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Saturday, September 29, 2012


Nonresidents of the U.S. are required to have a taxpayer identification number for most U.S. tax reporting purposes, including FIRPTA reporting on sales of U.S. real property interests. Since such persons do not have social security numbers, they have to apply to the IRS for an International Taxpayer Identification Number (“ITIN”) via a Form W-7 application.

The Form W-7 requires certain documentation to be attached. In the past, a U.S. notary could make a notarized copy of an applicant’s passport, and that would be sufficient. Since earlier this summer, however, applicants must submit original documentation or certified copies of their documentation certified by the issuing agency. The IRS may hold on to this documentation for up to 60 days. Would you want to mail in your passport and hope you get it back? And what if you needed to travel within 60 days?

Instead of submitting an original document, a certified copy from the issuing agency is usable. However, the time, cost, delay, and hassle of getting a certified copy of a passport will vary from country to country. Birth certificates may also be used.

More formal rules are promised for 2013, but there is no indication that there will be any easing of the above requirements. There are some exceptions to this reporting.

Even before these new rules, getting an ITIN has always been something of a pain. Now, it is more difficult than ever. While perhaps it may be easier for someone to defraud the IRS and obtain an ITIN on an invalid form of identification via a certified copy through a notary vs. a direct submission to the IRS, is this level of inconvenience really necessary? Does anyone at Treasury care anymore about inconvenience to taxpayers when writing rules? Anyone who has tried to read the FATCA rules already knows the answer to that.

IR News Release 2012-62

Wednesday, September 26, 2012


Facts & Law:

A. Income taxes must be assessed within 3 years of the later of the  date the return is filed or the due date of the return.

B. However, the assessment period remains open indefinitely “in the case of a false or fraudulent return with the intent to evade tax.”

C. A shareholder in a Subchapter S corporation is taxable on his or her pro rata share of the net income of the corporation.

D. A Subchapter S corporation files a fraudulent return. The taxpayer-shareholder had nothing to do with the preparation or filing of the return, and was not knowledgeable of the fraud.


Can the IRS assess the taxpayer for a corrected share of the income of the corporation more than 3 years after the filing and due date of the return?


No, according to the IRS.

Interestingly, fraud by one spouse in filing a joint tax return keeps the statute open for the other spouse. That was not persuasive here, because spouses are jointly and severally liable for joint return taxes.

In Vincent Allen, 128 TC 37 (2007), the Tax Court held that an income tax return preparer's fraud kept a taxpayer's income tax return open indefinitely. However, that precedent was not applicable here because the intent in that case was to evade the taxpayer’s tax – that was not the case here.

Chief Counsel Advice 201238026

Saturday, September 22, 2012


The cash value of a surrendered  life insurance policy is includable in gross income to the extent it exceeds the taxpayer's investment in the insurance contract. This excess is taxable as ordinary income.

There are two elements to this computation. First, what is the cash value. Second, what is the “investment in the insurance contract.” A recent case (Brown v. Comm.)  illustrates some elements that go into these two items.

Cash Value. In the case, the insured did not receive the cash value. Instead, it was applied by the insurance company to pay off a policy loan. The court nonetheless included the cash surrender value applied to the loan as being received by the insured.

Investment in the Insurance Contract. This generally is the total insurance premiums paid by the insured. However, the court recognized two reductions to the investment in the contract. First, the insured had surrendered some of his insurance coverage. This surrender was treated as a reduction in the investment in the contract. Second, during the term of the policy the insurance company had used some of the dividends earned on the policy to purchase additional coverage.

Oftentimes, the quick and dirty computation of the income arising from the surrender of a policy is the cash received by the insured, over the premiums previously paid. This case reminds us that adjustments to both these items may apply that can materially impact this computation.

