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Friday, December 28, 2007


A number of interesting year-end tax law changes were recently enacted. We will review a few of them in the coming postings. Let's start with two - AMT relief and mortgage discharge relief.

A. Alternative minimum tax exemptions have been increased for 2007, instead of being decreased as required under prior law. The exemption is increased to $66,250 (up from $62,550 in 2006) for married couples filing a joint return and surviving spouses, to $44,350 (up from $42,500 in 2006) for an individual who isn't married or a surviving spouse, and to $33,125 (up from $31,275 in 2006) for married individuals filing separate returns.

B. In recognition of the real estate debt problems many taxpayers are facing, a relief provision has been added for discharge of indebtedness of income relating to principal residences. Normally, if a lender relieves a borrower from having to pay off debt, the borrower incurs taxable income. Thus, for example, assume a taxpayer owns a house with a $300,000 mortgage. Due to increases under an adjustable mortgage, the taxpayer can no longer pay the mortgage. Due to decline in values, the house is only worth $250,000. The lender forecloses on the residence and acquires ownership to the residence, and does not pursue the borrower for the $50,000 loss it suffers due to the difference between the $300,000 loan amount and the $250,000 value of the house. Under normal circumstances, the taxpayer would incur $50,000 of ordinary income, unless the taxpayer was otherwise insolvent or other limited exceptions to discharge income applied under the Internal Revenue Code.

Under the new rules, if the discharge occurs before 2010, the indebtedness was incurred to acquire, construct, or substantially improve the individual's principal residence, and is secured by the residence, no discharge of indebtedness income will arise. The new rules are limited to $2 million of such "acquisition indebtedness." The exclusion rule will not apply to second homes, vacation homes, business property, or investment property, since these properties aren't the taxpayer's principal residence. It also will not apply to discharges of second mortgages or home equity loans, unless the loan proceeds were used to acquire, construct, or substantially improve the taxpayer's principal residence.

Note that a foreclosure is not required - a restructuring of a debt that involves a reduction in debt will also be covered, if the above requirements are met.

Tuesday, December 25, 2007


January 2008 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 3.16% (3.84%/December -- 4.07%/November -- 4.15%/October)

-Mid Term AFR - Semi-annual Compounding - 3.55% (4.09%/December -- (4.34%/November -- 4.3%/October)

-Long Term AFR - Semi-annual Compounding - 4.41% (4.67%/December -- (4.83%/November -- 4.82%/October)


Saturday, December 22, 2007


Common year-end tax planning advice is to consider selling publicly traded securities that have lost value, so as to obtain a loss deduction to offset otherwise incurred gains. However, as a practical matter, a taxpayer may like a particular stock and want to keep it in his portfolio. Therefore, thoughts are given to selling the stock to incur the loss, and then quickly buying it back to put it in the portfolio.

Code Section 1091, also known as the "wash sale rule," limits the ability to do this. If a share of stock or securities are sold at a loss, and substantially identical stock or securities are acquired within 30 days (before or after) the sale, the loss is disallowed. Some taxpayers have sought to get around the loss sale rule by repurchasing the stock or securities in an IRA or Roth IRA account, on the theory that the repurchaser is not the taxpayer, but a different legal entity and taxpayer.

In Revenue Ruling 2008-5, the IRS has advised that it considers the IRA or Roth IRA as effectively the same person as the taxpayer, and will apply Section 1091 to these types of purchases and resales. It based its ruling on a 1930's case that held that a trust controlled by a taxpayer was considered a mere agent for the taxpayer, allowing the application of the predecessor to Section 1091 to a sale by the taxpayer and a repurchase by such a trust.

Interestingly, the Ruling also disallows the use of Section 1091(d), which preserves the built-in loss in the property repurchased that is subject to Section 1091 through an upward adjustment in basis equal to the disallowed loss. No explanation is given, but presumably this is done in light of the tax-exempt nature of the IRA or Roth IRA.

Rev.Rul. 2008-5, 2008-3 IRB

Tuesday, December 18, 2007


Before we get to the main question, let's review why we care. Section 165(d) limits losses from wagering losses to the amount of wagering gains (regardless of trade or business status). However, if a gambler is in the trade or business of gambling, he or she can generally make the offset of losses against gains. If the gambler is not in the trade or business, the loss deduction is an itemized deduction and is subject to general limitations on itemized deductions.

One could argue that statistically speaking one cannot be in the trade or business of playing slot machines because there is no realistic expectation of profit when it comes to playing slot machines due to the built-in house edge. This is the tack taken by the IRS in a recent Tax Court case when it sought to deny trade or business status to a slot machine gambler.

The Tax Court took seriously the gambler's claims that she ran her slots activities like a business. The Court applied nine factors to the analysis, taken from the Section 183 regulations, to determine if the taxpayer had the requisite intent to profit. These factors are(1) the manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his or her advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or loss with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved.

In applying these factors, the Court noted that the taxpayer played slots regularly (every day), she was an "expert" on slot play, she expended substantial time and effort, she expected to make a profit, and also had success in her other business ventures. She also had a specific system to her play, and adjusted her play when the system did not produce profits. On the negative side, the Court noted that she never produced profits on an annual basis (even though she did hit some big jackpots).

In the end, the Court sided with the taxpayer and found a trade or business. However, don't bother reading the opinion for a description of successful slots playing techniques - as noted above, the taxpayer never did have a winning year.

Linda M. Myers v. Commissioner, T.C. Summ. Op. 2007-194

Friday, December 14, 2007


Code Section 6651(a)(1) provides for an addition to tax in the event a taxpayer fails to file a timely return (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect. What happens if an executor relies on his or her attorney to prepare the estate tax return, and the attorney doesn't prepare the return before the due date? Is the executor's reliance on the attorney reasonable cause?

No, says the Tax Court, in a case earlier this year. The Court quoted a Supreme Court case that provided:

Congress has placed the burden of prompt filing [of an estate tax return] on the executor, not on some agent or employee of the executor. *** Congress intended to place upon the taxpayer an obligation to ascertain the statutory deadline and then to meet that deadline, except in a very narrow range of situations.

However, the Court did provide some limited circumstances where reliance on an attorney could be a valid excuse. One of these is if the attorney specifically advised the executor of the due date of the return, but gave an erroneous date, and the return was filed late due to that erroneous advice.  Another is when the attorney erroneous advises that no return is due, causing the executor to file the return late.

Estate of Gertrude Zlotowski, et al., TC Memo 2007-203,

Tuesday, December 11, 2007


Insurance professionals have an incentive to find creative tax planning opportunities that involve insurance since their compensation is based on sales of policies. Such tax planning usually makes good sense, at least in appropriate circumstances, but sometimes that planning goes too far.

A recent Tax Court decision illustrates a planning arrangement that was marketed to many professionals as a method of generating income tax deductions for life insurance premiums, but which the IRS has successfully challenged in court. The case involved a partnership of 'S' corporations, whose shareholders were employed by the corporations and engaged to provide medical services to the partnership. Under the the Severance Trust Executive Program Multiple Employer Supplemental Benefit Plan and Trust (STEP) arrangement, a purported welfare benefit fund was established to pay severance payments to doctors that ceased to be employed. To fund those payments, the fund purchase life insurance on the lives the participants, which policies had significant cash values. Their 'S' corporations sought to deduct the premium payments as Section 162 business expenses to fund termination compensation.

An excerpt from the case best summarizes the Tax Court's dim view of the arrangement:

While the STEP plan may have been cleverly designed to appear to be a welfare benefits fund and marketed as such, the facts of these cases establish that the plan was nothing more than a subterfuge through which the participating doctors, through [the partnership], used surplus cash of the PCs to purchase cash-laden whole life insurance policies primarily for the benefit of the participating doctors personally. While employers are not generally prohibited from funding term life insurance for their employees and deducting the premiums on that insurance as a business expense under section 162(a), employees are not allowed to disguise their investments in life insurance as deductible benefit-plan expenses when those investments accumulate cash value for the employees personally.

Based on this view, the Court's disallowance of deductions for the premium payments should come as no surprise.

V.R. Deangelis M.D.P.C. & R.T. Domingo M.D.P.C., V.R. Deangelis M.D.P.C., Tax Matters Partner, ET AL. v. Commissioner, TC Memo 2007-360

Saturday, December 08, 2007


Auditors can ask for legal advice from the IRS's Office of the Chief Counsel. Such written advise is referred to as Field Service Advice, or an FSA.

In a recent tax case, the IRS had issued an FSA in regard to another taxpayer and acted consistently with it as to that other taxpayer. Later, in dealing with the taxpayer (who was a competitor of the prior taxpayer) under similar facts, the IRS disregarded the FSA and in effect treated the taxpayer different from its similarly situated competitor. The taxpayer sought to bind the IRS to the treatment it provided to the competitor, claiming that the IRS could not provide disparate treatment for itself, which treatment was further inconsistent with the previously issued FSA.

