WINDSOR UPHELD

Earlier this year, I discussed the Windsor case wherein a federal district court struck down Section 3 of the Defense of Marriage Act (DOMA), and allowed a marital deduction in the estate of a deceased same-sex spouse for assets passing to the surviving spouse. You can read that discussion here.

The Second Circuit Court of Appeal has upheld that decision, albeit on a stricter constitutional test than the rational basis test which was applied by the district court. Here, the appellate court applied an intermediate heightened level of scrutiny which is inbetween the rational basis test and strict scrutiny, and found that the DOMA provision did not meet that level of scrutiny.

Windsor, 110 AFTR 2d Para 2012-5378

WANDRY APPEAL WITHDRAWN

I have previously written about the Wandry decision here. Wandry is a favorable Tax Court Memorandum decision that accepted the use of a simplified formula gift clause (that is, one that did not involve disclaimer or charitable elements) as a method of avoiding an inadvertent taxable gift by reason of an IRS upwards revaluation of the value of gifted property.  The Government appealed the decision to the 10th Circuit Court of Appeals earlier this year. An appellate decision upholding Wandry would be welcomed by practitioners – a reversal would not.

Neither is going to happen now. Per the Tax Court website, the Government has voluntarily dismissed its appeal. At this point, I do not know why.

The dismissal is better than a reversal. However, I was looking forward to a more definitive ruling on the issue (one way or the other) due to the limited precedential value of a Tax Court Memorandum decision.

APPLICABLE FEDERAL RATES–NOVEMBER 2012

DO YOU KNOW ABOUT FIRST-TIME ABATE RELIEF?

[Prefer to watch instead of read? Go here.]

If you file an income tax return late, Code §6651(a)(1) imposes a penalty of 5% of the unpaid taxes for each month, up to 25%. If you don't pay income taxes when due, Code §6652(a)(2) imposes a 0.5% penalty for each of nonpayment, up to 25% of the unpaid taxes.

Since 2001, the IRS grants relief to taxpayers subject to these penalties if the taxpayers were otherwise fully compliant for the prior three years. See IRM §20.1.1.3.6.1. This is known as "First-Time Abate" (FTA) relief. Note that it can only be applied for one tax year.

Did you know about this? Don't feel bad if you don't. In a recent report by the Treasury Inspector General for Tax Administration, the IRS has failed to inform about 1.45 million taxpayers that qualified for relief under the program, and collected around $181 million in penalties from those taxpayers. Information on the program is not well-publicized on the IRS' website, nor in forms or penalty notices. Since the IRS does not generally advise taxpayers of the program, and only grants relief if request, if a taxpayer does not know about FTA then they missed out on the opportunity to avoid these penalties. These are not small numbers either - the average estimated penalties per taxpayer are $60,000 for late filing and $21,000 for late payment.

Another problem with the program has been that the above penalties can also be abated if the taxpayer can show reasonable cause. If a penalty is abated due to reasonable cause, the taxpayer can then use FTA in a following year. However, taxpayers may use FTA in a year even though they qualified for reasonable cause abatement. By using FTA instead of reasonable cause abatement, they have locked themselves out of using FTA for the next few years when they didn't have to.

The IRS has indicated it will be taking corrective action to address these problems with the FTA program.

Penalty Abatement Report, September 19, 2012

DOMA STILL THE LAW, ACCORDING TO THE IRS

There have been a number of cases that have declared that Section 3 of the Defense of Marriage Act is unconstitutional. That provision defines marriage for purposes of administering federal law as the “legal union between one man and one woman as husband and wife.” It further defines “spouse” as “a person of the opposite sex who is a husband or wife.”

See my prior posts here and here.

In a recent FAQ, the IRS has indicated that it will continue to treat same-sex married couples as unmarried individuals for tax provisions that relate to marital status, regardless of these court decisions. The FAQ also provides guidance on which member of the couple can claim a child as a dependent (either one, or if they both claim it, the one with whom the child lived with longer) and adoption expense credits.

Answers to Frequently Asked Questions for Same-Sex Couples

VIDEO EXPERIMENT

Time permitting, I am attempting a video experiment for those who would rather watch than read. Go here for the first one which I made this weekend for my last posting. After a few attempts, I’ll see if there are enough views to keep on going with the videos. These videos will mostly be shortened versions – for more details you can always read the written post to which it relates. Comments and suggestions are welcome at crubin@floridatax.com.

INCOME TAX GIFTING HAZARDS

[Prefer to watch instead of read? Go here.]

