blogger visitor

Wednesday, April 30, 2008


Under Internal Revenue Code Section 1446, foreign partners of a partnership that is engaged in a U.S. trade or business are subject to withholding of taxes attributable to their allocable share of the effectively connected income of that partnership. This can be unfair to a partner who would not have to pay taxes on that income due to other deductions available to the partner.

In the spirit of fairness, the IRS has issued final regulations allowing the partner to certify available deductions to the partnership, so as to reduce the amount of tax that must be withheld. The IRS doesn't freely give out this benefit - it requires that the taxpayer have filed returns for the prior 3 years for the first time it files, and has specific certification requirements.

Some of the highlights of the final regulations include:

a. A protective return of the partner is not a "return" for purposes of the filing requirements for prior years;

b. Foreign estates and their beneficiaries, and trusts that are not grantor trusts, cannot use these rules;

c. There are special limitations that apply to tiered partnerships;

d. The rules do not apply to partners of a publicly-traded partnership;

e. A provided certificate can only have a prospective effect;

f. The certificate does not effect the estimated tax obligations of the foreign partner;

g. The certificate does not affect the obligations of the partner to file a U.S. income tax return; and

h. The partnership must attach copies of the certificates received to its Section 1446 filings with the IRS.

Saturday, April 26, 2008


Under Code Section 2032, an estate can elect to value its assets for estate tax purposes on a date that is six months after the death of the decedent, instead of on the date of death. Thus, an estate can reduce its estate taxes if the overall value of those assets has declined in that six month period. In 2006, the Tax Court held that post-death changes in the character of stock owned by a decedent pursuant to a tax-free reorganization would be allowed to affect the alternative valuation date value of the stock for estate tax purposes. Herbert V. Kohler, Jr., et al., TC Memo 2006-152.

The IRS, in a direct attack on the Kohler decision, has announced that it will soon be issuing regulations that will limit Section 2032 value adjustments to those that occur to changes in market conditions. Thus, voluntary actions by interested persons that affect post-death value will not allow for the use of alternatve valuation. The regulations will define “market conditions” as events outside of the control of the decedent (or the decedent's executor or trustee) or other person whose property is being valued that affect the fair market value of the property being valued.

Preamble to Proposed Regulations 04/24/2008; Proposed Regulations Section 20.2032-1

Wednesday, April 23, 2008


A grantor trust generally is a trust whose income is taxed, in whole or in part, to the grantor/settlor, and not the trust or other beneficiaries. Grantor trust status is often intentionally sought as a way to shift tax incidents to the grantor and thus in effect allow transfers to the trust to effectively occur through the tax payments of the grantor without incurring a gift tax, or to avoid income tax consequences for transactions between the grantor and the trust.

As part of tax planning, the grantor may also seek to avoid having the trust being subject to estate tax at the death of the grantor. Therefore, tax planning is undertaken to give the grantor a power over the trust that will create a grantor trust, but which is not so broad as to result in estate tax at the grantor's later death.

One power often used to accomplish this dual purpose is to give the grantor the nonfiduciary power to replace trust property at any time with property of equivalent value. So long as the grantor is not also the trustee and the grantor's power is a nonfiduciary power, the Internal Revenue Code and Regulations are fairly clear that this will create a grantor trust. What has previously been understood by way of case law precedent is that such a power by itself will not create estate tax inclusion via Code Sections 2036 or 2038.

The IRS has now issued a Revenue Ruling that confirms this treatment under Sections 2036 and 2038, at least if the requirements of the Ruling are complied with. Those requirements are:

a. the trustee has a fiduciary obligation (under local law or the trust instrument) to ensure the grantor's compliance with the terms of this power by satisfying itself that the properties acquired and substituted by the grantor are in fact of equivalent value, AND

b. the substitution power cannot be exercised in a manner that can shift benefits among the trust beneficiaries.

