SUMMARY OF FLORIDA TAX LAW CHANGES [FLORIDA]

The Florida Bar has issued a summary of the tax provisions of the Florida 2006 Legislative Session. The highlights include:

• Increased business property sales tax exemptions to spur business investment

• Hurricane preparedness sales tax holiday renewed

• Sales tax holiday for purchase of energy efficient appliances for home or personal use

• Back to school sales tax holiday renewed

• Expanded ability of homeowner to repair or replace a home damaged in a casualty loss without triggering an adjustment to appraised values under the Save Our Homes ad valorem tax value limit rules

• Changes to homestead exemption

• Repeal of annual intangibles tax

• Authorizes an additional $2 per day rental car surcharge for counties.

BUILT-IN GAINS VALUATION DISCOUNT AND PARTNERSHIPS

In valuing stock in a corporation for estate and gift tax purposes, if the corporation's assets are appreciated, some discount in value will usually be allowed. This is because there is a future tax liability that relates to the stock - when the corporation sells the appreciated asset income tax will be imposed on the gain. Remember that the test for value of the stock for estate and gift tax purposes is the price that a hypothetical willing buyer would sell the stock to a hypothetical willing seller, neither being under any compulsion to buy or sell. Clearly, a buyer would note the future tax and reduce the purchase price since that future tax would reduce the assets of the corporation and thus the value of the stock upon sale of the appreciated assets.

A recent tax case acknowledges that this concept probably does not apply to valuing partnership interests in a partnership that has appreciated assets. This is because of Section 754 of the Internal Revenue Code - a provision that applies only to partnerships and not corporations. A buyer of a partnership that has made a Section 754 election gets the benefit of an adjustment in tax basis to the assets of the partnership allocable to the purchased interest, based on the purchase price paid for the interest. The effect of this election is that a buyer of a partnership interest, in the hypothetical purchase and sale used for valuation, will NOT have to pay future tax when the appreciated property is sold by the partnership (to the extent of the purchase price paid). Therefore, such a hypothetical buyer would not be able to convince a hypothetical seller to reduce the purchase price for this tax liability, and no discount for the future tax liability obtains. See Temple v. U.S., 97 AFTR 2d 2006-1649 (DC TX 2006).

Is it fair to for the court to assume that a Section 754 election would be made by the partnership, as the court in Temple did? Perhaps when the interest at issue is a control interest that would allow the buyer to make the election in its discretion. However, if the interest is only a minority interest or a limited partner interest so that the Section 754 election is in the hands of someone other than the buyer, perhaps this assumption is inappropriate. Note that in that circumstance, another partnership provision may come into play to reduce or eliminate the built-in gains deduction. That provision is Section 704(c), which will tax a contributing partner when the partnership sells the property on the gain in partnership property that existed at the time that such contributing partner made its contribution. This provision can redirect some of the appreciation in partnership assets to a partner other than the buyer, and thus would also reduce the valuation reduction for future taxes. This is also mentioned in the Temple case.

NONRECOGNITION TRANSFERS OF U.S. REAL PROPERTY INTERESTS

The U.S. taxes foreign persons on the disposition of U.S. real property interests (even though foreign persons are generally not otherwise taxable by the U.S. on their capital gains). Note that a U.S. real property interest is not just real property in its traditional sense, but can include interests in corporations and partnerships that own substantial U.S. real property.

Under complex regulations, foreign taxpayers engaged in some dispositions that bring ownership of the U.S. real property interest into the U.S., or that are engaged in certain "foreign-to-foreign" transactions, may be able to avoid current taxable gains. In Notice 2006-46, the IRS has announced its intention to modify applicable regulations and notices to somewhat liberalize these areas, including to coordinate them with new foreign merger rules under the corporate reorganization provisions. More particularly, the changes that will be forthcoming include:

-revising the rules relating to inbound asset reorganizations that are type ‘C’, ‘D’, and ‘F’ reorganizations, and to take into account the expanded types of statutory mergers and consolidations that now qualify as ‘A’ reorganizations;

-revising the rules to take into account foreign-to-foreign statutory mergers and consolidations and to create two additional exceptions that provide a foreign corporation with nonrecognition treatment on its transfer of a USRPI in certain foreign-to-foreign asset reorganizations;

-eliminating certain requirements for nonrecognition that currently exist; and

-modifying certain look back periods that are considered for imposing taxes and accrued interest on prior dispositions of the stock of foreign corporations.

