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Sunday, February 28, 2010


Code Section 881(a) imposes a 30% withholding tax on non-U.S. corporations receiving  fixed or determinable, annual or periodic (FDAP) income from U.S. sources (subject to reduction under applicable treaties). Does this tax apply to a guaranty fee paid by a U.S. corporation to a Mexico corporation? The Tax Court recently struggled with this issue in a decision that plumbed the depths of the concepts relating to FDAP taxation.

To be taxable, the guaranty fees would need to be (a) FDAP income, and (b) U.S. source. The parties conceded that the fees were FDAP, so the real issue was U.S. vs. foreign source.

The IRS argued that the fees are akin to the payment of interest, which are sourced to the location of the payor (here, the U.S.). The court noted that “interest” is compensation for the use or forbearance of money. It found that a guaranty is not a loan, and thus the interest sourcing rules do not apply.

The taxpayer argued that the Mexico corporation was performing a service. Services are sourced where they are performed, which the taxpayer further asserted occurred where the corporation is located – here, Mexico.

The court looked at Section 482 precedents. It looked at case law under Section 83. It could not find any precedent that clearly answered the question whether fees should be sourced as interest or services.

Thus, since there was no direct conclusion that the fees were either interest or services, the court was left with the task of analogizing to one or the other, to find the closest match.

The court examined other situations where it had applied the sourcing rules “by analogy,” including past efforts to source alimony, and commissions for issuing letters of credit. These areas were not helpful The court ultimately framed the goal of sourcing by analogy as “find[ing] the location of the business activities generating the income or *** the place where the income was produced.”  The business activities supporting the guaranty were the Mexico assets and Mexico management of the guarantor.  This led the court to conclude that the fees were more akin to services than interest, and that the fees were foreign source income not subject to the 30% tax.

Clearly, the court could have gone either way on this issue. The court’s detailed and principled analysis of the issue makes for interesting reading.

Container Corporation v. Commissioner, 134 T.C. No. 5 (2010)

Thursday, February 25, 2010


For awhile, “springing” insurance was a popular method of avoiding tax on IRA and qualified retirement plan assets. A recent case hammered the taxpayer who entered into such an arrangement.

While there are variations, the typical arrangement involved the creation of a pension plan in a closely-held entity, which received a roll-over distribution from the taxpayer’s IRA. The plan would then purchase a substantial life insurance policy. A feature of the policy would be that the insurance company would receive a substantial surrender charge if the policy was surrendered. The policy would then be sold to an insurance trust established by the taxpayer, removing the policy from the pension plan. The insurance trust would be buying the policy at a substantial discount in price – getting the insurance out of the pension plan at a reduced cost, and thus moving assets out of the plan without incurring an income tax. The insurance trust would often then convert the policy to one that did not have the surrender charge feature.

The taxpayer justified the sale of the policy at a reduced price by reducing the value of the policy by the potential surrender charge. For example, if the policy was purchased for $1.3 million and had a cash surrender value of $1.3 million and a $1 million surrender charge applied, the policy would be sold for the net $300,000 value. The “springing” part of the plan comes about when the policy is converted by the insurance trust to one that allows more direct access to the $1.3 million value without the surrender charge – thus springing the value back up.

The planning makes sense in theory. However, as one would expect, the IRS was not pleased with the technique. The Tax Court has now accepted the IRS’ theory that the value of the policy should be determined without reduction for the surrender value. Thus, the taxpayer in the case was deemed to have received about $1 million in taxable income attributable to the discount taken on the insurance policy that was sold that was attributable to the surrender charge on the policy.

I don’t know how many other similar cases are pending with the Service, but the Tax Court’s determination does not bode well for the taxpayers in those cases.

Karl L. Matthies, et ux. v. Commissioner,  134 T.C. No. 6 (2010)

Wednesday, February 17, 2010


The Internal Revenue Code “mailbox rule” provides that for purposes of most Code filing deadlines, a taxpayer will meet the deadline if the item is mailed on or before the required filing date (as evidenced by the postmark on the item). That is, the item does not have to be received by the IRS or other applicable recipient by the filing date – it is enough if it is properly mailed by that date. This explains the long lines at the post office each April 15.

In a recent case, a taxpayer was incarcerated. The taxpayer sought to obtain Tax Court jurisdiction over a tax matter by filing a petition with the Tax Court within the required 90 days after receipt of a deficiency notice. The taxpayer mailed a petition to the Tax Court, but the postmark was after the 90 day period expired.