What exactly is meant by b. is not entirely clear, but the Ruling does provide two safe harbors that satisfy b. This requirement will be satisfied if:

1. the trustee has both the power (under local law or the trust instrument) to reinvest the trust corpus and a duty of impartiality with respect to the trust beneficiaries; OR

2. the nature of the trust's investments or the level of income produced by any or all of the trust's investments does not impact the respective interests of the beneficiaries, such as when the trust is administered as a unitrust (under local law or the trust instrument) or when distributions from the trust are limited to discretionary distributions of principal and income.

Thus, while it may be possible to avoid Section 2036 and 2038 inclusion even without strictly following the above rules, the Ruling is a useful safe harbor to avoid the estate tax inclusion entirely.

Revenue Ruling 2008-22

Sunday, April 20, 2008


May 2008 Applicable Federal Rates Summary:

SHORT TERM AFR - Semi-annual Compounding - 1.63% (1.84%/April -- 2.24%/March -- 3.09%/February -- 3.16%/January)

MID TERM AFR - Semi-annual Compounding - 2.72% (2.85% /April -- 2.95%/March -- 3.48%/February -- 3.55%/January)

LONG TERM AFR - Semi-annual Compounding - 4.17% (4.35%/April -- 4.23%/March -- 4.41%/February -- 4.41%/January)


Wednesday, April 16, 2008


In recent months, the IRS has set up a conflict of interest between tax return preparers and their taxpayer clients. They have done this by requiring that for a return preparer to avoid a penalty on an erroneous tax position without specifically highlighting/disclosing the tax position, the preparer generally has to have a more likely than not belief that the reported position was correct. However, a taxpayer would be penalized for the same error only if there was no substantial authority for the position - this requires less belief in the correctness of the position than the more likely than not standard. This puts preparers in the uncomfortable position that if they have a taxpayer who wants to report a position based on substantial authority (and thus the taxpayer is not at risk for penalties if wrong), but there is not enough authority that the preparer has a more likely than not belief in the correct position, they are at risk of a penalty when their client is not. The effect is that the preparer either refuses to adopt the position, or must attempt to persuade the taxpayer to disclose the issue even though the taxpayer is justified in reporting the position.

Many members of Congress disapprove of these higher standards being imposed on preparers. A recent tax bill, H.R. 5719, the “Taxpayer Assistance and Simplification Act of 2008,” seeks to reduce the preparer standard to match the substantial authority standard for taxpayers in most situations. This bill is presently being debated in Congress. Whether it will be enacted into law is uncertain, since there are other provisions of the bill that President Bush does not favor, and he has threatened to veto the bill (these provisions relate to the termination of the IRS' authority to hire private debt collectors).

If relief comes, it will be too late for the April 15 deadline for 2007 individual income tax returns, but, depending on effective date provisions, may still come in time to exist in regard to the preparation of returns that are on extension and to perhaps avoid penalties on returns that have already been filed.

Sunday, April 13, 2008


As previously discussed, taxpayers should endeavor to file their income tax returns by April 15, even if they cannot fully pay their taxes on time, so as to avoid the late filing penalty. The late payments will still be subject to interest (presently at 6% per year) and the late payment penalty of 1/2 of 1% per month.

Taxpayers who need additional time to pay may qualify for a payment agreement with the IRS. The IRS has made this easy through an online process through their website at If eligible, a taxpayer can get a short-term extension with up to 120 days to pay, or a monthly payment plan.

The short term extension is still subject to late payment penalties and interest, but no fee is charged for it. A monthly payment plan will cut the late payment penalties in half, but a fee of $43 to $105 is charged.

A payment agreement can also be requested by filing Form 9465 with the filed income tax return.

Note that a few taxpayers may make late payments without interest or penalties without asking for permission. These include members of the military serving in combat-zone localities and taxpayers in certain designated disaster area (but note that specific extended deadlines for payment still apply).