The taxpayer sought to rely upon the case of International Business Machines Corp. v. United States, 343 F.2d 914  (Ct. Cl. 1965), cert denied 382 U.S. 1028 (1966). That case involved the failure of the IRS to issue similar private letter rulings on a similar issue at about the same time to two different taxpayers, which case held such disparate treatment was improper.

The U.S. District Court was not swayed by this argument, and found no obligation on the IRS to either treat the similarly situated taxpayers in the same manner nor to apply the FSA to the taxpayer.  The IBM case was rejected as precedent, in large part because an FSA is not the same as a private letter ruling. The Court noted the following differences between FSA's and private letter rulings:

-an FSA is issued to IRS field personnel whereas a taxpayer requests a PLR;

-a taxpayer requesting a PLR can rely on it because the ruling is binding on IRS with respect to that taxpayer, but FSAs cannot be relied on by taxpayers because they are not binding on IRS; and

-when taxpayers ask for PLRs they submit information to IRS and they are entitled to have a conference with it, while FSAs are issued without notice to the taxpayer and the taxpayer has no right to a conference with the IRS.

Thus, attempting to bind the IRS to a FSA may be difficult, if not impossible. Nonetheless, FSA's may still be useful in negotiating with the IRS, even if they have no binding effect.

Schering-Plough Corporation v U.S., 100 AFTR2d 2007-5522 (DC NY 12/03/2007).

Tuesday, December 04, 2007


The Treasury Department often publishes reports on areas of tax law, addressing issues that are of current concern. Such reports are useful as an indication as to what legislation may be coming. Of course, just because the Treasury Department has a concern in an area does not mean that legislation will always follow, or that Congress will enact that legislation.

A recent report highlights three areas of concern in the international tax arena. These are:

EARNINGS STRIPPING. Treasury is concerned that U.S. corporations owned by foreign persons, that undergo "inversion transactions" to insert a foreign holding company in a low or no tax jurisdiction, may be engaged in excess stripping of earnings from the U.S. through excessive interest payments. The study recommends that tax forms be modified to require more information about earnings stripping.

TRANSFER PRICING. Treasury believes certain areas of its transfer pricing rules require modernization or revision. More particularly, it is interested in addressing contributions for which arm's length consideration must be provided as a condition to entering into a cost sharing arrangement, and completing revisions to the related-party services regulations, as well as some additional other areas.

TAX TREATIES. Treasury is concerned that persons who are not residents of treaty jurisdictions continue to improperly gain benefits from the U.S. treaty network as to those treaties that do not have adequate limitations of benefits provisions (provisions that limit treaty benefits to residents of the treaty countries).

Report to the Congress on Earnings Stripping, Transfer Pricing and U.S. Income Tax Treaties, Nov. 28, 2007

Sunday, December 02, 2007


A recent tax case reminds of us an often overlooked income tax Code Section that can provide significant benefits to taxpayers - Code Section 1341. This Code Section is tied into the claim of right doctrine.

The claim of right doctrine typically applies where a taxpayer receives an income item in one year and reports it as income, even though there is a chance that the taxpayer will have to repay the amount in a future year. If the amount is repaid in a future tax year, the doctrine allows the taxpayer an income tax deduction in the year of REPAYMENT.

Oftentimes, the deduction in a later year is worth less in overall tax savings than the extra taxes imposed in the earlier year from the income. For example, tax rates may have been higher in the earlier year of income inclusion, so more taxes were paid in the earlier year than are saved from the deduction in the later year of repayment. Code Section 1341 provides relief, when it applies, by allowing further tax savings in the year of repayment to cover the shortfall in recovered income tax.

In Alcoa, Inc., and Affiliated Corporations, F/K/A Aluminum Company of America v. IRS, 100 AFTR 2d ¶ 2007-5506 (CA 3, 11/28/2007), the taxpayer tried a novel approach to Code Section 1341. Essentially, Alcoa claimed that it could have deducted environmental remediation costs in earlier tax years as it produced product, but it didn't. Later, under new environmental protection laws, Alcoa was forced to expend many millions of dollars on remediation costs relating to sites used for production in the earlier tax years. Since, due to a reduction in corporate tax rates, those deductions were not worth as much in tax savings in the years they were expended as the deductions would have been worth in the prior tax years if they had been deducted in those earlier years, it sought a $12+ million refund under Section 1341.

The appeals court found that Section 1341 did not apply, in large part because it could not equate Section 1341's requirement for an inclusion of an item in gross income in the earlier tax year as being the same thing as not taking a deduction against gross income in the prior tax year.  To rule otherwise would have opened the door to Section 1341 to taxpayers almost any time that it a taxpayer is faced with an expense it pays in a later year that can be related in any way to the fact that the taxpayer did not pay that expense in a prior year.

Thursday, November 29, 2007


The IRS has announced the interest rates for tax overpayments and underpayments for the calendar quarter beginning January 1, 2008.

For noncorporate taxpayers, the rate for both underpayments and overpayments will be 7%. This is a 1% reduction from the prior quarter.

For corporations, the overpayment rate will be 6% (a 1% reduction). Corporations will receive 4.5% for overpayments exceeding $10,000 (a 1% reduction). The underpayment rate for corporations will be 7%, but will be 9% for large corporate underpayments (1% reductions).

Rev. Rul. 2007-68

Tuesday, November 27, 2007


Assets of a decedent that is a participant in a retirement plan can be left to a surviving spouse to obtain the benefits of the estate tax marital deduction, and thus avoid current estate taxes at the death of the decedent. While there are reasons for leaving such plan assets outside of trust, decedents at times want to tie up the assets in trust, and thus a transfer to a QTIP trust may be advisable.

Natalie Choate, a leading authority on the tax aspects of retirement plans, recently reviewed four basic requirements needed to avoid tax problems with funding retirement assets into a QTIP. The four basic requirements are:

1. The QTIP trust should be named as the beneficiary. An alternative is to name a funding trust as a beneficiary, which allows the use of funding formulas to assure that only an amount of plan assets needed to minimize estate taxes end up in the QTIP trust. However, use of such a funding trust involves other tax issues and complexities that can be avoided by naming the QTIP trust as the beneficiary. In the event that this results in "overfunding" the QTIP trust, this overfunding can be ameliorated by a partial QTIP election for the overfunded QTIP trust.

2. Provisions must be added to require that the surviving spouse receives all of the income of BOTH the QTIP trust and the plan interest that is funded into it.

3. Properly specify how the income that must be distributed is to be computed. Such method must produce income in a manner acceptable to the IRS. Note that one acceptable method is to require a unitrust payout of from 3% to 5% of the trust's value each year.

4. A proper QTIP election needs to be made on the estate tax return.

SOURCE: Leaving Retirement Benefits to a QTIP Trust by Natalie Choate, Estate Planning Journal (WG&L)

Saturday, November 24, 2007


December 2007 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 3.84% (4.07%/November -- 4.15%/October -- 4.76%/September)

-Mid Term AFR - Semi-annual Compounding - 4.09% (4.34%/November -- 4.3%/October -- 4.73%/September)

-Long Term AFR - Semi-annual Compounding - 4.67% (4.83%/November -- 4.82%/October -- 5.03%/September)


Tuesday, November 20, 2007


The built-in gains value reduction for transfer tax purposes provides that the value of stock of a 'C' corporation is reduced by any untaxed gains inside the corporation. The theory is that a willing buyer would reduce the purchase price for such shares by the latent income tax liability inside the entity.

In a recent Tax Court case, the Tax Court recognized the value reduction. However, it did not allow a full reduction for the taxes that would arise on the sale or disposition of the corporate assets - instead, it discounted that reduction on the theory that the buyer would not sell all the assets at once but would only realize those gains (and resulting taxes) over time.

The Eleventh Circuit Court of Appeals has overturned that decision, and held that a 100% reduction in value for the income taxes on the built-in gains is appropriate. The Court ruled that the valuation should be conducted as if the corporation was liquidated, thus realizing its gains at the time of valuation. It did this based on its belief that a buyer would require a 100% reduction even if it did not intend to sell the corporate assets immediately.

Estate of Frazier Jelke III, 100 AFTR2d 2007-5475 (CA 11 11/15/2007)

Sunday, November 18, 2007


Unbeknownst to many charities, they have been recruited as policemen in the war on terror. Anti-terrorist measures impose penalties on grant-making nonprofit organizations that make grants to individuals or organizations that engage in or support terrorism - nonprofits who fail to police their grantmaking and properly investigate their grant recipients could find themselves in trouble. Therefore, nonprofit organizations making grants abroad need to be knowledgeable of these counterterrorism measures and comply with them. Unfortunately, the exact scope of protective measures that needs to be undertaken to avoid penalties is not clear.

The key provisions that nonprofits need to be wary of are:

a. Executive Order 13224 (Sept. 14, 2001) entitled "Blocking Property and Prohibiting Transactions with Persons Who Commit, Threaten to Commit, or Support Terrorism." The Executive Order prohibits transactions with individuals and entities deemed to be associated with terrorism. It blocks any assets controlled by the terrorist persons and those that have supported them. What is most troublesome about the Executive Order is that there is no knowledge or intent requirement. A nonprofit that has no intent to support terrorism and has no knowledge that it is doing so can still have its assets frozen if in fact a grant recipient is associated with terrorism; and

b. The USA PATRIOT ACT (10/26/01) imposes civil fines and imprisonment for persons providing material support or resources to terrorists.

