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Monday, December 29, 2014

Joint Obligors–Who Gets the Interest Deduction

In a recent Chief Council Advice, the IRS summarizes and reaffirms various principles that can be applied to determine who gets an interest deduction for payments made on a home mortgage when there is more than obligor under the mortgage. The principles applied should similarly apply to other types of interest deductions.

The affirmed and announced principles are:

  1. Funds paid from a joint account with two equal owners are presumed to be paid equally by each owner, in the absence of evidence showing that is not the case. [PLR 5707309730A; Mark B. Higgins v. Commisioner, 16 T.C. 140 (1951); Finney v. Commissioner, T.C. Memo. 1976-329]
  2. A deduction in respect of the payment of interest on a joint obligation is allowable to whichever of the parties liable thereon makes the payment out of his own funds. [Castenada-Benitez v. Commissioner, T.C. Memo. 1981-157; Rev.Rul. 71-179; Rev.Rul. 71-268]
  3. To claim an interest deduction it is necessary to be liable on the note. However, Treas.Regs. section 1.163-1(b) states that “Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.”
  4. Deductions need not be allocated in accordance with whom the Form 1098 reports as the payor.

The CCA applied these principles to three factual situations. Since the conclusions simply apply the foregoing principles without adding to them, I am not going to summarize them. Interested readers can read them directly.

CCA 201451027, December 19, 2014

Tuesday, December 23, 2014

Applicable Federal Rates – January 2015

Unofficial only – check IRS sources before using in planning and implementation!



Saturday, December 20, 2014

Highlights of Final Regulations for Reporting of Specified Foreign Financial Assets

The Treasury Department has issued final regulations relating to reporting of specified foreign financial assets on Form 8938. The highlights include:

  1. Dual Resident Taxpayers. Dual resident taxpayers reporting as a nonresident alien under a treaty do not need to file.
  2. Nonfilers. Persons who do not have to otherwise file an income tax return do not have to file a Form 8938.
  3. Nonvested Property. Property received in connection with the performance of personal services is not treated as having an interest until it is vested under Section 83.
  4. Disregarded Entities. Taxpayers need to look through them to calculate filing thresholds and reporting of assets owned.
  5. Jointly Owned Assets. Unmarried joint owners must include the full value of each jointly owned asset in determining filing thresholds and in reporting the assets themselves. Married persons filing separately must do the same.
  6. Foreign Current Exchange Rates. Now issued by the Bureau of the Fiscal Service (and not the Financial Management Service).

T.D. 9706, December 12, 2014

Tuesday, December 16, 2014


Earlier this week I wrote about a recent Florida case that upheld the ability of a trust “protector” to amend the provisions of a trust. You can read that posting here.

In that posting, I alluded to an interesting trust accounting issue. In the case, the purpose of the amendment made by the protector was to cut off the rights of the remaindermen (the decedent’s children) under the trust to receive accountings and object to the operation of the trust. The amendment was made to clarify that under the terms of the Family Trust which was being held for the decedent’s spouse, that when the spouse died the trust assets would not continue in trust for the children, but instead would pass to a new and separate trust for the children. It is the position of the spouse that since the children are not beneficiaries of the Family Trust being held for her, the trustee need not account to them under Florida law and they have no ability to object to the administration of the Family Trust. Their interests are only in a new trust to be created later.

According to an affidavit of the protector, who was also the decedent’s attorney, he intentionally set up the trust documents in this manner so that the decedent’s children could not challenge how the assets of the Family Trust were applied for his spouse.

Under Florida law, accountings must be distributed to “qualified beneficiaries.” Florida Statutes Section 736.0103(14) defines a “qualified beneficiary.” An element of the definition is that the subject person is a “beneficiary.” Section 736.0103(4) provides that to be a “beneficiary”, a person must have “a present or a future beneficial interest in a trust, vested or contingent, or holds a power of appointment over trust property in a capacity other than that of trustee.” (emphasis added). It is the position of the spouse that the language “in a trust” means that the interested person must have a beneficial interest in the subject Family Trust – an interest in a trust that receives the assets of the Family Trust does not make one a beneficiary of the Family Trust. Now that the appellate court has upheld the protector’s amendment to the Family Trust to clarify that it terminates at the death of the spouse, presumably the trial court will now rule on this question.

If the spouse is correct, this would create a major loophole in the statutory obligation to account. All that would be necessary to defeat the interests of remaindermen would be to draft in a manner that they receive their remainder interests in a new trust instead of the trust that held the assets before their remainder interest is funded. This would disturb a key policy of accountings which is that the remaindermen are the policemen of the trust since it is in their interest to make sure that the trustee lives up to its obligations – if they are blocked from receiving accountings or objecting to trust administration, then there will be no checks on the trustee other than the current beneficiary (who may in fact be the trustee).

I would expect that the spouse will not prevail in her argument. However, there is language in the statute to support a contrary ruling, so we will see what develops!

Minassian v. Rachins and Minassian, 4th DCA, Case No. 4D13-2241, December 3, 2014

Sunday, December 14, 2014


A recent Florida appellate court decision upholds the ability of a trust “protector” to amend the provisions of a trust.

Florida Statutes Section 736.0808(e) provides that “[t]he terms of a trust may confer on a trustee or other person a power to direct the modification or termination of the trust.” In the trust at issue, the trust instrument authorized a third party to modify or amend the trust provisions to correct ambiguities in the trust or correct a drafting error that defeats the settlor’s intent. During litigation involving the rights of children to challenge the administration of a trust held for the settlor’s spouse, the protector modified the trust language in an attempt to restrict the children’s right to challenge. The trial court disallowed the amendment. The appellate court found ambiguity in the trust document that was eligible for modification by the protector, and reversed the trial court and allowed the amendment to stand.

The children argued that the amendment power violated common law as an unauthorized delegation by the trustee of discretionary powers to another. The appellate court rejected this because it was not the trustee that delegated a duty here – it was the settlor. Further, Fla.Stats. 736.0106 allows common law to be overridden by the statutory provisions of the trust code.

The children also argued that Sections 736,0410-.0415 and 736.0412 are the sole means of modifying a trust under the Florida Trust Code, and that the terms of the trust are not permitted to override this limit, pursuant to Section 736.0105(2)(k). The appellate court did not agree to this restrictive reading, since otherwise Section 736.0808(3) would have no effect.

I have updated our Irrevocable Trust Amendment Mechanisms diagram for this case. You can download the new version here. The first page is a shortened version – the second page has the detail which you will need to zoom in on to read.

The more interesting question to me is what the wife and the protector were trying to accomplish by the amendment vis-à-vis the obligation to account to the children. This is addressed in Part II of this posting, to follow.

Minassian v. Rachins and Minassian, 4th DCA, Case No. 4D13-2241, December 3, 2014

Wednesday, December 10, 2014


Many employers offer or provide cash to employees to reimburse them for the cost of purchasing an individual health insurance policy. Others offer employees with high claims risk a choice between enrolling in the company’s standard group health plan or choice. Some companies purchase a product that allow employers to cancel their group policies, setup a reimbursement plan that works with brokers or agents to help employees select individual policies, and allow eligible employees to access premium tax credits.

The Department of Labor has announced that any of the above will be a violation of the Affordable Care Act – violating companies can be subject to penalties as high as $100 per employee per day. The bureaucratization and regulation of health care marches on.

If you think this may apply to you or your clients, see the FAQ below for more details.

FAQs about Affordable Care Act Implementation (Part XXII), November 6, 2014

Saturday, December 06, 2014

2014 Extenders Clear the House

For many years now, Congress has contributed to tax uncertainty by extending certain favorable tax provisions on a year by year basis. Thus, for example, in 2014 these extenders have expired. Neither the IRS, who has to prepare 2014 forms and computer programs, nor taxpayers, who may want to take advantage of these provisions, know what to do until Congress gets around to passing a law that extends them and makes them applicable in 2014.

