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Tuesday, March 29, 2011


Earlier this month, we discussed here the new FinCEN regulations that revise the rules applicable to FBAR/Form TD F 90-22.1 filings. The Treasury Department has now issued a March 2011 revision to the FBAR form and instructions, which incorporate the new provisions of the regulations.

The new instructions generally track the revised regulations, with some minor modifications. The form and instructions can be downloaded here.

I have written a journal article that provides a detailed analysis of the new rules in context of trusts and foreign accounts. After it is published, I’ll be able to share its content here.

Form TD F 90-22.1 (March 2011 version), available at

Monday, March 28, 2011


Last March, we discussed the bankruptcy case In re Chilton. That case held that unlike a traditional individual retirement account (IRA), an inherited IRA is not an exempt asset in bankruptcy. Our prior discussion can be read here.

That case has now been reversed. When Chilton was first decided, it was a case of first impression. Since then, there have been at least five other cases that ruled in an opposite manner. In reversing the bankruptcy court, the District Court held that (a) an inherited IRA holds “retirement funds” within the meaning of 11 U.S.C. §522(d)(12), and (b) such an IRA is tax exempt under Code §408(e). Thus, an inherited IRA qualifies as an exempt asset under 11 U.S.C. §522(d)(12).

Chilton v. Moser, 107 AFTR 2d 2011-XXXX, 2011 WL 938310 (2011, DC TX)

Thursday, March 24, 2011


Oftentimes, parties in litigation will direct property to a spouse or charity in settlement, and seek a marital or charitable deduction. At times, such settlements are motivated by and structured around the estate tax deduction. However, litigants or their counsel oftentimes do not realize that the deductions cannot be created out of whole cloth – there must be a bona fide dispute regarding the entitlement of the spouse or charity to the payment. That is, there must be some reasonable legal basis that entitled the spouse or charity to the settlement payment. That is, if such a payment was not directed for under the dispositive documents (including prior dispositive documents involved in the dispute) or some other binding obligation, parties should expect IRS resistance to deductions for such payments that are “created” in the settlement process.

A recent case compares and contrasts the allowable and not allowable situations. In Estate of Palumbo (3/9/11, DC PA), a charitable trust was a remainder beneficiary under various versions of a prior Will. However, in the decedent’s last Will, the trust was inadvertently left out. In settlement of a dispute as to the rights of the charitable trust against the residuary beneficiary named in the last Will, the trust received over $11 million. The estate sought a charitable deduction for the $11+ million. The IRS disallowed it.

The District Court noted that there was a bona fide dispute. Further, even though the charitable trust was not mentioned in the last Will, it could not be said that it had no legal right to the residuary estate. Perhaps it didn’t, but there was a bona fide dispute based on the prior Will and the admission of the drafting attorney of a scrivener’s error. Thus, the settlement payment to the charity was deemed to qualify for a charitable deduction as a Code §2055 deduction.

This result was contrasted by the court with the disallowance of a charitable deduction in the case of Bach v. McGinnes, 333 F.2d 979 (3d Cir.1964). In that case, a decedent’s surviving spouse did not like a dispositive plan of her decedent spouse that would only allow property to pass to charity only if certain named relatives predeceased her. To achieve a better result for the charity, after her spouse’s death the surviving spouse threatened her use of her spousal elective share against the estate – if exercised, it would reduce the economic interests of some of the beneficiaries. Due to that threat, the beneficiaries and the charity reached an agreement that resulted in a current remainder distribution to the charity. A charitable deduction was sought for the transfer to the charity. The IRS objected, and no deduction was allowed either by the District Court or the Court of Appeals.

What distinguishes Palumbo from Bach? In Bach, there was no legal argument raised that if successful would have resulted in a charitable gift to the charity. Thus, there was no bona fide legal dispute over the charity’s legal entitlement. Instead, the various parties arranged for the transfer to the charity because it otherwise best suited their economic interests, albeit some of them acting under the threat of a spousal elective share.

