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Monday, January 29, 2007


The estate tax marital deduction avoids estate taxes on assets passing to the surviving spouse of a decedent. If the assets pass to a trust to be held for the benefit of the surviving spouse, and the trust meets the requirements of Code Section 2056(b)(7), an election can be made (a "QTIP election") to qualify such a transfer for the marital deduction. The election is made on a the estate tax return (Form 706) for the decedent.

The QTIP election has some negative tax consequences. For example, at the death of the surviving spouse any remaining assets in the QTIP marital deduction trust are potentially subject to estate taxes in the estate of the surviving spouse.

It is not always necessary for assets passing into a QTIP trust to be subject to a QTIP election. For example, if the decedent has available unified credit to cover some or all of the transfer, a complete QTIP election is not needed to save estate taxes for the decedent's estate. In such a case, the QTIP election should not be made (at least not as to all of such a trust) to avoid the negative aspects of a QTIP trust.

Despite this typical planning, the estates of decedents sometimes make QTIP elections that are not needed. Even though a QTIP election is not needed to save estate tax, it still has legal effect and cannot simply be disregarded by taxpayers just because it wasn't needed.

So what should taxpayers do when an unnecessary QTIP election is made on an estate tax return? Private Letter Ruling 200702018 reminds us that the IRS has provided a relief mechanism for unnecessary elections. In Revenue Procedure 2001-38, the IRS provides that an unnecessary QTIP election will be disregarded if its procedures are followed. To come within the Revenue Procedure the taxpayer must produce sufficient evidence of the lack of need for the QTIP election. For example, the taxpayer may produce a copy of the estate tax return filed by the predeceased spouse's estate establishing that the election was not necessary to reduce the estate tax liability to zero, based on values as finally determined for federal estate tax purposes. Such information, including an explanation of why the election should be treated as void under the Revenue Procedure, should be submitted either with the Form 706 filed for the surviving spouse's estate, or with a request for a private letter ruling submitted at any time prior to filing that Form 706.

PLR 200702018, February 1, 2007

Saturday, January 27, 2007


As we previously wrote about, in 2006 the IRS acknowledged that telephone communications for a which a toll charge varied with elapsed time and not distance were not taxable. Taxpayers are allowed to file for a refund on their 2006 returns for such telephone taxes that were previously paid. A credit for the paid taxes can be obtained either by using certain safe harbor dollar amounts, or by calculating and requesting a credit for the actual amount of taxes paid.

The IRS has indicating that in reviewing 2006 tax returns that have already been filed, some taxpayers are (intentionally or unintentionally) abusing the system by seeking refunds for more than they are entitled. For example, some taxpayers are requesting refunds for the entire amount of their phone bills, not the just 3% tax on long-distance and bundled services. Others are making requests for thousands of dollars, indicating phone bills in excess of $100,000, which amounts exceed their entire income!

The IRS is now warning taxpayers that indiviuals requesting an inflated amount may see their entire refund frozen, may have their tax returns audited, and could even face criminal prosecution.

IR News Release 2007-16 (January 25, 2007)

Wednesday, January 24, 2007


February 2007 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.87%
(4.82%/January -- 4.91%/December -- 4.83%/November)

-Mid Term AFR - Semi-annual Compounding - 4.64%
(4.53%/January -- 4.68%/December -- 4.64%/November)

-Long Term AFR - Semi-annual Compounding - 4.80%
(4.68%/January -- 4.84%/December -- 4.84%/November)


Monday, January 22, 2007


Section 501(c)(3) status for an organization provides many benefits. Key among them are:

• Exemption from Federal income tax
• Tax-deductible contributions
• Possible exemption from state income, sales, and employment taxes
• Reduced postal rates
• Exemption from Federal unemployment tax
• Tax-exempt financing.

Qualifying for and obtaining recognition of Section 501(c)(3) status requires meeting stringent IRS requirements. Further, once status is recognized, the organization must operate within IRS parameters to maintain their exemption. There are also special IRS tax return requirements, the vagaries of taxable unrelated business income, and special treatment of employees, that must be dealt with. Few individuals new to the area are conversant with these rules, and indeed, many tax practitioners who do not regularly practice in the area may only have generalized knowledge of the rules.