An extenders bill has now passed the House of Representatives. At first, Harry Reid in the Senate indicated the Senate might not get to the bill, but it now looks like the Senate will have a straight up-or-down vote on the bill (so that it will not be changed in the Senate). There were prior moves afoot to make at least some of the extenders permanent, but the political environment in Washington has made that a non-starter.

So it looks like we will have extension law (for 2014 only), assuming the Senate approves the House bill and the President does not veto it. Here is a list of some of the key provisions that I thought worthwhile to mention (not exhaustive):

Individual Provisions

  • exclusion of up to $2 million ($1 million if married filing separately) of discharged principal residence indebtedness from gross income
  • deduction for mortgage insurance premiums treated as qualified interest
  • deduction for state and local sales taxes
  • above-the-line deduction for qualified tuition and related expenses

Business Provisions

  • research and experimentation credit
  • new markets tax credit
  • work opportunity tax credit
  • 15-year straight line cost recovery for qualified leasehold property, qualified restaurant property, and qualified retail improvements
  • increase in expensing limit and in investment based phaseout amount and expanded definition of Section 179 property for certain real property
  • RIC qualified investment entity treatment under FIRPTA
  • exceptions under Subpart F for active financing income
  • look-through treatment of payments between controlled foreign corporations
  • special 100% gain exclusion for qualified small business stock
  • reduction in S corporation recognition period for built-in gains tax

Charitable Provisions

  • basis adjustment to stock of S corporations making charitable contributions of property
  • special rules for contributions of capital gain real property for conservation purposes
  • tax-free distributions for charitable purposes from individual retirement account (IRA) accounts of taxpayers age 70 1/2 or older

Sunday, November 30, 2014

Valuing a 100% Interest in a Disregarded Entity

One would think that the value of a 100% interest in a disregarded entity would be the same as the net value of the assets of the disregarded entity. Such value of the 100% interest may be relevant for estate or gift tax purposes, or for charitable contribution deduction purposes for income or transfer taxes.

In Reri Holdings I v. CIR, the issue was whether an appraisal of the asset of a disregarded entity LLC was sufficient for income tax charitable deduction purposes when the charitable contribution was actually a transfer of the 100% member interest in the disregarded entity. Based on the Pierre case and other precedent, the IRS argued that the appraisal should have been of the LLC interest, and not the underlying asset. The taxpayer responded that such values should be the same, and thus there was substantial compliance in reporting and the charitable deduction should be allowed.

Reliance on Pierre and other similar cases is inappropriate, since those cases involved the transfer of partial interests in the LLC, not 100% of the LLC. In such cases, a hypothetical willing buyer would take into consideration the restrictions on the LLC interest that would apply after receipt of the partial LLC interest since he/she would be only a partial owner bound by those restrictions. Such restrictions are irrelevant when the hypothetical willing buyer owns 100% of the LLC interest since there are no internal LLC restrictions on his/her ownership that cannot be overcome by reason of that 100% ownership.

The Tax Court agreed with this distinction and found that generally the valuation of the asset of the LLC (after taking into consideration liabilities of the LLC) equates with the value of the 100% LLC interest. It did note, however, that in this case there may have been an external transfer restriction that applies to a successor owner of the LLC interest, which transfer restriction does not apply directly to the asset of the LLC. In that case, there might be a difference in value between a 100% member interest and the net value of the assets of the LLC. Thus, a separate valuation of the 100% member interest may be needed.

Conservative planners should assure that the valuations that they obtain for tax compliance purposes properly describe the interest actually being transferred, and that there are no reasons why the 100% member interest should be different than the net value of the LLC assets if that valuation of the member interest is based entirely on the net value of the LLC assets.

RERI Holdings I, LLC v. CIR, 143 TC No. 3, August 11, 2014

Friday, November 28, 2014 Date is Not Proof of Mailing Date

A taxpayer who receives a notice of deficiency (also known as a 90 day letter) has 90 days to file a petition to challenge the deficiency in Tax Court. This deadline is important, since this is the only method of challenging an IRS assertion of additional tax due without first paying the tax. Cases about when a petition is timely mailed for purposes of this 90 day rule are always popping up. For this purpose, the date of mailing is considered the date of filing under what is known as the “mailbox rule.”

In a recent case, a taxpayer received a 90 day letter and had to file his petition by March 3, 2014. On March 3, a stamp was printed using the online service The stamp was affixed to an envelope containing the petition, and the envelope was dropped off at the post office. When the Tax Court received the petition, it had a U.S. Postal Service postmark of March 4, 2014. However, the stamp that was printed through includes the date of purchase, which was March 3, 2014, and it also provides a log of when stamps are purchased. The government claimed the petition was mailed too late, based on the March 4 postmark. The taxpayer countered that the date could be used to prove mailing on March 3.

The court held for the government. The regulations provide that if the U.S. Postal Service postmark is legible, it controls the deemed date of mailing. Treas.Regs. Section 301.7502-1(c)(1)(iii)(A). The regulations further provide that if an envelope bears a USPS postmark, plus a postmark with a different date made by other means (e.g., an office stamp metering machine), the USPS postmark still applies. Treas.Regs. Section 301.7502-1(b)(3). This is pretty much what was going on here, treating the date as a third party postmark. So even if the taxpayer could produce other unequivocal and indisputable evidence that the envelope was dropped in the mail on a day before the postmark date, the court cannot consider it and the USPS postmark date still controls. The bottom line is that anyone making a filing by mail under the mailbox rule bears the risk that the Postal Service will not affix its postmark until a day after it is dropped off in a mailbox or at the post office.

This timely mailed, timely filed rule has application not just to Tax Court petition to filings, but to many tax filings and payments made directly with the IRS – so the above case and principles should apply equally in those circumstances.

So how to prove timely mailing when items are mailed on or close to the last day allowed for filing? Easy – the use of registered or certified mail. For example, certified mailing with a stamped receipt from the post office with the date of mailing, is all that is needed. This of course will require  a trip to the post office. And be careful with certified mail – it is not enough to affix certified mail documentation to the envelope and drop it in the mail or at the post office. You are going to need to stand in line and have the clerk hand stamp and return to you the dated mailing receipt.

The person who did the mailing in this case actually did go to the post office and did mail the petition via certified mail. However, she said the lines were too long and she just dropped the envelope off in a box, instead of getting the required hand-stamped receipt. As the song goes, “so close, and yet so far...”

Thursday, November 27, 2014

Saturday, November 22, 2014

Telephone Calls from the IRS

In the last week, I have received two messages on my answering machine at home purporting to be from the IRS, advising me that I owe taxes and if I don’t call them back I may be arrested. I’ve also gotten calls from other people about similar calls.

99% of these are scams. If the IRS has a problem with you, they will mail you notices – they will not call you first. If you want to be sure, don’t call back the number given. Instead, call the IRS at 1.800.829.1040 and they can tell you what, if anything, is going on with your tax account, including whether you owe any money.

For more on the ongoing telephone scams, see this IRS notice.

Friday, November 14, 2014

Waiver of Florida Spousal Homestead Rights by Deed Upheld

Summary: A recent Florida appellate decision finds that the joinder of a spouse on a deed of homestead property to a trust constitutes a valid waiver of homestead rights, even though the deed contains no waiver language.

