tax Court held that a bank
 every cost attributable to future          must capitalize loan origination costs
 profits were characterized as nonde-       incurred when making loans, which
 ductible, it would be necessary to         had lives that extended beyond the
 divide almost every cost between its       year in which the expenses were
 immediate impact and its contribu-         incurred. In processing consumer
 tion to future profits.                    and commercial loan applications, the
    For this reason, the Supreme Court      banks incurred various costs, includ-
 attempted to clarify the determina-        ing costs related to obtaining credit
 tion of capital expenditures by stating    reports, title reports, and property     ... the Third
 that "the mere presence of an inciden-     appraisals. When the banks ap-           Circuit held
 tal future benefit - some future           proved loan applications, the loan       that costs for
 aspect- may not warrant capitaliza-        closing process entailed additional      marketing,
 tion" ... although "a taxpayer's real-     procedures and costs, such as legal
 ization of benefits beyond the year in     costs and security interest recording    researching
 which the expenditure is incurred is       costs. The banks capitalized certain     and originating
 undeniably important in determining       loan origination costs for financial      loans are
 whether the appropriate tax treat-         accounting purposes in accordance        deductible as
 ment is an immediate deduction or         with Statement of Financial Account-      "ordinary and
 capitalization. "16 This standard         ing Standards No. 91 ("SFAS 91"),         necessary
 clarified the question as to when costs    adopted by the Financial Accounting
                                                                                     expenses" ...
may be considered capital expendi-          Standards Board in 1986.
tures; unfortunately it did not settle        For tax purposes, the banks cur-
the issue, and many questions persist      rently deducted the costs. In its
regarding capital expenditures.            opinion, the Tax Court appeared to
    Accordingly, §263 has been read to     rely heavily upon the creation of
require costs incurred to effectuate a     separate and distinct assets (i.e.,
capital transaction that results in a      loans) as a basis for requiring capi-
"significant long-term future benefit"     talization and amortization ofloan
to the corporation to be capitalizedY      origination costs, despite the admoni-
Thus, expenditures incurred by an          tion of the Supreme Court in
acquirer to effectuate an acquisition      INDOPCO that the creation of a
of stock or specific assets are not        separate and distinct asset is not
deductible and must be capitalized         determinative of the treatment of
under §263. Similarly, the Service         related costs. Moreover, the Tax
has generally concluded that the           Court "reiterate[d] that SFAS 91 does
costs of raising equity18 and legal fees   not control the correct characteriza-
incurred for advice related to proper      tion of the subject expenses," yet did
tax structure must be capitalized. 19      not engage in any independent analy-
Such costs include costs of negotiating    sis of the loan origination costs at
and drafting stock terms, registration     issue to determine whether they are
costs, underwriting commissions,           properly subject to capitalization
and the fees associated with tax           under Federal income tax principles?'
opinions regarding the structure of           In reversing the Tax Court deci-
the transaction.                           sion, the Third Circuit held that costs
                                           for marketing, researching and origi-
                                                                                                   23
 Feature
 Articles                                                           Michigan Tax Lawyer-4th Quarter 2000


                   nating loans are deductible as "ordi-      the transaction must be capitalized.
                   nary and necessary expenses" under         The costs must be capitalized,
                   IRC §162. 22 The Circuit Court dis-        ''because they are connected to an
                   agreed with the Tax Court on two           event ... that produced a significant
                   levels. "We believe that the Tax          long-term benefit." 27
                   Court took too broad a reading of             The Eighth Circuit vehemently
                   what Lincoln Savings meant by              disagreed with the Tax Court. In a
                   'separate and distinct assets,' as well   very scholarly opinion, the Circuit
                   as an overbroad reading of what can        Court utilized a somewhat cumber-
                   be said to 'create' such assets. "23 As    some but informative "decision-tree"
                   to what is a "separate and distinct        approach to its analysis, relying
                   asset," the Circuit Court refused to      heavily on the INDOPCO and Lincoln
                   follow the Tax Court's determination      Savings opinions of the Supreme
                   which would, in its words, extend "to      Court. The first question, according
 The first         cover ANY IDENTIFIABLE asset"             to the Eighth Circuit, is whether an
 question ...      (caps in original)?4                       expenditure creates or enhances a
 is whether an        In even more critical language, the     separate and distinct asset. As this is
                   Circuit Court concluded that the Tax      taken from the wording of §263 itself,
 expenditure       Court greatly stretched the required      it would appear that this step in the
 creates or        relationship between the expense in       Court's analysis is intended to snare
 enhances a        question and the capital asset, which     those expenditures, which are the
 separate and      is created. Distinguishing the PNC        direct purchase of a capital asset.
 distinct asset.   facts from those in Lincoln Savings, 25   In such cases, the expenditure clearly
                   the Circuit Court ruled that the PNC      must be capitalized. If not, further
                   expenses were "merely associated          analysis is required.
                   with the origination of the loans; the        The next question set forth by the
                   expenses themselves do not become         Court is whether the expenditure
                   part of the balance of the loan." As is   gives rise to a future benefit. 28 Any
                   discussed below, a literal reading of     expenditure that does not give rise to
                   this analysis would preclude capitali-    such a long-term benefit need not be
                   zation of an expense under §263 and       capitalized and may be currently
                   INDOPCO, unless it was the pur-           deducted from taxable income. On
                   chase of an asset or a contribution to    the other hand, if a long-term benefit
                   a fund which itself becomes an asset      is found, another level of review is
                   of the taxpayer. On the basis of this     required. The final prong set out
                   reasoning, the Circuit Court con-         by the Circuit Court is whether the
                   cluded that loan origination expenses     expense is directly connected with
                   are deductible as ordinary and neces-     the long-term benefit or if it is merely
                   sary business expenses under IRC          incidentally connected to it.
                   §162(a) and are not required to be            Having set out this logical method
                   capitalized under IRC §263.               of analysis, the Court applied it to the
                                                             facts in the case. The agreed facts
                   Wells Fargo-                              indicated that the officers in question
                   Internal Acquisition Costs                had received a salary from the bank
                   In Wells Fargo,2 6 the Eighth Circuit     well before any transactions were
                   Court was confronted with salary          contemplated, and that they likely
                   expenditures incurred by a bank           would have received a salary from
                   acquisition target in conjunction with    the bank (equal to what they actually
                   the sale of the bank. The Tax Court       received) even had there been no
                   ruled that the portion of those sala-     transaction.
                   ries that was attributable to the             With little analysis, the Court
                   services those officers performed in      found that these salary expenses did
24
                                                                                            Feature
Michigan Tax Lawyer'-4th Quarter 2000                                                       Articles