DID HIS LUCK RUN OUT?

Roger L. Watkins won over $12 million in the Colorado State Lottery, which he was to receive in twenty-five annual payments. After receiving six installments, Mr. Watkins divorced his wife and received half of the lottery rights. He then sold his half interest in the remaining payments to a third party for a lump sum.

Lottery payments are subject to federal income tax at ordinary income tax rates. These rates can be over twice as high as current maximum capital gains rates. Mr. Watkins claimed, rightly so, that his right to the annual payments was an asset, and that he sold it. If the lottery rights are a capital asset, the sale of those rights should generate capital gain, and since Mr. Watkins held those rights for over a year, he would qualify for long term capital gain treatment at the lower rates.

Section 1221 of the Internal Revenue Code defines a capital asset - it is "property held by the taxpayer (whether or not connected with his trade or business)" that does not fit within certain exceptions listed in the statute (such as inventory property). Based on this definition, Mr. Wakins can report the gain from the sale of the lottery rights as long term capital gain, and that is what he did. The IRS challenged this treatment, and it ended up before the 10th Circuit Court of Appeals.

Lucky in the lottery, unlucky in love (the divorce)...unlucky in appellate court. The appeals court applied the substitute-for-ordinary-income doctrine to hold that lottery payment rights are NOT a capital asset (or at least do not generate capital gain upon sale), even though there is no such exception from capital asset treatment in the statute. Under this doctrine, courts have indicated that when a lump sum payment is received in exchange for what would otherwise be received at a future time as ordinary income, capital gains treatment of the lump sum is inappropriate. This is so because the consideration is paid for the right to receive future income, not for an increase in the value of income-producing property.

WATKINS v. COMM., 97 AFTR 2d 2006-XXXX, (CA10), 05/10/2006

KEEP THOSE CHARITABLE TRUSTS SEGREGATED

If an individual leaves property to a qualified charity at their death, this will generally qualify for the estate tax charitable deduction (and thus the property so transferred will not be subject to federal estate tax). This applies even if the property is to be held in trust for the charity instead of an outright transfer. However, if persons or entities who are not charities are also beneficiaries of the trust, a "split-interest" trust will be created. For transfers to the trust to qualify for the estate tax charitable deduction (in whole or in part), the split-interest trust must have special provisions that do not apply to nonsplit-interest trusts established for charity.

In Galloway, Edmond C. v. U.S., 97 AFTR 2d 2006-XXXX, (DC PA 5/9/06), the decedent left a portion of his assets in a residuary trust. The residuary trust was divided into four shares - two for individuals and two for charitable entities. Distributions made to the individuals would not be made from the charitable shares, and thus could not reduce the amounts passing to charity. The estate took a charitable deduction (presumably limited to the amounts funded into the two charitable portions). The IRS disallowed the deduction, asserting that the trust was a classic split interest, where an interest in the same property passes to both charitable and noncharitable beneficiaries.”

The estate argued first that while there was technically only one trust, the division into four shares really created four trusts and thus the individuals had no interests in the charitable trusts. The District Court rejected this argument, citing similar prior cases when the form of creating separate trusts was not followed and thus resulted in the application of the split-interest trust rules.

The estate then argued that the split-interest trust rules should not apply since the policy of those rules was not implicated under the current facts. The District Court rejected this, noting that there was no ambiguity in the statute that would open the door to a policy/intent of the statute analysis.

In the end, the District Court applied the split-interest rules and denied the charitable deduction. The lesson for draftsman is simple - make sure that when trusts are being created in an estate plan for both individuals and charities, that true separate trusts are created for the charities (separate and apart from any interests held for noncharitable beneficiaries).