Brown v. Comm., 110 AFTR 2d 2012-XXXX (CA7 09/11/2012)

Tuesday, September 18, 2012


Taxpayers can make annual exclusion gifts of $13,000 each year per recipient, without incurring a gift tax and without using up a portion of their unified credit. This amount was originally at $10,000, and is now indexed for inflation. After spending a few years at $13,000 it is projected to move to $14,000.

This move up is not yet official.  Research Institute of America (RIA), a publishing house that serves tax professionals, has crunched the numbers and has made the determination that the increase will take place next year, based on their inflation computations.

Sunday, September 16, 2012


For the past few weeks I have been making a weekly presentation in our office regarding planning to make use of the $5.12 million unified credit equivalent amount before its scheduled reduction to $1 million in 2013. I have now made an online version of the presentation for all those that are interested but could not intend. You can view it on YouTube through this link.

If you would like a copy of the written materials that accompanied the presentation, send me a quick email at with a note to send the last chance planning materials.

Thursday, September 13, 2012


A recent Private Letter Ruling addressed some interesting issues relating to a modification of an irrevocable trust under state law that is made with the consent of the settlor and all beneficiaries.

A. Section 2036/2038 Inclusion in Settlor. The question was raised whether the settlor was at risk for inclusion of the trust assets in his or her taxable estate by reason of participation in the modification process. That is, was the exercise of his rights under state law sufficient to show that he has a retained interest in the trust under Section 2036 or 2038?

The IRS ruled that the settlor suffered no estate tax exposure. First, the IRS noted that the settlor did not retain the possession or enjoyment of, or the right to the income from, the trust property. Further, the IRS noted that Section 2038 will not apply if a settlor decedent held a power that could be exercised only with the consent of all parties having an interest in the transferred property, and the power adds nothing to the rights of the parties under local law (Treas. Regs. §20.2038-1(a)(2)). Since the beneficiaries were consenting to the modifications, even if the statutory modification power was an issue for the settlor, the regulation would apply to provide further protection against taxable estate inclusion.

B. Gift Tax Exposure to Settlor. The issue was also raised whether the Settlor’s consent to the modification could result in gift tax liability to the settlor. The IRS ruled that there was no gift tax exposure. First, the IRS noted that the settlor’s original gift to the trust was a completed gift since he did not retain any power to change the disposition for his own benefit or for the benefit of another.  Further, and similar to the 2038 Regulation discussed above, Treas. Regs. §25.2511-2(e) provides that a donor is considered to have a power if it is exercisable by him in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property or its income. Here, the power that the settlor had under state law to modify the trust could only be exercised with all of the beneficiaries (who thus have a substantial adverse interest), and thus for both of the above reasons the IRS saw no gift tax issues for the settlor.

C. GST Exemption Preserved. The trust at issue was exempt from generation-skipping tax by reason of allocation of the settlor’s GST exemption to it. The issue was raised whether the modification of the trust could jeopardize the exempt status of the trust.

The IRS noted that there is no guidance regarding whether the partial termination or modification of a trust will affect the status of a trust that is exempt from GST tax because sufficient GST exemption was allocated to it. So the IRS instead applied its regulations whether a “grandfathered” generation skipping trust is modified in a manner that the exempt status would be lost – i.e. Treas. Regs. §26.2601-1(b)(4). The IRS found that under the regulations the modifications did not rise to a level that would result in loss of exempt status - the partial termination and modification would not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation than the person or persons who held the beneficial interest prior to the modification and the partial termination and modification does not extend the time for vesting of any beneficial interest in the trust beyond the period provided for in the original trust.

While the exempt trust rules do not directly apply to this question, the IRS noted that “[a]t a minimum, a partial termination or modification that would not affect the GST status of a grandfathered trust should similarly not affect the exempt status of [a trust that is exempt by reason of allocation of GST exemption].” Accordingly, the IRS ruled that  the partial termination and modification of the trust did not cause it to lose its exempt GST status.

