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Wednesday, September 28, 2011


U.S. residents, and other nonresidents of Mexico, are restricted from owning certain real estate in Mexico. The Mexican Constitution prohibits foreigners from purchasing or owning real estate within 60 miles of an international border or within 30 miles of the Mexican Coast.

To facilitate foreign ownership, Mexico law allows for foreign persons to own property through a fideicomiso. A fideicomiso is a Mexico trust arrangement under which a Mexico bank acquires title to the real property, and foreigners own the beneficial interest.

A recently released letter from the Office Chief Counsel warns that such arrangements may constitute foreign trusts for U.S. tax purposes, and thus may trigger Form 3520 and 3520-A filing requirements for U.S. beneficiaries. Interestingly, the letter does not conclude one way or the other whether a fideicomiso will be treated as a trust, only that it may be. The taxpayer recipient of the letter was instructed to review Regs. Section 301.7701-4 for the definition of a trust for U.S. tax purposes, and Code Section 7701(a)(31)(B) and the Regulations thereunder for whether a trust is foreign.

There is a reasonable possibility that many fideicomisos will meet the regulatory definition of a trust (at least in the opinion of the IRS), even though common law trusts are not a regular feature of Mexico law. The Regulations define a trust as:

…an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust under the Internal Revenue Code if it was created for the purpose of protecting or conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

Further, if a fideicomiso is considered a trust, it should then be considered a foreign trust, at least if a Mexico bank serving as trustee.

However, one may be able to argue that a fideicomiso is more akin to a “business trust” which is subject to taxation as a business entity under Regulations Section 301.7701-4(b).

Some facets of U.S. reporting of interests in foreign trusts only apply if distributions are made to U.S. beneficiaries. However, rent-free use of trust properly can be treated as a distribution to a beneficiary, so this is a reporting trap for many if the fideicomiso is characterized as a foreign trust since most beneficiaries will not be paying rent to use the Mexico property.

The actual income taxation of the U.S. beneficiaries will depend on whether the trust is a grantor trust or a nongrantor trust (or, of course, whether the fideicomiso is taxed as a trust or a business entity). Also, different reporting requirements are triggered based on grantor vs. nongrantor trust status or busines entity status.

Thus, the IRS’ letter is helpful in reminding taxpayers of potential reporting and income tax issues relating to a fideicomiso interests. However, each case will require its own analysis as to whether a foreign trust or other entity exists, if a trust whether it is a grantor or nongrantor trust, and what particular reporting is required. If worth the cost, a private letter ruling as to “trust” status could also be sought from the IRS.

INFO 2011-0052 dated 11/17/2010 (released 6/24/11)

Tuesday, September 20, 2011




Sunday, September 18, 2011


Irrevocable life insurance trusts are a mainstay of transfer tax planning with the object of avoiding estate tax on life insurance policy payouts. Such trusts often provide a Crummey withdrawal feature to one or more trust beneficiaries, so that premium payments by the grantor are eligible for exclusion from taxable gifts as present interest annual exclusion gifts.

Clients are instructed that the grantor should transfer premium payments to the trust, and that the trust should remit the proceeds to the insurance company. Further, the trustee should provide notice to the beneficiaries of their withdrawal rights at or about the time of the contributions of premium amounts to the trust. These protocols are intended to minimize the risks of IRS challenge to present interest status of the contributions.

Oftentimes, clients disregard these instructions, and the grantor makes direct payments of premiums to the insurance company. This is what occurred in the recent Tax Court case of Estate of Turner v. Commissioner. As one might expect, the IRS challenged the present interest exclusion status of the premium payments. However, in a boon to other taxpayers who have similarly funded their premium payments, the Tax Court still allowed the present interest exclusion treatment.

The IRS first argued that the trust beneficiaries had no meaningful rights to withdraw the premium payments since they were not first paid to the trust. The Tax Court noted that the key factor in a present interest gift such as this is whether the beneficiary had the "legal right to demand" the withdrawal. Under the terms of the trust, the beneficiaries have the absolute right and power to demand withdrawals from the trust after each direct or indirect transferred to the trust. That the funding occurred indirectly was thus irrelevant to the right to demand.