FACTS: Jerome and Alma were married. In 2000, they executed a warranty deed conveying their homestead property to themselves as tenants in common. That same day, Jerome conveyed his one-half of the property to a 5 year qualified personal residence trust (QPRT). Alma joined on the deed. Jerome did not survive the 5 year term of the QPRT, so pursuant to the QPRT terms his half of the property reverted to his estate. Under his estate documents, the property was placed in trust for Alma when he died. The trust provided that at Alma’s subsequent death, the trust assets would pass to their daughter, Nancy. Ross, their other child, was excluded from receiving such trust assets. Ross sought to challenge the devise to Alma’s trust.

The appellate court determined that the transfer to the trust for Alma was a testamentary devise. Article X, section 4 of the Florida Constitution provides that a homestead cannot be devised if the owner is survived by a spouse, unless the devise is to the owner’s spouse if there are no minor children. Thus, the devise to the trust for Alma (with a remainder to Nancy) would not be valid in this case, unless Alma is treated as having waived her homestead rights when she signed the deed to the QPRT.

Fla.Stats. Section 732.702(1) provides a spouse’s homestead rights “may be waived, wholly or partly, before or after marriage, by a written contract, agreement, or waiver, signed by the waiving party in the presence of two subscribing witnesses.” The statute further provides that a waiver of “‘all rights,’ or equivalent language” may constitute a waiver of a spouse’s intestate rights in their spouse’s homestead.

The appellate court found that Alma’s signature on the deed constituted a waiver of her homestead rights based on the deed language that she “grants, bargains, sells, aliens, remises, releases, conveys, and confirms” the property “together with all the tenements, hereditaments, and appurtenances thereto belonging or in anywise appertaining.” Thus, the devise of the homestead to a trust for Alma (and later remainder to Nancy) was valid.

The appellate court was not concerned that Alma continued to assert homestead exemption from ad valorem taxation after the purported waiver. This is because “homestead” for ad valorem tax purposes is not subject to the same definition as for restrictions on testamentary devises.

COMMENTS: This is not the first time this issue has come up before a District Court of Appeal. A prior opinion in the Habeeb case reached a similar waiver conclusion, although that opinion was later withdrawn. Reasonable minds may differ whether signing a warranty deed that contains no explicit waiver language as to homestead rights should be properly interpreted as a waiver that meets the requirements of Fla.Stats. Section 732.702(1). Those who do not think so are on notice that one District Court of Appeal (and possibly two) disagrees with their position, and joint deeds should be entered into with a careful eye to homestead consequences.

This was a post-marriage waiver. Interestingly, the opinion made no mention of Fla.Stats. Section 732.702(2), which reads: “[e]ach spouse shall make a fair disclosure to the other of that spouse’s estate if the agreement, contract, or waiver is executed after marriage. No disclosure shall be required for an agreement, contract, or waiver executed before marriage.” Prudent practitioners generally accomplish post-nuptial waivers of homestead via a formal post-nuptial agreement that includes full financial disclosures. Perhaps there was some type of contemporaneous financial disclosure that made this a nonissue in this case. Perhaps the appellate court deemed the parties to have full financial knowledge of each other, but there is no indication of that in the opinion. Perhaps this was an oversight by the court or the parties in not addressing this requirement, or was a tactical decision not to raise the issue by the litigants that did not work out well for the losing party. In any case, the requirement for financial disclosure may be a saving grace for others that may be faced with a joint deed and an unintended waiver of homestead situation.

From a policy standpoint, there has already been some discussion among Florida attorneys about whether a statutory amendment is advisable to require that any waiver by deed of homestead rights have some requisite reference to homestead or at least require the use of the term “waive” or “waiver.” Having personally seen on more than one occasion such joint deeds sought to be applied against the homestead rights of a surviving spouse when the spouse did not realize that signing on the deed constituted a waiver, I would be in favor of it, particularly if the deed is to a revocable trust of the other spouse. In this case, it was not a big deal for the surviving spouse since she obtained a life interest in the residence through the trust that was established for her. But under the logic of the case, if the deed was to a revocable trust of the first spouse to die, and that trust did not (or was later changed to not) make a provision for the surviving spouse, the surviving spouse himself or herself could lose all economic rights and benefits in the homestead after the death of the first spouse.

While this case is a Florida case, it is likely of interest to many non-Florida practitioners who represent families with Florida family members or have clients contemplating or making a move to Florida.

Stone v. Stone, Florida 4th DCA, Case No. 4D11-4541, November 12, 2014

Thursday, November 13, 2014

Laches as a Limit on the Duty of a Trustee to Account

Doris Corya was a trustee (or co-trustee) of four trusts that failed to provide fiduciary accountings to a beneficiary otherwise entitled to receive accountings under Florida law. The failure to account went back many years – the oldest of the four trusts was established in 1953 (although Florida’s statutory obligation to account may not go back that far). Roy Sanders, a beneficiary, brought an action against Doris to compel the preparation and delivery of the unprepared fiduciary accountings. The trial court found that Doris was obligated to prepare and deliver such accountings, back through the date of the establishment of the trusts (since Doris was a trustee for each since the inception of each).

The appellate court reversed the trial court, requiring accountings only for a four year retroactive period. This was based on the statutory laches provision under Section 95.11(6), Florida Statutes, which reads:

Laches shall bar any action unless it is commenced within the time provided for legal actions concerning the same subject matter regardless of lack of knowledge by the person sought to be held liable that the person alleging liability would assert his or her rights and whether the person sought to be held liable is injured or prejudiced by the delay. This subsection shall not affect application of laches at an earlier time in accordance with law. (emphasis added)

Under Florida law, the failure to provide an accounting is both a breach of trust and a breach of fiduciary duty. Since the statute of limitations to bring an action against a trustee for breach of trust or breach of fiduciary duty is four years, four years is the “time provided for legal actions concerning the same subject matter.” Based on this, the appellate court limited the beneficiary to being able to compel only four prior years of accountings.

While this is a Florida case, states with similar statutory laches provisions may be influenced by the court’s determination. Further, the logic of limiting the duty to account to only those years where a suit for breach of trust or duty can be brought makes logical sense – if the beneficiary can only seek damages for the preceding four years, compelling accountings for years before that is probably not worth the cost and difficulties of preparing accountings for years before that.

The appellate court also implied that the common law concept of laches could apply, if the statutory provision did not. This is relevant both in Florida, and in states that may not have a statutory laches provision. This was determined to be the case, even though the beneficiary did not know that he or she was entitled to receive an accounting.

Most of the multi-year failure to account situations that I have seen arise from a lack of knowledge of the requirement to account by the trustee – and not a nefarious or intentional failure. To the extent this case is followed, it is helpful to those trustees by relieving them and the trust of the cost and burden of preparing many years of accountings once their duty becomes known, especially when historical information may be limited.

While the case will also benefit trustees with more nefarious intent, it is unlikely that such a laches rule would encourage trustees not to account. Most do so because they are required to do so, or to benefit from the shorter statute of limitations that arises in most jurisdictions as to items reported on the accounting. Being relieved of the obligation to have to account for more than 4 preceding years if called out for not accounting would not appear sufficient incentive in and of itself to shift a trustee that would otherwise account to deciding not to account – presumably they would have other motivation to not account before intentionally going down that road.

For a further discussion of this case, please also see the write-up here on Rubin on Rubin on Probate Litigation.

Corya and Sanders v. Sanders, 39 Fla.L.Weekly D2298a (4th DCA Fla., Nov. 5, 2014)

Wednesday, November 12, 2014

Caution with Automatic Removal of Ex-Spouse as a Beneficiary Upon Divorce

Fla.Stats. Section 732.703 provides for the automatic removal of a spouse as a beneficiary of a life insurance policy upon divorce. Many other states have similar provisions. It is easy to become complacent in expecting this statutory provision to automatically remove a former spouse.

