Stubbs Alderton & Markiles' attorney Michael Shaff co-authored the “Real Estate Investment Trusts Handbook, 2020-2021 ed.” This handbook will guide your Real Estate Investment Trusts (REIT) clients safely through the pitfalls of federal tax requirements, SEC rules, and state Blue Sky provisions. The book will also discuss the related tax requirements and SEC rules in order to maximize the profitable opportunities offered by REITs. provide analysis and guidance on the Sarbanes-Oxley Act requirements affecting REITs, reviews the effect of non-GAAP financial rules on REIT FFO reporting. and advises the reader on the latest rulings on Taxable REIT Subsidiaries (TRS.) The handbook also helps ensure total compliance with coverage of federal securities requirements, such as registration, disclosure, and financial statements. It contains income, asset, and distribution tests to help ensure appropriate tax guidance.
For more information and to purchase the Real Estate Investment Trusts Handbook, click here.
About Michael Shaff
Michael Shaff joined the firm in 2011 as Of Counsel. He is the Chair of the Tax Practice group. Michael specializes in all aspects of federal income taxation. Mr. Shaff has served as a trial attorney with the office of the chief counsel of the internal revenue service for three years. Mr. Shaff is certified by the board of legal specialization of the state bar of California as a specialist in tax law. Mr. Shaff is a past chair of the tax section of the orange county bar association. He is co-author of the “Real Estate Investment Trusts Handbook” published annually by West Group.
Michael received his A.B. at Columbia college in 1976, his J.D. from New York University School of Law in 1979 and his LL.M. in taxation from New York University School of Law in 1986. He is admitted to practice law in the states of California, New York, and Massachusetts and is a member of the Orange County Bar Association.
For more information about our Tax & Estate Practice contact Michael Shaff at
As COVID-19 continues to curtail economic activity, private companies granting equity-based incentive awards should consider whether the pandemic’s impact on their business warrants a new independent valuation of their equity securities.
As a reminder, with limited exceptions Section 409A of the Internal Revenue Code and its associated regulations (“Section 409A” and/or the “regulations”) require companies to issue equity-based incentive awards at fair market value (“FMV”) to avoid potentially significant tax penalties resulting from a determination that such awards constitute deferred compensation issued under non-qualified deferred compensation plans.
Determining FMV
Section 409A clarifies that a company may determine FMV for stock that is readily tradable on an established securities market (such as the NYSE or Nasdaq) by any reasonable method using actual transactions in such stock as reported by such market. However, determining FMV is more difficult for privately held companies, including early-stage companies, whose stocks are not freely transferrable and/or cannot be readily liquidated.
The regulations provide that such companies may determine FMV for their stock by the reasonable application of a reasonable valuation method, based on facts and circumstances existing as of the valuation date. Fortunately, the regulations also provide that the use of certain methods, including a valuation determined by an independent appraisal that meets the requirements of the regulations (a “409A valuation”), are presumed to be reasonable.
Impact of Material Events
Companies can generally rely on a 409A valuation for a period of 12 months after the valuation date. However, the use of such a valuation may not be reasonable if it fails to reflect information available after the date of the valuation that may materially affect the value of the company. The issue of a 409A valuation not accounting for a material event is more likely to arise when the material event increases the company’s value, since granting equity-based incentive awards at a price above FMV will not trigger the negative tax consequences associated with the issuance of deferred compensation under a nonqualified deferred compensation plan. Nevertheless, obtaining a new 409A valuation where a material event negatively impacts a company’s value merits review, at least from the perspective of the additional incremental value that may accrue to service providers who receive equity-based incentive awards. A lower valuation allows a company to issue options and other equity based compensation at a lower exercise price, meaning a greater potential upside for recipients.
Factors to Consider
While the recent decrease in the value of indices of publicly traded stocks appears to indicate that the COVID-19 pandemic has materially adversely impacted businesses overall, some businesses and sectors have increased in value. Each company must therefore determine how, and to what extent, the pandemic has impacted its value. Companies should consider the following in assessing the need for a new 409A valuation:
In addition, companies should consult with their 409A valuation provider, along with their tax, financial and legal advisors, to assist in their analysis. The cost of a 409A valuation is generally significantly less than the cost of a full appraisal but the potential benefits for incentive award recipients could be meaningful.
