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Abstract:
Private equity managers regularly convert a portion of their 2 percent annual management fees into additional carried interest. They do this primarily to convert the tax character of the resulting income. This special report explains the economics behind management fee conversions, describes their mechanics, and analyzes the arguments that could be made by the IRS to disallow their intended tax results. The report ultimately concludes that the IRS can make quite strong arguments under current law to deny managers the tax benefits they seek in converting fees.

Abstract:
Because of the uproar over "carried interests," it seems that almost everyone knows that the tax law currently allows private equity managers to pay capital gains taxes on a substantial part of the (often substantial) income generated by their services. While this result raises significant tax policy concerns, the basic tax law governing carried interests is well-settled, and legislative action therefore would be necessary to address these concerns.

In contrast, a little-known technique utilized by private equity managers to convert the character of their remaining compensation income is extremely aggressive and subject to serious challenge by the IRS. Private equity managers regularly attempt to convert their fixed annual two percent management fees into additional carried interest through so-called "management fee conversions." The tax result, if this technique is successful, is the conversion of current ordinary income into deferred capital gains.

Despite the recent spotlight on the taxation of private equity management compensation, surprisingly little attention has been paid to this particular tax minimization strategy. This article attempts to fill that void. Its purpose is twofold. First, it will describe the mechanics of management fee conversions, which are pervasive within the private equity community but not widely appreciated or understood outside of it. Second, it will discuss the tax issues stemming from management fee conversions, focusing on the IRS arguments that could be made to disallow their intended tax results.

Abstract:
Executive pay is currently a topic of significant interest for policymakers, academics, and the popular press. Just weeks ago, in reaction to widespread press reports and academic criticism of extravagant executive perquisites, the SEC proposed new regulations designed to change fundamentally the manner in which executive compensation is reported to share-holders. Despite all of this attention, one significant aspect of executive deferred compensation has gone virtually unnoticed - the federal tax rules governing this form of compensation are fundamentally flawed and must be extensively over-hauled. These rules are flawed because they often create a significant incentive for companies and their executives to structure deferred, rather than current, compensation, thereby producing highly inefficient and inequitable results. This Article addresses potential legislative reforms that would remedy this problem by neutralizing the tax treatment of current and deferred compensation. While this neutrality goal, which was part of the recent proposals made by President Bush's Advisory Panel on Tax Reform, is easy to describe in general and conclusory terms, the devil is in the details. There has been little serious academic analysis of how to implement a set of tax rules that would create neutrality while avoiding undue complexity. This Article attempts to fill that void.

taxes, executive compensation, corporate governance

Abstract:
In this Essay, we consider whether the Federal Election Commission (FEC) has the authority to regulate independent 527 organizations (e.g., Swiftboat Veterans for Truth, Moveon.org, etc.) as political committees under the Federal Election Campaign Act. This issue, which was hotly debated during the last election cycle when it was considered and ultimately tabled by the FEC, is an extremely complex one that requires a deep understanding of election, tax, administrative, and constitutional law. After considering how these areas of law intersect, we conclude that the FEC lacks the authority to regulate independent 527 organizations as political committees.

527 organizations, FEC, Buckley, MCFL

Abstract:
In employment and civil rights lawsuits, the alternative minimum tax may cause a plaintiff's net recovery to be taxed at rates significantly higher than the current maximum rate of 35 percent. This Essay discusses the ethical, fiduciary duty and malpractice implications for lawyers representing plaintiffs who may be affected by this tax trap.

Abstract:
This article considers whether a successful employment discrimination plaintiff may be entitled, under current law, to receive an augmented award (a gross up) to neutralize certain adverse federal income tax consequences. The question of whether such a gross up is allowed, the resolution of which can have drastic effects on litigants, has received almost no attention from practitioners, judges, and academics. Because of the potentially enormous impact of the alternative minimum tax (AMT) on discrimination lawsuit recoveries, however, the gross up issue is now beginning to appear in reported cases.

The three principal federal anti-discrimination statutes - Title VII, the Age Discrimination in Employment Act (ADEA), and the Americans with Disabilities Act (ADA) - generally confer broad equitable powers on the courts to devise remedies that will make the victims of discrimination whole in economic terms. The Internal Revenue Code (Code), however, sometimes operates to frustrate this make-whole objective by taxing a discrimination award more heavily than the components of the award would have been taxed had the components been earned in due course by the plaintiff. This excess taxation gives rise to what this article calls adverse tax consequences.

A discrimination plaintiff may suffer adverse tax consequences in two distinct ways. First, amounts recovered to compensate for back pay and front pay losses may be subjected to higher income tax rates than if such amounts had been earned as wages in due course. This increase in tax rates is typically due to the fact that the plaintiff's recovery is in a lump sum; as a result, a portion of the recovery may be subject to marginal rates higher than the plaintiff's typical marginal rate.

