Prepared by Worldwide ERC® Tax Counsel, Peter K. Scott
Peter Scott Associates
Current as of January, 2017
In connection with the evaluation of your Amended Value Option, the following may represent the key criteria for you and your tax advisor to consider:
- Any employee ("EMPLOYEE") wishing to take advantage of the Amended Value Option who lists his/her home with a real estate broker must include a suitable exclusion clause in the listing agreement whereby the listing agreement is terminated upon the sale of the home to either the employer or the relocation company.
- Under no circumstances should EMPLOYEE accept a down payment from any potential buyer.
- Under no circumstances should EMPLOYEE sign an offer presented by any potential buyer.
- EMPLOYEE enters into a binding contract ("Contract of Sale") with his/her employer or the relocation service company ("PURCHASER’’).
- After the execution of the Contract of Sale with PURCHASER and after EMPLOYEE has vacated the home, all of the burdens and benefits of ownership pass to the PURCHASER.
- The Contract of Sale between EMPLOYEE and PURCHASER at the higher price is unconditional and not contingent on any event, including the potential buyer obtaining a mortgage commitment.
- Neither EMPLOYEE nor the employer in the case of a relocation company transaction exercises any discretion over the subsequent sale of the home by the PURCHASER.
- PURCHASER enters into a separate listing agreement with a real estate broker to assist with the resale of the property.
- PURCHASER enters into a separate agreement to sell the home to a buyer.
- PURCHASER arranges for the transfer of title to the buyer.
- The purchase price eventually paid by the buyer has no effect on the purchase price paid to EMPLOYEE.
The 11 Key Elements Explained
The "11 Key Elements and Procedures of an Amended Value Option," have been a fixture on the relocation scene since their creation in 1985 by Worldwide ERC®'s Law and Government Relations Committee.
Before 1985, the industry struggled for some time to develop home purchase programs modeled on the inventory purchases approved by IRS in Rev Rul 72-339, 1972-2 CB 31, that had the flexibility to permit the transferee to market and establish the value of the home by finding a buyer before it came into inventory. These programs, which included variations on both the "assigned sale" and AV, were the subject of debate within the industry and a series of somewhat confusing and contradictory private letter rulings and technical advice memoranda issued by IRS.
It was uncertain whether these programs, which certainly were more efficient, less costly, and better accepted by transferees than the older inventory purchase program, were effective to avoid taxing the costs to the transferees, and if so, on what basis.
As noted, IRS rulings, none of which were binding on either IRS or taxpayers other than the taxpayer to whom the ruling was issued, added to the confusion. Although the rulings generally were favorable, except regarding assigned sales, they addressed different and sometimes confusing fact patterns, did not always employ the same terminology (for example, the terms "assigned sale" and "amended value" tended to be used interchangeably), and reached conclusions of which the rationale was difficult to clearly understand or apply.
In 1985, concern over this uncertainty was brought to a head by the issuance of PLR 8522002 (February 13, 1985). This ruling (actually, a technical advice memorandum that resulted from an audit of a particular company's home purchase program) held that the program caused tax to the employees. The program was called an AV program, but some of the facts stated in the ruling, and its apparent rationale, left considerable doubt as to whether the program was not actually a form of assigned sale. In addition, it was not clear what caused the program to be considered taxable, or how it differed from those in earlier, favorable rulings.
In PLR 8522002, three home-sale transactions were examined. In each of them, the employee was given an appraised value offer and 45 days to market the home. In each, the employee employed a real estate broker, included an exclusion clause in the listing agreement, and received an offer for the home at a higher price than the appraisal. The relocation management company used by the employer amended its offer to the higher figure, obtained a deed-in-blank from the employee, entered into its own listing agreement with the broker, purchased the home from the employee, and then proceeded to sell the home to the outside buyer. The burdens and benefits of ownership were passed to the relocation management company at the time of closing with the employee. These facts virtually could describe all AV transactions.
But IRS, in its analysis, stated that the employees "arranged" the sale of their homes at the higher price and "assigned" their sales to the company. Neither the ruling itself nor the background file reveals what facts support this assertion. IRS went on to say that each employee "used a realtor to find a buyer at the higher price and...was obligated to pay the realtor's fee if the house was sold to the purchaser produced by the realtor."
Again, nothing in either the ruling or background file supports the statement. IRS also noted that notwithstanding the exclusion clause, the broker "had reason to believe...that he would be paid a fee provided he produced a bona fide purchaser." IRS concluded that because the company paid a fee that the employee would have been obligated to pay, and because there was no evidence that the Realtor did not expect to receive it, the fee was a taxable, indirect reimbursement of the employee's moving expense. The ruling did not deal with the other costs of the transaction, nor did it attempt to distinguish prior rulings that appeared contradictory.
Following this ruling, the Law and Government Relations Committee attempted to clarify the situation. Because the new PLR was confusing, and because no facts were recited in it that would justify the conclusion that sales were "assigned" and obligations to the Realtors were incurred, the committee felt the ruling should not be considered authoritative.
Nevertheless, the ruling suggested the AV process to be at risk. Moreover, as noted, the record of rulings was not a model of consistency. Consequently, the committee undertook to develop standards and procedures that, if followed, would provide the best case for defending the most likely IRS arguments that AV transactions result in tax to employees.
Those arguments, then as well as now, are that the employee in substance sold the home, or that the employer paid an employee obligation for a real estate broker commission.