For more information or if you have questions about its effects on your business please contact our COVID-19 Task Force at or one of our attorneys at SA&M.
For a more in-depth discussion regarding the IRS’ rules and Section 409A, please see additional articles written by the Chair of our Firms Tax and Estate Planning Practice, Michael Shaff at .
Additional Resources:
Common Questions about Tax Rules for Pricing Options:
https://www.dailyjournal.com/mcle/449-common-questions-about-tax-rules-for-pricing-options
Taxation Of Deferred Compensation – An Overview of Section 409A.
https://stubbsalderton.com/taxation-of-deferred-compensation-an-overview-of-section-409a/
COVID-19 Client Resource Center
https://stubbsalderton.com/category/insights/covid-19-client-resources/
Authors: Louis Wharton
The IRS and the California Franchise Tax Board have issued guidance allowing an extension of time to pay income taxes and file returns.
CALIFORNIA: The California Franchise Tax Board has announced that the filing and payment deadlines of March 15th for entities and April 15th for individuals have been extended until June 15, 2020. That extension includes tax returns for 2019 and estimated tax payments for 2020. The FTB will not impose interest on tax payments otherwise due on April 15th that are made on June 15th as to taxes for 2019 and 2020. The FTB continues to require and collect installment payments for prior years.
FEDERAL:
The IRS will be granting automatic payment and filing extensions both for 2019 income, gift and FATCA taxes and 2020 estimated taxes through July 15, 2020. The IRS has suspended installment payments for prior years' taxes until July 15, 2020
“If you owe a payment to the IRS, you can defer up to $1 million as an individual and the reason why we’re doing $1 million is that it covers lots of pass-throughs and small businesses, and $10 million to corporations, interest-free and penalty-free for 90 days. All you have to do is file your taxes, you’ll automatically not get charged interest and penalties. Now, of course, any American has the right to extend their taxes, we’re not taking away that right.” To extend the time to file your individual income tax return, file an extension request with the IRS on Form 4868 by April 15th. That will get you an extension of time to file your 2019 federal income tax return through October 15, 2020 (but payment would be due by July 15th for individuals and June 15th for entities).
REFUNDS: If you expect an income tax refund, it makes sense to file timely.
For more information about the California Franchise Tax Board or our Tax & Estate Practice contact Michael Shaff at
The legal professionals at Stubbs Alderton & Markiles, LLP will continue to monitor changes to legislation and publish updates as information becomes available. Please contact one of our attorneys at SA&M if you would like to discuss how these changes might affect your business.
Stubbs Alderton & Markiles client, Growers Cold Storage celebrated a victory recently, when the LA County Assessor determined to reverse the reappraisal of their property. The Los Angeles County Assessor originally had determined that a change of ownership for property tax assessment purposes resulted from a series of mergers and recapitalizations involving commonly owned corporations and reassessed the surviving corporation's real properties. The assessor's office incorrectly determined that the totality of the transactions resulted in a change of ownership for the former group's real property. Our [SA&M] protest letter laid out the substance of the series of transactions and showed that the same shareholder controlled the corporation owning the real estate before and after the transactions, qualifying for an exemption from reassessment. The ownership division of the assessor's office agreed and reversed the reappraisal of the property.
Stubbs Alderton & Markiles' attorneys representing Growers Cold Storage in this matter were Michael Shaff and Scott Galer.
About Michael Shaff
Michael Shaff joined the firm in 2011 as Of Counsel. He is the Chair of the Tax Practice group. Michael specializes in all aspects of federal income taxation. Mr. Shaff has served as a trial attorney with the office of the chief counsel of the internal revenue service for three years. Mr. Shaff is certified by the board of legal specialization of the state bar of California as a specialist in tax law. Mr. Shaff is a past chair of the tax section of the orange county bar association. He is co-author of the “Real Estate Investment Trusts Handbook” published annually by West Group.
