blogger visitor

Monday, December 29, 2008


Section 529 plans are a popular method for savings and investments relating to education expenses. The plans allow investments to grow and be expended for qualified education expenses, free of income taxes. They also allow for contributors to use up to five years of present interest gift tax exclusions in one year, so as to avoid or limit gift taxes on funding of a plan account.

The Internal Revenue Code requires that investment planning and oversight for a plan account cannot be done at the direction of the contributor or beneficiaries of the plan. This requirement has previously been loosened by the IRS in Notice 2001-55, which together with regulations, allows the contributor to select a general investment strategy upon funding, which can be revised once a calendar year and upon a change of designated beneficiary.

As we all know, the investment markets have been wildly turbulent in recent months. To assist taxpayers in preserving value in Section 529 plan accounts in regard to the current state of the markets, the IRS has now announced that the once-per-calendar-year adjustment will be changed to two adjustments for calendar year 2009.

Such relief is beneficial to the plans and their beneficiaries - assuming that taxpayers are astute enough investors to exercise the adjustment powers in a manner that increases overall investment returns. One has to wonder, however, that if twice-per-year adjustments are worthwhile for 2009, then why not allow them for all future years?

Notice 2009-1, 2009-2 IRB, 12/23/2008

Thursday, December 25, 2008


Section 7701(l) of the Code authorizes the Treasury Department to prescribe regulations recharacterizing a multiple-party financing transaction as a transaction directly among any two or more of such parties where the Secretary determines that such recharacterization is appropriate to prevent the avoidance of any tax imposed by the Code. Existing regulations under that provision allows the IRS to disregard the participation of one or more intermediate entities in a financing arrangement where such entities are acting as conduit entities, and to recharacterize the financing arrangement as a transaction directly between the remaining parties to the financing arrangement for purposes of imposing tax under sections 871, 881, 1441 and 1442 of the Code. The regulations are primarily concerned with taxpayers being able to take advantage of advantageous treaty and Code provisions by inserting a qualifying entity or person inbetween an ultimate provider of financing (that would not benefit under the treaty or Code for the favorable benefits) and an ultimate buyer – e.g., “back-to-back” loan arrangements.

New proposed regulations have been issued under Proposed Regulations 1.881-3 that seek to prevent taxpayers from getting around the conduit rules by using a “disregarded entity” as an intermediate entity in a financing arrangement.

The Preamble to the regulations also indicate that separate guidance may be issued in regard to the use of hybrid instruments issued by an intermediate entity that is treated as debt under the laws of the foreign jurisdiction where the intermediate entity is resident and is not treated as debt for U.S. federal tax purposes. The IRS is studying when such arrangements will qualify as conduit arrangements.

Most troubling in the Preamble is a discussion that the IRS is considering issuing rules when equity ownership interests would be recast as financing interests and thus implicate the conduit rules. From the language of the Preamble, the IRS could be limiting this recharacterization to situations in which hybrid instruments are used (as discussed in the preceding paragraph) – that would not be so bad. However, if the discussion portends broad rules that will recast equity arrangements as part of conduit financing arrangements outside of the use of hybrid instruments, this could have a very broad (and chilling effect) on various existing financing arrangements. For example, a loan by a foreign lender to a partner or shareholder of a partnership or corporation, followed by a capital contribution of such loan proceeds to the partnership or corporation, could trigger application of the conduit rules. Hopefully, the guidance, if and when issued, will focus on equity arrangements only in situations where hybrid instruments are used.

Preamble to Prop Regs. 12/22/2008. Fed. Reg. Vol. 73, No. 246 p. 78254

Sunday, December 21, 2008

Tuesday, December 16, 2008


Corporations can often combine or be acquired without any of the parties recognizing gain or loss under the corporate reorganization provisions. One of the requirements for such treatment is that the equity owners of the target corporation continue their equity ownership via acquiring a substantial equity interest in the acquiring corporation (or a parent of the acquiring corporation) – this requirement is known as the continuity of interest requirement.

When a target corporation is insolvent, it may not be possible for the shareholders of the target to receive a substantial equity interest in the acquiring company because the value of the target is substantially held by the creditors of the target corporation. Under newly issued regulations, the IRS will now allow interests of creditors of the target that are exchanged for equity interests in the acquiring corporation to be counted as equity interests in the target corporation for purposes of the continuity of interest requirement, even if the target corporation is not in bankruptcy but is merely insolvent.

When the acquiring corporation issues consideration partly in stock, and partly with cash or other property, the new regulations provide a method of determining how much of a creditor’s interest is considered to be continuing as equity. Different rules apply for senior and junior indebtedness.

The new rules are a welcome method of both allowing for tax-free reorganizations for insolvent entities, and providing mechanical formulas for computing continuing equity for purposes of the continuity of interest test.

Treas.Regs. §1.368-1(e)

Sunday, December 14, 2008


IRA’s and other pension plans allow taxpayers to defer income taxes on contributed amounts and earnings until distribution. The deferral does not last forever – under the required minimum distribution (RMD) rules, taxpayers must make certain prescribed minimum distributions each year after age 70 1/2. The RMD for a given year is computed by multiplying a required distribution table percentage against the value of the account at the end of the preceding year.

With the broad investment market declines, many have seen their IRA and pension accounts lose substantial value. For taxpayers that do not need a full RMD, the RMD rules add insult to injury by (a) requiring annual distributions from the accounts, thus further depleting their balances, and (b) possibly causing account holders to sell investments at distressed values to be able to make the distribution.

In a relief measure, Congress has included in the recently enacted Worker, Retiree and Employer Recovery Act (which is expected to be signed into law by President Bush) a provision that waives the requirement for taxpayers to make an RMD in 2009. Therefore, taxpayers who do not need a full RMD distribution in 2009 do not have to make one.

The provisions apply to IRA’s, and many (but not all) pension plans. Individuals withdrawing under a five year method may also get an additional year to make withdrawals.

This is only a one year relief provision – RMD’s must recommence in 2010. Unfortunately, the provision does not apply to 2008 RMD’s – these must still be made in full. Of course, taxpayers who need full RMD distributions for living expenses will not benefit from this provision.

Wednesday, December 10, 2008


IRS Commissioner Douglas Shulman recently spoke to the George Washington University International Tax Conference. The Commissioner addressed several areas that the IRS is concerned about in the international arena. With such expressions of concern, taxpayers with interests in these areas should be forewarned that stricter or adverse IRS attention to these areas can be anticipated (although some of these areas are already feeling the heat).

TRANSFER PRICING - COST SHARING. The Commissioner is concerned that taxpayers are abusing existing transfer pricing cost sharing mechanisms to shift taxation of profits from valuable intangibles (e.g., new drugs) to offshore, low-tax jurisdictions. He indicated that the IRS is challenging such arrangements at audit when taxpayers are perceived to be crossing the line, and are also working on temporary regulations in the area.

CONTRACT MANUFACTURING. Subpart F of the Code attempts to tax foreign corporations controlled by U.S. persons on a current basis on profits that relate to sales of products that are involved in certain related party sales, instead of allowing taxes to be deferred offshore. Taxpayers have developed mechanisms of reducing exposure to Subpart F by engaging in contract manufacturing between related foreign companies. IRS attacks in regard to transfer pricing reviews of contract manufacturing pricing, and expansion of Subpart F income definitions and the "branch rule" to include contract manufacturing activities, are likely.

USE OF LOW OR NO TAX JURISDICTIONS BY FINANCIAL INSTITUTIONS. Attempting to book transactions as loans and swaps to shift profit to such jurisdictions, is something the IRS is concerned about.

USE OF HYBRID ENTITIES TO OBTAIN DOUBLE DEDUCTIONS OR CREDITS IN VARIOUS JURISDICTIONS. The IRS is concerned about hybrid entities abusing foreign tax credits - if two different taxpayers are getting the benefit of a credit, watch out.

AVOIDANCE OF WITHHOLDING TAXES. The IRS is concerned about institutional assistance by financial institutions in regard to foreign persons avoid U.S. withholding taxes.

UNDISCLOSED FOREIGN BANK ACCOUNTS OF U.S. PERSONS. Well, I think we all know the IRS is big on this issue (e.g., the recent UBS problems in Switzerland).

Saturday, December 06, 2008


Many taxpayers have funds in IRA accounts. If they want to use the funds for a business venture, a distribution of the funds is needed. Such distributions are generally taxable, and if the owner is not old enough, a 10% penalty tax to boot is imposed.

Some taxpayers have been using a special route to accessing these funds without current income taxes. It generally involves forming a new business corporation, establishing a 401(k) plan for the business that allows for investment in employer securities, rolling over the IRA funds (or other funds from a prior employer qualified plan) to the new 401(k) plan, and then using the funds to acquire stock in the new business. By transferring cash for stock in the new business, the corporation receives capital it can use for its business.

