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Friday, December 27, 2013


Code Section 368(a)(1)(E) generally allows a corporation to rejigger its debt and equity structure and then swap old interests for new interests with its stock and security holders, with no gain or loss to the current owners. A recent Legal Advice by Field Attorneys demonstrates an important limit to such E reorganization nonrecognition treatment.

To qualify for nonrecognition treatment, the old stock and securities that are exchanged for recapitalized stock and securities must have the same value. Kohler, TC Memo 2006-152. In the Legal Advice, the IRS determined that the stock surrendered by the stockholder had little or no value, and that the new stock issued in the reorganization did have value. Thus, nonrecognition treatment did not apply and the stockholder had to recognize gain on the transaction.

Thus, taxpayers need to keep in mind that an E reorganization is not an open door to any type of exchanges of stock and securities arising in a reorganization setting – an equal exchange of value requirement still applies (even though in many cases that is easily satisfied via a pro rata exchange of all existing equity and security interests for the newly issued interests).

Legal Advice Issued by Field Attorneys 20131601F

Friday, December 20, 2013


A recent appellate court decision supporting a challenge to a prenuptial agreement addresses two interesting concepts.

The divorce court recognized that a prenuptial agreement was voidable by the wife due to coercion at the time of signing. Since the wife had learned from her attorney shortly after the marriage that the agreement could be voidable, the divorce court went on to rule that by the time of divorce six years later, the concepts of ratification and laches (i.e., inequitable delay) prevented the wife from making a challenge at the time of divorce. Thus, the court in effect was requiring the wife to bring a challenge to the prenuptial agreement during marriage, instead of waiting until divorce.

The appellate court reversed the divorce court, and allowed the wife to challenge the prenuptial agreement. The appellate court could locate no authority inside or outside of Florida that requires a spouse to challenge a marital agreement during the term of the marriage, since forcing spouses to bring an action during marriage is just bad policy. More particularly, the court provided:

The parties concede that no case in Florida, nor any case in any other jurisdiction, has held that the equitable defenses of ratification and laches apply to validate a voidable prenuptial agreement on the basis that the disadvantaged spouse did not take some form of legal action during the parties' intact marriage to challenge the agreement. Other jurisdictions have declined to apply ratification and laches because it would be contrary to public policy to force a spouse who wanted to challenge the enforceability of a prenuptial agreement to do so prior to the dissolution of the marriage by death or divorce. See In re Estate of Hollett, 834 A.2d 348, 353 (N.H. 2003) (declining to consider “the wife's delay in challenging the agreement as substantive evidence of the agreement's voluntariness or ratification”); In re Flannery's Estate, 173 A. 303, 304 (Pa. 1934) (holding that laches did not bar a wife from challenging the prenuptial agreement during marriage and noting that in litigation between spouses “presumptions or estoppels by lapse of time, ordinarily, do not affect the rights of the wife”); Baker v. Baker, 142 S.W.2d 737, 748 (Tenn. Ct. App. 1940) (explaining that it would go against public policy to require a spouse to challenge a prenuptial agreement during marriage); Kellar v. Estate of Kellar, 291 P.3d 906, 918 (Wash. Ct. App. 2012) (refusing to apply the doctrines of ratification and laches because “considering a wife's delay in challenging a prenuptial agreement as evidence of ratification would penalize the wife for choosing not to disrupt her marriage”) review denied, 312 P.3d 652 (Wash. 2013).

The second interesting aspect of the case was the lesson it gives in how NOT to do a prenuptial agreement. In preparing these agreements, I am often asked, “How close to the wedding can the prenuptial agreement be signed?” There is no black and white answer to that question – but clearly the night before the wedding presents a big problem. The timetable in this case was:

a. Husband presents first draft to wife one month before the wedding.

b. Wife meets with her attorney 11 days before the wedding. The attorney advises her not to sign the agreement, and says she will speak to the husband’s attorney.

c. Wife does not speak any more with her attorney, but goes out to Las Vegas a few days before the wedding. She picks up her husband at 11 p.m. at the airport, he gives her a revised agreement, and sends her out to find a notary and to sign the agreement which has some changes from the prior version. She finds a notary and signs at 2 a.m. without reading the agreement, and then marries later that day.

Apparently, 2 a.m. on the day of the wedding is a bit too late.

SUSAN LEE FLAHERTY, Appellant, v. JERALD CHARLES FLAHERTY, Appellee. 2nd District. Case No. 2D12-3192. Opinion filed December 20, 2013

Saturday, December 14, 2013


Most will and trust disputes in Florida involve at least one mediation attempt – either by order of the trial court or agreement of the parties. Such mediations usually begin in the morning, and often do not wind-up until the evening or wee hours of the morning.

If a settlement is reached, smart mediators will attempt to have the parties negotiate and sign a binding settlement agreement before they leave. This is because if litigants have to time think about a settlement after leaving the mediation, they will often change heir minds and the settlement will evaporate. Thus, at the end of the mediation, litigants are often both physically and emotionally exhausted.

In a recent Florida case, the trial court allowed one of the parties to a will contest to escape from a mediated settlement agreement. The party claimed she was coerced into signing the mediation agreement after the mediator allegedly denied her request to take the agreement home over the weekend to study it.

The trial court noted:

The Court believes that the request for additional time to review was not given the priority or emphasis it should have because Ms. Linda Pierce was fatigued and emotionally distraught from the extensive mediation efforts. However, it is clear that Ms. Linda Pierce, after taking one night to reflect and review the terms of the Agreement, immediately went to the office of the mediator on Saturday morning and hand delivered a note requesting that the Agreement be rescinded. Ms. Linda Pierce also met with her attorney early the next Monday morning and instructed him to file a Motion to Vacate the Settlement Agreement. When Mr. Cummings suggested he could not file such a motion as it would put him in a position of a conflict of interest, Ms. Linda Pierce asked him to draft the Motion, which she then filed pro se.

The trial court concluded that Ms. Pierce had not “freely, knowingly and intelligently entered into the agreement.”

The appellate court reversed the trial court and ordered the settlement agreement to be enforced. To void the agreement, the presence of fraud, misrepresentation, coercion, or overreaching is needed. Fatigue, distress, and second thoughts are not enough.

The appellate court noted that emotion is not grounds to set aside an agreement, since courts recognize that it is normal for parties in these matters to be emotionally upset. Further, the parties were ably represented by counsel experienced in probate law, and the parties reviewed and corrected several drafts of the agreement over the course of the mediation. While the challenging party may have at one point made a request to review the agreement over the weekend, the fact that at the end of the day she had read and signed the agreement without requesting additional time for review was evidence of lack of coercion.

TAMRA E. PIERCE, Appellant, v. LINDA MARIE PIERCE IN RE: ESTATE OF CECILIE REDLINGER PIERCE, DECEASED, Appellee. 1st District. Case No. 1D13-1546. Opinion filed December 10, 2013



Monday, December 09, 2013


In the recent 2nd DCA case of Berlinger v. Casselberry, the court allowed a continuing writ of garnishment against distributions to be made to a beneficiary of what appears to be a discretionary trust, for unpaid alimony obligations of the beneficiary. This opinion resolves (at least within the 2nd DCA) some statutory questions regarding continuing writs of garnishment, but raises others.

The continuing writ is not a surprise here, since it is specifically contemplated by Fla.Stats. Section 736.0503(3) that provides special limitations on creditor protection and spendthrift trusts for unpaid support and maintenance obligations. Fla.Stats. Section 736.0503(3) is a codification of Bacardi, 463 So.2d 218 (1985), which voided the application of spendthrift provisions of trusts for similar marital obligations. Since 736.0503(3) is expressly subject to 736.0504 by its language, the issue remained whether 736.0504 prohibits garnishment in the circumstances of a discretionary trust. 736.0504 limits creditor rights against discretionary trusts. Thus, an argument exists that 736.0504 overrides 736.0503(3) when a discretionary trust exists. The Berlinger court ruled that a writ of attachment can still apply, notwithstanding the existence of a discretionary trust under 736.0504 and the reference to it in 736.0503(3).

The Berlinger decision relies in part on Bacardi. Since Bacardi predated the establishment of Florida’s trust code in Chapter 736, and indeed was codified into 736.0503(3), its continued application perhaps can be questioned. By relying on Bacardi in part, the 2nd DCA indicates it still applies separate and apart from Chapter 736.

