APPLICABLE FEDERAL RATES – JUNE 2010

TAX COURT COMBINES GIFT AND SALE TRANSACTION

In a recent Tax Court decision, the Court applied the step transaction doctrine to collapse a separate gift and sale of LLC interests to gift trusts into a gift transaction. Perhaps the precedential value of the case can be limited due to some bad facts present in the case, but the broad use of the step transaction doctrine simply by reason of a taxpayer bifurcating transfers into a gift and sale element so as to be able to use available gift and generation skipping tax exemptions is quite troubling.

The decision is also somewhat troubling since it involves many elements that are present in current sales transactions that are undertaken in transfer tax planning. However, the particular holding of the case does not act to convert the entire sale transaction into a taxable gift but appears to only have created a gift to the extent of discounts taken on the sold property.

For a more detailed review of the case and its facts, click here or go to http://tinyurl.com/2b74mce for a summary in map format which can be viewed using most versions of Adobe Acrobat or Adobe Reader (click on the ‘+’s in the map to expand it).

Suzanne J. Pierre, TC Memo 2010-106

A METHODOLOGY FOR DISCOUNTING JOINT OWNERSHIP INTERESTS

Federal transfer taxes are based on the value of the property transferred. When the property transferred is a joint interest in property, some reduction from the pro rata share of the full value of the property is appropriate since a willing buyer would not pay 100% of the pro rata share of the value due to restrictions on enjoyment of the property or freely liquidating the property.

All qualities of appraisals to quantify this discount are obtained by appraisers, ranging from detailed to valuations akin to estimates. In a recent case gift tax case, the Tax Court rejected the data and appraisals offered by both the IRS and the taxpayer. Instead, the Tax Court applied its own methodology. This well-thought-out methodology should be useful to appraisers and taxpayers alike.

The property interest involved was a 50% tenancy-in-common interest of residential real property situated in Hawaii.

FIRST, determine a value as if partition is not necessary to sell the property.

  A. Determine the pro rata share of the appraised value of the full parcel, projected 1 year into the future (the estimated time to complete the sale in the case).

  B. Reduce that value by an appropriate discount for the time period needed to sell.

  C. Reduce by the pro rata share of selling costs (e.g., broker fees).

  D. Reduce by estimated operating costs for the time period needed to sell.

SECOND, determine a value as if partition is necessary to sell the property.

  A. Determine the pro rata share of the appraised value of the full parcel, projected 2 years into the future (the estimated time to complete both the partition and the sale).

  B. Reduce that value by an appropriate discount for the time period needed to partition and sell.

  C. Reduce by pro rata share of selling costs (e.g., broker fees) and partition costs.

  D. Reduce by estimated operating costs for the time period needed to partition and sell.

Then, find a value in-between FIRST and SECOND, based on an expert opinion on the likely need of a partition (in the case, that was estimated at 10% likelihood of need for partition).

Andrew K. Ludwick, et ux.,, TC Memo 2010-104

TAX COMPETITIVENESS SURVEY

A theme we have often mentioned is that capital flows to where it is best treated. Obviously, the level of tax imposed on businesses is a key element of how capital is treated in any given jurisdiction.

A 2010 KPMG guide analyzes the current tax competitiveness of 10 major countries, and 41 major cities in those countries. Among those countries, Mexico provides the best overall tax environment, with Canada following closely in second place. Japan and France find themselves in the highest tax positions at number 9 and 10 respectively. Below is the table published in the report:

Note that the tax competitiveness analysis also includes a  currency factor  so that the results are not entirely based purely on tax issues.

Below is a listing of the top 10 major cities in the subject jurisdictions. Interestingly, Vancouver has a better tax environment than two Mexican cities, even though Mexico as a country has an overall better tax environment than Canada.

The entire KPMG report can be viewed here.

TRUSTEE FEES

We are often asked what a reasonable trustee fee is. Like many states, Florida does not provide a statutory schedule as to what is a reasonable fee.

One way to get a feel for an appropriate fee is to see what professional trustees charge. A recent blog posted its survey results as to current rates being charged by various trustees. The results can be viewed here.

Near as I can tell, these fees relate to fees charged when the investment of the trust assets is being handled by someone other than the trust company. Such investment advisory services can add materially to the fees being charged.

ANOTHER CHINK IN THE ASSET PROTECTION ARMOR?

A recent federal case involving Florida's creditor protection law is generating a significant amount of commentary and criticism. While this case involves Florida creditor protections, the larger question of federal interests overriding state creditor protections has relevancy in all states.

In SEC v. Solow, 2010 WL 303959 (S.D. Fla 2010), a federal court imposed a contempt order on Mr. Solow. Mr. Solow was the subject of a significant disgorgement order by the SEC. Prior to the imposition of the order, but clearly in contemplation of SEC and other sanctions, Mr. Solow engaged in various structuring transactions to move assets beyond the reach of creditors, including mortgage and transfers of Florida property owned jointly with his spouse and an offshore trust.

There is little doubt that such transactions were undertaken by Mr. Solow with the purpose of using creditor protection laws to move assets beyond the reach of the SEC. However, Mr. Solow made the argument that he should not be held in contempt for undertaking such actions, because the SEC could not reach the value of the jointly held residence under Florida law even before he undertook any of his transfers since the assets were protected as property held as joint tenants by the entirety. Generally speaking, property held by a husband and wife as joint tenants by the entirety cannot be reached by the creditor of one spouse alone.