This can be a mistake. For example, while the Florida law provides that this removal of a former spouse will apply to an insurance policy owned by an employee benefit plan, the statute provides that this change will not occur if there is a conflict between this provision and federal law. Such a conflict may exist as to ERISA plans. Even in those states whose statute does not expressly provide that the statute will not apply if there is a conflict with federal law, the principal of federal supremacy will nonetheless result in an override of the state law provision. See also here for another example of federal override of state statutes in this context.

Besides conflict with federal law, the Florida statute provides 9 other circumstances when the statute will not apply. Thus it is imprudent to blindly rely on the statute without at least reviewing all the statutory exceptions. The more conservative course when dealing with a divorce situation is to obtain a list of beneficiary designations and then make sure each designation is specifically dealt with – either by operation of the statute without an applicable exception, or formal changes of beneficiaries.

Thursday, November 06, 2014

Interest Deductions When Interest Added to Principal Balance

A cash basis taxpayer owes interest and principal to a lender on a home mortgage loan. The taxpayer goes to another lender, borrows additional money against the residence, and uses the loan proceeds to pay off the accrued interest on the first loan. Such an interest payment should be deductible (assuming the interest is otherwise deductible under the Code).

Now look at a similar factual situation. Here, the taxpayer does not borrow money from a new lender, but modifies his existing loan with the existing lender to add the accrued interest to the principal balance. When such accrued interest is eliminated via an increased principal loan balance, can the taxpayer likewise treat that as a deductible interest payment?

Notwithstanding that the taxpayer is in a similar economic situation in both circumstances, the Tax Court has ruled that no interest deduction is allowed in the second circumstance. This is based on the settled principle that a cash basis taxpayer can deduct interest only when paid, and the delivery of a promissory note to satisfy an interest obligation is not treated as payment. In the second circumstance, “the borrower is able to postpone paying the interest until some time in the future, over the life of the loan or as part of a balloon payment at maturity...No money changed hands; petitioners simply promised to pay the past-due interest, along with the rest of the principal, at a later date.”

So while the economics of these two situations is similar, sometimes form over substance matters!

Copeland, TC Memo 2014-226

Sunday, November 02, 2014

Some 2015 Inflation Adjustments

Section 877A(g)(1)(A) 5 year average income threshold for being a covered expatriate $160,000
Section 877A(a)(1) covered expatriate gross income exclusion $690,000
Section 911 earned income exclusion $100,800
Section 2010 unified credit basic exclusion amount $5,430,000
Section 2503 annual exclusion amount $14,000 (unchanged)
Sections 2503 and 2523 annual exclusion amount for gifts to noncitizen spouses $147,000
Section 4161 tax on arrow shafts $0.49 (bet you didn’t know there was such a thing)
Section 6039F large gift from foreign persons reporting threshold $15,601
Section 6601(j) 2% interest portion under Section 6601 $1,470,000

Rev.Proc 2014-61

Saturday, November 01, 2014

IRS to Ease Up on Civil Forfeitures for Structured Deposits

Depositors to banks who intentionally limit cash deposits to under $10,000 to avoid triggering information reporting requirements by the bank (currency transaction reports) can be committing a crime, even though they are unaware that such “structuring” is illegal. Such activities can lead to forfeitures of the funds involved.

A lot of publicity has been given to the unfairness of these forfeitures when the deposited proceeds are from legal sources and/or the depositors were not knowledgeable of the illegality of structuring. See this story, for example. This is part of larger concerns about general abuse of civil forfeiture laws by government entities in general, where such seizures occur without regard to whether the persons involved are charged or convicted of a crime.

The Chief of IRS Criminal Investigation, presumably in response to this adverse publicity, has now indicated that it will scale back such forfeitures for structuring. The following is the statement given by Richard Weber to the New York Times:

After a thorough review of our structuring cases over the last year and in order to provide consistency throughout the country (between our field offices and the U.S. attorney offices) regarding our policies, I.R.S.-C.I. will no longer pursue the seizure and forfeiture of funds associated solely with “legal source” structuring cases unless there are exceptional circumstances justifying the seizure and forfeiture and the case has been approved at the director of field operations (D.F.O.) level. While the act of structuring — whether the funds are from a legal or illegal source — is against the law, I.R.S.-C.I. special agents will use this act as an indicator that further illegal activity may be occurring. This policy update will ensure that C.I. continues to focus our limited investigative resources on identifying and investigating violations within our jurisdiction that closely align with C.I.'s mission and key priorities. The policy involving seizure and forfeiture in “illegal source” structuring cases will remain the same.

Thursday, October 30, 2014

IRS Proposes Elimination of 36 Month Discharge of Indebtedness Reporting

Unless a statutory exception applies, when a debt is discharged without payment being made, the debtor will have discharge of indebtedness income under Section 108 of the Code. So that the IRS is alerted to this income, Section 6050P requires applicable financial entities to issue an information report to report the discharge of debt.

There are 8 events that give rise to this reporting – 7 of them relate to an event that coincide with an actual discharge of debt. One of them does not – under the 36 month rule reporting is required if no payment has been received on the indebtedness for 36 months (unless debt collection action occurs within 12 months or there are facts and circumstances showing the debt has not been discharged).

This can result in the debtor receiving notice on a Form 1099-C of a discharge, even though one may not really have occurred. There is no law that says that a debt discharge occurs either legally or for federal income tax purposes just because a payment hasn’t been made for 36 months.

This reporting can lead to various problems if the debt was not actually discharged. The IRS may initiate compliance activities based on the Form 1099-C, if the debtor does not report the corresponding income. The debtor may still be subject to collection enforcement activity from the creditor. The debtor may believe he has to report discharge of indebtedness income even though the debt has not been discharged. If the debt is discharged in a later tax year, the IRS may not be alerted to it in that later year.

For these reasons, the IRS has issued proposed regulations to remove the 36 month rule. Presumably neither debtors nor lenders will be interested in raising objections to this rule, and it will be made effective and incorporated in final regulations soon.

Prop Reg § 1.6050P-1

Thursday, October 23, 2014

Federal Tax Lien Did Not Survive Death of Joint Tenant

Two individuals (Cunning and Wren) acquired real property in the U.S. Virgin Islands as joint tenants with rights of survivorship (JTWROS) in 2005. In 2010 the IRS filed a federal tax lien against Cunning in the U.S. Virgin Islands. Cunning died in 2011, so that Wren succeeded to 100% ownership of the real property.

The IRS sought to continue its tax lien against the real property.The District Court in the Virgin Islands ruled that the lien died with Cunning such that Wren owns the interest free of the tax lien.

In most states, when property is held in joint tenancy with a right of survivorship, liens issued against a deceased joint tenant's interest in the property are extinguished when the deceased joint tenant dies and any other living joint tenants succeed to his share. Federal tax liens do not create any property rights in favor of the IRS beyond those that otherwise exist under state law.  United States v. Craft, 535 U.S. 274, 278. Thus, the IRS has the same rights, and only the rights, of other lienholders in the subject jurisdiction, and is subject to the above general rule in those states where the rule applies.

The legal theory of this general rule is that the surviving joint tenant does not obtain ownership by succession to the the rights of the first joint tenant to die. Instead, the survivor’s interests in the property were established at the time the property was initially conveyed into the joint tenancy. Thus, the survivor did not receive property subject to a lien against the first joint tenant, and that lien is extinguished.

The District Court determined that while there was no case law in the U.S. Virgin Islands on this issue, it believed the Supreme Court of the U.S. Virgin Islands would apply the above general rule. Thus, it found that the IRS lien died with Cunning.