The result was the "11 Key Elements and Procedures of an Amended Value Option," which was published in fall 1985.
With that brief history in mind, let us examine the relevance of the 11 key elements.
First, their purpose must be kept in mind. The committee did not set out to create rigid requirements. Rather, it sought to craft standards for a "best" program from a tax perspective. Consequently, although the 11 key elements are not a required part of an AV program, a program lacking any of the elements clearly will entail a higher tax risk than one that conforms to all 11 of them, and one lacking certain elements almost certainly will be considered taxable.
For example, if the employee's listing agreement does not contain an exclusion clause (element one), the employee likely will be considered to have incurred an obligation for a real estate commission in most states when the home is sold to a buyer procured by the broker. That commission will be taxed to the employee.
Further, if either of elements two or three is violated (the employee accepts a down payment or signs a contract with an outside buyer), the same result will occur, as is likely if the employer or relocation management company fails to enter into its own listing agreement with the broker (element eight).
Others of the 11 key elements seek to counter IRS arguments that there were not two independent sales. Thus, element five requires that once the employee has vacated the home all the burdens and benefits of ownership pass to the company; element six says that the amended offer at the higher price is unconditional and not contingent on any event (which would include, for example, the closing of the outside sale); and element 11 provides that the eventual price paid by the outside buyer can have no effect on the price already paid to the employee.
These three elements (five, six, and 11) are indispensable in establishing the existence of two, independent sales, with the employer or relocation management company assuming substantial risk, and avoiding IRS arguments that the real seller is the employee.
Second, since 1985, IRS has three times undertaken in-depth consideration of AV transactions, in 1988, again in 1994-95, and in 2004-05. In all three instances, Worldwide ERC®, on behalf of the relocation industry, made detailed submissions and engaged in extended dialogue with IRS.
Following its first two considerations, IRS did not formally endorse the AV transaction, but agreed informally, as a result of its discussions with Worldwide ERC®, that the method does not result in taxing employees on the costs incurred. After the uncertainty engendered by the Tax Court’s Amdahl opinion, and the IRS audits that followed, in 2005 ERC succeeded in getting IRS to rule formally on AV transactions. It did so in Rev. Rul. 2005-74, 2005-2 C.B. 1153, approving transactions based on facts that closely mirror the 11 key elements.
All of the discussions with IRS have focused on AV transactions modeled on the 11 key elements, and they were provided to the IRS as a part of the consideration that led to Rev. Rul. 2005-74. Thus, although IRS never has approved the elements as such, it is fair to conclude that its understanding of AV transactions is based on them, and that the transactions it accepts are ones conforming to the 11 key elements. Consequently, companies should be very wary of programs that do not conform to them.
Third, since 1985, the basic transaction model has not changed. But, companies have become more sophisticated at managing the risks involved. For example, better assessment of the buyer's likely mortgage qualification has reduced the incidence of fall-throughs, and companies have developed better procedures for managing inspections and mortgage payments. But the basics remain the same. Given better risk management, and the resulting lower risk, following the 11 key elements is more important than ever if the tax protection they are designed to obtain is to be continued.
Fourth, the late 1990s have witnessed the increasing use of the BVO, which is a cousin of the AV but a program that further reduces cost and risk to the company by reducing the incidence of inventory properties. IRS never has considered the BVO method, and it is not discussed in Rev. Rul. 2005-74. Although a good argument can be made that it should be treated the same as an AV, and that the method is covered by the analysis in Rev. Rul. 2005-74, the answer is not clear. See Buyer Value Option. Moreover, that answer is certain to depend on the same factors addressed in the 11 key elements for AV transactions. Consequently, it is extremely important that companies using the BVO method conform to them.
Finally, with the exception of the Amdahl case the tax law relevant to home purchase transactions has not changed since 1985. The very same rulings and authorities that were relevant then are just as relevant today. Indeed, the only significant tax law development since 1985, the Amdahl case, makes it absolutely clear that companies must be more careful than ever in designing and operating their home purchase programs.
In Amdahl, the issue was the character of the deduction for the home purchase and sale costs incurred by the company. However, in finding that the company was entitled to take business expense deductions as opposed to capital losses, the Tax Court held that neither Amdahl nor its relocation management companies ever became the owner of the employee homes, despite procedures fairly common in the industry. Subsequently, IRS began to contend in employment tax audits that home purchase expenses should have been treated as wages to the employees and been subject to withholding and employment taxes, leading to the Worldwide ERC® effort that resulted in Rev. Rul. 2005-74. Notwithstanding the ruling, some companies will still face scrutiny of their home purchase programs in the future. Preparing for that eventuality is exactly why the 11 key elements were designed-that is, ensuring that the employer will have a solid case that it did, in fact, buy and own employee homes, and that it, not the employees, was the real seller on the second sale. Although the Amdahl case is poorly reasoned and is diminished in importance by Rev. Rul. 2005-74, the fact remains that it inspired renewed IRS examination of home purchase transactions, and some of those examinations will continue to occur. As noted, these examinations will involve, among other things, the very same questions the 11 key elements seek to address.
For all the reasons above, the 11 key elements should still be followed and, if anything, are even more important today than they were in 1985. Every company engaging in AV or BVO home purchases would find it a wise investment of time to revisit the elements and measure its current program against them, as well as against Rev. Rul. 2005-74. Doing so will, as it always has, provide the best case that the expenses are not taxable to employees.