OOPS, WHAT WAS I THINKING? HOW TO FIX A BOTCHED TRANSACTION THOMAS L. EVANS Kirkland & Ellis LLP Chicago, Illinois [email protected] (312) 862-2196 State Bar of Texas 27th ANNUAL ADVANCED TAX LAW COURSE August 27-28, 2009 Houston CHAPTER 9 Thomas L. Evans Professional Profile Thomas Evans is a partner in the Chicago office of Kirkland & Ellis LLP. He focuses his practice on the tax aspects of complex business transactions (including acquisitions, joint ventures, IPOs, LLC agreements, incorporation of partnerships), tax controversy and litigation, restructuring, and general tax advice and planning. His clients are engaged in financial services, telecommunications, energy, and manufacturing, among other industries. Mr. Evans is a frequent lecturer and speaker at tax-related seminars and Partner conferences and has written numerous articles relating to his area of Chicago practice. Phone: +1 312-862-2196 Fax: +1 312-862-2200 [email protected] Other Distinctions Certified Public Accountant (Arizona) Practice Areas Awards: Tax Texas Excellence in Teaching Award - University of Texas Law School, 1991 Admissions Kugle, Byrne & Alworth Ethics Teaching Award - University of Texas Law 1984, Illinois School, 1993 1994, Texas 2001, District of Columbia Texas Excellence in Teaching Award - University of Texas Law School, 1997 Education Publications University of Chicago Law School, J.D. 1983 with Evans, "The Evolution of Federal Income Tax Accounting - A Growing Trend Honors; Order of the Coif (top 10% of graduating class); Towards Mark-to-Market?" 67 Taxes 824 (December, 1989). This article Received the Isaiah H. was presented in the Fall of 1989 at the University of Chicago Federal Tax Dorfman Prize for Outstanding Conference. Papers presented at the Conference are traditionally published Work in Labor Law in the December issue of Taxes. University of Illinois, B.S., Finance 1976 with Honors Evans, "Accounting For Long-Term Contracts Under Section 460," University of Texas School of Law, 37th Annual Taxation Conference, October, 1989. Evans, "The Taxation of Multi-Period Projects: An Analysis of Competing Models," 69 Texas Law Review 1109 (1991). Evans, "The Taxation of Nonshareholder Contributions to Capital: An Economic Analysis," 45 Vanderbilt Law Review 1457 (1992). Evans, "The Realization Doctrine After Cottage Savings" 70 Taxes 897 (December, 1992). This article was presented in the Fall of 1992 at the www.kirkland.com University of Chicago Federal Tax Conference. Papers presented at the Conference are traditionally published in the December issue of Taxes. Evans, "Lower of Cost or Market Method Needs Reform," 64 Tax Notes 1349 (September 5, 1994). Evans, "Clear Reflection of Income: Using Financial Product Principles in Other Areas of the Tax Law" 73 Taxes 659 (December, 1995). This article was presented in the Fall of 1995 at the University of Chicago Federal Tax Conference. Papers presented at the Conference are traditionally published in the December issue of Taxes. Evans, "Partnership Taxation - Recent Developments," University of Texas School of Law, 43rd Annual Taxation Conference, December, 1995. Evans, "Update on Income Tax: Current Developments," 12th Annual Tax Conference, Closely Held Businesses and Their Owners, Arizona Society of Certified Public Accountants, November, 1996. Evans, "Partnership Taxation - Recent Developments," Annual Tax Conference, Austin Chapter Texas Society of Certified Public Accountants, December, 1996. Kleinbard and Evans, "The Role of Mark-to-Market Accounting in a Realization-Based Tax System," 75 Taxes 788 (December, 1997). Evans, "Continuity of Interest and Continuity of Business Enterprise Doctrines in Corporate Reorganizations: The New Rules," University of Texas School of Law, 46th Annual Taxation Conference, November, 1998. Evans, "Respecting Foreign Mergers," Tax Notes (July 3, 2000). Evans, "Amortization of Intangible Assets Under Section 197-Application to Business Transactions," 35th Annual Southern Federal Tax Institute, September 19, 2000. Prior Experience Senior Tax Counsel - Cleary, Gottlieb, Steen & Hamilton, New York (1997-2001) Professor of Law - University of Texas School of Law, Austin, Texas (1989-2001) Associate Tax Legislative Counsel - U.S. Department of the Treasury, Office of Tax Policy (Tax Legislative Counsel) (From 1985-1987, Attorney-Advisor) Associate, Kirkland & Ellis, Chicago, Illinois www.kirkland.com Oops, What Was I Thinking? How to Fix a Botched Transaction Chapter 9 TABLE OF CONTENTS I. THE INCOME TAX IMPLICATIONS OF FIXING MISTAKES. ....................................................................... 1 A. Introduction. .................................................................................................................................................... 