Getting More Assets to Family Members Under a CLAT

A Charitable Lead Annuity Trust (CLAT) is an estate planning tool, whereby a taxpayer transfers assets to a trust. The trust provides that a fixed annual amount will be paid to a charitable organization for some period of time, and then anything left in the trust at the end of the charitable term gets paid to the remainder beneficiaries, which are often members of the taxpayer’s family.

These trusts are typically structured as "nongrantor" trusts, so that the funding taxpayer does not have to pay the income taxes on the income of the trust during the trust term. However, by being a nongrantor trust, the funding taxpayer does not get an income tax charitable deduction for funding.

These trusts are also often structured to be "zeroed-out." This means that the amount to be paid to the charity during its lead interest is high enough, so that on an actuarial basis nothing is expected to be transferred to the remainder beneficiaries because it will have all been previously transferred to the charity. This is done to avoid an up-front taxable gift to the remainder beneficiaries. However, by structuring in this manner, there is a good possibility that if the investments of the trust do not outperform the applicable IRS interest rates, there will in fact be nothing left for the family members at the end of the charitable term.

In a recently published article, Glenn Kurlander discusses a method for getting more assets to the family remaindermen method without increasing the tax cost. His proposed structure is that the trust will be a grantor trust, so that the funding taxpayer receives an income tax deduction on funding. To the extent of the taxes saved on funding, he would structure the trust to not zero-out the remainder interest, but to allow a taxable gift that generates an amount in gift taxes equal to the income tax savings. Since the gift taxes and the income tax savings net each other out, there is no net cost to having a greater amount going to the family remaindermen. This enhanced gift to the family remaindermen occurs by lowering the amount paid to charity and thus increasing the actuarial value of the remainder interest, and thus also the amount that which will eventually pass to the remainder beneficiaries. While Mr. Kurlander indicates this technique is only useful to those who have already used up their gift tax unified credit so that the gift generates a gift tax, it should likewise provide the same net benefits even if the gift tax portion of the transaction is covered by some or all of the gift tax unified credit - in this situation, the income tax savings compensates the funding taxpayer’s estate for the loss of the unified credit and thus future increased estate or gift taxes.

What about the funding taxpayer now being taxed on the income of the trust? This tax is avoided by having the trust invest in municipal bonds, which are not taxable. A laddered portfolio would be used to maximize interest and reduce risk. While not discussed in the article, such investments may need to be specifically mandated in the trust instrument to avoid issues of allowable investments under the Prudent Investor Rule and similar state law concepts of fiduciary investment.

Kurlander, Glenn, The Family Centric CLAT Can Provide More for Remainder Beneficiaries, WGL Estate Planning Journal, January 2006

You Be the Judge - Litigation Settlement Proceeds

Facts: Taxpayer-employee sued his employee for various damages. The employee and the employer settle the lawsuit, and taxpayer-employee is paid $40,000, less tax withholdings. The taxpayer claims the payment was to compensate him for a physical injury so that it was not taxable to him. The settlement agreement between the employer and the employee does not indicate the proceeds were paid to compensate the employee for physical injury.

The Law: Code Section 104(a)(2) provides an exclusion for "the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness."

The Issue: Can the employee deduct the payment if the settlement agreement doesn’t say it was for physical injury?

The Holding: No deduction allowed. The Court noted that a taxpayer seeking to exclude money damages from income bears the burden of proving that the exclusion applies. The fact that the settlement agreement did not indicate the payment was for physical injury meant the taxpayer did not bear his burden of proof.

The Lessons:

a. Make sure your settlement agreement describes what the settlement payment is for, if you are trying to claim that the proceeds received are of a type that are not subject to income tax.

b. Where the settlement agreement is silent, a court may look to the original complaint and pleadings to see what damages the claimant was originally seeking. Make sure your complaint has the description of the claim that you want the settlement proceeds (or indeed, an ultimate court judgment recovery) to be characterized as.

Rivera V. Baker West, Inc., 96 AFTR 2d 2005-XXXX, (CA9), 12/13/2005.

It's Not to Late for a 2005 Charitable Deduction!

For all procrastinators out there, it is not too late to make a charitable deduction in 2005 and receive an income tax deduction. If you put a charitable deduction on your credit card in 2005, you can deduct it in 2005, even though you do not pay your credit card bill until 2006. (Rev.Rul. 78-38)

For assistance in finding charities that accept credit card donations, check out the website of Network for Good.

No Deduction for Religious Education Expenses

In a recent Tax Court case, the taxpayers paid tuition to an Orthodox Jewish day school. The tuition was allocable in part to religious education, and part to secular education. The taxpayers sought to take a charitable deduction for the portion attributable to the religious education.

The basis for this claim was Code Section 170(f)(8). Generally, taxpayers cannot receive a charitable deduction for contributions when they receive something back of equal value - a "quid pro quo." When something is received back of lesser value than the contribution, rules apply to get documentation from the charity as to the value of what was received back. Code Section 170(f)(8) provides that payments for "intangible religious benefits" are deductible without such documentation. The taxpayers argued that under this provision the religious education given their children was an "intangible religious benefit" and thus deductible without being limited by the quid pro quo rules.

The Tax Court dodged the issue on a technicality by finding that Code Section 170(f)(8) did not apply and thus the tuition was not deductible because the school was not engaged EXCLUSIVELY in religious activities (a requirement of the applicable of the "intangible religious benefits" exception). Therefore, it left open for another day the question whether payments for religious instruction to an organization that does not engage in any secular activities would be deductible.

Where does this leave things under the law?

-amounts paid to organizations for secular, or combined secular and religious education, is not deductible

-amounts paid to organizations for religious education, if the organization conducts only religious activities - unknown deductibility

-amounts paid to wholly religious organizations as outright gifts or dues should be deductible

Sklar v. Comm., 125 TC No. 14 (12/21/05)

More Abuse In Regard to Automobile Contributions to Charity

Under recent changes in the law, the charitable deduction of a taxpayer who contributes an automobile to charity cannot exceed the sales proceeds received by the charity. This was to shut down a perceived abuse - that taxpayers were contributing their old cars to charity and taking a charitable deduction in excess of the true value of the automobile.

There is an exception to this rule - if the automobile is sold by a charity to a needy individual at a price less than fair market value, the limitation to the sales price will not apply. The IRS now believes that this exception is giving rise to further abuse. They believe that charities that sell automobiles at auction are improperly claiming the application of this exception.

The IRS has announced that it will not accept acknowledgments by a charity that the exception for sale to a needy individual apply in regard to sales at auction. They further warn charities that they may be subject to penalty for providing such acknowledgments.

Gulf Opportunity Zone Act of 2005

Earlier this week, President Bush signed the Gulf Oportunity Zone Act of 2005. The law originated as additional relief for Hurricane Katrina, and was expanded to include relief for Hurricanes Rita and Wilma and now includes some other miscellaneous tax relief. Some of the key provisions include:

• Tax incentives to encourage rebuilding of the areas hardest hit by Hurricane Katrina (designated as the Gulf Opportunity Zone. These include 50% bonus first-year depreciation, a substantially increased Code Section 179 expensing allowance, a five year net operating loss carryback, partial expensing of demolition and cleanup costs, increased rehabilitation tax credits, and boosted higher-education credits for those attending school in the Gulf Opportunity Zone.
• Some of the KETRA tax breaks from Hurricane Katrina are extended to areas affected by Hurricanes Rita and Wilma. These include retirement plan relief measures (e.g., exemption from the 10% penalty tax for up to $100,000 of qualified distributions), eased casualty loss rules, larger corporate charitable contribution limits for donations to hurricane aid, and a special employee retention credit.
• New bond provisions designed to stimulate rebuilding in the affected areas, such as new authority for Louisiana, Mississippi and Alabama to issue a special class of bonds outside of the normal state volume caps.
• Extensions of some expiring provisions, such as the special rule giving military personnel the option of treating their tax-free combat pay as income when computing their eligibility for the earned income credit.
• Technical corrections to a number of earlier laws from 2003-2005.

IRS User Fees to Jump

IRS user fees are about to change - and the direction is up of course. On a percentage basis, some of these increases are quite substantial. At a time when the IRS response time on many ruling requests is longer than ever, the fee increases remind us that government enterprises are immune from the competitive market pressures that keep prices under control in the private sector.

Some key changes:

• The fee for IRS Chief Counsel private letter rulings will increase from $7,500 to $10,000. Under the new fee schedule, taxpayers earning less than $250,000 can request a private letter ruling for a reduced fee of $625 while a fee of $2,500 will apply to requests from taxpayers earning from $250,000 to $1 million.
• The fee for requests for changes in accounting methods for businesses will increase from the previous $1,500 to $2,500.
• For corporate taxpayers, the cost of a pre-filing agreement will increase from the previous three-tiered structure, which was capped at $10,000, to a new flat fee of $50,000. Also, Advance Pricing Agreements, which previously cost from $5,000 to $25,000, will now cost from $22,500 to $50,000.
• For employee plans, fees for opinion letters on prototype IRAs, SEPs, SIMPLE IRAs and Roth IRAs, which were previously $125 to $2,570, will now range from $200 to $4,500. Fees for exempt organizations rulings, which previously cost $155 to $2,570, will now range from $275 to $8,700.
• User fees for exempt organization applications and requests for group exemption letters, which currently range from $150 to $500, will increase to $300 to $900.

Hurry up and get those rulings in - most of these increases are effective on February 1.

You Be the Judge - Insurance and Divorce

It is time for a round of "You Be the Judge," this time dealing with a divorced husband who failed to change the beneficiary designation on his life insurance policy from his former wife.

