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Editor’s Note…

As Flaster/Greenberg turns “30” this year, I cannot help but nostalgically reflecton how we have transformed the firm overthe last 15 years from a small tax boutiqueinto a full-service business law firm, withnearly 50 professionals.Most recently, we enhanced ourEmployee Benefits Practice Group withthe addition of Elliot D. Raff and Marc R.Garber (Of Counsel), with prospective new attorneys expected to join the firm in thecoming months.Lastly, with the objective of broadeningour base of readership, we may soon offere-mail transmission of this Report as analternative to postal service.

If you provide us with your e-mail address and the e-mail addresses of colleagues who would be interested in receiving our quarterly Tax and Business Report, we would be pleased to include that information in the distribution database. Please send the e-mail addresses to my attention at: Rick.Flaster@flastergreenberg.com.

Richard J. Flaster

New Jersey Enacts Tax Amnesty

By Alan H. Zuckerman

ew Jersey has recently enacted a short term Tax Amnesty Program which will permit a taxpayer who owes any New Jersey tax for any return due on or after January 1, 1996 and prior to January 1, 2002,to pay the tax by June 10, 2002 and in such case no penalties, interest orcollection costs will be charged, and there will be no criminal prosecution.Copyright © 2002Tax & Business Report•Flaster/Greenberg P.C.

www.flastergreenberg.comSpring 2002

AX AND

USINESS

EPORT

A Newsletter from the Tax & Corporate Practice Group

AX AND

USINESS

EPORT

A Newsletter from the Tax & Corporate Practice Group

The amnesty apparently applies not only tounreported tax liabilities, but also to tax liabili-ties that are currently the subject of audit,assessment or dispute–other than a taxpayer who is under criminal investigation. However,if the taxpayer has filed an administrativeappeal or a complaint in Tax Court withrespect to the tax in question, the tax amnesty applies only if the Director of the Division of Taxation consents to allow the taxpayer to takeadvantage of the amnesty program. If the tax-payer elects to take advantage of the amnesty program, the taxpayer must waive all rights toappeal the tax assessment and to claim any refund with respect to the tax paid.If a taxpayer who is eligible to take advan-tage of the amnesty fails to do so, the Division will be thereafter precluded from waiving orabating penalties or interest, and an additional5% penalty will ultimately be imposed in addi-tion to the normal penalties, interest, andcosts of collection.

Observations:

◆

While the tax amnesty program provides a window of opportunity for taxpayers to pay outstanding New Jersey tax liabilities at asignificantly reduced cost (as a result of the waiver of penalties, interest and collectioncosts), it will create a significant hardshipto those taxpayers who are unable to pay their New Jersey tax liabilities by June 10,2002, because it will thereafter prevent waiver of penalties and interest as well asengender an additional 5% penalty.

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Since the window covers tax liabilities forreturns due on or after January 1, 1996, atax liability arising during 1995 couldpotentially enjoy protection under theamnesty if reportable on a tax return dueafter January 1, 1996.

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The amnesty program appears to apply toboth corporate and individual taxpayersand to apply to any state tax liability andnot just income tax liabilities.

In This Issue…

New Jersey Tax Amnesty............1New IRS Proceduresfor Issuing EINs........................1New Federal Tax Stimulus Law....2ESOPs as a Business Tool............3

Alan H. Zuckerman

New IRS Procedures for IssuingEmployer Identification Numbers

By Richard J. Flaster

he IRS recently consolidated its processing of requests for Employer Identification Numbers(“EINs”) from the existing 10 Service Centers to the three located in Brookhaven, NY;Cincinnati, OH, and Philadelphia, PA. Calls to the Internal Revenue Services’ 800 number(866-816-2065), which were previously forwarded to the region of the applicant, are now apparently being connected to any one of these three Service Centers. As a result of thisconsolidation, applicants are encountering material delays in obtaining EINs.Previously, the Philadelphia Service Center could not issue an EIN number for a New Jersey or Florida entity, because the first two digits of the EIN indicated the business location of thetaxpayer and the applicable Service Center. However, it can now do so, since the first two digitsof the EIN number are no longer relevant to location.

Tax & Business Report•Flaster/Greenberg P.C.