Michael received his A.B. at Columbia college in 1976, his J.D. from New York University School of Law in 1979 and his LL.M. in taxation from New York University School of Law in 1986. He is admitted to practice law in the states of California, New York, and Massachusetts and is a member of the Orange County Bar Association.
For more information about our Tax & Estate Practice contact Michael Shaff at
In addition to a number of business tax changes, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) added a number of important changes for individuals as follows. The changes discussed are not all of the changes for individuals.
(1) The first date the qualified stock becomes transferable, including, solely for this purpose, transferable to the employer.
(2) The date the employee first becomes an “excluded employee” (i.e., an individual: (a) who is one-percent owner of the corporation at any time during the 10 preceding calendar years; (b) who is, or has been at any prior time, the chief executive officer or chief financial officer of the corporation or an individual acting in either capacity; (c) who is a family member of an individual described in (a) or (b); or (d) who has been one of the four highest compensated officers of the corporation for any of the 10 preceding tax years. [This requirement may well limit the availability of the deferral in many cases.]
(3) the first date on which any stock of the employer becomes readily tradable on an established securities market;
(4) the date five years after the first date the employee's right to the stock becomes substantially vested; or
(5) the date on which the employee revokes his or her election. (Code Sec. 83(i)(1)(B), as amended by Act Sec. 13603(a))
Michael Shaff joined the firm in 2011 as Of Counsel. He is the chairperson of the Tax Practice Group. Michael specializes in all aspects of federal income taxation. Mr. Shaff has served as a trial attorney with the office of the Chief Counsel of the Internal Revenue Service for three years. Mr. Shaff is certified by the Board of Legal Specialization of the State Bar of California as a specialist in tax law. Mr. Shaff is a past chair of the Tax Section of the Orange County Bar Association. He is co-author of the “Real Estate Investment Trusts Handbook” published annually by West Group.
For more information about our Tax & Estate Planning Practice or questions on how the new Tax Law will affect your business contact Michael Shaff at
A real estate investment trust (a “REIT”) is a corporation or an association otherwise taxable as a domestic corporation intended to own interests in real property or in debt secured by real property. The principal advantage of a REIT for holding real property is the deduction for dividends paid that enables a REIT to avoid corporate level taxation.
To qualify as a REIT, a corporation must satisfy a number of, shareholder, income and asset tests, including income tests requiring that at least 75 percent of its gross income must be derived from real estate sources, principally (i) rents from real property, (ii) interest on debt obligations secured by mortgages or deeds of trust on real property, (iii) gains from the sale of real property; and that at least 95 percent of the corporation’s gross income must be derived from interest or dividends as well as real estate income qualifying for the 75 percent of income test.
As a statutorily favored entity, REITs are often the objects of generous revenue rulings and private letter rulings. For example, in late 2012, the Internal Revenue Service released several favorable private letter rulings on the issue of REITs holding an interest in a passive foreign investment company (a “PFIC”) or a controlled foreign corporation (a “CFC”), ruling that the Subpart F Income of a CFC (CFCs are foreign corporations at least 50% of whose stock, by vote and value, is owned by US shareholders and are subject to federal income tax on their undistributed “Subpart F Income”) and the foreign personal holding company income of a PFIC in each case recognized by a REIT owning interests in a CFC or a PFIC may be treated as qualifying for the 95 percent of income test under Section 856(c)(2).[1] A PFIC is a foreign corporation, at least 75% of whose income is “passive income” and at least 50% of whose assets are held for the production of passive income. For that purpose, “passive income” is generally dividends, interest, royalties, rents, annuities, and gains from the sale of property. US shareholders are required to include in income their share of certain of the PFIC’s excess distributions.
In addition to the income tests described above, to qualify as a REIT, at least 75% of the value of the corporation’s assets must consist of real estate assets, cash and cash items and government securities as of the last day of each calendar quarter. In a recent private letter ruling, the Service held that the value of deferred organizational expenses carried as an asset on a REIT’s balance sheet would be considered zero for purposes of the quarterly asset test.[2] By so ruling, the IRS enabled the REIT not to have to consider the deferred organizational expenses in comparison to the value of its real estate, government securities and cash and cash items.