The great rush is on to complete major gifting in 2012 before the unified credit equivalent amount is reduced from $5.12 million to $1 million in 2013 and thereafter. While planners are focused on transfer tax savings and issues, they must also consider the income tax consequences of the gifts.

Basis Step-Up Issues. Most planners, even those without a strong income tax background, are aware of the trade-off in making a lifetime gift of appreciated property versus transferring such property at death. If a gift is made of the property, the recipient usually receives the same basis that the donor had in the property. If the recipient then sells the received property, it will have to pay income tax on the appreciation that exists in the property, as if the donor had sold it. If the property was held until death and then transferred, the basis of appreciated property would be adjusted at death to the value of the property. This allows the recipient to then sell the property without ever paying income tax on the appreciation that occurred while the decedent owned the property.

Liabilities in Excess of Basis Issues. For those planners that plan on using limited liability company or limited partnership interests to fund 2012 gifts, another income tax issue exists that is not as well-known and is not being widely discussed should be on the review checklist. This involves the transfers of interests in these entities when the entities have mortgage or other indebtedness.

In this circumstance, it is possible that the share of the entity’s indebtedness that is allocable to the transferred interest exceeds the donor’s tax basis in the interest. In that circumstance, a gift of the interest may generate a gain to the donor to the extent that the indebtedness share allocable to the transferred interest exceeds the basis – that is, the donor can be treated as having sold the interest for the amount of the share of the entity indebtedness even though the transaction looks like a gift.

This circumstance is often referred to as a “negative capital account” situation. It typically arises from real estate or other business entities that borrow money and generate tax deductions for the partners or members. These deductions reduce the basis of the owners’ interests, often without an offsetting repayment of the debt or receipt of profits by the entity. Alternatively, the entity may borrow funds and then distribute the cash proceeds to members or partners, again reducing the owners’ basis in their interest while still maintaining the same level of debt in the entity.

Gift tax transfers to grantor trusts may avoid or defer the gain aspects, since the donor/grantor will be treated as still owning the transferred interest for income tax purposes. However, the planning can get tricky to cover the circumstances of death of the participants and beneficiaries. For example, if the grantor trust status terminates by reason of the death of a beneficiary during the grantor’s life, this may trigger a deemed sale at that point in time.

While the above focuses on interests in partnerships and LLC’s, similar issues can also arise if real property or other property is directly transferred if that property is encumbered. Therefore, planners are encouraged to make sure they have their income tax bases covered in addition to transfer tax planning, in making these last minute 2012 gifts. Also, since a transfer at death provides a direct means of eliminating a negative capital account, consideration should be given to finding alternative assets to gift for this reason alone.

IRS EASES RULES ON GIFT-GIVING BY PRIVATE FOUNDATIONS TO FOREIGN ORGANIZATIONS

New Proposed Regulations expand the class of persons who can issue written advice that a foreign organization is eligible to receive grants from a private foundation that constitute qualifying distributions for Code §4942 minimum distribution requirements and that are not taxable expenditures under Code §4945. Previously, such persons included only legal counsel for the donor or donee organization. Now, other attorneys, CPAs and enrolled agents can do so.

FACTS: Distributions to foreign organizations by private foundations can run afoul of two excise tax provisions. First, Code §4942 imposes a minimum level of distributions to qualified recipients each year. Unless a private foundation has enough distributions to other qualified recipients to meet the minimums, it will want distributions to foreign organizations to count towards the minimum. Second, Code §4945 imposes an excise tax on a private foundation’s “taxable expenditures.” Taxable expenditures include expenditures for other than a charitable purpose. Private foundations making grants to foreign organizations want those grants to avoid being characterized as a taxable expenditure.

Generally, grants for charitable purposes to certain foreign organizations may be treated as qualifying distributions under Code §4942 if the private foundation determines that the foreign organization is an organization described in sections 501(c)(3) and 509(a)(1), (a)(2), or (a)(3) (i.e., it is a "public charity") that is not a supporting organization described in section 4942(g)(4)(A)(i) or (g)(4)(A)(ii) or is an organization described in sections 501(c)(3) and 4942(j)(3) (i.e., is a "private operating foundation"). However, grants to organizations controlled, directly or indirectly, by the foundation or one or more of its disqualified persons are not qualifying distributions unless the grant is redistributed for charitable purposes within the period specified in Code §4942(g)(3).