Tax & Corporate Practice Group Services

Federal and State Taxation

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Tax planning

◆

Corporations, partnerships andLLC’s

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Sales, mergers and acquisitions

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IRS rulings

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Tax litigation

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Tax collections/liens

Business Corporate Services

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Business formations

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Structuring ownershiparrangements

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Corporate control/managementcontracts

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Shareholder disputes

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Contracts

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Sales, commercial mergers andacquisitions

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Securities and finance

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Buy-ins/Buy-outs

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Employee agreements andterminations

Wealth Preservation andTransfer

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Estate planning

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Drafting wills, trusts and otherestate planning documents

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Administration of estates and trusts

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Guardianships and conservatorships

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Litigation involving trusts andestates

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Asset protection

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Business transfers from onegeneration to the next

Technology, E-Commerce andInternet

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Contract agreements

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Protecting intellectual property rights

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Licensing

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Government regulation

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Venture capital

Employee Benefits

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Implementation and administrationof qualified retirement plans

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Employee Stock Ownership Plans(ESOPs)

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Stock options, phantom stock andSAPs

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Plan qualification, IRS audits andcompliance issues

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Cafeteria plans and other welfarebenefit programs

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Employee benefit trusts

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Deferred compensationarrangements

This report is for general use andinformation, and the content shouldnot be interpreted as renderinglegal advice on any matter. Specificsituations may raise additional ordifferent issues and such informationshould be coordinated withprofessional legal advice.

New Federal Tax Stimulus Law

By Richard J. Flaster

he Job Creation and Worker Assistance Act of 2002 (the “Act”) wassigned into law by President Bush on March 9, 2002 and provides forseveral new taxes. In general terms, the following is a summary of the Act’s most-significant tax savings features:

◆

Extra First-Year Depreciation:

Taxpayers may take an additional first- year depreciation deduction for qualified property in an amount equalto 30% of its adjusted basis. Qualified property generally includes new property acquired during the period September 11, 2001 throughSeptember 10, 2004 and placed in service by December 31, 2004 andhaving a recovery period of 20 years or less.

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Higher “Luxury Car” Deduction:

Luxury cars can also qualify for the Extra First-YearDepreciation Deduction up to the prescribed limit, and the deduction limit for first-yeardepreciation is increased to $7,660 for new automobiles acquired and placed in serviceduring the period from September 11, 2001 through December 31, 2002.

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Longer Net Operating Loss Carryback Period:

The loss carryback period has beenincreased from two years to five years, effective for tax years ending before January 1, 2003.Taxpayers may elect to opt out of the extended carryback period.

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No S Corporation Basis Increase Upon Cancellation of Debt:

Last year, the SupremeCourt held in Gitlitz v. Commissionerthat an S corporation shareholder could obtain a stock basis increase upon a cancellation or discharge of debt to the insolvent or bankrupt S corpo-ration and thereby transform the shareholder’s unusable suspended S corporation losses intonet loss carrybacks/carryovers which could be used to shelter the shareholder’s personalincome. The Act now repeals the Gitlitzrule for all cancellations or discharges of indebted-ness after October 11, 2001 (other than discharges of indebtedness after October 11, 2001,but before March 1, 2002 which arise pursuant to a bankruptcy reorganization plan filedbefore October 11, 2001).

Richard J. Flaster

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Limitation on Use of Non-AccrualMethod of Accounting:

The Act general-ly limits the use of the non-accrual methodof accounting (viz., which allows taxpayersto exclude accrued income derived fromservices rendered which are not anticipatedto be collected) to apply to uncollectibleincome either derived from “qualified serv-ices” (viz., health, law, engineering, archi-tecture, accounting, actuarial service, per-forming arts by consulting services) or touncollectible income derived by othersmall businesses with average annual grossreceipts for the three preceding tax yearsthat is not in excess of $5,000,000.

Luxury cars can also qualify for the Extra First- Year Depreciation Deduction up to the prescribed limit…

s both a retirement plan and a tool of corporate finance, an employeestock ownership plan (“ESOP”) is a hybrid vehicle that can provide atax-advantaged way for the owner of a privately held business totransfer ownership while retaining a significant measure of control overfuture sales of the corporation’s stock. However, an ESOP and thoseresponsible for it, are subject to extensive regulation by both the InternalRevenue Code (the “Code”) and the Employee Retirement IncomeSecurity Act of 1974 (“ERISA”). Further, since ESOPs serve as both aretirement plan and tool of corporate finance, and corporate executives typ-ically also serve as ESOP trustees, the ESOP trustees must pay specialattention to fiduciary issues in the formation and administration of the ESOP.