COMMENT: Modification of irrevocable trusts with the involvement of the settlor are common. Confirmation that such modifications do not adversely impact the settlor when the settlor retained no rights or interest over the trust, and further do not upset the GST exempt status of the trust, is reassuring.

However, there may be circumstances when the modification may involve a shift of a beneficial interest to a lower generation – such a circumstance would not fit within the facts of this ruling on the GST issue. Presumably that should not impact the exemption allocation, but it does remain an open issue.

PLR 201233008

Saturday, September 08, 2012


Russell Long, describing tax reform, once said, "Don't tax you, don't tax me.  Tax that fellow behind the tree."

A variation that taxpayers who make mistakes on their tax returns often claim is, “Don’t penalize you, don’t penalize me, it was TurboTax’s fault, so set me free.”

The so-called “TurboTax defense” is raised by taxpayers to avoid penalties – they claim reasonable cause for their tax return errors because they used TurboTax or similar return preparation software to prepare the erroneous tax return. That is what Brenda Bartlett claimed when she was penalized for not reporting all her income on her tax return. Brenda maintained that the failure to report was an honest mistake resulting from her lack of familiarity with the TurboTax program and that she relied on the audit portion of the program to catch any mistakes she made.

The Tax Court rejected her defense, since the problem was that Brenda entered the information incorrectly into the program – not that the program made a mistake. The Court noted:

TurboTax is only as good as the information entered into its software program…Simply put: grabage in, garbage out.

Brenda Frances Bartlett v. Commissioner, T.C. Memo. 2012-254 (Sept. 4, 2012)

Sunday, September 02, 2012


Dr. James formed an irrevocable trust in Nevis, West Indies for asset protection purposes. He properly reported the trust to the IRS on a Form 3520-A, but neglected to file a Form 3520. He is at risk for a penalty of the greater of $10,000 or 35% of the gross reportable amount – not an insignificant penalty (more than $578,000 in penalties for Dr. James). Code section 6677(a).

As is the case for many penalties, there is an exception if the failure to file was due to reasonable cause and not due to willful neglect.  Dr. James claimed that he reasonably relied on his accountant to advise him on what returns should be filed, and that he had no personal knowledge of the Form 3520 filing requirements.

A taxpayer may reasonably rely on an expert’s advice as to tax filing obligations – this can constitute reasonable cause under the above penalty exception. In many cases, however, the facts do not support the exception. For example, the taxpayer may not have provided adequate information to the professional, or did not engage the professional to advise him on all required tax filings.

In the case of Dr. James, he had enough favorable facts to allow for a further review whether reasonable cause existed for his failure to file. These facts included:

     a. Dr. James gave his accountant all the applicable trust documents;

      b. Dr. James relied on the accountant to advise him on all required trust filings;

     c. The accountant did advise him on some tax matters relating to the trust;

     d. The accountant prepared Dr. James’ personal returns. On those returns he checked the box ‘no’ to the question whether Dr. James received a distribution from, or was the grantor of or transferor to, a foreign trust. This could be construed as advice to Dr. James that a Form 3520 was not needed.

     e. Dr. James believed he filed all required returns, based on his discussions with his accountant.

Dr. James is not out of the woods yet – the case was simply a denial of the IRS’ motion for summary judgment that the exception to the penalty did not apply. Based on the court’s opinion, it would seem that the IRS has a difficult road ahead in convincing the court to apply the penalty.

The case is also representative of the zealousness with which the IRS is pursuing offshore accounts and trust nonreporting. It would seem that this was not a case of an intentional or egregious nonfiling, especially given the reliance on the taxpayer’s accountant and that other disclosure reporting was undertaken by the taxpayer of the trust to the IRS – instead, it looks more like a zero tolerance policy by the government. The case does not reveal whether Dr. James avoided reporting income from the trust – if he did that might provide additional justification for the IRS to throw the book at him.  

James,  110 AFTR 2d ¶2012-5196 (2012, DC FL)