Second, an employment discrimination recovery could implicate the AMT. If so, the AMT may cause the recovery to be effectively taxed at rates significantly higher than the top marginal rate of 35 percent. In fact, in certain cases, the AMT may cause the tax on the recovery to exceed 100 percent - meaning that a victorious plaintiff would owe more in taxes than her recovery. This AMT trap is notoriously absurd as a matter of tax policy and undermines the national policy of encouraging the pursuit of meritorious civil rights claims. Yet, the trap persists, at least in most areas of the country.

The resolution of the gross up issue depends ultimately on whether the federal anti-discrimination remedial provisions permit judges to shift the liability for these adverse tax consequences from the plaintiff - on whom the Internal Revenue Code specifically imposes the liability - to the defendant - whose unlawful conduct necessitated the lawsuit that caused the adverse tax consequences. The potential vehicle for this shift is the broad equitable powers conferred upon courts to fashion relief in order to make victims of discrimination whole.

The issue of whether these broad equitable powers allow judges to shift a portion of the plaintiff's federal income tax liability to defendants is particularly interesting since both the plaintiff's tax liability and the defendant's discrimination liability arise from federal statutes passed by Congress. Thus, the resolution of the issue depends on which body of statutes, the Internal Revenue Code or the pertinent federal anti-discrimination statute, prevails over the other.

More generally, though, the issue concerns the courts' willingness to delve into federal income tax matters and focus on after-tax dollars, which are meaningful, rather than pre-tax dollars, which are meaningless. Courts typically have been reluctant to get their hands dirty with tax law if they can avoid it. Determining after-tax income can be a painstaking process and predicting future after-tax income even more so. Nevertheless, we conclude that courts have the authority to provide gross ups to discrimination plaintiffs and should exercise this authority whenever adverse tax consequences are substantial.

Abstract:
This article considers whether the Treasury's check-the-box regulations, which have been widely praised by tax practitioners, are valid. These regulations generally allow any unincorporated entity to elect whether it will be treated as a corporation or a partnership for tax purposes. When these regulations were first proposed, there was some debate as to whether such an elective regime was foreclosed by the statutory scheme, which requires that "associations" be taxed as corporations. This article argues that the focus of this debate was misplaced because, even assuming that the statutory scheme itself was sufficiently ambiguous as to permit an elective regime, the meaning of the term "association" was settled by the Supreme Court in the 1935 case of Morrissey v. Commissioner. In that case, the Court interpreted the term to mean any unincorporated entity that sufficiently resembles a corporation. Because this interpretation is inconsistent with a purely elective regime, this article argues that the check-the-box regulations are invalid.

The basis for this argument is a trilogy of Supreme Court opinions that hold that when the Court interprets a statutory term, that interpretation is binding on the Executive Branch and may be altered only by an act of Congress or a subsequent opinion of the Court. Therefore, these cases stand for the proposition that, at least as far as the Executive Branch is concerned, a judicial interpretation of a statute is effectively incorporated into the underlying statute.

This article also argues that the promulgation of the check-the-box regulations are but one example of the Treasury's and the IRS' recent tendency to promulgate taxpayer-friendly rules that are invalid. The article discusses the etiology of this phenomenon.

Abstract:
Proponents of campaign finance reform generally assume that, by definition, all section 527 organizations are partisan, election-driven organizations. They also believe that by self-identifying to the IRS, these organizations receive substantial tax benefits. Based on these presuppositions, reformers argue that strict regulation of 527 organizations is both constitutional and normatively beneficial. In this Essay, I argue that once section 527 is carefully analyzed from a tax perspective, it becomes evident that these assumptions are flawed. Ultimately, I conclude that section 527 should not be used as a mechanism for regulating campaign finance.

Abstract:
The IRS recently disclosed that it has identified more than 100 executives at 42 leading public corporations that participated in a tax shelter designed to defer the recognition of income from the exercise of stock options. While the agency thus far has identified approximately $700 million in unreported gains from these shelters, it predicts that the revenue loss to the government will ultimately exceed $1 billion. Compared to most tax shelters, this particular transaction (commonly known as the "Executive Compensation Strategy" or "ECS") is remarkably simple. Rather than exercise the options individually, a participating executive instead transfers the options to a family limited partnership in exchange for the partnership's 30-year unsecured balloon promissory note. Very shortly thereafter, the partnership exercises the options, sells the underlying shares, and invests the proceeds in other investments. Pro-moters of the shelter claim that the partnership takes a cost basis in the options, resulting in little or no gain to the partnership upon exercise. Meanwhile, promoters assert, the executive does not realize income until principal payments are made the on the note 30 years in the future.

