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Saturday, December 25, 2010


Unlike the transfer tax area, only modest changes were made to the foreign provisions of the Internal Revenue Code. Continuing our review of the changes, below is a summary of the new provisions, most of which relate to temporary extensions of various favorable rules. For what they are worth (which may be quite a lot to those few taxpayers that are impacted), here they are:

A. The Subpart F exception for active financing income is extended.  The temporary exclusions will apply to tax years of a foreign corporation beginning after Dec. 31, 1998 and before Jan. 1, 2012, and to tax years of U.S. shareholders with or within which such tax years of foreign corporations end.

B. The look-through treatment for payments between related controlled foreign corporations under the foreign personal holding company income rules are extended through 2011.

C. The withholding tax exemption for RIC interest-related dividends and short-term capital gains dividends paid to foreign persons is extended for tax years beginning in 2010 and 2011. Also, the inclusion of RICs in the definition of qualified investment entity is extended for certain FIRPTA purposes through 2011.

D. The IRS authority to reduce withholding rate to 15% on USRPI gains passed through to foreign persons by U.S. partnerships, trusts or estates is extended through 2012.

E. Gain recognition expansion for Code §684 for transfers to nonresident aliens at death and to foreign grantor trusts that were to apply in 2010 will apply only to the extent the election is made to not have the estate tax apply.

F. The allowance of Code §199 deduction for Puerto Rico activities is retroactively extended two years to taxpayer's first six tax years beginning after 2005.

G. The possessions tax credit for American Samoa is extended through 2011 for existing claimants.

Tuesday, December 21, 2010


I will undertake to summarize the key provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 over several postings. Let’s start with the new transfer tax provisions. Note below that there are some unique opportunities for conducting generation skipping transfers prior to 1/1/2011.

A. Estate and GST taxes reimposed for 2010, with reimposition of prior basis step-up regime.

     1. But with election available to avoid estate tax in 2010 on 2010 deaths, which would use the EGTRRA limited basis step-up provisions.

          a) In that situation, the deadline for filing the Form 8939 relating to basis allocation is delayed until 9 months from date of enactment.

     2. But GST tax rate set to zero. Decedent is still considered to be "transferor" for GST purposes.

          a) This is an incentive to make generation skipping transfers prior to the expiration of 2010, including distributions out of trusts that will be taxable distributions or taxable terminations.

               (1) Outright gifts are subject only to potential gift taxes.

                    (a) Which will deplete the estate for estate tax purposes if the transferor survives an additional three years.

               (2) Or to trusts where beneficiaries are all skip persons.

                    (a) Consider opting out of GST exemption allocation to avoid unnecessarily wasting GST exemption.

               (b) Post-2010 distributions to beneficiaries at the grandchild level (but not to beneficiaries of younger generations) will not be subject to GST tax, per Code §2652(a).

                    (c) If some desired beneficiaries are grandchildren and some are greatgrandchildren, you may want to have separate trusts for the different generation levels.

     3. QDOTs subject to estate tax if noncitizen surviving spouse died in 2010.

B. Increase in exclusion amounts and exemptions to $5 million for 2010-12, with inflation adjustment in 2012.

     1. This is an incentive to make lifetime transfers before 12/31/12 to the extent of available exclusions, since the larger exclusion amounts may revert to much lower amounts in 2013.

          a) But generally want to defer until at least 1/1/11 since gift tax exemption does not increase to $5 million until 2011.

     2. However, gift tax exemption remains at $1 million for 2010 gifts.

C. Maximum estate, gift and GST taxes reduced to 35% through 2012.

     1. This is an incentive to make lifetime transfers before 12/31/12 to the extent of available exclusions, since the rates may revert to much higher levels in 2013 (i.e., 55% maximum rates).

     2. And gift and estate tax rates are reunified.

D. Extended filing deadlines for estates of decedents dying from 1/1/10 to 12/17/10.

     1. 9 months from 12/17/2010 for filing an estate tax return, paying estate tax, making a disclaimer of an interest passing by reason of decedent's death, and filing of GST tax returns and making elections required on a GST tax return).

          a) But watch state law limits on time to make a disclaimer.

E. A surviving spouse can use the unused exclusion amount of his or her LAST deceased spouse for estate tax purposes (but only for spouses dying before 12/31/12).

     1. But it requires an election to be made on the estate tax return of the first spouse to die. This may mean a return is needed even though one would not otherwise be required.

     2. IRS can readjust available unused exclusion amount of first spouse to die, even though statute of limitations for examining that estate tax return has expired.

     3. GST exemption amounts are not portable.

     4. Credit shelter trusts (in lieu of maximizing transfers to surviving spouse or a marital deduction trust) may still be desirable at the death of the first spouse to allow for full use of GST exemption of first spouse, and to protect against estate tax at second death arising from appreciation in the value of assets.

          a) However, credit shelter trusts lose the opportunity for basis step-up at the death of the surviving spouse.

F. Return to 2001 rules and rates will occur on 1/1/13 (unless subsequent changes are made by law).

1. Here we go again!

Wednesday, December 15, 2010


With the passage of the tax bill today in the Senate, it is looking more and more likely that the Bush tax cuts will be extended for 2 more years, and favorable changes to estate, gift, and generation skipping taxes will be enacted into law. Consideration by the House is next.

The new estate tax rules will introduce a new concept – portability of exemption amounts. To the extent a spouse does not fully use the new $5 million exemption during lifetime time and at death, the surviving spouse can use the unused portion as well as his or her remaining exemption. One quirk of the pending law is that it will require estates of the first spouse to die to file an estate tax return, even if no taxes are due by reason of full coverage under the decedent’s exemption amount, so as to allow portability of the unused exemption to the surviving spouse. This will provide work to accountants that might otherwise see a significant diminution in estate tax return work due to the increased exemptions. Further, the IRS will be able to audit the return of the first spouse at any time to adjust the remaining exemption amount, even after the statute of limitations for the assessment of tax have expired.

In a provision very favorable to taxpayers, the $5 million exemptions will be indexed for inflation starting in 2012. Of course, the measure of inflation is the government’s computation, which many believe significantly understates actual inflation (see But a half a loaf is much better than no loaf.

At first blush, it might seem that the new portability rules do away with the traditional dual arrangement of a by-pass trust and a marital gift/trust to make use of the first spouse to die’s exemption. However, there are still reasons to use such arrangements – principally to help prevent appreciation in assets pushing the family above the combined $10 million exemption, and to allow full use of the first spouse to die’s $5 million GST exemption. However, the use of a by-pass trust eliminates the ability to get a step-up in basis on the trust’s assets at the death of the first spouse. Thus, disclaimer trust arrangements may be the way to go, allowing the decision of whether and how much to fund into a by-pass trust for the surviving spouse to be made after the death of the first spouse based on the circumstances at that time.

Sunday, December 12, 2010


The last minute efforts of Congress and the President to deal with the expiration of the Bush tax cuts on December 31 have been interesting, to say the least. It has also contributed to making year-end tax planning the most complicated and speculative it has been in recent memory, if ever.

The current proposal, backed by President Obama and most Republican Congressmen and Senators, is embodied in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. The Senate and House will be voting on the Act this week. What is keeping things interesting is that the House Democratic caucus met on Thursday and voted to reject the plan. What this means is that for the Act to clear Congress is that it will probably need the votes of many of the lame duck "blue dog" Democrats who were defeated in the recent election. An interesting artifact of the recent election is that while the general shift in Congress was towards the right on economic issues, many Democrats who were conservative on economic issues were swept out of office as part of the big wave, leaving the remaining Democrats further to the left on economic issues than where they were as a whole prior to the election.

For those not following things, the following is a list of the key tax provisions of the Act:

-Existing income tax rates will remain in place for another two years.

-Personal exemption phase-out repeal is delayed for two years.

-The temporary repeal of the itemized deduction limits are extended for two years.

-Capital gains and qualified dividend rates remain the same for two years.

-Individual alternative minimum tax exemptions are increased for two years.

-The unified credit for estate and gift taxes is increased to $5 million per person and $10 million per married couple, and will be indexed for inflation beginning in 2012. The generation skipping tax exemption will also be at $5 million. The exemption is portable between spouses. A 35% maximum rate is imposed for two years for estate, gift and generation skipping taxes. The new tax regime is retroactive to January 1, 2010, but allows an election to choose no estate tax and modified carryover basis for estates arising in 2010.

-FICA tax reduction for employees in 2011 from 6.2 percent to 4.2 percent.

Tuesday, December 07, 2010


Code §642(h)(1) permits the capital loss carryover of an estate to be carried over to the beneficiaries succeeding to the estate property upon termination of the estate. What happens if the beneficiaries do not actually succeed to any property?