DIAGRAM OF TIPRA 2005 PROVISIONS

President Bush has signed into law TIPRA 2005 (Tax Increase Prevention and Reconciliation Act of 2005). A handy expandible/collapsible summary of the key provisions can be viewed by clicking on the link TIPRA 2005 [http://www.floridatax.com/Articles/TIPRA%202005%20Principal%20Provisions%20Summary.mmap].

However, to view this "mindmap" you will first need to install on your computer the viewer software (unless you have Mindmanager software already installed on your computer). Mindmaps in general, and Mindmanager software in particular, is a very useful method and program for storing, viewing, and manipulating information, so I encourage you to try it out. Click on the link Mindmanager Viewer Program [http://www.mindjet.com/us/download/viewer.php?s=3] to go to the download page for the viewer software.

APPLICABLE FEDERAL RATES - UPDATE FOR JUNE 2006

JUNE 2006 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.93% (4.79%/May -- 4.71%/April)

-Mid Term AFR - Semi-annual Compounding - 5.00% (4.78%/May -- 4.67%/April)

-Long Term AFR - Semi-annual Compounding - 5.25% (4.94%/May -- 4.73%/April)

DIRECTION OF RATES: Up

BUY-SELL AGREEMENT UPHELD FOR PURPOSES OF SETTING ESTATE TAX VALUE

A business interest owned by a decedent is subject to estate tax at its fair market value at death. This value is generally the price that an unrelated buyer and seller would agree to, neither being under any compulsion to buy or sell.

However, if certain requirements are met, a buy-sell agreement that provides for a price for the purchase of the decedent's business interest at death can be used to set the value of the business interest for estate tax purposes. Generally, a buy-sell agreement will function to set the value if the offering price is fixed and determinable under the agreement, the agreement is binding on the parties both during life and after death, and the restrictive agreement must have been entered into for a bona fide business reason and must not be a substitute for a testamentary disposition. In 1990, a new requirement was added to these common law rules - to be respected the terms of the agreement must further be comparable to similar arrangements entered into by persons in an arms' length transaction (Code Section 2703(b)(3)).

Until now, there have been no cases wherein the Section 2703(b)(3) requirement has been met. In Estate of Pearl I. Amlie, TC Memo 2006-76, the requirements of Section 2703(b)(3) were found to have been met. The case provides some instruction for those that seek to meet the Section 2703(b)(3) requirement.

First, in analyzing the application of Section 2703(b)(3), the Court noted that while the applicable Regulations favored having multiple comparables for purposes of making the "comparable" determination, it was not an absolute requirement. Second, another factor that practitioners should keep in mind, and that carried a lot of weight with the Tax Court, was that the parties employed a valuation consultant at the time of the agreement to establish what a market comparable price should be.

The case also provides a useful summary and practical example of the common law requirements that must be met in addition to the new requirement of Section 2703(b).

DOWN PAYMENT ASSISTANCE PROGRAMS

In the tax world, as in the rest of the world, there is usually a right way and a wrong way to do things. A recent ruling illustrates this in regard to charitable Section 501(c)(3) organizations.

Charitable organizations that seek to qualify as tax-exempt organizations under Section 501(c)(3) must be operated exclusively for charitable purposes. Some of these organizations provide down payment assistance to buyers of residential real property to help people in need acquire a home. Revenue Ruling 2006-27 provides three examples of such programs - two qualify under Section 501(c)(3) and one doesn't. Can you figure which one doesn't qualify?

a. A non-profit corporation X helps low-income individuals and families buy decent, safe and sanitary homes by providing part or all of the funds needed to make a down payment. It requires home inspections to ensure that the houses will be habitable. It provides financial counseling seminars and other educational programs to prepare potential home buyers for the responsibility of home ownership. Funding comes from a broad based fund-raising program, and it receives support from a wide array of sources. X ensures that its grant making staff doesn't know the identity or contributor status of the party selling the home to the grant applicant (or any other party who may receive a financial benefit from the sale), and it doesn't accept contributions contingent on the sale of any particular properties.