On its face, there is nothing illegitimate about such an arrangement – it makes use of legitimate provisions of the tax laws, including the roll-over rules and the ability of certain plans to own employer securities. In practice, some of those that have used such arrangements may not have been strictly following all required retirement plan rules and regulations, so those taxpayers who have not done so may be vulnerable to attack. From an overall policy standpoint, one can speculate that such use of IRA funds is beneficial, since the funds are being put to use in job creation business development activities.

Of course, since it has the “appearance” of use of IRA funds that circumvents the taxable distribution rules, one would expect the government to be bothered by such use. Such expectations have been borne out – the IRS has issued a Memorandum for the directors  of the Employee Plans Examinations division and the Employee Plans Rulings & Agreements division expressing hostility to these arrangements and areas for attack. Indeed, the IRS has adopted the acronym “ROBS” for these rollover to business start-up arrangements. This acronym speaks volumes about the IRS’ attitude towards them.

Possible lines of attack described in the Memorandum include purported violation of antidiscrimination provisions and prohibited transactions relating to deficient valuation of the stock received in the transaction by the plan and payment of promoter fees. The Memorandum also addresses statute of limitations issues since many of these transactions done in the past are close to the expiration of the applicable limitations periods.

There are several promoters out there that seek to educate and assist taxpayers with these types of transactions. Before undertaking them, taxpayers or their advisors should familiarize themselves with the issues raised by the Memorandum.

Memorandum of Michael D. Julianelle, October 1, 2008 (

Thursday, December 04, 2008


For individuals who are not U.S. citizens, Code Section 7701(b) provides rules for determining whether the U.S. will treat them as resident aliens (and thus generally subject their worldwide income to U.S. income tax). I recently prepared a map of the test for a client – for those who are interested it can be accessed here (

Please note that this is an expandable map and works well with recent versions of Adobe Acrobat or Adobe Reader. It may not work with non-Adobe PDF readers.

Thursday, November 27, 2008


Generally, life insurance proceeds are received by the beneficiary free of income taxes. However, in 2006, an important exception to that rule was applied for employer owned life insurance taken out on the life of an employee (EOLI). We first discussed the new exception under Code Section 101(j) back in August 2006 when it was enacted. The IRS has recently finalized regulations regarding reporting under the new rules, so this is a good time to review the area.

The exception was added to prevent businesses from insuring their employees and receiving the death benefits, often without the knowledge and/or consent of the employees. It generally operates to make the insurance proceeds received by a business at the death of an employee taxable to the business to the extent the proceeds exceed premiums and other amounts expended for the policy.

There are many legitimate uses of EOLI, such as key-man life insurance to assist a business in weathering the loss of a key employee. Section101(j) provides an exception for many EOLI policies (essentially, an exception to an exception) that allows businesses to continue to obtain a full Section 101 exclusion for proceeds. To obtain such continued exclusion, the insurance must be on the life of qualified employees, reporting to the IRS and the employee whose life is insured must be undertaken, and the employee must consent.

It is easy to fall outside of the "exception to the exception" and thus subject EOLI death proceeds to income taxation. The following is a listing of many of the areas where businesses with EOLI may inadvertently put themselves into a taxable situation:

a. Insuring the lives of employees who are not covered employees (generally, covered employees are those who are employed within 12 months of death, or were, when the policy was issued, a director, highly compensated employee or highly compensated individual of the business);

b. Not realizing that the EOLI rules apply to all persons engaged in a trade or business, not just corporations (and thus includes partnerships, LLC's, and sole proprietorships);

c. Not realizing that the EOLI rules are not limited to key-man insurance, but may also apply to insurance to fund deferred compensation, to fund a death benefit plan, to fund a buyout of stock or partnership interests, split dollar arrangements, and insurance in VEBAs, qualified retirement plans and in rabbi trusts;

d. The employee does not receive the required coverage information and provide his or her consent BEFORE the policy is obtained; and

e. Material changes in coverage can trigger taxability unless notice requirements are met.

Thus, the door is wide open to continuing full exclusion of EOLI death benefits - provided that the business takes care to comply with the reporting and consent rules.

Sunday, November 23, 2008


Both corporations and partnerships at times receive "capital contributions" from persons other than shareholders or partners/members. For example, such business entities often receive grants and subsidies from federal, State, and local governments.

Code Section 118 of the Code provides that such capital contributions to corporations do not give rise to income to the corporation. Other Code provisions reduce the basis of contributed property (or other corporate property when the contribution is cash) to offset such nontaxation and/or to prevent the corporation from depreciating such contributed property. These rules only apply to capital contributions - not amounts paid in exchange for goods or services.

If the entity receiving the contribution is a partnership (or LLC or other entity taxable as a partnership), Section 118 does not apply since it only addresses corporations. Nonetheless, partnerships receiving property from nonpartners have asserted that Section 118 concepts, or a nonstatutory common law capital contribution concept, apply to avoid income to partnerships in the same manner as Section 118.

The IRS is having none of that theory. In a Coordinated Issue Paper, it has stated that there is no corollary to Section 118 for noncorporate entities taxable as partnership, such that capital contributions to those entities by nonowners will be considered as taxable to the entity (and thus to its owners, per the pass-through nature of partnership) .

Coordinated Issue Paper All Industries, Exclusion Of Income: Non-Corporate Entities And Contributions to Capital (LMSB4-1008-051), Nov. 18, 2008

Saturday, November 15, 2008


A husband and wife enter into a prenuptial agreement. The agreement provides that it continues to apply even through "separation and reconciliation." Instead of separating and reconciling, the couple divorces and remarries. The issue arises whether the agreement continues to apply to the new marriage.

This was the issue in a recent Florida case, where after remarriage the husband died, and the wife sought to exercise property rights she had given up under the prenuptial agreement. Do you think the agreement continued to apply - that is, does "separation and reconciliation" mean the same thing as "divorce and remarriage?"

In my mind, the answer is no way - divorce is the legal dissolution of marriage - separation is just that, the parties ceasing to live together but without divorce. The trial court didn't agree with me (or the surviving wife), and held that "separation and reconciliation" = "divorce and remarriage," and thus the agreement continued to apply to the new marriage. It held this, even though as a general rule a prenuptial agreement does not survive the termination of a marriage.

The appellate court did read it my way, however.  It reversed the trial court, holding that the wife was free of the prenuptial agreement after the divorce, and that the "separation and reconciliation language" did not carry it over to the remarriage.

Clients often wonder why lawyers often take 10 words to say something in an agreement that could have been said in 5. This case is one reason - no matter how obvious a word may seem, sometimes you have to add a lot more language to make sure every knows what you meant if the parties want to fight about it. Its also a little bit scary, since this is not the first time I have seen plain language distorted by a trial judge beyond what was ever intended or its common, everyday meaning. Luckily, the appellate court was able to correct the error in this case, but there are instances where it is not economically viable to appeal or where the appellate court is not of a mind to disturb the ruling of the trial court.

SVETLANA A. OZEROVA HERPICH v. THE ESTATE OF HOWARD M. HERPICH, 33 Fla. L. Weekly D2653a, (5th DCA), Case No. 5D07-3920. Opinion filed November 14, 2008.

Wednesday, November 12, 2008


Taxpayers often use charitable remainder trusts to avoid current tax on appreciated property. This is usually accomplished by the contribution of appreciated property to a charitable remainder trust, and then the trust sells the asset. Since the trust is tax-exempt, no current income tax is due on the sale. However, under the tiered income rules, as distributions are made to the grantor, those gains will be taxable to the grantor. Therefore, such planning is usually a deferral mechanism, not a tax elimination mechanism.

Some taxpayers have gone further. After the trust sells the property, the grantor and the charitable remainder beneficiary sell their trust interests to a third party. The grantor claims a stepped-up basis in his or her retained interest in the trust, and thus that there is no gain on the sale. The grantor also claims to avoid the uniform basis rules (which would apply a $0 basis to the grantor's interest) by reason of the combined sale with the remainderman. Thus, the grantor effectively gets a large chunk of change equal to the retained value of his or her trust interest, without incurring any income tax - and the gain on the sale of the contributed property is never taxed.

In a recent Notice, the IRS has indicated that it does not believe that the grantor gets the step-up in basis from the sale of the property by the charitable remainder trust. However, it has gone further than just making its views public - it has declared such transactions to be a "transaction of interest." As a transaction of interest, persons entering into these transactions on or after November 2, 2006, must disclose the transaction to the IRS. Further, advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations. Failure to comply with such requirements can result in significant penalties.

Notice 2008-99, October 31, 2008

Saturday, November 08, 2008


Presently, the unified credit is scheduled to shelter $3.5 million in assets per person in 2009. In 2010, there is no estate tax. In 2011, the unified credit is scheduled to return to $1 million.

What can we expect of President-Elect Obama? Of course, its too soon to tell, but his campaign promise was to make permanent the 2009 rates and credit - a $3.5 million unified credit equivalent and a 45% maximum estate tax rate.