In a recent Chief Counsel Advice, the estate agreed with the IRS to turn over all of its assets to settle income tax liabilities of the decedent. The beneficiaries who would have received a distribution from the estate were thus barred from receiving anything. Nonetheless, they deducted capital losses of the estate. The Advice indicates that the beneficiaries should not be allowed the deduction.

Treas. Regs. § 1.642(h)-4 does provide an example of a beneficiary receiving a loss even though there were insufficient assets to actually distribute anything to the beneficiary. This is based on the premise that such a beneficiary would have gotten something but-for the loss, and thus suffered it and should receive the capital loss deduction. Nonetheless, the Advice indicated that there was no way the beneficiaries could receive anything pursuant to the settlement agreement, and thus they could not use this example. The Advice does not provide any details on the economics of the settlement – it would seem that if the losses were large enough that if they did not occur and the IRS liability could have been satisfied with something left over for the beneficiaries, then the beneficiaries suffered the loss at least in part and thus should get at least some of the losses. Such an analysis would seem to be required by the definition of beneficiaries in regard to a testate estate under Treas. Regs. § 1.642(h)-3(a) which definition includes persons who bear the burden of any loss for which a carryover relates. Thus, it would seem that an analysis should have been undertaken to determine if any amounts would have been left to the beneficiaries if the IRS was paid its liability in full, assuming that no losses had occurred. However, the Advice does not undertake this analysis and simply hangs its hat on the fact that the agreement existed so the beneficiaries could receive nothing and thus no losses would be allowed to them – end of story.

Treas. Regs. § 1.642(h)-3(b) provides a definition of a “beneficiary” for an intestate estate. That includes heirs and kin of the decedent under an insolvent intestate estate that receive nothing but would have received something if the estate was not insolvent. This concept, if applicable to a testate estate also, should allow a deduction here, at least in part, if the losses were large enough to have cost the beneficiaries part of what they otherwise would have received even after the IRS was paid in full. The Advice noted that the estate at issue above was a testate estate, so the intestate estate rule did not directly apply and would not be applied. More reasonably, the Advice should have used the intestate rule to inform it regarding the need to track the actual economics in the testate situation, but as noted, such an economic analysis was not undertaken.

Perhaps we may see more on this issue if the taxpayers decide to litigate the issue.

CCA 201047021

Saturday, December 04, 2010


On Thursday of this week, Senate Finance Committee Chair Baucus introduced an amendment to the Middle Class Tax Cut Act of 2010. It is more likely than not that this amendment will not be currently passed into law, but nobody knows for sure. Indeed, whether the Middle Class tax Cut Act will find its way into law is unknown. While the proposed changes provide substantial estate, gift and generation-skipping tax relief, some of the effective dates provide new risks for any year-end 2010 planning.

Since the proposals are not law, we will not go into great depth in reviewing them at this point. Some of the highlights are:

a. The 2009 estate, gift and GST exemption amount of $3.5 million will be made permanent and indexed for inflation starting in 2011. The maximum rates will be 45%. This change will be retroactive to 1/1/2010, with the reinstatement of normal basis-step up rules – however, taxpayers with transfers in 2010 can elect to apply the 2010 repeal rules instead (with their limited basis adjustments) .

b. The gift tax unified credit will be re-unified with the estate tax exemption, as of 12/2/2010.

c. Provisions will be enacted that resolve many of the 2010 tax uncertainties, including allowing direct skips in trust to take advantage of the move-down rule even if there was no GST tax imposed on the funding in 2010.

d. Unused unified credit of one spouse can be used by the surviving spouse, if an election is made.

e. GRATs will have to have a minimum 10 year period and some value in the remainder interest to obtain favorable GRAT treatment.

A MAJOR aspect of these new rules is that if these amendments are enacted into law, any gifts made after December 2, 2010 will NOT be able to use the 35% gift tax rate and the exemption from GST tax that has been available since January 1, 2010. However, it appears such gifts and transfers will obtain the benefits of the increased unified credit and lower maximum tax rate that are coming in at the same time.

Planning in 2010, especially late this year, has been challenging, to say the least. A large part of this has to do with uncertainties regarding transfers to generation skipping tax trusts and how those trusts will be treated in future tax years. Now, to add uncertainty to uncertainty, any transfers made now through the end of December (or the enactment into law of these provisions if that comes sooner) will face the uncertainty of whether they will be under the 35% maximum gift tax rate and whether they will be exempt from GST tax. Fun, fun, fun!

One word of caution – the above is based on summaries of the proposed changes that I have seen and not a review of the actual legislation. Planners should conduct their own review to determine how exactly the proposals would apply to their situation. 

Wednesday, December 01, 2010


Each spouse is jointly and severally liable for the tax, interest, and penalties (other than civil fraud penalty) arising from a joint return. However, the Internal Revenue Code provides various routes for relief for an “innocent spouse.”

One of those routes is relief under Code §6015(f). A spouse can obtain equitable relief from joint liability if “taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency.” The procedures for obtaining Code §6015(f) relief are provided for in Rev.Proc. 2003-61.

A recent Tax Court case illustrates the application of the rules in that Revenue Procedure, and further demonstrate the Tax Court favorably granting relief to a spouse under those procedures even though the spouse knew at the time she signed and filed the tax return that there was a good chance the taxes indicated as due on the return would not be paid.

Under Rev.Proc. 2003-61, a prerequisite to equitable relief is that seven threshold conditions described in Section 4.01 must be met. If they are met, the the IRS will ordinarily grant relief to a requesting spouse if three safe harbor conditions in Section 4.02 are met.

In the recent case, a former wife passed the seven threshold conditions of Section 4.01. However, due to her having filed the return with knowledge that the taxes would likely not be paid, she did not meet the three safe harbor conditions of Section 4.02.

Nonetheless, all is not yet lost for a spouse that fails the three safe harbor conditions. In that circumstances, the spouse has one more chance – the IRS can still grant equitable relief after applying a balancing test that weighs various factors in Section 4.03 of the Revenue Procedure. Luckily for the spouse in this case, the Tax Court found enough factors in the wife’s favor that it found the spouse eligible for equitable innocent spouse relief.

I have put together a MindMap that summarizes the various routes to innocent spouse relief, including the various conditions, safe harbors, and factors applied under Rev.Proc. 2003-61, for anyone that wants to dig down into the details of these provisions. Click HERE for an Adobe Acrobat version, and HERE for a flash version. In this case, the wife could not use the relief mechanisms of Code §6015(b) or (c) because the tax due had been reported by the taxpayer on a return.

Gail P. Drayer v. Comm., TC Memo 2010-257

Saturday, November 27, 2010


The Internal Revenue Code allows nonprofit educational organizations to be exempt from income tax under Code §501(c)(3). In making a determination whether an organization is “educational,” the IRS will determine whether an organization actually is engaged in educational activities. While this is an appropriate line of inquiry, inquiries into the substance and political correctness of the items that the organization intends to teach should not be relevant.

According to pleadings filed in a civil action, Z Street is a nonprofit organization which educates the public about Zionism, and about the State of Israel and its battle with terror.  As a nonprofit educational organization, Z STREET has applied for certification that donations made to it are charitable, and therefore exempt from federal income tax, under Code §501(c)(3).

Z Street is contending that the IRS is asking improper questions and unduly delaying its exempt organization application. As part of its court filing, Z Street has indicated that an IRS agent has informed it that the IRS is “carefully scrutinizing organizations that are in any way connected with Israel,” and that there are such “cases… being sent to a special unit in the D.C. office to determine whether the organization’s activities contradict the Administration’s public policies.”

If true, such inquiries by the IRS should not be permitted (as not relevant to the “educational” aspects of the organization). Further, it raises that the specter that the IRS may be denying exempt organization status because an organization’s activities are not in accord with the Administration’s policies – an improper, if not unconstitutional, politicization of what should be a policy-neutral exempt organization review.

To support its claim, Z Street has indicated that another Jewish organization applicant has been asked questions such as (1) [d]oes your organization support the existence of the land of Israel, and (2) describe your organization’s religious belief system towards the land of Israel.

It is true that an institution's purpose must not be so at odds with the common community conscience as to undermine any public benefit that might otherwise be conferred. Bob Jones Univ. v. U.S., 461 U.S. 574 (1983). In Bob Jones Univ., Code §501(c)(3) status was denied to a school that imposed racial discrimination. However, in that case, the U.S. Supreme Court noted that “[w]e are bound to approach these questions with full awareness that determinations of public benefit and public policy are sensitive matters with serious implications for the institutions affected; a declaration that a given institution is not “charitable” should be made only where there can be no doubt that the activity involved is contrary to a fundamental public policy.” Merely disagreeing with the Administration on foreign or religious policy should not give rise to a clash with fundamental public policy justifying  denial of Code §501(c)(3) status.