The Service has long treated various fixtures as real estate assets for REIT qualification purposes, going back to 1973 when it held that a building’s “total energy system,” powered by turbines, would qualify as a real estate asset.[3] More recently, relying in part on that 1973 revenue ruling, the Service agreed to treat an offshore oil drilling platform (exclusive of machinery) as real property.[4]
The Service has also been issuing favorable “infrastructure” rulings for REITs engaged in owning wireless cell towers. In those rulings, the cell towers are held to qualify as real property and the income attributable to tenants’ payments for power generated by the REIT’s on-site generators is treated as includible in rents from real property.[5]
The Service also provided a favorable published revenue ruling to the effect that investments in money market funds qualify as “cash items” for purposes of the 75 percent of assets quarterly REIT qualification test.[6] In reaching its favorable conclusion, the Service looked to the Investment Company Act of 1940.[7] While the Investment Company Act itself does not define the term “cash item,” the Securities and Exchange Commission issued a no-action letter, upon which the Service relied in issuing its private letter ruling, to the effect that an investment in a money market fund is a cash item under Section 3(a)(1)(C) of the Investment Company Act.[8]
In addition to the income and asset tests, the REITs dividend distributions must be pro rata within the meaning of Section 562 in order to be deductible. In Private Letter Ruling 201244012 (Nov. 2, 2012), the Internal Revenue Service issued a favorable ruling on the issue of whether dividends distributed among three different classes of stock of a REIT would be deductible. In order for a REIT to be able to deduct dividend distributions, a REIT’s distributions must be made pro rata among the shareholders in accordance with the rights and preferences set forth in the REIT’s corporate charter.[9] REIT “distributions must not prefer any shares of stock of a class over other shares of stock of that same class. The distribution must not prefer one class of stock over another class except to the extent that one class is entitled (without reference to waivers of their rights by stockholders) to that preference.”
In that letter ruling, the subject REIT adopted some of the liquidity features of a mutual fund. The REIT had issued shares of its common stock (the “Class E Shares”) to accredited investors in a private placement on its formation. Thereafter, the REIT filed a registration statement to register the sale of two new classes of its stock, Class A and Class M. The Class A Shares and Class M Shares were to be offered for sale on a daily basis at the net asset value (“NAV”) for shares of such class plus, with respect to Class A Shares, applicable selling commissions and would be repurchased by the REIT at the NAV for such share class. Subject to certain limitations, the REIT intended the share repurchase plan to allow holders of Class A Shares and Class M Shares to request that the REIT repurchase their shares in an amount up to an agreed percentage of the REIT’s NAV after such shares have been outstanding for at least one year. The Class A Shares would be subject to a selling commission (“Selling Commission”) to the extent not otherwise waived or reduced and paid directly by the shareholder, in addition to the NAV for such shares. No Selling Commission would be charged with respect to the Class M Shares. Despite the differences among the three classes of stock, the Service held that dividend distributions on all of the classes of stock would be deductible as pro rata according to the terms and preferences stated in that REIT’s charter documents.[10]
The Service continues its long-standing practice of issuing favorable rulings, private as well as published, on REIT qualification issues, including assets constituting real property, and the types of income qualifying for the 75% of income and 95% of income REIT qualification tests. Because of the Service’s willingness to accept reasonable pro-REIT analyses in issuing private letter rulings, practitioners may feel more comfortable relying on the analysis set forth in private letter rulings when opining on REIT issues, especially in the context of a REIT that is not publicly issued and traded.
Michael Shaff joined Stubbs Alderton & Markiles, LLP in 2011 as Of Counsel. He is chair person of the Tax Practice Group. Michael specializes in all aspects of federal income taxation. Mr. Shaff has served as a trial attorney with the office of the Chief Counsel of the Internal Revenue Service for three years. Mr. Shaff is certified by the Board of Legal Specialization of the State Bar of California as a specialist in tax law. Mr. Shaff is the past chair of the Tax Section of the Orange County Bar Association. He is co-author of the “Real Estate Investment Trusts Handbook” published by West Group. Michael’s practice includes all aspects of federal and state taxation, including mergers and acquisitions, executive compensation, corporate, limited liability company and partnership taxation, tax controversies and real estate investment trusts.