Similarly, grants for charitable purposes to certain foreign organizations may be treated as other than taxable expenditures under section 4945 if the private foundation makes a good faith determination that the foreign organization is a public charity (other than a disqualified supporting organization) or an organization described in sections 501(c)(3) and 4940(d)(2) (an "exempt operating foundation").

If the foreign organization does not have an IRS determination letter that confirms it comes within the above classes, a good faith determination by the private foundation that the foreign organization comes within the above classes will achieve the desired results under Code §§4942 and 4945. Under the current regulations, a “good faith determination” may be based on an affidavit of the foreign organization, or an opinion of counsel of either the grantor or the grantee. The affidavit or opinion must set forth sufficient facts concerning the operations and support of the grantee for the IRS to determine that the grantee would be likely to qualify within the required classes.

The new Proposed Regulations both expand and contract who can issue the above opinion. The opiner must now be a "qualified tax practitioner" who is subject to the requirements in Circular 230, including the requirements in current §§10.37 and 10.51(a)(13) (or successor provisions). A qualified tax practitioner means an attorney, a certified public accountant ("CPA"), or an enrolled agent, as those practitioners are defined in §§10.2 and 10.3 of Circular 230, and thus expands who can issue the opinion. However, the class is contracted to exclude foreign counsel unless the foreign counsel is a qualified tax practitioner.

The written advice must meet the requirements of Treas. Regs. §1.6664-4(c)(1), which are the standards that must be taken into account in determining whether a taxpayer has reasonably relied in good faith on advice for purposes of Code §6664. Additionally, as is the case under the present regulations under Code §§4942 and 4945, the written advice must provide sufficient facts about the operations and financial support of the foreign organization for the IRS to determine that the grantee would be likely to qualify as a public charity (other than a disqualified supporting organization) or as a private operating foundation or an exempt operating foundation, as applicable.

While the above changes are in Proposed Regulations, the Proposed Regulations indicate that they may be relied upon on or after September 24, 2012 (unless and until subsequently revised by the IRS including via Temporary or Final Regulations).

COMMENTS. Private foundations are often discouraged from making grants to foreign charitable entities because of the expense involved in making the above determinations. By expanding the class of persons who can provide the requisite opinions to include CPA’s and enrolled agents, the cost of such determinations may decrease. The Treasury Department also believes that by making it easier for private foundations to obtain such opinions, this will encourage more private foundations to obtain written tax advice and thus improve the quality of the determinations being made.

Absent regularly practicing in this area, the time involved for professionals to familiarize themselves with requirements of Code §§4942 and 4945 as to foreign grants (including the above rules) is itself a built-in cost to private foundations making foreign grants. One has to wonder how many enrolled agents have the knowledge or experience to properly address these issues. Nonetheless, the desire of the Treasury Department to reduce costs and expand the class of persons who can make opinions is to be commended.

However, the Treasury Department and the IRS are considering future amendments to take away the ability of the private foundation to rely on an affidavit of the foreign organization, which is an existing alternative to obtaining an opinion of counsel. For those organizations that can obtain such an affidavit, one would think that removing its use would actually raise the cost of compliance. Since the purpose of these modifications is to reduce taxpayer cost, hopefully the Treasury Department and the IRS will not undertake such a change.

REG-134974-12, Preamble to Proposed Treasury Regulations (09/21/2012); Proposed Treas. Regs. §53.4942(a)-3; Proposed Treas. Regs. §53.4945-5

IRS SET TO EASE PRACTITIONER RULES

Almost every email I send out to anyone has this at the end:

CHUCK

Charles (Chuck) Rubin, Esq.
Gutter Chaves Josepher Rubin Forman Fleisher P.A.
Board Certified in Taxation

PRINCIPAL PRACTICE AREAS. Preserving and enhancing individual, family, and business wealth through: Planning to Minimize Taxes (U.S. & International)| Estate Planning, Charitable, Marital and Succession Planning | Business Structuring and Transactions | Trusts & Estates Administration | Creditor Protection | Trust, Estate & Tax Litigation and Disputes

CONTACT INFORMATION. Boca Corporate Center | 2101 Corporate Blvd., Suite 107 | Boca Raton, Fla. 33431-7343 | (561) 998-7847 | (561) 892-0221 (fax) | crubin@floridatax.com | www.floridatax.com | www.rubinontax.blogspot.com

REQUIRED CIRCULAR 230 DISCLOSURE. Pursuant to the provisions of Internal Revenue Service Circular 230 that apply to written advice provided by Federal tax practitioners, please be advised (a) that if any advice herein relating to a Federal tax issue would, but for this disclaimer, constitute a "reliance opinion" within the meaning of Circular 230, such advice is not intended or written to be used, and cannot be used by the affected taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer, and (b) any written statement contained herein relating to any Federal tax issue may not be used by any person to support the promotion or marketing of, or to recommend, any Federal tax transaction(s) or matter(s) addressed herein. We would be happy to discuss the effect of this disclaimer, and alternatives to this disclaimer, with you if desired.