 not create or enhance a separate and     Service, with the assistance of the
 distinct asset?9 Under its stated        Tax Court, has incorrectly forced
methodology, such a finding required      capitalization of expenses on the sole
that it look next to whether the          basis that the expenses are associated
 expenses gave rise to a long-term        with some future benefit. The two
benefit. Accepting the finding by the     courts deviate somewhat in how they
Tax Court on this issue, the Circuit      would apply this additional analysis,
Court ruled that the expenditures         but the theme is clear: many expen-
did contribute to the creation of a       ditures have been capitalized since
long-term benefit. 30 The benefit,        INDOPCO that should properly have
although not stated, would seem to        been currently deducted.
be the enhanced value to the taxpayer         The cases also agree that the
resulting from the acquisition.           distinction between deductible and
   Having found a long-term benefit,      capitalizable business expenses is
the Court next examined the relation-     difficult to define, and is really an art
ship between the expenditure and the      more than a science. Both opinions
long-term benefit that was created.       go to great length to caution readers
Because the salaries would have been      that the particular facts and circum-
paid whether or not an acquisition        stances surrounding the expenditure         ... the
had taken place, the Court deter-         will be determinative of the capitali-      distinction
mined that the salary expenses arose      zation/deduction decision. PNC              between
directly from the employment relation-    Bancorp advises that the issue turns
ship between the taxpayer and its         on, ''whether given expenditures            deductible and
officers, and were only indirectly        relate to the corporation's operations      capitalizable
associated with the creation of a         and betterment into the indefinite          business
long-term benefit."                       future, indicating the need for capi-       expenses is
   Similar to PNC Bancorp, an aggres-     talization, or are instead geared           difficult to
sive reading of this case could support   toward income production or other           define, and is
a vast divergence from our prior,         current needs, suggesting deductibil-
relatively well-established, under-       ity."32 Underlying the PNC Bancorp          really an art
standing of §263. From this case, it is   opinion is a clear sense that the fact      more thana
arguable that, to the extent no mar-      that loan origination is a very large       science.
ginal employment costs are incurred,      part of what a bank does in its daily
no salaries need be capitalized despite   operations makes the costs associated
the degree of the employees' involve-     with that activity a deductible ex-
ment in capital transactions. The         pense. An interesting issue is
Eighth Circuit is quick to point out,     whether a manufacturer with infre-
however, that this is a decision which    quent loan origination costs would
turns on facts and circumstances and      be permitted to deduct those expenses
that the Court does not intend by this    as they arise.
opinion to create a bright-line rule.         Wells Fargo starts its analysis with
                                          a first step intended to cull those
Reconciling Wells Fargo                   expenditures which are clearly capi-
and PNC Bancorp                           tal in nature- where the cost is to
Certain similarities and differences      purchase an asset or make a contribu-
are noted between Wells Fargo and         tion to a fund which itself becomes an
PNC Bancorp. These two cases,             asset of the taxpayer. It continues,
delivered just three months apart, are    saying that where an expense does
alike in their strong criticism of the    not fit into this category, it may still
IRS' overreaching pursuit of capitali-    be capitalizable. To require capitali-
zation of expenses after INDOPCO.         zation in such cases, there must be a
The two opinions agree that the           benefit extending into future tax
                                                                                                   25
 Feature
 Articles                                                            Michigan Tax Lawyer-4th Quarter 2000