So what should nonprofits do to minimize their exposure under these provisions? At a minimum, before making grants to foreign organizations or individuals (or even domestic organizations), they need to consult the government lists that identify organizations and individuals suspected of having connections to terrorism. The principal list is the Specially Designated Nationals list (the "SDN list") maintained by the Treasury Department's Office of Foreign Assets Control ("OFAC") and accessible at Other lists include the U.S. Government Terrorist Exclusion List ("TEL") maintained by the Department of Justice and lists maintained by the United Nations and the European Union. As a practical matter, nonprofits should consider subscribing to a commercial service that scans the databases. One of these is the OFAC Analyzer, accessible at

Various agencies and organizations have issued guidance on additional actions that nonprofits should undertake, beyond checking the lists. However, meeting all suggested actions would be cumbersome, expensive, if not near impossible for many nonprofits. Therefore, nonprofits will need to develop their own internal guidelines based on these recommendations - understanding that the further they stray from the recommendations the greater their exposure if in fact they unknowingly make a prohibited grant but balancing their budget, staff availability and other constraints on full compliance. The guidelines that should be reviewed in developing internal guidelines are:

a. The 2006 Treasury Department "Anti-Terrorist Financing Guidelines: Voluntary Best Practices for U.S. Based Charities." These can be viewed online at:

b. The Principles of International Charity, available online at:

Tuesday, November 13, 2007


Estate planning is not a "set it and forget it" process, or at least it shouldn't be. Even with the best of planning, circumstances change and a review of an individual's situation and estate planning is advisable. The following is a (non-exclusive) list of life and business events that should trigger a review of an estate plan and applicable estate planning documents, or at least a consultation with one's estate planner:

  • Birth of a child or grandchild;
  • Marriage of self or heir;
  • Divorce;
  • Death of a spouse or child;
  • Major change in the tax laws;
  • Major change in financial circumstances, such as a substantial inheritance;
  • Change of domicile to a new state or country;
  • Acquisition of out-of-state or out-of-country property;
  • Major illness;
  • Acquisition or sale of a business or real estate, including major liquidity events;
  • Major charitable gifting;
  • Acquisition of life insurance or significant annuity policies;
  • Significant gifting to friends or family members;
  • Or in the absence of any of the above, the passage of 4-5 years since the last review.

Ideally, clients should consult with their professionals BEFORE some of these events occur so as to allow for effective tax planning when income or transfer taxes are involved.

A suggestion for estate planners is to provide a listing of these events to their clients at the completion of the planning process to help educate them about when to have their estate planning reviewed. A memo to be kept with the client's set of estate planning documents is an easy way to accomplish this.

Sunday, November 11, 2007


Most Florida attorneys will tell you that the homestead laws of Florida are a challenge to understand and apply. One important aspect of homestead law are the limits on who homestead property can be transferred to, both during lifetime and at death - when spouses and lineal descendants exist, these limits can apply. An invalid transfer can result in unexpected consequences, including the eventual passage of the property to persons that may not have been intended to receive it.

To make matters slightly easier for those with issues in this area, I am posting a summary table that details the restrictions on transfers on Florida homestead property, both during lifetime and at death. These restrictions arise both under the Florida Constitution and statutory law. A permanent link to the table is also being placed in the links in the right column of this blog.

There are other aspects of homestead not addressed in the table, including the definition of homestead property, creditor protection aspects, and ad valorem tax aspects.

Friday, November 09, 2007


Currently, individuals over age 70 1/2 can make direct distributions to most public charities from their IRA of up to $100,000 per year. Such a direct distribution avoids the need to include such distributions in income and then seek an offsetting charitable deduction, which complete offset may often not be available.

This direct gift provision is set to expire at the end of 2007. There is a chance that this provision will be extended through 2008. However, President Bush has threatened a veto of the "extender" legislation due to some tax increases that are included in the proposed law (such as taxation of carry interests of hedge fund managers as ordinary income and not capital gain). Therefore, at this point in time, it is hard to say whether the direct to charity rules will survive into next year. Taxpayers who are on the fence about whether to make such transfers in 2007 or 2008 may want to make the transfers in 2007 in case the provision is not extended.

Tuesday, November 06, 2007


The IRS, in finalizing proposed Regulations in the tax-free reorganization area, has continued the process of liberalizing "continuity" requirements. In the latest Regulations, the IRS has given its blessing to certain post-reorganization transfers that can be made without jeopardizing required continuity of interest rules.

More particularly, the Regulations allow transfers of stock or assets to shareholders, so long as not all of the stock acquired is so transferred, and the transfer is of such a magnitude as to constitute a liquidation of the distributing corporation. Other transfers of assets or stock are also permitted so long as none of the affected corporations are terminated by such transfers. To use these rules, the continuity of business enterprise rules must also be followed.

Treas. Reg. §1.368-2(k)(1)(i)

Sunday, November 04, 2007


In August 2007, the IRS issued a Notice [Notice 2007-72] that it was designating a form of charitable contribution as an item "of interest." As such, persons entering into those types of transactions, and their advisors making tax statements with respect to them, are subject to disclosure and list maintenance requirements.

The IRS is now beginning to examine exempt organizations and government entities suspected of participating in successive member interest contribution arrangements. As part of the examination, the organizations receive an extensive questionnaire, which the IRS indicates it is using to determine if these types of transactions should be treated as a tax avoidance type of transaction, and whether the transaction should be designated as a listed transaction.

So what is a successive member interest contribution? According to the IRS:

In a typical transaction, Advisor owns all of the membership interests in a limited liability company (LLC) that directly or indirectly owns real property... that may be subject to a long-term lease. Advisor and Taxpayer enter into an agreement under the terms of which Advisor continues to own the membership interests in LLC for a term of years (the Initial Member Interest), and Taxpayer purchases the successor member interest in LLC (the Successor Member Interest), which entitles Taxpayer to own all of the membership interests in LLC upon the expiration of the term of years. In some variations of this transaction, Taxpayer may hold the Successor Member Interest through another entity, such as a single member limited liability company...After holding the Successor Member Interest for more than one year (in order to treat the interest as long-term capital gain property), Taxpayer transfers the Successor Member Interest to an organization described in § 170(c) (Charity). Taxpayer claims the value of the Successor Member Interest to be an amount that is significantly higher than Taxpayer's purchase price [and] a charitable contribution deduction...based on this higher amount.

The IRS is concerned with the large discrepancy between (1) the amount Taxpayer paid for the Successor Member Interest, and (2) the amount claimed by Taxpayer as a charitable contribution.  It also has the following concerns which may be present in some variations of this transaction: (1) any mischaracterization of the ownership interests in LLC; (2) a Charity's agreement not to transfer the Successor Member Interest for a period of time (which may coincide with the expiration of the applicable period in § 6050L(a)(1)) [relating to the obligation of a charity to report the details of a sale of contributed property that it received within 3 years of the sale]; and (3) any sale by Charity of the Successor Member Interest to a party selected by or related to Advisor or Taxpayer.

It goes without saying that any exempt organization that is approached to participate in one of these contribution arrangements should probably decline, at least until more guidance is issued by the IRS as to when, if , and under what circumstances, such transactions will be respected as legitimate.

Tuesday, October 30, 2007


An estate may elect under Internal Revenue Code Section 6166 to pay the portion of federal estate tax attributable to a closely held business interest in up to ten equal annual installments starting no later than five years after the regular due date for payment if certain requirements are met, including the requirement that the value of the business interest is more than 35% of the decedent's adjusted gross estate. The purpose of the deferral is to protect businesses – without it, many times a business would have to be sold to pay estate taxes which are due within 9 months of the date of death. By obtaining a substantial deferral to pay the tax, the heirs have a long time to spread out the payments and/or make arrangements for sale or payment of the tax.

The Internal Revenue Code allows the IRS to demand a bond or lien to secure the payment of the tax. Presently, the Internal Revenue Manual REQUIRES estates to furnish a surety bond as a prerequisite for granting the installment payment election. Instead of furnishing a surety bond, the estate may choose to elect a special lien on property.

Earlier this year, the Tax Court ruled that this mandatory bond or lien was not intended by Congress and is inappropriate. Instead, the IRS needs to examine each situation to see if a bond or lien is needed and appropriate. Estate of Edward P. Roski, Sr., et al. v. Commissioner, 128 T.C. No. 10, 04/12/2007.

The IRS now acknowledges and agrees to make the examination on a case-by-case basis for each estate electing under Section 6166. Pending the issuance of Regulations, it has issued a notice that it will consider the following factors in examining whether a bond or special lien is needed, namely:

--The duration and stability of the business.

--The ability of the estate and business to pay the installments of tax and interest timely.