Thursday, April 10, 2008


When a testator specifically leaves real estate or other property under his estate planning documents, and that property is encumbered by debt, it is important that the estate planner determine the testator's desires as to the debt and make proper provision for it. This is because the treatment of that debt at death can dramatically impact both the recipient of the property and the residuary beneficiaries of the estate. For example, if the recipient of the property is to receive it free and clear of the debt, then the estate will have to pay off the debt with other estate assets. This payment will usually directly decrease the assets left for the residuary beneficiaries. Alternatively, if the debt is not paid off, the net value passing to the beneficiary receiving the property can be substantially diminished.

This effect of these issues was illustrated in a recent Florida appellate case. In the case, a decedent left 3 family farms to one of his sons. At the time of death, the farms were encumbered by over $240,000 in debt. The decedent's remaining property was to be divided among 5 beneficiaries (one of which was the son who received the farms). The Last Will had no specific provision as to whether the debt should be paid off by the estate, although it did provide that all of the decedent's legal debts should be paid.

During the course of administration, the estate paid off the debt, so that the son received the farms free of debt. One of the residuary beneficiaries sued, claiming that the payment was not authorized.

Fortunately for the residuary beneficiaries, Florida law has a provision on point which provides “[t]he specific devisee of any encumbered property shall be entitled to have the encumbrance on devised property paid at the expense of the residue of the estate only when the will shows that intent” and that “[a] general direction in the will to pay debts does not show that intent.” FS Section 733.803. Based on this statute, the payment of the debt by the estate was held to be improper.

Whether this is what the testator intended is unknown. Therefore, to make sure that the testator's intent is properly implemented, planners need to specifically inquire of the testator what is desired, and if needed, make specific provision in the Last Will if the default result under Florida law will not accomplish this intent. Even when it is intended that the debt not be paid from the residuary as per the default scheme under the statute, a specific statement to that effect may still be helpful so that the decedent's heirs are comfortable that the statutory scheme was specifically desired by the testator.

In re: Estate of James Ollis Woodward a/k/a James O. Woodward. BRIAN WOODWARD, Appellant, v. ELLEN C. SMITH, as personal representative of the estate of James Ollis Woodward, Appellee. 2nd District. Case No. 2D07-713. Opinion filed April 9, 2008.

Monday, April 07, 2008


As surely as April 15 comes every year, there will be taxpayers who do not file their income tax returns on time or who do not pay their income taxes on time. Here's a quick refresher on penalties relating to income tax filings, courtesy of the IRS:

FILING LATE: If you do not file your return by the due date (including extensions), you may have to pay a failure-to-file penalty. The penalty is usually 5 percent for each month or part of a month that a return is late, but not more than 25 percent. The penalty is based on the tax not paid by the due date (without regard to extensions). If you file your return more than 60 days after the due date, the minimum penalty is $100 or, if less, 100 percent of the tax on your return. For any month both the penalty for filing late and the penalty for paying late apply, the penalty for filing late is reduced by the penalty for paying late for that month, unless the minimum penalty for filing late is charged.

PAYING TAX LATE: You will have to pay a failure-to-pay penalty of ½ of 1 percent (0.5 percent) of your unpaid taxes for each month, or part of a month, after the due date that the tax is not paid. This penalty does not apply during the automatic six-month extension of time to file period if you paid at least 90 percent of your actual tax liability on or before the original due date of your return and pay the balance when you file the return.

The failure-to-pay penalty rate increases to a full 1 percent per month for any tax that remains unpaid the day after a demand for immediate payment is issued, or 10 days after notice of intent to levy certain assets is issued.

For taxpayers who filed on time, the failure-to-pay penalty rate is reduced to ¼ of 1 percent (0.25 percent) per month during any month in which the taxpayer has a valid installment agreement in force.

BOUNCED CHECKS: If you write a check to pay your taxes and the check bounces, the IRS may impose a penalty. The penalty is either 2 percent of the amount of the check - unless the check is under $1,250, in which case the penalty is the amount of the check or $25, whichever is less.