                   years and the expense must be di-          what we have all been led to believe
                   rectly connected to the creation of        in the years since INDOPCO.
                   that future benefit. It is the question       Despite the apparent disagreement
                   of the direct or indirect nature of that   as to how severely the two circuits
                   relationship between the expense           would limit the reach of §263, both
                   and the benefit, which appeared to         opinion.s are clearly beneficial to
                   be determinative in the Wells Fargo        taxpayers.
                   case.
                      PNC Bancorp, on the other hand,         Broader Reach for
                   seems to start and end with Wells          PNC Bancorp and Wells Fargo?
                  Fargo's first step. The Third Circuit       The most important question in the
                   criticized the Tax Court for taking         aftermath of these cases is how far
                   the fact that the loan origination          their influence will extend. It is
                  costs were associated with the cre-          possible that they will be limited
                   ation of assets of the bank "to the        either by the fact that they represent
                  faulty conclusion that these expenses       only two of twelve Federal Circuit
                  themselves created the loans (cita-          Courts of Appeals, or that they will
                  tions omitted). We conclude that the         be limited to the specific facts found
                  term 'create' does not stretch this         in those cases. The IRS will surely
The most          far." 33 The Court continued by citing      attempt to limit their scope in these
important         favorably from the taxpayer's brief,        ways. Unless the Supreme Court
question in the   "both the Tax Court and the govern-         takes up these issues again, the
aftermath of      ment effectively have transformed           geographical reach of these cases will
                  that language, by subtle but signifi-       be a product of their ability to influ-
these cases is                                                ence other Circuit Courts with their
                  cant degrees, from a test based on
how far their     whether a cost 'creates' a separate         reasoning.
influence will    and distinct asset, into a much more           Particularly because of the admoni-
extend.           sweeping test that would mandate            tions in both cases that the particular
                  capitalization of costs incurred 'in        facts and circumstances involved are
                  connection with' or 'with respect to'       paramount to the decisions, courts
                  the acquisition of an asset."34             taking up these issues in the future
                     This language infers, and some will      will find a great deal oflatitude to
                  argue that it is much stronger than         follow the reasoning contained in
                  an inference, that only those expendi-      these cases to reach a desired result,
                  tures which become all or a part of         without necessarily continuing in the
                  the separate and distinct asset them-       spirit of these cases. Even a lower
                  selves are capital expenditures. 35         court within these circuits could
                  This would theoretically include only       easily distinguish future cases based
                  the purchase price for capital assets       on facts and circumstances. There-
                  and contributions to funds which            fore, the reach of these cases will rely
                  themselves become capital assets of         entirely upon the desire of courts
                  the taxpayer. All other expenditures        across the country to expand, con-
                  would be merely "associated with" or        tract, or hold constant the scope of
                  "in connection with" the creation of        the IRS' ability to force capitalization.
                  an asset, and could be deducted                Even with this in mind, taxpayers
                  currently. Such a position would            and their advisors should reexamine
                  unquestionably be a great departure         their understanding of §263 and
                  from established INDOPCO doctrine.          INDOPCO in light of PNC Bancorp
                  The question is whether such a              and Wells Fargo. It is likely that
                  holding is actually incorrect in light      many taxpayers, across the country,
                  of §263 and Supreme Court prece-            will view these cases as an opening
                  dent, or if it is simply different from     to currently deduct expenses that
26
                                                                                                                             Feature
 Michigan Tax Lawyer-4th Quarter 2000                                                                                        Articles

undoubtedly would have been capital-                         ers while bringing additional burden
ized prior to these cases. The Third                         on decision-makers to determine their
Circuit criticized the Service's zealous                     individual level of aggressiveness
reading of INDOPCO. "INDOPCO,                                in light of the particular facts and
which signaled the Supreme Court's                           circumstances of their business.
previously announced tests for capi-
talization were not exhaustive, may
well have been viewed by the IRS as                               Jay M. Frucci is an Associate Attorney in
a green light to seek capitalization                              the Corporate, Banking and Real Estate
                                                                  Group of Dickinson Wright PLLC. The                 This issue
of costs that had previously been                                 focus of his practice is on mergers and
considered deductible in a number                                                                                     should now be
                                                                  acquisitions as well as general corporate
of businesses and industries."36                                  matters. Jay earned his J.D. from Wayne             considered as
One can easily foresee a future court                             State University Law School in 1994.                one among
opinion equally as critical of taxpay-                                                                                those that
ers for their aggressive interpretation                           Lisa M. Kiner works in the Federal
                                                                                                                      present great
of Wells Fargo and PNC Bancorp.                                   Specialties Services group in the Detroit
                                                                  office of Ernst & Young as a Tax Consult·           opportunity for
                                                                  ant. Her current practice comprises tax             tax savings to
Conclusion                                                        planning for mergers and acquisitions,
Any tax professional who addresses                                benefits, audit readiness, IRS negotia-             taxpayers .••
the deduction/capitalization issue                                tions and on-line transactions. Usa
would be well-served to review these                              graduated from the University of Michigan
                                                                  with an A.B. in Economics as well as a
recent cases, applying the reasoning                              Juris Doctorate. Upon graduation from
of these opinions to his or her particu-                          the University of Michigan's Law School,
lar facts and circumstances. This                                 Lisa joined Miller, Canfield, Paddock &
issue should now be considered as                                 Stone as an Associate in the Federal
one among those that present great                                Taxation and Employee Benefits Groups.
opportunity for tax savings to taxpay-

-----------------------------ENDNOTES-----------------------------
1.   The authors would like to thank the following individuals whose contributions helped to refine and improve the
     analysis contained in this article: Trevor Wetherington of Ernst & Young and John Gatti of Ernst & Young.
2.   INDOPCO, Inc. v. Comm'r, 503 U.S. 79 (1 992).
3.   Unless otherwise noted, all references to Sections, often abbreviated as u§", shall indicate the Internal
     Revenue Code of 1986, as amended, or to the Treasury Regulations promulgated thereunder.
4.   Commissionerv. Idaho Power Co., 418 U.S. 1, 17 (1974) (capitalization requirement takes precedence over
     provisions allowing for the deduction of business expenses).
5.   INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).
6.   See, Comm'rv. Lincoln Sav. & Loan Ass'n, 403 U.S. 345, 352 (1971) (setting forth the deduction criteria).
     Some courts state the criteria for deduction as a four-part test, combining parts four and five (ordinary and
     necessary, respectively) into a single part four.
7 . See, generally Comm'rv. Groetzinger, 480 U.S. 23 (1 987).
8. Welch v. Helvering, 290 U.S. 111, 114 (1 933).
9. Deputyv. DuPont, 308 U.S. 488, 495 (1940).
10. Welch, 290 U.S. at 113 (citing McCulloch v. Maryland, 17 U.S. 316 (1 81 9)). See also, Mason & Dixon Lines,
    Inc. v. U.S., 708 F.2d 1043 (6th Cir., 1983) (rejecting the argument that an expense was not "necessary''
    because it could have been avoided by exercising greater care).
11. Comm'rv. Tellier, 383 U.S. 689 (1 966).
12. Treas. Reg. §1.263(a)·1(b).
13. See, e.g., Lincoln Sav. & Loan Ass'n vs. Comm'r, 403 U.S. 345 (1 971 ), rev'd, 422 F.2d 90 (9th Cir., 1970),
    rev'd, 51 T.C. 82 (1 968).