--The tax compliance history of the business.

Note, however, that special effective provisions detail to which estates these provisions will apply.

Notice 2007-90.

Saturday, October 27, 2007


If a decedent's IRA is payable to his or her estate, the ultimate beneficiary typically must withdraw the IRA at a rate now slower than that which would have been imposed on the decedent if he or she had lived (based generally on life expectancy). If the decedent had named the beneficiary directly, the beneficiary could withdraw it out over his or her own life expectancy (that is, slower, if the beneficiary is younger than the decedent). Taxpayers like to take funds out of an IRA as slow as possible (if not actually needed) so that tax on the withdrawals can be deferred and deferral of tax on earnings continues for the assets retained in the IRA.

In a recent private letter ruling a decedent had inadvertently left off his daughter from his beneficiary designation (she had been on a prior version). A new form was requested by the IRA custodian to correct the error, but the decedent died first.

The interested parties were able, after the death of the decedent, to obtain a reformation of the beneficiary designation form by a state court to add the daughter. A ruling was then sought from the IRS, confirming that the reformation would be respected and the daughter could use her own life expectancy.

The IRS did not issue a favorable ruling, citing rules that require a beneficiary designation to be in place prior to death to be effective for these purposes. This was likely a surprise to the daughter and her advisors, since on similar facts in the past the IRS had given effect to such reformations by way of private letter ruling. Further, the IRS has also respected modifications to trusts post-death to qualify them as proper designated beneficiaries. Since private letter rulings are not binding on the IRS except as to the taxpayers to whom they are issued, such a reversal of policy is permissible, albeit unexpected.

PLR 200742026

Tuesday, October 23, 2007


Social security taxes (FICA) are imposed at the rate of 6.2% on the wages of taxpayers, with a matching 6.2% tax on their employers - the self-employed pay a tax of 12.4%. This tax is not applied against all wage income - wages higher than the wage base are not taxed.

In 2007, the wage base limit was $97,500. In 2008, it will increase for inflation to $102,000. Therefore, wage earners who earn at or above these levels will see a $279 tax increase, and their employers will also see a $279 tax increase. A self-employed wage earner will pay an additional $558.

Taxpayers who earn wages at these levels are often pleasantly surprised when their take home pay increases during the calendar year after their wages have passed the wage base limit since withholding for social security taxes disappears. For taxpayers who do not get a significant raise, they will be waiting longer for this happy day in 2008 than in 2007.

Saturday, October 20, 2007


2008 adjustments to pension contribution, benefit and computation limits have been released. While many inflation adjustments are in fact unchanged, here are some changes that are of interest:

-The limitation on the annual benefit under a defined benefit plan increases from $180,000 to $185,000.

-The limit on the annual additions to a participant's defined contribution plan account increases from $45,000 to $46,000.

-The maximum amount of annual compensation that can be taken into account for various qualified plan purposes increases from $225,000 to $230,000.

Wednesday, October 17, 2007


November 2007 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.07% (4.15%/October -- 4.76%/September -- 4.94%/August)

-Mid Term AFR - Semi-annual Compounding - 4.34% (4.3%/October -- 4.73%/September -- 5.03%/August)

-Long Term AFR - Semi-annual Compounding - 4.83% (4.82%/October -- 5.03%/September -- 5.24%/August)


Monday, October 15, 2007


The Treasury Inspector General for Tax Administration recently issued a report raising concerns about taxpayer compliance with the like-kind (Section 1031) exchange rules. It is likely that this report will eventually result in greater IRS scrutiny of reported Section 1031 exchanges. The following concerns were mentioned, and thus such issues may garner more scrutiny in regard to such reviews:

-transactions involving property that is not "like-kind;"

-incorrect basis figures, especially upon ultimate disposition of property acquired in the exchange;

-related party exchanges; and

-exchanges involving second homes or vacation homes.

You can read the report here.

Saturday, October 13, 2007


To be taxed as an S corporation, an election must be filed with the IRS at any time during the tax year before the election year, or it can be made effective retroactively to the first day of the tax year if made on or before the 15th day of the third month of that tax year. Taxpayers seem to have a lot of problems meeting this deadline, and for years the IRS has offered various methods of relief for late filed elections.

The relief continues - in Rev.Proc. 2007-62, an additional method for having a late election accepted by the IRS has been promulgated. Under this Revenue Procedure, the IRS will respect a late filed election under the following conditions:

--The entity fails to qualify for its intended status as an S corporation on the first day that status was desired solely because of the failure to file a timely Form 2553 with the applicable campus;

--It has reasonable cause for its failure to file a timely Form 2553;

--It has not filed a tax return for the first tax year in which the election was intended;

--The application for relief is filed no later than 6 months after the due date of the tax return (excluding extensions) of the entity seeking to make the election for the first taxable year in which the election was intended; and

--No taxpayer whose tax liability or tax return would be affected by the S corporation election (including all shareholders of the S corporation) has reported inconsistently with the S corporation election, on any affected return for the year the S corporation election was intended.

While helpful, this method can only be used where reasonable cause for the failure to timely file exists. A key benefit of this method is that no private letter ruling filing fee applies.

If an entity cannot use this method, it can explore the availability of the other relief methods under Rev.Proc. 97-48 and Rev.Proc. 2003-48.

Tuesday, October 09, 2007


A decedent died owning a 50% joint ownership interest in art. On his estate tax return, a very substantial discount in the value of the joint interest was taken to account for the joint ownership nature of ownership. After several procedural gyrations, the discount for joint ownership issue came before the federal District Court. The IRS argued for a 0% discount due to joint ownership - the estate argued for a 44% discount.

The Court ruling allowed only for a 5% discount. This does seem to be a little on the low side, since if a joint owner wanted to cash out his or her joint interest, the probable method would be to have the entire item sold at auction. An auction is always open to the lack of a reasonable amount of bidding risk and the possible "steal" of the artwork for a low price. Would someone purchasing a joint ownership interest (that is, in trying to apply the willing buyer/willing seller standard for estate tax valuation) discount the purchase price only 5% for this risk of loss?

Stone v. U.S., 100 AFTR 2d 2007-5512 (DC N.D Cal. 2007)

Saturday, October 06, 2007


The U.S. and Canada recently signed a 5th Protocol (amendment) to their income tax treaty. Highlights of the Protocol include:

  1. Zero Withholding on Interest Payments. The current Treaty provides for a 10% withholding rate on cross-border interest payments. This is reduced to 0% under the new Protocol.
  2. Arbitration. The Protocol provides for mandatory arbitration procedures for disputes with regard to certain Treaty provisions.
  3. Transparent Entities. The Protocol has provisions allowing for reduced Treaty rates when transparent entities (such as LLC's) are involved.

The Protocol needs to be ratified by the U.S. Senate and and the Canada Parliament before it enters into force.

Wednesday, October 03, 2007


The IRS has summons authority to gain access to taxpayer and third party documents. However, if the documentation is protected by the work product privilege, such access is difficult to obtain.

The work product privilege privilege protects written statements, private memoranda and personal recollections, prepared or formed by an adverse party's counsel in the course of his legal duties. It is intended to prevent a litigant from taking a free ride on the reasoning and thinking of his opponent's lawyer and thus avoid deterring a lawyer's committing his thoughts to paper.

A document is eligible for protection under the work product rule where it was created “because of” anticipated litigation and wouldn't have been prepared in substantially similar form but for the prospect of that litigation.  In addressing whether a tax opinion issued prior to audit is covered by the work product privilege, the IRS recently proclaimed that a "document prepared in anticipation of an audit, even if it focuses on a particular transaction or item, is not prepared in anticipation of litigation. If a document is prepared before even an audit has been initiated, the specter of litigation is, absent [special facts], too insubstantial and attenuated to support a conclusion that the possibility of litigation is concrete or significant" enough to bring such a document under the privilege.

Note, however, that this pronouncement was made in an Action on Decision whereby the IRS was disagreeing with an appellate court ruling that was opposite to what it is asserting. Therefore, the IRS' position on this issue, as announced in the AOD, should not be taken as a correct interpretation of law, but merely a strong indication of the IRS' intent to fight the work product privilege in similar circumstances.

AOD 2007-004 (10/1/07)

Sunday, September 30, 2007


U.S. taxpayers who require an employer identification number (EIN) generally obtain one by filling out a Form SS-4 and submitting it to the IRS via mail, phone, fax, or over the internet. The IRS has now further simplified the process by allowing one to be issued immediately over the internet without using a Form SS-4. Instead, the online service prompts the taxpayer with questions, with succeeding questions varying based on the prior responses. The system also provides help screens so that the taxpayer does not have to go look at the Form SS-4 instructions to complete the answers.

At the end of the process, an EIN is issued to the taxpayer and a confirmation notice is provided which the taxpayer can view, print and/or save, so that the taxpayer does not have to wait to receive one in the mail.

An authorized person can go through the process on behalf of the taxpayer. However, in that case, no confirmation notice is immediately provided, and it is instead mailed to the taxpayer. At first review, the process does not appear to provide for issuance of an EIN to a foreign entity.

