blogger visitor

Sunday, April 30, 2006


The State motto of New Hampshire is "Live Free or Die." Perhaps Florida should adopt the variation "Live Here or be Taxed," as another Florida tax enters the dust bin. Last week, the Florida Senate voted to repeal the annual intangibles tax. The Florida House had previously voted on the same thing. Governor Bush is expected to sign the bill into law, fulfilling a campaign pledge from when he first ran for office. While Governor Bush had successfully reduced the rate of tax over his two terms of office, the elimination of the tax was his ultimate goal.

Florida is often thought of as a "debtors haven, " with its expansive collection of laws protecting debtors. It should likewise be considered a "tax haven," since it has no State income tax, no State estate or gift tax, has a 3% per year cap on increases in ad valorem taxes on homesteads, and has sales tax holidays for back to school shopping and hurricane supply shopping. For those that are concerned that Florida has too little tax revenue - the fight in Tallahassee this year is not about how to raise taxes but how to (or whether to refund to taxpayers) the large tax surplus Florida presently enjoys.

For those clients who have used annual intangibles taxes to minimize or avoid the intangibles tax, assuming the bill is signed into law, this end of year chore will not be needed anymore. This is good news for clients, but even better news for their brokers and financial advisors who had to do the annual paperwork to shuffle assets into and out of these trusts.

Thursday, April 27, 2006


When the IRS asserts that an insufficient amount of tax has been reported by a taxpayer, it generally must follow certain procedural steps before it can collect the additional tax.

First, it must issue a Notice of Deficiency. This Notice of Deficiency allows the taxpayer to petition the Tax Court for a redetermination of the asserted deficiency, without having to pay the tax first. If it does not issue the Notice of Deficiency, the IRS cannot proceed to the next step of "assessing" the tax - an assessment is made by recording the liability on the books of the IRS, nor the further steps of collecting the tax, including through levy against taxpayer assets.

There are exceptions to the need for a Notice of Deficiency. For example, one is not needed when the assessment arises from methematical or clerical errors, it arises from a tentative carryback or refund adjustment, or is based on the receipt of a payment of tax. Further, a taxpayer can waive the need for a Notice of Deficiency.

In Manko v. Comm., 126 T.C. No. 9 (4/20/06), the IRS and the taxpayer entered into a Form 906, Closing Agreement on Final Determination Covering Specific Matters - a closing agreement that bound the IRS and the taxpayer to the treatment of certain tax issues. The IRS never issued a Notice of Deficiency. The IRS proceeded to levy on the assets of the taxpayer for the agreed upon tax. The taxpayer objected. In its decision, the Tax Court sided with the taxpayer and held that notwithstanding the Closing Agreement, the IRS must follow the statutory procedures and issue a Notice of Deficiency before it can levy to collect the tax.

The IRS argued that issuing a Notice of Deficiency would have allowed the taxpayer to then go to Tax Court and reopen the issues of the Closing Agreement, thus obviating the benefits of using Closing Agreements to avoid litigation. The Tax Court was not impressed with this argument, noting that while the taxpayer could go to Tax Court, the Closing Agreement was still binding on the taxpayer so the agreements in the Closing Agreement could not be overturned by the Tax Court.

Interestingly, the Tax Court did recognize that there is a type of Closing Agreement that does not require a Notice of Deficiency to enforce. This is a Form 866, Agreement as to Final Determination of Tax Liability. The principal difference between the Form 866 from a Form 906 is that a Form 906 covers only the specific taxes addressed in the Agreement, while the Form 866 effects all tax issues for the subject tax year. Since the taxpayer under a Form 866 has agreed to the total amount of the taxpayer's liability for the tax year, a Notice of Deficiency provides no further procedural safeguards to the taxpayer since there is nothing left to the taxpayer to challenge in Tax Court, and thus it is not needed before the IRS can levy.

Tuesday, April 25, 2006


Owners of an Individual Retirement Account (IRA) who have reached the age of compulsary IRA distributions must withdraw a minimum amount from their IRA each year. The IRS provides a table of what percent of the IRA assets must be withdrawn each year. The Internal Revenue Code requires these distributions so that the owner starts to recognize the deferred taxes attributable to the IRA.