The interesting question here is whether Berlinger can be read to say that a continuing writ of garnishment can be obtained by other creditors NOT described in 736.0503(3) when a discretionary trust is involved. The opinion does not rule this out, and perhaps can be read to broadly say that continuing writs of garnishment are not prohibited in any circumstances against discretionary trusts by 736.0504. Or does the special language of 736.0503(3) and the public policy of Bacardi justify a continuing writ of garnishment only in the circumstances described in 736.0503(3)? Here is the key language of the opinion:

"According to section 736.0504(2), a former spouse may not compel a distribution that is subject to the trustee's discretion or attach or otherwise reach the interest, if any, which the beneficiary may have. The section does not expressly prohibit a former spouse from obtaining a writ of garnishment against discretionary disbursements made by a trustee exercising its discretion. As a result, it makes no difference that the instant trusts are discretionary. Casselberry is not seeking an order compelling a distribution that is subject to the trustee's discretion or attaching the beneficiary's interest."

BRUCE D. BERLINGER, Appellant, v. ROBERTA SUE CASSELBERRY, Appellee. Case No. 2D12-6470. District Court of Appeal of Florida, Second District. Opinion filed November 27, 2013

Saturday, November 30, 2013


A recent Tax Court case addressed some interesting issues relating to the estate tax value of an LLC interest. Below is a summary of these issues.

A. Valuation of An Interest as a Full Member Interest or an Assignee Interest. The operating agreement for the LLC interest provided that if an LLC interest is transferred outside of the family, the new owner is a mere assignee that cannot participate in management unless all of the other members vote to admit the new owner as a full member. At the time of the decedent’s death, the LLC interest at issue was owned by a trust, and included in the decedent’s gross estate via Code Section 2038. The interest in the hands of the trust was a full member interest.

The estate sought to value the transferred interest as an assignee interest only. The Tax Court declined, and said it should be valued as a member interest because that is what it was immediately before death. Nonetheless, since a buyer would consider the restrictions on transfer in the operating agreement in determining what it would pay, such nonfamily/assignee restrictions should still be a factor in the final valuation.

B. Net Value vs. Income Approach. The estate sought to value its LLC interest based on the historical distributions made to its members (i.e., an income approach), especially because it wanted to characterize the LLC as an assignee interest that could not participate in management.

The IRS instead valued the LLC interest based on a net asset value approach – valuing the assets of the LLC, deducting LLC liabilities, and then multiplying that net value by the percentage of the LLC attributable to the subject LLC interest.

Note that both approaches are the starting point for valuation – once a preliminary value for the interest is obtained then appropriate discounts for lack of control and lack of marketability as to the LLC interest are applied.

The court noted that a net asset method of valuation applies to mere holding companies since they are not managed for current income, while an earnings-based method applies to going concerns. It also noted a mixed net value and income/distribution capitalization approach has been applied in other cases for a closely held real estate firm. While the court did acknowledge that the rental of the LLC’s real estate constituted an operating business and thus suggested some focus on historical distributions to members, it applied the net asset value approach for the value of the LLC interest (even though the real estate itself had been valued using an income approach) – this was done partly because no evidence appears to have been accepted into evidence as to those values. Cases cited by the Tax Court for applying a mixed valuation approach were  Estate of Andrews, 79TC 938 (1982) and Estate of Weinberg v. Commissioner, T.C. Memo. 2000-51. Thus, the case does not foreclose a mixed approach in general – just under the lack of evidence presented in this case.

C. It Can Be Difficult for a Taxpayer to Claim a Lower Value than Originally Reported. Here, the estate argued for a valuation lower than the value it reported on the estate tax return. This is often a negotiating tactic for estates on audit, and at other times such assertions of lower values are wholly bona fide after a different set of professionals review the initial reporting. The Tax Court was resistant, noting:

"[V]alues or discounts reported or claimed on an estate tax return may be considered admissions and, to some extent binding or probative, restricting an estate from substituting a lower value without cogent proof that those admissions are wrong.” Estate of Deputy v. Commissioner, T.C. Memo. 2003-176 [TC Memo 2003-176], 2003 WL 21396789, at *5 n.6; accord Estate of Hall v. Commissioner, 92 T.C. 312, 337-338 (1989). We have no cogent proof that the value that petitioner relied on in reporting the value of the subject interest on the Schedule G is wrong.

Estate of Diane Tanenblatt, et al. v. Commissioner, TC Memo 2013-263

Friday, November 29, 2013


Two individuals borrowed money from the mother of one of them. A mortgage was prepared to secure the debt, but it was not recorded in the public records.

Oftentimes, mortgages are not recorded between friends and family. They will allow the holder to foreclose on any debt defaults, so they still provide protection to the lender. However, other lenders are not on notice of the debt and thus the mortgage may be subordinated to later mortgages and security interests.

The borrowers sought to deduct interest that they paid to the lender.  Code Section 163(h) prohibits an interest deduction for personal interest, but provides an exception for qualified residence interest.  The statute requires that to be qualified residence interest, the debt must be “secured by the residence.”

The taxpayers asserted that an unrecorded mortgage still secures the related debt. What beat the taxpayers here was Treas. Regs. § 1.163-10T(o)(1), which requires that a mortgage be “recorded, where permitted, or is otherwise perfected in accordance with applicable State law.” Thus, the Tax Court denied the deduction, and thus reminds taxpayers that if they want an interest deduction in these situations, they will need to record the mortgage.

Christopher DeFrancis and Jennifer Gross v. Commissioner, T.C. Summary Opinion 2013-88

Saturday, November 23, 2013


Under Florida law, a creditor cannot file an effective claim against an estate more than 3 months after publication of the Notice to Creditors, UNLESS the creditor is a known or reasonably ascertainable creditor that was not sent a Notice to Creditor. Therefore, such a known or reasonably ascertainable creditor that has not received notice can file a claim more than 3 months after the publication date, so long as it is not more than 2 years after death of the decedent (per the absolute 2 year deadline of Fla.Stats. Section 733.710).

Can such a creditor directly file a claim, or does the creditor also have to file a motion for leave to file a later claim within the 2 year period? In Morgenthau v. Estate of Andzel , 26 So.3d 628 (Fla. 1 st DCA 2009) and Lubee v. Adams, 77 So.3d 882 (Fla. 2d DCA 2012), two District Courts of Appeals require that the motion be filed to trigger a court review whether the creditor is a known or reasonably ascertainable creditor that should have received notice – the mere filing of the claim is not enough. Now, along comes a new case, Golden v. Jones, 2013 WL 5810360 (4th DCA 2013), which provides that the motion is not required.

Legislative relief on the need to file such a motion may be forthcoming. But until it does, or unless the Florida Supreme Court resolves the split among its Circuits, creditors outside the 4th DCA should nonetheless file the motion to protect their late filed claims.

For additional write-ups on the case, see Rubin on Probate Litigation (Jenna Rubin) and the Probate and Trust Litigation (Juan C. Atunez) blogs.

Golden v. Jones, 2013 WL 5810360 (4th DCA 2013

Saturday, November 16, 2013


I’ve been putting these tables together since 1990 – formerly on paper and mailed out, now on our firm’s website. Below are the updated 2014 tables with the recent inflation adjustments.

You can access these charts whenever you want here, or from the link in the links section on the right. Since it is a good idea to glance at these things at least once a year, I have also reproduced the federal items below to make that task easy for you (you will need to click the link to see the Florida items).

















Wednesday, November 13, 2013


A regular part of planning for high net worth families are dynasty trusts – long term multi-generational trusts that are exempt from generation skipping tax. The trusts are more attractive than ever, with expanded generation skipping tax exemptions ($5.25 million in 2013) and an extended or eliminated rule against perpetuities provisions in many states.

The typical thought is that these trusts will grow and service many generations of beneficiaries. Hugh Magill, the Executive Vice President and Chief Fiduciary Officer of Northern Trust has combined Northern Trust’s data from its many years of trust administration and some modeling, and gleaned some observations about how such trusts actually operate, and might operate in the future. Some of his observations (mixed in with a few of my own) that may challenge your assumptions about dynasty trust include:

A. The number of beneficiaries will multiply faster than you think. With some reasonable assumptions about child-bearing ages and  each family unit having two children, in 50-60 years time a pot trust could have as many as 30 current beneficiaries.  As time progresses, the number increases potentially so that if a trust lasts for a very long time (as some may anticipate), it could have as many as 160,000 to 500,000 beneficiaries! As Hugh speculates, who would want to be trustee of that trust?! Obviously, the more beneficiaries there are, the quicker the trust will be depleted (depending on distribution standards used). Having an early termination of the pot trust via a break up into separate per stirpes trusts will reduce this, but will still result in continual subdivision and shrinkage of each trust as they pass through the generations. Hugh also raises the question of fairness – at what generation level would it be more equitable for a pot trust to divide per capita (equally per beneficiaries) rather than per stirpes?