The taxpayer nonetheless claimed that the mailing was timely under the “prison mailbox rule.” This rule was established by the U.S. Supreme Court in Houston v. Lack, 487 U.S. 266 (1988). There, the Supreme Court ruled that a prison inmate's notice of appeal in a habeas corpus case was deemed filed at the time he delivered it to prison authorities for forwarding to the court.

The taxpayer claimed that he gave his Tax Court petition to prison authorities for mailing before the expiration of the 90 day period, and thus met the 90 day filing requirement, even though the actual posting came after the 90 days. The 10th Circuit Court of Appeals noted that it is an unaswered question whether the prison mailbox rule of Houston will apply for tax purposes, since the Internal Revenue Code has its own explicit mailbox rule under Code Section 7502.

Unfortunately for the taxpayer, the Court did not find adequate proof that the taxpayer had submitted the Tax Court petition to prison authorities prior to the 90 day deadline. Indeed, the Court appeared to be highly skeptical of that claim. Therefore, it denied the taxpayer’s claim of a timely filed petition on those grounds.

This result was unfortunate for other similarly situated taxpayers. First, by ruling on the grounds of lack of evidence of timely delivery to prison officials, the Court expressly held open for another day the question whether the "prison mailbox rule" applies for federal tax purposes. Second, it raises practical difficulties for a prisoner that seeks to apply it, as to how to produce sufficient evidence of delivery of items to prison officials for mailing.

Hatch v. Comm., 105 AFTR 2d 2010-xxxx (10th Cir), 1/21/2010

Sunday, February 14, 2010


The following is a communication we will be sending out to our firm’s clients and friends. Since it is of relevance to all of our readers, I am also posting it here.

As you are most likely aware, we are now 1 1/2 months into an unprecedented period when the federal estate tax does not apply. This period will come to an end on December 31, 2010.  Few thought that Congress would have let this come to pass. Many have thought that Congress would have acted by now to reinstate the tax for the rest of 2010 (and possibly even retroactively to January 1), but each day ticks by without any resolution.

So what does this mean for the average person with existing estate planning documents? Oftentimes, dispositions in Last Wills and trusts expressly incorporate and reference the available estate tax credits and exemptions in allocating the passage of assets to various persons and trusts. What will happen if someone dies in 2010 when the estate tax credits and exemptions do not exist or apply? No one is really sure – however, there are situations when if the terms of the document are literally applied, unusual and unexpected results may arise. There may also be opportunities to address planning for special asset basis rule adjustments that apply only in 2010.

Some states have introduced or enacted legislation that would treat the decedent as dying on December 31, 2009, for purposes of applying the terms used in Last Wills and trusts. While not a perfect solution, persons in those states will likely have the issue fully taken care of by such laws. Florida is taking a different tack, and may have a new law soon that will allow these issues to be taken before a judge for resolution. Some documents may have already been drafted with an eye towards there being no estate tax in 2010, and thus already have the current situation well covered. For those that are alive and competent, a review of existing estate planning documents may be in order, to assure no problems with a 2010 death or to make changes to avoid an undesirable disposition.

Some situations are more likely to have 2010 issues than others. Particularly, persons who have their assets divided into marital trusts and shares, and nonmarital trusts and shares (often referred to as “family trusts” or “credit shelter trusts”), and have materially different beneficiaries in those shares, may need remedial action – such as where the surviving spouse is the principal beneficiary of one share but not the other. Second marriage situations are a particular circumstance that may require review. Clearly, elderly persons in poor health are more likely to be impacted by the 2010 situation than others.

Most situations will probably not need any corrective action. Further, if the testator survives until 2011 when the estate tax is restored, the 2010 issues go away on December 31, 2010.

Nonetheless, it is usually a good idea to have your estate planning documents reviewed each year for changes in the law, family situations, assets, business circumstances, and other changed  facts. Most firms, like our firm, do not undertake a continued client relationship that includes a duty to advise clients of changes in the law that affect their situation, given the impossibility of that task due to the volume of documents, changes in lawyer personnel, and regular changes in the law.

Therefore, we recommend that you give consideration to having your documents reviewed by your estate planning professionals, both for 2010 issues and for an overall review of your situation.

Thursday, February 11, 2010


Florida Governor Charlie Crist is proposing a 1% reduction in the corporate income tax rate, from 5.5% to 4.5%, on the first $1 million of a corporation's taxable income as part of various proposed tax relief measures. The governor is also recommending a  10–day back to school sales tax holiday. The holiday would apply to clothing selling for less than $100 and school supplies selling for less than $10.

A cynic might suggest that these reductions are an attempt to demonstrate the Governor’s conservative stripes, as part of a hotly contested Republican primary contest for one of Florida’s Senate seats. Whatever the reason, there are many who will welcome tax relief, if it can find its way into law.