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[1] Priv. Ltr. Rul. 201246013 (Nov. 16, 2012).
[4] Priv. Ltr. Rul. 201250003 (Dec. 14, 2012).
[5] Priv. Ltr. Rul. 201301007 (Jan. 4, 2013); see also Priv. Ltr. Rul. 201129007 (Jul. 22, 2011).
[6] Rev. Rul. 2012-17, 2012-25 I.R.B. 1018 (June 15, 2012).
[7] 15 U.S.C. §§80a-1, et. seq. I.R.C. Section 856(c)(5)(F) so authorizes (“All other terms shall have the same meaning as when used in the Investment Company Act of 1940...”).
[8] Op. Off. of Chief Counsel, No. 200010241124 (Oct. 23, 2000), available at http://www.sec.gov/divisions/investment/noaction/2000/willkiefarrgallagher102300.pdf.
[9] Treas. Reg. §1.562-1.
[10] See Treas. Reg. §1.562-2(a).
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For more information regarding REIT or about the Tax Practice at Stubbs Alderton & Markiles, LLP, please contact Michael Shaff at or (818)444-4522.
1. General Rule. Section 409A calls for the annual taxation of a nonqualified deferred compensation plan that violates the provision of Section 409A. (IRC §409A(a)(1)(A).) Amounts deferred and subject to inclusion under Section 409A(a)(1)(A) are also subject to a penalty tax of 20% of the amount included (the additional 20% tax) in income. (IRC §409A(a)(1)(B); Prop. Reg. §1.409A-4.) As a general rule, for purposes of Section 409A, a deferred compensation plan is any written or oral, vested, legally binding right to receive compensation in a later year. (Treas. Reg. §1.409A-1(b)(1).)
2. When is deferred compensation not subject to tax under Section 409A? If the deferred income would not be included in income when paid, such as a right to receive a payment under a cafeteria plan, it is not subject to Section 409A. (Treas. Reg. §1.409A-1(b)(1).) Vested rights in a qualified defined benefit retirement plan (such as pension and profit-sharing plans, IRAs and government retirement plans) are outside the ambit of Section 409A.
In addition, as long as the deferred compensation is subject to a substantial risk of forfeiture, it is exempt from Section 409A. That rule can exempt from the scope of Section 409A income that is subject to vesting.
Also exempt from the inclusion rules of Section 409A are short term deferrals that meet either of (a) deferrals of up to 30 days in the case of the employer’s normal pay periods or (b) deferrals of up to 2 ½ months after the end of the taxable year.
Options, stock appreciation rights and other equity based deferred compensation are subject to additional tests for exemption from Section 409A. Nonqualified stock options do not result in current taxation under Section 409A if the exercise price may never be less than the fair market value of the stock on the date of option grant, the number of shares for which the option is exercisable is fixed at grant, the transfer or exercise of the option is subject to taxation under Section 83 and Regulation 1.83-7, and the option does not provide a feature for the deferral of income beyond the date of exercise or transfer or the date that the stock received on exercise become substantially vested under Regulation 1.83-3.
Stock appreciation rights must set the base for sharing in the appreciation in the value of the stock at the current fair market value on the date of issuance of the rights.
Section 409A effectively put an end to phantom stock and dividend equivalent rights as an effective form of deferred or incentive compensation. Section 409A would tax the annual appreciation on phantom stock and unpaid accruing dividend equivalent rights. (Treas. Reg. 1.409A-1(b)(5)(i)(D) and (E).)
Statutory options, even those issued under a Section 423 plan that are issued with an exercise price at less than the fair market value of the stock on the date of grant, do not create deferred compensation for purposes of Section 409A. (Treas. Reg. §1.409A-1(b)(5)(ii).) Stock options that qualify for incentive stock option treatment by definition are issued with an exercise price no higher than the stock value on the date of issuance of the option.