                                                                                                                                    27
 Feature
 Articles                                                                               Michigan Tax Lawyer-4th Quarter 2000


                  -------------ENDNOTES (continued)--------------
                   14. See, Treas. Reg. §1.446(c)(1 )(ii) (providing that expenditures associated with the creation of an asset with a
                        useful life extending substantially beyond the taxable year, shall be charged to a capital account and not to
                        an expense account). See also, Treas. Reg. §§1.461-1 (a)(1),(a)(2) (regarding assets with a useful life that
                        extends substantially beyond the close of the taxable year).
                   15. Encyclopedia Britannica, Inc. v. Comm'r, 685 F.2d 212, 217 (7th Cir., 1982).
                  16 . INDOPCO, supra, note 2.
                  17. See, INDOPCO, supra, U.S. v. Gilmore, 372 U.S. 39 (1963). See also, Woodwardv. Comm'r, 397 U.S. 572
                        (1970); U.S. v. Hilton Hotels, 397 U.S. 580 (1970).
                  18. See, Rev. Rul. 69-330,1969-1 C.B. 51.
                  19. See, Rev. Rul. 67-125, 1967-1 C.B. 31.
                  20. PNC Bancorp v. Comm'r, 212 F.3d 822, (3rd Cir. 2000).
                  21. This analysis only applied to costs associated with successful loans. The parties agreed that loan origina-
                       tion costs associated with unsuccessful loans should be currently deducted.
                  22. Supra, note 21.
                  23. ld.
                  24. ld.
                  25. In Lincoln Savings, the Supreme Court found that contributions which formed the corpus of a reserve fund
                       were capital expenditures.
                  26. Wells Fargo v. Comm'r, 2000 US App. Lexis 22201 (8th Cir. 2000).
                  27. Norwest Corp., et at. v. Comm'r, 112 T.C. No.9 (March 8, 1999). (Wells Fargo is the successor corporation
                       to Norwest Corp.)
                  28. To avoid any confusion, the Court made clear that if step one of the decision tree is satisfied, a future benefit
                       is necessarily present. "IF AN EXPENDITURE CREATES OR ENHANCES A SEPARATE ASSET, THEN IT
                       IS A CAPITAL ITEM WHICH (BY ITS VERY NATURE) PROVIDES LONG TERM BENEFITS AND MUST
                       BE CAPITALIZED." Wells Fargo, supra note 23. (caps in original~ Tax Notes Today).
                  29. Supra, note 26.
                  30. ld.
                  31. ld.
                  32. Supra, note 21.
                  33. PNC Bancorp, Id. at 830.
                  34. PNC Bancorp, ld. at 830.
                  35. Although not addressed, one would assume that this analysis would not override any related laws or
                       regulations, such as §263A.
                  36. PNC Bancorp, ld. at 824.




                  You will note that the Feature Article                      the footnotes for this article were
     Note from    "The Whittling Away of INDOPCO:                             omitted when originally
     the Editor   PNC Bancorp and Wells Fargo" by                             published in last quarter's issue.
                  Jay Frucci and Lisa Kiner has been                          I apologize to them and you for this
                  republished because inadvertently                           omission.




28
 Michigan Tax Lawyer-4th Quarter 2000                                               Short Subjects

Michigan State University- Detroit College of Law Opens
Low-Income Taxpayer Clinic
By: Professor Michele L. Halloran          complies with the low-income require-
 In January 2000, Michigan State           ments ofiRC § 7526 if"at least 90
 University- Detroit College of Law        percent of the taxpayers represented
 opened its Low-Income Taxpayer            by the clinic have incomes which do
 Clinic with the approval and guidance     not exceed 250 percent of the poverty
 ofMSU-DCL's faculty and adminis-         level, as determined under criteria
 tration. The Tax Clinic is a legal-       established by the Director of the
 services clinic providing no-cost,        Office of Management and Budget,"
 high-quality legal assistance to low-     and the amount in controversy for
 income taxpayers from the Greater         a taxpayer for any taxable year
 Lansing area who have cases or            generally does not exceed $50,000.
 controversies with the Internal Rev-     IRC § 7526(b)(l)(B)(i). The term
 enue Service or who are non-filers.      "clinic" expressly includes a clinical
 "Low income" is measured at 250           program at an accredited law school.
 percent of applicable federal poverty     IRC § 7526(b)(2)(A). In determining
 guidelines. Under the income criteria    whether to award a grant to a
 for 2000 established by the IRS for      low-income taxpayer clinic under
 the provision of clinic services, a      IRC § 7526, the Secretary is required
 taxpayer from a one-person household     to consider the following factors:
can have income of up to $20,875 and         • The numbers of taxpayers the
qualifY for clinic services, while the         clinic will serve, including the
income ceiling for a taxpayer from a           number of ESL persons within
five-person household is $49,875. In           the service area;
addition, the clinic provides free           • The existence of other low-
return preparation and educational             income taxpayer clinics in the
services concerning income tax rights          same area;
and responsibilities to persons for          • The quality of the clinical pro-
whom English is a second language              gram, including the qualifica-
("ESL"). The Tax Clinic, as a compo-           tions of its administrators and
nent ofMSU-DCL, has exempt status              representatives and its record in
under IRC § 501(c)(3).                         providing clinical services; and
    The MSU-DCL Tax Clinic currently         • The availability of other funding
receives its primary funding through           sources available to the clinic.
the Internal Revenue Service's Low-            IRC § 7526(c)(4).
Incom~ Taxpayer Clinic Program,               Because MSU-DCL's clinical pro-
authonzed under IRC § 7526. This          grams are integral parts of the law
Code provision authorizes the award       school education made available to
of grant monies to a clinic that "does    students, the project's goal also is to
not charge more than a nominal fee        ensure that law students acquire
for its services (except for reimburse-   hands-on experience in addressing
ment of actual costs incurred); and       and litigating matters before the IRS
represents low-income taxpayers in        and the United States Tax Court, in
controversies with the Internal Rev-      preparing returns for ESL persons,
enue Service; or operates programs to     including nonresident aliens, and in
inform individuals for whom English       client counseling and law office
is a second language about their          management. Currently enrolled
rights and responsibilities under this    students who have successfully
title." IRC § 7526(b)(l)(A). A clinic     completed their first-year courses,
                                                                                                29
 Short Subjects                                                     Michigan Tax Lawyer-4th Quarter 2000