This shelter can be attacked from a variety of perspectives. Commentators who have previously examined the shelter have focused on whether the sale of the options to the partnership is made at arm's length. If the sale does not constitute an "arm's length transaction," regulations under IRC Section 83 effectively disregard the sale, causing the executive to recognize income when the partnership exercises the option and defeating the purpose of the shelter. Unfortunately, because the arm's length issue is inherently dependent upon the unique facts and circumstances of each transaction, it is not an ideal "silver bullet" issue for attacking the shelter.

Another way to attack the shelter is to argue that the mere receipt of the partnership's promise to pay constitutes a taxable event for the executive, thereby undermining completely the goal of the shelter. This Article analyzes this issue, concluding that, because the partnership's promise constitutes a third-party compensatory promise (i.e., one made by a party external to the service relationship), it is immediately taxable to the executive upon receipt. In discussing this issue, the Article examines the origin and development of the economic benefit doctrine, as well as the history and purpose of IRC Section 83. The Article closes with an explanation of why limiting tax deferral to the second-party promise context comports with sound tax policy.

Abstract:
Congress has granted a tax subsidy to physically injured tort plaintiffs who enter into structured settlements. The subsidy allows these plaintiffs to exempt from the tax the investment yield imbedded within the structured settlement. The apparent purpose of the subsidy is to encourage physically injured plaintiffs to invest, rather than presently consume, their litigation recoveries. While the statutory subsidy by its terms is available only to physically injured tort plaintiffs, a growing structured settlement industry now contends that the same tax benefit of yield exemption is available to plaintiffs’ lawyers and non-physically injured tort plaintiffs under general, common-law tax principles. If the structured settlement industry is correct, then all tort plaintiffs and their lawyers may invest their litigation proceeds in a tax-free manner simply by using structured payment arrangements Structured arrangements would therefore be far superior to traditional tax-favored retirement accounts (e.g., 401(k)s, IRAs), which provide the same tax benefit of yield exemption but are subject to significant constraints. Accordingly, if proponents of structured arrangements are correct in their interpretation of the tax law, these arrangements can be described as “super-IRAs,” because they provide full yield exemption without any corresponding limitations or restrictions. This Article examines the taxation of structured payment arrangements, ultimately concluding that the structured settlement industry’s positions are unpersuasive. Nevertheless, because of the muddled state of the tax law on the issue, the Article recommends legislative and administrative action to close the yield exemption loophole with respect to its unintended beneficiaries.

Abstract:
This article analyzes Internal Revenue Code § 162(m), which in general denies public companies a deduction for annual non-performance-based compensation in excess of $1,000,000 paid to senior executive officers. Congress enacted § 162(m) with the intent to reduce the overall level of executive compensation and to influence the composition of executive compensation in favor of components that are more sensitive to firm performance. Notably, § 162(m) represents the most direct Congressional effort to influence executive compensation design. In light of recent events, Congress is being called upon to once again address the perceived problem of overgenerous executive pay packages. Accordingly, it is an opportune time to study the impact of § 162(m).

This article predicts the likely effects of § 162(m) under the two currently prevailing (but opposing) views of how executive compensation arrangements are negotiated in the public company context, ultimately concluding that the provision is likely ineffective under either view. In addition to predicting the likely effect of § 162(m), the article discusses the empirical studies of its impact since its enactment almost fifteen years ago. Finally, the article describes some of the unintended incidental effects of the provision, such as its discouragement of certain compensation components that are arguably more efficient than the components typically used by public companies.

Abstract:
The tax treatment of contingent attorney's fee arrangements has been the subject of much recent debate and litigation. Some courts and commentators conclude that a plaintiff must include the entire settlement amount, including attorney's fees, in her gross income, while other courts and commentators conclude that a plaintiff must include only her recovery net of attorney's fees. Because of the alternative minimum tax, the resolution of this issue may have a significant effect on the plaintiff's tax liability.

In analyzing the issue, courts and commentators have focused on the assignment of income doctrine by inquiring whether, upon execution of a contingent fee agreement, the plaintiff should be treated as transferring merely the income from the attorney fee portion of the claim (the fruit) or the attorney fee portion of the claim itself (the tree). This Article explains that this focus on the assignment of income doctrine is misplaced because that doctrine does not apply to commercial arm's length transactions, such as contingent fee arrangements. Because courts and commentators have begun their analysis by focusing on the wrong issue (i.e., the assignment of income doctrine), no one has set forth a correct analysis of this controversial issue. This Article attempts to provide such an analysis.

Abstract:
In this report, Polsky addresses the controversial issue of whether the contingent attorneys' fee portion of a taxable recovery is included in, or excluded from, the claimant's gross income.

Several courts have concluded that the contingent fee portion is excluded from the claimant's gross income. In reaching their conclusions, these courts determined that contingent fee arrangements operate to transfer a portion of the claimant's claim to the attorney for tax purposes. Polsky concludes that these courts erroneously neglected to apply section 83 to this transfer. Had they applied section 83, he contends, these courts would have concluded that the contingent fee portion must be included in the claimant's gross income.