Publicly traded stock is easily valued based on one of several methods, the last sale before the option is granted, the closing price, the arithmetic mean of the high and low trading price or other method described in the plan, including a thirty day averaging method. (Treas. Reg. §1.409A-1(b)(5)(iv)(A).)
If the stock is not traded on an established securities exchange, the stock’s fair market value may be based on a reasonable valuation method, which may be based on “the value of tangible and intangible assets of the corporation, the present value of anticipated future cash-flows of the corporation, the market value of stock or equity interests in similar corporations and other entities engaged in trades or businesses substantially similar to those engaged in by the corporation the stock of which is to be valued, the value of which can be readily determined through nondiscretionary, objective means (such as through trading prices on an established securities market or an amount paid in an arm's length private transaction), recent arm's length transactions involving the sale or transfer of such stock or equity interests, and other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation method is used for other purposes that have a material economic effect on the service recipient, its stockholders, or its creditors.” (Treas. Reg. §1.409A-1(b)(5)(iv)(B)(1).)
There is a presumption of reasonableness, which the Service may try to rebut with a showing that the method or application was grossly unreasonable (Treas. Reg. §1.409A-1(b)(5)(iv)(B)(2).), if the value of the stock on grant is based on an independent appraisal meeting the test for an independent appraiser for valuing employer securities to be purchased by an ESOP.
A value reached by agreement of the parties will not qualify for the presumption of reasonableness. Section 409A has its own set of option modification rules very similar to the ISO modification rules of Section 424(h). An option or other stock right deemed modified is treated as a newly issued right and must satisfy the requirements of Section 409A, including the requirement that the exercise price must not be less than the value of the underlying stock on the date of grant.
3. Substantial Risk of Forfeiture. Compensation subject to a substantial risk of forfeiture is not treated as deferred compensation under Section 409A. Under the Section 409A regulations, compensation is subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial. (Treas. Reg. §1.409A-1(d)(1).) The concept of “substantial risk of forfeiture” is borrowed from Section 83, but the definition is not identical. Not any substantial contingency will suffice; the only acceptable condition must be the performance of future service under the Section 409A regulation. A covenant not to compete would probably not qualify as a substantial risk of forfeiture for purposes of Section 409A as it requires the forbearance from services, not the performance of services.
4. Performance based compensation is not treated as deferred compensation subject to Section 409A. The term “performance-based compensation” means compensation the amount of which, or entitlement to which, depends on the satisfaction of pre-established organizational or individual performance criteria that relate to a performance period of at least 12 consecutive months. Performance criteria are pre-established if established in writing no later than 90 days after the service period begins, provided that the outcome is substantially uncertain when the criteria are established. However, performance-based compensation doesn't include any amount or portion of any amount that will be paid regardless of performance or based upon a performance level that is substantially certain to be met when the criteria are established. (Treas. Reg. §1.409A-1(e)(1).)
5. Deferral Election. A service provider may elect to defer compensation without creating deferred compensation under Section 409A if the deferral election is made before the beginning of the year in which the services are performed. (Treas. Reg. §1.409A-2(a)(3).) In the first year that the service provider is eligible to elect to defer compensation, an effective deferral election may be made within the first thirty (30) days that the service provider is eligible to defer compensation. (Treas. Reg. §1.409A-2(a)(7).)
6. Corrections. There is an opportunity for correcting a “plan” subject to Section 409A by December 31, 2012 (IRS Notice 2010-6, 2010-3 IRB 275) for a plan provision that is eligible for correction under any other section of that Notice.
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Michael Shaff, Of Counsel with Stubbs Alderton & Markiles, LLP discusses the ins and outs of Section 409A, which regulates taxation of nonqualified compensation plans. Michael specializes in all aspects of federal and state taxation, including mergers and acquisitions, executive compensation, corporate, limited liability company and partnership taxation, tax controversies and real estate investment trusts.
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Should you have further questions or concerns about deferred compensation or our Tax & Estate Planning Practice Group, please contact Michael Shaff at or (818) 444-4522.