b. A nonprofit corporation Y provides services similar to those provided by X. However, to finance its down payment assistance activities, Y relies on most of its support from sellers and other real-estate related businesses. In deciding whether to provide assistance to a low-income applicant, Y's grant making staff knows the identity of the home seller and may also know the identities of other interested parties and is able to take into account whether the home seller or another interested party is willing to make a payment to Y. There is a direct correlation between the amount of the down payment assistance provided by Y in connection with each of these transactions and the amount of the home seller's payment to Y.

c. A nonprofit corporation Z combats community deterioration in an economically depressed area. Z cooperates with government agencies and community groups to develop a plan to attract new businesses to the area. It helps low and moderate-income families to acquire decent, safe and sanitary housing in the area. It provides counseling and financial assistance to prepare home buyers for the responsibilities of home ownership. Funding comes from a broad based fund-raising program that attracts gifts, grants and contributions from several foundations, businesses and the general public.

Under the Revenue Ruling, organizations X and Z, under examples a. and c., qualify for Section 501(c)(3) status. Corporation Y under b. does not. The problem under b. is that home sellers are providing funding to the program, and then receive a benefit from it when their contributions are directed to buyers of their properties based on the contributions given. While the IRS acknowledges some charitable benefit arises to the buyer from the transaction, the benefit to the seller keeps the program from being operated EXCLUSIVELY for charitable purposes and thus disqualifies corporation Y from Section 501(c)(3) status.

MAJOR TAX BILL ON ITS WAY!

After failing to reach agreement late last year, tax conferees of the House of Representatives and the Senate have reached an agreement on H.R. 4297, the “Tax Increase Prevention and Reconciliation Act” or TIPRA. Assuming passage by the House and Senate, and a non-veto by President Bush, a new tax law can be expected shortly. Highlights of the new law include:

... Favorable Code Sec. 179 expensing provisions to remain in place through the end of 2009 (instead of through the end of 2007).

... Favorable tax rates for capital gains and qualified dividend income will remain in place through 2010 (instead of sunsetting after 2008).

... For 2006, the alternative minimum tax exemption amount for married taxpayers would increase to $62,550 and for unmarried individuals to $42,500 (instead of dropping to $45,000 and $33,750, respectively).

... The exception under subpart F for active financing and insurance income would be extended for two years, to tax years of foreign corporations beginning before Jan. 1, 2009, and for any tax year of a U.S. shareholder with or within which the tax year of the foreign corporation ends.

... The active business test for tax-free corporate spin-offs would be simplified .

... At the election of a taxpayer, the sale or exchange of musical compositions or copyrights in musical works created by his personal efforts would be treated as the sale or exchange of a capital asset.

... Corporations with assets of at least $1 billion would face a modified schedule of estimated tax payments.

... The $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs, would be eliminated for tax years beginning after Dec. 31, 2009.

... The 50% W-2 wage limit on the Code Sec. 199 domestic production deduction would be modified.

... For tax years beginning after 2005, the age at which the kiddie tax applies would be changed from under 14 to under 18 years of age.

... Information reporting would be required for interest paid on tax-exempt bonds after Dec. 31, 2005.

... Taxpayers would have to make partial payments to IRS while an offer-in-compromise is being considered by IRS.

IRA'S, QTIP TRUSTS, UNITRUSTS, AND POWERS TO ADJUST - PUTTING IT ALL TOGETHER

Some spouses desire that when they pass away, instead of their Individual Retirement Account (IRA) funds being made immediately available to the surviving spouse they want the IRA funds to be held in trust for the surviving spouse. This may be desireable where there are concerns about the surviving spouse’s ability to directly manage the IRA funds, or whether there is a desire to make provisions of the remaining assets to children after the death of the surviving spouse (including just to children of the first spouse to die, in a second marriage situation). By leaving the assets in trust instead of outright to the surviving spouse, the IRA and the trust must meet the special qualifications of the Code for the estate tax marital deduction - otherwise the IRS may become a taxable asset for estate tax purposes.

The usual method of qualifying a trust for a surviving spouse for the estate tax marital deduction is to qualify it as a Qualified Terminable Interest Property trust (commonly known as a "QTIP Trust"). One of the requirements that a QTIP Trust must meet is that all of its income must be distributable to the surviving spouse on an annual or more frequent basis. In the context of an IRA, the IRA and QTIP Trust must be arranged so that both the income of the IRA is distributed to the QTIP Trust annually, and then that income must be distributed to the surviving spouse.