B. Applying some Monte Carlo modeling and assumptions, a median result for a $5.25 million dynasty trust established in 2012 estimates growth to $9.8 million in 2029, and then it starts to decline, reaching $4.1 million in assets by 2071. However, these are 2012 dollars – if inflation is considered, that $4.1 million will be worth much, much less than $4.1 million in today’s dollars.

C. If the trust is a grantor trust, that will boost the return somewhat since it will have a few years of not being taxed at the beginning of its life, but that treatment ends when the grantor dies. This treatment augments the median value estimate to $5.3 million in 2071.

D. Note, however, that these projections involve a diversified portfolio of marketable assets and securities. If the trusts are funded with discounted assets and/or highly appreciating assets, the growth of the trust and its size over time can be substantially increased.

E. Payout standards will also impact how long the trust will maintain significant assets – obviously, the more that is paid out in distributions, the fewer the assets that will remain and grow in the trust. Planners may want to consider scaling back from mandatory income, significant unitrust, and/or HEMS distributions after a generation or two to help the trust maintain its assets – perhaps limiting distributions to health and education purposes.

The fact that a dynasty trust may not last as long as originally anticipated may not be of much concern to many grantors. While there are those grantors who are looking to carry the trust as far into the future as possible (especially in very high net worth families), many grantors will not even have known what a dynasty trust is when they first walk into their lawyer’s office. Such grantors will often have no problem with such trusts exhausting themselves sooner, rather than much later.

Thanks to Hugh Magill for his work and observations, and his permission to me to attempt to restate them here – and my apologies in advance to Hugh if I have incorrectly summarized any of his points.

Sunday, November 10, 2013


A recent Tax Court case illustrates a trap for the unwary in regard to the computation of self-employment taxes.

Spouses subject to community property laws obtain an interest in the assets and income of their spouses. Unlike what one might expect, this “sharing” does not apply, however, in regard to self-employment tax computations.

Self-employment taxes are based on net earnings from self-employment. Code §6017 expressly provides that for a husband and wife filing a joint return, the income is not aggregated for purposes of computing the tax, but computed separately.  That section is silent as to community property income. However, Code § 1402(a)(5) specifically addresses community income in defining net earnings – the general rule is that income and deductions will be attributed to the spouse carrying on the trade or business (but it will be shared if the spouses jointly carry on the business).

In the case, the wife tried to use the losses from the husband’s accounting practice to offset the income from her realty business for self-employment tax purposes. The Tax Court did not allow it, based on the foregoing provisions.

Donald and Brenda Fitch, TC Memo 2013-244

Friday, November 08, 2013


In a recent Tax Court case, a decedent had sold properties to trusts in exchange for fixed annuity payments. The decedent died during the term of the annuities, and the IRS sought to include the value of the transferred properties in the decedent’s gross estate under Code §2036. The IRS was able to prevail.

The estate argued that the transfers of the properties to the trusts avoided Code §2036 by constituting “bona fide sales for adequate and full consideration.” The Court ruled against this argument for several reasons:

    a. The decedent did not receive adequate and full consideration since the present value of the annuity payments did not equal the value of the property transferred - i.e., there was a gift element to the transfer.

    b. There was no “bona fide” sale in an arm’s length transaction sense, since the decedent prepared the trust agreement in the absence of meaningful negotiation or bargaining with other cotrustees or future beneficiaries. The decedent formed the transaction, fully funded the trust, and essentially stood on both sides of the transaction.

    c. An argument, borrowed from transfers to partnership cases, that the transaction qualified for sale exception due to nontax purposes for the transaction failed. It first failed because the Tax Court did not equate this type of transfer with a transfer to a partnership where nontax purposes are a relevant aspect. It also found as a factual matter that there really were no nontax purposes for the transaction.

The estate also argued that the decedent had not retained an interest in the property under Code §2036 - i.e., that there was no “express or implied agreement at the time of transfer that the transferor will retain lifetime possession or enjoyment of, or right to income from, the transferred property.” A provision in the annuity trust agreement allowed for additional income to be distributed to the decedent at the direction of the trustees. There were 3 trustees - the decedent and two children. The court noted that “because decedent and her children could make distributions of additional income to decedent when and in the amount they pleased, decedent maintained the same enjoyment of the properties and their income stream as she had before she transferred the properties to the annuity trust.” This fact (notwithstanding Byrum), combined with the decedent’s continued control over the transferred property per how the trust was operated, and the use of the income from the properties to discharge her personal legal obligations, was enough for the court to find a Code §2036 retention of interest.

The estate nonetheless argued that the transaction was a bona fide sale for an annuity, and thus the decedent did not retain an interest in the property that was transferred but simply exchanged it for an annuity. The Court noted that in Ray, 762 F2d at 1363, that a sale for an annuity would not be respected as such when “(1) the property the taxpayers transferred to the trust was, in effect, the only source for their “annuity” payments; (2) since the trust's income was designed to equal the annual payments to the taxpayers,  the “annuity” payments would not be paid from the trust corpus; and (3) the trust corpus would be available for “ultimate distribution to the trust beneficiaries.”  By contrast, “a sale in exchange for an annuity occurred where the parties structured the transaction as an annuity obligation, the amount of the annuity did not bear a mathematical relationship to the trust income, the transferor did not control the property transferred, and the trust corpus was used to pay the annuity rather than simply providing for annuity payments as a conduit for the trust income.” The court held that the facts of this case more closely resembled the earlier “no sale” factors then the later “sale” factors.

Estate of Helen A. Trombetta et al. v. Commissioner, T.C. Memo. 2013-234

Monday, November 04, 2013


Florida comes in at a very respectable #5. Woe to those in the bottom three – California, NY, and NJ.


Go here for a more readable version of the diagram and other background information.

Saturday, November 02, 2013


In Rev. Proc. 2013-35, the IRS has published inflation-adjusted amounts to various taxes, exemptions, and other items. The unified credit basic exclusion amount for transfer tax purposes, along with the GST tax exclusion, has been increased to $5.34 million.

I have updated my historical table of transfer tax rates to include 2014 – a copy can be viewed and downloaded from here. It can also be accessed at any time from the list of links in the right hand column. I keep a copy under the glass of my desk since questions about a particular rate or exemption from a prior year always come up.

For those with an interest in the full list of inflation adjusted items, click here for Rev.Proc. 2013-35.

Sunday, October 27, 2013


As a practitioner in Florida, a state without a state individual income tax, planning for state income taxes is not an every day event. Nonetheless, it does come up on occasion, and of course, it is a regular issue for residents of states with such taxes.

Below is an overview and primer on a planning technique that has received some favorable private letter rulings. It generally involves the transfer of assets (oftentimes a highly appreciated asset) to a trust in an asset protection trust jurisdiction. The principal purpose of the arrangement is to avoid state income on income and gains from the asset.

Thanks to Stephen Liss of Barclays for much of the information for this primer, taken from his presentation on the subject in Boca Raton last week.

I. Benefits

     A. Avoid state income taxes on sale of appreciated assets and other investment earnings

     B. Asset protection

     C. Grantor retains access to gifted property via usual asset protection trust mechanisms

II. Elements

     A. Trust in an asset protection trust jurisdiction (e.g., Delaware, Nevada) that has no state income tax

          1. Delaware useful with its directed trust statute

     B. Non-grantor trust

          1. To avoid state income tax to the grantor under grantor trust rules

          2. Typically done by requiring an adverse party to have to consent to distributions to spouse or grantor (i.e., a trust beneficiary)

               a) Can have several beneficiaries and allow distribution only on consent of one of them

     C. Funding via incomplete gift

          1. To avoid transfer tax on funding of the trust

III. Detriments

     A. Need for a local trustee in the trust jurisdiction

     B. Costs

          1. Drafting

          2. Accounting/tax returns

          3. PLR cost, if sought

          4. Trustee fees

     C. Makes no sense if grantor will not already be in the highest federal tax bracket, per trust tax rate compression which will push the trust quickly into the highest income tax bracket. Saving state income taxes while increasing federal income taxes will diminish or eliminate the benefits of the planning

     D. Distributions of trust income to the grantor (or other beneficiaries) may still be subject to state income tax

IV. Watch

     A. Confirm qualification under state law to avoid income tax

          1. Some states, such as Illinois, Virginia, and Wisconsin may tax the trust or the settlor if the settlor was a resident there when the trust was established

          2. Some states will subject the trust to tax if there is a resident co-fiduciary

V. Candidates

     A. Grantor is in a high income tax state

     B. Grantor is in a high or the top federal income tax bracket

     C. Pending sale of a highly appreciated asset

Wednesday, October 23, 2013


A U.S. shareholder of a controlled foreign corporation (CFC) has gross income on its share of the CFC's subpart F income. This income includes “foreign base company sales income” or FBCSI. FBCSI generally involves income from the related party purchases or sales of property.