An interesting question that has received very little attention is whether legislative changes in this area will repeal the scheduled elimination of the step-up in basis provisions (which provisions adjust the basis of assets of a decedent to the estate tax values). This elimination is scheduled to begin in 2010, although some step-up is allowed for in smaller estates.

Not allowing for a basis step-up will create a bookeeping nightmare for taxpayers, who will have to somehow figure out for inherited property what the decedent paid for the property and what basis adjustments may have occurred during the decedent’s lifetime. Let’s keep our fingers crossed that Congress will repeal the elimination as part of the expected revisions to estate and gift taxes.


I had the pleasure to lecture on the topic of asset/creditor protection for athletes to the Sports Financial Advisors Association Conference today. If you would like to read my outline, I have posted it online at

Wednesday, November 05, 2008


Section 2519 serves as a backstop to the marital deduction provisions of the Internal Revenue Code. When property passes into a QTIP trust for the benefit of a spouse, the transferor spouse (or the estate of the transferor spouse) avoids gift or estate taxes by electing the gift or estate tax marital deduction. While this avoids a current gift or estate tax, at the death of the surviving spouse the remaining assets are included in the gross estate of that spouse and thus may be subject to estate tax at that time.

To prevent surviving spouses from gifting away their interests in QTIP trusts during lifetime so as to avoid the estate tax on the trust assets at death, Section 2519 creates a taxable gift equal to the value of a QTIP trust when the spouse-beneficiary disposes of all or a part of his or her income interest (less, the value of any retained income interest of that spouse-beneficiary). Effectively, any distribution from a QTIP trust to persons other than the spouse-beneficiary will trigger this taxable gift. This taxable gift occurs, for example, if a QTIP trust is commuted, paying the value of the income interest to the spouse-beneficiary and the remaining assets out to the remaindermen.

Oftentimes, in the settlement of trust litigation, the parties desire to pay some of the assets of a QTIP trust out to one or more remaindermen. Normally, if even $1 is paid out to a remaindermen, a full taxable gift based on the value of the trust (less, the value of the spouse's retained income interest) is triggered.

A recent private letter ruling provides a method for avoiding the application of Section 2519 on the entire trust, when only a partial distribution is occurring to the parties. In the ruling, the IRS ruled that Section 2519 will apply to only one QTIP trust that is commuted, when prior to the commutation, the QTIP trust is divided into 5 different QTIP trusts. More particularly, the IRS ruled that the 4 QTIP trusts that were not commuted were not subject to Section 2519, thus substantially limiting the effect of the Section to the one QTIP trust that was commuted after the division.

Private Letter Ruling 200844010, 10/31/2008

Saturday, November 01, 2008


Florida's Constitution provides that if a decedent's homestead passes to the heirs of the decedent, third party creditors of the decedent cannot reach or levy against the homestead. What happens if the decedent provides in his or her last Will that the homestead is devised to a child, but should be used (along with other non-homestead property that is specifically devised) to pay debts of the decedent if there are insufficient other assets?

Florida's 3rd District Court of Appeals had previously provided that the constitutional protection trumps the decedent's direction, and thus the homestead would continue to be exempt from creditors of the decedent. That court, on rehearing en banc, has changed its collective mind - thus, if directed by a decedent, his or her homestead will be encumbered by the debts of a decedent even if the property will otherwise pass to a protected heir.

Cutler v. Cutler, 3rd DCA, Case No. 3D04-3070 (September 3, 2008).

Thursday, October 23, 2008


U.S. persons and entities with interests in non-U.S. corporations take heed – noncompliance with information reporting requirements will soon lead to automatic imposition of substantial U.S. penalties. The reporting at issue is for Form 5471, which must be filed by U.S. persons with certain stated interests in foreign corporations. The persons who must file are listed in the instructions to the form, which can be reviewed at

The penalties for nonfiling are significant, especially since they do not relate to any specific amount of tax being due and are imposed even if the taxpayer owes no U.S. income tax.  Each failure to file results in a $10,000 penalty, and a 10% reduction in available foreign tax credits.

In the past, such penalties were typically imposed only at the discretion of a tax auditor after a return is audited. Now, starting January 1, 2009, all late filed returns will automatically be assessed penalties. Taxpayers will then need to be able to show reasonable cause for nonfiling to be able to get the penalties removed.

Perhaps this wouldn’t be such a big deal, if there weren’t so many taxpayers that did not file the Forms due to ignorance of the filing requirement. Of course, the larger taxpayers who have and can afford knowledgeable tax advisors, will likely not run afoul of the rules. Thus, it is likely that the penalties will disproportionately fall on smaller taxpayers who can ill afford such substantial penalties.

Anyone with interests in foreign corporations who may be subject to the reporting should check immediately with their tax advisors to determine if it is advisable whether filings should be undertaken prior to January 1, 2009, especially as to returns due for prior years.

Wednesday, October 22, 2008


A new provision enacted under the Emergency Economic Stabilization Act of 2008 has stepped up the record keeping and reporting obligations of securities brokers. Brokers are presently required to report sale information to the IRS each year, to assist the IRS in determining if taxpayers are properly reporting their securities gains and losses.

The new provision now requires the broker to include in the report information on the taxpayer's adjusted basis in sold securities, and whether the gain or loss on sale is long-term or short-term. I am sure the brokerage industry is thrilled with the additional headaches and compliance costs imposed on them by Congress. This reporting kicks in after 2010.

Wednesday, October 15, 2008


As previously discussed, changes to preparer penalties had created a conflict between tax return preparers and taxpayers. The essence of the controversy was that taxpayers could report a tax issue based upon a "reasonable basis," and would be insulated from penalties if the position turned out to be wrong. However, a preparer could be penalized for the same reporting, unless he or she could show that the reported position was more likely than not to be sustained, a substantially higher standard than the taxpayer's "reasonable basis" standard. Thus, to protect themselves from penalty, preparers might encourage their clients to adopt a safer tax position than the taxpayer had to adopt under the reasonable basis standard and had to struggle to protect both themselves and their clients on issues where there was uncertainty.

The recently enacted tax act has now dropped the preparer standard down to the same "reasonable basis" standard as applies to the taxpayer. This is a welcome provision that avoids preparers having to make defensive disclosures to taxpayers to protect themselves and otherwise complicating their practice and making them a policeman for the IRS.

To summarize the revised rules:

a. Both taxpayers and their preparers can avoid penalties relating to a tax return position if there is "substantial authority" for the position. Generally, substantial authority exists if the weight of authorities supporting the taxpayer's treatment is substantial in relation to the weight of those that take a contrary position. Substantial authority includes the Code and other statutes, regs (final, temporary, and proposed), court cases, tax treaties, statements of Congressional intent, and administrative pronouncements (revenue rulings, revenue procedures, private letter rulings, technical advice memoranda, actions on decisions, general counsel memoranda, press releases, notices, and similar documents).

b. If the tax return position is adequately disclosed to the IRS in accordance with IRS requirements, the standard for avoiding penalties is dropped to a lower "reasonable basis" standard.

c. However, for tax shelters and listed transactions, penalties can be avoided only if there was a reasonable belief that it was more likely than not that the position would be sustained on its merits.

Interestingly, the change in the law does not allow for a reduction in the "more likely than not" standard under c. even with disclosure, which is a change from prior law.

Code Section 6694(a), as revised.

Saturday, October 11, 2008


In my posting of September 6, 2008, I discussed the controversy that had arisen over real property "short sales" in Florida. If you recall, a "short sale" occurs when a buyer purchases encumbered real property for less than the existing debt on the property, and the existing lender allows the buyer to obtain the property without a mortgage lien relating to the portion of the debt that the buyer is not taking over. Problems arose when the Florida Department of Revenue indicated that documentary stamp taxes on the real property deed would be based on the amount of the existing mortgage debt, not the lesser purchase price paid by the buyer.

The Department of Revenue has now resolved this issue in a manner favorable to taxpayers. At least in situations involving unrelated buyers and sellers, it has indicated in a recently issued Technical Assistance Advisement that the documentary stamp taxes will be calculated on the lower purchase price paid by the buyer, without regard to the portion of the mortgage debt that is not taken over by the buyer. It has based its position on the interpretation that consideration passing between the buyer and the seller is equal only to what the buyer is paying. The fact that there is a simultaneous reduction in the mortgage debt by the lender should not affect the consideration amount between the buyer and seller.

Given that Florida is one of the states suffering the most from real estate value declines, and the continued need for short sales to help clear the market of properties which are encumbered in excess of their current values, it is noteworthy that the Department of Revenue adopted a position that is both legally sound and will help provide relief to the current real estate crisis.

Technical Assistance Advisement 08B4-006, September 23, 2008

Thursday, October 09, 2008


There are three certainties in life - death, taxes, and increases in U.S. information reporting requirements. In compliance with the third of these certainties, the U.S. Treasury Department has issued a new FBAR form that expands reporting of foreign accounts beyond those previously required.