Florida Governor's Press Release, 01/26/2010

Sunday, February 07, 2010


A number of readers have indicated they would like to be able to read Rubin on Tax while waiting in lines, such as at the grocery store. Okay, maybe not many. Maybe not any. Nonetheless, if you have an iPhone and would like to be able to read your dose of Rubin on Tax whenever and wherever you want, now you can do so.

To get the app (its free), on your iphone or in the App Store search for ‘rubinontax’ (no spaces) and it should then be available for download and installation. If you like it, don’t be afraid to leave a favorable comment for the app – if you don’t…well, I’m sure you will like it!

Saturday, February 06, 2010


Taxpayers can avoid the Code §6662 penalty for substantial underpayment of income tax by adequately disclosing amounts on the income tax return. A recent Revenue Procedure provides details as to when the inclusion of “amounts” on a return constitutes adequate disclosure for this purpose. These rules will also apply for purposes of avoiding preparer penalties.

The following summarizes the requirement of disclosure for “amounts” to meet the adequate disclosure requirements:

A.  The money amounts entered on the forms must be verifiable. A number is verifiable if, on audit, the taxpayer can prove the origin of the amount (even if that number is not ultimately accepted by the Internal Revenue Service) and the taxpayer can show good faith in entering that number on the applicable form.

B. However, for certain items [which are listed in Rev.Proc. 2010-15, § 4.02, such as itemized deductions], a disclosure of an amount is not adequate when the understatement arises from a transaction between related parties. If an entry may present a legal issue or controversy because of a related-party transaction, then that transaction and the relationship must be disclosed on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement.

C. When the amount of an item is shown on a line that does not have a preprinted description identifying that item (such as on an unnamed line under an "Other Expense" category) the taxpayer must clearly identify the item by including the description on that line. For example, to disclose a bad debt for a sole proprietorship, the words "bad debt" must be written or typed on the line of Schedule C that shows the amount of the bad debt.

D. In all cases, for such a disclosure to be adequate, the following general requirements must be met: (1) There must be a reasonable basis for the item as defined in Treas.Reg. §1.6662-3(b)(3); (2) The item is NOT attributable to a tax shelter item as defined in   section 6662(d)(2); and (3) The item is properly substantiated and the taxpayer kept adequate books and records with respect to the item or position.

Overall, these requirements are probably “fair” as to whether the IRS was given adequate notice of the particular items on the form. However, the requirement for a special disclosure for the related party items puts a burden (and a trap for the unwary) for taxpayers and their preparers, and may cross the line in having taxpayers and their preparers act as policemen for the IRS.

Rev.Proc. 2010-15

Thursday, February 04, 2010


We all know the expression “blood is thicker than water.” Presumably, that is what a trust settlor had in mind when she made a class gift to her grandchildren, and included language that such grandchildren would only include “descendants by blood.”

The settlor’s son married his wife in 1966. Six months after the marriage, the son and his wife had a child. The birth certificate listed the settlor’s grandchild as the son’s child. The son and his wife divorced in 1971, and signed a marital agreement that provided that the settlor’s grandchild was a child of the marriage.

In 1999, DNA testing revealed that the settlor’s grandchild was not in fact the son’s biological child. A dispute subsequently arose after the settlor’s death whether this child is a qualified grandchild and beneficiary of the settlor per the limitation that the grandchild be a “descendant by blood” to the settlor.

Finding water to be as thick as blood in this instance, Florida’s 2nd DCA determined the grandchild to in fact be a blood descendant of the settlor, even though there was no biological link. The court relied in part on prior case law, even though such case law existed prior to the age of DNA paternity testing, and an interpretation that the “blood” limitation was only meant to exclude adopted lineal descendants, and not descendants where paternity had been acknowledged at some point.


Tuesday, February 02, 2010


Starting this year, Code §2511(c) takes effect. This provision provides that notwithstanding any other provision of §2511, and, except as provided in regulations, a transfer in trust shall be treated as a transfer of property by gift, unless the trust is treated as a wholly owned grantor trust.

Some practitioners have suggested that this provision means that a gift to a wholly owned grantor trust will NOT be treated as a gift under the Code, even if it otherwise would be treated as a gift. This reading does not appear to be correct, and the IRS has now issued a Notice confirming that.

So what does the provision mean? Only that transfers to a trust will be treated as a gift, unless the trust is a wholly owned grantor trust. Previously, it was possible to transfer property to a trust but it could be characterized as an incomplete (and thus a nontaxable) gift depending on the facts and circumstances, including retained powers of the transferor. This result has been legislated away.

Come January 1, 2011, this provision sunsets – good riddance.

NOTICE 2010-19