However, Treas. Regs. §1.954-3(a)(4)(i) excludes from FBCSI income derived in connection with the sale of personal property manufactured, produced or constructed by the CFC. A recent private letter ruling addressed the question whether planting and growing activities constitute manufacturing or production for this purpose.

The IRS did allow for the growing activities to constitute production under the facts of the ruling. So it is useful that the IRS did not declare that growing activities cannot be production.

Beyond that, it is hard to say what the IRS meant. Did they say that growing activities in conjunction with other related production activities can give rise to excluded production income for the combined activities, but that pure growing activities alone will not? Or did they say that growing activities alone can constitute production if and when it meets the specific tests provided in the regulations, such as the substantial transformation test, the substantial in nature test, or substantial contribution test?

PLR 201340010

Saturday, October 19, 2013


I have previously written on the “quiet disclosure” alternative for complying with U.S. offshore reporting requirements. See my prior posts here and here. Under this alternative, late filing taxpayers will not participate in the Offshore Voluntary Disclosure Initiative (OVDI) program. Instead, they will simply file the delinquent returns and reporting forms late – (i.e., a “quiet disclosure”), and hope that the IRS does not pick up on them for audit or penalty purposes.

A key benefit of the OVDI program is the substantial mitigation of criminal tax prosecution. Those that proceed with a quiet disclosure do not obtain this benefit. Nonetheless, in pursuit of a policy of seeking to have taxpayers become compliant by whatever means, perhaps the Treasury Department would not want to pursue criminal prosecutions against quiet filers since that would likely deter future compliance by other taxpayers. Presumably, Treasury would prefer “quiet disclosure” to no disclosure.

Recent discussions by professionals suggest that quiet filers may be more at risk than they suppose. For example, some practitioners have indicated that it is clear that the IRS has figured out a way to detect non-program disclosures, and that such filers may be subject to civil penalties higher than those imposed on OVDI participants (even OVDI participants that opt out of OVDI penalty procedures).

See Jaime Arora, IRS Auditors Taking Closer Look at 'Quiet' Disclosures of Offshore Accounts, 2013 TNT 202-4 (10/18/13) for an article on this subject. Thanks to Mitchell Goldberg of our firm for bringing this article to my attention.

Sunday, October 13, 2013


Code §6166 can be a lifesaver for estates with large business assets. The provision will allow qualifying estates to defer payment of estate taxes on their business interests, and then pay off the tax liability over a 10 year period. Interest must be paid annually on the unpaid tax. Essentially, the IRS becomes a bank and allows the estate to defer full payment of the estate tax for up to 15 years. The purpose of the section is to avoid a fire sale of the business interest to pay estate taxes, and thus to allow a more orderly sale to occur or to allow time to pay the tax out of the cash flow of the business or other sources.

In a recent Tax Court case, an estate made several years of interest payments, but then stopped. The estate applied for, and received, additional extensions to make interest payments based on inability to pay and ongoing estate litigation issues. Eventually, however, the IRS lost patience and asserted its rights under Code §6166(g)(3)(A) to terminate the deferred payment arrangement when payments are late. The estate sought to challenge such termination as an abuse of discretion by the IRS.

The Tax Court ruled in favor of the IRS and upheld the termination of the Code §6166 election.

Some takeaways from the case:

     a. The estate was embroiled in litigation between beneficiaries and its fiduciaries. To a certain extent, the IRS was sympathetic and granted extensions of times for interest payments. At some point, the IRS lost patience and terminated the election. Oftentimes in estate litigation it is difficult or impossible for the disputants to act coherently or uniformly as to applicable tax issues. Such problems may be used to obtain discretionary extensions of time to pay interest and taxes from the IRS, but the IRS may or may not by sympathetic to such requests.

     b. The fact that the total amount of estate tax due is under audit and the subject of dispute with the IRS will not bar the IRS from being able to terminate the Code §6166 election for nonpayment. In this case, one of the business properties was the subject of dispute as to value – the original Form 706 reported its value at approximately $9 million (the value upon which the original Code §6166 deferral was sought and obtained), a supplementary Form 706 reported it at $0, and the IRS is now seeking to value at over $90 million (yikes!). The Tax Court explicitly ruled that such pending valuation matters were not a bar to the IRS terminating the election for nonpayment.

Estate of Franklin Z. Adell, TC Memo 2013-228 (September 30, 2013)

Thursday, October 10, 2013


Libertarians exclaim – “see, the government is shut down and people barely notice!” Big government types exclaim – “see, the government is shut down and things are terrible!”

Well, there is one group that should be happy  - federal tax delinquents. The IRS has updated its website to advise:

During the lapse in appropriations, the IRS is not sending out levies or liens - either those generated systemically or those manually generated by employees.

The website further advises:

In non-criminal cases, the only enforcement actions the IRS is taking during the appropriations lapse involve isolated instances where we need to take immediate action to protect the government's interest.

Viva la shutdown!

Just so no one gets the wrong idea that there is only good news:

Taxpayers should continue to file and pay taxes during a lapse in appropriations as they would under normal government operations. Individuals who requested an extension of time to file should file their returns by Oct. 15, 2013. Taxpayers can file their tax return electronically or on paper, though the processing of paper returns will be delayed until full government operations resume. Payments accompanying paper tax returns will still be accepted as the IRS receives them. Tax refunds will not be issued until normal government operations resume.