The Form TD F 90-22.1 (known as the "FBAR") is a reporting form required of U.S. persons that have interests in non-U.S. accounts. It is a Treasury Department form, not an IRS form. It is not filed with a tax return, but is due on a different day and location than income tax returns. The Form is problematic, since many persons that are required to file it do not know about it, and the penalties for noncompliance can be severe. The extension of the reporting requirements will only exacerbate these problems.

Some of the expansions in reporting include the inclusion of interests in foreign mutual funds, and the inclusion of reporting by foreign entities (such as the extension of reporting to U.S. unincorporated branches of foreign entities).

The new Form must be used after 12/31/08. Click on the following link to view a summary of who is subject to the reporting requirements under the instructions to the new Form -

A copy of the Form and instructions is available at

Saturday, October 04, 2008


The bailout law passed by Congress included a number of tax provisions - some related to the bailout and some not. Some of the principal changes include:

a. Compensation Deductions Limited. The new law limits to $500,000 the compensation deduction for pay of principal officers of employers who have assets acquired by the federal government that meet the thresholds including in the new law. The golden parachute nondeduction rules and the excise tax on golden parachute payments are also being expanded to include golden parachutes to such employers.

b. Mortgage Debt Forgiveness Relief Extended. The exclusion from gross income for up to $2 million of mortgage debt relief has been extended for 3 more years.

c. Alternative Minimum Tax Relief. AMT exemption amounts are increased, but only for 2008. Absent further legislative changes, in 2009 the exemptions will return to 2000 levels.

d. Various Tax Provisions are Extended. The deduction for state and local sales taxes has been retroactively extended through 2009. Also extended is the above-the-line deduction for higher education expenses and educator expenses, the additional standard deduction for state and local property taxes, the allowance of nontaxable transfer of IRAs to charities has been extended two years, the research credit has been extended and modified, the tax credit for new markets has been extended one year, the Subpart F extension for active financing income has been extended for one year, and various charitable deduction enhancements have been extended, along with many other narrowly focused extensions.

Wednesday, October 01, 2008


Code Section 382 limits trafficking in net operating losses by imposing restrictions on use of net operating losses of a corporation after a substantial change in ownership. One of the restrictions that arises after such a change in ownership is that the available net operating losses are effectively written down to the fair market value of the corporation at the time of change in ownership.

Given such restrictions, taxpayers are encouraged to make capital contributions to a loss corporation before a change in ownership to beef up its value and thus reduce the write-down of its NOLs. To restrict this gamesmanship, Code Section 382(l)(1)(A) will disregard any capital contribution received by a loss corporation as part of a plan a principal purpose of which is to avoid or increase any limitation under Code Section 382. Code Section 382(l)(1)(B) then goes on to provide that any capital contributions made during the two years leading up to the change in ownership will be presumed to be part of such a plan and disregarded, except as provided in regulations.

Surprisingly, the IRS has indicated that regulations will be issued that will not provide for a per se presumption of a plan to avoid Code Section 382limitations for contributions in the two years leading up to the change in ownership. Instead, it will apply a facts and circumstances analysis to determine if there was a plan to avoid the Code Section 382 limitations. Further, the regulations will have certain safe harbor capital contribution situations that will not give rise to a finding of a plan to avoid the limitations.

These safe harbor capital contributions are:

(1) The contribution is made by a person who is neither a controlling shareholder (determined immediately before the contribution) nor a related party, no more than 20% of the total value of the loss corporation's outstanding stock is issued in connection with the contribution, there was no agreement, understanding, arrangement, or substantial negotiations at the time of the contribution regarding a transaction that would result in an ownership change, and the ownership change occurs more than six months after the contribution.

(2) The contribution is made by a related party but no more than 10% of the total value of the loss corporation's stock is issued in connection with the contribution, or the contribution is made by a person other than a related party, and in either case there was no agreement, understanding, arrangement, or substantial negotiations at the time of the contribution regarding a transaction that would result in an ownership change, and the ownership change occurs more than one year after the contribution.

(3) The contribution is made in exchange for stock issued in connection with the performance of services, or stock acquired by a retirement plan, under the terms and conditions of certain regulations under Code Section 355.

(4) The contribution is received on the formation of a loss corporation (not accompanied by the incorporation of assets with a net unrealized built in loss) or it is received before the first year from which there is a carryforward of a net operating loss, capital loss, excess credit, or excess foreign taxes (or in which a net unrealized built-in loss arose).

The inclusion of practical safe harbors is always welcome!

Notice 2008-78

Sunday, September 28, 2008


Under Code Section 1031, taxpayers can exchange property of like-kind without incurring current gain - that is, they can defer gain recognition by rolling over their tax basis into the replacement property. While most often applied to real property, such exchanges can include exchanges of trade or business property.

The goodwill or going concern value of a business is per se not property that can be like-kind and thus cannot qualify for Section 1031 nonrecognition. Therefore, in the exchange of a business property, the taxpayer needs to identify what portion of the business assets are in the nature of goodwill.

A recent article in the publication Business Entities discusses the IRS treatment of intangibles in Section 1031 exchanges. Determining which intangible assets are part of goodwill and which are not is a difficult task. The term “goodwill” has generally been defined as the expectancy of continued patronage. This expectancy may be due to the name or reputation of a trade or business or any other factor. The term “going concern value” has generally been described as the additional value that attaches to property because of its existence as an integral part of an ongoing business activity.

Prior to the enactment of Code Section 197 relating to the amortization of goodwill and other intangibles, there was frequent litigation about which intangible assets were part of goodwill. In Newark Morning Ledger, 507 US 546 , 123 L Ed 2d 288 (1993) the Supreme Court noted that the value of every intangible asset is related, to a greater or lesser degree, to the expectation that customers will continue their patronage (i.e., goodwill). Nevertheless, for purposes of amortization, the Supreme Court held that a taxpayer who is able to prove that a particular asset can be valued and has a limited useful life that can be ascertained with reasonable accuracy may still depreciate the asset's value over its useful life.

Code Section 197 ended the debate about which intangible assets were separate enough from goodwill to be amortizable. However, the issue of separateness remains for purposes of Section 1031, and the IRS continues to be expansive in categorizing intangible assets as part of related to goodwill, so as not to qualify for like-kind exchange treatment.

For example, in TAM 200602034, the IRS held that a taxpayer's trademarks and trade names were a component of goodwill or going concern value, and thus their exchange could not qualify for like-kind exchange treatment. In Memorandum 20074401F, the IRS determined that a taxpayer's advertiser accounts and subscriber accounts were closely related to goodwill and could not be distinguished from the taxpayer's trademarks and trade names, and thus were ineligible for like-kind exchange treatment.

Therefore, taxpayers engaged in Section 1031 exchanges with trade or business property can expect IRS resistance to like-kind treatment for many of the intangible assets of the business. Whether the IRS' broad sweep up of intangible assets into goodwill is legally appropriate remains to be seen.

Source: IRS Applies Expansive Definition of Goodwill for Section 1031 Purposes, Authored by Holly Belanger, Business Entities (WG&L)

Wednesday, September 24, 2008


Internal Revenue Code Section 897 subjects foreign taxpayers to U.S. income tax on their gains from sales and dispositions of U.S. real property interests. Code Section 1445 imposes a 10% withholding tax, to be collected by purchasers, when a foreign taxpayer sells a U.S. real property interest. This tax is credited against the actual tax liability of the seller, with any excess withholding being refunded.

Because the purchaser must withhold the 10%, the purchaser must determine whether a seller of U.S. real property is a foreign taxpayer. Many purchasers will assume that if the seller is a U.S. entity, then there is no foreign seller and withholding is not required.

In Chief Counsel Advice 200836029, the IRS reminds taxpayers that if the seller of U.S. real property is a disregarded entity, and the owner of the disregarded entity is a foreign person, the purchaser is obligated to withhold on the transaction. How is a purchaser supposed to know if a selling entity is a disregarded entity, so as to determine if it is obligated to withhold?

One approved mechanism is to obtain a certification from the entity that it is not foreign and is not a disregarded entity. The Treasury Regulations provide suggested language for such a certification. If the entity is a disregarded entity, then additional certification will be needed to show that the owner is not a foreign person and is itself not a disregarded entity. If the appropriate certifications cannot be obtained, then the purchaser should withhold and pay over to the IRS the required 10% withholding.

For sure, many taxpayers (and their real estate counsel) believe that if the seller is a U.S. entity, they do not need to inquire further and do not have to withhold. To avoid being responsible for the withholding and potential interest and penalties out of their own pockets, taxpayers and their counsel should seek and obtain a nonforeign certificate (with the appropriate "nondisregarded entity" language) from all domestic entity sellers.