Just because Z Street has made these factual allegations in its court filings does not mean they are true. However, if they are, it is hoped that further judicial attention will be focused on the appropriateness of the questions being asked and whether the IRS is improperly basing exempt organization determinations on whether an organization’s activities are in concert with Administration policies.


Monday, November 22, 2010


Owners of investment real property in Florida often rent out their property to farmers - not so much for the rent but to obtain an agricultural classification for ad valorem tax purposes. The agricultural classification will typically result in much lower taxes.

Florida law now expressly provides that the agricultural classification can continue even if the real property is listed for sale. The Florida legislature had previously passed this law, but it was vetoed by Governor Charlie Crist. The legislature voted to override the veto and thus is now law (effective July 1, 2010).

The classification applies based on the use of the property on January 1 of the tax year. Thus, owners who put their property up for sale during a period that includes January 1 can now squeeze out at least one more year of lower ad valorem taxes.

Wednesday, November 17, 2010


Mr. and Mrs. Au erroneously deducted gambling losses to offset other income, in violation of Code §165(d). Code §165(d) only allows gambling losses to be deducted to the extent of gambling winnings.

The IRS sought to impose the 20% accuracy-related penalty under Code §6662 for the understatement of tax. The taxpayers objected, claiming that they deducted the losses only because their tax preparation software allowed them to do it – thus, they had reasonable cause which is an exception to the 20% penalty.

The Tax Court rejected the reasonable cause claim. This is not the first time it has done so. See, for example, Parker v. Comm., T.C. Memo 2010-78 (June 21, 2010).  That case involved the TurboTax tax preparation software, and this defense is often referred to as the “TurboTax Defense.”

In the Au’s case, the Court found that the taxpayers did not provide evidence of a mistake in the software instructions, nor of a thorough effort by the taxpayers to determine their correct tax liability. This seemingly leaves the door open to the successful use of the TurboTax Defense if a taxpayer can actually prove up a mistake in tax preparation software or its instructions.

To be fair (to TurboTax), the opinion did not indicate whether the software used was TurboTax or some other company’s software. I am sure that TurboTax does not appreciate the colloquial use of the term “TurboTax Defense” since it implies that their tax preparation software makes mistakes. Perhaps they may take some comfort in the credo that there is no such thing as bad publicity, or does that only apply to celebrities?

Au v. Commissioner, T.C. Memo. 2010-247

Sunday, November 14, 2010


There are a lot of people in Washington D.C. that believe there are massive numbers of U.S. taxpayers who are avoiding U.S income taxes through offshore accounts and entities. To attack this avoidance, as part of the Hiring Incentives to Restore Employment Act of 2010 (HIRE Act, P.L. 111-147, 3/18/2010) the Foreign Account Tax Compliance Act (FATCA) installed a new withholding tax and reporting regime on various payments to offshore entities. In October, the IRS issued Notice 2010-60 to provide some guidance on how the new provisions will apply (the new provisions commence operation in 2013).

The new provisions and the IRS’ planned implementation rules boarder on the incomprehensible. They are the height of “bureacracyspeak.” Rules exist, subject to exceptions, which are themselves subject to additional exceptions. The rules contain definitions, which to determine their application, require the application of other definitions. Payors and offshore financial institutions have to run through a gauntlet of determinations regarding the status of accounts, payees, and various categories of taxpayers.

Those seeking to apply the rules will have to master the following new terms and definitions:

-Financial Account. Code §1471(d)(2).
-Financial Institution (FI). Code §1471(d)(5).
-Foreign Financial Institution (FFI). Code §1471(d)(4).
-Non-Financial Foreign Entity (NFFE).
-Recalcitrant Account Holder. Code §1471(d)(6).
-Specified United States Person (Code §1473(3)).
-Substantial United States Owner. (Section 1473(2))
-United States Account. Code §1471(d)(1).
-United States Owned Foreign Entity. Code §1471(d)(3).
-Withholdable Payment (Code §1473(1)):
-Withholding Agent (Code §1473(4).

A payor of a payment that may be subject to withholding will have to make determinations place the payee and/or the payment into one of the following 9 categories:

- U.S. Entity Payee (no withholding).
- Participating FFI (no withholding).
- Code §1471(f) entity (no withholding).
- Deemed compliant FFI (no withholding & will not be a NFFE).
- Nonparticipating FFI (withholding).
- NFFE Payee.
- Excepted NFFE (no withholding).
- Code §1472(c)(2) low risk entity (no withholding).
- Other NFFE (withholding).

Undoubtably, there will be a number of offshore entities that legitimately invest in the U.S. that will say to heck with this, and cease to invest in the U.S. or in its securities markets, rather than attempt to comply with this monster or be burdened by its withholding taxes. Yet there has been hardly a mention in the financial press of the potential deleterious effects of these new provisions – both as to compliance costs and the loss of capital investment in the U.S. Ah, for the good old days when Congress considered the impact of its legislation on the U.S. economy.

Wednesday, November 10, 2010


The end of 2010 brings unique opportunities and problems relating to gifting. There is a strong interest in making gifts in 2010 since the maximum federal gift tax rate is 35%, and generation-skipping taxes do not apply. Absent a change in the law, come January 1, 2011 the maximum federal gift tax rate will increase to 55%, and generation-skipping taxes (at 55%) are again in effect.

Therefore, in many circumstances it may make sense to make a gift in 2010 to take advantage of the lower rate. However, there are some important considerations in undertaking such planning.

First, in many circumstances it is desirable to delay the gifts until as close as possible to (but before) January 1, 2011. This is because if the transferor dies in 2010 there will be no estate tax. Therefore, death allows for a tax-free transfer (if the gift recipient would also be the recipient at the transferor’s death), while a taxable gift incurs up to a 35% gift tax. To avoid an unnecessary gift tax, the gift should be delayed to as close as possible to the end of the year to avoid the situation of the gift being made and then the transferor dying in 2010. Also, deferring the gift will allow for consideration of any changes that may occur in the law prior to January 1, 2011 that may impact on the tax planning.

Second, if the gift involves a transfer to a trust, there are some uncertainties regarding the application of the generation-skipping tax in future years. More particularly, if the gift in 2010 is effectively a "direct skip" because it is a transfer to a trust for which all of the beneficiaries are skip beneficiaries (i.e., they are all two or more generations removed from the transferor), future distributions from that skip trust to skip beneficiaries may still incur generation-skipping tax. In normal circumstances, such a direct skip funding would change the generation levels for a generation-skipping trust. That is, if grandfather made a gift to a generation-skipping trust, as a direct skip, future distributions to grandchildren from the trust (but not great grandchildren or more remote descendents) will not be subject to generation-skipping tax. However, since generation-skipping taxes do not apply in 2010, it is unknown if this generation exemption will apply to post-2010 distributions to a grandchild from such a trust that is funded in 2010.

Further, if the transferor to a trust involved a transferor with unused generation-skipping tax exemption, there is a fair amount of uncertainty how or if to apply that exemption to the trust for purposes of computing the inclusion ratio and applicable generation-skipping taxes for future distributions out of that trust.

Third, the common understanding is that the maximum gift tax rate in 2010 is 35%. This is correct, but there are two important considerations to paying gift tax in 2010. Accelerating transfer taxes to 2010 means you are paying taxes sooner than you might otherwise. This deprives the transferor and his family unit from the ability to invest and earn from such transfer taxes. It is a maxim of tax planning that, all other things being equal, it is better to pay a tax tomorrow than today from a financial standpoint.  Also, if the transferor dies within three years, estate taxes will be payable on the gift tax amount paid to the IRS. Since the maximum estate tax rate is 55% starting in 2011, the combined 35% gift tax rate and a 55% estate tax rate on gift taxes paid can result in a combined maximum rate of approximately 54%, which is barely better than the maximum 55% rate which would apply 2011 and beyond on gifts.

Therefore, it is advisable to consider making gifts in 2010, but the above considerations, among others, need to enter into the analysis.

Sunday, November 07, 2010


In a recent Florida case, a separated husband and wife each had their own homesteads (although the wife’s was situated in New York). The local property appraiser denied granting a homestead exemption to the husband for his Florida residence.

CONSTITUTIONAL PROVISIONS.  Article VII, Section 6(a) of the Florida Constitution provides that a homestead exemption extends to “[e]very person who has the legal or equitable title to real estate and maintains thereon the permanent residence of the owner, or another legally or naturally dependent upon the owner.” However, section 6(b) directs that “[n]ot more than one exemption shall be allowed any individual or family unit or with respect to any residential unit” (emphasis added). There is no constitutional or statutory definition of the term “family unit” nor is there case law interpreting the term in context of the tax exemption.