An EIN issued in any manner by the IRS (phone, fax, mail, or online) takes up to two weeks before it becomes part of the IRS' permanent records. While you can use an issued EIN immediately, you must wait until it is part of the IRS' permanent records before you can file an electronic return, make an electronic payment, or pass an IRS Taxpayer Identification Number matching program.

The online application can be accessed at or by following the links starting at

IR 2007-161

Thursday, September 27, 2007


Before the IRS can adjust or assess income taxes for a tax year, it must send a statutory notice of deficiency (also known as a "90 day letter") to the taxpayer, advising the taxpayer of its intent to assess taxes. This notice requires the IRS to wait 90 days before it can assess the taxes, during which period the taxpayer can petition the Tax Court to challenge the proposed assessment. If the taxpayer does not file a timely Tax Court petition, the only way to obtain judicial review of the tax assessment is to pay the taxes and sue for a refund in federal court. Thus, a taxpayer cannot generally obtain judicial review (without paying the tax) unless the taxpayer files a Tax Court petition within the 90 day period.

Under Code Section 6330, a taxpayer can obtain a judicial "due process" hearing in regard to the IRS seeking to levy on his or her assets. Generally, this hearing cannot be used to review the proper assessment of the tax that the IRS is trying to collect - that is, it cannot be used as a backdoor method of getting such a review outside of the above 90 day review procedures. However, Section 6330 does provide that the tax can be reviewed if the taxpayer "did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability."

In a recent Tax Court case involving Section 6330, the taxpayer did not receive his 90 day letter until 12 days before the expiration of the 90 day period due to the taxpayer moving from his last address known to the IRS. The legal issue was whether having only 12 days to file a petition with the Tax Court (which the taxpayer did not do) denied him the "opportunity to dispute" the underlying tax liability. The Tax Court ruled that 12 days was not enough to give him such an opportunity, and thus allowed review of the tax liability in the Section 6330 due process hearing.

Kuykendall, 129 T.C. No. 9 (2007)

Tuesday, September 25, 2007


Florida's scheduled vote on January 29 on a constitutional amendment to revamp its homestead property exemption tax system has been cancelled by a Tallahassee judge. The judge indicated that the amendment is confusing and misleading to voters.

One problem with the amendment is that the ballot summary doesn't tell voters that the new system will phase out the popular Save Our Homes tax cap limiting taxable homestead value increases at 3 percent a year. It is also misleading in promising "everyone" a minimum $50,000 homestead tax exemption.

This does not mean that the vote is off for good. The Florida Legislature may appeal the ruling, or simply correct the defects in its October 3 special session.

Saturday, September 22, 2007


The IRS has issued the following adjustments to certain transfer tax and foreign items that are adjusted annually based on the prior year's inflation:

GIFT TAX EXCLUSION - For gifts made in 2008, the annual gift tax exclusion will remain unchanged at $12,000 per recipient.

ANNUAL EXCLUSION FOR GIFTS TO NONCITIZEN SPOUSES. For 2008 gifts, the exclusion will be $128,000 ($125,000 in 2007).

REPORTING OF GIFTS FROM FOREIGNERS. For gifts from a nonresident alien individual or an inheritance from a foreign estate, reporting is required if the aggregate amount of gifts from that person exceeds $100,000 during the tax year. For gifts from foreign corporations and foreign partnerships, the reporting threshold amount will be $13,561 in 2008 ($13,258 in 2007).

ESTATE TAX SPECIAL USE VALUATION REDUCTION. For decedents dying in 2008, the maximum decrease in value of qualifying assets for special use valuation is $960,000 ($940,000 in 2007).

2% INTEREST RATE PORTION ON DEFERRED ESTATE TAX. In determining the part of the estate tax that is deferred on a farm or closely-held business that is subject to interest at a rate of 2% a year, the tentative tax will be computed on $1,280,000 ($1,250,000 in 2007) plus the applicable exclusion amount.

EXPATRIATION PRESUMPTIONS. Subject to certain exceptions, a tax avoidance motive is presumed for an expatriate whose average annual net income tax liability for the 5 tax years ending before the date of loss of citizenship or residency exceeds $139,000 in 2008 ($136,000 in 2007) or whose net worth on that date exceeds $2 million.

FOREIGN EARNED INCOME EXCLUSION. The foreign earned income exclusion amount increases is $87,600 in 2008 ($85,700 in 2007).

Wednesday, September 19, 2007


October 2007 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.15% (4.76%/September -- 4.94%/August -- (4.91%/July)

-Mid Term AFR - Semi-annual Compounding - 4.3% (4.73%/September -- 5.03%/August -- (4.89%/July)

-Long Term AFR - Semi-annual Compounding - 4.82% (5.03%/September -- 5.24%/August -- (5.09%/July)


Monday, September 17, 2007


Under Code Section 174, research and development expenses are immediately deductible when incurred in a trade or business. This provision will also apply to new businesses despite the fact that no trade or business was being conducted at the time, if there is a realistic prospect that the taxpayer will later enter into a trade or business utilizing the technology developed. If deductibility is not allowed under Code Section 174, the expenses usually must be capitalized into the cost of the developed technology and thus not available for immediate tax deduction.

David Saykally went into the software development business. His intent at the time he was developing his software was to license the software to a wholly owned company, which would use the software in its business. In 1995 and 1996, Saykally deducted R&D expenses of $68,000 and $1,422,000.

The IRS challenged the deductions claiming that Saykally was not going to use the developed software in his own business. The Tax Court held for the IRS, and the 9th Circuit Court of Appeals has now affirmed the Tax Court.

Therefore, software developers who incur R&D expenses for software that they will license need to be careful if they want to currently deduct those expenses. As noted in the Tax Court case, development for license is NOT necessarily fatal to a Code Section 174 deduction. In distinguishing Saykally's situation from that in Scoggins v. Commissioner, 46 F.3d 950 (9th Cir. 1995), rev'g  T.C. Memo. 1991-263, the Tax Court noted that a deduction was allowed in Scoggins even when there was a licensing arrangement because the taxpayer there still intended to otherwise use the developed technology in its own trade or business. Since Saykally had no intent to otherwise use the developed technology himself, no R&D deduction is allowable.

David M. Saykally, 100 AFTR2d Para. 2007-5250 (CA 9 8/16/2007).

Friday, September 14, 2007


The IRS has announced the interest rates for tax overpayments and underpayments for the calendar quarter beginning October 1, 2007.

For noncorporate taxpayers, the rate for both underpayments and overpayments will be 8%.

For corporations, the overpayment rate will be 7%. Corporations will receive 5.5% for overpayments exceeding $10,000. The underpayment rate for corporations will be 8%, but will be 10% for large corporate underpayments.

Rev. Rul. 2007-56

Thursday, September 13, 2007


Employers regularly adopt plans or agreements to pay compensation to one or more employees at a later point in time. Usually, the employees don't want to be taxed at the time the agreement is entered into, but only when the compensation is paid (well, they probably NEVER want to be taxed, but clearly prefer waiting until payment at least). Various provisions of the Internal Revenue Code may affect the ability to "defer" income taxation on such compensation.

One of the newest provisions is Code Section 409A, which applies to nonqualified plans (that is, deferred compensation arrangements that do not meet the specific Code requirements for retirement/deferred compensation payouts). Under Code Section 409A , all amounts deferred under a NQDC plan are currently includible in income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income, unless the plan (a) meets certain stated distribution, acceleration of benefit, and election requirements, and (b) is operated in accordance with these requirements.

In 2007, the IRS issued regulations under Code Section 409A that required that all plans be in writing and contain requirements provided for in those regulations. Initially, it gave taxpayers until January 1, 2008 to get compliant plans in place.

Acknowledging that this was too quick a deadline, the IRS has now extended the written plan deadline until December 31, 2008. Taxpayers have until that date to adopt a fully complying written plan if (1) the plan is operated in accordance with the requirements of Section 409A and applicable regulations and guidance through that date, and (2) the plan is amended on or before December 31, 2008 to comply retroactively to January 1, 2008. However, to use this extended time period, taxpayers must still comply with certain written designation of a time and form of payment requirements by January 1, 2008.

Undoubtedly, there are numerous employers who may have plans or agreements as to paying deferred compensation but who are not aware of Code Section 409A and/or its written plan requirements. If there is any question, such employers should consult with their tax counsel soon to determine whether they come within Code Section 409A, and if yes, to assist with the preparation of a complying written plan.

Notice 2007-78

Monday, September 10, 2007


One of the more ridiculous notions out there is that tax planning techniques can be patented. Whether they can be patented as a legal matter is presently a disputed issue - the layman has to wonder, however, how someone can "own" a series of financial, trust, or asset transactions that are designed to achieve tax benefits. The uncertainty hasn't stopped some attorneys and other professionals from seeking patent protection for techniques they claim to have invented.

A measure of sanity may soon be arriving. Last week, the House of Representatives enacted legislation that, at least on a prospective basis, declares that tax planning techniques cannot be patented. Hopefully, this will pass into law.