Presumably this applies even when the seller is a U.S. corporation, since such a seller can be a disregarded entity by reason of being a qualified Subchapter S subsidiary. In such case there is probably no withholding anyway because the parent S corporation would have to be domestic, but the certificate should still be sought because to get a valid domestic certification in this case, the certification needs to be issued by a non-disregarded parent owner of the disregarded Subchapter S affiliate instead of the disregarded affiliate itself.

Wednesday, September 17, 2008


If you are one of the brave ones that prepares and files your own federal income tax return, you probably use one of the commercial tax preparation software programs to assist you. When you are ready to file your tax return, the programs typically prompt you to file your tax return electronically. This is tempting because it avoids the need for printing out the return and mailing it to the IRS (including saving the postage), and for last minute filers it avoids waiting in line at the post office.

However, when you reach the point in the program to file electronically, if your income exceeds certain thresholds the program will charge you $15 to $30 extra. The IRS believes these fees are dissuading taxpayers from filing electronically. It would like more people to file electronically, since it avoids errors and reduces processing costs. Therefore, the IRS is trying to get the software companies to drop the filing fees.

It is estimated that $1 billion in electronic filing fees are collected each year, so giving up those fees will be costly for the software companies. While they still may do their patriotic duty and reduce or eliminate the filing fees, we shouldn't be surprised if the losses in fees are offset by increases in the prices for the software itself.

Saturday, September 13, 2008


Under the Internal Revenue Code, there are advantages for a Section 501(c)(3) organization to be classified as a "publicly supported" organization. To be "publicly supported," that organization must meet certain mathematical tests demonstrating a broad base of donor support (as compared to a small non-public pool of donors, such as a single family).

Previously, organizations that expect to meet the public support test would file a Form 1023 exemption application and seek a five year advance ruling. With such a ruling, the organization would generally be treated as publicly supported for its first five years. Then, it would need to submit a Form 8734 to show that its fundraising meets the publicly supported requirements, and if it did, the IRS would issue a final ruling establishing publicly supported status (or if it did not meet that status, it would be reclassified as a private foundation).

The IRS has now withdrawn the need to file a Form 8734 after 5 years. Instead, the taxpayer makes its own determination after 5 years, and if it meets the publicly supported requirements (and for so long as it does), it will report as a public charity without the need for a final determination by the IRS. The IRS will police the fulfillment of the public support requirement by new disclosures required on the Form 990 filings of the entity (assuming such a filing is required).

Note that if a public charity does not meet the public charity support requirements for two continuous years, it will lose its public charity status.

The IRS has issued a FAQ in question and answer format that address various transitional rules and other issues relating to the new reporting method.


Wednesday, September 10, 2008


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

For noncorporate taxpayers, the rate for both underpayments and overpayments will be 6%.

For corporations, the overpayment rate will be 5%. Corporations will receive 3.5% for overpayments exceeding $10,000. The underpayment rate for corporations will be 6%, but will be 8% for large corporate underpayments.

Rev. Rul. 2008-47

Saturday, September 06, 2008


Florida imposes documentary stamp taxes on the transfer of real property, based on the amount paid for the property. Amounts paid for the property include mortgage indebtedness that encumbers the property.

The declines in real property values has given rise to a substantial increase in real property "short sales." These sales are purchases by third parties of distressed real property from the owners at a sales price less than the current mortgage indebtedness, with the lender typically forgiving the unpaid mortgage amount.

The question arises whether documentary stamp taxes should be computed on the full mortgage amount (before the forgiveness), or on the lower purchase price paid by the buyer. By analogizing to existing rules that impose documentary stamp taxes on the full indebtedness amount when a mortgage holder transfers encumbered real property back to the lender as a deed in lieu of foreclosure, the Florida Department of Revenue has informally advised that it believes documentary stamp taxes in a short sell should likewise be based on the full amount of the mortgage debt.

There are practical difficulties with using the full amount of the mortgage debt. For example, buyers may not be aware of the full amount of the debt when they buy, even though they are responsible for the documentary stamp taxes (along with the seller). Further, since sellers are usually responsible by contract for payment, imposing higher taxes only increases the financial burden and distress of the home seller.

It is expected that the Department of Revenue will be issuing guidance to taxpayers within the next two weeks. If the Department indicates that the higher tax amounts are due, there is a possibility that the Legislature could try to reverse it through legislation, at least in regard to situations involving insolvent sellers.

Thursday, September 04, 2008


Presently, partnerships, estates and trusts are generally obligated to file their income tax return by April 15, and can obtain 6 month extensions to October 15 (such dates are extended to the next business day if they fall on a weekend or federal holiday). These are the same dates that apply to individuals.

If you are an individual taxpayer on extension waiting for a Form K-1 from a partnership, estate or trust to complete your federal income tax return, it might not show up until you have to file the return, since the partnership, estate or trust doesn't have to complete its return until the same day that the individual taxpayer has to file its return.

The IRS has decided to help taxpayers with this problem. One way to resolve the problem would be to extend the individual 6 month extension period to give more time for taxpayers to receive the K-1 and finish their return. Surely, accountants would appreciate that type of relief.

Unfortunately, the IRS went the opposite direction, and SHORTENED the extension period for partnerships, estates and trusts from 6 months to 5 months. While this will help individual taxpayers, it will put more time pressure on tax preparers to complete the partnership, estate and trust returns.

No change is being made for S corporations, another entity that provides Forms K-1's. Since S corporations are required to file their returns on March 15, the existing six month extension already expires on September 15 - one month before the extension expiration for individual taxpayers.

These new rules will be effective for tax returns due in 2009 and thereafter.

IRS News Release IR-2008-84


Hopefully, you have noticed an absence of postings over the last two weeks. I have been on vacation - posts to restart shortly.

Sunday, August 24, 2008


Code Section 121 allows taxpayers to exclude up to $250,000 of gain from sale of a principal residence from federal income taxation ($500,000 for married couples). To qualify for the exclusion, the sold residence must have been used as the taxpayer's principal residence for at least 2 years in the 5 years preceding sale.

The Housing Assistance Tax Act of 2008 has enacted a new limitation on the exclusion. Code Section 121(b)(4) now provides that if a residence was at any time NOT used as a principal residence of the taxpayer, the portion of the gain allocated to periods of "nonqualified use" will not be available for exclusion. Thus, if a taxpayer rented out a residence or used it only as a vacation home for a period, but still otherwise used the residence as a principal residence for the requisite 2 years out of the preceding 5, the full exclusion may not be available.

The available portion of the gain available for exclusion is determined by multiplying the gain on sale by a fraction. The numerator is the period that the residence was used as a principal residence by the taxpayer, and the denominator is the entire period of ownership of the taxpayer. The resulting amount of gain is eligible for exclusion (up to the maximum $250,000/$500,000 exclusion limits), and the remaining gain is not excluded.

There are some finer details to the new rules, including:

a. In applying the above "nonqualified use" fraction, the period of "nonqualified use" in the numerator does not include periods before 1/1/09 (but such periods before 1/1/09 are not excluded from the denominator);

b. The numerator also does not include any time period of "nonqualified use" arising in the prior 5 years before sale that occur AFTER use a principal residence;

c. The numerator also does not include periods of "nonqualified use" (up to 10 years) due to service as a member of the uniformed services or the Foreign Service, or as an employee of the intelligence community; and

d. The numerator also does not include periods of "nonqualified use" (up to 2 years) due to change of employment, health conditions, or any other unforeseen circumstances as may be specified by IRS.

Note that the formula determines how much of the GAIN is eligible (and not eligible) to be subject to the exclusion - it does not adjust the statutory amount of the exclusion. Thus, in some circumstances, if the gain amount is high enough and a small enough portion is treated as allocable to nonqualified use, the remaining gain may still be excluded by the full applicable statutory exclusion amount. For example, if the taxpayer has $1 million of gain, and 1/5 of the gain is treated as allocable to periods of nonqualified use, $800,000 is still eligible for the statutory exclusion (up the available $250,000/$500,000 maximum). Thus, the full statutory exclusion amount may at times still be available even with periods of nonqualified use, given enough gain.

Sunday, August 17, 2008


S corporations may pay fringe benefits for the benefit of its shareholders, as well as its other employees. However, special rules apply as to whether these benefits will be taxable to shareholders who receive them if those shareholders own 2% or more of the stock of the corporation.

Not all fringe benefits will be taxable to the shareholders. For a quick review of what expenses can and cannot be received free of income tax, click here to see a summary chart.

Thursday, August 14, 2008


Successful stock market day traders like to be characterized as mere investors for federal income tax purposes - this allows them to pay taxes on their trading gains at preferential capital gains rates. Unsuccessful stock market day traders want to avoid the "investor" label, and instead they want to be characterized as engaged in the trade or business of trading. This is because they don't want capital loss treatment for their trading losses - capital losses can only be used to offset capital gains (except as to $3,000 per year which can be used to offset ordinary income). Further, their trading expenses can only be deducted to the extent they and any other miscellaneous itemized expenses exceed 2% of adjusted gross income.