The IRS also argued that there was no meaningful withdrawal rights because some, or even all, of the beneficiaries may not have known they had the right to demand withdrawals per the absence of notice to them. Again, the Tax Court indicated such lack of notice did not affect the "legal right to demand" withdrawals and thus lack of notice was not determined to be an impediment to present interest status. The court appropriately noted that lack of notice was not an impediment in the Crummey case, either.

Does this mean that taxpayers can now make direct premium payments that bypass the trusts, and avoid delivering withdrawal notices to beneficiaries? For taxpayers that end up in the Tax Court, and that are willing to front the litigation costs to get there, the answer is probably yes. However, since the IRS has not conceded this issue, and since other courts may not agree with this interpretation, proper contribution and withdrawal notice protocols should still be observed (but with the comfort that favorable Tax Court treatment will backstop the protocols if they are not fully observed). Also, practitioners should confirm that their life insurance trust forms allow for withdrawals for both direct and indirect contributions.

Estate of Turner v. Comm'r, T.C. Memo. 2011-209 (Aug. 30, 2011)

Thursday, September 15, 2011


Grantors and contributors to charities often need to know if the charities qualify as "public" charities under Internal Revenue Code Section 170(b)(1)(A)(vi), so as to properly determine various tax consequences. Code Sections for which such status is relevant include Sections 170, 507, 545(b)(2), 642(c), 4942, 4945, 4966, 2055, 2106(a)(2), and 2522.

Grantors and contributors can request a copy of the charity’s exemption letter to determine if the IRS has recognized its status under Section 170(b)(1)(A)(vi). Alternatively, the status can be reviewed in IRS Publication 78, “Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986.” This publication is available in paper, or online through 

But what if the charity has had its Section 170(b)(1)(A)(vi) revoked, but the grantor or contributor is not informed of this? For example, the charity may provide the contributor with a copy of the original exemption letter, even though it has been revoked. Alternatively, the grantor or contributor may check the status online and see the charity has the proper status, but perhaps the IRS had not yet updated its database to show a revocation.

Under recently issued Regulations, the IRS will allow a contributor or grantor to rely upon an IRS determination letter or ruling (notwithstanding its revocation) until the IRS publishes notice of a change of status. Reg. Section 1.170A-9(f)(5)(ii). This is both a good and a bad thing. It is good, in that it provides a clear methodology to determine status, without risk that the status may have been changed. It is bad, since it imposes a clear burden on the taxpayer to review Publication 78, as updated, to confirm that there has been no revocation.

Previously, newly formed charities had only a five year advance ruling period for their “public charity” status – at the expiration of the period the charity had to go back to the IRS and seek a permanent ruling. While this process has been changed, there are organizations out there with ruling letters that have a fixed advance ruling period expiration date, but that are no longer obligated to seek a permanent ruling. The Regulation provides that a taxpayer may rely on advance rulings that expired on or after June 9, 2008.

A taxpayer cannot use these reliance rules if it was responsible for, or aware of, an act or failure to act that resulted in the organization's loss of classification under Section 170(b)(1)(A)(vi) or acquired knowledge that the IRS had given notice to such organization that it would be deleted from such classification. At first glance, this would appear to be a problem for large contributors, since if a contributor makes a large enough contribution to an organization, this may mathematically remove it from “public charity” status. However, the Regulations anticipate this and provide that an outsider to the charity (that is, is not a founder, creator, or foundation manager) will not be considered responsible for, or aware of, a loss of public status if it received and relied upon a written statement by the charity that the grantor contribution will not result in the loss of public status. Reg. Section 1.170A-9(f)(5)(iii). Such written statement must meet specific criteria, including the provision of five years of financial data to allow for a computation of public charity status.

Note that the online Publication 78 describes various types of exempt organizations. Various codes are used to assist readers to determine the status of the organization. The code needed to confirm public charity status is actually the absence of a code, or “none.” Below is a table of the various codes.