IRS Operations During The Lapse In Appropriations

Saturday, October 05, 2013


Okay, I know what you are thinking – what is a “net, net gift?”
Most estate planners know that a “net gift” is a gift transfer when the donee assumes responsibility for applicable gift taxes. Normally, a donor is responsible for gift taxes on a gift, and they are paid from separate assets or funds of the donor. If it is a net gift, the donee pays the taxes – usually, but not always, from the assets that are gifted. Since the donor is receiving consideration for the gift (the payment of tax paid by the donee), the amount of the gift subject to gift tax is reduced.
A “net, net gift” adds in a second payment obligation. Here, the donee also agrees to pay any increase in estate taxes imposed on the donor’s estate under Code §2035(b) relating to the gift. That provision adds back to the gross estate any gift taxes paid on a gift if the donor dies within 3 years of the gift. Remember that there is an advantage to making gifts and paying gift taxes, instead of holding the assets until death and paying estate taxes. If a gift tax is paid by the donor, the tax is gone and no gift or estate tax is paid. If the gift is not made, the estate tax on the same transferred assets are still included in the gross estate and are thus subject themselves to estate tax. Code §2035(b) was enacted to prevent death bed gifts from obtaining this gift tax benefit – if death occur within 3 years the gift tax is subject to estate tax so no transfer tax benefit arises from the gift.
The Tax Court had previously ruled in McCord v. Commissioner, 120 T.C. 358 (2003) that a net, net gift payment obligation could not reduce the value of a gift for gift tax purposes. The Court was reversed by the 5th Circuit Court of Appeals in Succession of McCord v. Commissioner, 461 F.3d 614 [98 AFTR 2d 2006-6147] (5th Cir. 2006), which allowed the reduction. Since the current case is not a 5th Circuit case, the Tax Court is not bound by the Court of Appeals in Succession of McCord under the Golsen rule. Nonetheless, the Tax Court discarded its prior analysis in McCord and allowed a gift tax value reduction for the Code §2035(b) estate tax assumption element.
Here are some interesting take-always from the opinion:
     a. Computing the actuarial value of the assumption of the contingent obligation to pay estate taxes if the donor does not survive three years is not simple. For those with an interest, the petitioner’s attorney and her appraiser wrote an article on the subject which was referenced in the opinion: Michael S. Arlein & William H. Frazier, “The Net, Net Gift”, 147 Tr. & Est. (Arlein & Frazier) 25 (2008).
     b. A relatively large gift is needed to obtain a material reduction from the net, net gift. A large gift was involved in the case – total gifts of more than $71.5 million. The value of the estate tax assumption obligation (and thus the gift tax value redction) was determined to be approximately $5.8 million.
     c. If the payment of consideration is “too speculative,” then no reduction in the value of the gift should apply. The Court of Appeals in McCord applied the willing buyer/willing seller test to this determination by asking whether a willing buyer would insist that the seller factor the contingency into the price – if yes, then it should be recognized as consideration reducing the amount of the gift.
    d. If actuarial science cannot reasonably determine a value for a contingency, then it will likely be ignored. The opinion cited Robinette v. Helvering, 318 US 184, wherein the Supreme Court disregarded a contingency when the factors to be considered in fixing the values of the contingent remainders on the date of the gifts included: (1) whether a daughter would marry; (2) whether a daughter would have children; and (3) whether those children would reach the age of 21. The Supreme Court noted: "[W]e have no reason to believe from this record that even the actuarial art could do more than guess at the value here in question.”
     e. The computation here is not beyond the reach of actuarial science. The court noted:
In this case, as in McCord, the contingency in issue is whether petitioner would survive three years after the date of the gift. Like the contingency in Smith, this contingency is simple and based on the possibility of survivorship; it is not complex like the contingency in Robinette, which depended on multiple occurrences.
     f. The fact that estate tax rates and exemption amounts may fluctuate over the three year term of Code §2035(b) does not create enough uncertainty as to make it impossible to value the contingent tax payment obligation.
     g. One of the theories applied in a net gift situation is the ‘estate depletion theory.’ Under the estate depletion theory, a donor receives consideration in money or money's worth only to the extent that the donor’s assets have been replenished. The IRS argued that the donor obtained no replenishment, only the donor’s estate. The Court equated the donor and the donor’s estate for this purpose, rejecting the IRS argument.
     h. The dissenting opinion did make an interesting policy argument that favors the IRS. Code §2035(b) was intended to put a donor who makes a gift subject to gift tax the day before he dies on the same footing as he would be if he did not make the gift and thus the gifted assets are instead subject to estate tax. By allowing a reduction in the amount of the gift for the contingent payment obligation, the amount of the gift tax is reduced, and thus the amount of the add-back under Code §2035(b) is effectively reduced. Thus, there is still a benefit to making a death bed gift notwithstanding Code §2035(b) if a net, net gift is made – and as such, the operation and purposes of Code §2035(b) can be partially subverted.
Steinberg v. Comm., 141 TC No. 8 (9/30/13)

Tuesday, October 01, 2013


Most taxpayers making charitable contributions will transfer their own funds or property to the charitable recipient. What happens if another person or entity makes the actual transfer to the charitable recipient?

Prior case law will allow a charitable deduction to a taxpayer, if the funding of the charitable contribution is made by an agent of the taxpayer acting for the taxpayer.  Skripak, 84 TC 285 (1985) ; Weitz, TC Memo. 1989-99.

A recent Tax Court Memorandum decision expands on these principles. The key take-always from the decision are:

a. For the taxpayer to be able to deduct the contributions, the taxpayer will need to show that he or she bears the economic burden of the contributions.

b. A written agency agreement establishing the agency relationship is not required. However, there must be some evidence of the agent’s asset to act on the taxpayer’s behalf.

c. Agency will be easier to establish when the agent has property of the taxpayer and uses that property to make the contribution.

d. However, and contrary to the desire of the IRS, if the agent uses its own funds with the understanding that the taxpayer will reimburse the agent, the taxpayer will be treated as bearing the economic burden of the contributions. An actual failure to reimburse, however, will open the door to denial of the deduction.

Zavadil, TC Memo 2013-222

Saturday, September 28, 2013


The IRS will issue inflation-adjusted transfer tax and foreign reporting items for 2014 based on fiscal year 2013 inflation, but it hasn’t done so yet. Thomason Reuters does its own computations of what it estimates will be the adjustments for 2014, and these tend to be very accurate. So, for a peek at what the 2014 adjustments will likely be:
b. GIFT TAX ANNUAL EXCLUSION AMOUNT  - $14,000 per recipient (unchanged);
d. FOREIGN GIFT REPORTING THRESHOLDS – $100,000 aggregate gifts from a nonresident alien individual or foreign estate; $15,358 for gifts from foreign corporations and foreign partnership;
e. COVERED EXPATRIATE INCOME THRESHOLD – $157,000 average annual net income tax for preceding five years;
f. FOREIGN EARNED INCOME EXCLUSION – $99,200 ($1600 increase from 2013).

Sunday, September 22, 2013


Earlier this summer, Florida’s land trust statute underwent a substantial revision. Below are the major highlights:

1. Florida has separated out the title aspects of land trusts from the other provisions. This is because the title aspects apply both to land trusts under the land trust statute, and trusts that are not land trusts (i.e., Chapter 736 trusts). The title rules are now in Fla.Stats. §689.073(1). The land trust provisions remain in Fla.Stats. §689.071.

2. The title aspects (relating generally to a trustee having full authority to sell, mortgage, and similarly deal with the subject real property) are pretty much the same as they used to be, and are triggered by the designation of the titleholder in a recorded  transfer instrument as “trustee” or using “as trustee” language, and specifically conferring on the trustee the power and authority to protect, to conserve, to sell, to lease, to encumber, or otherwise to manage and dispose of the real property described in the recorded instrument. As noted above, these provisions apply both to land trusts and Chapter 736 trusts. The purpose of these title rules is to allow persons dealing with the trustee in a sale or conveyance or similar title transactions to deal only with the trustee and to not be concerned about rights of beneficiaries or other provisions of an unrecorded trust instrument.

3. The law is now clear that a land trust is generally not subject to Chapter 736 (the provisions of Florida law governing trusts). This is in accord with the general difference between a land trust and other trusts subject to 736. Land trusts are principally only title holding devices, with the trustee subject to substantial beneficiary control. Because of the limited authority and discretion of a land trustee, the more extensive provisions of Chapter 736 do not apply.

4. So what is a “land trust” that is subject to Fla.Stats. §689.071? For trusts formed after June 28, 2013, there are two elements: (a) A recorded instrument confers on the trustee the title powers and authorities  described in Fla.Stats. §689.073(1) (as discussed under 2. above), AND (b) the trustee’s duties under the trust agreement, including any amendment made on or after such date, are no greater than those limited duties described in paragraph (2)(c) of Fla.Stats. §689.071. Whether earlier trusts are land trusts will turn on an express designation as such in a recorded instrument or intent of the parties to have a land trust can be discerned, and whether an express or implied intent to be governed by Chapter 736 exists.

5. The beneficiary’s interest in a land trust will now be treated as personal property (and not real property) ONLY IF such a declaration is made in a recorded instrument or in the trust agreement.

6. The UCC is coordinated with the statute in regard to granting security interests in a beneficiary’s interest. If the interest is treated as personalty, the personalty provisions of the UCC secured interest rules apply – if it is real property, a mortgage will be needed.

Tuesday, September 17, 2013


In a welcome modernization, the Florida Department of Revenue now allows for online payment of documentary stamp taxes, such as those imposed on issuers of promissory notes and other written indebtedness.

Higher volume taxpayers must register and use Form DR-225. Others can use Form DR-228 without having to formally register. You can access the system here (click on Documentary Stamp Taxes) once opened.

Sunday, September 15, 2013


A downside to the IRS’ recognition of same sex marriages is that such couples must file in 2013 as married – they can file jointly or or as married filing separately. This means they may now suffer higher income taxes due to the marriage penalties that exist in the Internal Revenue Code.

To avoid future headaches, such couples should check on their current wage withholding and estimated taxes, and adjust them upward if needed, if their taxes will be going up based on their new marital status.

Thursday, September 12, 2013


In a recent appellate case, the taxpayer filed required FBAR’s late, using the filing procedure allowed for late filings under the 2009 OVDI FAQ. Nonetheless, the court found that the FAQ relief from civil penalties was not a bar to the government asserting criminal penalties.

Thus, those doing late filings under the OVDI FAQs should not consider them necessarily safe from criminal prosecution.

In the case, the taxpayer did not qualify for using the late filing FAQ anyway, since not all offshore income had been reported timely. Nonetheless, it appears the court would still have allowed criminal liability even if the FAQ applied.