William Holsinger fell into the unsuccessful category, losing over $180,000 in trading activities in 2001. William claimed he was in the trade or business of trading, and sought ordinary loss treatment for his trading (even though, in 2000, when he had trading profits, he reported those as investment capital gains). He also sought ordinary loss treatment for losses incurred in 2002. The IRS disallowed the ordinary loss treatment, indicating that Mr. Holsinger's trading activities were insufficient to give rise to trade or business status.

To determine whether a trade or business exists for trading activities, the courts look at the taxpayer's investment intent and the frequency, extent, and regularity of the taxpayer's securities transactions. More particularly as to stock market trading activities, a taxpayer's stock market activities constitute a trade or business if the trading is substantial, and the taxpayer seeks to catch the swings in the daily market movements and to profit from these short-term changes rather than to profit from the long-term holding of investments.

Mr. Holsinger's trading activities were somewhat substantial - in 2001, Mr. Holsinger conducted 289 trades. In 2002 he conducted 372 trades.

However, in neither year did he trade on more than 45% of the available trading days. Further, Mr. Holsinger rarely bought and sold the same securities on the same day, and held many stocks for more than 31 days at a time. As such, it was difficult to show that he was seeking to capture "daily" market movements, as opposed to seeking to capture profits from more long-term market movements.

Ultimately, the Tax Court held that his trading activities were not sufficient to get out of investor status, in large part due to the extended holding period of many of his purchases (i.e., more than one day).

Holsinger v. Comm., TC Memo 2008 –191

Sunday, August 10, 2008


We recently addressed the FDIC insurance limits on various types of bank accounts. Not all accounts with banks are FDIC insured. Many don't need it - that is, some assets are effectively owned by the client so they are not impacted by a failure of the institution itself.

The American Bankers Association has issued a memo that addresses deposit accounts, fiduciary accounts, and custody accounts, and the general operation of such accounts in the event of a financial institution failure. The memorandum provides:

Assets held in deposit accounts become liabilities of the bank. As such, deposits create a debtor-creditor relationship between the bank and the depositor. In exchange for the money deposited, a liability of the bank is created which is the bank’s contractual promise to repay the amount on deposit plus, where applicable, interest. Deposit accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000 per individual per bank.

Assets held in trust and fiduciary accounts do not become assets or liabilities of the bank and are, indeed, segregated from the bank’s assets. The bank acts as trustee or fiduciary to the account and, in this connection, provides investment management, investment advice and other services to the account. Account ownership remains vested in the individuals or entities for whose benefit the bank is acting as trustee or fiduciary and the assets are not subject to the claims of creditors.

Assets held in custodial accounts in the trust department of a bank do not become assets or liabilities of the bank and are segregated from the bank’s assets. The bank’s role as custodian is to hold the assets for safekeeping, to collect dividends and interest and provide other similar services. Account ownership in the assets remains vested in the individuals or entities for whose benefit the bank is acting as custodian and the assets are not subject to the
claims of creditors.

What happens if a bank fails?

Since deposit accounts become liabilities of the bank, it follows that the depositor would become a creditor in the event a bank failed. However, the FDIC insures depositors for up to $100,000 per individual per bank.

Since assets held in trust, fiduciary and custodial accounts do not become assets or liabilities of the bank (title is held by the account’s owner(s)), it follows that none of this property is subject to the claims of the bank’s creditors. As a result, a failure of a bank will have no adverse effect on trust, fiduciary or custodial accounts: they remain the property of the account’s owner(s).

In the event that a bank with trust, fiduciary or custodial powers fails, the FDIC will seek to transfer responsibility for administration of the accounts to a successor trust institution as quickly as possible. Provided this effort is successful, the account beneficiaries would need to either accept this new arrangement or make provisions with the successor bank for alternative arrangements. Should the search for a successor trustee to the failed bank be unsuccessful, the FDIC will then promptly notify all affected beneficiaries to either personally reclaim their property or designate an alternate institution to which the trust, fiduciary or custodial property may be conveyed.

Therefore, the safety of trust, fiduciary and custodial assets is not dependent upon whether the bank has assets greater than its liabilities. Property held in these accounts belongs to the owner(s) of the accounts and would be unaffected by a bank failure.

One area of failure that has not been widely explored is what happens to securities in a brokerage account held in street name, if the brokerage house goes under. As many readers are already aware, securities held in a brokerage account these days is typically held in "street name," and not registered with the issuer in the name of the client. There are some questions as to who is the legal owner of such securities (the client or the brokerage house) and whether the client will always receive back all of such securities.

Thanks to Tim Peters at Key Private Bank in North Palm Beach, Florida for providing the materials which this post was based upon.

Wednesday, August 06, 2008


For income tax purposes, taxpayers are required to maintain permanent books of account and records sufficient to sufficient to establish the amount of gross income, deductions, credits, or other matters reported to the IRS (Treas.Regs. §1.6001-1(a)). Some taxpayers are less fastidious than others in maintaining adequate books and records, so the question often comes up whether a given level of record and bookkeeping will be sufficient to uphold a deduction.

In 1930, it was held that a famous actor, playwright and producer could deduct entertainment expenses based on estimated expenses, rather than having to produce detailed records of each expenditure. The holding in this case became known as the "Cohan Rule" - that is, that if a taxpayer can substantiate that a legitimate deduction was incurred, courts will be willing to use the documentation available to estimate the deductible amount.

In opposition to the Cohan Rule, Congress by statute does require more detailed receipts and records for certain types of expenses before a deduction will be allowed. These expenses include travel and entertainment expenses, business gifts, deductions relating to listed property (certain types of property that are prone to taxpayer abuse, such as autos, computers, cell phones, and property used for entertainment), and charitable contributions.

In a recent article in Practical Tax Strategies, Paul G. Schloemer conducted a survey of tax cases where the Cohan Rule was invoked, to see if the rule still has viability today. Happily, he reports that the rule is alive and well.

Of course, all invocations of the Cohan Rule will not result in deductibility. Mr. Schloemer notes that there are two key variables that courts will look for in allowing a taxpayer to rely on the Cohan Rule. The first is that SOME documentation will be needed - oral testimony alone probably will not cut it. The second variable is the veracity of the taxpayer's testimony, since the court will need to have some level of trust in the taxpayer's assertions before it will allow deductions under the rule.

Schloemer, Paul G., Cohen Rule Still Secures Some Deductions Despite Statutory Limits, Practical Tax Strategies (WG&L)

Saturday, August 02, 2008


Over the past several weeks, several banks have failed, and their depositors paid out by the FDIC. While the FDIC may pay out more than the insured amount, the actual amount of deposit insurance per account at a given bank is $100,000 (or $250,000 for certain IRA's and other similar deferred accounts).

However, depositors can have different types of accounts at the same bank, and their interest in each can each be insured separately up to $100,000. Since the various types of accounts and applicable rules are lengthy, I have prepared a useful summary which can be accessed here.

The FDIC also provides a calculator that can assist in determining amounts insured at a given bank.

Thursday, July 31, 2008


Internal Revenue Code Section 212(1) allows a deduction to individual taxpayers for expenses relating to the production or collection of income. Therefore, if one attended a seminar to learn investment trading techniques, that should be deductible, right?

That's what Carl Jones thought, when he deducted the expenses of a day-trading seminar that he attended to improve his day trading skills. Unfortunately, both the IRS and the Tax Court disagreed, based on an obscure, but directly on point, provision of the Internal Revenue Code Section 274(h)(7).

This provision provides in plain and simple language that "[n]o deduction shall be allowed under section 212 for expenses allocable to a convention, seminar, or similar meeting." This provision is hard to locate, in large part because the title of Section 274 gives only the faintest warning of the existence of the prohibition - "Disallowance of certain entertainment, etc., expenses."

Carl Jones' case is not that interesting, but I mention it here as a public service because I am sure that Carl Jones is not the only one out there that is unaware of the deduction prohibition for seminar attendance. As a tax matter, note that Section 274(h)(7) only applies for Section 212 expenses. If attendance at a seminar qualifies as a Section 162 "trade or business" expense, the provision does not apply.