1 B. Summary of Conclusions. ............................................................................................................................... 1 II. THE DUTY TO CORRECT A DISCOVERED ERROR RELATING TO A PREVIOUS TAX RETURN. ........ 2 A. Introduction. .................................................................................................................................................... 2 B. Obligation of Client to File an Amended Return. ........................................................................................... 2 C. Ethical Obligations Regarding Amended Returns. .......................................................................................... 3 III. PROFESSIONAL STANDARDS APPLICABLE TO TAX PROFESSIONALS ADVISING CLIENTS ON POSITIONS TO BE TAKEN ON TAX RETURNS. ............................................................................................. 5 A. Introduction. .................................................................................................................................................... 5 B. ABA Formal Opinion 85-352 (July 7, 1985) – History. ................................................................................. 5 C. Substance of Opinion 85-352. ......................................................................................................................... 5 D. Is the Realistic Possibility of Success Standard Still Practical? ...................................................................... 6 E. The Same Realistic Possibility of Success Also Applies to Accountants. ...................................................... 6 F. Circular 230. .................................................................................................................................................... 7 IV. UNWINDING OR RESCINDING A TRANSACTION –THE PROBLEM. ......................................................... 8 A. The General Tax Rule For Rescissions – According To The IRS. .................................................................. 8 B. Policy Behind Rules – Claim of Right. ........................................................................................................... 8 C. Revenue Ruling 80-58, 1980-1 C.B. 181. ....................................................................................................... 9 D. Recent Private Letter Rulings Allow Rescissions of Entity’s Tax Form, Rescinding the Formation of C Corporations. ........................................................................................................................ 10 E. Other Rulings Dealing with Rescission. ........................................................................................................ 11 F. Stock Options & Other Compensatory Rescissions Are Likely Protected Under Revenue Ruling 80-58. ................................................................................................................................................. 12 G. The Status Quo Requirement. ........................................................................................................................ 13 H. What If the Parties Recognize the Transaction In Different Taxable Years? ................................................ 13 V. THE REFORMATION DOCTRINE. ................................................................................................................... 14 A. Description of Reformation Doctrine. ........................................................................................................... 14 B. The Majority Doctrine – The IRS Is Not Bound By Retroactive Reformations. .......................................... 14 C. The Minority Doctrine Which Respects Retroactive Reformations. ............................................................. 15 D. The Correction of Mistake Doctrine. ............................................................................................................. 16 E. Tax Planning With Reformation Proceedings. .............................................................................................. 17 F. Strength of Reformation Argument – A Reporting Position? ....................................................................... 17 G. When Will the Same-Year Rule the Rescission Doctrine Not Protect A Taxpayer? .................................... 18 H. The IRS May Contend that the Issuance of Debt Cannot Be Rescinded ....................................................... 19 I. The Same-Year Rule May Not Allow Taxpayers To Avoid Form Over Substance Arguments if the Rescission is not “Clean.” ...................................................................................................................