There were some bad facts that surely contributed to the government’s attitude, and possibly that of the court. For example, there was an offshore trust, and lots of money being spent. Nonetheless, the taxpayer hardly reported any income and sought financial aid for his children’s education. The taxpayer was also a CPA. Whether a different result would have arisen absent these facts cannot be gauged.

US v. Simon, 7th Circuit Court of Appeals, August 15, 2013

Sunday, September 08, 2013


Transfers to charitable lead trusts during lifetime can provide tax benefits to the donor, and can avoid inclusion of the transferred property in the gross estate of the donor for federal estate tax purposes at death. However, donors often try to keep things “all in the family” by having the required distributions from the lead interest being made to a family private foundation of which the donor is a founder and/or manager. In those situations, the donor must deal appropriately with both the trust and the foundation to obtain completed gift treatment and to avoid gross estate inclusion. Retained powers and authority via the foundation can jeopardize these items.

A 2013 private letter ruling provides a useful roadmap for obtaining both completed gift treatment and avoiding gross estate inclusion, when a private foundation is involved. The donor must act to separate himself from managing either the trust, or funds of the trust that are received by the foundation. The particular things that were done to obtain the desired tax treatment included:

a. the donor cannot serve as trustee of the charitable lead trust;

b. while the donor can serve as a director of the foundation, the donor is not permitted to vote on matters relating to disbursements or grants of funds received from the trust;

c. a quorum of the Board of Directors of the foundation, excepting the donor, established a committee, with the sole authority to receive, separately invest and make all investment decisions and administrative, grant and distribution decisions on behalf of the foundation with respect to and regarding all funds received by the foundation from the trust. The committee consists of at least three members, at least one of whom is not a director of the foundation and at least one of whom is not related or subordinate to any director of the foundation as defined by § 672(c). All actions by the committee shall require unanimous consent.

c. any funds received by the foundation from the trust will be segregated into a separate account. The committee will administer and distribute the separate account. The donor will have no power over the account or the committee.

PLR 201323007

Sunday, September 01, 2013


In a recent Tax Court case, a 40% shareholder of an S corporation medical practice was locked out of the office and the practice by the 60% shareholder. Nonetheless, at the end of the tax year, the S corporation issued a Form K-1 to the 40% shareholder allocating to him $215,920 of business income and $2,344 of interest income.

The 40% shareholder sought to disallow the allocation of income to him, since he could not participate in the business. His theory was that by reason of the lockout, he ceased to be the beneficial owner of the shares. Points should be given for the creative theory, even though it was not successful.

A taxpayer is the beneficial owner of property if the taxpayer controls the property or has the economic benefit of the property. The Tax Court found that the 40% shareholder still retained beneficial ownership since there was no agreement transferring any rights to the stock, and the 40% shareholder still retained his economic rights as a shareholder.

What could the 40% shareholder have done here? One thought is that he could have transferred his shares to a nonqualified shareholder (such as a nongrantor trust), thus terminating the S election of the company. Some shareholder agreements restrict such transfers, but in the scope of the wider controversy or in the absence of such a restriction, this may have solved his problem. However, in this case under applicable state law, perhaps the shares could not be transferred to someone other than a licensed professional.

Kumar v. Commissioner, TC Memo 2013-184

Thursday, August 29, 2013


Since the U.S. Supreme Court ruled in Windsor, 133 S. Ct. 2675 (2013) that same sex married couples would be recognized for federal purposes, a question has existed as to what happens if a same sex couple married in a state that allows such marriages, but moves to or lives in a state that does not. The IRS has now issued a Revenue Ruling that provides that the key fact for federal tax purposes is where the couple married. If they marry in a state that recognizes same sex marriages, the IRS will treat them as married for federal tax purposes – even if they move to or reside in a state that does not.

This rule will greatly simplify tax administration, as well as simplify the lives of same sex married couples. There is now only one question to determine marital status – was the marriage in a state that recognizes same sex marriage.

The ruling also clarifies that for federal tax purposes the term “marriage” does not include registered domestic partnerships, civil unions, or other similar formal relationships recognized under state law that are not denominated as a marriage under that state’s law.

Rev.Rul. 2013-17

Saturday, August 24, 2013


For much of the 1980's and 1990's, federal transfer tax rates, exemptions, and credits were static and easy to remember. Then the roller coaster changes started. I don't know about you, but the number of changes has exceeded my capacity to remember them all. I've kept a cheat sheet under the glass of my desk for a few years. I have now expanded and updated it, and thought it would be worthwhile to put it out there for others. You can download a copy of the table from here

For other helpful tables and charts, take a look at the links in the column on the right.

Tuesday, August 20, 2013


At times, persons acquire property in their own names, but the true owner is a third party. Generally, for the IRS to respect the true owner as the owner for tax purposes (and not tax the titleholder), there must be a written nominee or agency agreement (among other requirements). In a case that may be useful to taxpayers who want to prove up a nominee/agent relationship for tax purposes but did not enter into a written agreement, the Tax Court respected an agency relationship without such an agreement.

In the case, a son and daughter-in-law purchased three parcels of realty on behalf of the father’s real estate development business. The deeds were in the name of the son and daughter-in-law.  This was done because the business had exhausted its own lines of credit.  As cash flow from sales of the parcels were received, the funds were turned over to the father. The son was also an employee of the business.

The IRS sought to tax the son and daughter-in-law on the gains from the sale of the parcels. The son and daughter-in-law argued that the income really belonged to their father, per their agency relationship.

Notwithstanding the absence of a written agency agreement (at least one was not mentioned in the opinion), the court respected the agency relationship and determined that the son and daughter-in-law were not the owners of the parcels for income tax purposes.

Chad B. Hessing, et ux., TC Memo 2013-179

Saturday, August 17, 2013


A recent private letter ruling illustrates how a non-U.S. procurement corporation can generate Subpart F income, but also illustrates an exception to the creation of that income.

10% or more shareholders of a controlled foreign corporation (CFC) have to pick up their pro rata share of the Subpart F income of the CFC when it is earned, regardless of whether the CFC distributes the income to its shareholders. One type of income that is characterized as Subpart F income is “foreign base company sales income” (FBCSI). FBCSI includes income from the purchase of personal property from any person on behalf of a related person, provided that the property both is manufactured, produced, grown or extracted outside of the CFC's country of organization and is sold for use, consumption or disposition outside of such country. Code §954(d)(1).

In the ruling request, a disregarded entity owned by a CFC entered into a buying agency agreement under which the disregarded entity performed various procurement-related activities. The disregarded entity was responsible for ensuring that the products purchased by related entities met standards of design, image, quality, vendor compliance, and brand. The disregarded entity received payments from affiliates as compensation for the procurement activities. As a disregarded entity, its activities (and income) were attributed to the CFC that owned it.

The IRS first ruled that the income earned by the procurement CFC would normally constitute FBCSI and thus Subpart F income. Interestingly, FBCSI arose even though the disregarded entity did not take title to the purchased goods, even though the language of the Code clearly supports a reading that acquisition of title is required.

The IRS further ruled that there was no FBCSI in this circumstance since the CFC had made a substantial contribution through its employee to the manufacture, production or construction of the property that was sold. Treas. Regs. §1.954-3(a)(4)(iv). It would have been instructive to see what type of contribution the procurement CFC did to meet this exception since I’d be interested to see what activities a procurement agent would be doing to meet this exception. Unfortunately, that information was not included in the ruling request.

PLR 201332007

Monday, August 12, 2013


A recent Claims Court case addressed whether a radio station's assets include goodwill.

The case involved a country music station in Los Angeles. The station was exchanged by its owner for several other stations. The parties agreed to an allocation of the $185 million purchase price to the tangible assets of the radio station ($3.4 million), some intangible assets ($4.9 million), and then with the bulk of the price being allocated to the FCC license ($176.7 million). No value was allocated to goodwill. These allocations were based on an appraisal.

The IRS asserted the station had $73.3 million of goodwill, by attributing a lower value to the FCC license and allocating the residual portion of the purchase price to goodwill. The appraiser for the taxpayer had indicated that broadcast stations do not possess any goodwill - the IRS contested that assertion.