That last block of text above (which I have underlined) arises from the Circular 230 rules governing practitioners, and is intended to make clear that any tax advice rendered does not constitute a ‘covered opinion’ that would require an extensive list of items and analysis to be included in the communication. A similar block of text will be found in most emails of other tax professionals, and indeed in emails of many nontax professionals, too.

In a remarkable reversal of direction, the IRS in proposed regulations will soon make the need for these disclaimers go away. Recognizing that few clients understand them, and that they have become so commonplace that few people even reads them, they are ready to withdraw the disclaimer requirements.

Further, and just as importantly, the IRS will withdraw Treas. Regs. § 10.35 in its entirety. As mentioned above,  these “covered opinion” regulations provide extensive requirements on what a tax practioner must review and put into a tax opinion. The IRS is recognizing that many of the items they require are often not needed, that these requirements increase costs for clients and practioners without providing a worthwhile benefit, and that the problems of tax promoter abuse are abating and were not really reduced by these rules anyway.  Instead, all advice will be governed instead by streamlined, common sense requirements that are similar to those in present Treas. Regs. § 103.7.

Unfortunately, these proposed rules cannot be relied upon until final regulations are issued, so the Internet will continue to be clogged with these unnecessary bits of data on emails. Hopefully, the final regulations will not be too long in coming.  In the meanwhile, don’t delete that disclaimer language from your emails just yet.

IS IT NECESSARY TO RESIDE ON HOMESTEAD PROPERTY ?[FLORIDA]

Can you tell the difference between these two rules of entitlement to homestead status for ad valorem tax purposes?

Fla. Const. Article VII, §6(a): Every person who has the legal or equitable title to real estate and maintains thereon the permanent residence of the owner, or another legally or naturally dependent upon the owner, shall be exempt from taxation thereon . . . upon establishment of right thereto in the manner prescribed by law.

Fla.Stats. §196.031(1): Every person who, on January 1, has the legal title or beneficial title in equity to real property in this state and who resides thereon and in good faith makes the same his or her permanent residence, or the permanent residence of another or others legally or naturally dependent upon such person, is entitled to an exemption . . . as defined in s. 6, Art. VII of the State Constitution.

Okay, I underlined the difference, and the title of this article also clues you in. This difference was the principal issue in a recent Florida Supreme Court case. Under the case, two Honduran parents own a residence on Key Biscayne, Florida. They have temporary visas only, and thus are ineligible to indefinitely remain in the U.S. They live in the residence with their three minor children. The children are U.S. citizens. Miami-Dade County denied homestead status to the residence because the parents were in the U.S. on a temporary basis.

Florida case law does hold that one who does not possess the legal right to permanently reside in Florida cannot establish that their “permanent residence” is being maintained on Florida real property. Therefore, at first it appears that the temporary visas may be an issue here given the requirements for permanent residence.

However, on closer examination, both the Constitutional provision and the statutory provision allow qualification if the residence is the permanent residence of one legally or naturally dependent on the owner – the owner himself or herself need not permanently reside on the residence. Further, the appeals court noted that there is not even an obligation of the owner to reside on the property at all (whether permanently, or otherwise). While there is such a residency requirement for the owner in the statute, there is not one in the Constitution. Thus, the requirement of residency in the statute is unconstitutional. As an aside, this requirement in the statute is probably a hold over from a time when the Constitution did in fact require the owner to reside on the property (which is no longer the case).

The court went on to uphold the homestead status as a factual matter, since the children were eligible to stay in the U.S. permanently, even though the parents could not.  While homestead status itself is not worth that much in savings for ad valorem taxes, presumably the County and taxpayers were more concerned about eligibility of the residence for the Save our Homes cap on annual increases in value for ad valorem tax purposes – an issue that can result in substantial tax savings over time.

While not discussed in the case, once the children are old enough to cease to be the dependents of their parents, then the above provisions will no longer apply and homestead status will then be lost.

Pedro J. Garcia v. David Andonie, Fla. Supreme Court Case No. SC 11-554 (Octo ber 4, 2012)