NPA ASSOCIATES, LLC, v. CUNNING, EST, 114 AFTR 2d 2014-XXXX, (DC VI), 10/17/2014

Wednesday, October 15, 2014

IRS Modifies Offshore Filing Procedures

The IRS has issued FAQs relating to the new streamlined procedures for offshore compliance, and for Delinquent International Information Return Submission Procedures.

The FAQs for the streamlined program provide more detailed guidance on how the 5% penalty will be computed, how 100% owners of an incorporated business will be treated, and how stock of a foreign corporation will be valued.

The FAQ for Delinquent International Information Return Submission Procedures remove an implied requirement of reporting in the prior IRS announcements – the FAQ provides that these procedures can be used even if the taxpayer has unreported income or unpaid tax from the unreported foreign financial assets. Interestingly, the corollary Delinquent FBAR Submission Procedures remain unavailable for taxpayers with such unreported income or unpaid tax.

Below is a more detailed analysis of the new provisions by my partner, Richard Josepher:



    The IRS issued updates to its 2014 Offshore Voluntary Disclosure Frequently Asked Questions (“FAQs”) on October 8, 2014.  A careful review of the ramifications of these FAQs results in what may be construed as a tacit admission by the IRS that taxpayers have available to them voluntary disclosure options in addition to four offshore voluntary disclosure options provided by the IRS in its June 18, 2014 changes to the 2012 OVDP (“Offshore Voluntary Disclosure Program). The four options were the (1) OVDP, (2) Streamlined Filing Compliance Procedures, (3) Delinquent FBAR Submission Procedures, and (4) Delinquent International Information Return Procedures (hereinafter the “Four Options”).

    While the IRS does has never expressly stated that there are no offshore voluntary disclosure options other of the Four Options, it has strongly discouraged taxpayers from making disclosures other than under the Four Options. 
    For an in-depth discussion of the New Offshore Procedures see the several Rubin On Tax Blog prior articles posted in July and August - the final posting which has links to the prior postings can be viewed here.

    I.     Discussion Regarding Former FAQ 18 and Delinquent International Information Return Procedures.  In Delinquent International Information Return FAQ 1, the IRS  clarifies that, unlike 2012 FAQ 18, under the 2014 Procedures:
“Taxpayers who have unreported income or unpaid tax are not precluded from filing delinquent international information returns (emphasis supplied).”
    The new FAQ was necessary because 2014 FAQ 18 had linked the new Delinquent International Information Return Procedures to 2012 FAQ 18 (the “former FAQ 18"). Former FAQ 18  applied only if a taxpayer had not omitted income from an offshore entity and had reported and paid all taxes.  Specifically,  2014 FAQ 18 stated the following:
“If you have circumstances covered by former FAQ 18, you should not  you should not use OVDP and should see section 3 of the “Options Available For U.S. Taxpayers with Undisclosed Foreign Accounts” (section 3 contains the “Delinquent International Information Return Procedures”).
    2012 FAQ 18 read in part as follows:
“The IRS will not impose a penalty for the failure to file the delinquent Forms 5471 and 3520 if there are no under-reported tax liabilities and you have not previously been contacted regarding an income tax examination or a request for delinquent returns.”
    The October 8, 2014 FAQ 1 clearly distinguishes the 2014 Delinquent International Information Return Procedures from the 2012 procedures. Under 2012 FAQ 18, the fact that there was omitted offshore income or unpaid tax does not disqualify a taxpayer from filing a delinquent international information return.

    Neither the October 8, 2014 FAQ, nor the prior information on the IRS Offshore Web-site explains the rationale for the new FAQ.

    The IRS has not previously stated that it will accept delinquent filings where there is omitted offshore financial asset income–even in cases where the taxpayer can establish “reasonable cause” for the non-reporting. 

    The logical inference from the new FAQ 1 is the following: If there is “reasonable cause” for a failure to file a return associated with a foreign financial asset, since there would be no delinquent information return penalty under current statutory law, there is no basis for the IRS’ imposition of an offshore penalty-whether under the OVDP, the Streamlined Procedures or otherwise.

    As explained in the new FAQ 1, as well as in the explanation of the Delinquent Information Return Procedures issued in June, 2014, the IRS may impose a late filing penalty if an IRS examination determines that “reasonable cause was not established.” Further, there are absolutely no assurances that taxpayers filing delinquent offshore returns outside of the OVDP won’t be subjected to significant penalties to contest or pay  if “reasonable cause” is not established.

    II.    Discussion Regarding Additional Streamlined FAQs (for taxpayers residing in the United States) .  The October 8, 2014 Streamlined FAQs clarify the requirement that while only 3 prior years of income tax returns must be amended and filed and whereas penalties for delinquent international information returns apply for only a three year period, there is 6 year FBAR (FinCen From 114) filing and penalty period. The  5% streamlined penalty base applies for such 3 and 6 year periods.  Further, as stated in FAQ 6 below, even if  delinquent international information returns were filed within the most recent 3 years, if related gross income was not reported, then the asset is included in the penalty base. This would be the case regardless of whether there was “reasonable cause” for the omission and should be considered when considering filing within or outside of the Streamlined Procedures.  FAQ 5 addresses the look-through treatment of disregarded entity as opposed to such assets owned by an entity which is not a disregarded entity. Bank accounts owned by the disregarded entity are considered as owned directly by the owning member whereas bank accounts owned by a corporation are not.

     New FAQs 4,  6 and 7 read as follows:
 “FAQ 4: Q:  I am a U.S. resident making a Streamlined Domestic Offshore submission. I am the 100-percent owner of an incorporated business with various assets, including financial accounts. Does the 5-percent penalty base include the stock in the corporation or just the underlying financial accounts?

 A. The penalty base includes the stock in the corporation (and not the underlying financial accounts) unless it is a disregarded entity for federal income tax purposes. Under the instructions for Form 8938, stock in a foreign corporation is a specified foreign financial asset. Whether the stock in the foreign corporation or the underlying foreign financial accounts are reportable on Form 8938, and therefore are included in the penalty base, depends on whether the corporation is a disregarded entity. If it is, the instructions require the reporting of the underlying foreign financial accounts, which would then be included in the penalty base. However, if the corporation is not a disregarded entity, then the instructions provide that the taxpayer is not considered the owner of the underlying assets solely as a result of the taxpayer’s status as a shareholder. The same principle would apply to assets that are held in a foreign partnership or trust.”

FAQ 6:Q.     How do I calculate the 5-percent penalty for Streamlined Domestic Offshore filers?

 A.    Begin the computation by identifying the assets included in the penalty base for each of the last six years. These assets include:

--For each of the six years in the covered FBAR period, all foreign financial accounts (as defined in the instructions for FinCEN Form 114) in which the taxpayer has a personal financial interest that should have been, but were not reported, on a FBAR;
--For each of the three years in the covered tax return period, all foreign financial assets (as defined in the instructions for Form 8938) in which the taxpayer has a personal financial interest that should have been, but were not, reported on Form 8938.
  --For each of the three years in the covered tax return period, all foreign financial accounts/assets (as defined in the instructions for FinCEN Form 114 or IRS Form 8938) for which gross income was not reported for that year. (Emphasis added).
   Once the assets in the penalty base have been identified for each year, enter the value of the taxpayer’s personal financial interest in each asset as of December 31 of the applicable year on the Certification by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures (Form 14654). For any year in which a foreign financial account was FBAR compliant and (for the most recent three years) in which a foreign financial asset was both Form 8938 and Form 1040 compliant, the amount entered on the form will be zero. Once the asset values have been entered on the form, add up the totals for each year and select the highest aggregate amount as the base for the 5-percent penalty.”

