Tax Planning

Experts highlight the tax issues every financial adviser should know

Tax Watch: H&R Block nailed for calling its loans refunds

Apr 2, 2001 @ 12:01 am

By Mark Battersby

A federal court has ruled that H&R Block's advertising of certain loan products violated the law governing trademarks last year, when it offered a "no-additional-charge refund anticipation loan," or Nacral.

The Federal Trade-Mark Act of 1946, also known as the Lanham Act, governs the registration of trademarks, trade names and other identifying marks used in interstate commerce, and protects registered trademarks from interference or infringement.

Nacrals, unlike refund anticipation loans, or Rals, feature no interest and no fees. Consumers are charged one price for tax preparation services whether they accepted or declined the Nacral.

To qualify for a Nacral, consumers must make certifications not required for other refunds. H&R Block advertised the Nacral through various media as a "refund," "refund amount" or "a check in the amount of your refund." The IRS, however, requires e-file providers to identify the products in their advertising as loans, not refunds.

In 2000, H&R Block dramatically increased its client base in Hampton Roads, Va., and in other areas where the advertising appeared. And despite the fact that H&R Block had earlier agreed to a consent order to refrain from advertising Rals as a "refund," "refund amount" or "amount of your refund," they continued the advertisements.

JTH Tax Inc., doing business as Liberty Tax Service, opened offices in the Virginia Tidewater area, including several offices in Hampton Roads. Alleging that H&R Block employed false and misleading advertisements to market its products, Liberty sought recovery under the Lanham Act.

U.S. District Court Judge Raymond Alvin Jackson, reviewing the Lanham Act requirements, noted that the advertising in question was "partially literally false" and "partially literally true - but misleading."

He found that Liberty proved that the advertising was likely to influence a consumer's purchasing decision, based on H&R Block's intentional bad-faith conduct and on survey results.

The court granted injunctive relief that required H&R Block to stop advertising loan products as refunds, to advertise loan products as such clearly and to cease referring to a loan product as an "advance," "refund amount" or a check in the "amount of your refund," unless the advertisement clearly stated that the product was a loan.

Finally, H&R Block was forbidden to use the term or mark "Rapid Refund" with loan products. That was later clarified so as not to restrict H&R Block's right to use its "Rapid Refund" mark outside advertising.

The court awarded Liberty $506,477, plus attorneys' fees and court costs, from H&R Block's profits, but did not award damages.

Cite: JTH Tax Inc., et al., v. H&R Block Eastern Tax Services Inc., et al., No.2: 00cv51

Rules are clarified

on issue discounts

* The IRS and the Department of Treasury recently proposed regulations for the federal tax treatment of annuity contracts issued by some insurance companies.

The proposed regulations provide guidance on whether the annuity contracts can be excluded from the definition of a debt instrument under the original-issue-discount provisions of the tax law. Such discounts arise when a security is issued at a price below its face value.

The tax laws already contain rules for the treatment of debt instruments with original-issue discounts. In this instance, the Internal Revenue Service defines "debt instrument" as a bond, debenture, note, certificate or other evidence of indebtedness. Other sections of the tax law, however, exclude some annuity contracts from the definition.

In general, the original-issue-discount provisions apply to both issuers and holders of debt instruments. If a contract is a debt instrument with such a discount, the tax rules require the holder of the contract to include the discount in current income on a constant-yield basis, regardless of the holder's overall method of accounting.

By contrast, the holder of an annuity contract to which this rule applies is usually allowed to defer recognizing economically earned income until distributions are made on the contract.

Section 1275, "OID Definitions," excepts two types of annuity contracts from the definition of "debt instrument." One is an annuity contract that "depends (in whole or in substantial part) on the life expectancy of one or more individuals."

The other exception applies, under certain circumstances, if the contract "is issued by an insurance company subject to tax under Subchapter L" of the tax regulations.

The proposed regulations provide that an annuity contract issued by a foreign insurance company will be treated as if it was issued by an insurance company subject to tax under Subchapter L for its income earned on the annuity contract.

Although that exception to the original-issue-discount rules first appeared in 1984, Congress did not elaborate on the phrase "an insurance company subject to tax under Subchapter L," nor did it explain the purpose of the provision.

The IRS and the Department of Treasury believe that the exception was originally intended to preserve the balance between the tax treatment of holders of annuity contracts and of issuers of such contracts.

That balance does not exist when the annuity contract is issued by a foreign person not required to calculate personal income with respect to the contract under Subchapter L.

A public hearing is scheduled for May 8.

Cite: REG-125237-00

Tax-free exchange

isn't tangle free

* The taxpayer, called John's Co. by the IRS, owns a park that it has held as investment rental property. A single-member limited liability company, "Accommodate LLC," owns, holds, leases, finances and disposes of real property. Accommodate LLC is treated as a division or branch of its sole member, "Exchange Co."

A registered charity, "Conservation Organization," wishes to acquire the park for public use. Under an option agreement between John's Co. and Conservation Organization, John's has the right to enter into a tax-free exchange or swap of all or any part of the park.

Conservation Organization has agreed to cooperate with John's in bringing about such an exchange.

The option agreement clearly states that if John's engages in a Section 1031, "Like-Kind," tax-free exchange, title to the park will be transferred to the Conservation Organization by an accommodation party, while Conservation Organization will accept the title as if it were transferred directly from John's.

Accommodate has acquired replacement property that it has leased to John's. Accommodate has assigned to John's its interest in the replacement property that it acquired. In exchange, John's has assumed the related liabilities of Accommodate LLC.

The IRS has ruled that an exchange of the park for the replacement property will qualify for non-recognition and that the property will qualify as replacement property.

In so ruling, the IRS has concluded that John's has the requisite intent to exchange, as evidenced by the agreements John's has entered into; that the steps of the transaction are interdependent and are integrated parts of an overall plan; and that Accommodate LLC's relationship with John's is not an agency relationship.

Cite: PLR 200111025


has hand slapped

* The U.S. Tax Court has ruled that a pensioner may not adjust the basis in his retirement annuity to account for inflation when calculating the amount of the pension that is subject to federal income tax.

In 1988, Kenneth Nordtvedt retired from Montana State University. He had participated in the Montana Teachers Retirement System, a qualified defined-benefit pension program. During his employment, Mr. Nordtvedt made mandatory after-tax contributions and also made additional after-tax contributions to build up his retirement base.

On retirement, his nominal basis in the pension plan was $36,734, and he had been receiving a gross annual pension of $26,313.

The retirement system determined that the taxable amount of his pension income received in 1996 was $24,843, based on the nominal value of his after-tax contributions and his age at retirement. Mr. Nordtvedt reported $22,979 of his pension as subject to tax in 1996, arguing that the difference was his own adjustment for inflation.

Tax Court Judge Robert P. Ruwe noted that there is no statutory or regulatory provision permitting Mr. Nordtvedt to exempt gain attributable to inflation.

There is no language in the statute, the regulations or the legislative history, said the Tax Court, permitting the determination of the taxable amount of a pension to be adjusted for inflation.

In Hellermann v. Commissioner, 77 T.C. 1361, taxpayers argued that gain realized from the sale of property should be adjusted for inflation occurring during the ownership of the property. The court disagreed.

In this case, the court rejected the taxpayer's position, noting that the gain must be measured on the basis of the nominal gain on the sale of property, not on the basis of a gain reduced by an inflation factor or real gain in an economic sense.

Cite: Kenneth L. Nordtvedt v. Commissioner, 116 T.C. No. 13


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