The current version of the law does not disturb prior patents - although it does say that it should not be interpreted as to validate prior tax planning patents.

H.R.1908, the Patent Reform Act of 2007

Wednesday, September 05, 2007


According to the Summer 2007 of the IRS Statistics of Income, a significant reduction in federal estate tax returns has occurred in the new millennium.

The total number of estate tax returns filed fell by 58 percent to about 45,000 in 2005 from about 108,000 in 2001. The total amount of assets represented by these returns also fell but by far less. Total gross estate (assets) on these returns fell by 14 percent to $185 billion in 2005 from $216 billion in 2001. Meanwhile, net estate taxes reported on these returns declined by even less, only 8 percent.

The reduction in returns filed is due to the steady increase in the unified credit equivalent amount allowed for federal estate taxes from $600,000 to $1.5 million for decedents dying in 2005. Since estates with less than the available credit equivalent in assets do not need to file, increases in the credit result in few returns.

It is likely that this trend will continue as the exemption continues to grow (through 2009). The current credit equivalent amount is $2 million.

Sunday, September 02, 2007


The IRS trusts tournament poker winners to pay income taxes on their winnings as much as it trusts other gamblers. That is, it doesn't trust them at all.

In a recently issued Revenue Procedure, the IRS is requiring tournament operators to withhold 25% of poker winnings if the proceeds are more than $5,000 over the entrance fee. Information reporting to the IRS about such payments are also required. Rev. Proc. 2007-57, 2007-36 IRB 547.

Gamblers shouldn't feel slighted –Congress really doesn't trust the average U.S. wage earner either, per its continued retention of the wage withholding system. However, some believe that the wage withholding system is not based on a lack of trust but on a belief that the U.S. taxpayer will be more accepting of higher income tax rates if their employers pay the taxes( instead of the wage earner writing a check out of his or her own bank account).

This has not been a good tax year for tournament poker players. Earlier this year, the Tax Court held that tournament poker is a wagering activity, losses from which are subject to the limits of deduction under Code Section 165(g). Under Section 165(g), such losses can only be used to offset winnings – losses in excess of winnings are disallowed. Tschetschot, TC Memo 2007-38.

Thursday, August 30, 2007


A trust that owns stock in a Subchapter S corporation can elect to be taxed as an "electing small business trust" or "ESBT." Such an election is one method of avoiding the prohibition on trust ownership of Subchapter S corporation stock.

After making the ESBT election, the portion of the trust that owns the Subchapter S stock is taxed separately from the remaining portion of the trust. Code Section 641(c)(2)(C) limits the deductions and losses of the ESBT share to those that pass through to it as a shareholder of an 'S' corporation, losses from the disposition of the 'S' corporation stock, and a share of trust administration expenses.

What happens if the trust had a net operating loss attributable to the pass-through of 'S' corporation stock as of the time of its ESBT election? The Code is not entirely clear on whether the ESBT can deduct that NOL.

Code Section 642(h)(1) indicates that on the termination of a trust, the net operating losses of the terminating trust carry over to the beneficiaries receiving the assets of the terminating trust. Arguably, then, such losses should carry over to the ESBT trust as successor to the pre-ESBT trust. Since the losses came from the 'S' corporation, the limits under Code Section 641(c)(2)(C) on losses that are deductible by an ESBT perhaps should not apply.

In a recent Chief Counsel Advice, the IRS has indicated that the NOL cannot be carried over to the ESBT (although it can be used by the non-ESBT portion of the trust). The rationale of the Advice is that the Code Section 641(c)(2)(C) list of allowable ESBT deductions is the exclusive list of deductions, and that a Code Section 642(h)(1) NOL carryover is not included in that list (even though one could argue that it is included via Code Section 641(c)(2)(C)(i), relating to Subchapter S items described in Code Section 1366)).

Unless they feel strongly that the Advice is erroneous, practitioners should count as a "cost" to electing ESBT status the possible loss of prior NOL's attributable to the 'S' stock, unless those losses can effectively be used by the non-ESBT portion of the electing trust.

CCA 200734019 -- 08/24/2007

Tuesday, August 28, 2007


A recent article in the Estate Planning Journal provides some recommendations on drafting cohabitation agreements for unmarried couples (Goffe, Wendy S., Preparing Effective Cohabitation Agreements for Unmarried Couples). Such agreements are similar to the prenuptial and post-nuptial agreements entered into by their married counterparts. Such cohabitation agreements typically address expense sharing, how income will be shared or separated, how assets will be titled, and what happens to property upon termination of the relationship.

As noted in the article, what may come as a surprise to many is that cohabitation between unmarried persons, if there is a sexual relationship involved, is illegal in the State of Florida. More particularly, Florida Statutes Section 798.02 provides: "If any man and woman, not being married to each other, lewdly and lasciviously associate and cohabit together, or if any man or woman, married or unmarried, engages in open and gross lewdness and lascivious behavior, they shall be guilty of a misdemeanor of the second degree…"

This raises the question whether a cohabitation agreement is enforceable in Florida, since arguably it is void as against public policy or because it is based on illegal consideration (the illegal relationship described in the above law).

This issue has not been fully resolved in Florida. The principal case in the area is Poe v. Levy's Estate, 411 So2d 253 (4th DCA 1982). That case holds that if there is valid consideration (promises or other amounts paid) for an agreement between cohabitating parties aside from sexual relations, then the agreement will not be void. Therefore, if a Florida cohabitation agreement includes consideration outside of the sexual arena, then enforceability should not be an issue. However, there are not a lot of cases on the issue, so even though Poe supports this rule, if it comes up in other Florida appellate districts, a different result is possible.

Friday, August 24, 2007


Nevada recently enacted unique legislation that will enhance the use of its corporations for asset protection purposes. More particularly, it became the first state to enact legislation that provides that a charging order will be the sole remedy for creditors of stockholders of certain Nevada corporations in regard to those shares.

The concept of a "charging order" comes from the partnership and LLC arena. If a debtor owns an interest in a partnership or LLC, and a creditor of that debtor obtains a "charging order" against that interest to collect its debt, the creditor does not become a full owner of the interest. Instead, the creditor's interest is limited to receiving distributions from the entity to the extent that the entity otherwise makes distributions to its owners. If other persons control the entity, this wait for a distribution can be quite lengthy. Further, once the creditor is paid off with distributions, its interest in the entity terminates and the debtor owner thereafter receives back its full ownership rights. Therefore, obtaining a charging order is not as good a remedy for a creditor as being able to force a judicial sale of the interest of the debtor. If the creditor can force a judicial sale, the creditor immediately gets the sale proceeds from the interest – or if it purchases the interest with its debt, it gets full ownership rights forever in the entity and the debtor loses all rights.

Some jurisdictions limit a creditor's rights to a charging order. By doing so, debtors receive creditor protections because the creditor can no longer force

Until the new legislation in Nevada, the charging order remedy had no application to stock in a corporation. By providing that a charging order will now be the sole remedy for creditors of Nevada corporation stockholders as to their shares, Nevada is now providing a significant (and presently unique) method of asset protection.

The new legislation does not apply to all Nevada corporations. For example, the corporation must have more than 1 stockholder and less than 75 stockholders. It cannot be a subsidiary of a publicly traded entity, nor a professional corporation. It will also not apply to any liabilities arising from an action filed before July 1, 2007. Contractual remedies offered by a stockholder to a creditor will not be overriden by the new law.

What happens if the debtor stockholder lives outside of Nevada – will the protection apply? The question of whether the law of Nevada or the law of the residence of the debtor stockholder will apply is unknown – indeed, this is an issue that applies to all the various asset protection statutory protections offered by the various states. Until the issue is resolved, a reasonable approach for persons outside of Nevada is to adopt the attitude of "what do I have to lose" by using a Nevada company, since the possibility that it could work will provide negotiating leverage with creditors. The answer to what is lost by using a Nevada corporation instead of a corporation in one's home state is mostly just the increased costs involved, such as payment of registered agent fees for a local Nevada registered agent, the costs of a service to assist with formation, other Nevada fees, and possibly the need to register the company to do business in a different state.

Wednesday, August 22, 2007


September 2007 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.76% (4.94%/August -- (4.91%/July -- 4.78%/June)

-Mid Term AFR - Semi-annual Compounding - 4.73% (5.03%/August -- (4.89%/July -- 4.59%/June)

-Long Term AFR - Semi-annual Compounding - 5.03% (5.24%/August -- (5.09%/July -- 4.85%/June)


Friday, August 17, 2007


Under the check-the-box rules, entities owned by one person can often elect (or by default may be treated as) a disregarded entity for tax purposes. This generally means that the income and expenses of the entity are not taxable or reportable by the entity but are instead treated as being incurred directly by the owning person or member. Qualified subchapter S subsidiaries are similarly treated.