Do not fall into the trap of not filing your tax return on time just because you can't pay the tax on time.

Note that the above are only penalties - interest on late payments of tax will likely also apply.

FS-2008-19, March 2008

Thursday, April 03, 2008


As the economy moves closer to (or deeper into, depending on who you believe) recession, the number of credit card holders who will obtain reductions in their credit card debt from the issuer is likely to increase. Those debtors will eventually learn that the discharge of debt is taxable to them.

Section 108 of the Internal Revenue Code provides that such income will not arise in certain specified situations, including a discharge in a Title 11 bankruptcy, when the debtor is insolvent, when the debt is qualified farm indebtedness, when the debt is qualified real property business indebtedness, or when the debt is qualified principal residence indebtedness.

A recent Tax Court case highlights the creative arguments raised by taxpayers to come within Section 108 when the taxpayer doesn't fit within any of the above exceptions. In shooting down 2 taxpayer theories, it is evident that taxpayers should not expect any leniency from the IRS or the Tax Court on these issues.

The taxpayer first tried to use Code Section 108(e)(5). That provisions avoids debt discharge income where the buyer of property negotiates with the seller/creditor for a discharge of all or part of the purchase money indebtedness. The resulting discharge of indebtedness is characterized not as taxable income but in effect as a retroactive reduction of the purchase price. However, in this case the credit card company was found not be a seller of property, so the provision was held not to apply.

The taxpayer then tried to claim that the case of Earnshaw v. Comm., T.C. Memo 2002-191 stands for the proposition that the discharge of interest on debt is not income to the debtor. The Tax Court disagreed, finding that the case only applied to reductions in debt due to a bona fide dispute about the amount of the debt involved. While not discussed in the case, if the interest payment would have been deductible to the debtor, then Code Section 108(e)(2) would then have avoided debt discharge income to that extent. This provision avoids debt discharge income on debt that would be deductible if actually paid by the debtor. Presumably, the taxpayer in the Tax Court case could not use that provision because the expenses were personal, nondeductible expenses so that interest relating to their purchase would not be deductible.

Ancil N. Payne, Jr., et ux. v. Commissioner, TC Memo 2008-66

Tuesday, April 01, 2008


When an individual dies, his or her assets are subject to a 10 year estate tax lien in favor of the IRS for any unpaid estate taxes. Many would think that the lien would be divested as to any third party purchaser of estate assets for fair value, since the purchaser would not have any involvement in the computation or payment of estate taxes. However, they would be wrong, as several title companies found out in a recent tax case.

In that case, a decedent died owning 3 houses. The 3 houses were deeded out to the appropriate heir and her spouse, and then they sold the houses to 3 purchasers. Ultimately, the IRS challenged the value of another estate asset, and assessed additional estate tax. Since it was unable to collect the unpaid tax from the estate, it came after the 3 purchases pursuant to its 10 year estate tax lien. Note that the purchasers didn't even buy the properties from the estate, but from a successor in interest to the estate (the heir and her husband).

Ultimately, the purchasers were held liable for the unpaid estate taxes (actually, the title insurers ended up paying the taxes pursuant to title insurance policies purchased by the purchasers). The case demonstrates that real property purchasers ignore the 10 year estate tax lien at their own peril, and that the IRS will come after unrelated third party purchasers when it cannot collect estate taxes from the estate. As an aside, the third party purchasers were not able to challenge the additional tax assessment that they ended up paying, because they were not the taxpayer.

Of course, knowledgeable purchasers are not without protection against estate tax liens. When a title search shows that property was owned by a decedent within the past 10 years, a purchaser can insist on the seller obtaining a release of lien from the IRS. The purchaser can also wait for a closing letter to be issued that demonstrates that estate tax has been satisfied. Further, if the executor had applied for and obtained a discharge of personal liability from Code Section 2204, the lien would have been released as to any purchasers.