                   who meet the academic and moral            law students participate in periodic
                   standards established by the Dean,         strategy meetings, in which they
                   and who are supervised by members          have the opportunity to interactively
                   in good standing of the Michigan           discuss the substantive and proce-
                   State Bar are allowed to provide legal     dural problems of their own cases
                   representation to indigent persons,        and those of other students. Clinical
                   and make court appearances as              residents enter into written confiden-
                   permitted by MCR 8.120. Clinical           tiality agreements and strictly main-
                   residents apply for and receive "spe-      tain the confidentiality of information
                   cial orders" permitting them to repre-     relating to each client's tax matter.
                   sent clients before the IRS. A client's       MSU-DCL's Tax Clinic prides itself
                   state and local tax issues may also be     on its dual character as an important
                   addressed if the Clinic is handling a      community service project, and as a
                   federal tax case or controversy for        vehicle through which law students
                   the client. Students enrolled in this      can learn and incorporate essential
                   program must have completed MSU-           lawyering skills. The Clinic's "com-
                   DCL's basic tax class, and have com-       munity service" aspect is demon-
                   pleted or be concurrently enrolled in      strated in several ways:
                   a second class, Practice and Procedure       • The Tax Clinic empowers low-
                  Before the IRS. Work is progressing              income taxpayers in the commu-
                  toward incorporation of a second-tier            nity who are in controversy with
                  Tax Clinic class as part ofMSU-DCL's             the IRS and taxpayers for whom
                  curriculum (presently, students who              English is a second language by
                  have successfully completed Tax                  offering the highest quality legal
                  Clinic I and who wish to garner more             representation, advocacy and
                  experience may do so through a                   community service.
                  directed study). Clinical faculty             • It provides competent, experi-
                  provide professional skills training to          enced, and inexpensive legal
                  student clinicians and afford them the           services, helping to ensure
                  opportunity to gain practical experi-            taxpayer compliance with
                  ence in representing clients in admin-           federal, state and local tax laws.
                  istrative proceedings before the IRS          • It increases public awareness
                  and in judicial proceedings before the           and understanding of the tax ·
                  United States Tax Court. Through                 laws by disseminating infor-
                  their participation in the Tax Clinic,           mation - identifying current
                  law students develop important                   legal issues and anticipating
                  lawyering skills by interviewing and             future ones.
                  counseling clients; conducting factual        • It promotes volunteerism
                  investigations; performing legal                 by integrating community
                  research; analyzing the provisions               service into legal education.
                  and impact of tax treaties between            • It partners with other institu-
                  various countries and the United                 tions of higher education and
                  States; negotiating compromises;                 other nonprofit organizations to
                  drafting documents; and litigating               be able to confer more effective
                  tax cases.                                       service.
                     Although law students enrolled             The Tax Clinic also furthers legal
                  in the Tax Clinic are responsible for       education by
                  their own caseloads, they are closely         • Building lawyering competencies
                  and carefully supervised by clinical             through service learning in a
                  faculty in all aspects of their represen-        teaching clinic that serves the
                  tation of clients. In addition to their          legal needs oflow-income
                  classroom and on-site clinical work,             taxpayers.
30
Michigan Tax Lawyer-4th Quarter 2000                                                       Short Subjects

   • Offering students a model of           Grand River Avenue, and is open
      practice that provides them           year-round for walk-in consultation
      with comprehensive exposure           or for consultation by appointment.
      to fundamental lawyering skills       The Clinic welComes referrals from
      while providing legal services        Tax Section members oflow-income
      to low-income taxpayers.              and ESL clients in the Greater
   • Teaching students basic income         Lansing area. For more information,
      tax law and practice and pro-         please contact the MSU-DCL Tax
      cedure before the IRS, and            Clinic by telephone at (517) 336-
     having the students apply these        8088, by fax at (517) 336-8089, or
      concepts to practice at the Clinic.   by e-mail at hallorll@dcl.edu.
   • Teaching law-office management
      and client-service skills.
   • Increasing student awareness             Professor Michele L. Halloran has
      and understanding of the art            directed MSU-DCL Tax Clinic since
      oflawyering, specifically as it         August 2000. Formerly, she headed
                                              Howard & Howard Attorneys, P.C.'s state
     relates to their work at the             and local tax practice, was an Administra-
      Clinic.                                 tive Law Judge with the Michigan Tax
   Prospective employers benefit              Tribunal, a law clerk to Michigan Supreme
from MSU-DCL's Tax Clinic as well,            Court Chief Justice MaryS. Coleman, a
for they are able to hire versatile           prehearing attorney with the Michigan
                                              Court of Appeals, and a law clerk to the
students who are far ahead of their           State Board of Tax Appeals.
counterparts in their knowledge of
substantive and procedural tax law,
their ability to research sometimes
arcane tax questions, and their client
management skills.
   Eleven students have participated
in this clinical program during the
first nine months of its operation;
eight more have enrolled in Tax Clinic
I for the Spring 2001 term, which
coincides with filing season. Since its
opening, the Tax Clinic has prepared
returns for 72 ESL individuals from
30 countries, and has provided con-
sultation to other low-income people
concerning a variety of tax issues
with the IRS. As the visibility of the
Tax Clinic increases in the commu-
nity, the number of individuals who
will seek the services the Clinic
offers will multiply dramatically,
thus allowing MSU-DCL students
to cultivate their lawyering skills by
representing clients in sophisticated
tax matters in a busy setting akin to
that of a small law firm.
   The MSU-DCL Low-Income
Taxpayer Clinic is housed in the
heart of East Lansing in the
CampusTown Mall at 541 East
                                                                                                       31
 Short Subjects                                                   Michigan Tax Lawyer-4th Quarter 2000