The IRS has put out an excellent resource to educate those involved in the exempt organizations world on all of these issues. Two words that almost never are used together in the same sentence are "tax" and "entertaining," but I am about to do so. At a new website,, the IRS has created an entertaining method of educating interested persons about these tax issues. Avoiding a mere dry recitation of rules and regulations, the Service is to be applauded for attempting to ease the burden of learning about these rules by including games, challenges, graphics, and sound files to make the education process as painless as possible.

This is an excellent website for practitioners to direct their clients, to help them with their exempt organizations and applicable compliance burdens. Tax practitioners may also benefit from a visit, if only for a refresher on some aspects of exempt organizations they may not have thought about recently.

Thursday, January 18, 2007


Under Code Section 351, taxpayers generally do not recognize gain or loss when they transfer assets to a corporation in exchange for control of the corporation. An important exception to this rule is Code Section 357(c)(1), which provides that if the transferee corporation assumes liabilities of the transferor in excess of the adjusted basis of the transferred assets, the transferor recognizes gain to that extent.

At times, a Code Section 351 transaction can also qualify as an acquisitive 'D' reorganization under Code Section 368(a)(1)(D). That provision generally allows for the acquisition of assets of one corporation by another commonly controlled corporation in exchange for stock of the acquiring corporation. Thus, when there is a transfer between commonly controlled corporations the transfer can constitute both a Section 351 transfer and a 'D' reorganization.

Previously, 'D' reorganizations were subject to the same gain recognition rule under Section 357(c) for liabilities in excess of basis as Section 351 transfers. However, under the American Jobs Creation Act of 2004, 'D' reorganizations are now NOT subject to Section 357(c). So what happens if the acquiring corporation assumes liabilities of the transferring corporation as part of the transaction that are in excess of the adjusted basis of the transferred assets when the transaction qualifies both under Section 351 and a 'D' reorganization? This issue was recently addressed in Revenue Ruling 2007-8.

Under the Revenue Ruling, the IRS concludes that Section 357(c) will not apply, per 'D' reorganizations not being subject to it (even though Section 351 transfers are subject to it). It also noted that an overlap can exist between a 'G' reorganization and a Section 351 transfer, and that Section 357(c) will not be applied in that situation either.

Why did Congress change the law in 2004 to exclude 'D' reorganizations from the reach of Section 357(c)? The Ruling advises that this was done because in such transactions the transferor ceases to exist and cannot be enriched by the assumption of its liabilities. It further shows that the amendment was made to conform the treatment of 'D' acquisitive reorganizations to the treatment of other acquisitive reorganizations.

Rev. Rul. 2007-8, 2007-7 IRB

Monday, January 15, 2007


A few months ago, we discussed how the Pension Protection Act of 2006 provides for the use of “inherited IRA” accounts for the receipt of nonspousal qualified plan assets at the death of a participant. See MORE DETAILS ON NONSPOUSAL ROLLOVER OF INHERITED QUALIFIED PLANS (click on the link and read the August 29, 2006 entry). As noted, a primary purpose of the new option was to allow nonspousal qualified plan recipients to have certain available deferred payout options even if the plan itself did not specifically allow for them – such payout options are available if the proceeds are placed into a qualified “inherited IRA.”

The IRS has now issued guidance on inherited IRA accounts, and there are some unexpected provisions. These include:

·A qualified plan IS NOT required to allow for distribution to an inherited IRA. This appears to contradict the expressed purpose of the changes in the law, which was to make the deferred payout arrangements available to all nonspousal beneficiaries regardless of the provisions of the qualified plan from which the proceeds would be paid. We can expect some vocal opposition to the IRS’ interpretation of the new law in this regard.

·If the qualified plan provides for a 5 year payout of benefits to nonspousal beneficiaries if the participant dies before the “required beginning date,” the inherited IRA is also stuck with that 5 year payout rate instead of being able to use the life expectancy of the beneficiary.

·The IRA must be established in a manner that identifies it as an IRA with respect to a deceased individual and also identifies the deceased individual and the beneficiary, for example, “Tom Smith as beneficiary of John Smith.”

·If a qualified plan does offer the inherited IRA rollover option, but not to all participants, it must offer them in a nondiscriminatory manner.