In recent years, many States have adopted versions of the Uniform Principal and Income Act that modify traditional definitions of "income" for trust accounting and similar purposes. Such modifications include powers in the trustee to adjust receipts between income and principal, and unitrust provisions that define income as a fixed percentage of the annual value of the principal assets. The IRS in turn has issued regulations that will generally respect such "income" characterizations if certain requirements are met.

Consequently, there have been a lot of questions on how the new State law definitions of income interface with the requirements for distributing the income of an IRA and QTIP Trust in a manner that allows for the estate tax marital deduction. In Revenue Ruling 2006-26, the IRS has made some pronouncements that will help guide practitioners in this area.

Some of the key conclusions of the Revenue Ruling are:

a. If applicable State law alloallows for a power to adjust as provided for under the Uniform Principal and Income Act, trustee reallocations between income and principal of both the IRA and the QTIP Trust under those provisions will produce “income” that can be used to satisfy the QTIP Trust requirements;

b. If “income” is computed under the IRA or the QTIP Trust using State law unitrust provisions that meet the requirements of the Section 643(b) regulations, such computations will produce “income” that can be used to satisfy the QTIP Trust requirements;

c. If IRA “income” is computed using the provisions of the Uniform Principal and Income Act that characterize 10% of certain distributions as “income,” or that allow for an allocation to income to satisfy the estate tax marital deduction (e.g., Fla.Stats. §738.602(3) and (4)), computations of income under those provisions will NOT in and of themselves produce “income” that can be used to satisfy the QTIP Trust requirements.

NO HOMESTEAD EXEMPTION IF PRESENT ONLY ON TEMPORARY VISA [FLORIDA]

Florida provides a reduction in ad valorem property taxes on the principal residence of Floridians. Even more important than the dollar reduction in taxes that arises directly from the exemption is the 3% per year maximum increase in taxable value that is afforded under the Florida Constitution. In a period of rapid price appreciation (such as the last few years), this dollar cap on increases in taxable value has provided a valuable tax benefit to Florida homeowners.

To qualify for the exemption, the residence involved must be a "permanent residence" of the affected taxpayer. In a recent case, two homeowners immigrated from Switzerland and resided legally in the United States. They had lived and worked in Charlotte County, Florida for at least five years. They held social security numbers and drivers' licenses, paid federal income tax, and had filed a Declaration of Domicile in Florida. Further, they had applied for permanent residence status in the U.S. with the Bureau of Citizenship and Immigration Services.

With this factual background, the homeowners applied for homestead exemption for their residence in Charlotte County. Noting that the homeowners had only temporary visas to be in the U.S., the tax appraiser denied their application. The homeowners appealed that denial.

The homeowners argued that neither the Florida Constitution, nor the Florida Statutes that provided factors for review in determining permanent residence status, mentioned visa status. However, Rules enacted by Florida did indicate that a person in the U.S. on a temporary visa could not qualify for permanent residence status. There is also case law that overides those Rules when an applicant is seeking political asylum in the U.S.

In the end, the appellate court upheld the Rules - notwithstanding all of the connections of the homeowners to Florida and the U.S., they could not qualify for homestead exemption due to their temporary visa status.

[ANDRE DEQUERVAIN and ESTHER MAISCH, Appellants, v. V. FRANK DESGUIN, as the Property Appraiser of Charlotte County, Florida; VICKIE POTTS, as the Tax Collector of Charlotte County, Florida; and JAMES ZINGALE, as Executive Director of the Department of Revenue, State of Florida, Appellees. 2nd District. Case No. 2D05-1880. Opinion filed May 5, 2006.]

U.S. NO LONGER A 'TAX HAVEN"

Once upon a time (after the Reagan tax cuts in the 1980's, to be more precise), the United States was known as a tax haven since its tax rates were substantially lower than those of most other developed countries. Time has past, tax competition has worked its wonders, and the U.S. now lags the other developed countries in tax competitiveness. In the competition for capital, this has real world consequences for productivity and living standard enhancements.