               New IRS Ruling Sanctions
               "Reverse" Like Kind Exchanges
              By: David B. Deutsch                          exchanges if the replacement property
                Section 1031 provides an exception to      is identified by the taxpayer within
               the general rule requiring the current      forty-five (45) days after the taxpayer
               recognition of gain or loss realized        transfers the relinquished property,
               upon the sale or exchange of property.      and the taxpayer receives the replace-
               Specifically, under Section 1031(a), no     ment property within one hundred
               gain or loss is recognized if property      eighty (180) days after the taxpayer
               held for productive use in a trade or       transfers the relinquished property. 6
               business or for investment is ex-              On April 25, 1991, the Treasury
               changed solely for property of a like       Department promulgated final regu-
               kind to be held either for productive       lations which provide the rules for
               use in a trade or business or for           deferred like kind exchanges under
               investment. 1                               Section 1031(a)(3). 7 The preamble
                  The rationale offered by Congress        of the regulations provides that the
               for the non-recognition of gain or loss     deferred exchange rules under Section
               is that if the taxpayer's money is still    1031(a)(3) do not apply to "reverse
               tied up in the same kind of property        exchanges" or "reverse Starkers" (i.e.,
               as that in which it was originally          exchanges where the replacement
               invested, he should not be able to          property is acquired before the
               deduct his theoretical loss on the          relinquished property is transferred).
               exchange, nor should he be charged          However, the preamble indicates
              with the tax on the theoretical profit. 2    that the Department of Treasury will
              Accordingly, the calculation of profit       continue to review the non-recognition
               or loss is deferred until it is realized   status of a reverse exchange.
              in cash, marketable securities or other         Despite the Treasury Department's
              property not of the same kind. More-         position on reverse exchanges, a
              over, this deferred tax may be avoided       taxpayer occasionally must acquire
               altogether, if the replacement property    replacement property before the
              passes through an estate and its basis       disposition of relinquished property.
              is stepped up to the date of death          For example, the contingencies or the
              value. 3                                    sale of the relinquished property may
                  This non-recognition rule had been      not be removed prior to the date of
              part of the Internal Revenue Code           closing on the replacement property,
              since the 1920's. However, despite          or the taxpayer's financing commit-
              this provision's long history, for          ment at favorable rates may expire
              many years it was unclear whether           if the replacement property fails to
              a transaction in which the transfer         promptly close before the relinquished
              and receipt of the subject properties       property closes, or perhaps the re-
              occurred over a period of time, rather      placement property will require con-
              than simultaneously, could qualify for      struction or improvements that will
              non-recognition of gain or loss under       take more than one hundred eighty
              Section 1031. Finally, in Starker v.        (180) days to complete. To avoid these
              U.S. 4 the Ninth Circuit held that a        problems, taxpayers have engaged in
              non-simultaneous or deferred ex-            so-called "parking" or "warehousing"
              change of property qualified as an          transactions in order to accomplish
              exchange under Section 1031.5               reverse exchanges. In a typical "park-
                 Starker was a major taxpayer vic-        ing" transaction, the taxpayer "parks"
              tory and prompted a response from           the replacement property with an
              Congress in the Tax Reform Act of           accommodation party until such time
32            1984, by permitting non-simultaneous        as the taxpayer arranges for the
Michigan Tax Lawyer-4th Quarter 2000                                                    Short Subjects

 transfer of the relinquished property           the property that are treated as
 to the ultimate purchaser in a simulta-         beneficial ownership of the prop-
 neous or deferred exchange. Once a              erty under applicable principles of
 transfer is arranged, the taxpayer              commercial law (i.e., contract for
 transfers the relinquished property to          deed), or interest in an entity that
 the accommodation party in exchange             is disregarded for tax purposes
 for the replacement property, and the           (i.e., a single member limited
 accommodation party then transfers              liability company) and that holds
 the relinquished property to the ulti-          either legal title to the property
 mate purchaser. In other situations,            or other such indicia of ownership;
 an accommodation party may acquire          2. At the time of the transfer of
 the desired replacement property on             ownership to the Exchange Accom-
 behalf of the taxpayer and immedi-             modation Titleholder, it is the
 ately exchange such property with the          taxpayer's bona fide intent that the
 taxpayer for the relinquished property,        property be held by the Exchange
 thereafter holding the relinquished            Accommodation Titleholder repre-
 property until the taxpayer arranges           sent either replacement property
for a transfer of such property to the          or relinquished property in an
ultimate purchaser.                             exchange that is intended to
    On September 15, 2000, the Internal         qualify under Section 1031;
Revenue Service issued Revenue               3. No later than five (5) days after
Procedure 2000-378 which provides               the transfer of ownership of the
a safe harbor for the qualification of          property to the Exchange Accom-
certain reverse like kind exchanges             modation Titleholder, the taxpayer
under Section 1031. Specifically, the           and the Exchange Accommodation
Internal Revenue Service will not               Titleholder enter into a written
challenge the qualification of property         agreement known as the Qualified
as either "replacement property'' or            Exchange Accommodation Agree-
"relinquished property" (as defined in          ment ("QEA Agreement") that
Section 1.1031(k)-l(a)) for purposes of         provides that the Exchange
Section 1031, or the treatment of the           Accommodation Titleholder is
exchange accommodation titleholder              holding the property for the benefit
as the beneficial owner of such prop-           of the taxpayer in order to facili-
erty for tax purposes if the property           tate an exchange under Section
is held in a Qualified Exchange Accom-          1031, and the taxpayer and
modation Arrangement ("QEAA").                  the Exchange Accommodation
For purposes of the Revenue Proce-              Titleholder agree to report the
dure, property is held in a QEAA if all         acquisition, holding, and disposi-
of the following requirements are met:          tion of the property in accordance
   1. Qualified indicia of ownership of         with Revenue Procedure 2000-37.
      the property is held by a person          Further, the QEA Agreement
      who is not the taxpayer or a              must specify that the Exchange
      disqualified person (as defined in        Accommodation Titleholder will
      Treas. Regs. Section 1.1031(k)-1(k)       be treated as the beneficial owner;
      ("Exchange Accommodation              4. No later than forty-five (45) days
      Titleholder"). Such ownership             after the transfer of the ownership
      must be held by the Exchange              of the replacement property to the
      Accommodation Titleholder at all          Exchange Accommodation Title-
      times from the date of acquisition       holder, the relinquished property
      until the property is transferred.       is properly identified in accordance
      "Qualified indicia of ownership"         with Treas. Regs. Section
      means legal title to the property,        1.1031(k)-1(c)(4);
      other indicia of the ownership of     5. No later than one hundred eighty                     33
 Short Subjects                                                       Michigan Tax Lawyer-4th Quarter 2000