FACTS. Husband and wife divorce. The marital settlement agreement described certain life insurance policies on the life of the husband and provides, "Husband shall receive as his own and Wife shall have no further rights or responsibilities regarding these assets." Ex-wife was named as beneficiary of the life insurance policies, and husband never bothers to change this after the divorce. Husband dies. A dispute arises whether the ex-wife waived her rights to receive the insurance proceeds at death, or whether she is still entitled to receive them.

DECISION: Ex-wife wins- she gets the insurance proceeds.

WHY: The Court acknowledges that under Florida law the ex-wife can waive her rights to receive the insurance proceeds as part of a divorce settlement, but that the settlement must specifically refer to rights to the "proceeds" of the policy to be an effective waiver. Since there was no such waiver of "proceeds" here, the ex-wife gets to keep the policy payout.

LESSONS? Make sure your marital settlement agreement specifically includes rights to insurance "proceeds" if a waiver is intended, and/or make sure the divorcing spouse files a change of beneficiary form to remove the former spouse. This is probably also good advice in regard to a prenuptial or postnuptial agreement.

Smith v. Smith, 30 Fla.L.Weekly D2845b (5th DCA 2005)

Applicable Federal Rates - Update for January 2006

December 2005 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.33% - (4.29%/Dec. -- 4%/Nov.)

-Mid Term AFR - Semi-annual Compounding - 4.43% - (4.47%/Dec. -- 4.19%/Nov.)

-Long Term AFR - Semi-annual Compounding - 4.68% - (4.73%/Dec. -- 4.52%/Nov.)

Corporate Return Audit Triggers

Potential audit triggers for corporate tax returns from a former IRS field agent:

Refunds in excess of $2 million. Congress' Joint Committee on Taxation must review all refunds over a prescribed amount, arising from net operating loss carrybacks and credit carrybacks. In 2005, the prescribed amount was $2 million. Agents are required to contact such corporations and request information to verify the accuracy of the refund, as well as its origin .

Balance sheet "loans to shareholders" (the IRS may try to recharacterize these as "constructive dividends") .

Agents check for Schedule M-1 line items such as travel and entertainment expenses. The absence of such Schedule M-1 line items could trigger an audit.

Schedule M-1 line items such as "tax-exempt" or "tax-deferred" income could also be a red flag.

Link

European LLC's Deemed Corporations for U.S. Purposes

Since the enactment of the check-the-box regulations, taxpayers have a substantial amount of flexibility in electing to characterize non-U.S. entities as “associations” (taxable as a corporation), or as pass-through entities (taxable as a partnership or sole proprietership). However, taxpayers do not have absolute discretion in this regard - certain listed entities are “per se” corporations that must almost always be taxable as a corporation.

The IRS has now updated its list of “per se” corporations. It now includes the European Union’s new business entity known as the Societas Europaea (SE), which is essentially a European LLC. Also now characterized as “per se” corporations are the Aktsiaselts of Estonia, the Akciju Sabiednba of Latvia, the Aktiengesellschaft of Liechtenstein, the Akcine Bendroves of Lithuania,and the Delniska Druzba of Slovenia.

T.D. 9235, December 16, 2005

Interest Rates For tax Overpayments and Underpayments

The IRS has announced that the interest rates for tax overpayments and underpayments for the calendar quarter beginning Jan. 1, 2006, will remain the same as last quarter.

Thus, for noncorporate taxpayers, the rate for both underpayments and overpayments for the first quarter of 2006 will be 7%.

For corporations, the overpayment rate for the first quarter of 2006 will be 6%. Corporations will receive 4.5% for overpayments exceeding $10,000. The underpayment rate for corporations will be 7%, but will be 9% for large corporate underpayments.

U.S. Tax Competitiveness

In November 2005, the Congressional Budget Report issued a report on how U.S. corporate tax rates compare to other developed countries. So how do U.S. rates compare?

According to the Report, the top statutory corporate rate in the U.S. is one of the highest among all developed countries. Nonetheless, it is comparable to the rates in other similar, large industrialized economies (members of the Group of Seven).

The Report notes that the relatively high rate creates incentives for U.S. and foreign multinational companies to use international tax planning to reduce their U.S. taxable income by shifting it to low-tax countries. The rate also affects the incentives for business investment.

Also according to the Report, historical trends suggest that countries do not choose their tax rates independently of one another. After the U.S. and the United Kingdom reduced their corporate tax rates in the 1980's, other OECD countries reduced theirs, apparently in response and perhaps out of concern that they would otherwise lose investment or a portion of their tax base to other nations. Those other countries eventually reduced their own tax rates by even more than the United States.

An implication of the Report - U.S. corporate tax rates can use some lowering to remain competitive in the search for international investment capital.

Real Estate Investor vs. Developer - More "Development" Allowed?

Individuals and pass-through entities owning undeveloped real property desire to be characterized as "investors" for federal income tax purposes - that is, that their real property holdings are treated as capital assets that incur capital gain on sale. The alternative is usually developer/ordinary income treatment. Ordinary income rates can be twice as much as capital gain rates.

Under the Internal Revenue Code, undeveloped real property will lose its capital gain character if it is “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.” For 60 years, the IRS and taxpayers have disputed what level of development activity a taxpayer can undertake without crossing the line from investor to developer.

A recent article by Ira Feldman, CPA posits that in recent years, a passive investor in undeveloped real property generally has to undertake more preliminary development-type activities to realize value from its investment, and that the IRS may be acknowledging this by allowing some level of development activity without the taxpayer being treated as a dealer. [PLAN NOW TO AVOID DEALER STATUS FOR 'INVESTMENT' REAL ESTATE, Practical Tax Strategies, Nov 2005, Practical Tax Strategies / Taxation for Accountants (WG&L)]

Mr. Feldman cites several recent Private Letter Rulings in which the IRS has allowed certain development activities without imposing dealer status, including:

-subdivision of parcels to smaller parcels
-multiple sales
-entry roadway built
-development agreement with town
-land planning
-preliminary engineering.

See PLR's 200510029, 200242041, 200530029.

Equity Increases Are Not "Acquisitions" Under New Bankruptcy Rules

Under the Florida Constitution, the homestead of an individual is generally not subject to claims of creditors of that individual. Other states also provide exemptions for homestead interests. However, under the recent revisions to the bankruptcy law, homestead interests acquired within 1215 days of a bankruptcy filing cannot receive the benefit of these state homestead protections (beyond $125,000 in protection). Generally, this is aimed at making it more difficult for debtors to acquire a protected interest to shield themselves from existing creditors.

So what happens if a homestead is acquired more than 1215 days before a bankruptcy filing, but the homestead is encumbered by a mortgage and mortgage payments (and thus equity increases) occur within the 1215 days? Are these equity payments the acquisition of a homestead interest such that they are subject to the 1215 day rule?

In a case of first impression that is favorable to debtors, a Texas bankruptcy court has held that such regular loan payments within 1215 days of filing are NOT homestead acquisitions for purposes of these rules. It remains to be seen whether other bankruptcy courts similarly interpret the law, and whether non-regular loan payments will be similarly treated.

In re: Kevin Blair and Susan Blair, US Bankruptcy Court, N.D., Texas, Dallas, No. 05-35922-HDH-7

Business Mileage Reimbursement Rate Changed Again

Many people use their personal automobile to conduct business activities. Such use can be deducted on a "per mile" basis.

Due to the run-up in gasoline prices in recent months, the per mile deduction was increased from 40.5 cents to 48.5 cents. With gas prices backing down, the IRS has set the rate at 44.5 cents for 2006.

Note that if you are taking a mileage deduction, one of the first things the IRS may look at on audit is whether you are counting miles when you are commuting between home and work. Generally, these are not deductible except at times in regard to a temporary work location.

How NOT to Structure an Offshore Trust

U.S. persons often establish offshore trusts to hold assets to protect them from future creditors. Generally, to be effective for this purpose the settlor of the trust needs to give up power over the trust assets - otherwise a U.S. court can force the settlor to direct the payment of the trust assets to his creditors if a judgment creditor arises. Instead, most of the power over the trust is vested in a foreign trustee.

To maintain some control over the trust, the settlor often retains the power to remove and replace the trustee. That way, if the trustee starts investing in assets the settlor does not like, or is not applying the trust assets in a favorable manner, the settlor can fire him and find another trustee that is more accommodating.

A recent case in South Florida illustrates that even this apparently innocuous remove and replace power can open the door enough for a creditor to exploit. In this case, the creditor happened to be the IRS. Since the taxpayer had a remove and replace power over the foreign trustee, the Court directed the taxpayer to exercise that power and appoint a U.S. trustee. Since the Court could then exercise jurisdiction over a U.S. trustee, the effect of this will be to bring the assets within the Court's jurisdiction and allow for its application to the creditor/IRS. The trust also had the problem of having the law of the trust change to the law of the jurisdiction of the trustee in the event of a change of the trustee, which further compounds the creditor protection problem.

How should the trust have been structured to avoid this exposure? At a minimum, the trust should have not allowed for the appointment of a trustee in the U.S. Prudent use of a "trust protector" to exercise powers such as these might also diminish the exposure.

As an aside, offshore asset protection trusts are NOT recommended for purposes of avoiding federal income tax obligations.

United States v. Grant,
96 AFTR 2d 2005-270 (SD Fl., Sept. 2, 2005)

Greenspan Would Not Rule Out Tax Increases for Entitlement Reform

Both Social Security and Medicare have long term fiscal challenges in front of them - not enough taxes are or will be collected to fully fund expected benefits as benefits continue to grow and the working population ages. There are two principal ways out of the problem - cut benefits, or raise taxes (or some combination of both).

Federal Reserve Board Chairman Alan Greenspan has weighed in on the issue, and surprising some he indicated that tax increases should not be ruled out. In a recent speech, he indicated, however, that he would still prefer that reforms come primarily, if not wholly, from spending cuts and not taxes. A principal focus of the speech was that reform be addressed sooner, rather than later, before the problem gets too large.

