A recent article in Forbes talks about a tax strategy called a variable prepaid forward contract (VPFC). It’s a deal where someone who owns a bunch of stock gets a big sum of money upfront in exchange for promising to deliver some of their stock later. This can be useful for people who have a lot of stock in one company and want to diversify their investments without having to pay taxes on their stock gains right away. A VPFC, or variable prepaid forward contract, is a type of financial agreement where someone agrees to sell a certain number of shares of a company’s stock at a fixed price in the future. The IRS is starting to challenge these agreements, saying they could be treated as if the person actually sold the shares, even though they technically didn’t.
For example, let’s say a person named Aidan owns a lot of shares in a company that is doing well. He wants to sell some of the shares to diversify his investments, but he doesn’t want to pay taxes on the profit he would make from selling the shares. So, he enters into a VPFC where he agrees to sell the shares at a later date for a fixed price. However, the IRS might say that this is the same as actually selling the shares, and could still make Aidan pay taxes on the profit.
In simple terms, the IRS is taking a closer look at these types of agreements and might treat them as if the person actually sold their shares, even if they technically didn’t. This could affect how people manage their investments in the future. Aidan made a deal with Big Bank to use 200,000 of his 400,000 shares of Oliver, Inc. for five years. He’ll get 75 percent of the current value of the shares (which is $15 million) now, and then he’ll have to give a certain number of shares back to the bank at the end of the contract. He can choose to give the actual shares or pay the cash equivalent. If the value of the shares goes up, he’ll get a portion of the extra money. This deal protects him from the shares losing value but lets him benefit if they go up in value. Aidan has a contract with Big Bank where he can either give them 200,000 shares of Oliver, Inc. stock or the cash equivalent, depending on the stock price at the end of five years. If the stock is trading below $100, he has to give all the shares. If it’s between $100 and $120, he gives enough shares to make $20 million. If it’s over $120, he gives only 75% of the shares and keeps the rest. This is not considered a sale of the stock, so he can defer paying taxes on any profits. In 1997, a law was passed to prevent taxpayers from avoiding taxes by entering into certain types of financial transactions. If a taxpayer holds an investment that has gone up in value, they will be treated as if they sold it and then immediately re-bought it if they do certain things, like making a deal to sell it in the future.
Some people thought that a certain type of financial deal didn’t count as a sale under the law, but recent statements from government agencies suggest that there may be other factors to consider. Two shareholders owned a lot of stock in a private company and also controlled a big part of a public company. They wanted to raise money for the private company by selling a small part of the public company. They did this by selling a type of financial contract that was tied to the performance of the public company. They didn’t report any profit from this on their tax returns. The contracts were set up by an independent trust and backed by government bonds and promises from the shareholders. The shareholders still had control over the public company’s stock and the right to get any money the stock made. If the trust ended, the people with the contracts would get the stock or an equal amount of money, but they couldn’t choose to get cash instead. The IRS analyzed a situation where shareholders invested in a company through a type of financial contract. The IRS concluded that the shareholders should have to recognize their share of the profit from the investment, even though they didn’t actually sell the shares. This is important because it shows how the IRS decides when a sale has technically happened, even if it doesn’t seem like it. It’s a reminder to be careful when setting up investments to make sure they meet certain requirements to avoid the IRS claiming a sale has taken place. Two companies issued instruments to investors, which could be exchanged for shares of a third company at maturity. The number of shares depended on the value of the stock at that time. The issuing company could choose to give cash instead of shares at maturity. The IRS analyzed the financial instruments and said they could be seen as a combination of a put option and a call option, and as a prepaid contract. The instruments put the issuer in a situation similar to having to sell or pay back the investors if the value of the stock falls, and only allowing the investors to benefit if the stock goes above a certain amount. The IRS might try to classify the instruments as something else, but there’s a specific definition for this type of contract in the law that might prevent that. We’ll have to wait and see what the IRS decides. If you make a special type of investment called a variable prepaid forward contract (VPFC) with your stocks, it might not be considered a sale for tax purposes, as long as it meets certain conditions. The IRS is expected to make rules that say when a VPFC is okay and when it’s not. So, if you’re thinking about making this kind of investment, it’s important to consider these rules before going ahead. Bobby G. Stevenson and his wife are in a legal dispute with the IRS over their taxes. The IRS is using a tax law from 1986 to argue that the Stevensons owe more money. The Stevensons are using a court case to fight the IRS. In the court case, the IRS is using guidance documents to support their argument, but these documents are not binding. The Stevensons are also affected by a type of investment called a Variable Prepaid Forward Contract (VPFC), which can last for a few years. With a VPFC, the Stevensons got cash upfront, and they have to give back shares in the future. The IRS is saying that this type of investment is a “constructive sale” under the tax law. The IRS looked at different factors to make this decision, like the sales price being fixed and the risk of loss for the Stevensons. If a taxpayer enters into a financial transaction that has the effect of reducing their risk and opportunity for income, they may need to consider the factors discussed in FSA 200111011. Until regulations are issued, they may want to request a private letter ruling from the IRS to determine if the transaction results in a sale of the underlying shares of stock. The IRS has previously determined that certain instruments did not result in a sale of shares of stock. Holding the underlying shares and entering into a variable forward contract may have additional tax implications. There are ongoing discussions about safe harbor rules for certain types of financial transactions. If the difference between the lowest and highest stock prices is small and the stock is unpredictable, a taxpayer might want to ask the IRS for a private ruling on whether using VPFCs counts as selling the stock. This advice comes from a lawyer named Jeffrey L. Rubinger, who works at a firm in Miami. He has a law degree and a master’s in taxation, and he is licensed to practice law and is a certified accountant.
Source: https://www.floridabar.org/the-florida-bar-journal/irs-starting-to-challenge-popular-tax-deferral-technique/
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