The overarching question arising from this case is whether the SEC, and indeed other federal agencies, have the ability to override state creditor exemptions, in  the same plenary fashion that the IRS has. There is plenty of language in the opinion to suggest that a federal court has the equitable power to so override state exemptions, at least in favor of the SEC. However, there are a number of facts and circumstances involved in this case that make it unclear whether such a general rule can be extracted. As I see it, some of these are as follows:

-This case involves whether a contempt order should be imposed on Mr. Solow. It does not address the question whether the SEC can get its hands on the assets themselves which are now presently controlled by Mrs. Solow and/or an offshore trust. Therefore, while the case may be precedent for the ability of the court to put Mr. Solow behind bars, it is questionable whether the case is precedent for the ability of the federal agency to actually reach the assets in satisfaction of its disgorgement order.

-The case involves a "disgorgement order." The opinion notes that a disgorgement order is something different from a creditor judgment. Therefore, perhaps, the holding of the case is limited to disgorgement order situations.

-The case involves the SEC. It is unknown whether the law and theory of the opinion can be extended to other federal agencies, but of course one could expect those other agencies to try.

-The case involves transfers conducted after Mr. Solow was in hot water. The court cites heavily to its "equitable" powers in exercising its contempt powers. An asserted principle of asset protection is that transfers undertaken before a creditor shows up on the scene are entitled to significantly more respect under state creditor protection laws than transfers undertaken to provide specific protection against a known creditor. This principle is typically applied pursuant to the concept of "fraudulent conveyance." Thus, the precedential value of the opinion may be limited to egregious transfers of assets undertaken in regard to a known creditor, and may not apply towards general transfers undertaken well in advance of any creditor problems.

-Interestingly, the case makes no reference to the Supremacy Clause of the US Constitution. Presumably, such a clause would impact greatly on any actual attempt to collect assets that are otherwise protected under state law by a federal agency. Its absence here is not problematic because this again, is not a recovery of assets case but a contempt case.

To the dismay of the asset protection bar, these type of cases with bad facts often encourage courts to find a way to reach the right result. What ends up happening, however, is that case law that arises in such egregious cases ends up becoming the law for everyone, including persons not engaging in such egregious conduct. The creation of such exceptions to statutory and common law creditor protections tips the balance in favor of creditors and sacrifices the policy protections Inc. in the statutory and common law protections.

SEC v. Solow, 2010 WL 303959 (S.D. Fla 2010)

TURNABOUT [FLORIDA]

Florida attorneys often help their clients use Florida’s homestead protection to protect assets from claims of creditors pursuant to Article X, Section 4 of the Florida Constitution. In a recent case, the client used the homestead protection to stiff his law firm in regard to their fee.

In the case, a law firm took on a matter to collect homeowners’ insurance proceeds from an insurer on the client’s homestead that related to hurricane damage. The law firm was successful and was due a contingent fee from the client. The client terminated the contingent fee arrangement without payment, so the law firm asserted a charging lien against the insurance proceeds for its fee.

Under Florida law, if a homestead is damaged through fire, wind or flood, the proceeds of any insurance recovery are also treated as homestead property. Since the client could not, through an unsecured agreement, enter into an enforceable contract to divest himself of his constitutional homestead protections, the trial court held, and the appellate court affirmed, that the law firm could not claim a lien in the insurance proceeds.

This does not mean that the law firm cannot seek to collect its fee from other assets of the client. But if there are no other assets, the law firm  lost out on its fee even though the client gets to enjoy the fruits of its labor.

Interestingly, the client was represented by an attorney on this fee dispute. I hope the attorney got his fee paid in advance or received a sufficient retainer to cover his fees!

Quiroga v. Citizens Property Insurance Corporation, 3rd DCA, Case No. 3D0-2942

MORE ON EXEMPT ORGANIZATION STATUS REVOCATIONS

Earlier this week, I wrote about how exempt organizations that do not file their Form 990’s for 3 consecutive years face automatic revocation of their status. The day after that was written, the IRS released a FAQ discusing the issue.

The FAQ did not bring any real relief to taxpayers, but did answer some questions. Some of the highlights included:

-confirmation that revocation is automatic – that is, the IRS has no discretion not to revoke.

-confirmation that if revoked, the entity will have to begin filing regular tax returns, pay applicable federal taxes, and transfers to it will lose whatever applicable contribution deductions would have been allowed.

-the revocation is effective as of the filing due date of the third year (and thus not at the later date when the IRS takes official action).

-an extension of time to file the applicable Form 990 will stave off the revocation if the 3rd required return is filed within the allowed extension.

-a full application process will be needed to reinstate status, including payment of applicable user fees. If reinstated, the effective date will be the date of the application, so there may be a gap “taxable” period between revocation and reinstatement. The organization can request an effective date back to the date of revocation, but the request will be granted only if the IRS finds the organization had “reasonable cause” for not filing the return for the three consecutive ears.

While not mentioned in the FAQ, note that the revocation of exemption will also probably affect state and local exemptions that are based on federal exempt status.

Automatic Revocation of Tax-Exempt Status for Failure to File Annual Return or Notice – Frequently Asked Questions and Answers, April 27, 2010