Motorcycles and Administrative Discretion Do Not Always Mix

Generally, amounts withdrawn from an Individual Retirement Account (IRA) are taxed to the recipient. However, if the withdrawn amount is paid into another IRA or eligible retirement plan for the recipient within 60 days of the original withdrawal, taxation is avoided.

If the 60 day period is violated, the IRS does have discretion to extend the 60 day period. In an attempt to test the limits of a kinder, more gentle IRS, a taxpayer who had withdrawn substantial funds from his IRA and not recontributed them to another IRA or retirement plan within 60 days tried to get the IRS to extend the 60 day period. Noting that the taxpayer never told anyone at any of the involved financial institutions that he intended to recontribute the funds, that the taxpayer did not have any desire to recontribute until his tax advisor told him he was taxable on the withdrawn, and that he used some of the proceeds to buy a motorcycle, the IRS refused to grant an extension.

For those that may be in similar straits, Section 408(d)(3)(I) of the Internal Revenue Code provides that the Secretary may waive the 60 day requirement where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirement. Revenue Procedure 2003-16 provides that in determining whether to waive, the IRS will consider all relevant facts and circumstances, including: (1) errors committed by a financial institution; (2) inability to complete a rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error, (3) the use of the amount distributed (for example, in the case of payment by check, whether the check was cashed); and (4) the time elapsed since the distribution occurred.

Therefore, if you missed the 60 day deadline but fall within the above criteria (and, apparently, you did not use any of the proceeds to buy a motorcycle), you may be able to get relief from the IRS.

PLR 200548030, December 2, 2005

When the IRS Tells its Examiners What to Look For, You Ignore that Guidance at Your Own Risk

To help its auditors when conducting a tax audit, the IRS often provides written guidance regarding what the auditor should focus on. This information is often available to the public. If you are a taxpayer in a field or area that is subject to such guidance, it is prudent to review that information. If an auditor comes in the door, you can be assured he will be consulting those guidelines in conducting the audit. By having part of the IRS' "game plan" in advance of an audit, the taxpayer can more closely comply with what the IRS desires and thus limit the risk of an audit examination.

For example, earlier this week the IRS issued a "Field Directive on the Planning and Examination of Cost Segregation Issues in the Biotech/Pharmaceutical Industry." This examination guidance deals with the issue of putting the various assets typically owned by biotech and pharmaceutical industries into the proper depreciation categories. Since different categories of assets give rise to different periods of depreciation, placement into the proper category is needed for computing the correct depreciation deduction. While it is obvious into which category some assets belong, others can be more difficult to categorize. Taxpayers who want to minimize audit risk on this issue are well served to consult the Field Directive in making its categorizations.

To see the table itself, go to link.

Non-Mortgage Waiver of Florida Homestead Protection Allowed!

Florida provides an exemption against forced sale for homestead property. This arises under Florida’s Constitution, which provides:

"There shall be exempt from forced sale under process of any court, and no judgment, decree or execution shall be a lien thereon, except for the payment of taxes and assessments thereon, obligations contracted for the purchase, improvement or repair thereof, or obligations contracted for house, field or other labor performed on the realty, the following property owned by a natural person:

(1) a homestead, if located outside a municipality, to the extent of one hundred sixty acres of contiguous land and improvements thereon, which shall not be reduced without the owner's consent by reason of subsequent inclusion in a municipality; or if located within a municipality, to the extent of one-half acre of contiguous land, upon which the exemption shall be limited to the residence of the owner or his family[.]" Art. X, § 4(a), Fla. Const. (2004).

Generally, a homestead owner can get around this limitation and provide an interest which can be reached by a creditor by providing the creditor with a mortgage on the homestead property. The question arises whether the homestead owner can be waived outside of a mortgage - for example, in a provision under a contract?

Florida’s Third District Court of Appeal recently had reason to address this issue, when a law firm included a provision in a retainer agreement with its client that the client waived homestead protection in regard to collection of attorney’s fees. The Florida Supreme Court has previously ruled that such waivers would not be enforceable (Sherbill v. Miller Mfg. Co., 89 So. 2d 28 (Fla. 1956)) , so one would expect the Third DCA to follow this precedent and disallow the waiver. However, the Court instead said that the Supreme Court case was based on a prior version of the Constitution, and under the current homestead provision the homestead protection can be waived outside of a mortgage. Demayo v. Chames and Heller & Chames, P.A., 3rd District. Case No. 3D04-117. L.T. Case No. 01-7497. Opinion filed November 30, 2005. Thus, the Court gave effect to the waiver in the retainer agreement.

If allowed to stand, the consequences of this decision may be far reaching. The dissenting opinion notes the likely consequence if the Florida Supreme Court does not reverse the appellate court:

"This brings me to what I fear most about the change the majority has wrought today. That is that the waiver of the homestead exemption will become an everyday part of contract language for everything from the hiring of counsel to purchasing cellular telephone services. The average citizen, who is of course charged with reading the contracts he or she signs, as this court knows all too well, often fails to read or understand boilerplate language detailed in consumer purchase contracts, language which the contracts themselves often permit to be modified upon no more than notification in a monthly statement or bill. Nonetheless, under the majority's application of article X, section 4, such consumers may lose their homes because of a "voluntary divestiture" of their homestead rights for nothing more than failure to pay a telephone bill. This inevitably will result in whittling away this century old constitutional exemption until it becomes little more than a distant memory."

Seeing how the appellate court has effectively overidden Supreme Court precedent (something which is not supposed to happen, at least without good cause), we can probably expect an appeal to the Supreme Court - thus, the last word on this issue has probably not yet been heard.

Tax Complexity

As Congress deals with various tax measures, the usual calls for tax simplication are made. So how complex is the federal tax system?

Complexity is a difficult concept to measure. One objective indicator is how words there are in the applicable tax laws. John Walker, of the site www.fourmilab.ch, has indexed the Internal Revenue Code and sets the number of words at 3.4 million. If Treasury Regulations are added in, add another 6 million words to the total, with the combined total approaching 10 million words. If you want to add in Treasury Department pronouncements, such as publications, revenue rulings, revenue procedures, private letter rulings, and other explanations of the law, the number becomes incalculable.

To put these numbers in context, there are 602,585 words in the Old Testament. In the New Testament, there are 180,552 words. So who has the more difficult job - bible scholars or tax attorneys? Even without the word differential, the Bible is static - the Internal Revenue Code and its interpretation is a moving target with the constant tinkering and revision of Congress and the Treasury Department.

As the Wall Street Journal noted in a November 1 article on the subject ("Taxing Words"), Ronald Reagan's 1986 tax reform cut the Internal Revenue Code in half, but it has since grown back like jungle brush, thicker than ever. Will this year's tax acts add or take away from the size of the Code? I think we can all predict the answer to that.

That $3 Checkbox

When you file your income tax return, there is a box that taxpayers can “check off” to send $3 of their taxes to the Presidential Election Campaign Fund. This Fund provides funds to candidates to help finance presidential campaigns. When initiated in 1981, 28.6% of taxpayers made the designation. In recent years, this has dropped to 9.1%.

There are various theories discussed for why the participation has dropped. One theory is that the computer/electronic tax preparation software discourages taxpayers from participating, based on default assumptions of “no participation” and inadequate descriptions. According to this theory, the explosion of use of this software has accelerated the decline.

Working with Commisioners of the Federal Election Commission, the Campaign Finance Institute has been able to bring the purported problem to the attention of the tax preparation software producers and tax preparers. In response, two of the major software producers have now agreed to modify their software.

H &R Block has agreed -- in all of its TaxCut boxed software and online products -- to:

--Change “I want to contribute $3” to “I want to designate $3” to the Presidential Fund (This is followed by the caution “Checking the box will not change your tax or reduce your refund,” a key Form 1040 phrase that the company added last year at CFI’s request); and

--Add to its explanation of the Fund the following Form 1040 language: “The fund reduces candidates’ dependence on large contributions from individuals and groups and places candidates on an equal footing in the general election.”

Intuit agreed -- for all versions of consumer TurboTax -- to:

--Eliminate the pre-filled in “No” check box;

--Change “Do you want $3 to be contributed” to substitute “designated” for the last word (The caution remains, “Note: Selecting Yes will not increase your tax due or reduce your refund”) ; and

--Amplify its current explanation of the Fund to include the missing 1040 phrase, “and places candidates on an equal footing in the general election.”

All of the changes will go into effect in consumer product and web updates for Tax Year 2005.

It will be interesting to see if this reverses the slide in taxpayer participation, or whether the decline arises for other reasons (including the reduction in the number of tax filers that actually owe tax and intentional decisions not to participate in public finance of elections).

Private Trust Companies

At times, families often seek to establish their own trust company to serve as fiduciaries of estates and trusts of family members. Such a trust company can reduce the costs involved with using third party trust companies, allows for continuity, management and control of the fiduciary function by a family, and avoids some of the drawbacks to both third party trust companies and individual fiduciaries. Indeed, several well-known trust companies got their start as private trust companies for a family.

Since the trust company is generally established and controlled by senior family members, tax issues arise regarding whether this “related” relationship gives rise to retained control by family members such that the grantor trust rules may be inadvertently brought into play, and that also may result in unintended estate tax inclusion in family members of the trust assets.

In a favorable ruling, the IRS has confirmed that when properly structured (including provisions that exclude family members from participating in discretionary decisions and having adequate trust company “firewall” provisions), the private trust company is not a “related or subordinate” party for purposes of these tax provisions and does not otherwise give rise to undesired grantor trust consequences. Private Letter Ruling 200546052, 11/18/2005.