To "encourage" owners to make their required distribution, a whopping 50% penalty is imposed for failure to take the distribution. However, if the owner can show that the failure to withdraw was due to reasonable error and reasonable steps are being taken to remedy the shortfall, the IRS will waive the penalty.

The fly in this waiver ointment has been that the owner must FIRST pay the penalty, and THEN apply for a waiver. For large distributions, this can be a substantial financial burden, and indeed could prevent some taxpayers from even applying for the waiver.

In good news for taxpayers, the IRS has withdrawn its requirement (which was provided for in an IRS Publication and form instructions) that the penalty be paid first before a waiver application can be made.

Saturday, April 22, 2006


An important recommendation in many estate planning scenarios is that a child receive his or her inheritance in a trust, instead of outright. By using a trust to hold such property, the property is generally segregated and will likely be treated as the "separate property" of that child in the event the child ever goes through a divorce. As separate property, the other spouse should not receive an interest in that property as part of the divorce.

Not only will the trust property be treated as separate property, but the income distributed from the trust to the child (or property acquired with that income) can likewise receive separate property treatment. A recent Florida case indicates how NOT to deal with the income from a trust if one wants to preserve separate property status.

In the case, the wife/beneficiary received substantial income distributions from the trust - in excess of $8,000 per month. Instead of keeping these proceeds in a separate account, she placed them into a joint bank account with her husband. The couple pretty much lived off this income for their 19 year marriage, since the husband's sole source of income was Social Security disability payments of $569 per month.

During the course of the marriage, the couple used the funds of the joint account to purchase property in Alabama.

At the time of the divorce, the wife argued that the Alabama property was purchased with her separate property (the income of the trust for her benefit), and thus should not be factored into a property division with the husband. She argued that when she placed the assets into the joint account, she did not intend a gift to her husband. The appellate court, in reviewing these facts, held that the Alabama property was marital property, not the wife's separate property.

The two principal facts that worked against the wife appear fairly obvious, in retrospect. First, she should not have placed the income distributions in a joint account with her husband. Second, she should not have purchased the Alabama property in joint names. If she had avoided either of these, she might have prevailed. Now of course she may not have been concerned about planning for divorce during the term of her marriage, but this lack of planning did have a material effect in the end.

Thus, while the "segregation" principle seems obvious to some, it is not obvious to all. If an individual is interested in preserving separate property from a claim of a divorcing spouse, the individual needs to make the effort during marriage to segregate and keep those assets separate and apart from joint assets of the spouses or the assets of the other spouse.

Stough v. Stough, 1st DCA, April 21, 2006

Thursday, April 20, 2006


May 2006 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.79% (4.71%/April -- 4.53%/Mar)

-Mid Term AFR - Semi-annual Compounding - 4.78% (4.67%/April -- 4.46%/Mar)

-Long Term AFR - Semi-annual Compounding - 4.94% (4.73%/April -- 4.63%/Mar)


Tuesday, April 18, 2006


A taxpayer can exclude up to $250,000 of gain from the sale (or exchange) of a home owned and used by him as a principal residence for at least 2 of the 5 years before the sale. The exclusion doesn't apply if, within the 2-year period ending on the sale date, there was another home sale by the taxpayer to which the exclusion applied.

A reduced maximum homesale exclusion may apply to a taxpayer who fails to qualify for the 2-out-of-5-year ownership and use rule, or who previously sold another home within the 2 year period ending on the sale date of the current home in a transaction to which the exclusion applied. The failure to meet either rule must result from the home being sold (or exchanged) due to (1) a change of place of employment, (2) health, or (3) to the extent provided by regulations, other unforeseen circumstances. A home is sold due to unforeseen circumstances if the primary reason for the sale is the occurrence of an event that the taxpayer could not reasonably have anticipated before buying and occupying the residence.

In a recent private letter ruling, the taxpayer attempted to use the unforseen circumstances exception. After buying a residence with three bedrooms which was sufficient for his three sons and himself, he decided to adopt an orphan girl from a foreign country. Under State law, the taxpayer could not adopt her unless she had a separate sizable bedroom. To qualify for the adoption, the taxpayer sold his home which he had used and owned as his principal residence for less than two years, so as to rent a larger home.