“FAQ 7:Q.      I am a U.S. resident who filed compliant tax returns (including Forms 8938) and FBARs for the most recent three years for which tax returns were due. However, I failed to properly report a foreign financial asset in years prior to that and did not make a voluntary disclosure. I am otherwise eligible to make a Streamlined Domestic Offshore submission. May I make a streamlined submission and, if so, how is the 5-penalty calculated?
A.     You may make a streamlined submission. Because the most recent three years are fully compliant, there will be no assets in the penalty base for those years. Follow the procedure in answer 6 above for the three years prior to that to calculate the aggregate year-end account balances and year-end asset values for each of those three years. The penalty is 5 percent of the highest aggregate amount.”
    III.    Conclusion.  The IRS has clarified that  filing of delinquent international information returns is permitted under the 2014 Delinquent International Information Return Procedures even though there is omitted income from the offshore entity. Although the October 8, 2014 FAQs don’t concern late filed FBARs in cases where there is omitted income, by analogy to the Delinquent Information Return Procedures, there is now “FAQ precedent” for the proposition that if the taxpayer has “reasonable cause,” delinquent FBAR filings outside of the Streamlined Procedures should be considered where “reasonable cause” can be demonstrated. There appears to be no reason for the distinctions between late international information return procedures and late FBAR procedures, and a late filed FBAR should not automatically result in a streamlined filing and a 5% penalty. This is especially the case where the filings under the Streamlined Procedures carry no assurances of limited penalties.

    Based upon the foregoing, non-compliant taxpayers who have wondered whether they must pay at least a 5% offshore penalty under the Streamlined Procedures as the price of coming into offshore compliance may now have an  answer from the recent FAQs: A viable compliance option is a filing outside of the OVDP and outside of the Four Options in cases where reasonable cause can be established. The cautious taxpayer should consider obtaining “pre-clearance” similar to that available under the OVDP to assure that he is not disqualified from making a voluntary disclosure. Further, all other appropriate due diligence should be performed so that the filing does not result in unanticipated civil or criminal penalties.  After all, surprises are for kids.

Thursday, October 09, 2014

Treasury Makes Life Easier for Holders of Canadian Retirement Account Interests

Summary: Treasury automates the process for U.S. taxpayers making an election to defer taxation of Canadian RRSPs and RRIFs and to eliminate some information reporting requirements as to those accounts.

U.S. persons are generally not subject to U.S. income tax on individual retirement accounts ("IRAs") until distributions are taken. Canada has retirement accounts similar to IRAs. These are known as Canadian registered retirement savings plans (“ RRSPs” ) and registered retirement income funds (“ RRIFs” ). Similar to U.S. treatment, Canada does not impose its income tax on these accounts until distributions are made from them.

If the beneficiary of an RRSP or an RRIF is a U.S. citizen or resident for U.S. income tax purposes, the deferral of U.S. income tax on earnings of the funds that applies to U.S. IRAs does not apply under U.S. income tax law because these are not U.S. IRAs. This can leave the beneficiary in the unhappy situation of being taxed by the U.S. on the earnings of the Canadian retirement accounts as those earnings accrue but are not distributed, and then being taxed by Canada when distributions are made from the account. Since these events may occur in different tax years, foreign tax credits may not be available to eliminate this double taxation.

The Income Tax Convention between the U.S. and Canada provides a relief mechanism for U.S. taxpayers who are beneficiaries of RRSPs and RRIFs. Under Article XVIII(7) of the Convention, as amended by the 2007 Protocol, a natural person who is a citizen or resident of the United States and who is a beneficiary of a trust, company, organization or other arrangement that is a resident of Canada, generally exempt from income taxation in Canada and operated exclusively to provide pension or employee benefits, may elect to defer taxation in the United States, subject to rules established by the competent authority of the United States, with respect to any income accrued in the plan but not distributed by the plan, until such time as and to the extent that a distribution is made from the plan or any plan substituted therefor.

In Rev.Proc. 2002–23, a procedure for making the treaty election was established, which required the filing of a statement each year with the beneficiary's income tax return. In 2004, the IRS released Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans. This Form facilitated the required reporting and the making of the election.

In Rev.Proc. 2014-55, Treasury has now further simplified the treaty election and reporting process. Essentially, qualified taxpayers are treated as having made the treaty election simply by including in gross income distributions made from the RRSP or RRIF. There is no other notice or filing requirement necessary.

This is a little confusing, since most tax elections require some type of statement or filing with the IRS. Here, while the plan is being held and no distributions are being made, no income is reportable pursuant to the election. But the election itself is not made until a later distribution is made that is reported as income. Even that election itself is odd because no statement is made or boxes checked  - the reporting of the income on the return is the whole election. Such election is then given retroactive effect per the statement in the Rev.Proc. that provides the taxpayer "will be treated as having made the election in the first year in which the individual would have been entitled to elect the benefits under Article XVIII(7) with respect to the plan." The election procedures under Rev.Proc. 2002-23 or under Form 8891 no longer apply.

There are 4 requirements before this automatic, retroactive election applies. These are that the beneficiary:

        A) is or at any time was a U.S. citizen or resident (within the meaning of section 7701(b)(1)(A)) while a beneficiary of the plan;

        B) has satisfied any requirement for filing a U.S. Federal income tax return for each taxable year during which the individual was a U.S. citizen or resident;

        C) has not reported as gross income on a U.S. Federal income tax return the earnings that accrued in, but were not distributed by, the plan during any taxable year in which the individual was a U.S. citizen or resident; and

        D) has reported any and all distributions received from the plan as if the individual had made an election under Article XVIII(7) of the Convention for all years during which the individual was a U.S. citizen or resident.

Once made, the election cannot be revoked without the consent of the Commissioner.

If a beneficiary has previously reported the undistributed income of the Canada plan in his or her U.S. gross income, this election is not available without the consent of the Commissioner.

The Rev.Proc. also simplifies the U.S. information reporting in regard to these accounts. Regardless of whether the beneficiary is eligible to make the above election, Forms 8891, 3520 and 3520-A need no longer be filed for these accounts. However, information reporting on Form 8938 and on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR) will still apply. Previously, there was an exception for Form 8938 reporting if Form 8891 reporting occurred - but since Form 8891 is now obsolete this exception should not apply anymore.

Rev. Proc. 2014-55, 2014-44 IRB, 10/07/2014

Saturday, October 04, 2014

Hidden Gift in Merger Transaction

Summary: Disguised gifts found in a merger transaction, along with an interesting story on how the gifts came about.

Most tax practitioners are trained to look behind the transfers occurring in family corporate transactions to determine if a disguised gift is being made. A recent Tax Court case provides a real world example of such gifts

In the case, the parents' manufacturing company was merged with another company owned by their sons. The Tax Court found that the parents' company was substantially undervalued in the merger. Therefore, the parents received less stock in the resulting entity (and the sons received more) than was appropriate based on the relative values of the two companies. This resulted in a taxable gift of $29.6 million from the parents to the sons.

We could stop here and view this as an instructive case on how, if the IRS can successfully challenge values in mergers involving family entities, gifts can arise. However, this case has another interesting aspect.

This is that it is possible that this taxable gift would not have arisen but for the involvement of estate planning attorneys. At a point in time prior to the merger, estate planning attorneys determined that it would be more beneficial for the family if certain intellectual property relating to a manufacturing process for computer circuit boards belonged to the sons' company and not the parents' company. This is because the value of the process would thus not need to be transferred from the parents to the sons during their lifetime or at death in a taxable gift or taxable transfer at death. Factually, however, there was no transfer documentation showing a transfer of ownership of the process from the parents' company where it had been originally developed. Nonetheless, through interviews with the principals and other review of available evidence, the estate planning law firm believed there was enough support to treat the process as having previously been transferred to the sons' company at the time of the formation of that company. They were able eventually to convince the CPAs of the same, even though prior tax returns did not support such a change in ownership of the process. To have some documentation for the ownership in the event of a later IRS examination, the law firm prepared a bill of sale to memorialize a prior transfer of the process to the sons' company.