Foreign Life Insurance Policy Reporting

U.S. taxpayers are generally required to report their ownership interests in non-U.S. bank accounts using Form 90-22.1. At first analysis, one wouldn't think that an interest in a foreign life insurance policy is a reportable account. However, some practitioners have been advised that the Department of Treasury believes that premium payments for insurance policies with cash surrender value or other investment features constitute "deposits" within the meaning of Form 90-22.1. Therefore, if a life insurance policy is a "whole life" or other type of policy with investment value, then it is an "other financial account" subject to reporting. Whether this is a correct interpretation is unknown, but conservative reporting would indicate that such policies should be reported.

IRA Taxable at Full Value for Estate Tax Purposes

When an individual dies, his assets are subject to federal estate taxes based on the value of those assets (subject to reduction for applicable deductions and credits). For this purpose, value is the price that the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.

There is precedent that allows for the reduction in value for taxes that would have to be paid when the successor owner sells the subject property. There is also precedent for taking into consideration costs that would need to be expended to sell the subject property.

The Tax Court recently addressed the issue whether the value of IRA account for estate tax purposes should be reduced by the income taxes that will eventually be paid on distributions from the IRA. The logic of the estate's argument was that the IRAs that were involved were not transferable and therefore were unmarketable. According to the estate, the only way that the owner of the IRAs could create an asset that a willing seller could sell and a willing buyer could buy is to distribute the underlying assets in the IRAs and to pay the income tax liability resulting from the distribution. Upon distribution, the beneficiary must pay income tax. Therefore, according to the estate, the income tax liability the beneficiary must pay on distribution of the assets in the IRAs is a “cost” necessary to “render the assets marketable” and this cost must be taken into account in the valuation of the IRAs.

Unfortunately for the estate, the Tax Court did not buy into this argument, and held that the IRA was includible at the value of the securities held in the IRA, withour reduction for future income taxes. Kahn v. Comm., 125 T.C. No. 11 (2005).

More Year End Planning Ideas

Since for individuals income tax system is generally a calendar year system, the end of the year presents opportunities for tax planning. Here are some ideas for consideration (but please consult with your tax advisor before undertaking any to confirm it makes sense in your specific situation):

-Sale of capital gain and capital loss properties to (a) offset each other, and (b) avoid limitations on deductibility of capital loss property

-Defer income until 2006

-Avoid or reduce penalty for underpayment of estimated tax by increasing income tax withholding on wages and pension/IRA distributions

-Increase your basis in partnerships and Subchapter S corporations to allow deductibility of losses

-Set up a qualified tuition program (529 plan) – this allows for tax-free earnings accumulations and tax-free distributions if used for qualified higher education expenses

-Minimize Florida intangible taxes through conversion of assets to nontaxable assets or use of swing trusts

-Make annual exclusion gifts of $11,000 per recipient to reduce estate and gift taxes

-Set up a retirement plan

-Make expenditures that qualify for Section 179 $105,000 business property expensing option

-Accelerate deductions (e.g., pay union or professional dues, preparing professional subscriptions, etc.)

Applicable Federal Rates - Update for December 2005

December 2005 Applicable Federal Rates Summary (Rev.Rul. 2005-77):

-Short Term AFR - Semi-annual Compounding - 4.29% - (4%/Nov. -- 3.89%/Oct.)

-Mid Term AFR - Semi-annual Compounding - 4.47% - (4.19%/Nov. -- 4.08%/Oct.)

-Long Term AFR - Semi-annual Compounding - 4.73% - (4.52%/Nov. -- 4.40%/Oct.)

Tax Bill Expected Soon

Congress is hard at work on a new tax bill. Since different versions are out of committee and are before the House and Senate, the final look of the bill is not yet known. Items included in one or both bills include:

- numerous extensions of expiring tax provisions

- hurricane relief (relief similar to that in the Katrina Emergency Tax Relief Act of 2005 (KETRA) to victims of Hurricanes Rita and Wilma, and would also offer extra tax breaks for rebuilding in the Hurricane Katrina disaster area),

-charitable giving provisions (charitable contributions from IRAs),

-extension for existing favorable capital gain and dividend rates.

Given the substantial differences between the House and Senate versions, what finally makes it into the final bill is anyone’s guess.

Hybrid Cars - Better to Buy Now or Later?

WHY BUY IN 2005? As previously discussed, for buyers situated in states that charge sales tax, the ability to deduct sales taxes for federal income tax purposes is due to expire on December 31, 2005. Therefore, unless this deductibility is extended, it is advantageous for those persons to purchase large ticket items in 2005.

If the vehicle is a qualified hybrid vehicle, a deduction of up to $2,000 of the cost is also allowed if the vehicle is purchased in 2005. This is a useful deduction since it is "above the line" - it is deductible even if you do not itemize deductions, and is not subject to the phase-out of itemized deductions that applies to higher income taxpayers.

WHY BUY IN 2006? In 2006, a qualified hybrid will qualify for a tax credit from $400 to $3,400, depending on the model. A tax credit (the 2006 and beyond incentive) is better than a tax deduction (the 2005 incentive) of the same amount, since it reduces taxes dollar-for-dollar. A tax deduction only reduces the amount of income subject to tax, and thus does not reduce the tax bill dollar-for-dollar.

SO WHICH YEAR TO BUY IN? A comparison needs to be made in regard to whether a tax deduction of up to $2,000 is better in 2005, or a tax credit for the particular model car for a 2006 purchase of hybrid. Other factors favoring a 2005 purchase are the more immediate tax benefit on a 2005 tax return (instead of a 2006 return), and the above sales tax deduction for 2005 if applicable. One last factor to consider is that the tax credit will only fully apply to 60,000 vehicles from each manufacturer - thereafter, the credit is reduced and eventually eliminated for such manufacturer. A 2006 purchase runs the risk that your desired hybrid model may not qualify for the full credit due to this limit.

Hong Kong Seeks to Abolish Its Estate Taxes

Hong Kong's Legislative Council has passed the Revenue (Abolition of Estate Duty) Bill 2005 which seeks to amend the Estate Duty Ordinance to implement the proposal announced in the 2005-06 Budget to abolish estate duty. The Ordinance will commence operation on Feb. 11, 2006.

The Secretary for Financial Services and the Treasury, Frederick Ma, said that apart from removing the unfairness and obstacles arising from the collection of estate duty, another key objective of the proposed abolition was to facilitate the further development of Hong Kong as an important asset management center. The government consulted the public last year on whether to abolish estate duty. By and large, the majority view tended to support abolition. Ma believed that by abolishing estate duty, Hong Kong can attract more local and overseas investors to hold assets here. More companies and professionals will come here, which will facilitate the further development of asset management services, create more employment opportunities, and in turn make Hong Kong more competitive as an international financial center. "The abolition of estate duty is not only a tax concession but also a long term strategic investment in Hong Kong's financial services industry and the overall development of the economy," he stressed. It is estimated that the proposal to abolish estate duty will cost the government annual revenue of around 1.5 billion HK dollars (193.55 million US dollars).

Tax Return Filing Obligations Imposed on Bankrupt Debtors

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) amends the U.S. Bankruptcy Code by adding new tax return responsibilities for debtors. Most BAPCPA provisions apply to cases filed on or after Oct. 17, 2005.

If debtors fail to file a return that becomes due after the date of their bankruptcy petition, or fail to file an extension, the IRS may request the Court to order a conversion (change from Chapter 7 to Chapter 11 or from Chapter 11 to Chapter 13, for example) or dismiss the case. To have their plan confirmed, Chapter 13 debtors must also file all tax returns with IRS for the four-year period before the bankruptcy petition. The debtor must establish filing by the first meeting of creditors.

Seven days before the first meeting of creditors, debtors must give trustees a copy of their most recently filed federal tax return or a transcript of the return. Similarly, copies of amendments to the returns, and any past due returns filed while the case is pending, must also be filed with the court if requested. The returns or transcripts must be provided to the court at the same time they are filed with IRS. If the returns or transcripts are not filed, a Chapter 7 discharge will not be granted, or a Chapter 11 or 13 plan will not be confirmed. In addition, debtors must also provide a copy of the tax return or transcript to requesting creditors.

Lottery Luck Runs Out in Recent Case

After the lottery winner checks to see how much he won, his or her next thoughts turn to what will be left after taxes. Since lottery payouts are taxed as ordinary income, a good piece of each payment goes to the IRS.

Some lottery winners sell their right to payments over many years to a third party buyer. The issue arises whether such sale can be taxed as a sale of a long term capital asset (if the original payout stream was held for long enough) so as qualify for the 15% maximum tax on individual capital gains. These rates can be less than 1/2 of the ordinary income rates.

In conformance to other recent rulings, the U.S. Tax Court has confirmed its reading of the law that long term capital gain treatment is not available. The Tax Court applied the "substitute for ordinary income doctrine" to disallow capital gain treatment. Under this doctrine, a court will narrowly construe the term "capital asset" when a taxpayer makes an attempt to transform ordinary income into capital gain. Prebola v. Commissioner, TC Memo 2005-261 , 2005 RIA TC Memo ¶2005-261

Bankruptcy Act is a Mixed Bag for Taxpayers

While some taxes are discharged in bankruptcy, not all are. For example, income taxes cannot be discharged if they are from tax returns due within three years of the bankruptcy petition filing date, or if they are assessed or assessable within 240 days of the petition. In the past, taxpayers have used offers in compromise and successive bankruptcy filings to get more taxes covered by the discharge. The new bankruptcy laws restrict these strategies by suspending the running of the time periods and adding additional days in these situations. The new law also resolves an existing uncertainty in the law by unequivocally providing that the "automatic stay" provisions that apply to tax issues do not apply to post-petition taxes.

There are some rule changes that benefit taxpayers. One change is that the IRS needs to file a timely claim for nondischarged taxes in Chapter 7 bankruptcies. This was not the case in the past. Another benefit of the new law is that which allows tax authorities to set off pre-petition tax refunds due to a debtor against pre-petition taxes owed by the debtor. This benefits debtors because it stops interest from accumulating on pre-petition taxes due by the debtor and set-offs of other debts are not normally allowed by the bankruptcy court.