On the facts, the IRS concluded that the taxpayer's primary reason for selling his home was an unforeseen circumstance, thus allowing him to exclude gain on the sale. Note, however, that a full $250,000 exclusion may not available - in these circumstances the exemption is prorated for the period of qualifying use.

PLR 200613009.

Sunday, April 16, 2006


Generally, expenses are capitalized if they are made to place property in an ordinarily efficient operating condition (as in the case of expenses to remedy a condition that existed when the property was acquired), or if they add to a property's value, substantially prolong its useful life, or adapt it to a new or different use. From an income tax standpoint, most taxpayers would rather have a current ordinary and necessary expense and not a capitalized expense. A current expense can be used to generate an immediate income tax deduction - a capitalized expense gets added to the tax basis of an asset and provides a tax benefit only by depreciation or amortization deductions over time or as reduced gain on sale.

The IRS and some courts have treated the costs of removing asbestos from a building as a capital expenditure because it results in an improvement in the property by reducing or eliminating human health risks. With enhanced concerns about the negative health aspects of mold, in recent years mold removal has increased. Since asbestos removal and mold removal seem to share many common attributes and purposes, there has been a concern that mold removal costs would be treated by the IRS in the same manner as asbestos removal costs - that is, as capital expenses.

In a favorable private letter ruling, the IRS has issued a private letter ruling that mold removal costs by a building owner who leased out the building was not a capital expenses, but a currently deductible ordinary and necessary business expense. In the ruling, the IRS noted that the removal project did not structurally alter the building or adapt it to a new or different use - so remediation actions that do involve structural alterations or adaption to a new use may end up with capitalized expenses. PLR 200607003.

Wednesday, April 12, 2006


A benefit of giving assets in trust, instead of outright, is the "spendthrift" protection often accorded by State law. This protection has the objective of protecting a beneficiary from himself - by insulating the trust assets from claims of the creditors of a beneficiary the trust assets are protected for future use of the beneficiary or successor beneficiaries of the trust.
In asset/creditor protection planning, the IRS is something of a supercreditor, since it often has powers superior to regular creditors. A recent IRS Internal Legal Memorandum (ILM 200614006, April 7, 2006) is illustrative of this special status, wherein the IRS analyzes its powers to reach trust property held in a spendthrift trust.
In the situation that is analyzed, an individual dies and pursuant to his estate planning documents a trust is established for his daughter. The trust has spendthrift provisions. The daughter is also trustee of the trust, and provides for the payment of current income to the daughter, and fixed distributions of portions of the principal of the trust at specified times in the future. The daughter has delinquent tax obligations to the IRS.
The ILM determined that a federal tax lien applies to the daughter’s interests in the trust as a beneficiary since a tax lien attaches to all property and rights to property of a delinquent taxpayer. Citing case law, the ILM provides that spendthrift provisions, which are state-created exemptions, cannot defeat a federal tax lien, even if effective against the claims of other creditors.
In regard to enforcing the lien, the ILM provides that the IRS can levy upon and seize the entire stream of income payments that are due to the daughter (including future income payments, presumably as and when they are due to be paid). It further provides that the IRS can levy on the future mandated principal payments, but the IRS cannot accelerate the time of payment.
It is interesting to note that the ILM did not address what would occur if the payments to the daughter were to be made only in the discretion of the trustee. In the facts given, both the income and future principal distributions involved MANDATORY distributions.
As an alternative to a levy, If a trustee ignores a tax lien on the trust assets and makes distributions to a delinquent taxpayer, the ILM notes that the IRS can sue the trustee for conversion.

Monday, April 10, 2006


In valuing a block of shares of stock of a corporation that do not constitute enough shares to control the corporation, for federal gift tax purposes or for the purpose of computing a charitable deduction a minority interest discount is generally applied. That is, in calculating the value of the shares an acknowledgment is made that since the owner of the shares at issue does not have majority control over the corporation, the value of the shares should be reduced to reflect this lack of control because an unrelated buyer would generally pay less on a per share basis for shares that do not provide control than for a block of shares that constitutes control.