In valuing the companies in the merger, the position was taken that the ownership of the process was in the sons' company. The Tax Court determined that such a transfer of ownership to the sons' company never took place and thus that the parents' company was worth a lot more in the merger (per the substantial value of the process) than the parents received stock for. This was the source of the large gift found by the Tax Court. One has to wonder whether this gift would have arisen if the estate planning attorneys had not gotten involved.

This case was just resolved. However, the merger and resulting gift occurred in 1995. Thus, in addition to the large gift tax liability, there will be a substantial interest amount due on that gift tax liability. Luckily for the taxpayers, the Tax Court found that based on their reliance on counsel they had reasonable cause for their underpayments of gift tax and are not liable for accuracy -related penalties.

William Cavallaro et ux. v. Commissioner, T.C. Memo. 2014-189

Thursday, October 02, 2014

Court Grants 44.75% Fractional Discount in Artwork, but Don't Get Too Excited

SUMMARY: An appellate opinion granting a 44.75% discount for a fractional ownership interest in artwork has limited precedential value.

The Fifth Circuit Court of Appeals recently overruled the Tax Court's 10% fractional interest discount allowed for artwork in an estate tax valuation case. Instead, the appellate court allowed in full the 44.75% discount taken on the Form 706.

The case is of benefit to taxpayers because it does affirm the Tax Court's conclusion that a fractional interest discount is allowable for divided family ownership interests in artwork. The IRS had argued (and lost) before the Tax Court that no fractional interest discount was appropriate. After determining that some fractional discount was appropriate, the Tax Court crafted its own appropriate discount of 10%.

However, the case is not an endorsement the 44.75% discount is appropriate. Instead, the appellate court allowed the full discount taken based more on procedural issues than an objective determination that such a large discount is sustainable in a bona fide valuation dispute. This is because in the Tax Court proceeding, the IRS offered no testimony or evidence on value other than its zero discount position. Once the Tax Court determined that the zero discount position was incorrect, the Tax Court had to determine the value based on the evidence before it. Since the only evidence before it was evidence of the taxpayer supporting the 44.75% discount, the appellate court found that the Tax Court was obligated to accept that 44.75% discount because there was no contrary testimony or evidence offered by the government.

So what does this case offer us? It does sustain a fractional interest discount in artwork in a family situation, but only provides limited guidance as to what an appropriate discount should be. Also, the Tax Court opinion conclusion that restrictions in a co-tenancy agreement that limited the sale of the co--owned art only upon agreement of all owners was not a restriction that could be considered in valuing the fractional interests (i.e., it could not be used to reduce value) is an item to consider in transfer tax valuations. The Tax Court's conclusion was that Code Section 2703(a)(2) prevented the consideration of such a restriction. That Code provision provides that "[f]or purposes of this subtitle, the value of any property shall be determined without regard to... any restriction on the right to sell or use such property." Interestingly, the Tax Court did not hold that the unanimous consent provision was a restriction on sale per se, because cotenants cannot sell the jointly owned property without the consent of all joint owners even without such an agreement. Instead, the unanimous consent provision was interpreted as a waiver of the right of partition of the cotenants, which restriction was nonetheless still described under Code Section 2703(a)(2) and thus was not allowed to enter into the valuation equation.

Estate of Elkins, Junior V. Comm., 114 AFTR 2d 2014-5985 (CA5), 09/15/2014

Saturday, September 27, 2014


SUMMARY: A change in function of a Section 501(c)(3) organization results in the IRS revoking its exemption.

To receive Section 501(c)(3) status, exempt organizations apply for exemption from the IRS. The exemption application provides details on what the organization intends to do, and the IRS confirms that it is an appropriate activity for a Section 501(c)(3) organization.

Many times, as organizations evolve they move into other areas and functions. Such organizations must monitor their functions and determine that the new functions are exempt functions under Code Section 501(c)(3).

In a recent Taxpayer Assistance Memorandum, an exempt organization and public charity was formed to operate a private school. Over time, its function drifted to the purchase or lease of school buildings that it then renovated, leased, and subleased to nonexempt charter schools. The IRS determined that such landlord functions were not an exempt purpose under Code Section 501(c)(3), and it revoked the exempt status of the organization.

The TAM is interesting for a number of reasons, including:

   1. It is a warning to exempt organizations that the IRS will not tolerate mission creep away from the original exempt purposes of the organization. Organizations undergoing a change in purpose and function should advise the IRS of these changes prospectively and confirm that such changes do not jeopardize exempt status.

   2. Leasing real estate is generally a nonexempt trade or business carried on for profit.

   3. At times, a business can be regarded as exempt if it is an integral part of the exempt activity of a related exempt entity. Counsel for Bibliographic and Information Technology, T.C. Memo. 1992-364. In the TAM, the lessees, while they were schools, were not exempt entities.

   4. Further, an organization may conduct a business in a charitable manner to promote the exempt purpose of an unrelated exempt organization. For example, the provision of leased space at rents well below market the levels can be exempt. Rev.Rul. 69-572. This was not helpful in the TAM because again, the lessees were not exempt organizations. Further, while the exempt organization did reduce the rents below market values, the reduction was not low enough since the exempt organization recovered its costs and also accumulated a surplus.

   5. That an organization conducts some exempt activities along with its non-exempt activities may not act to save the exemption. Here, the organization conducted an educational summer program. The TAM concluded that this constituted only a minor portion of its time and resources, and thus the activity could not be considered a substantial purpose or basis for exemption. The TAM cited the U.S. Supreme Court in Better Bus. Bureau of Washington, D.C. v. U.S., 326 U.S. 279,283 (1945) which provided "that the presence of a single non-educational [exempt] purpose, if substantial in nature, will destroy the exemption [under § 501(c)(3)] regardless of the number or importance of truly educational [or other exempt] purposes."

TAM 201438034

Thursday, September 25, 2014



SUMMARY: The Tax Court rules against informal abandonment of resident status.

Individuals who are admitted to the US as lawful permanent residents ("green card" holders) are treated as U.S. residents for income tax purposes. Code section 7701(b)(1)(A)(i). As such they are subject to U.S. income taxes on their worldwide income. Resident status is deemed to continue unless it is rescinded or administratively or judicially determined to have been abandoned. Treas.Regs. section 301.7701(b)-1(b)(1).

In a recent Tax Court case, a green card holder argued that he ceased to be a U.S. resident for income tax purposes by informally abandoning his U.S. resident status by selling his Hawaii residence, moving away, and only visiting the U.S. infrequently thereafter. In support of such informal abandonment, the taxpayer cited United States v. Yakou, 428 F.3d 241 (D.C. Cir. 2005). In that case, a defendant who held a green card was able to successfully argue he was not a U.S. person under the Arms Export Control Act via having left the U.S.

The Tax Court found that Yakou did not apply. Principally, this was because the Arms Export Control Act and related law was silent on how lawful permanent resident status terminated for those purposes. Under Treasury Regulations, however, there is explicit guidance on how permanent resident status is terminated for tax purposes. Treas.Regs. section 301.7701(b)-1(b)(3) provides:

Administrative or judicial determination of abandonment of resident status. An administrative or judicial determination of abandonment of resident status may be initiated by the alien individual, the Immigration and Naturalization Service (INS), or a consular officer. If the alien initiates this determination, resident status is considered to be abandoned when the individual's application for abandonment (INS Form I-407) or a letter stating the alien's intent to abandon his or her resident status, with the Alien Registration Receipt Card (INS Form I-151 or Form I-551) enclosed, is filed with the INS or a consular officer. If INS replaces any of the form numbers referred to in this paragraph or §301.7701(b)-2(f), refer to the comparable INS replacement form number. For purposes of this paragraph, an alien individual shall be considered to have filed a letter stating the intent to abandon resident status with the INS or a consular office if such letter is sent by certified mail, return receipt requested (or a foreign country's equivalent thereof). A copy of the letter, along with proof that the letter was mailed and received, should be retained by the alien individual. If the INS or a consular officer initiates this determination, resident status will be considered to be abandoned upon the issuance of a final administrative order of abandonment. If an individual is granted an appeal to a federal court of competent jurisdiction, a final judicial order is required.