Source: New Law Toughens Rules for Avoiding Taxes Through Bankruptcy, Practical Tax Strategies, Nov 2005 by Randall K. Hanson and James K. Smith

Homestead Property and Florida Probate

Florida law regarding homestead is quite complex, with Florida appellate courts constantly addressing homestead issues. A recent appellate court decision summarized various principles of Florida law when a decedent's homestead was left under his Last Will to his three children:

the homestead property passed free of claims of the decedent's creditors since all of the devisees were heirs of the decedent, that is, they were within the class of persons who could be a beneficiary of the decedent under the laws of intestacy;

the homestead was not part of the probate estate as there was no explicit direction to sell the homestead;

even though not part of the probate estate, the personal representative nonetheless could take control over the homestead to protect it;

however, this power of control did not give the personal representative the power to sell the homestead.

Harrell v. Snyder et al, 5th District Court of Appeals Case No. 5D04-1961 (November 4, 2005)

Florida Intangible Tax Planning Deadline Approaching

Florida persons owning intangible property are subject to an intangibles tax. The tax rate has been reduced for 2006 from $1,000 per $1,000,000 of taxable intangible assets (e.g., stocks and bonds) to $500 per $1,000,000 of taxable intangible assets.

The tax is imposed based on assets owned on January 1. Since assets owned before and after that date do not enter into the computation, the tax is essentially avoidable with proper planning. This planning includes:

–transferring intangible assets to a special type of trust before January 1, under which neither the trust nor any beneficiary is subject to intangibles tax (note that while trusts are exempt from the tax, Florida beneficiaries can be taxed on their trust interests depending on the terms of the trust). After January 1 (subject to a reasonable waiting period) assets are typically then returned to the original owner(s);

–converting assets to intangible assets that are not subject to the tax before January 1, such as into Florida municipal bonds and funds owning exclusively such bonds; and

–owning assets in non-Florida limited partnerships that are not managed or controlled in Florida.

A single individual is not taxed on the first $250,000 of his or her taxable intangible assets, and a married couple has a $500,000 exclusion.

The end of the year comes upon us quicker than you would expect. For those who need year end planning, now is the time to get started.

IRS Automatic 6 Month Extensions for Income Tax and other Returns Now Allowed

Old Rules. Currently, most taxpayers other than corporations can receive a full six-month extension of time to file their income tax returns, but to obtain the full six-month extension they must file one application for an initial extension of time and then a second one. For example, individual income taxpayers request an initial four-month automatic extension on one form and then use a second one to request a two-month discretionary extension. Similarly, trusts and partnerships request an initial three-month automatic extension on one form and then use a second one to request a three-month discretionary extension.

The Change. To reduce the complexity of the pre-existing extension process, and to provide cost savings and other benefits to taxpayers and IRS, new regulations simplify the extension process by allowing most taxpayers to file a single request for an automatic six-month extension of time to file.

New Rules - Individuals. An individual may obtain an automatic six-month extension to file an income tax return by submitting a timely, completed application for extension on Form 4868. There is no need to sign the request or explain why an extension is sought. As under the pre-existing process, taxpayers must make a proper estimate of any tax due and failure to pay any tax as of the original due date of the return may subject the taxpayer to penalties and interest. (Reg. § 1.6081-4T )

New Rules - Corporations. The regulations don't change the rules on filing extensions for corporate income tax returns. Currently, corporations may obtain an automatic six-month extension of time to file their income tax returns by submitting Form 7004, Application for Automatic Extension of Time To File Corporation Income Tax Return. Corporations don't have to sign the extension request or give a reason for the request. Form 7004 does not extend the time for payment of tax—corporations filing Form 7004 must compute the total amount of their tentative tax and make a remittance of any balance due.

New Rules - Gift Tax Returns. Under Code Sec. 6075(b)(2) , an individual who makes a gift and who requests an automatic extension of time to file his income tax return is deemed to have an extension of time to file the return required by Code Sec. 6019 . Donors who do not request an extension of time to file an income tax return to request an automatic six-month extension of time to file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, by filing a new version of Form 8892, Payment of Gift/GST Tax and/or Application for Extension of Time to File Form 709. ( Reg. § 25.6081-1T ) Under the regs, Form 8892 no longer requires an explanation of the need for the extension of time to file or a signature.

Warning! An extension to file a tax return is NOT an extension to pay the taxes due under the return. If a sufficient tax payment is not made by the original due date of the return, penalties will likely apply for the late payment.

IRS Extends Withholding Program Amensty

Under Section 1441 of the Internal Revenue Code, U.S. payors of certain types of income to nonresidents (e.g., U.S. source interest, dividends, and rents) are obligated to withhold tax at 30% (or lower treaty rates) when such income is paid to a nonresident. This assists the IRS in collecting these taxes that might not otherwise be paid by foreign persons by shifting the payment obligation to the U.S. payors.

Since September 29, 2004, the IRS has had a program for U.S. payors that have withholding obligation issues. Under the program, the U.S. withholding agent agrees to identify to the IRS areas in which it isn't in compliance with obligations on payments to foreign persons, pays tax, interest, and any penalties, and implements corrective procedures to ensure future compliance. In turn, the IRS agrees not to impose penalties on underpayments that are due to reasonable cause, and will provide the withholding agent with written acknowledgement that its compliance procedures and policies are acceptable.This program was set to expire on December 31, 2005. However, due to the heavy volume of use, the IRS has now extended the deadline of the program to March 31, 2006. Revenue Procedure 2005-71.

Buy-Out Insurance Owned by Corporation Does Not Increase Estate Tax Values

To provide liquidity to a decedent's estate, or to provide for succession of ownership, buy-sell agreements are often entered into obligating a corporation to buy the stock of a major stockholder at the death of that stockholder. This purchase obligation is often funded by the corporation purchasing a life insurance policy on the life of the shareholder. That way, when the shareholder dies, the corporation receives the life insurance proceeds and thus has the cash to purchase the stock.

Since the estate of the decedent shareholder is subject to estate tax based on the value of the stock, the question arises whether the value of the stock (which is based on the value of the assets of the corporation) should be increased to account for the life insurance proceeds payable to the corporation. There has been case law to the effect that such insurance is NOT included in the valuation computation, but in a recent case the Tax Court ruled that the insurance proceeds should be counted in determining the value of the corporation (and the stock of the decedent stockholder).

In a ruling favorable to taxpayers, the U.S. Eleventh Circuit Court of Appeals reversed the Tax Court and held that the insurance proceeds should not be taken into account. The Court noted that the value of the insurance payout was offset by the obligation of the corporation to purchase the shares, and thus should not impact valuation of the company or the shares. Estate of Blount v. Comm., 96 AFTR 2d 2005-XXXX, (10/31/2005 CA11).

Nonresident Wage Earners May Not Need to File a U.S. Income Tax Return

Generally, nonresident individuals of the U.S. who perform services in the U.S. are required to file a U.S. income tax return (Form 1040NR), regardless of the level of income arising from those services. The IRS has now announced it will amend its Regulations to eliminate the filing requirement for nonresident alien individuals who have U.S. source effectively connected wages in amount below amount of one Code Sec. 151 personal exemption (which is presently $3,200). This amendment will be effective for tax years beginning on or after 1/1/2006 and will apply even if the nonresident alien also has U.S. source fixed or determinable income if that tax liability thereon is fully satisfied by withholding by the payor of such fixed or determinable income (e.g., dividends and interest). Notice 2005-77.

Florida Filing Extensions for Hurricane Victims

Corporate Tax Returns: The Florida Department of Revenue has indicated that it will follow the special tax relief granted by the IRS for filing of corporate income tax returns. The Department will extend the due date for filing the Florida corporate income tax return and tax payments to March 15, 2006. The extended due date applies to taxpayers affected by Hurricane Katrina with original or extended due dates on or after August 29, 2005, taxpayers affected by Hurricane Rita with original or extended due dates on or after September 23, 2005, and taxpayers affected by Hurricane Wilma with original or extended due dates on or after October 23, 2005.

Intangible Tax Returns: The Florida Department of Revenue has extended the filing deadline for intangible taxes until January 18, 2006 for taxpayers with valid extensions in those counties in Florida designated disaster areas, which include: Broward, Miami-Dade, and Monroe Counties and any counties or parishes in Mississippi, Louisiana, Texas and/or Alabama.

Hurricane Wilma!

Due to Hurricane Wilma and extended power outages, we have not been able to do our regular blog posting. We hope to get things back to normal sometime this week. To those of you in South Florida, we wish you a speedy recovery from the storm.

Applicable Federal Rates - Update for November 2005

November 2005 Applicable Federal Rates Summary (Rev.Rul. 2005-71):

-Short Term AFR - Semi-annual Compounding - 4% - (3.89%/Oct. -- 3.9%/Sept.)

-Mid Term AFR - Semi-annual Compounding - 4.19% - (4.08%/Oct. -- 4.19%/Sept.)

-Long Term AFR - Semi-annual Compounding - 4.52% - (4.40%/Oct. -- 4.52%/Sept.)

IRS Guidance for Private Foundations

Does your family operate a private foundation? Are you the CPA or attorney for a private foundation? Are you curious about private foundations? The IRS now has a website on the life cycle of a private foundation, with lots of information regarding setting up, operating, and terminating one.

The link is http://www.irs.gov/charities/charitable
/article/0,,id=127912,00.html.

Spend it Now, Not Later

The remaining months of 2005 may provide a last chance opportunity for taxpayers who itemize deductions to deduct state and local sales taxes in lieu of state and local income taxes.