REGULATORY RULE. However, this a regulatory provision on the issue. Florida Administrative Code Rule 12D-7.007(7), provides as follows: “If it is determined by the property appraiser that separate permanent residences and separate “family units” have been established by the husband and wife, and they are otherwise qualified, each may be granted homestead exemption from ad valorem taxation under Article VII, Section 6, 1968 State Constitution. The fact that both residences may be owned by both husband and wife as tenants by the entireties will not defeat the grant of homestead ad valorem tax exemption to the permanent residence of each.”

There is also case law that recognizes separate homestead exemptions for creditor protection purposes under similar facts.

The property appraiser argued that the application of the FAC rule would make his job in reviewing homestead exemptions virtually administratively unworkable, because no property appraiser has the staff or resources to verify whether a married couple is, in fact, maintaining two separate permanent residences and family units.

The court was not impressed. It held that in circumstances when a husband and wife have established two separate permanent residences in good faith and have no financial connection with and do not provide benefits, income, or support to each other, each may be granted a homestead exemption if they otherwise qualify.

Wells v. Haldeos, 2D09-4250, 2010 WL 4137581 (Fla. Dist. Ct. App. Oct. 22, 2010)

Saturday, October 30, 2010


While we are on the subject of 2011 inflation adjustments, due to a lack of significant inflation in 2010 the annual exclusion amount for gifts for federal gift taxes will remain at $13,000. This is the amount that a donor can gift to any given recipient in a calendar year that is not treated as a taxable gift.

The current official rate of inflation is in the neighborhood of 2-3%. If that doesn’t square with your perception of inflation and rising prices, don’t judge yourself too harshly. Go ahead and visit the charts at This website compiles its own inflation statistics, inlarge  part by ignoring changes made by the government in the CPI rules that now act to depress the “official” rate of inflation. According to Shadowstats, inflation is currently at around 8%.


The IRS has announced the following 2011 inflation adjustment amounts that relate to international issues:

1. EXPATRIATION. An individual with “average annual net income tax” of more than $147,000 for the five taxable years ending before the date of the loss of United States citizenship under  §877(a)(2)(A) is a covered expatriate for purposes of   §877A(g)(1). Also, for taxable years beginning in 2011, the amount that would be includible in the gross income of a covered expatriate by reason of §877A(a)(1) is reduced (but not below zero) by $636,000.

2. FOREIGN EARNED INCOME EXCLUSION. The foreign earned income exclusion amount under §911(b)(2)(D)(i) is $92,900.

3. ANNUAL EXCLUSION GIFTS TO NONCITIZEN SPOUSES. The first $136,000 of gifts to a spouse who is not a citizen of the United States (other than gifts of future interests in property) are not included in the total amount of taxable gifts under §§2503 and  2523(i)(2) made during that year.

4. NOTICE OF LARGE GIFTS RECEIVED FROM FOREIGN PERSONS. Recipients of gifts from certain foreign persons may be required to report these gifts under §6039F if the aggregate value of gifts received in a taxable year exceeds $14,375.

5. TAX ON ARROW SHAFTS. The tax imposed under §4161(b)(2)(A) on the first sale by the manufacturer, producer, or importer of any shaft of a type used in the manufacture of certain arrows is $0.45 per shaft. 

Okay, the last one has nothing to do with international taxes – it is in here just to see if you are paying attention. Did you know there was a special tax on “arrow shafts?” No, I didn’t think so. but then again, neither did I until about five minutes ago.

Rev.Proc. 2010-40

Sunday, October 24, 2010


A basic tenet of federal income tax is that all accessions to wealth are income to the recipient, absent a statutory exclusion. What happens if a for-profit corporation receives funds by the government – is that income? It would seem silly – the government giving money away with one hand, and then taking some of it back in tax with the other. However, it happens all the time. For example, Social Security payments can be taxable to recipients.

This issue came up in regard to grants to broadband communications companies under the American Recovery and Reinvestment Act of 2009, and reminds us of an advantageous characterization of such payments if the recipient is a corporation. Revenue Procedure 2010-34 recently provided a safe harbor interpretation for the communications companies, using Code Section 118.

Code Section 118 permits corporations to receive contributions to capital in a nontaxable manner. Most capital contributions come from shareholders of a corporation, and the Code Section 118 clearly avoids income to the corporation on its receipt. Further, Code Section 118 will also apply to contributions received from non-shareholders. However, in that situation, the corporation must reduce its tax basis in assets acquired within 12 months of the contribution (or other property of the taxpayer if such assets are not purchased in that period), pursuant to the rules of Code Section 362(c)(2)(B).  Thus, the reduction in basis does impose a tax cost to the recipient corporation by way of reduced depreciation or increased gains/reduced losses in regard to corporate property.

The Revenue Procedure confirmed the application of these provisions to most of the grants, but did not apply them to reimbursement for pre-application expenses and certain specified grants. The Procedure is silent as to why some of the grants do not qualify.

Code Section 118 only applies to corporations. The Revenue Procedure confirms this when it excludes noncorporate taxpayers from the coverage of the Procedure.

An interesting question is what happens if the recipient corporation does not acquire enough property within 12 months of a grant, and has insufficient basis in its other property, to apply a full basis reduction equal to the capital contribution.

Revenue Procedure 2010-34

Saturday, October 16, 2010


Generally, interest paid by a taxpayer on personal items is not deductible. However, the Code allows an interest deduction for "acquisition indebtedness" for a qualified residence of a taxpayer for up to $1 million of indebtedness. A taxpayer may also deduct interest on up to $100,000 of "home equity indebtedness."

If a taxpayer incurs a mortgage debt on a qualified residence of over $1 million when he buys the residence, clearly he can deduct interest on the first million dollars of debt. Can he use the "home equity indebtedness" provisions to obtain an interest deduction on the first $100,000 over the first million dollars of debt? Until now, the answer was no, at least according to 2 Tax Court Memo decisions and a 2009 Chief Council Advice.

Happily for taxpayers (or at least for those that can afford to take on mortgages in excess of $1 million), the IRS has reversed its position and will now allow the use of the "home equity indebtedness" provisions for interest on the first $100,000 of acquisition indebtedness in excess of $1 million already allowed. The IRS based its decision on the fact that there is no provision in the Code that restricts "home equity indebtedness" to indebtedness not incurred in acquiring, constructing, or substantially improving the residence.

It is not often that the IRS reverses both itself and the Tax Court in a manner favorable to taxpayers. This is something of an early holiday gift for sure.

For any taxpayers that are eligible for additional interest deductions under these rules for prior open tax years, they should consider filing an amended tax return to obtain the benefit of this ruling.

Revenue Ruling 2010-25

Wednesday, October 13, 2010


Florida’s Uniform Fraudulent Transfer Act will allow a creditor to reach an asset transferred from a debtor to a third party if the transfer is found to constitute a fraudulent transfer. However, Fla.Stats. §726.102(2)(b) will exempt transfers of assets that are generally exempt from creditors under nonbankruptcy law from the fraudulent conveyance rules.

In Scott E. Rubenstein et al. v. Comm., an insolvent father transferred his exempt homestead to his son. The IRS sought to set aside the homestead transfer as a fraudulent conveyance so as to assist in collecting the father’s income tax liabilities. The son argued that under the above Florida statute, the homestead was an exempt asset and thus the fraudulent conveyance rules could not apply to it.

That may be true for other creditors, but not the U.S. The IRS is not bound by the exempt status under Florida law as to homestead property in collection matters, and thus as to the U.S. the homestead was NOT generally exempt from creditors under nonbankruptcy law. As such, it was likewise not exempt from the application of the Fraudulent Transfer Act.

Scott E. Rubenstein et al. v. Comm., 134 TC No. 13 (6/7/10)

Friday, October 08, 2010


On May 6, the stock market fell victim to the “flash crash.” In a short period of time, the market took a major dive, and then quickly recovered. Experts are still looking for what triggered the unusual movement.

Many taxpayers who had standing stop-loss orders on their securities had their securities sold for a gain or loss due to the large percentage swing that occurred.

Under the wash sale rules, those taxpayers who repurchased the same securities within 30 days cannot deduct any losses from such sales – instead, the losses will be figured into their basis on the subsequent sale of the securities.

Essentially arguing that since losses from the flash crash are deferred, some taxpayers sought a special dispensation from the IRS Commissioner that in regard to securities that were sold for a gain, the taxpayers would be allowed to repurchase their sold securities and avoid having to recognize their gains.