The IRS has had problems with this in the employment tax area in regard to wage withholding and FICA and FUTA taxes. In 1999, the IRS announced that these liabilities can either be met by the disregarded entity under its own name and taxpayer identification number, or by the owner under its name and taxpayer identification number. In 2005, it issued proposed regulations that would ignore the disregarded entity rules in this area, thus imposing the obligations solely on the disregarded entity.

The IRS has now issued final regulations, putting the 2005 proposed regulations into action. They will apply to wages paid on or after January 1, 2009, so they are not immediately applicable. A disregarded entity that is subject to these rules is treated as a corporation for purposes of applying the withholding tax rules.

Under these rules, an individual who is the owner of a disregarded entity treated as a sole proprietorship will not be treated as an employee, but as self-employed for purposes of the employment tax rules.

New regulations now will also treat these disregarded entities as separate entities for certain excise taxes reported on Forms 720, 730, 2290, and 11-C, as well as for excise tax refunds or payments claimed on Form 8849, and excise tax registration on Form 637. These rules are effective January 1, 2008, a year before the employment tax rules.

T.D. 9356 ; Reg. § 1.34-1 ; Reg. § 1.1361-4 ; Reg. § 301.7701-2

Wednesday, August 15, 2007


A child is given over by his natural parent to adoptive parents. The adoptive father raises the child, and then passes away without a last will. The child seeks to receive his intestate share of his adoptive father's property, but finds out that no formal adoption occurred. The child asserts that even though he was never actually adopted, he was "virtually adopted" and thus should receive his intestate share. Florida statutes make no mention of the concept – does the child have any rights?

A recent Florida case confirms that virtual adoption does indeed exist in Florida. Reviewing the case law on the unusual subject, the appeals court laid out the five necessary elements that need to be present to make a case for "virtual adoption" in regard to inheriting property from a deceased adoptive parent:

  1. an agreement between the natural and adoptive parents (regarding the transfer of custody and providing for the adoption);

  2. performance by the natural parents of the child in giving up custody;

  3. performance by the child by living in the home of the adoptive parents;

  4. partial performance by the foster parents in taking the child into the home and treating the child as their child; and

  5. intestacy (dying without a last will) of the foster parents.

If virtual adoption is found, the child's rights to property are based on contract principles.

In the instant case, one of the elements was missing, so virtual adoption was held not applicable.

In re Estate of Ladislav Louis Musil, deceased. GERALDINE DOUGLASS, Appellant, v. ROSA FRAZIER, as Curator of the Estate of Allen Frazier, deceased, Appellee. 2nd District. Case No. 2D06-2114. Opinion filed August 15, 2007.

Sunday, August 12, 2007


Tax effects flow from the date transactions occur. For example, in a recent Tax Court case, a dispute arose in regard to a change in ownership of interests in a limited liability company (LLC). For LLC's taxable as a partnership, the members are of the LLC are taxable directly on their percentage share of the income and losses of the LLC. Therefore, a transfer of an interest will result in changes to the shares of income (or loss) to be allocated to the involved members, effective as of the date of transfer.

Oftentimes, the documentation for such a transfer does not get completed until after the date the transfer occurred. Therefore, the documentation will often indicate a date the documents are signed, and a retroactive "effective date" for the transfer. In the case mentioned above, the taxpayers had such a retroactive effective date. However, they did not report their ownership as being changed as of the retroactive effective date in filing their tax returns. The IRS sought to apply the retroactive date – and the taxpayers argued that such a retroactive date would be an unenforceable backdating of a document and should be ignored. In the end, the IRS position was upheld. It is interesting that this is the opposite of what you would expect – normally it is the taxpayer that wants to use the prior effective date and the IRS seeking to ignore it.

The case was instructive of several principles that apply to retroactive effective dates. These include:

-impermissible "backdating" generally involves an effort to make it appear that the document in question was executed on a date prior to its actual execution date; i.e., there is an effort to mislead the reader. Therefore, if one is seeking a retroactive effective date for tax purposes, the first requirement is that the document be above board as to what is going on. Thus, showing the true date the agreement is signed, along with an earlier "effective as of" clause, is advisable. What is not advisable is to date an agreement as being signed on a date that is earlier than the date of actual signing.

-To be effective, a retroactive effective date must be allowable under applicable state law. In the case, the Tax Court noted that this was the case in Georgia, the state involved.

-The purpose of the retroactive dating cannot be to obtain an unwarranted tax benefit. In the case at issue, the IRS didn't really care which members picked up the income – changing the percentage ownership among them did not avoid tax it just shifted it among the members. While one could see a situation where the IRS would care (based on relative tax rates, or available losses) which member picked up the income, the fact that the parties are acting at arms-length also goes a long way to protect against a "tax benefit" objection by the IRS.

-The Tax Court will be more willing to accept a retroactive effective date if it can be shown that the later written documents is merely a memorialization of a prior oral agreement. Therefore, if this is the case, it would probably be helpful to recite this in the documentation.

Barry E. Moore, et ux., TC Memo 2007-134

Thursday, August 09, 2007


The conventional wisdom is that taxpayers should contribute all that the law allows (but of course, no more than they can afford) to tax-deferred retirement plans. This allows for a current income tax deduction for the contribution (and thus instant savings on income taxes), and deferred income taxes on growth on the contributed assets.

However, the conventional wisdom is not always correct. Some number crunching CPA's have confirmed that older workers may be better off not contributing everything they can. This is due to the confluence of several factors, including (a) mandatory minimum distribution requirements that require distributions to made soon after retirement, which distributions will be taxable, and (b) the fact that under current law, the current rates of income tax are slated to materially increase in 2011. Thus, current income tax deductions at today's lower rates will result in higher taxes when paid out of the retirement account at later higher rates.

For this to occur, however, the assets not transferred to the retirement plan would need to be invested in a low tax investment, such as long term investments in securities that are taxable only on sale. Otherwise, the tax benefits of deferring current investment income in the retirement plan will again swing the computation in favor of making a deductible contribution to the retirement plan.

Of course, if a taxpayer loses out on employer-matching of contributions to a retirement plan by not making their own contribution, then the balance will also swing in favor of making the retirement plan contribution.

Source: Baxendale, Sidney J. & Levitan, Alan S., Reduce Pre-Tax Retirement Contributions For More After-Tax Wealth, Practical Tax Strategies (July 2007)


My experiment to link to a descriptive summary map (a "mindmap") didn't work out so well - some of you had trouble opening the linked .pdf file. I am trying a new service that looks like it will work better.

To download or read the summary of audit triggers, click on the link for the summary of Common Estate Tax Audit Triggers and How to Avoid Them by Jill Miller from the August 2007 issue of Estate Planning Journal (after clicking the link, click the Download button on the webpage, and then you can either "open" or "save" the file).

I like to use mindmaps to visualize summarize things that contain a lot of information - hopefully this will work out and I can use them for blog posts. Feel free to send me an email at if you have any problems or comments, and my apologies to anyone who had trouble with the link.

Monday, August 06, 2007


Estate tax audits can be costly, both in regard to professional fees and increased taxes. A recent article summarizes a number of audit triggers that can usually be avoided when the estate tax return is carefully prepared.

Click on the link to see the highlights of Common Estate Tax Audit Triggers and How to Avoid Them by Jill Miller from the August 2007 issue of Estate Planning Journal (after clicking the link, click the Download button on the webpage, and then you can either "open" or "save" the file).

Saturday, August 04, 2007


The requirements for estates that file a Florida Estate Tax Return for Residents, Nonresidents, and Nonresident Aliens (Form F-706) with no tax due have changed.

Effective July 1, 2007, Florida law no longer requires the estate of a decedent who died after December 31, 2004, to file a Florida estate tax return (Form F-706) if a state death tax credit or a generation-skipping transfer credit is not allowed by the Internal Revenue Code.

This is welcome news – until now, Florida has required the return even though Florida no longer imposes an estate tax.

However, this provision does not apply to estates of decedents dying after December 31, 2010.

Thursday, August 02, 2007


Sections 608.406 and 608.407, Florida Statutes, were amended during the 2007 legislative session. Effective July 1, 2007, the name of a new limited liability company and the new name of an existing limited liability company must be distinguishable from the names of all other filings filed with the Division of Corporations, except for fictitious name registrations and general partnership registrations. The name must also contain the words "limited liability company," the abbreviation "L.L.C.," or the designation "LLC" as the last words of the name. "Limited Company," the abbreviation "L.C.," and the designation "LC," are no longer acceptable suffixes.

Monday, July 30, 2007


Under Code Section 165(g), when a security becomes worthless (other than a security in certain affiliated corporations), the taxpayer will be treated as having sold the security. The Code provides that this will usually result in a capital loss for the taxpayer to the extent of its adjusted basis in the security.

Taxpayers would prefer to receive an ordinary loss, since the Internal Revenue Code limits the use of long term capital losses. Some commentators have suggested that if a taxpayer "abandons" a security, it avoids the application of Code Section 165(g) and thus allows for ordinary loss treatment.

