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Wednesday, September 15, 2021

Indirect Loans Between a Private Foundation and a Disqualified Person Are on the IRS' Radar

Code Section 4941(d)(1)(B) treats lending transactions between a private foundation and disqualified person as an act of self-dealing (although an interest-free loan by the disqualified person to the private foundation is not self-dealing) subject to an excise tax. What happens if the private foundation owns an interest in an entity, and that entity holds a promissory note of a disqualified person? Does this avoid self-dealing?

In Rev. Proc. 2021-40, the IRS advises that it will no longer issue private letter rulings regarding the applicability of the self-dealing rules under this fact pattern. Taxpayers should take this as a warning that the IRS may seek to treat such arrangements as self-dealing.

Rev Proc 2021-40, 2021-38 IRB


Sunday, August 15, 2021

Foreign Grantor Trust Making a Distribution to Owner/Beneficiary - One or Two Penalties for Nonreporting?

 A U.S. grantor of a foreign trust that is a grantor trust that receives a distribution from the trust as a beneficiary has two U.S. filing requirements attributable to the foreign trust status:

 

  1. Code Section 6048(b) requires U.S. owners of any portion of a foreign trust to ensure that the trust files a return for the tax year. A 5% penalty applies for noncompliance under Code Section 6677(b).
  2. Code section 6048(c) requires U.S. beneficiaries of a foreign trust that receive a distribution from the trust to report the distributions. A 35% penalty applies for noncompliance under Code Section 6677(a).

 

Forms 3520 and 3520-A are used for these reportings.

 

Before his death, Joseph A. Wilson received a $9.2 million distribution from a foreign grantor trust of which he was 100% owner. No filings were made under the above two provisions. The IRS imposed a 35% penalty of $3,221,183.

 

Wilson (and after his death) his estate claimed that when he was the owner of the trust, then only the 5% penalty should apply. The District Court ruled in favor of the estate.

 

On appeal, the 2nd Circuit Court of Appeals reversed and held that both penalties could apply (although technically the 5% penalty did not apply because that penalty is measured against the assets remaining in the trust at the end of the year and that amount was $0).

 

The taxpayer made numerous technical arguments based on various arguments that parsed the language of the various provisions. But in the end, the appellate court determined that the two reporting requirements were separate reporting requirements and the penalty provisions were also separate, with each applicable to its one particular reporting requirement to which it relates. No language in the statute supported an argument that only one of these penalties could be assessed when there are reporting failures under the two separate reporting requirements.

 

Estate of Wilson v. U.S., 2nd CA, Case No. 20-603 (July 28, 2021)

Thursday, August 05, 2021

New Homestead Laws in Florida

In its most recent legislative session, the Florida legislature enacted a number of additions and modifications to Florida statutory law relating to Florida's homestead exemption. These provisions can be summarized as enhancing or clarifying the exemption. The following is a summary of the new provisions, along with some excerpts.

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 736.0201(7): A proceeding to determine the homestead status of real property owned by a trust may be filed in the probate proceeding for the settlor’s estate if the settlor was treated as the owner of the interest held in the trust under s. 732.4015. The proceeding shall be governed by the Florida Probate Rules.

This provision provides jurisdiction to the probate court in a probate proceeding of a revocable trust settlor to determine the homestead status of real property owned by a trust. This should only apply to revocable trusts defined under Fla.Stats. § 733.707(3) and not other trusts, per the reference to Fla.Stats. § 732.4015. Fla.Stats. § 732.4015 references Fla.Stats. § 733.707(3). Generally, a revocable trust described in Fla.Stats. § 733.707(3) is one which the grantor has a right of revocation at death. Fla.Stats. § 733.707(3)(e) defines a “right of revocation” for this purpose as the power to amend or revoke the trust and revest the principal of the trust in the decedent, or withdraw or appoint the principal of the trust to or for the decedent’s benefit.

This provision was added due to a perceived lack of apparent authority for the probate court to otherwise make that homestead determination in these circumstances. Bill Analysis and Fiscal Impact Statement, to CS/CS/SB 1070 dated April 15, 2021, Page 5.

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 736.1109 (1): If a devise of homestead under a trust violates the limitations on the devise of homestead in s. 4(c), Art. X of the State Constitution, title shall pass as provided in s. 732.401 at the moment of death.

The constitutional restrictions on the devise of homestead are not defeated via ownership of the homestead of a decedent in a trust, subject to statutory carve-outs. This provision clarifies that if there is an improper testamentary devise in the trust, the property will pass to the same recipients who would receive it as if the decedent died owning the property directly and had attempted an invalid testamentary devise - that is Fla.Stats. § 732.401 of the Probate Code would apply, and the title passage occurs at the moment of death even though titled in the trust.