Not surprisingly, the Commissioner declined, per their being no authority in the Internal Revenue Code for such a deferral. Beyond the lack of specific authority, additionally there is no constitutional or statutory requirement that gains and losses be treated in the same manner under law. Indeed, the Code is rife with provisions that limit the use of losses (e.g, the $3,000 capital loss limitation, passive loss limitations, etc.) that have no corollary deferral of gain. The Code is not the place to go looking for fair and balanced provisions that impact the taxpayers and the government in equal measure.

Information Letter 2010-0188

Thursday, September 30, 2010


A taxpayer in the business of selling property holds it in inventory. A taxpayer that rents property does not. In many circumstances, rental treatment is superior to inventory treatment – such property can be depreciated (and thus generate depreciation deductions), and it can be swapped in tax-free exchanges under Code Section 1031 for other like-kind property.

What if the taxpayer BOTH sells and rents property? In a recent Chief Counsel Advice, the taxpayer acquired property. Pending sale of the property, it rented it out. In selling property, it would typically swap the property for other property so as to minimize gain recognition on the swaps. The question was whether the taxpayer could depreciate the property and use Code Section 1031, or must the taxpayer hold the property as inventory instead.

There is no fixed rule in these circumstances. Instead, the taxpayer should examine its PRIMARY PURPOSE for holding the asset to determine whether it is inventoriable. In the situation that was analyzed, the IRS concluded the property belonged in inventory. Some of the factors noted by the IRS that tipped the scales towards inventory were (1) 91% of the taxpayer’s income came from sales with only 9% from rental operations, and (2) much of the new equipment was sold before it could be rented out. Of course, in this situation it was probably in the IRS’ interest to conclude the property was inventory, so as to deny the depreciation deductions and the gain deferral under Code Section 1031. Nonetheless, per the above facts it was probably a reasonable conclusion as to the taxpayer’s PRIMARY purpose.

Chief Counsel Advice 201025049

Saturday, September 25, 2010


Congress has now passed the Small Business Jobs Act of 2010. The Act provides some welcome tax relief to business that hopefully will spur growth and job creation. However, Congress was stingy, with most of the tax benefits expiring after 2011. I remember, even though it was many years ago, when if a tax benefit was a good idea, it was enacted permanently because it was a good idea, and would not expire after a few years. These days, tax legislation tends to make increases in penalties and compliance obligations permanent, while tax benefits and reductions are only temporary. If Congress was really serious about these issues, it would make the changes on a permanent basis (or at least as permanent as a law that could be changed at any time in the future can be).

Below is a summary of the key new provisions.

I. Expensing

     A. Increase of §179 annual expensing to $500,000 from $250,000 for 2010 and 2011

          1. Increase threshold for beginning of phase-out to $2,000,000

          2. Will allow expensing of some types of depreciable real property

          3. Reducing back to $25,000 in 2012

     B. Extension of 50% bonus first year depreciation for qualified real property

     C. First year depreciation cap for autos and trucks increased by $8,000 for 2010

     D. Deduction for start-up expenses increased to $10,000 from $5,000 for 2010 and 2011

II. Credits

     A. Eligible small business credits can be carried back 5 years instead of one year, and extension of carryforward periods

III. Gain Exclusions

     A. Gains from the disposition of qualified small business stock can now be 100% excluded (up from 75%) and will not be an AMT tax preference item for stock acquired before 2011

     B. S Corporation built-in gains period reduced to 5 years for 2011

IV. Misc.

     A. 2010 health insurance expenses are deductible in computing self-employment tax

     B. Substantiation requirements for cell phones and similar equipment are elimianted by removing them from being "listed property"

     C. Recipients of rental real estate income are deemed to be in a trade or business for information reporting requirements (and thus must report all expenditures of $600 or more)

     D. Increased penalties for failure to file information returns

V. Retirement Plans

     A. Roth options added to Section 457 plans

     B. Retirement plan distributions may be rolled over to Roth IRA accounts (other than periodic distributions, minimum required distributions, and hardship distributions)

VI. International

     A. Guaranty fees paid by a U.S. person are U.S. source income, as well as fees paid by a foreign person if effectively connected with a U.S. trade or business (overides Container Corp., 134 TC No. 5 (2010))

Thursday, September 23, 2010


In a recent Private Letter Ruling, the IRS addressed a trust established by a decedent that was a beneficiary of the decedent's IRA. It was clear from the trust instrument that the decedent desired that the IRA payouts be based on the age of the designated beneficiary so as to defer distributions and income taxes, pursuant to applicable tax rules. However, the subject trust allowed for the appointment of a charitable beneficiary, which power prevented there from being a designated beneficiary that would allow for the "stretch" of the post-death IRA payouts. To address this situation, a state court action was filed and an order obtained that removed the problem power to appoint a charitable beneficiary. The question before the IRS was whether this state court reformation would be given retroactive effect so as to allow for a designated beneficiary.

Generally speaking, state court reformation of dispositive instruments will be respected by the IRS only if there is a specific tax statute authorizing such reformation. There is no such specific statutory authorization in regard to determining if there is a designated beneficiary of an IRA trust. However, the beneficiaries of an IRA are measured/determined on September 30 of the year following the death of the decedent. This would imply that if a reformation is undertaken prior to such September 30 date, such reformation should be given tax effect. Indeed, this reasoning was followed in Private Letter Rulings in the past that allowed qualification of a designated beneficiary through state court reformation actions.

In this most recent ruling, the IRS has changed its analysis, and it denied effective retroactive effect to the change to the trust. Thus, the state court reformation was not effective to allow the subject trust to have a designated beneficiary for IRA purposes.

It would appear that the IRS had legal wiggle room to provide a favorable result for the trust, as evidenced by its prior rulings. It will be interesting to see if the taxpayer under the subject ruling, or some similarly situated taxpayer, litigates this issue in the hopes that the court will adopt the IRS' earlier analysis of the issue.

PLR 201021038

Sunday, September 19, 2010


There is an often an estate tax advantage to an estate borrowing funds, especially from related parties. If the estate is in a high estate tax bracket, it can deduct the interest, and thus save estate taxes. For example, if the estate is solidly in or above the 45% tax bracket, then the estate tax savings are at least 45% of the interest cost. The recipient will have to pay income taxes on the interest income, but maximum income tax rates in this example would be higher than the estate tax savings (except perhaps in some states with high state income tax rates), so a net tax savings would result. If the lender is a tax-exempt entity such as a family foundation, then the income taxes are almost entirely eliminated, enhancing the overall tax savings (even though the savings accrue for charitable purposes).

This is what the Estate of Henry Stick did – it borrowed funds from a family foundation (well, in this case, the remainder beneficiary actually did the borrowing). However, the estate failed to appreciate the simple mathematics at work that address the estate tax deduction, and thus lost its estate tax deduction for the interest paid when the Tax Court reviewed the matter.

Treas. Regs. §20.2053-3(a) requires that estate tax deductions must be actually and necessarily incurred, to be deducted. In the context of interest expense for borrowings by the estate, the Tax Court looks to see if the borrowing was needed by examining whether there are enough liquid assets to pay the estate tax liability and other administrative expenses. In the Stick Estate, the estate had approximately $1,953,617 in liquid assets. Putting together its administrative expenses and federal and state estate taxes, these obligations totaled $1,723,799. Thus, at least in the absence of other compelling circumstances, there was no need for the estate to borrow funds. In a short and sweet opinion, the Tax Court noted the excess of liquid assets over obligations and denied the interest deduction for the loan taken.

Estate of Henry H. Stick, TC Memo 2010-192



Saturday, September 18, 2010


The inaugural edition of the U.S. News & World Report law firm rankings came out this week. I am happy to note that our firm received Tier 1 rankings in the Miami metropolitan area in the areas of Tax Law and Estates and Trusts.

We also received a Tier 2 national ranking in Tax Law. We note in that regard that almost all of the Tier 1 and Tier 2 rankings were given to law firms ranging in size from 100+ to thousands of attorneys, and that at 9 lawyers we were the smallest firm to make it into those tiers – thus validating our business model to deliver large firm quality services in a small, boutique firm environment.

Thank you to all attorneys and clients who participated in the surveys that allowed us to receive such favorable rankings.


