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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).