·If the decedent was required to take a required minimum distribution (RMD) before he died but did not, that RMD portion cannot be rolled over to the inherited IRA.

Notice 2007-7, 2007-5 IRB ; IR 2007-7

Thursday, January 11, 2007


Shares of stock, like other assets, are subject to estate tax based on fair market valuation at the date of death (or six months after using alternate valuation rules). If the stock is publicly traded, the value is easily determined based on the trading values on the date of death or the alternate valuation date.

At times, a decedent may own shares in a publicly traded corporation, but his or her shares are not registered for public sale. Further, the shares may be owned by affiliates of the public company, triggering Rule 144 restrictions on resale. In these situations, a discount off of the trading values for the shares is appropriate. Such cases may degenerate into a "battle of the experts" between the IRS and the estate to determine what appropriate valuation methodology and discount applies.

Such a battle occurred in the recent case of Estate of Georgina T. Gimbel, et al. v. Comm., TC Memo 2006-270 (12/19/2006). In the case, the decedent's shares were both unregistered and subject to Rule 144 resale restrictions. The Tax Court made some interesting observations and conclusions in arriving at a final value:

1. The Court found that the "dribble-out" method of valuation applied to a number of the shares. This method is based on Rule 144 restrictions, which limit the number of shares of restricted stock that can be sold in any 3 month period. The maximum number of shares that can be sold is the greater of 1 percent of the outstanding class of stock to be sold or the average weekly trading volume for the previous 4 weeks. In the case, this formula when applied meant that it would take at least 39 months to sell all of the decedent's shares. The dribble-out method applies time value of money discounting principles and risk of loss due to value fluctuations, to discount value for the required delay if it was desired to sell the shares. The Court found that a 14.4-percent discount from the valuation date trading value was appropriate.

2. In factoring in that the shares were not registered for public sale, the Court considered the likelihood (or actually, the unlikelihood) that the company would register the shares for sale.

3. Another factor in accounting for the nonregistered nature of the shares was the likelihood that the subject shares could be sold "unregistered" in a private placement.

4. Another valuation factor was the likelihood that the issuer of the shares would repurchase the shares from the successor owners.

Monday, January 08, 2007


Fraudulent conveyance law may allow a creditor to recover assets transferred by a debtor to third parties. A common misconception is that a debtor can transfer assets to third parties (including trusts) without being subject to fraudulent conveyance rules if the transfer is made to protect the assets against FUTURE creditors of the debtor (as contrasted with EXISTING creditors at the time of transfer).

A recent appellate court decision demonstrates that this is incorrect. In the case, the U.S. sought to recover assets transferred to a trust by a taxpayer using provisions of the Washington state uniform fraudulent conveyance act. The appellate court upheld the trial court in finding a fraudulent conveyance, based on the taxpayers' repeated admissions that they transferred property to the trust in order to avoid potential future creditors. This intent to defraud FUTURE creditors was enough to find the requisite "actual intent to hinder, delay or defraud a[ ] creditor" required under the statute. Note that Florida has a substantially similar statute to Washington in this regard.

This is not to say that there is no difference in the application of fraudulent conveyance law regardless of whether the affected creditor is a present creditor or was a future creditor at the time of transfer. For example, a creditor in existence at the time of transfer at times will not need to show actual or constructive intend to hinder, delay or defraud if the transfer was made when the debtor was insolvent or the transfer renders the debtor insolvent. A mere future creditor cannot rely solely on insolvency under many fraudulent conveyance acts but instead must still show actual or constructive intent to hinder, delay or defraud.

U.S. v. Townley, Slip Copy, 2006 WL 1345248 (9th Cir. No. 04-35767)

Saturday, January 06, 2007


Under Internal Revenue Code Section 678, a person is treated as the owner of any portion of a trust with respect to which that person has the power, solely exercisable by himself or herself, to vest the corpus or the income in himself or herself. When a person is treated as the owner of a portion of a trust under section 678, special rules apply to not tax the trust directly. Instead, the person treated as the owner takes into account the trust's items of income, deduction, and credit attributable to that portion of the trust.

As Thomas B. Goldsby, Jr. learned, the "portion" of the trust that the deemed owner is taxable on can be limited at times to the income of the trust, and not the corpus.