The Tax Foundation now advises that the U.S. corporate tax rates are the second highest among developed countries:

IRS PROVIDES GUIDANCE FOR AVOIDING CFC INCOME ON LEASING OF VESSELS

As a general rule, foreign corporations not conducting business in the U.S. nor receiving income from the U.S. are not subject to U.S. income taxes. U.S. shareholders of the foreign corporation can generally defer U.S. tax on that income until the income is reinvested in the U.S. or distributed to those U.S. shareholders.

However, under the Controlled Foreign Corporation (CFC) rules, these U.S. shareholders will be taxed by the U.S. as the income is earned by the foreign corporation, but only for certain types of income. One category of income that used to result in immediate tax to the U.S. shareholders was foreign shipping income of the foreign corporation. However, the recent Jobs Creation Act of 2004 eliminated foreign shipping income as a type of income that automatically results in taxation to the U.S. shareholders.

There are other types of income that still result in current taxation to the U.S. shareholders under the CFC rules. For companies engaged in the leasing of vessels in foreign commerce, one particular type of income that is subject to current tax is "foreign personal holding company income" (FPHCI). FPHCI can include rental income, so there is presently a lot of interest and focus on when the leasing of a vessel will constitute FPHCI.

Generally, rents derived in an active trade or business from an unrelated person will not be FPHCI. The Jobs Act added a new provision clarifying that rents derived from leasing an aircraft or vessel in foreign commerce won't fail to be treated as derived in the active conduct of a trade or business if, as determined under IRS regulations, the active leasing expenses are not less than 10% of the profit on the lease. Therefore, taxpayers are interested in how to establish they are engaged in foreign commerce for purposes of the exclusion from FPHCI treatment.

Under Notice 2006-48, the IRS has now provided guidelines and direction for taxpayers attempting to determine the application of these provisions to their situation - taxpayers with issues in this area should consult (the provisions of the Notice are of such narrow interest as not to warrant detailed analysis in this posting). While future regulations will be issued to address these issues, taxpayers may rely on the Notice provisions in making current (and prior) determinations. Taxpayers with these issues should consult the Notice for the details of these provisions. The Notice also includes guidance on the exception to gain recognition on the transfer abroad of business assets by U.S. taxpayers used in a foreign trade or business in regard to leased vessels used in foreign commerce under Code Section 367.

FLORIDIANS RECEIVE SALES TAX RELIEF FOR PURCHASE OF HURRICANE SUPPLIES [FLORIDA]

Governor Bush has signed into law an exception from sale tax collections on certain hurricane supplies. The exception will apply for purchases made only on or between May 21, 2006 through June 1, 2006. The exemptions are on:

   -any portable self-powered light source selling for $20 or less;
   -any portable self-powered radio, two-way radio, or weatherband radio selling for $50 or less;
   -any tarpaulin or other flexible waterproof sheeting selling for $50 or less;
   -any ground anchor system or tie-down kit selling for $50 or less;
   -any gas or diesel fuel tank selling for $25 or less;
   -any package of AAA-cell, AA-cell, C-cell, D-cell, 6-volt, or 9-volt batteries, excluding automobile and boat batteries, selling for $30 or less;
   -any cell phone battery selling for $60 or less and any cell phone charger selling for $40 or less;
   -any nonelectric food storage cooler selling for $30 or less;
   -any portable generator used to provide light or communications or preserve food in the event of a power outage selling for $1,000 or less;
   -any storm shutter device selling for $200 or less;
   -any carbon monoxide detector selling for $75 or less;
   -any blue ice selling for $10 or less; or
   -any single product consisting of two or more of the above items, or other tax-exempt items, selling for $75 or less.

CHANGE IN NOTIFICATION SERVICE FROM BLOGLET TO FEEDBLITZ

Due to intermittent problems with our Bloglet notification service, we are switching to a similar service called Feedblitz, which will also send out an email to subscribers advising when a new post has been added to this blog. If you had subscribed to Bloglet, your subscription has been automatically transferred to Feedblitz.

Please bear with us in the next few days as we work out the bugs (if any) in the new system.

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