Introduction to ESOPs:

An ESOP is a “qualified plan” that is designed to invest primarily in the stock of the sponsoring corporation (“employer securities”). As such, an ESOP (like any qualified plan) conveys three significant tax benefits:

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Permissible contributions are currently deductible;

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The ESOP’s earnings build up tax-free until distributed;

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Distributions may be made on a tax-free basis as rollovers.Employer securities may be contributed directly to the ESOP each year by the corporation,or the ESOP may borrow funds (or use seller financing) to purchase a large block of employersecurities. Either way, employer securities are allocated to accounts established in the ESOP inthe name of each participant. As a “qualified plan,” an ESOP must satisfy many of the same rules that apply to profitsharing plans, such as minimum coverage and vestingrequirements. In addition, there are many other ESOPrequirements. For example, participants can demand adistribution in the form of employer securities insteadof cash (subject to certain exceptions). While the rulesapplicable to qualified plans generally are complex, theadditional rules applicable to an ESOP administrationare even more challenging. However, ESOPs do convey special tax benefits not available for other qualified plans.This article will discuss the special ESOP tax benefitsthat relate to ESOPs as a business succession tool.

Used to Spread Employee Ownership:

Since an ESOP must cover broad categories of employees and invest primarily in employer securities, its use will generally entail a spreading of ownership of the corporation among employees. However, this may occur gradually over timeand may be limited by the amount of employer securities contributed to or acquired by theESOP, and by the buy-out provisions at the time of benefit distributions.

Used as a Tool of Corporate Finance:

Although normally the corporate sponsor of aqualified retirement plan may not make a loan to the plan nor sell property to a plan, ESOPsqualify for exceptions to such prohibitions. For example, a loan may be made directly to theESOP or the corporation may obtain a loan and extend a matching loan to the ESOP (“back-to-back ESOP loan”). The proceeds are then used to purchase employer securities. Alternately, thecorporation may sell the stock to the ESOP in exchange for a promissory note given by theESOP. Thereafter, the corporation makes deductible annual contributions to the ESOP to fundrepayment of the loan. As the ESOP repays the loan, a proportionate number of shares arereleased to the participant accounts. Through this “leveraged” approach, the corporation may beable to obtain more attractive financing and repay it through deductible contributions over along period of time.

Used as Exit Strategy for an Owner:

In a privately held C corporation, an ESOP offersthe opportunity for an owner to extricate himself from sole ownership in the corporation anddiversify his investment assets through a special tax-free exchange. The owner sells his stock tothe ESOP, reinvests the sale proceeds in marketable stocks or securities, and does not incurtaxation on the gain until the sale of the replacement stock or securities. In order to qualify:1.The ESOP must, immediately after the transaction, hold at least 30% of either each class of the corporation’s stock or of the total value of all stock;

ESOP as a Business Succession Tool

By Elliot D. Raff

www.flastergreenberg.com

Elliot D. Raff

2.The shareholder must file an election withthe IRS and the corporation must file a written acknowledgment that it is poten-tially subject to certain excise taxes;3.The shareholder must purchase “qualifiedreplacement property” (generally, stock ina domestic corporation) during a “replace-ment period” beginning three monthsbefore and ending 12 months after thetransaction;4.The former selling shareholder (and certainfamily members and other key shareholders)may not receive any allocation, as an ESOPparticipant, of the employer securitiesacquired by the ESOP in the exchange fora period of 10 years, effectively precludingparticipation in the ESOP.Given the requirement to purchase qualifiedreplacement property within 12 months of thesale, these exchanges usually involve leveragedESOPs; otherwise, the shareholder would nothave proceeds to reinvest within the deadline.

Observations:

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A tax-free exchange with a leveragedESOP can be a powerful tool for businesssuccession planning. Since only 30% of thecorporation’s stock must be owned by theESOP, the remaining 70% could be disposedof through a different avenue for a businesssuccession and/or estate planning purposes.For example, a typical transaction involvesan ESOP acquiring 30% of a corporation’sstock, and a management group and/orthe corporation itself acquiring some or allof the balance.

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Such an exchange allows the owner tobetter plan and manage retirement incomeby having his large holding of employersecurities replaced on a tax-free basis witha diversified portfolio that can be managedto generate income or appreciation, asneeded.

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A degree of control over the corporationcan be retained during a transition to new executive officers. This can be accomplishedby having the selling shareholder serve asan ESOP trustee, with the authority to actas a shareholder, and with managementcontrol negotiated to allow managementoversight over certain major transactions.

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As noted above, those who control anESOP will be subject to ERISA’s fiduciary duties. ESOP trustees often face uniquefiduciary problems, particularly whereofficers and/or directors serve as theESOP trustees. Often the appropriateERISA considerations differ from and may be at odds with appropriate corporateconsiderations and the wrong approachcould result in personal liability underERISA. Thus, careful attention tofiduciary duties and regular involvementof ERISA counsel is critical.

…ESOPs do convey special tax benefits not available for other qualified plans