                     (180) days after the transfer of              Exchange Accommodation
                     ownership of the property to                  Titleholder with respect to
                     the Exchange Accommodation                    the property;
                     Titleholder, (a) the property is           6. The taxpayer and the Exchange
                     transferred through a qualified               Accommodation Titleholder
                     intermediary (as defined in                   may enter into purchase and
                     Section 1.1031(k)-l(g)(4)) to the             sale agreements with respect to
                     taxpayer as replacement property;             the property, which may include
                     or (b) the property is transferred            fixed or formula prices, provided
                     to a person who is not the tax-               that the term of such purchase
                     payer or a disqualified person as             and sale agreements is not in
                     relinquished property; and                    excess of one hundred eighty-
                6. The combined time period that                   five (185) days from the date
                     the relinquished property and the             the property is acquired by
                    replacement property are held                  the Exchange Accommodation
                    in a QEAA does not exceed one                  Titleholder; or
                    hundred eighty (180) days."                 7. The taxpayer and the Exchange
                 In addition, Revenue Procedure                    Accommodation Titleholder enter
              2000-37 allows a great deal offlexi-                 into agreements or arrangements
              bili ty with respect to the type of                  providing that any variation in
              permissible economic relationships                   the value of a relinquished
              between the taxpayer and the                         property from the estimated
              Exchange Accommodation Titleholder.                  value on the date of the Exchange
              Specifically, the following types of                 Accommodation Titleholder's
              arrangements are permitted:                          receipt of the property be taken
                1. The Exchange Accommodation                      into account upon the Exchange
                    Titleholder may serve as a                     Accommodation Titleholder's
                    qualified intermediary (as                     disposition of the relinquished
                    defined in Treas. Regs.                        property through the taxpayer's
                    Section 1.1031(k)-1(g)(4));                    advance of funds to, or receipt
                2. The taxpayer or disqualified                    of funds from, the Exchange
                    person may guarantee some                      Accommodation Titleholder. 10
                    or all of the obligations of the
                    Exchange Accommodation                      David B. Deutsch is a shareholder at
                    Titleholder, including secured              Couzens, Lansky, Fealk, Ellis, Roeder &
                    or unsecured debt incurred to               Lazar, P.C. Mr. Deutsch's areas of practice
                                                                include mergers and acquisitions, business
                    acquire the property, or indemni-           and tax planning, entity selection and
                    fies the Exchange Accommodation             formation, family business transfers and
                    Titleholder against costs and               succession planning, and planning issues
                    expenses;                                   relating to corporations, partnerships and
               3. The taxpayer or a disqualified                limited liability companies.
                    person may loan funds to the
                    Exchange Accommodation                ------------ENDNOTES-----------
                    Titleholder;                          1.    IRC §1031(a)(1)
               4. The property may be leased by           2.    HR Rep No. 704, 73d Cong, 2d Sess (1934)
                    the Exchange Accommodation            3.    IRC §1014(a)
                    Titleholder to the taxpayer or        4.    602 F. 2d 1341 (9th Cir. 1979)
                    a disqualified person;                5.    602 F. 2d at 1355
               5. The taxpayer or a disqualified          6.    IRC§1031(a)(3)
                    person may manage the property,       7.    Treas. Regs. §1.1031(k)-1
                    supervise the improvement of the      8.    Rev. Proc. 2000-37
                    property, act as a contractor, or     9.    Rev. Proc. 2000-37, Section 4
34                  provide other services to the         10.   Rev. Proc. 2000-37, Section 4
                                                                                     State and Local
Michigan Tax Lawyer-4th Quarter 2000                                                     Tax Update