The provision applies only to revocable trusts and testamentary trusts. 

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 736.1109 (2) A power of sale or general direction to pay debts, expenses and claims within the trust instrument does not subject an interest in the protected homestead to the claims of decedent’s creditors, expenses of administration, and obligations of the decedent’s estate as provided in 736.05053.

If a trust holds an interest in a decedent’s protected homestead at death, this provision codifies a parallel probate result which applies to directly owned homesteads, such that a general power of sale or direction to pay debts, expenses, and claims of the decedent in the trust instrument does not in and of itself make the homestead subject to claims of the decedent’s creditors, expenses of administration, and obligations of the decedent’s estate.

The provision applies only to revocable trusts and testamentary trusts. 

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 736.1109(3) If a trust directs the sale of property that would otherwise qualify as protected homestead, and the property is not subject to the constitutional limitations on the devise of homestead under the State Constitution, title shall remain vested in the trustee and subject to the provisions of the trust.

Homestead property owned by a decedent that is protected homestead (i.e., it is directed to pass to an heir) and that is devisable, passes automatically at death to the recipient heir(s) and is not part of the probate estate. However, that is not the case if the decedent’s last will requires that property be sold and the proceeds to be divided among the heirs of the decedent or applied to estate obligations.

This provision extends this principle to when a trust owning the property has the direction for sale - in that circumstance, the trustee retains title to the property, and it does not pass automatically to the designated heir(s). 

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 736.151 Homestead property.—

(1) Property that is transferred to or acquired subject to a community property trust may continue to qualify or may initially qualify as the settlor spouses’ homestead within the meaning of s. 4(a)(1), Art. X of the State Constitution and for all purposes of general law, provided that the property would qualify as the settlor spouses’ homestead if title was held in one or both of the settlor spouses’ individual names.

(2) The settlor spouses shall be deemed to have beneficial title in equity to the homestead property held subject to a community property trust for all purposes, including for purposes of s. 196.031.

This provision is part of the new community property trust provisions of the Florida Trust Code. They seek to allow homestead protections to homestead property held in a community property trust. 

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 736.1104. Person Killer not entitled to receive property or other benefits by reason of victim's death --

(3) A beneficiary of a trust who was convicted in any state or foreign jurisdiction of abuse, neglect, exploitation, or aggravated manslaughter of an elderly person or a disabled adult, as those terms are defined in s. 825.101, for conduct against a settlor or another person on whose death such beneficiary's interest depends is not entitled to any trust interest, including a homestead dependent on the victim's death, and such interest shall devolve as though the abuser, neglector, exploiter, or killer had predeceased the victim.

This provision will void transfers of homestead interests in trusts where the recipient is convicted of neglect, exploitation, or aggravated manslaughter. What happens if the surviving spouse is the person so convicted? Does the spouse lose the interest if it was devised to the spouse under the trust? It would appear that the trust transfer is void, but would the Florida Constitution limits on devise when there is a surviving spouse restore the transfer to the trust? Interestingly, the Constitution does not directly provide that the spouse succeeds to the interest - this incurs under Florida statutory law. That being the case, does this mean that this provision can be interpreted as also overriding the statutorily required transfer to the surviving spouse in the event of a prohibited devise, and/or does the Florida Consitution nonetheless still require passage to the surviving spouse since it is the spouse that the constiutional interest seeks to protect (in addition to the protection of minor children)?

Note that a surviving spouse is entitled to the decedent’s homestead under the Florida Constitution (wholly, or in part, if there are surviving minor children), such that presumably this statutory provision does not void that spouse’s interest if they are the person so convicted. 

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 Changes to Fla.Stats. Section 196.075.

This statute is modified to avoid the need for representations of income beyond the first year of exemption in regard to the additional homestead ad valorem exemption to persons 65 or older at lower income levels. 

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 Changes to Ad Valorem Valuation of Homesteads. 

Chapter 2021-31 (H.B. No. 7061) made several changes to Florida Statutes regarding the ad valorem value of homestead interests, principally:

 1. Adding  new exceptions to the rule that ad valorem values are adjusted upon a change of ownership when the change or transfer is the removal from the title of a co-tenant holding title by joint tenancy with right of survivorship when the other co-tenants remain on the title. Such removal may be by instrument or the death of the co-tenant. 

2. Relating to adjustments in value of damaged property. 

3. Relating to adjustments in value of voluntarily elevated property. 

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 Change to Fla.Stats. Section 719.103(25).

A change to this statute provides that a unit in a co-op is an interest in real property. 

The effect of this change is that such units can now qualify as homestead property for all purposes under Article X, s.4 of the Florida Constitution. This resolves disparate results among courts and different provisions of Article X, s. 4 as to whether a co-op unit can qualify as homestead property.