Estate of Antonio J. Palumbo, 107 AFTR 2d 2011-XXXX, (DC PA), 03/09/2011

Saturday, March 19, 2011


The Florida Constitution prohibits a decedent from devising his or her homestead to third parties if the decedent is surviving by a spouse at death. When there are no surviving lineal descendants of the decedent, the surviving spouse will receive 100% of the homestead if an invalid devise is attempted.

Virginia Habeeb died in November 2008, survived by her husband Mitchell and no lineal descendants. Virginia owned homestead property. Her last will gave a life estate interest to Mitchell, with the remainder interest to her sister. Mitchell died about a year later, and his estate challenged the devise as invalid under the Constitution, and asserted that the entire homestead passed to Mitchell at Virginia’s death.

In 1979, Virginia and Mitchell had owned the subject condominium as tenants by the entireties. In that year, Mitchell and Virginia signed a Ramco form warranty deed granting to Virginia a fee simple interest in the condominium. Based on this, Virginia’s estate claimed that Mitchell had waived his homestead rights in the condominium, and thus no homestead restrictions on the devise applied at Virginia’s death. Both the trial court and the appellate court agreed with Virginia’s estate.

Virginia’s estate had several obstacles to overcome to assert a valid waiver, per the requirements of Fla.Stats. Section 732.702. That statute, in 1979, allowed for a waiver BY A WRITTEN CONTRACT, AGREEMENT, OR WAIVER. The statute further required that each spouse make a FAIR DISCLOSURE TO THE OTHER OF HIS OR HER ESTATE if the waiver is signed after marriage.

A. WRITTEN CONTRACT, AGREEMENT OR WAIVER ISSUE. Virginia’s estate argued that the warranty deed constituted the waiver of homestead rights. Clearly, the deed contained no waiver language, and did not mention the term “homestead.” Fla.Stats. section 732.702(1) does indicate that a waiver of “all rights” or equivalent language, as to property or an estate will constitute a waiver of homestead, so there is no requirement of an express reference to homestead rights to have a valid waiver.

In reviewing the issues, the appellate court noted that the Ramco form provides that the grantor “grants, bargains, sells, aliens, remises, releases, conveys, and confirms” to the grantee “all that certain land” as well as “all the tenements, hereditaments and appurtenances thereto” to the grantee. The court indicated that the term “heriditaments” includes “anything capable of being inherited.” Based on this language, the court found a valid “waiver” by Mitchell of his homestead rights.

This appears to be quite a stretch. There is no express waiver language whatsoever. Further, the deed language can be read as a waiver of any retained rights of Mitchell that arose by reason of HIS ownership interest in the property – not those under separate homestead provisions applicable to his wife’s subsequent ownership. Additionally, there was no mention of any discussions, knowledge, or other direct evidence of intent by Mitchell, that indicated he knew of his homestead rights or that he knew he was waiving them (other than an implied intent based on Mitchell’s actions after Virginia’s death and prior to Mitchell passing away).

B. FAIR DISCLOSURE ISSUE. Most knowledgeable practitioners implementing a post-marital waiver of homestead rights would have the spouses prepare a written disclosure of assets, or at least a written acknowledgment of knowledge of each other’s assets, to meet the fair disclosure requirement. There is no evidence that Mitchell or Virginia made such disclosures to each other in 1979 when the transfer was made to Virginia.

The appellate court was undisturbed by this lack of evidence or disclosure. Instead, it relied on (a) the parties having been married around 30 years at the time of the 1979 transfer, (b) the deed having been prepared by an attorney and signed before two witnesses and a notary public, (c) the parties preparing later estate planning documents based on the real estate transfer and without regard to homestead restrictions, and (d) Mitchell not having made objections during the period he survived Virginia.

Again, the courts appear to have really stretched to find a waiver, when there clearly was no express evidence of one.