For tax years beginning in 2005, taxpayers may elect to take state and local general sales and use taxes as an itemized deduction, instead of deducting state and local income taxes. Internal Revenue Code Section 164(b)(5). Electing taxpayers may either (a) deduct their actual sales and use taxes or (b) use IRS-published tables and then add to the amount from those tables the actual amount of their sales tax for certain "big-ticket" items—motor vehicles, boats, aircraft, homes (including mobile and prefabricated homes), and home building materials.

This provision primarily benefits taxpayers who live in states without an income tax, but some taxpayers in other states may benefits if they made major purchases during the year and their state income tax is relatively low.

This option to deduct sales taxes is set to expire at the end of 2005. While it may be extended, there is no way of knowing what Congress may do. Accordingly, individuals who are considering the purchase of a big ticket item (such as an automobile) may want to complete the purchase in 2005 to achieve a higher itemized deduction for sales taxes.

She Should Have Waited Until Mom Died

Joint bank account cases often make for interesting reading. Here is an interesting case from Florida’s 4th District Court of Appeals, issued on October 19, 2005.

Facts:
a. Mom opens a bank account with daughter - the account is held as joint tenants with rights of survivorship.
b. Daughter withdraws money from the account for her own use.
c. Mom does not agree to the withdrawal and asks for the money back.
d. Mom dies, and her estate demands the money back from daughter.
e. Daughter argues that since Florida law says that a bank can pay the assets from a joint account to one of the joint account holders without consulting the other, and that since she would have gotten the funds when mom dies, she can keep the money.

Decision: Daughter owes the money back. The Court held that (i) the above Florida law is for the protection of the bank, and does not create legal entitlements to ownership of assets in a joint account, (ii) that daughter would have gotten the money when mom died is irrelevant to what occurs during lifetime, and (iii) authorization to withdraw the funds is not the same thing as authorization to use the funds for personal benefit.

Observation: If daughter had left the money in mom's account until mom died, there's a good chance she would have gotten all the funds!

Sandler v. Jaffe, 30 Fla. L. Weekly D2446a (4th DCA 2005)

Disregard Entities - A Little Less Disregarded

Under federal tax rules, at times an entity owned by another taxpayer may be "disregarded" for tax purposes. This generally means that all of the tax incidents of the disregarded entity are reported by its owner. The two principal types of disregarded entities are Qualified Subchapter S Subsidiaries and entities that are owned by one owner and are not taxed as a corporation/association under the check-the-box rules (e.g., single member limited liability companies).

The "disregarded" status of such entities may soon disappear for certain tax issues. Under proposed regulations, such entities would cease to be disregarded for employment tax and related reporting purposes, as well as for certain excise tax rules. Since the rules are only proposed, they are not currently applicable. Preamble to Prop Reg 10/17/2005 ; Prop Reg § 1.34-1 ; Prop Reg § 1.1361-4 ; Prop Reg § 301.7701-2.

2006 Indexing Updates

The Social Security Administration has announced that the wage base for computing the Social Security tax in 2006 rises to $94,200 from $90,000 in 2005, an increase of about 4.67%. This means that the amount of wages subject to these taxes has now increased, and thus the total Social Security taxes of a wage earner who earns at or in excess of the maximum will also be increased. The OASDI tax rate for wages paid in 2006 is set by statute at 6.2 percent for employees and employers, each. Thus, an individual with wages equal to or larger than $94,200 would contribute $5,840.40 to the OASDI program in 2006, and his or her employer would contribute the same amount. The OASDI tax rate for self-employment income in 2006 is 12.4 percent. Note that this increase does not impact the Medicare Hospital Insurance program tax - this tax rate is 1.45 percent for employees and employers, each, and 2.90 percent for self-employed persons - this tax, which is in addition to the above OASDI taxes, has no cap and thus is applied to all wages no matter how high.

Also for 2006, the limit on the income tax exclusion for elective deferrals of wages, that is - the maximum amount an employee may defer into 401(k) plans, 403(b) annuities, SEPs, and the federal government's Thrift Savings Plan, increases from $14,000 to $15,000. The limitation on the annual benefit under a defined benefit pension plan increases from $170,000 to $175,000. The limit on annual additions to a participant's defined contribution pension account increases from $42,000 to $44,000.

Year End Tax Planning

Some year end planning considerations to start thinking about -

A deduction for college tuition is scheduled to go off the books unless Congress extends it. You may want to prepay in 2005 tuition not due until early 2006 if that lets you increase your tax savings from the expiring deduction.

The Energy Tax Incentives Act of 2005 provides a new tax credit for making certain energy-saving improvements around the house. But the new credit is not available until 2006, so you may want to hold off on the improvements if possible.

On January 1, 2006, the deduction for buying a hybrid automobile converts to a tax credit that's probably more valuable to auto buyers than the deduction. So if you are thinking about buying a hybrid, you may want to delay your purchase until 2006.

The Katrina Emergency Tax Relief Act of 2005 allows some taxpayers to claim bigger charitable deductions than in the past because the Act lifts restrictions that limited the deductions. But it's only a temporary reprieve; the restrictions return after December 31, 2005. So, if the restrictions apply to you, you may want to consider accelerating your charitable donations from 2006 to 2005.

Contributing Your Car to Charity

A popular method of gifting to charities is to contribute an automobile that would otherwise be sold or traded in. Unfortunately, there was a perception that taxpayers were putting a value on the contributed automobile that was oftentimes much higher than what the charity could get for the car when it sold it.

Under new rules that take effect this year, the deduction for “qualified vehicles” (motor vehicles, boats and planes that aren't inventory or held for sale in the ordinary course of business) contributed to charity for which the claimed value exceeds $500 is dependent on the charity's use of the donated property. If the charity sells the vehicle without any “significant intervening use” or “material improvement,” or transfers it to other than a needy person at a price significantly below fair market value in furtherance of its charitable purpose, the donor's charitable deduction can't exceed the charity's gross proceeds from the sale. The IRS has released new Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes to report such transfers.

No Private Cause of Action Against Section 501(c)(3) Entities

Code Section 501(c)(3) organizations are generally exempt from federal income taxes, and contributors receive a tax deduction for their contributions.

In an interesting case, an individual sued a hospital and related health care entities, claiming damages for failing to provide “mutually affordable medical care” to indigent or uninsured patients without regard to their ability to pay, as purportedly required for the Code Section 501(c)(3) status of the health care entities. The individual alleged that due to the defendants' tax-exempt status under the Internal Revenue Code, the Defendants entered into an express or implied contract with the United States, the Commonwealth of Pennsylvania, and local government bodies and agreed to provide affordable medical care to all hospital patients, to abstain from “humiliating” debt collection practices, and to prevent any private entities from deriving a profit from Defendants' healthcare operations.

While an interesting argument, it was not a good argument, and the case was dismissed. FELICIANO v. THOMAS JEFFERSON UNIVERSITY HOSPITAL, 96 AFTR 2d 2005-XXXX, (DC PA), 09/28/2005.

50% Limit on Charitable Contributions Temporarily Suspended

Generally, individuals making substantial charitable deductions cannot use the charitable income deduction to eliminate all of their taxable income. A 50% limit applies to qualified contributions to the appropriate taxable entity- the maximum charitable deduction allowed is 50% of the adjusted gross income of the taxpayer (without regard to net operating loss carrybacks). Lower percentage limits may apply based on the type of property contributed and the type of entity that receives the contributions.

As part of the Hurricane Katrina Emergency Tax Relief Act of 2005, this 50% limit is suspended for cash contributions made to publicly supported charities. This will apply only for contributions made through December 31, 2005. Interestingly, there is no requirement that the recipient charity be engaged or involved in hurricane relief efforts.

Some recipients will not qualify:

-Section 509(a)(3) "supporting organizations’
-Donor advised funds
-Private nonoperating foundations

Gifts to Foreign Charities

If you would like an income tax deduction for gifts for use abroad, generally gifts cannot be made to organizations organized in a foreign country. Listed below are some general planning arrangements that allow for making tax-deductible gifts that are directed for use abroad:

-gifts to organizations organized in certain countries with tax treaties allowing for the deduction (e.g., Israel, Canada, Mexico)

-gifts to domestic "friends of" organizations that provide financial support to foreign charities (so long as such organizations are not obligated to transfer gifts to a foreign organization)

-gifts to a "donor advised fund" that makes international grants

-gifts through U.S. private foundations that meet specific expenditure rules for grants to foreign organizations

-gifts to domestic organizations that directly expend funds abroad in furtherance of their exempt purpose.

Shareholder Prevails on Loan Characterization

Shareholders of Subchapter C corporations (that is, corporations that have not elected Subchapter S status) are subject to tax on dividends distributed from the corporation (to extent of the undistributed earnings of the corporation). To avoid or defer this tax, shareholders do a lot of things to get access to the money but not pay the tax. One common mechanism is for the shareholder to borrow the money from the corporation so that it is not treated as a dividend distribution. Shareholders that do this need to cross their i's and dot their t's - have a written promissory note, a reasonable rate of interest, have security for the debt, and other evidence of arms-length debt to overcome an IRS that is interested in characterizing the loan as a dividend distribution.

Note, however, that the lack of proper documentation is not always fatal to loan treatment should the IRS contest the issue. In a recent Tax Court case, the IRS's determination that a software developer/consultant had constructive dividends from advances which his closely owned consulting corporation made to him or on his behalf, and which were used for new home purchase and various personal expenses, was rejected - the taxpayer proved that the advances were nontaxable loans. Although advances weren't memorialized in any formal loan documents, weren't subject to any fixed repayment schedule, and weren't secured, loan treatment was still supported by facts taxpayer made reasonable interest payments, repaid a relatively substantial portion of the loan principal, had reasonable prospects of repaying balance, and had expressly agreed with another shareholder to use the funds as loans. Nariman Teymourian v. Commissioner, TC Memo 2005-232, 2005 RIA TC Memo ¶2005-232 (2005).