Goodwill is "the value of a trade or business attributable to the expectancy of continued customer patronage," which expectancy may be due "to the name or reputation of a trade or business or any other factor." Code §197; Treas. Regs. §1.107-2(b)(1). The taxpayer argued that since a station would lose customers if it fundamentally changed is format or on-air personalities, there was no inherent value attributable to future customer patronage. The court found that just because continued customer patronage could disappear if critical business elements are changed by a buyer does not mean there was no expectation of continued customer patronage at the time of sale. Such an interpretation could be used to assert "no goodwill" by many other types of business since most businesses could suffer a lost of continued customer patronage if significant changes are made to the business. Thus, the court rejected the premise that broadcast stations cannot have goodwill.

The taxpayer also argued that an underperforming business lacks goodwill. This was also rejected. The court noted that a tendency of old customers to resort to the old business may exist even when a firm is unprofitable. To accept the taxpayer's position would be to accept that goodwill could come and go as quickly as profits or losses arise.

While the court found there could be goodwill, in this case, it found as a factual matter, based on the value of the other assets of the seller and the use of residual method for determining goodwill, there was in fact no material goodwill that was sold in this instance. Further, the court found that when the residual method of determining goodwill is used, and the parties based on their allocations leave nothing for goodwill, then goodwill is presumed to be zero even if there is goodwill as a factual matter (citing Republic Steel Corp., 28 AFTR 175 (Ct. Cl. 1941).

Deseret Management Corp.
, 112 AFTR 2d Para 2013-5151 (Ct. Fed. Cl. 7/31/2013)

Friday, August 09, 2013


It is fairly commonplace for owners of closely held corporations to loan funds to their corporation without full loan documentation. Oftentimes, there is nothing establishing the debt other than an entry on the corporation books, without any mandatory repayment date. A recent Tax Court case instructs that the absence of more comprehensive loan documentation in terms can result in the disregard of loan status. If the loan status is not respected, repayments may constitute taxable distributions or compensation payments.

In the case, the sole stockholder of an S  corporation transferred funds to the corporation. Such advances were characterized as loans on the tax return of the corporation. The taxpayer later treated payments to the shareholder as a repayment of the loan. The IRS challenged and was successful before the Tax Court in converting those payments from a nontaxable loan repayment to taxable compensation income to the stockholder.

The bottom line here is that the IRS was not convinced that the advances were loans instead of capital contributions. Factors that influenced the court included a lack of written agreements or promissory notes, a lack of interest, no security, and no fixed repayment schedule. Repayment was seen as dependent on the success of the business (since payments were made out of positive cash flow) and not as an unconditional obligation.

To avoid these issues, loans to closely held shareholders should bear as many of the following indicia of loan as possible:

a. A written obligation;

b. Interest;

c. Fixed repayment schedule and maturity date:

d. Security for repayment;

e. A reasonable debt/equity ratio;

f. Minimal or no subordination to other creditors of the corporation; and

g. Actual repayments independent of profits.

Clearly, not all of these are necessary. However, the case does suggest that at least items a.-c. should be included at a minimum.

Another important fact here is that the stockholder was a key employee of the company, but received no wages or other compensation. If that had occurred, that would have been another helpful fact for the taxpayer.

Glass Blocks Unlimited, TC Memo 2013-180

Sunday, August 04, 2013


The IRS office of Chief Counsel addressed a SCIN transaction, and concluded that the value of the note was includible in the gross estate of a decedent. While not binding on taxpayers, the Chief Counsel Advice is indicative of areas that the IRS will scrutinize in SCIN transactions.

A self-cancelling installment note (SCIN) is a promissory note issued to a seller, typically in exchange for the sale of property or a loan of funds. What makes the SCIN unique is that if the holder dies while any amounts are unpaid under the note, the remaining balance is cancelled and does not have to be repaid. Estates of decedents holding a SCIN at death will usually argue that the SCIN balance at death is not subject to estate tax, and that there was no gift on the establishment of the SCIN.

In the SCIN at issue, the term of the notes were based on the taxpayer’s life expectancy under the Section 7520 tables. The notes required interest payments only, with a balloon principal payment at the end of the term. To compensate the notes for the risk of loss by reason of death, some of the notes provided for a principal amount double of that which a normal note would carry, and others included an above-market interest rate.

Factors and Considerations of the IRS as to Whether the Decedent Received a SCIN of Equal Value to What Was Sold – i.e., Avoiding a Gift on Creation, or Whether Transferred Property Should be Included in the Issuer’s Gross Estate Under Section 2038:

     a. Family SCINS are presumed to be gifts, citing Estate of Costanza v. Comm'r, 320 F. 3d 595 (6 th Cir. 2003).

     b. The presumption may be rebutted by an affirmative showing that there existed at the time of the transaction a real expectation of repayment and intent to enforce the collection of the indebtedness.

          1. Helpful facts are that the note provides for regular principal and interest payments, and that the issuer needed the payments for living expenses.

          2. Unfavorable facts are balloon principal payments and lack of need of payments for living expenses.

          3. If the payor does not have sufficient assets to pay the obligations in full, that can be used to show there is no expectation of full payment. Thus, where the payor is a trust or entity that does not have sufficient seed money or cash flow to pay the enhanced principal and interest amounts in full, this will be a bad fact.

     c.  Code Section 7520 tables are not useful in valuing the SCIN or setting the note repayment term. Instead, the notes should be valued based on the willing-buyer willing-seller standard of Treas. Regs. §25-2512-8.

          1. Illness or other items impacting life expectancy must be factored in, including in regard to the term of the SCIN.

CCA 201330033

Wednesday, July 31, 2013


Estate planners often have clients that want to include directions in their wills and trusts that don’t directly relate to dispositions of assets. Such “dead hand” attempts to control events from the grave can at times be challenged on public policy grounds.

In a recent 4th DCA case, a decedent included a provision in a codicil to his last will, requiring employment of his son after the decedent dies by a corporation controlled by him (he owned 100% of the stock). Besides ruling against the son that the language relating to lifetime employment was only precatory, the court found that even if it was not precatory it was unenforceable since it conflicts with the fiduciary duties of the officers and directors of the corporation.

A testamentary direction to guarantee Thomas employment within the company, regardless of circumstances or detriment to the corporation, could compel the violation of fiduciary duties of the officers and directors to the corporation. This would be a violation of statutory duties and the public policy behind them.

Interestingly, in support of its conclusion the DCA noted two Florida cases that voided directions in a will to a personal representative to hire a specific lawyer and to hire a specific real estate agent to assist in estate administration - In re Estate of Marks, 83 So. 2d 853 (Fla. 1955) and In re Estate of Fresia, 390 So. 2d 176 (Fla. 5th DCA 1980). These cases provide that a will provision cannot compel a personal representative to hire a specific person who would be acting in a fiduciary capacity because of the confidential relationship between the personal representative and a fiduciary. How many last wills have you seen that direct appointment of an attorney for the estate? I know I’ve seen more than one!

THOMAS GRANT, Appellant, v. BESSEMER TRUST COMPANY OF FLORIDA, INC., as personal representative of the Estate of Milton Grant, Appellee. 4th District. Case No. 4D11-3614. July 3, 2013

Monday, July 29, 2013


Notwithstanding failing to assess estate tax against an IRA beneficiary wihin the Code §6901 four year transferee statute of limitations, in U.S. v. Maureen G. Mangiardi et al, the IRS was permitted to collect estate taxes under its estate tax lien more than 12 years after estate taxes were assessed.

FACTS: Joseph Mangiardi died on April 5, 2000. He died owning assets through a revocable trust of about $4.57 million and an IRA worth $3.85 million. Estate taxes were determined to be approxmately $2.47 million.

The estate received four years of payment extensions under Code §6161, claiming inability to pay due to reductions in the value of publicly traded securities from a declining market. Only $200,000 in estate taxes have been paid, and there are inadequate assets in the revocable trust to pay the estate taxes. The IRS now seeks to collect against Maureen Mangiardi as a transferee owner of IRA assets of the decedent under the 10 year estate tax lien of Code §6324, in an amount equal to the value of the IRA assets she received.