Saturday, September 10, 2011


Individuals who were not domiciled in Florida are not eligible to serve as a Personal Representative of a Florida decedent, except under limited circumstances (e.g., if they are related within certain stated family relationships to the decedent).  Fla. Stats. Section 733.304. Florida law also provides that persons who are served a copy of the Notice of Administration must file an objection to the appointment of a Personal Representative within three months of service. Fla.Stats. Section 733.212(3).

A recent Florida Supreme Court case took on the question whether the three-month objection period applies to a challenge of an individual to serve as Personal Representative when that person is not within the class of persons authorized to serve as a Personal Representative (in this case, because he was not domiciled within Florida and was not within the requisite family relationship). The Supreme Court took on the case due to a split between appellate courts on this question.

The Court determined that the three-month objection period does apply.

This is an important case because many times estate beneficiaries do not engage counsel to assist them until a dispute or problem arises, and that often occurs beyond the three-month objection. At that time, their counsel may note that the Personal Representative is not qualified to serve. Per this decision, in most cases it will now be too late to seek the removal of the Personal Representative as a disqualified person under the statute.

The door to objections is not completely closed, however. The opinion is clear that if there was fraud or misrepresentation relating to the petition for administration, a later action for removal should not be time-barred.

 Hill v. Davis, Fla. Supreme Court case No. SC 10-823, September 2, 2011

Monday, September 05, 2011


When a corporation makes a check the box election, it is treated as having liquidated and then being reestablished as a partnership. In context of an insolvent corporation, this raises questions about worthless stock treatment, bad debts, and other tax consequences. A recent Chief Counsel Memorandum provides the IRS' opinion on these issues.

WORTHLESS SECURITY DEDUCTION. In the deemed liquidation of a solvent corporation, the shareholders realize gain or loss based on the deemed distribution that occurs. However, an insolvent corporation has no net assets to distribute. Therefore, the shareholders do not receive anything and thus there is no sale or exchange to fix gain or loss. See Rev. Rul. 2003 – 125. In this circumstance, however, the shareholders will be entitled to a worthless security deduction in the amount of their basis in their stock pursuant to Code Section 165(g). Code Section 165(g) provides that if any security which is a capital asset (such as a share of stock in a corporation) becomes worthless, a loss from a seller or exchange of that security is deemed to occur.

Note that this result holds even if the shareholder is a corporation owning 80% or more of the stock of the insolvent subsidiary. That is, Code Section 332 (which applies to liquidations of corporate subsidiaries into a parent corporation) will not apply to disallow the loss. This result occurs because Code Section 332 will not generally apply to the liquidation of an insolvent subsidiary when the parent corporation receives no assets as shareholder.

TAXABLE SUBSTITUTION OF LIABILITIES. The substitution of a debt instrument that differs materially in kind or in extent from an existing debt instrument may constitute a sale or exchange of that debt instrument under Code Section 1001. Changes in obligor of the debt instrument can constitute such a taxable substitution.

Since an insolvent corporation will likely have liabilities to its shareholders or third parties, the issue arises whether such a substitution of debt occurs when the debt is deemed transferred and reestablished in the partnership, since at a minimum, there is a new obligor for federal tax purposes. Notwithstanding this new obligor, the Memorandum concludes that there is no such taxable substitution occurring under Code Section 1001.

BAD DEBT DEDUCTION. We noted above that the shareholders of the insolvent corporation are eligible to receive a worthless stock deduction upon the deemed liquidation of the corporation. This might lead you to believe that a creditor of the corporation should likewise receive a bad debt deduction under Code Section 166 since the corporation disappears. Code Section 166 allows as a deduction any debt which becomes worthless within a taxable year. However, you would be wrong in that conclusion (at least according to the Memorandum).

The Memorandum determines that Code Section 166 does not apply because the full amount of the liability is treated as surviving the liquidation and being assumed by the partnership. Thus, the debt was not rendered worthless by reason of the election.

BASIS IN PARTNERSHIP INTEREST AND PARTNERSHIP BASIS IN ASSETS. The Memorandum then addresses various basis issues arising from the deemed liquidation and deemed formation of the partnership. Interested persons should consult the Memorandum – we will not run through them here to avoid the risk of readers never wanting to read this blog again.

Office of Chief Counsel Memorandum AM2011-003, August 26, 2011