How should this principal be applied when several taxpayers make gifts of shares of a corporation to a charitable recipient, if each taxpayer is only transferring a minority interest, but taken all together the total shares transferred by all of the shareholders constitutes control? In Koblick v. Comm., T.C. Memo. 2006-63 (April 3, 2006), the taxpayers argued that since control was being transferred in the aggregate, a reduced minority interest discount should be allowed under these facts.

The Tax Court looked at its decision In N. Trust Co. v. Commissioner, 87 T.C. 349 (1986). There, four shareholders agreed to transfer each of their 25-percent noncontrolling interests in their closely held corporation to certain long-term trusts. The taxpayers contended that the minority discount should be 90 percent. However, the Court allowed only a 25-percent discount. The Court determined that the taxpayers, by following a prearranged agreement to transfer the shares simultaneously, "marched in lockstep" and that "[s]o marching, their position was no different than that of a single majority shareholder."

The Court in Koblick noted that they were faced with a similar situation since the transferring taxpayer and the two other shareholders of a closely held corporation had a prearranged plan to transfer their minority shares simultaneously to the charitable recipient. Applying the "lockstep" principle, the Court found the IRS’ proposed minority interest figure of 22 percent to be too high and instead allowed only a 10 percent discount.

Note that in the N. Trust Co. case, the taxpayers wanted a large minority interest discount, to have a smaller taxable gift subject to gift tax. In the current case, the taxpayers wanted a smaller minority interest discount, so that they could obtain a larger income tax deduction for a charitable gift.

Friday, April 07, 2006


The IRS has announced the interest rates for tax overpayments and underpayments for the calendar quarter beginning April 1, 2006.

For noncorporate taxpayers, the rate for both underpayments and overpayments will be 7%.

For corporations, the overpayment rate 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.

Wednesday, April 05, 2006


With April 17 approaching, there will be some taxpayers who will be unable to pay their income taxes on time. Such taxpayers should nonetheless timely file their tax returns - the IRS imposes separate penalties for late filing and late payment so by filing (even though not paying), the late filing penalty is avoided.

The late payment penalty is 0.5% of the net tax tax due (reduced for credits for withheld taxes and estimated taxes) for each month that the payment is late, up to a 25% maximum. Of course, interest also applies to the unpaid taxes.

Here are some ideas to avoid the penalties (and interest, if the tax can be paid):

a. Borrow the tax payment from friends or family.

b. Bank loans (including home equity loans).

c. Credit card payment (where allowable by the credit card issuer). However, these providers charge a 2.49% fee, plus their usual interest.

d. Request an installment payment agreement from the IRS (using Form 9465). There is a $43 fee for these agreements. Interest is still charged on the unpaid tax, but the late payment penalty is reduced by 50% if the return is filed by the due date (including extensions).

e. Possible qualification for a 120 day extension to pay, or a payroll deduction installment agreement with the IRS.

Sunday, April 02, 2006


Art is in the eye of the beholder, but how to value it for tax purposes? The valuation of art has significance for income tax charitable deductions, gift taxes on gifts, and estate tax when a decedent passes away while owning art.

The IRS imposes various appraisal requirements on taxpayers in different circumstances. But in an audit situation, how will the IRS do its own valuation?

In regard to an item with a value of $20,000 or more, the auditing agent must refer the valuation to the Art Advisory Panel. This is a panel of about 20 art experts, including curators, dealers and auction house representatives, who meet in Washington several times a year to review art appraisals. The Panel's conclusion becomes the official position of the Service on valuation.

If a taxpayer wants to avoid a future dispute with the IRS, or simply wants certainty in tax consequences, he or she can seek a ruling on the value of art or collectibles, but only if certain criteria are met. The requirements are:

1. The ruling request must be made AFTER the property is transferred;
2. The taxpayer must first obtain a qualified appraisal;
3. At least one of the items transferred must have a value of at least $50,000; and
4. A copy of Form 8283 and the appraisal must be attached to the ruling request.

The fee for an advance determination is $2,500 for the first three items and $250 for each additional item. Once the advance ruling is given, it is binding on the IRS.

For more information, see Practical Planning Strategies for Art and Collectibles, D.T. Leibell and D.L. Daniels, 33 Estate Planning, No. 3, 27 (March 2006).