COMMENTS. The holdings of the case can be distilled to (a) a warranty deed between spouses can constitute a waiver of homestead right, and (b) disclosure of assets can be inferred from the length of marriage. The courts’ clearly reached to find compliance with the statutory requirements of waiver, especially since when there is doubt whether a constitutional right has been waived, there is a presumption against the waiver (as acknowledged by the appellate court in its opinion!). While perhaps the reaching did not result in an egregious result in this case, it provides fodder and precedent for assertions of waiver of homestead without clear disclosure of assets or clear waiver language in future cases.

While the courts were applying the waiver statute as it existed in 1979, the portions of Fla.Stats. Section 732.702 addressed in the case are essentially unchanged, so that the analysis has continued application to such waivers being made today.

As an aside, a useful summary table of the Florida restrictions on transfers of homestead property is available here.


Tuesday, March 15, 2011


The IRS has issued information from the 2009 income tax filing season. As a voluntary compliance system, taxpayers often are interested to know their chances of audit. Below are some interesting facts and statistics.

Individual returns filed 142,823,105
Audits of individual returns 1,581,394
Individual audits that were only correspondence audits 78.3%
Audit rates for individual returns with $200,000 to $1 million in income 2.5%-2.9%
Audit rates for individual returns with more than $1 million in income 8.4%
Audit rates for corporations (excluding S corporations) 1.4% (with percentages increasing significantly with increased total assets – e.g., 45% for corporations with $5-$20 billion in assets
Audit rates for partnerships and S corporations .4%
Offers in compromise 57,000 filed and 14,000 accepted
Criminal investigations 2010: 4,706 investigations – 3,034 referrals for prosecution – 2,184 convictions
Incarceration rate for convicted taxpayers 81.2%

2010 Data Book (Pub 55B)

Saturday, March 12, 2011


Gross income generally includes all income from whatever source derived. At times, entities may receive amounts from nonowners that enhance its capital. For example, local government or groups may make contributions to encourage an entity to set up or expand business in a locality. Are such transfers gross income to the entity?

Code §108 provides that in “the case of a corporation, gross income does not include any contribution to the capital of the taxpayer.” Thus, such capital contributions are not gross income to a corporation.

Contributions to noncorporate entities, like partnerships or LLC’s, are not expressly covered by Code §118.  Outside of the statute, there are common law cases that provide situations when a capital contribution is not taxable. For example, in Edwards v. Cuba Railroad, 5 AFTR 5398 (S.Ct. 1925), third party contributions to capital of a corporation were not considered income.

This would lead one to believe that in the appropriate circumstances, similar contributions to capital by nonowners in noncorporate entities should not be taxable. However, IRS Appeals, in an Appeals Technical Guidance Program Settlement guidelines manual effective on March 2, 2011, has indicated that Code §118 exclusion concepts should not be applied to noncorporate entities.

There are several justifications given for this position. First, it is asserted that the common law rules were replaced by Code §118, and thus the exclusion applies only so far as Code §118 goes. Second, expanded definitions of gross income have effectively voided prior case law precedent of exclusion, such as in Cuba Railroad. Third, the IRS indicated that it is a taxpayer choice as to what form of entity to operate under, and they should be bound by the particular tax provisions that relate to the chosen entity.

Such positions are not law but are only the IRS’ opinion in regard to analyzing its litigation strategy. Given the prior precedent, one can expect some taxpayers to challenge these positions in court even the the manual indicates that the chances of taxpayer success are “remote” and the government’s hazards of litigation are de minimis.

Appeals Technical Guidance Program Settlement, March 2, 2011

Monday, March 07, 2011


A dynasty trust is a trust that provides for an existence that may span many generations. Once upon a time, the rule against perpetuities limited the term of a trust to 2 or 3 generations at most. Now, many states have no limits on the term of a trust, or have very long limits (such as Florida). For transfer tax planning purposes, if the trust is exempt from generation skipping tax by reason of the allocation of the grantor’s GST exemption, the trust assets can be held to benefit many generations without being subject to estate or generation skipping taxes as each generation dies off and new beneficiaries arise.