Carl H. Jones, 131 TC No. 3 (2008)

Saturday, July 26, 2008


Since U.S. transfer taxes (estate and gift taxes) are calculated on the value of the property transferred, taxpayers seek low values while the IRS seeks high values. When the asset in question is an interest in a business entity (e.g., stock in a corporation), valuation experts recognize that the stock of an entity may be worth less than the value of the assets owned. Valuation adjustments (commonly referred to as "discounts") are typically applied for lack of control, and for lack of marketability.
Sometimes the interests of the taxpayer and the IRS are reversed - the IRS seeks a low value for an asset and the taxpayer seeks a high value. For example, a taxpayer seeks a high value for shares of stock when they are being contributed to charity, so as to maximize his or her charitable income tax deduction. Here, the IRS has to be mindful since the arguments it makes for a low value may be used against it in a later transfer tax case when it is seeking a high value for the same type of asset.
In a recent case, the IRS did not seem too concerned about that, when it argued for (and indeed prevailed in court) for a 35% lack of control discount and a 45% lack of marketabilty discount relating to shares of stock in a corporation. If a taxpayer sought those levels of discount in a transfer tax case, the IRS would clearly have vigorously objected. But here, such levels were acceptable since it the IRS was looking to reduce value.
It is only a matter of time before taxpayers try and use these discount levels in transfer tax cases. Will what was good for the goose, also be good for the gander?
Bradley J. Bergquist, et al. v. Commissioner, 131 T.C. No. 2 (2008).

Wednesday, July 23, 2008


A restricted management account (RMA) is an account under which the owner of cash and/or securities places those items in the hands of an investment manager to manage for an extended period of time. The account agreement usually provides that the items will be kept under such management for a fixed number of years. This allows the account manager to make long term investment decisions, and thus to put less focus on short term profits to retain client business.

Some assert that an ownership interest in an RMA is worth less for gift and estate tax purposes than the assets held in the RMA, by reason of the obligation to keep management with the investment manager for a fixed period of time. The IRS has now issued a Revenue Ruling that such valuation adjustments are inappropriate.

One leg of the IRS position is that a willing buyer would not reduce what they would pay for the underlying assets by reason of them being bound by this management restriction, and thus the willing buyer/willing seller test for value does not justify a reduction. However, if you ask yourself the question, would you pay the same for $1 million dollars in securities that are under such a restriction and as you would pay for $1 million dollars that are not under such a restriction, it seems obvious that you (or any other willing buyer) would pay less in the first circumstance. It doesn''t take a professional appraiser to question the validity of the IRS' conclusion.

The other argument of the IRS is that no reduction is allowed per Code §2703(a)(2). This provision provides that for federal estate, gift, and generation-skipping transfer tax purposes, the value of any property shall be determined without regard to any restriction on the right to sell or use such property, and thus the account management agreement should not give rise to a valuation adjustment.  However, under Code §2703(b), Code §2703(a)(2) will not apply if to a restriction (1) that is a bona fide business arrangement; (2) that is not a device to transfer property to members of the decedent's family for less than full and adequate consideration in money or money's worth; and (3) whose terms are comparable to similar arrangements entered into by persons in an arm's length transaction. The Ruling concludes that this exception does not apply, but provides no convincing argument or precedent why the exception could not be valid in many circumstances.

Therefore, while the Ruling will result in challenges to valuation adjustments taken for RMA's, whether the IRS is correct on this issue is probably still an open question.

Revenue Ruling 2008-35, 2008-29 IRB 116.

Monday, July 21, 2008


On July 10, I commented on recent IRS guidance relating to interest expense deductions of partners in securities trading partnerships. A more detailed analysis of that guidance was published on pages 98 & 99 of the July 14, 2008 edition of Tax Notes. The article makes good reading, and you can read it by clicking here. The most interesting part, in my opinion, is the highlighted commentary at the end of the second page - but that's probably because the commentator was me!

Tuesday, July 15, 2008


In 1992, several Shell Oil affiliates transferred various properties to Shell Frontier Oil & Gas Inc. in a Section 351 transaction. As a Section 351 transfer, the shareholders of Shell Frontier received a basis in their Shell Frontier stock equal to the basis of the property transferred to Shell Frontier.

Shell Western E&P Inc. was one of the companies contributing properties to Shell Frontier. As it turned out, the basis of much of the property transferred by Shell Western far exceeded its value. Due to this disparity, when Shell Western later sold some of its shares in Shell Frontier, it realized substantial losses (in the hundreds of millions of dollars) since it received proceeds for that stock in excess of its basis in the stock..

The IRS was not too pleased with these losses, and challenged them on various grounds. The first line of attack was that the assets contributed to Shell Frontier (oil shale rights and offshore leases) were not “property” for Section 351 purposes because they had no value (and thus no tax basis for them should be given to Shell Western). The appellate court made short shrift of this argument, noting that just because the properties were not income producing did not mean they had no value. Further, the court acknowledged that there is no requirement under Section 351 that a positive value is required for an item to be "property" for Section 351 purposes. The court also rejected the IRS attempt to categorize the properties as equivalent to stock in a wholly insolvent corporation that is in receivership (which stock had been previously held not to be "property" under Section 351).

The IRS also attempted to characterize the transfer of the loss properties as a sham transaction. The appellate court found too much substance and non-tax purpose for the transfer for a sham argument to succeed. An interesting aspect of the case was that the structuring plan came from the Shell Oil tax department. However, the department specifically held back from management the tax benefits of the transaction, so that management would base its decision solely on nontax reasons. This worked well to eliminate the punch from the IRS' argument that the purpose of the tax transaction was entirely or substantially tax motivated.

Lastly, the IRS attempted to use Section 482 to deny loss treatment to the taxpayer. However, insufficient evidence to invoke Section 482 was provided at trial. The appellate court also noted that even if Section 482 evidence had been provided, there was insufficient evidence of an improper purpose to evade taxes to allow for a Section 482 adjustment that would override the Congressional purposes of Section 351 transactions.

Thus, in the end, the IRS lost and Shell's losses were respected.

SHELL PETROLEUM INC. v. U.S., 102 AFTR 2d 2008-XXXX, (DC TX), 07/03/2008

Saturday, July 12, 2008


Contracts often contain release or exculpatory language that seek to protect a party from liability for future activities. Such clauses are disfavored in the law because they relieve one party of the obligation to use due care and shift the risk of injury to the party who is probably least equipped to take the necessary precautions to avoid injury and bear the risk of loss. Nevertheless, because of the countervailing policy that favors the enforcement of contracts as a general proposition, unambiguous exculpatory provisions are enforceable.

While  such clauses will be enforceable, there are limits. A recent Florida case points out two of those limitations. In the case, a builder of a residence included a very broad clause that released the builder from any liability for faulty construction whether based on negligence, gross negligence, strict liability or intentional conduct. The 5th District Court of Appeals noted at least two problems with the release language.

First, it noted that the release clause is unenforceable to the extent it seeks to release the builder for an intentional tort. Second, it noted that a party may not contract away its responsibility to comply with a building code when the person with whom the contract is made is one of those whom the code is designed to protect. Consequently, to the extent that the builder's release language sought to protect it against liability from such sources, it was unenforceable.

SUE A. LOEWE AND WARREN LOEWE, Appellant, v. SEAGATE HOMES, INC., Appellee. 5th District. Case No. 5D07-1683. Opinion filed July 11, 2008.

Thursday, July 10, 2008


Earlier this year, in Revenue Ruling 2008-12, the IRS ruled that the interest expense of a partnership engaged in trading activities for the account of its owners is characterized as investment interest expense of limited partners for those who do not materially participate in the business. While most expenses of partners in limited partnerships that conduct business activities are treated as "passive" if the partner does not materially participate, Regs. Section 1.469-1T(e)(6) provides that an activity of trading personal property for the account of owners of interests in the activity is NOT a passive activity (without regard to whether such activity is a trade or business activity), and thus passive loss treatment is not appropriate.

In Revenue Ruling 2008-38, the IRS has followed up on the earlier ruling and has indicated that the investment interest expense is business expense under Code Section 62(a)(1), and is not an itemized deduction. An accompanying Notice indicated that the expense is reported on Schedule E.  The IRS guidance is useful for taxpayers. By characterizing the interest expense relating to the trading activities of the partnership as not being an itemized deduction under Section 63(d), it is effectively deductible for individual taxpayers even if they do not itemize their deductions. However, since investment interest deductions are not subject to the phase-out of itemized deductions under Code Sections 67 and 68 (unlike many other itemized deductions), the characterization of the deductions as itemized deductions will often not be a big deal to many taxpayers who otherwise itemize.

The IRS also indicated that any investment interest expense of the trading partnership that relates not to its trading activities but to its investment property is an itemized deduction. If a partnership has both types of interest expense, the taxpayer must allocate the individual's net investment income between the two categories of investment interest expense using a reasonable method of allocation. The Ruling provides an example of a reasonable method - allocate to each category based on the relative amounts of interest expense directly attributable to the two types of activities. Since this may unduly skew the bulk of the interest expense to investment activities (and thus making the deduction an itemized deduction to that extent) when the bulk of the indebtedness relates to investment activity and not trading activity, another reasonable method of allocation may be desired. While the Ruling provides no further guidance on what is reasonable, perhaps allocations based on relative amounts of gross income derived by the two types of activities, or the relative amounts of gross assets involved in each of the activities, may also pass muster as reasonable methods of allocation, and should be considered by taxpayers if they provide more favorable results.