If the expiration of the 2001 tax breaks are allowed to proceed as planned, 2011 will see the highest tax hike in U.S. history. Discussion is heating up regarding extending some or all of the existing breaks, so perhaps not all of the changes will arrive in 2011. Below is a table of many of the looming changes:



10% income tax rate disappears
amount of income covered by 15% income tax rate shrinks
top 25%,  28%, 33% & 35% income tax rates convert to 28%, 31%, 36%, and 39.6% rates
45% estate tax top rate (although there is no estate tax in 2010) increases to 55%, with 5% surtax to phase out graduated rates for the highest estates
estate tax unified credit exemption equivalent (was $3.5 million in 2009) reduced to $1 million
15% capital gains rate increased to 20% (18% for assets held at least 5 years)
15% qualified dividend income tax rate eliminated – increased to ordinary income rates
income exclusion for employer provided education assistance eliminated
above-the-line student interest income tax deduction reduced
household and dependent care income tax credits reduced
ability of heirs and estates to use Section 121 home sale exclusion of decedent eliminated
backup withholding rates on various types of income raised
reduction in itemized deductions for higher income taxpayers applies once again
phase-out of personal exemptions for higher income taxpayers applies once again
15% accumulated earnings and personal holding company tax rates increased to 39.6%
generation skipping tax reinstated, with a $1 million exclusion amount and a 55% rate
transfers at death to nonresident aliens appreciation in property subject to income tax
35% maximum gift tax rate increased to 55%

Sunday, September 12, 2010


Florida, along with many other states, allows a competent individual to prepare a written preneed guardian declaration that names a person to serve as guardian for the declarant in the event of incapacity. This is an important tool, allowing persons to name who shall be responsible for their person and property in the event of incapacity, and thus avoiding relatives, caretakers, or others who the declarant does not want to serve from being named guardian. We all know people that would not be good guardians, either because they lack the requisite skills, are too self-centered, or that may act with bad motives (for example, seeking to conserve assets which they may inherit in the future instead of using such assets to support the ward).

In the event of incapacity, what weight must the guardianship court give to the preneed declaration? Fla. Stats. §744.3045 indicates that the declaration is a rebuttable presumption that the preneed guardian is entitled to serve. However, the court may disregard the declaration if the preneed guardian is found to be unqualified to serve by the court. Thus, if the named guardian is unfit, or unsuitable, or if a conflict of interest exists between the guardian and the ward, the court need not point the named person.

In a case arising in Miami-Dade County Circuit Court, the guardianship court declined to follow a declarant’s naming of three persons to serve as preneed guardian, and named one person only to serve as guardian. The court did this based on representations that the declaration required unanimous actions by the three appointed guardians, and that this was not workable because the guardians disagreed as to certain care-giving issues.

In an opinion that gives due recognition and respect to the declaration, the Third DCA reversed the guardianship court and required the appointment of all 3 named guardians. The appellate court noted that the intent of the ward is the polestar that should guide probate judges in the appointment of guardians, and that this was not respected in this case.

There were a number of procedural problems with the guardianship court’s order. First, the court never examined the declaration itself, and the representation to the court that it required unanimous action by the guardians was erroneous. Further, there was no finding  by the court that any of the named guardians was unqualified, unwilling, or unable to serve as guardian.

Therefore, we don’t know if the court would have upheld the lower court if in fact unanimous action was required. To avoid this issue entirely, practitioners should give thought to avoiding a requirement for unanimous action when multiple guardians are named (even the appointment of 2 guardians has the risk of deadlock). Alternatively, they could give final decision-making power to one of the named guardians in the event of deadlock on any given issue.

It is always reassuring when the courts give due regard to statutory presumptions, although it did take an appellate court reversal to reach that result in this case (but again, in the guardianship court’s defense, that was due in large part to a misrepresentation by one of the attorneys before the court.

Acuna & Magill v. Dresner, 2010 wl 3025111 (3rd DCA 2010)

Wednesday, September 08, 2010


Craig and his sister were the two remaindermen that succeeded to his parents’ property at the termination of  10 year QPRTs that the parents set up. Craig wanted to transfer his remainder interest in the property to his sister when the QPRTs terminated. His attorney told him he could disclaim his QPRT interests, and that his interests would pass to his sister without gift tax. Thus, he entered into disclaimers to accomplish this.

Oops! After doing the disclaimers, he learned that the nine month period for doing a qualified disclaimer for gift tax purposes ran from the time of establishment of the QPRTs (well, actually from the time when Craig became an adult after the QPRTs were established), and not from the 10 year termination date of the QPRTs. Therefore, his disclaimers were done too late. As nonqualified disclaimers, they transferred his interests to his sister under state law, but resulted in a taxable gift by him to his sister since they were not qualified disclaimers under Code Section 2518. The IRS sought to impose gift taxes.

That would seem to be the end of the story. However, resourceful Craig learned that under applicable Massachusetts law, a written instrument may be reformed or rescinded in equity on the grounds of mistake when there is “full, clear, and decisive proof” of the mistake. Craig thus brought an action to rescind the disclaimers.

While the action commenced in state court, it was eventually removed to federal court. Applying Massachusetts law, the court allowed the rescission.

Could it be that simple? Could a state law rescission of a transaction eliminate the federal transfer tax consequences that arose on the original transfer prior to its rescission? The IRS claimed that while the rescission may be binding for state law purposes, it could not  undue the original gift tax consequences of the disclaimer transfer.

Clearly, the government has a valid concern that rescissions that eliminate taxable gifts can be problematic, since there often will not be an adverse party at the court proceeding that would inhibit collusive agreed rescissions between the parties that are entered into to avoid gift taxes. Indeed, there are a number of court decisions that will disregard a rescission for these purposes, at least when the government is not a party to the rescission proceedings.

Nonetheless, Craig was able to persuade the federal District Court that under his facts, the taxable gift was eliminated. The key facts that appear to have persuaded the Court were (a) the rescission action was heard by a federal court, not a state court, and (b) the IRS was a party to the action, thus eliminating the risk of collusion by the private parties.

The case instructs us that if a taxable transfer was the result of a transfer only undertaken by a mistaken belief that the transfer was free of gift tax, and if state law allows for rescission due to mistake, it may be possible to unwind the taxable transfer. However, to accomplish this, it will likely be necessary to find a procedural route that brings the IRS in as a party.

Breakiron v. Gudonis, 106 AFTR 2d 2010-XXXX (DC MA), 08/10/2010

Sunday, September 05, 2010


Code Section 501(c)(3) organizations are generally exempt from federal income taxes, and contributors may qualify for charitable deductions for their contributions. Such organizations by default are typically treated as "private foundations," but if qualified, they can achieve non-private foundation status. Non-private foundation status is preferable, because it avoids the potential application of various excise taxes to the organization, and may allow for greater income tax charitable contribution deductions for donors.

Beyond this private/non-private dichotomy, "churches" have further advantages. First, a church escapes from private foundation status without having to demonstrate public financial support, unlike most other private charities. Further, churches are exempt from annual information filings and exempt application procedures, and there are restrictions on audits of churches.

Many religious organizations can qualify as Code Section 501(c)(3) organizations due to their religious activities. However, not all religious organizations are "churches" for purposes of the above rules - only a smaller subset of such organizations will qualify as churches.

The Internal Revenue Manual provides 14 criteria that will be examined to determine if an organization is a church for these purposes. These criteria are (1) a distinct legal existence, (2) a recognized creed and form of worship, (3) a definite and distinct ecclesiastical government, (4) a formal code of doctrine and discipline, (5) a distinct religious history, (6) a membership not associated with any other church or denomination, (7) an organization of ordained ministers ministering to their congregations, (8) ordained ministers selected after completing prescribed courses of study, (9) a literature of its own, (10) established places of worship, (11) regular congregations, (12) regular religious services, (13) Sunday schools for religious instruction of the young, and (14) schools for the preparation of ministers.  The courts do not strictly apply this 14 criteria test, although they will often heavily consider these factors. Instead, the courts often apply an "associational test." Focusing on the association of congregants and believers, this test examines whether there is a body of believers or communicants that assembles regularly for communal worship.

In a recent case before the Court of Appeals for the Federal Circuit, a religious organization challenged the IRS' rejection of its status as a church, which rejection had been upheld by the Court of Federal Claims. Among other arguments, the organization argued that its "electronic ministry" qualified it as a church. The organization asserted that its members regularly assembled to worship as a virtual congregation by listening to sermons broadcast over the radio and the Internet at set times.

The Appeals Court noted the overlap between the 14 criteria test and the "associational test," and that to qualify as a church the religious organization must create the opportunity for members to develop a fellowship by worshiping together. Applying this test, the court noted that listeners simultaneously receiving the organization's message over the radio or the Internet did not mean that those members associated with each other and worshiped communally. Further, a "call-in" show that enabled individuals to call and interact with the organization's clergy over the telephone, with such calls being simultaneously broadcast, did not provide individual congregants with the opportunity to interact an associate with each other and worship.

Thus, the Appeals Court refused to qualify the organization as a church.