U.S. Income Taxes Remain Highly Progressive

The IRS has released its latest tax statistics, disclosing date for tax year 2003. Some of the key numbers regarding progressivity:

a. The top 1 percent of U.S. taxpayers, who earn a minimum annual income of at least $300,000, paid more than a third of personal income taxes in 2003.

b. The top half of all U.S. taxpayers accounted for all but 4 percent of the 2003 individual income tax receipts.

c. The top 10 percent of taxpayers, with an income of at least $95,000, were responsible for two-thirds of personal income taxes paid for the year.

The next time you hear that a proposed tax cut will only cut the taxes of the richer half, well that's because they are the only ones paying taxes to begin with!

Mail Rules

All tax systems have deadlines - deadlines for filing items, deadlines for making payments. The taxes under the Internal Revenue Code are no different. Since most items and payments are submitted via mail, when are items deemed filed and how does a taxpayer prove submission?

Certain rules have been developed in regard to these issues, both under the Internal Revenue Code and under common law. As much as you would think these issues have been resolved after so many years, there are still some open questions on these issues. Just this week, the U.S. Supreme Court refused jurisdiction over a case that addressed the issue whether a taxpayer can attempt to prove receipt of an item filed with the IRS if it was not submitted via certified or registered mail.

Below is a general overview of the two key issues (when is an item deemed filed, and how does one prove filing).

1 Proof of Receipt by IRS-------------------------------------------------------------

-1.1 Proof of registered or certified mail and that envelope was properly addressed is prima facie evidence of delivery (Code Sec. 7502)

-1.2 Common Law Mailbox Rule: when mail is properly addressed and deposited in the U.S. mails, with proper postage, there is a rebuttable presumption of receipt by the addressee

---1.2.1 There is a split among the courts whether this can be used absent use of registered or certified mail (that is, whether Sec. 7502 overrides the common law mailbox rule)

-----1.2.1.1 The Supreme Court recently refused to review a recent case that held that Sec. 7502 does not override the common law mailbox rule [Sorrentino, 94 AFTR 2d 2004-5902, cert denied 10/3/2005]

-----1.2.1.2 Prop. Reg. Sec. 301.7502-1(e) provides in effect that Code Sec. 7502 overrides the common law mailbox rule

-1.3 Effect: to avoid any question as to IRS receipt, use certified mail or registered mail

2 Time of Filing or Payment-------------------------------------------------------------

-2.1 When received after a filing date, the IRS will use the postmark date as the mailing/filing date so effectively deemed filed/paid as of the date of mailing (Sec. 7502(a)

---2.1.1 if the postmark date is on or before the due date (Sec. 7502(a)(2))(A))

---2.1.2 if the item was properly addressed and mailed (Sec. 7502(a)(2)(B))

-2.2 When sent by registered or certified mail, the date of registration or certification is treated as the postmark date for this purpose

3 Exceptions-------------------------------------------------------------

-3.1 Court filings, other than Tax Court

-3.2 Currency or other medium of payment unless actually received

-3.3 items requiring by law to be delivered by means other than mailing

Monitoring Insurance Policies In Trusts

Owning life insurance through irrevocable trusts is a common estate planning device to limit exposure to U.S. estate taxes. The trustee of the trust has some standard jobs, including receipt of premium funds and payment of premiums, and Crummey notices. What is often overlooked is the trustee's obligation to exercise oversight of the policy.

While in practice probably not observed by any but the most scrupulous corporate trustees, all life insurance trustees should give due consideration to the following:

• Analysis of the proposed carrier, before the policy is acquired.
• Analysis of the proposed or existing policy.
• Regular monitoring of the insured's health, to determine whether premium payments should be continued and whether a different policy with a different anticipated scope of coverage is advisable.
• Annual consultation with an insurance agent to review the policy and the factual situation.

There are consultants who can be engaged by the trustee to assist in these matters (e.g., Advicon). By engaging in these activities, a trustee will go a long way towards both doing a good for the trust beneficiaries and protecting itself from litigation by disgruntled beneficiaries.

Does the $125,000 Homestead Exemption Cap Apply in Florida?

Inside and outside of bankruptcy, an individual’s homestead is exempt under Florida rule from the reach of his or her creditors (with some exceptions). In the recent Bankruptcy Act, Congress limited this protection in bankruptcy to the first $125,000 of value of a homestead if the debtor has owned the homestead for less than 1,215 days. Or at least, that is what everyone originally thought.

An opinion of an Arizona bankruptcy court (In re McNabb) held that the $125,000 cap did not apply in states such as Arizona (and by implication Florida) where state legislatures have officially "opted out" of the Federal scheme of exemptions found in the Bankruptcy Code. This opinion was based on a literal reading of the statute, which apparently was not well drafted and left the door open for this interpretation.

The bankruptcy courts in Florida have now entered the fray. In a recent ruling, Judge Mark of the Southern District of Florida decided that the cap did apply - the opposite finding of In re McNabb. How this issue will be ultimately resolved is unknown (including resolution through the passage of a Congressional "glitch" bill), but Judge Mark’s ruling is clearly not heartening to Florida debtors who have not owned their homesteads for the requisite 1215 days.

IRS Helps Practitioners with Charitable Remainder Unitrusts Forms

Updating its forms from 15 years ago, the IRS has issued sample charitable remainder unitrust forms for use by practitioners in drafting effective split-interest charitable trusts. Generally, a charitable remainder unitrust is a trust that provides for the payment of a fixed percentage of a trusts assets on an annual or more frequent basis to one or more individuals, followed by the transfer of the remaining trust assets to one or more qualified "charitable" organizations. It allows taxpayers to enjoy the income/cash flow from assets while stil obtaining valuable tax benefits due to its charitable nature.

The particular trusts provided are:

-inter vivos and testamentary trusts for one measuring life
-inter vivos and testamentary trusts for term of years
-inter vivos and testamentary trusts for 2 measuring lives
-inter vivos and testamentary trusts for 2 measuring lives

Rev. Procs. 2005-54 through -59.

IRS Warns Taxpayers Regarding Evasion of FIRPTA Withholding Requirements

The IRS is warning real estate and tax professionals of the withholding tax and filing requirements for two transactions in which a foreign person disposes of a U.S. real property interest:

Option Transactions. Under U.S. tax law, a foreign person that sells or exchanges a U.S. real property interest must report the gain on a U.S. tax return, and the buyer of the U.S. real property interest must withhold and pay to the IRS 10 percent of the gross amount paid to the foreign person. A U.S. real property interest includes options or contracts to acquire land or land improvements and leaseholds of land or land improvements. The disposition of such an option or contract by a foreign seller is reportable on the foreign seller's U.S. tax return and is subject to a 10 percent withholding tax payable by the buyer to the IRS. Under U.S. tax law, the buyer must determine if the seller is a foreign person. If the seller is a foreign person and the buyer fails to withhold, the buyer can be held liable for the withholding tax.

The IRS has become aware of instances in which foreign persons have acquired options or entered into contracts to purchase U.S. real property interests and sold the options or assigned the contracts before such instruments are exercised or executed and title to the underlying property is taken. Buyers of the options or contracts are failing to withhold and remit to the IRS the required 10 percent from the proceeds of the sale.

Transfer to a Shareholder. The IRS is also aware of potentially abusive transactions where a foreign corporation arranges a sale of its U.S. real property interest to a buyer and then transfers its U.S. real property interest to its foreign individual shareholder. The foreign shareholder then sells the U.S. real property interest to the buyer. The foreign shareholder takes the position that, because he or she, rather than the corporation, is selling the property, some or all of the gain inherent in the foreign corporation's U.S. real property interest is subject to a maximum capital gains rate of 15 percent. That is, the foreign shareholder claims that the transfer of the U.S. real property interest by the foreign corporation to the shareholder does not result in any tax (if the foreign corporation had directly sold the U.S. real property it would have been subject to tax at a rate as high as 35 percent).

The shareholder's position is incorrect. Generally, the foreign corporation (and not the foreign individual shareholder) is taxed on all of the gain inherent in the U.S. real property interest. The transaction is treated as a taxable sale of the U.S. real property interest by the corporation, either because the corporation is making a distribution to the foreign shareholder of the U.S. real property interest (which would constitute a deemed sale of such interest at the corporate level) or because the corporation is viewed as selling the entire U.S. real property interest directly to the buyer. In cases where the foreign corporation is treated as making a distribution of the U.S. real property, the foreign corporation is also subject to a withholding tax of 35 percent on the gain in the property, unless it qualifies for reduced withholding.

Hurricane Katrina and the Politics of Estate Tax Repeal

Hurricane Katrina postponed action that was to be undertaken on estate tax repeal at the beginning of the current Congressional session. The large emergency expenditures have further made the case for repeal more difficult, at least in the eyes of many. A recent story by Time that a Senator is out looking for a victim of Katrina that was a business owner and whose estate is subject to estate tax, so as to utilize such a victim to revitalize the repeal effort probably isn't going to help repeal efforts, either.

Link

IRA's, Computers & College

Distributions from qualified retirement plans and IRAs before age 591/2 generally are hit with a 10% penalty tax under Code Sec. 72(t)(1) . There are a number of exceptions to the penalty including one for distributions from an IRA used to pay for qualified higher education expenses. ( Code Sec. 72(t)(2)(E) ) For this purpose, qualified higher education expenses are expenses for tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. ( Code Sec. 72(t)(7) , Code Sec. 529(e)(3)(A) )

Is a computer required "equipment" for this purpose? According to the U.S. Tax Court, and although my own children will disagree, a computer is generally not required equipment for a college student these days. Mr. Gorski’s daughter attended Miami University in Ohio, and used IRA funds to buy a computer for her. Mr. Gorski admitted that there was a bank of computers available for student use located in the university's library but he said that there were only four or five computers available for 15,000 students at any time. He further testified that by having her own computer, his daughter would not have to use these library computers and risk walking from the library back to her dorm room late at night. The Tax Court said that while the Gorskis' concern for their daughter's safety was understandable, it and other arguments advanced by them did not prove that the purchase of a computer was required by Miami University, and imposed a 10% early withdrawal penalty on the Gorskis. Gorski, TC Summary Opinion 2005-112.