Michigan Supreme Court                    affirmed the Tax Tribunal's decision
Finds that MailingNotice to               to cancel a use tax assessment. At            Recent
Corporation's Last Known                  issue was the interpretation ofM.C.L.      Developments
Address Satisfies Statute                 205.94(D; M.S.A. 7.555(4)(f), which
                                          exempts from use .tax "property sold to
 Reversing the appellate court and
                                          a person engaged in a business enter-
reinstating the circuit court's grant
                                          prise and using and consuming the
 of summary disposition for the plain-
                                          property" for agricultural or horticul-
tiffs, the Michigan Supreme Court,                                                   --- mailing tax .
                                          tural production. The parties did not
in Smith v. Cliffs on the Bay Condo-
minium Association (617 N.W.2d 536;
                                          dispute that the Association was           delinquency
                                          engaged in a business enterprise. The      and redemption
2000 Mich. LEXIS 2063 (October 10,
                                          Court examined administrative rules        notices to a
2000)), found that following the statu-
                                          to determine that commercial dairy
tory notice requirements for mailing
                                          farming (i.e., milk production) falls      corporation at
tax delinquency and redemption                                                       its last known
                                          within the scope of the exemption.
notices to a corporation at its last                                                 address
                                          The milk testing, required by law,
known address provides adequate
constitutional notice.
                                          essentially establishes quality control,   provides
                                          which is part of the production pro-       adequate
   The dispute involved a parcel
                                          cess, the Court noted. Accordingly,        constitutional
ofland, located adjacent to a con-
                                          the Court concluded that the Tax
dominium complex, that was not
                                          Tribunal's finding that the exemption
                                                                                     notice.
included in the condominium associa-
                                          applied to the Association was
tion's original land description, and
                                          supported by the evidence.
was later conveyed to the association
in a separate deed. Tax bills were .
                                          Property Taxes on Leased
sent to the defendant's last known
                                          Land Should be Deducted,
address and remained unpaid.
                                          Tax Tribunal Rules
The parcel ofland was sold to the
plaintiffs in a 1980 tax sale.            On remand, the Michigan Tax Tribu-
   The Court of Appeals, relying on       nal, in Freedom Village of Holland v.
Dow v. Michigan, 396 Mich. 192; 240       City of Holland (MTT Dkt. Number
N.W.2d 450 (1976), found that the         170827 (August 22, 2000)) considered
state did not use "such means as one      whether property taxes on leased land
desirous of actually informing the        were properly accounted for as an
property owner might reasonably           operating expense in determining the
adopt" when it failed to make further     valuation of the subject property.
inquiry as to the defendant's current     The taxpayer's lease specifically stated
address after the notice of hearing       that the lessee/taxpayer was respon-
was returned as undeliverable. The        sible for the property taxes. Thus, the
Supreme Court noted that the Gen-         Tribunal concluded that the deduction
eral Property Tax Act, M.C.L. 211.1       of the land lease expense as well as
et seq.; M.S.A. 7.1 et seq., provides     the associated property taxes was
that it is sufficient to mail notice to   proper under the income valuation
the owner at the owner's last known       method.
address.
                                          Wetlands Property was Properly
Michigan Court of Appeals Holds           Excluded from Special Assessment
that Use Tax Exemption Applies            District, Michigan Court of Ap-
to Milk Testing Equipment                 peals Rules
In Michigan Milk Producers Associa-   In Blaser v. Township of East Bay (242
tion v. Department of Treasury (2000  Mich. App. 249; 617 N.W.2d 742; 2000
Mich. App. LEXIS 204 (September 12, . Mich. App. LEXIS 186 (August 18,
2000)), the Michigan Court of Appeals 2000)), the Michigan Court of Appeals                         35
 State and Local
 Tax Update                                                       Michigan Tax Lawyer-4th Quarter 2000


                affirmed the Tax Tribunal's decision,      M.C.L. 211.9c; M.S.A. 7,9(3) to revise
                holding that the township properly         the definition of inventory to exclude
                excluded wetlands property from a          leased personal property and property
                special assessment district. In order      which has been depreciated or amor-
                to build a sewer system, the township      tized under the Internal Revenue
                was required to have signatures from       Code.
                over half of the land owners in the
                special assessment district. The           Michigan Department of
 The Court      signature petition met that require-       Treasury Withdraws Outdated
 noted that the ment if the wetlands were excluded,        Letter Rulings
 township was   but represented only about one-third       On August 18, 2000, the Michigan
 statutorily    of the relevant land owners if the         Department of Treasury ("Depart-
                wetlands were included. The Court          ment") issued Revenue Administrative
 required to    noted that the township was statuto-
 exclude the                                               Bulletin ("RAB") 2000-6 which with-
                rily required to exclude the wetlands      draws various letter rulings. RAB
 wetlands       because the wetlands would not             2000-6 states that the Department
 because the    benefit from the sewer system.             determined the withdrawn letter
 wetlands would The Court found that the signature         rulings no longer served as good ex-
 not benefit    petition was sufficient because it         amples because of changes in the law,
                represented over half of the relevant      or because they confused rather than
 from the sewer land owners.
 system.                                                   helped the public. The letter rulings
                                                           withdrawn concern various state taxes,
                Michigan Legislature Adds                  including sales and use taxes, Single
                Personal Property Tax                      Business Tax, individual income tax,
                Exemption for Inventory                    motor fuel and motor carrier tax,
                   On October 24, 2000, Gov. John          severance tax, and estate tax.
                   Engler approved legislation that
                   exempts inventory from personal          Th1s update was prepared by Marjorie Bilyeu
                   property taxation. The bill (House       Gell and Jennifer Troyer of KPMG LLP.
                   Bill 5153, Public Act No. 317) amends

Section News
                   The following After Hours Tax Law Seminars will be held at the MSU
                   Management Education Center. For further information, call ICLE at
                   (877) 229-4350.
                   January 23, 2001
                   Business Valuations
                   Speaker: Edward Dupke, Rehman Robson, P.C.; Grand Rapids

                   February 20, 2001
                   Tax Aspects of Buying and Selling a Business
                   Speaker: Mark Larson, Dykema Gossett, Detroit

                   March 20, 2001
                   Tax Practice, Procedure and Litigation
                   Speakers: Eric M. Nemeth, Raymond & Prokop, Southfield,
36                           and Trevor T. Wetherington, Ernst & Young, Detroit
                                                                                      Periodicals Postage

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                                                                                at Royal Oak, Michigan 48067




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             Qhairperson ·
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.. ..• .·.· . i(:ri~·±. w~i~~· .· .· . . .
              Vh::e•Chairperson··••

             Edward M, Deron
             treasurer   ·

                                                                    Ronald T. Charlebois
             Sherill Siebert                                        Powers Chap
             Secretary                                              3001 W s· Bman DeAgostino
                                                                              19 eaver #704
                                                                    Troy, Ml 48084

              Aaron H. Sherbin
            . Editor

								
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