This should not mean that religious organizations that provide electronic broadcast of their services cannot meet the definition of a "church" for these purposes. However, it does suggest that such organizations must conduct a material part of their activities through in person, communal worshiping activities to qualify under the 14 criteria test or the "associational test."

Foundation of Human Understanding v. U.S., 106 AFTR 2d ¶2010-5204 (CA Fed Cir 08/16/2010)  

Friday, September 03, 2010


Foreign entities that provide limited liability to their owners, shareholders, or members will generally be classified by the U.S. as corporations/associations for U.S. income tax purposes. However, if such entities make a check-the-box election with the IRS, they can be classified as a disregarded entity (if there is one owner) or a partnership (if there is more than one owner) - although some types of entities are not eligible at all for such elections.

Since the election is due within 60 days of formation of the entity, as a practical matter it may be difficult to know at the time of filing how many owners there will be. Therefore, some entities may be filing check-the-box elections as partnerships when they end up having only one owner, and some entities may be filing as disregarded entities when they actually have more than one owner.

The IRS is now allowing such entities to correct their elections, without being stuck with an erroneous/invalid election. There are some conditions attached, but they are not too onerous:

1. Original or amended returns must be filed by the owners and the entity consistent with the revised/corrected treatment;

2. All required amended returns must be filed by the expiration of period of statute of limitations on assessments for the applicable tax years; and

3. A corrected Form 8832 is filed with the IRS and attached to the appropriate returns.

While I don’t know how often this problem actually arises, any relief for taxpayer errors is always welcome.

Rev.Proc. 2010-32

Monday, August 30, 2010


When dealing with clients on evaluating and settling estate and trust litigation, attorneys need to be cognizant of some psychological factors that may inhibit their clients from rationally acting or evaluating the case in their own self-interest. A recent article in the Estate Planning Journal discusses some of these factors. With knowledge of these factors, the attorney can better understand what may be motivating his or her client, and also work to reduce the influence of factors that are distorting client perceptions and evaluations.

1. ENDOWMENT EFFECT. A client under the influence of the endowment effect will exaggerate the value of his or her position simply by reason of ownership of items involved, or by holding such a position for a period of time. That is, things take on more value if they are actually owned or the longer they are held or owned, than would otherwise be the case.

2. PASSIONS. Obviously, client emotions and passions influence judgment. In estate and trust litigation, these passions will include grief, guilt, sibling rivalry and other jealousy, hostility towards second (or subsequent spouses), etc.

3. UNDERVALUE OF COSTS. Litigants tend to overly discount the likely future cost of litigation.

4. SELF-SERVING BIAS. Litigants will tend to view situations in a way that make themselves look correct and as acting from good motives, while viewing opponents as wrong or acting with bad intent.

Pointing out these factors to clients may help them in being more objective and to help diffuse the impact of such distortions. The author also notes that in regard to self-serving bias, bringing this to the attention of a litigant may not be enough. In that case, the author believes that asking the client to list the weaknesses in his or her own case will help reduce the impact of this bias.

Helsinger, Howard M., Advising the Trust or Estate Litigant: When to Raise or Fold, Estate Planning Journal (WG&L, July 2010)

Sunday, August 22, 2010


Two brothers brought suit against their step-siblings and the estate of their step-mother for a share of ownership of real properties that were devised to them by their step-mother, but which were transferred out of the step-mother's death in the months before her death. A settlement agreement was reached that provided for cash payments to the brothers. The attorney for the brothers received a contingency fee, and that was that. Well, until the IRS came a-knocking.

The estate had deducted the brothers' settlement payments as claims against the estate for federal estate tax purposes. On audit, this claim was denied, and thus additional estate taxes, penalties, and interest were imposed. By this time, the estate had already distributed all of its assets. The IRS came after the brothers for the amounts due, under Code Section 6901 transferee liability.

The brothers raised a number of well thought-out reasons why transferee liability did not apply. Unfortunately, the Tax Court rejected them all. These issues are instructive, and thus are summarized below:

a. The brothers asserted that they did not receive "property of a decedent," which is a requirement for transferee liability. They based this argument on their having sued their step-siblings, and that the settlement funds were thus paid by the step-siblings and not the decedent's estate. The court rejected this because the actual funds were paid to them from the estate and because the estate was a co-defendant. But the court went on to address what would be the case if the payments had in fact been paid by the step-siblings directly. The court noted that if the step-siblings received property from the estate, and then paid the brothers from their own funds, transferee liability would still apply since a "transferee of a transferee" is still liable.

b. The brothers argued that they were not "transferees" because they received their settlement proceeds not as beneficiaries but in exchange for a waiver of their right to sue to enforce the terms of the will. However, the court characterized the settlement proceeds as a substitute for the real property devised to them, which was thus received as transferees.

c. The brothers argued that the portion of the settlement that was paid to their attorney for his contingency fee was not property received by them for transferee liability purposes. The court rejected this, acknowledging that such fees were authorized and attributable to the brothers, and thus deemed received by them before the attorney was paid.

Note that Code Section 6901 does not independently create transferee liability. Instead, a transferee must first have liability for the estate taxes under applicable State law or state equity principles. In this case, as in most such settlement circumstances, this is not much of a hurdle to the IRS since under the law of most (if not all) States, a beneficiary will be liable for estate obligations to the extent of distributions received by the beneficiary.

While not addressed in the opinion, the brothers perhaps may be able to sue and collect from the other estate beneficiaries who received estate assets to the extent that a portion of the estate tax liability is apportioned to them under the applicable State law and their shares were not previously charged with their apportioned liability. Also, perhaps the fiduciaries of the estate may have some liability to the brothers for the penalties that were incurred attributable to estate issues.

The lesson from this case is that every plaintiff in estate litigation needs to determine what the federal estate tax exposure is of the plaintiff upon success or settlement. More particularly, counsel for such plaintiffs need to think about whether tax, penalties and interest will be apportioned to their clients. If yes, should this be varied by agreement? If yes, how can their clients monitor estate tax compliance and audit activity to protect their interests? If yes, should other parties be burdened with the penalties or interest? If yes, how can their clients be sure the other parties will pay their respective shares in case the IRS comes after only their clients for any deficiency?

We can't tell from the opinion whether the brothers knew of the risk of estate taxes being imposed on them by reason of the settlement, but I suspect the answer is no. This is doubly so as to the penalty portions of the liability.

Carl M. Upchurch, et al. v. Commissioner, TC Memo 2010-169,

Saturday, August 14, 2010


On August 10, the Education Jobs and Medicaid Assistance Act was signed into law. The new law contains several new provisions relating to the foreign tax credit.

First, new Code §909 is added to the Internal Revenue Code. Without getting bogged down in the details, the new provision delays the foreign tax credit or deduction for a taxpayer until the foreign income that gives rise to the foreign tax is taken into account by the taxpayer – if this never happens, then the credit or deduction is lost for good. The delay is triggered by a “splitting” transaction which is when the related income is taken into account by related entities or persons to the taxpayer who seeks the credit or deduction. Congress was concerned that some taxpayers were engaging in tax structuring so that foreign income was incurred by related persons or entities that are not currently subject to U.S. tax while still allowing the income to generate U.S. foreign tax credits that can be used to offset U.S. tax on other foreign income. The deferment of the credit or deduction will also apply for deemed paid credits under Code §§902 and 960.

Another new provision is Code §901(m), which acts to disallow a portion of the foreign tax credit or deduction for actual or deemed asset acquisitions that arise in certain circumstances (referred to as “covered asset acquisitions”). The genesis of this provision is a concern that U.S. taxpayers were obtaining basis step-ups in foreign assets in transactions that did not result in a basis step-up for foreign purposes. Thus, such assets could generate more income or gain or less depreciation in foreign jurisdictions than is arising in the U.S., giving rise to more foreign tax and less U.S. tax. The new provision, again in a complex manner, targets this extra foreign income tax and denies foreign tax credits and deductions for it. Covered asset acquisitions include (a) Section 338 qualified stock purchases that are treated as asset acquisitions, (b) other transactions which are treated as asset acquisitions fore U.S. tax purposes but are treated as stock acquisitions or are disregarded for purposes of the foreign income taxes of the relevant foreign jurisdiction (e.g., the purchase of shares of a corporation that is disregarded for U.S. tax purposes), and (c) acquisitions of partnership interests for which a Code §754 election is in place. Again, the common denominator in these acquisitions is a basis step-up in assets for U.S. purposes, but not foreign tax purposes.