GOP to Seek Tax Rate Increase?

According to the Wall Street Journal,

"a handful of GOP Senators think a tax increase is needed to pay for Katrina pending. Their immediate target is the 15% rate on capital gains and dividends that was a crucial part of the wildly successful 2003 tax cuts. Those rates are set to expire in 2008, which would mean a big tax increase back to a 35% rate on dividends, and 20% on capital gains."

But even with Hurricane Katrina and the Gulf War, is a tax hike needed?

"$262 billion. That's the amount of additional revenue that the federal government will collect in the fiscal year that ends this month, a roughly 15% increase. This is the largest annual increase in federal revenues, even after inflation, in American history."

Link

Tax Planning that Violates Foreign Law

Generally, the U.S. will not assist in the collection of taxes of a foreign jurisdiction, under a long standing common law principle. This principle was brought into play earlier this year when the U.S. Supreme Court considered the issue whether a crime occurs in the U.S. under U.S. wire fraud statutes when activities are undertaken in the U.S. that result in the defrauding of non-U.S. (Canadian) tax authorities. In Pasquantino v. U.S., 96 AFTR 2d 2005-5392, (S Ct), 04/26/2005, the Supreme Court held the common law principle did not provide insulation against a U.S. wire fraud prosecution.

The Supreme Court’s interpretation of the wire fraud statute was also interesting. 18 U. S. C. §1343 prohibits the use of interstate wires to effect "any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses." By holding that Canada's right to receive tax revenue was "money or property," the use of U.S.interstate wires to effect such a scheme was found to be a violation of the statute.

The obligations of tax planners to consider whether their planning results in a violation of foreign law has long been debated. Pasquantino is a warning to practitioners that there are limits out there that may require them to address foreign tax law in their planning, but where those limits are is still an uncertain area.

Applicable Federal Rates - Update for October 2005

October 2005 Applicable Federal Rates Summary (Rev.Rul. 2005-66):

-Short Term AFR - Semi-annual Compounding - 3.89% (3.9% - September)
-Mid Term AFR - Semi-annual Compounding - 4.08% (4.19% - September)
-Long Term AFR - Semi-annual Compounding - 4.40% (4.52% - September)

2006 Inflation Adjustments

The following anticipated 2006 cost-of-living adjustments are expected:

a. For gifts made in 2006, the gift tax annual exclusion will increase to $12,000 (up from $11,000 for gifts made in 2005).

b. For estates of decedents dying in 2006, the limit on the decrease in value that can result from the use of special valuation will increase to $900,000, up from $870,000 in 2005.

c. For gifts made in 2006, the annual exclusion for gifts to noncitizen spouses will be $120,000 (up from $117,000 in 2005).

Subchapter S Income in the Divorce Scenario (Florida)

The Florida Supreme Court recently ruled that “pass-through” income of an S corporation that is not distributed to shareholders does NOT constitutes income within the meaning of chapter 61, Florida Statutes (2004), for purposes of calculating alimony, child support, and attorney's fees.

However, where the undistributed “pass-through” income has been retained for noncorporate purposes, such as to shield income from reach of the other spouse during dissolution, this improper motive for its retention makes it available “income.” When the issue of whether undistributed “pass-through” income was retained for corporate purposes is contested, the shareholder-spouse is given the burden of proving that income was properly retained for corporate purposes rather than impermissibly retained to avoid alimony, child support, or attorney's fees obligations by reducing the shareholder-spouse's amount of available income. In such an inquiry, the factors to be considered include the extent to which the shareholder-spouse has access to or control over the “pass-through” income retained by the corporation, limitations set forth in section 607.06401(3) governing corporate distributions to shareholders, and the purposes for which “pass-through” income has been retained. In this inquiry, the shareholder-spouse's ownership interest should be considered, but is not dispositive, even where the spouse is sole or majority shareholder in corporation and has ability to control the retention and distribution of the corporation's income.

Zold v. Zold, 30 Fla. L. Weekly S626a (Florida Supreme Court 2005)

Corporate Ruling Requests Will Be Expedited

The IRS allows taxpayers to submit ruling requests on the application of tax law to specific situations. The private letter ruling received from the IRS that addresses the issue can be relied on by the taxpayer (and only that taxpayer) as to the IRS' interpretation of the tax issue.

The IRS response time on a ruling request can at times be quite lengthy. This lengthy time often discourages taxpayers from making a request in the corporate area, since the taxpayer does not want to hold off on the planned transaction that long while waiting for the ruling.

In a helpful announcement, the IRS advised that it is beginning a pilot program to have letter rulings issued within 10 weeks of application in regard to Section 355 (corporate spin-off and split-off transactions) and Section 368 (corporate reorganization transactions).

Rev. Proc. 2005-68.

Mileage Rates Updated

Due to recent fuel price increases, the IRS announced that optional standard mileage rates for expenses incurred on or after 9/1/2005 are increased: for business use, 48.5¢ per mile; and for medical or moving use, 22¢ per mile. Rev Proc 2004-64, 2004-49 IRB 898 , is modified. ( Ann. 2005-71, 2005-41 IRB ).

IRS Indicts Survivor Star

Back in law school, my professor in Criminal Tax class shared with us how the IRS loves to indict celebrities and high profile individuals for tax fraud. The reason for this is the high amount of publicity that such indictments (and convictions) garner, thus enhancing the public perception of risk of tax fraud prosecutions should they engage in fraudulent behavior.

Over the years, I have seen this play out many times with major and minor celebrities. The most recent example is Richard Hatch, a star of the reality television show Survivor.

Hatch was recently indicted on ten counts of tax evasion and bank fraud. While his attorney calls the indictment "a publicity scheme," Hatch could end up paying fines of over $1 million and spending 73 years in jail if convicted on all counts.Hatch is accused of not reporting his $1 million in winnings and that he pocketed $36,500 in donations to his foundation. According to various internet sources, earlier this year Hatch had made a plea agreement with the government but he backed out of the deal.

Private Inurement and §501(c)(3) Status - Proposed Regulations Issued

Organizations that seek exemption from federal income tax under §501(c)(3) of the Internal Revenue Code cannot operate in a manner that its earnings benefit private individuals or organizations. An organization seeking exemption files an application with the IRS to see if it qualifies.

Once qualified, an exempt organization may be subject to a special excise tax if it operates in a manner that benefits private interests (Code §4958). Proposed regulations issued on September 8, 2005 provide proposed guidance on the interaction between Code §4958 violations and §501(c)(3) status.

These proposed regulations provide that the anticipated violation of Code §4958 by an organization applying for Code §501(c)(3) status may jeopardize the issuance of a favorable Code §501(c)(3) ruling.

Further, for organizations that already have a Code §501(c)(3) ruling, the regulations provide certain criteria to be applied by the IRS in determining whether an organization’s Code §501(c)(3) ruling should be revoked. These factors are (A) the size and scope of the organization's regular and ongoing activities that further exempt purposes before and after the excess benefit transaction or transactions occurred; (B) the size and scope of the excess benefit transaction or transactions (collectively, if more than one) in relation to the size and scope of the organization's regular and ongoing activities that further exempt purposes; (C) whether the organization has been involved in repeated excess benefit transactions; (D) whether the organization has implemented safeguards that are reasonably calculated to prevent future violations; and (E) whether the excess benefit transaction has been corrected (within the meaning of section 4958(f)(6) and §53.4958-7 of this chapter), or the organization has made good faith efforts to seek correction from the disqualified persons who benefitted from the excess benefit transaction.

Prop Reg § 1.501(c)(3)-1 , Prop Reg § 53.4958-2.

Joint Property Conversion and Need to File Claim in Probate [Florida]

Generally, anyone who believes a decedent owes him or her property must file a claim against the decedent’s death within 90 days of publication of a notice to creditors. Florida law allows for an exception where fraud exists, estoppel applies, or there is insufficient notice of the creditors period.

In a recent case, a decedent transferred property in a joint account to an account in his own name before his death. The joint tenant, his wife, did not file a timely claim against the estate. She came up with two principal defenses to her failure to file a timely claim.

The first was that under the "trust exception," a claim did not need to be filed. The trust exception generally provides that if the decedent was holding property in trust for someone, a timely probate claim need not be filed to obtain that property by the beneficiary. However, the Appeals Court recognized that the "trust exception" has been restricted to express trusts, and no longer applies to constructive or resulting trusts and would not apply in this case.

The wife also tried to claim that this situation is not a claim against an estate, but simply a determination of who owns property. The Appeals Court did not accept his argument either, finding that many creditor issues regarding property are really claims of unlawful possession or theft and should be cast as claims against the estate.

DEBRA JEAN SCOTT, v. MELISSA SCOTT REYES, Appellee. 2nd District. Case Nos. 2D04-4610 & 2D04-5345. Consolidated. Opinion filed September 9, 2005

Florida Homestead Law Quiz

Question: Decedent’s Florida Last Will provides for $150,000 specific bequest to A, and residuary beneficiary is B. Assets of estate include $50,000 cash, and $500,000 homestead. Decedent is not survived by spouse or a minor child. Should the homestead be sold to help satisfy the cash devise?

Answer: No! The Florida Supreme Court provides that the homestead in this situation is not an estate asset available to satisfy specific bequests. Instead, it passes with the residuary. If the Will had directed sale of the homestead to satisfy bequests, that would be a different story, however.

McKean v. Warburton, 30 Fla. L. Weekly S61 (Fla. September 8, 2005)