President Obama’s 2012 budget includes a provision that would limit the GST exemption benefits to a maximum of 90 years. 90 years is still a long time to be exempt from transfer taxes, but it still is a lot shorter than “forever.”

The proposal does not apply to existing trusts – that’s a good thing. Further, with the House of Representatives in the control of the Republicans, it is unlikely that this provision will make it into law in the near future.

However, like a bad penny, once these type of proposals are out there, they tend to show up again and again. This doesn’t mean it will ever pass - just that it will be hanging out there like the Sword of Damocles waiting for the winds of political fortune to shift so as to improve its chances of passage.

Just another reason to giving strong consideration to making gifts during 2011 and 2012 under the favorable gift-giving transfer tax environment.

Sunday, March 06, 2011


FinCEN has issued final regulations addressing various FBAR reporting issues. These rules are effective as of March 28, 2011 for reported due by June 30, 2011 for 2010 years and thereafter.

The new regulations do not address all reporting issues, but they do provide a fair amount of clarification. Per my initial reading of the regulations and the issued comments and explanations, some key points include:

--The use of IRC residency test for U.S. residents subject to reporting has been adopted.

--Clarification has been provided that the U.S. status of entities for reporting purposes is determined by where they are formed.

--Signature authority over an account that triggers reporting now includes ability to control disposition of assets by non-written communication, not just written communications.

--Officers or employees who file an FBAR because of authority over accounts of their employers are not expected to personally maintain records of the accounts.

--Omnibus accounts with U.S. financial institutions that hold assets thrugh a global custodian are generally not reported, so long as the u.s. person cannot directly access the foreign holdings maintained at the foreign institution.

--Domestic trusts with foreign accounts must file FBARs - the test is not the §7701(a)(3) definition of a domestic trust, but whether the trust has ben created, organized or formed under the laws of the U.S.

--Domestic corporations do not include  Section 897(i) electing corporations, per the focus on jurisdiction of formation and not tax elections to be treated as domestic entities.

--There is no mention of foreign persons doing business in the U.S. as persons that must file, notwithstanding prior proposals on that score.

--"Bank accounts" include certificate of deposit and other time deposits.

--Life insurance and annuities are "accounts" but only if they have a cash value. Presumably these rules should not capture term policies, but that is not 100% clear, unless it is established that unearned premium is not cash value.

--Clarifies that determining whether a trust is a grantor trust for purposes of reporting by a U.S. grantor occurs under Internal Revenue Code rules.

--Fully discretionary trust beneficiaries do not have a "present income interest" that will subject them to reporting. Nor do remainder beneficiaries by reason of that status alone.

--The former trust protector provision that could have given rise to reporting has been removed, but it may still have application under the anti-abuse rule when appropriate.

--Anti-avoidance rules have been added.  A United States person that causes an entity, including but not limited to a corporation, partnership, or trust, to be created for a purpose of evading this section shall have a financial interest in any bank, securities, or other financial account in a foreign country for which the entity is the owner of record or holder of legal title.

--Relief for beneficiaries is granted when the trust already reports.

--If someone has more than 24 accounts to report, they need only provide certain basic information.

--Consolidated reports allowed if domestic entity own more than 50% of another reporting entity.

Of course, the 2009 HIRE Act will also require similar reporting Code §6038D reporting of foreign financial assets. Why Congress could not direct FinCEN and the IRS to come up with one filing and one set of rules for foreign financial asset reporting borders on the ridiculous – taxpayers now will have to struggle with two sets of complex and overlapping reporting requirements.

Amendments to the Bank Secrecy Act Regulations – Reports of Foreign Financial Accounts, Federal Register, Vol. 76, No. 37, p. 10234