As you would expect, the IRS doesn't like that end-around the capital loss rules. After noting that Code Section 165(g) was enacted to foreclose taxpayers with worthless securities from deducting their losses as ordinary, in the Preamble to proposed regulations issued under Code Section 165(g) the IRS is asserting that the same policy is at issue with this type of "abandonment" planning. To avoid what it perceives as an incorrect result, in Proposed Regulation Sections 1.165-5(i) the IRS has indicated that an abandonment of a security will be treated the same as worthlessness, and capital loss treatment will result.

REG-101001-05, Abandonment of Stock and Other Securities., 07/27/2007

Saturday, July 28, 2007


Under the Internal Revenue Code, miscellaneous itemized deductions are allowed for individuals (which include trusts and estates) only to the extent that the aggregate deductions exceed 2 percent of adjusted gross income. However, certain expenses of an estate or trust are not subject to the 2 percent floor. These expenses are administration expenses which would not have been incurred if the property were not held in the estate or trust (Code Section 67(e)). There has been a significant amount of litigation about what expenses come within this exception – especially as to whether investment advisory fees come within it.

The IRS has now issued proposed regulations on what test should be used to determine whether a deduction comes within the exception. The test employed by the proposed regulations is whether an expense is "unique" to an estate or trust – if it is unique it is not subject to the 2 percent floor. For this purpose, a cost is "unique" if an individual could not have incurred that cost in connection with property not held in an estate or trust.

The proposed regulations indicate that the following expenses are "unique" and thus should not be subject to the 2 percent floor, namely expenses in connection with fiduciary accountings, judicial or quasi-judicial required filings, fiduciary income tax and estate tax returns, the division or distribution or income or corpus to or among beneficiaries, trust or will contests or constructions, fiduciary bond premiums, and communications with beneficiaries regarding estate or trust matters. It also provides a list of items that are NOT unique and thus not subject to the 2% floor, namely relating to the custody or management of property, advice on investing for total return, gift tax returns, defense of claims by creditors of the decedent or grantor, and the purchase, sale, maintenance, repair, insurance or management of non-trade or business property.

The IRS also indicates it will "unbundle" fees for various services, so that each service will need to be addressed on a separate basis.

Of course, these are only proposed regulations, and are not currently applicable, but they are a clear indication of the course the IRS wants to take.

COMMENT: It is interesting that the Code uses the language which "would not have" been incurred if the property was not held in the trust or estate, and the IRS converts this to which "could not have" been incurred in the proposed regulations. It is difficult to determine if this is a meaningful difference, but it seems like it could (or should we say "would") be in some circumstances.

Proposed Regulations Section 1.67-4.

Tuesday, July 24, 2007


The IRS issued a mixed ruling to a taxpayer involved in a contingent payout sale under the installment sale method. In the ruling, a Subchapter S corporation sold assets. Part of the sales price included future payments contingent on earnings of the buyer.

The installment sale rules provide for deferral of income tax on gains from the sale of property when payments will be made in future years. In calculating gains each year, the seller's basis in the sold asset(s) are allocated to each payment as it is received. However, when, due to contingent payment provisions, the total price cannot be determined but the payment period is fixed, the taxpayer's basis (including selling expenses) is allocated to the tax years in which payments are to be received in equal annual increments. Treas.Regs. §15a.453-1(c)(3)(i).

In the ruling, the taxpayer applied for a special basis allocation that would allow it to apply its basis earlier than provided under the above contingent payment rule. The IRS allowed the revised method.

However, the IRS also indicated that Code Section 453A interest on the contingent payment amount would be imposed. Code Section 453A generally provides that interest is chargeable on tax deferred on the installment method to the extent that the deferred payments exceed $5 million. By charging interest on the contingent payment, the IRS is effectively saying that interest could be payable on payments that may never be received. This seems unfair, and clearly is an unfavorable application of the provision. Further, it is not clear how a taxpayer could even apply this in situations where the amount of the future contingent payment is unknown.

PLR 200728039

Saturday, July 21, 2007


The IRS does not have forever to pursue taxpayers for errors or omissions on their income tax returns. For income tax purposes, the IRS must assess additional income taxes within 3 years after the later of the date the tax return was filed or the due date of the tax return.

There are some exceptions to the 3 year limit. One major exception is found in Code Sec. 6501(e)(1)(A) ,which provides for a 6 year period of limitations if the taxpayer omits from gross income an amount that's greater than 25% of the amount of gross income stated in the return. For example, if a taxpayer reports $100,000 of income, but the IRS find that the taxpayer did not report a $35,000 gain on the sale of property, the taxpayer has omitted more than 25% of his or her gross income and the IRS can assess additional tax for up to 6 years.

What if the taxpayer overstated his or her tax basis of an asset, and this resulted in income of more than 25% of the reported income not being reported on the income tax return? Is this an "omission," or some type of error that does not allow the use of the 6 year statute of limitations? Tax basis is the "adjusted cost" of an item of property, and is used to compute net gain or loss on sale for income tax purposes. It may also affect other items, such as depreciation deductions.

This was the issue in a recent Tax Court case – the IRS was arguing that when a taxpayer overstated his basis in an asset, which resulted in a more than 25% omission in gross income, that the IRS had a 6 year period of limitations to assess more income tax. The Tax Court ruled with the taxpayer on this one. The Tax Court noted that the Supreme Court held that "omits" means something "left out" and not something put in and overstated (such as additional basis), and thus the 6 year statute does not apply. Bakersfield Energy Partners, LP, Robert Shore, Steven Fisher, Gregory Miles and Scott McMillan, Partners other than the Tax Matters Partner, 128 TC No. 17 (2007.

Coincidentally, the Claims Court also recently interpreted Code Section 6229(c) in a similar manner. Code Section 6229(c) has a similar 6 year extended statute of limitations for 25% omissions, but applies in the partnership audit area. Grapevine Imports Ltd. v. U.S., 100 AFTR 2d ¶2007-5065 (Ct Fed Cl 7/17/2007)

Thursday, July 19, 2007


August 2007 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.94% (4.91%/July -- 4.78%/June -- 4.79%/May)

-Mid Term AFR - Semi-annual Compounding - 5.03% (4.89%/July -- 4.59%/June -- 4.57%/May)

-Long Term AFR - Semi-annual Compounding - 5.24% (5.09%/July -- 4.85%/June -- 4.84%/May)


Tuesday, July 17, 2007


Both churches and qualified religious organizations are exempt from income tax under Code Section 501(c)(3). However, there are advantages to being a "church" as compared to a "religious organization." These include reduced reporting requirements, enhanced charitable deductions for contributors, and the ability to obtain Section 501(c)(3) status without filing a Form 1023 with the IRS. Therefore, many organizations that would qualify as exempt religious organizations like to go the extra mile if possible and be qualified as a "church." In deciding whether an organization is a church, the IRS examines 14 criteria – the more that are present, the more likely a "church" exists. These criteria are:

1) a distinct legal existence;

2) a recognized creed and form of worship;

3) a definite and distinct ecclesiastical government;

4) a formal code of doctrine and discipline;

5) a distinct religious history;

6) a membership not associated with any other church or denomination;

7) an organization of ordained ministers;

8) ordained ministers selected after completing prescribed studies;

9) a literature of its own;

10) established places of worship;

11) regular congregations;

12) regular religious services;

13) Sunday schools for religious instruction of the young; and

14) schools for the preparation of its ministers.

What happens if an organization is involved in creating and establishing churches – is that enough to qualify that organization as a church? In a recent private letter ruling, despite having many of the above factors present, the organization was denied status as a church. The principal reasons for the denial were that the organization did not have a regular, established congregation of members of its own who meet together, as a church, for regular worship services and instruction of the young, and further did not ordain ministers, operate Sunday schools for religious instruction of the young, and did not have a code of discipline, a distinct ecclesiastical government, an established place of worship, or a membership not associated with other local churches or denominations.

While the churches established by the organization had these criteria, these churches were deemed to be independent of the founding organization, and thus those criteria could not be claimed by the founding organization itself. Perhaps if the founded churches were affiliated and/or controlled by the founding organization, a favorable finding as a church might have been issued.

PLR 200727021

Saturday, July 14, 2007


Exempt organizations are generally required to file a Form 990 or 990-EZ each year. However, the Form 990 requirement is not applicable to organizations with less than $25,000 in annual receipts.

The IRS recently published a news release, reminding such small exempt organizations that while they do not need to file the Form 990 or 990-EZ, there is a new requirement to file Form 990-N, "Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990 or 990-EZ." This filing requirement commences in 2008.

The filing is simple enough, and will include providing a legal name and mailing address, any other names used, a Web address if one exists, the name and address of a principal officer and a statement confirming the organization's annual gross receipts are normally $25,000 or less. While not fully developed yet, the IRS will provide a free, electronic means of filing the form.

While the filing does not include much information, this should not lull small exempt organizations into believing that they can ignore the filing or that penalties for nonfiling are de minimis. If the filing is not made for three years, the organization will automatically lose its exempt status.

For more information on these filing requirements, see Code Section 6033(i) & (j).

News Release 2007-129, 07/12/2007