Maureen asserts two defenses. First, Code §6901 provides for the assessment and collection of taxes from a transferee with the same three year statute of limitations on assessment applicable to the estate under Code §6501, plus one extra year. Code §6901(c). The IRS did not assess taxes against Maureen within this period and never assessed under Code §6901. Instead, the IRS sought to collect the tax directly under the Code §6324 10 year estate tax lien against all gross estate assets. Maureen claimed that an assessment against her within the Code §6901 four year period was required. Unfortunately for her, other courts have previously held that the IRS can proceed to collect under Code §6324 without having to assess the transferee under Code §6901 (including one involving the same estate as the instant case, but which the court did not cite). These cases included Mangiardi , Joseph Est v. Com., 108 AFTR 2d 2011-6776 (2011, CA11), aff’g (2011) TC Memo 2011-24; United States v. Geniviva, 16 F.3d 522, 525 (3d Cir. 1994); Culligan Water Conditioning of Tri-Cities, Inc. v. U.S., 567 F.2d 867, 870-71 (9th Cir. 1978); United States v. Russell, 461 F.2d 605, 606 (10th Cir. 1972); U.S. v. Motosko, No. 8:12-cv-338-T-35-TGW, 2012 WL 2088739; United States v. Matzner, No. 96-8722-CIV, 1997 WL 382126.

Maureen also argued that the 10 year lien had expired by the time the IRS sought to collect from her. While more than 10 years had expired since assessment of the estate tax, the IRS countered that the 10 year lien period was extended by the four year extension of time to pay granted to the estate which extended the statute against the estate. The court nonetheless ruled that since Maureen’s liability, as a transferee, was derivative of the estate’s liability as transferor, the four year extension granted to the estate also extended the statute for collections against her, citing United States v. Kulhanek, 755 F. Supp. 2d 659 (W.D. Pa. 2010).

COMMENTS. The above result is bad for IRA and other beneficiaries for many reasons. First, it allows beneficiaries to be hit with estate taxes many years after death, and without knowledge that taxes were never paid and thus that the potential liability existed.

Second, this extended time period can be more than 10 years, since extensions granted to the estate extend this 10 year period. Presumably, if estate taxes are extended for 10 or 15 years under Code §6166, this extension can be tacked on to the 10 year estate tax lien period.

Lastly, it would appear that an IRA beneficiary is liable as a transferee for the full amount of IRA assets that are inherited. However, the IRA beneficiary really does not benefit by the full amount, since income taxes will have to paid by him or her on amounts withdrawn from the IRA. This is unfair – the beneficiary will be liable for more in estate taxes than the net amounts received from the IRA. While Code §691(c) may provide an income tax deduction for the estate taxes attributable to the IRA, mismatched tax years between deduction and income may void or limit the benefit of this deduction to the IRA beneficiary.

United States v. Maureen G. Mangiardi et al., No. 9:13-cv-80256 (USDC So.D.Fla.)

Friday, July 26, 2013


Section 529 plans offer many advantages in regard to funding education. Key among these are tax-free growth, tax-free distributions for educational purposes, and the ability to use up five years of annual exclusion gifts in one year. Nonetheless, the use of such a plan is not always a no-brainer, especially when compared to other vehicles, such as irrevocable gift trusts.

A recent article highlights some of the negative aspects of Section 529 plans. The following summarizes many of these, both from the article and from my own analysis and research notes:

  • The plans have limited investment choices, especially as compared to trusts. These choices are dictated by the rules of the state in which the plan is located;
  • The plans will typically be used to pay tuition costs. However, since individuals can make tax-free gifts of tuition costs directly, this reduces the ability of donors to deplete their estates by make such tuition gifts – instead, they use up some of their annual exclusion amounts to fund the plan and thus payments that could have been made free of estate tax anyway;
  • Earnings withdrawn for non-qualified (i.e., noneducational) expenses are subject to income tax and a 10% penalty tax;
  • The unused portion of the annual exclusion will be included in the donor’s taxable estate for estate tax purposes if the donor dies within 5 years of the funding, if more than one year’s funding is undertaken at one time;
  • It is difficult to get any tax benefits from losses;
  • “Educational” uses are limited to college and post-secondary school expenses;
  • Once a maximum account size is reached, no additional contributions are permitted; and
  • Spouses cannot be beneficiaries.

Therefore, planners should always compare the use of a Section 529 plan to other available alternatives, including irrevocable gift trusts.

Liss, Stephen, Rethink the Use of 529 Accounts for Funding College Costs, WG&L Estate Planning Journal, August 2013

Tuesday, July 23, 2013


Many thanks to Juan Antunez for his kind words and mention of the Florida Irrevocable Trust Amendment Mechanisms in his recent blog posting, which you can read here. For those that are unaware, Juan always posts very interesting articles on case law and developments in his Florida Probate & Trust Litigation Blog.

Saturday, July 20, 2013


For many years, nongrantor trusts have suffered an income tax disadvantage as compared to individuals. These trusts move much quicker to the highest marginal income tax rate on undistributed income then individuals. Compare this table with this table. In 2013, a trust or estate will be subject to the maximum 39.6% rate after $11,950 of taxable income.  A single person doesn’t hit the maximum rates until over $400,000 in income.

This problem has been exacerbated in 2013 by the overall increase in rates, including increases in the maximum capital gains rate and qualified dividend income rate from 15% to 20%. Trusts and estates are subject to the 20% rate again after about $12,000 in income, while individuals don’t suffer it until after $400,000 in income.

Further, the new Obamacare 3.8% tax on investment income applies to trusts after MAGI of about $12,000, while single individuals do not suffer it until MAGI of $200,000.

Lastly, these rate differentials may be further exacerbated by applicable state income taxes.

Putting aside trust taxation of capital gains which are not included in DNI, these rate differentials are not an issue for nongrantor trusts that require all income be distributed to the beneficiary, since that distribution will result in the beneficiary being taxed on the trust income instead of the trust (aside from the above capital gains). Nor is this an issue for grantor trusts when the income is already taxable to an individual other than the trust. Thus, this tax issue is principally an issue for trusts that have discretionary income standards, including those that distribute income only on an ascertainable standard, since that will open the door to years when all income may not be distributed to beneficiaries and will be taxable to the trust.

One approach to this problem is to draft the trust to give the beneficiary a power to withdraw trust income beyond the above $12,000 (as adjusted each year) thresholds. If exercised, this will shift the income over to the beneficiary to be taxed at the beneficiary’s tax rates, which should be at worst the same as the trust maximum rate, but hopefully lower based on the other income of the beneficiary. The maximum withdrawal amount will be limited by the 5 by 5 power limitations of Section 2514, so that the maximum withdrawal each year can be no more than the greater of $5,000 or 5% of the value of the trust. This will avoid a taxable gift if the power is not exercised – i.e., the lapse of the power will not be a taxable gift by the beneficiary to the other trust beneficiaries.

Interestingly, if the power of withdrawal is not exercised, the problem diminishes somewhat as the portion of the trust that is not withdrawn will be treated as a grantor trust and taxed to the non-withdrawing beneficiary in future years (and thus not to the trust). As an aside, trusts funded with Crummey withdrawal power gifts that are not exercised will also see this benefit as to the portion of the trust not so withdrawn each year that a contribution is made.

Putting aside the foregoing income tax benefits of this power of withdrawal, such a power of withdrawal in a discretionary trust or an ascertainable income standard trust may be problematic, for many reasons. First, the settlor may not want all of that income to be automatically distributed to the beneficiary – otherwise, the grantor would not have used a discretionary or ascertainable standard for income distributions. Second, the beneficiary may not be in a good position to receive that income – either due to age, disability, drug and other personal issues, marital and creditor issues, or other of the many reasons for not distributing assets to a beneficiary. Third, such distributions may defeat desired accumulations of income in the trust – especially when the trust is GST or estate tax exempt at the death of the beneficiary or future beneficiaries. Fourth, the failure to withdraw may constitute a contribution to the trust for local creditor protection laws and divorce laws – thus potentially exposing the nonwithdrawn assets and other trust assets to increased creditor and divorce risk.

Assuming the foregoing objections are not enough to overcome the desires to implement this type of income tax planning, note that when distributions are made to the beneficiary they will draw out a prorata portion of all classes of income of the trust. Since capital gains and qualified dividend income are subject to  much lower maximum rate than ordinary income, it would be nice if the trustee could cherry pick or maximize which items of income are distributed (the ordinary income items) and leave behind in the trust those items that are taxed at relatively lower rates (the capital gains and the qualified dividend income). Unfortunately, Subchapter J does not work that way.

However, James G. Blase in the June 2013 issue of Estate Planning Journal discusses a formula power of withdrawal approach that he believes would allow for the distribution of only the highly-taxed ordinary income items. His proposed distribution language is quite lengthy, and whether the IRS would respect his interpretation is unknown at this point. For those with an interest, I highly recommend his article, entitled Drafting Tips That Minimize the Income Tax on Trusts – Part 1 since it has an extended discussion about these issues.