Lastly, new language under Code §904(d)(6) seeks to restrict the availability of foreign tax credits and deductions for taxpayers that have income which would be treated as U.S. source but which is instead characterized as foreign source under a treaty. The concern is that this increase in foreign source income under a treaty, which is often of a type that is lightly taxed by the foreign jurisdiction, creates more foreign source income than is appropriate (which foreign source income allows for greater taxpayer credits and deductions). The new provision effectively creates separate baskets for each such item of income, thus allowing only the foreign taxes imposed on each such item to be creditable or deducted. Thus, each item of income must be separately tracked and analyzed.

COMMENTS: The foreign tax credit is already a complex area, that is little understood beyond those that often deal with it. The foregoing provisions address legitimate concerns of the government. However, the remedies further complicate the area, and will result in additional taxpayer compliance costs and frustration. Taxpayers would like to understand the laws applicable to them, and would also not like to have to pay substantial fees to advisors and accountants to have them explained and applied. The complexity of these new provisions indicates the total disregard for these taxpayer concerns by Congress.

Monday, August 09, 2010


Several years ago I posted my summary table on Florida’s homestead restrictions on transfer. As those who have dealt with these restrictions know, they can be difficult to both remember and correctly apply.

I have now updated the table for the new election available to a surviving spouse on a bad devise to obtain a 50% tenancy in common interest in lieu of a life estate.

The table is available here.

Thursday, August 05, 2010


Dr. Howard was the sole shareholder, officer, and director of his personal service corporation. Back in 1980, he entered into an employment agreement and a covenant not to compete with the corporation.

In 2002, the corporation sold the practice. In the sale, $549,900 of the purchase price was paid to Dr. Howard as a sale of his personal goodwill in the practice (instead of such amount being paid to the corporation for its goodwill). Dr. Howard reported the sale of the goodwill on his individual return, as capital gain.

The IRS challenged the sale, claiming the goodwill belonged to the corporation.

The court acknowledged that the “essence of goodwill is the expectancy of continued patronage, for whatever reason…the probability that old customers will resort to the old place without contractual compulsion.” As such, the court also recognized that a professional that works for a personal service corporation can have personal goodwill. Unfortunately, in this circumstance, the goodwill that was sold was held to be corporate goodwill, and not goodwill belonging to Dr. Howard.

What did in Dr. Howard was the employment agreement and the covenant not to compete that he had with the corporation. Relying on prior case law, the court determined that the personal relationships with the patients became the property of the corporation by reason of those agreements. Absent such agreements, the court would likely have ruled differently.

The sad part of the case is that Dr. Howard really did not need an employment agreement nor a covenant not to compete, since he was the sole shareholder. Those items generally protect the corporation vis-a-vis its employees, but as a practical matter Dr. Howard was protecting himself (as shareholder) from himself (as employee).

A curious part of the case is that the IRS and the court converted the payment to Dr. Howard to a taxable dividend to him. One would think that the proper tax accounting would have been income to the corporation, followed by either a dividend (or liquidating distribution if applicable) to Dr. Howard.

Howard v. U.S., 106 AFTR2d 2010-xxxx (7/30/2010)

Monday, August 02, 2010


The following summarizes the interesting recent changes made to Florida’s Probate Code.


1. Fla.Stats. § 655.935 - Safe Deposit Boxes


1.1 Lessor may have obligation to gather information and copies regarding items removed from the decedent's safe deposit box.

1.2 COMMENT: Helpful to avoid cases of "disappearing dispositive documents."


2. Fla.Stats. § 731.110 - Caveats


2.1 Provides noncreditors may file caveats prior to death, subject to 2 year expiration period.

2.2 COMMENT: A procedural break to noncreditors.


3. Fla.Stats. § 731.201 - Notice


3.1 Clarification of formal and informal notice definitions by reference to particular Probate Rules.

3.2 COMMENT: Clarification is always a good thing.


4. Fla.Stats. § 732.401 - Surviving Spouse Interest in Homestead


4.1 In lieu of receiving a life estate in homestead that is improperly or not devised, the surviving spouse may elect to receive a 50% tenants in common interest (with the other 50% vesting in the decedent's descendants).

4.2 6 month election period.

4.3 Election filed in real property records.

4.4 Disclaimer of surviving spouse's interest in homestead will not act to divest statutory remaindermen of their interest.

4.5 Fla.Stats. § 732.4015 directs that disclaimed spousal interest passes in accordance with Chapter 739 (Fla.Stats. § 732.4015).

4.6 COMMENT: Useful method to reducing conflicts between surviving spouse and decedent's descendants, especially if descendants are not lineals of the surviving spouse.


5. Fla.Stats. § 732.4017 - Lifetime Homestead Transfers


5.1 Irrevocable inter vivos transfers will be respected as such and will not be treated as testamentary transfers subject to restrictions on devises.

5.2 Such transfers include transfers in trust, and transfers when transferor retains rights in the property or transfers are subject to contingencies.

5.3 COMMENT: Useful in avoiding arguments that irrevocable inter vivos transfers will not be subject to testamentary homestead restrictions.


6. Fla.Stats. § 732.805 - Marriage Obtained by Fraud, Duress, or Undue Influence


6.1 Surviving spouse will not have listed marital rights, including rights under the Probate Code.

6.2 COMMENT: Having seen too many instances of fraudulent marriages of elder persons, this is a good thing. The litigators will like this, too.


7. Fla.Stats. § 733.1051 - Revisions of Wills for 2010 Decedents


7.1 Provides a procedure for court review and revision of Wills with dispositive provisions that are affected by repeal of estate tax in 2010.

7.2 COMMENT: I preferred some of the other approaches that treated the decedent as having died on 12/31/09. This one requires litigation, and may require having draftsman declare their own errors to obtain relief.

Friday, July 30, 2010


With a year without estate tax, and reversion to 2001 rules in 2011, 2010 surely goes down as one of the most challenging years in transfer tax planning. One of the big issues in 2010 is whether taxpayers should be making taxable gifts. As with most planning issues, there is no cut and dried answer - the circumstances of the taxpayer need to be considered. Below are some of the key pros and cons of making taxable gifts in 2010.


-With lower stock market and real estate values, the transfer value (and thus transfer costs) are likely lower than in the past.

-The maximum gift tax rate is only 35% in 2010, returning to 2001 rates in 2011. If the transferor survives three years from the date of the gift, any gift tax paid escapes transfer tax, thus reducing the maximum effective rate to below 26%.

-If the Bush tax cuts are allowed to expire, income tax rates will increase. Therefore, gifting strategies that allow income to accrue in lower rate taxpayers will be more valuable than in the past.

-With a low interest rate environment, many gifting strategies produce lower gifts than in high interest rate years.

-Direct gifts to lower generations, as opposed to gifts to generation skipping trusts, may be more favored in 2010 than in other years due to uncertain availability of generation skipping tax exclusion ratio benefits for transfers to trusts.


-If the transferor dies in 2010, no gift tax would apply. Therefore, unnecessary transfer taxes are incurred. However, this risk can be minimized by waiting to complete gifts until very close to the end of the year. This also allows for more flexibility should Congress change the transfer tax laws prior to the end of 2010.

Sunday, July 25, 2010


Prepaid forward contracts were a popular item in the early 2000’s. Such arrangements would allow the holder of substantially appreciated public stock (such as a founder whose stock had run up substantially in the bull market) to receive a payment of 75%-80% of the value of his or her shares, have an upside if the stock appreciated in value thereafter in the next few years, have no downside risk, and be able to defer income taxes on the funds paid until the transaction closed a few years later. A principal issue regarding such transactions was whether the upfront payment constituted a taxable sale in the initial year, or whether deferral existed until the transaction completely closed in a later year. Something of a sweet deal, Revenue Ruling 2003-7 allowed for nonsale treatment for prepaid forwards, at least under the facts of that ruling.

Taxpayers who participated in those transactions could typically receive a better financial deal if as part of the transaction they also lent the shares that were subject to the transaction so that the investment entity involved could sell those shares short or otherwise hedge their risks. This is what the Anshutz Company did in the prepaid forward contracts it entered into in the early 2000’s.

The Tax Court has now determined that the Anshutz Company was not entitled to defer its gain, but instead had income upon entering the prepaid forward contract. The court noted that the prepaid forward, in combination with the share lending transaction, resulted in almost all incidents of ownership having been given up by the taxpayer, and thus it was appropriate to trigger gain in the year the taxpayer received the cash proceeds.

Since many of these transactions occurred awhile ago, of those older ones only those that are either under audit, in litigation, or for which the taxpayers have extended the applicable statute of limitations, will be affected by the new decision. Presumably, those whose transactions did not include the stock lending element will not be as adversely impacted by the Tax Court’s analysis, but it remains to be seen how the IRS will interpret the precedential value of the case in those situations.

Anschutz Company v. Commissioner, 135 T.C. No. 5 (2010)