Sunday, July 06, 2008


The IRS has issued Proposed Regulations under §6694, to assist tax return preparers in avoiding penalties under that provision. So long as tax return preparer has a "reasonable basis" for a return position, the penalty can be avoided through proper disclosure if the position later turns out to be wrong. The Proposed Regulations provide significant detail as to what will constitute proper disclosure. Notably, "boilerplate" language to clients to meet the disclosure requirements will not be acceptable.

A quick summary of the Proposed Regulations as to preparers who sign the return, based on how an erroneous reporting issue is characterized, is as follows:

a. There was no "reasonable basis" for the filing position. In this situation, the penalty will almost always apply.

b. There was a "reasonable basis," but not "substantial authority" for the filing position. To avoid a penalty, the preparer must meet disclosure requirements. This will either mean full disclosure to the IRS in accordance with its disclosure rules, or in the case of an income tax return, the preparer delivers the prepared return with proper disclosures to the taxpayer.

c. There was "substantial authority," but no reasonable belief by the preparer that the position was more likely than not reported correctly. Again to avoid a penalty, the preparer must meet disclosure requirements. In this situation for an income tax return, the preparer can meet the disclosure requirements by advising the taxpayer of the applicable penalties and penalty standards.

d. The preparer had a reasonable belief that the reported position was more likely than not reported correctly. In this case, no penalty will apply (with or without disclosure).

Different rules apply for preparers who do not sign the return. Further, the above general rules are subject to various particular refinements in the Proposed Regulations. A more detailed outline of the new provisions can be read here (or click on the .docstock icon below).

Summary of Proposed Regulation Regarding Tax Return Preparer Penalties - Get more Legal Forms

Wednesday, July 02, 2008


Effective this past June 17, the U.S. undertook a wholesale revision as to how it will tax its expatriates – persons giving up their U.S. citizenship or long-term permanent residency. In lieu of the special 10 year sourcing rules that previously applied, the U.S. will subject an expatriate to immediate U.S. income tax as if the expatriate had immediately sold all of his or her assets for their fair market value. Further, any future gifts or bequests of property to a U.S. citizen or resident will be subject to U.S. transfer taxes. Of course, both of these general rules are subject to various statutory exceptions and refinements, including the general income and asset thresholds that must be met before these rules will apply to an expatriate.

To assist in the rapid digestion of the new rules by those who are interested, I have prepared the following summary of the new statutory provisions. Click on the .docstoc logo below to open the summary, or you can also get to it here.


Thursday, June 26, 2008


The assessed value of real property is typically adjusted by the county tax appraisers upon a sale of real estate, based on the amount paid for the real estate. However, if the real estate is owned by an entity, such as a corporation, LLC, or partnership, and it is the ownership interests in the entity that are sold (and not the real estate itself), the property appraiser typically has no notice of the sale or the price involved, and thus no valuation adjustment based on the sale usually occurs. As sale of interests in entities becomes more popular as a method of avoiding documentary stamp taxes, the problem of lack of notice to the tax appraiser has become worse.

Under recent changes to Florida law that became effective this month, an entity owning real estate must now report the sale of interests in the entity to the property appraiser. For this purpose, the reporting is triggered by a transfer of control of the entity or more than 50% of the interests in the entity (with exceptions for transfers between legal and equitable title and transfers between husband and wife or due to dissolution of a marriage). The reporting is not limited to "sales" of interests in entities - any transfer of control is subject to reporting.

The penalties for not reporting can be significant. For failing to report, the owner will be penalized for taxes avoided by such failure for up to 10 years, 15% interest on that amount each year, and a further penalty of 50% of the taxes avoided. Such penalty will become a lien against the subject real property, or if no longer owned, other real property of the owner owned in Florida.

Until the Department of Revenue issues Rules under the new law, the method of reporting and the forms to be used are unknown. Further, the statute is unclear as to who exactly must do the reporting. It appears that it is the entity that owns the real property that must report and that bears the penalty if reporting does not occur. Other issues that will hopefully be resolved include how to determine control and changes in control when interests in an entity are owned by other entities, how the rules will apply when interests in an entity that own the entity that owns the real estate are disposed of (that is, how the rules will apply to multi-tiered ownership structures), whether transfers that do not reflect typical sale transactions (such as transfers of interests in corporate reorganizations) will need to be reported, how the consideration on the sale will be allocated to the underlying real estate if the entity owns other assets or has liabilities, and how reporting will occur if the consideration received for the ownership interests is not based on cash consideration.

While at first glance it appears that the reporting requirement is not that big a deal, it is likely to present substantial administrative headaches for taxpayers and property assessors alike. There is also likely to be a substantial amount of unintended noncompliance, since many taxpayers and nonreal estate attorneys will likely not be aware of the need for reporting simply because of transfers of interests in entities.

Fla.Stats. §193.1556.


The IRS has provided recent guidance as to the revisions to various filing and disclosure requirements that impact exempt organizations. Many of these requirements were changed as part of the Pension Protection Act of 2006, but not all exempt organizations are aware of the changes. Some of the highlights of the changes, and the IRS guidance as to how those changes are implemented are:

a. SMALL ORGANIZATION EXEMPTION FROM FILING FORM 990. Generally, organizations with less than $25,000 in gross receipts do not need to file an annual Form 990. However, under the 2006 Act, nonfilers must give electronic notice to the IRS of their nonfiling. This is done through the use of the Form 990-N e-postcard. This is due by the 15th day of the 5th month after the close of the tax year, although there are some limited exceptions that exempts some organizations from even having to file the e-postcard form. If an organization does not file for 3 years, the penalty is severe – revocation of tax-exempt status.

b. SUPPORTING ORGANIZATION MANDATORY FILINGS. Supporting organizations are now required to file an annual information return, regardless of the level of gross receipts. The filing includes information on organizations supported, the type of organization that the supporting organization is, and certifying lack of control by disqualified persons.

c. MANDATORY ELECTRONIC FILING. Organizations with assets over $10 million must now file their Form 990 electronically.

d. FORM 990-T. Organizations with $1,000 or more of unrelated business income must file a Form 990-T. This filing requirement may apply even if a Form 990 is not required (e.g., churches still need to file the Form 990-T if applicable, even though they do not have to file a Form 990). The public and inspection and disclosure requirements applicable to Forms 990 are now extended to Form 990-T, although schedules, attachments and supporting documents that don’t relate to the imposition of the unrelated business income tax don’t have to be made available to the public.


Sunday, June 22, 2008


Qualified personal residence trusts ("QPRTs") are most often used in wholly domestic U.S. estate planning. A QPRT is a trust established to hold a personal residence of the grantor. The grantor retains the rent-free use of the residence for a fixed number of years. At the end of the term, the ownership of the residence passes to other named beneficiaries of the trust.

QPRTs provide a valuable transfer tax benefit. If the grantor survives the term of the trust, the amount of the taxable transfer is limited to the present value of the remainder interest of the trust, established at the time of the trust creation and funding. This means that the portion of the value of the property equal to the number of years of free use by the grantor is transferred free of gift and estate taxes to the other trust beneficiaries. Further, any appreciation in value of the residence during the term is also transferred to the other trust beneficiaries free of U.S. federal transfer taxes.

A recent article (Using a U.S. Qualified Personal Residence Trust in Cross-Border Planning, J.F. Meigs and R.R. Gager, 35 Estate Planning, No. 7, 22 (July 2008)) reminds us that the QPRT can also be used in an international context. For example, U.S. citizens or domiciliaries can fund a QPRT with a residence that is located outside the U.S. - there is no restriction to using domestic real property. The same transfer tax benefits will generally apply for both U.S. and non-U.S. residences. However, since not all foreign jurisdictions recognize the concept of a trust or allow trusts or non-locals to own interests in their real property, this planning may not be available for property in all jurisdictions, at least without additional planning to work around these limitations.

On the other side of the coin, foreign persons for U.S. transfer tax purposes (non-U.S. citizens who are not domiciled in the U.S.) may want to consider the use of QPRT when acquiring a U.S. residence, since such persons are subject to U.S. estate tax at death on their directly owned U.S. real property interests.  However, such persons are at a disadvantage as compared to U.S. persons. When a QPRT is established, a current taxable gift occurs, equal to the discounted present value of the remainder interest (that is, the value of the property, reduced actuarially to account for the fact that the beneficiaries will not receive the property for the term of the trust). For U.S. grantors, this gift is typically absorbed or covered by their $1 million unified credit, so that no current gift tax needs to be paid. Since nonresidents do not have such a unified credit, upon establishment of the QPRT it is likely that a current gift tax will be paid. The nonresident grantor, if he or she survives the term of the QPRT, will still obtain the same overall transfer tax benefits as a U.S. grantor, subject to this advance payment of transfer taxes (which a U.S. grantor would effectively not pay until a later gift, death or may never pay, depending on how the use of his or her unified credit from the lifetime gift at establishment of the QPRT ultimately effects other gift or estate tax obligations from subsequent transfers).