Mr. Goldsby was an income beneficiary and trustee of a trust. Instead of receiving the income of the trust, he allowed it to remain in the trust - although it was treated on the books and records as segregated and due to Mr. Goldsby. The trust contributed a conservation easement in real property it owned to charity which qualified for the charitable income tax deduction. Mr. Goldsby reported himself as owning the portion of the trust making the contribution, and sought to take the income tax deduction individually. The IRS challenged his use of the deduction, asserting that Mr. Goldsby was taxable only on the "income" portion of the trust and that the contribution was made from principal or corpus, so that deduction was not allocable to him under the grantor trust rules.

Mr. Goldsby did make some interesting arguments, but they were all rejected by the Tax Court. First, he asserted that since he left undistributed net income in the trust, this was effectively mingled with and converted to corpus, and thus he still should have been entitled to the deduction. This was rejected because under the trust agreement Mr. Goldsby had no interest in corpus and because the net income was separately accounted for on the trust books and records as undistributed income and not principal.

Second, Mr. Goldsby argued that the conservation easements came from the undistributed net income, regardless of whether that income was converted to principal. However, Mr. Goldsby provided no evidence how the contribution was made from such net income instead of the principal assets of the trust,and thus this argument was also rejected.

Thus, in situations where an income tax item relates to corpus/principal and not income, and the grantor trust rules are involved, care must be taken to determine whether the grantor trust rules apply to income only, or also to principal in determining which taxpayer bears the benefits or burdens of the tax item.

Thomas B. Goldsby, Jr., TC Memo 2006-274

Monday, January 01, 2007


Florida law allows employers to protect themselves by entering into noncompete agreements with employees. Such agreements generally provide that if the employee ceases to work for the employer, the employee may not work for a competitor or take on former clients of the employer for period of time and/or in a fixed geographic area.

Violations are generally enforceable by injunction - a court can prohibit a violating former employee from working for a competitor or otherwise violating the agreement. The agreement may also allow for monetary damages to the employer.

There are limits to monetary damages that can be imposed. In a recent case, an insurance agency entered into a noncompete agreement with one of its agents. The agreement provided that the insurance agency would receive as liquidated damages in the event of a breach of the agreement by the agent (a) $10,000, plus (b) the entire commissions earned by the agency on the accounts sold and/or serviced by agent during the 24 months before the agent ceased to work for the agency. The agent stopped work for the agency and went to work for a competitor, violating the agreement.

The agency obtained a damages award for$161,572.88 under the liquidated damages provision. The agent challenged the damage award, claiming that the liquidated damages provision was unenforceable as a penalty.

The appellate court noted that parties to a contract may stipulate in advance to an amount to be paid as liquidated damages in the event of a breach, provided that the damages resulting from the breach are not readily ascertainable, and provided that the sum stipulated as damages is not so grossly disproportionate to any damages that might reasonably be expected to follow from a breach that the parties could only have intended to induce full performance, rather than to liquidate their damages. If, however, a penalty provision is disguised as a liquidated damages provision, it is unenforceable. The theory is simply that we do not allow one party to hold a penalty provision over the head of the other party "in terrorem" to deter that party from breaching a promise.

In the case at issue, the court had a problem with three aspects of the liquidated damages provision. First, the agency was entitled to 100% of the commissions payable to the agency on the agents accounts for the prior 2 years - however, if the agent had stayed with the firm some portion of those fees would have been payable to the agent so ALL of the commissions payable to the agency is not a fair measure of damages to the agency. Second, the damages were based on ALL of the agent’s former accounts, not just the ones that followed the agent to her new place of work. Again, this was deemed to be an unfair measure of damages suffered by the agency from the breach of contract. Lastly, in addition to these penalties, another $10,000 penalty was thrown in for good measure.

Based on these observations, the appellate court held that the monetary damages were in the nature of a penalty and were not enforceable as liquidated damages. Using the case as a guide, employers can allow for monetary damages for these types of breaches, but they must be a fair measure of actual damages likely to be suffered from the breach.

JANE MARIE BURZEE, Appellant, v. PARK AVENUE INSURANCE AGENCY, INC., Appellee. 5th District. Case No. 5D05-3608. Opinion filed December 29, 2006.