Since the taxpayer did not follow the above procedures, he will still be considered to be a U.S. resident regardless of any informal abandonment. The court noted that lawful permanent resident status for Federal income tax purposes turns on Federal income tax law and is only indirectly determined by immigration law. The court also was influenced by the House Ways and Means Committee report accompanying the enactment of section 7701(b)(1)(A)(i) and (6) which provided that “an alien who comes to the United States so infrequently that, on scrutiny, he or she is no longer legally entitled to permanent resident status, but who has not officially lost or abandoned that status, will be a resident for tax purposes.” H.R. Rept. No. 98-432 (Part 2), supra at 226, 1984 U.S.C.C.A.N. at 1166.

Thus, green card holders who desire to terminate their U.S. resident status for income tax purposes via abandonment should follow the procedures set out in the regulations and not rely on other mechanisms or arguments.

Gerd Topsnik v. Commissioner, 143 T.C. No. 12, 09/23/2014

Wednesday, September 17, 2014


A recent Tax Court case adds to the rules that now exist whether frequent flyer miles will be considered taxable income. Below is a summary.

1. The general rule under Announcement 2002-18 is that awarded miles, whether issued by an airline for purchasing tickets, or from other issuers (well, at least rental car companies and hotels) in exchange for purchases, is not presently taxable. The IRS reserves the right to change this rule in the future on a prospective basis.

2. That announcement indicates the awarded miles will be taxable if they are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes.

3. In Shankar and Trivedi v. Commissioner, the Tax Court ruled that the receipt of points issued by a bank that were redeemed to purchase an airline ticket were taxable. The points were a noncash award for opening a bank account, and the court characterized the points as being in the nature of interest on money. The court did not believe Announcement 2002-18 applied. A reasonable conclusion from this case is that if miles are issued in payment of compensation for the use of money, then they will be taxable as interest income.

Shankar and Trivedi v. Comm., 143 T.C. No. 5 (August 26, 2014)

Saturday, September 13, 2014


SUMMARY: If interest is not timely paid on related party indebtedness, the payee may need to report original interest discount income.


How often do you see or implement interest-bearing related party loans (e.g., among family members or between related corporations or other entities)? Pretty often, I’m sure.

How often do you see these loans not kept current? Not a rare occurrence.

How often do you see interest income picked up on the income tax return of the holder relating to unpaid interest income? Maybe not so much.

Such holders are running a significant risk of omitting an item from income.

On what theory? Most of these taxpayers are cash basis, not accrual basis, so their method of accounting should not be giving rise to income. Section 7872 requires imputed interest income on many of these loans, but not if they have adequate stated interest (even if that interest is not paid timely) – so if there is an adequate stated interest rate on the loan, Section 7872 should not apply.

That leaves us with the original issue discount (OID) rules, and therein is the problem. The OID rules are not the easiest to work with for those that don’t have regular exposure to them. Nonetheless, let’s go through it on a simple conceptual level to see why many commentators conclude OID arises on these loans when interest is not paid currently.

The OID rules effectively put a debt obligation holder on the accrual basis for interest that accrues on the debt. Here are the steps:

1. OID exists if the “stated redemption price at maturity” (SPRM) on a debt obligation exceeds the issue price.

2. The issue price is pretty simple – effectively what was received in exchange for the debt obligation. In a plain vanilla loan, it will be the principal amount paid to the borrower.

3. The SPRM is the sum of all payments due to be made at any time under the obligation, OTHER THAN FIXED AND PERIODICAL INTEREST PAYABLE IN ANNUAL OR LESS INSTALLMENTS (I.E., QUALIFIED STATED INTEREST, OR “QSI”). Treas. Regs. §1.1273-1(b). Assume we have $100 loaned, and a promissory note that requires $100 of principal repayments over the term of the note, along with monthly interest payments at or above the required applicable federal rate. There is no OID here, because the SPRM is the same $100 as the $100 issue price – the interest payments do NOT go into the SPRM figure because they are fixed and periodical and payable in annual or less installments.

4. The possibility of late or nonpayment of interest does not in and of itself create OID, so long as the interest is “unconditionally payable.” Treas. Regs. §1.1273-1(c)(ii). Interest is unconditionally payable if (a) reasonable legal remedies exist to compel timely payment, or (b) the debt instrument contains terms that make the likelihood of late or nonpayment a remote contingency. (a) above generally means that the holder can accelerate the debt and commence enforced collection action upon default, and (b) generally means that the penalty for nonpayment is so high that the debtor will have a strong incentive to stay current. Since most debt instruments will allow for acceleration and collection action after default (after a reasonable grace period), most such debt instruments with regular interest payments will not trigger OID.

5. The problem is that in determining whether interest is unconditionally payable, the loan default provisions are not taken into account if the lending transaction does not reflect arm's length dealing and the holder does not intend to enforce the remedies or other terms and conditions. When the debt is between related parties, the question of arm’s length dealing probably always is a question, but that alone is not enough to find that the interest is not “unconditionally payable.” The second requirement of intent to enforce is a harder question to determine in advance. But once there is a default on an interest payment, if the holder does not impose the requisite harsh penalty or does not commence enforcement action, that would appear to be strong evidence of the holder’s intent not to enforce the remedies or other terms and conditions, at least at that time.

Thus it would appear that in related party loan situation, if the creditor defaults on an interest payment and the holder does not begin enforced collection action, that OID probably starts to accrue – either thereafter or possibly back to the commencement of the loan. Failure of the holder to report OID may subject the holder to penalties and interest on omitted income.

Perhaps the imposition of a significant monetary penalty on the payor for the late payment is enough to obviate the risk of OID under the provisions described under (b) under my discussion at 4. above without the need for the holder to commence enforced collection action. However, since there is still a question of intent to enforce, unless and until such penalty is actually collected it would appear the OID risk remains.

Note that the OID rules do not apply to all debt instruments, especially as to debt instruments issued in exchange for property – such instruments may be governed by other Code provisions such as Section 483.

Monday, September 08, 2014


Under Florida law, a decedent will be restricted in devising his or her homestead property at death. If those restrictions apply, surviving spouses and heirs received the interests they would receive under intestacy law. For this reason, among others, a determination is often needed whether residential property qualifies as “homestead” for these purposes.

In a recent Florida case, at the time of the decedent’s death his decedent’s former wife was living in the former marital home with the two children of the marriage pursuant to a provision in a marital settlement agreement awarding the former wife exclusive use and possession until the youngest child graduated from high school. After that, the residence would be sold and the proceeds split between the former husband and wife. The decedent held a tenants in common ownership interest in the residence with his former wife.

The decedent did not reside in, or otherwise have any use or possession of the residence at his death. The court nonetheless found it to be homestead property. How so?

It is a common misconception that a decedent must reside on the property for it to be his homestead. It is enough that the owners family resides on the property. Here, the decedent’s sons, whom he still supported financially, continued to live on the property.

Homestead status was relevant here since it resulted in the decedent’s new wife obtaining an interest in the homestead that she would not have otherwise received, pursuant to Florida intestacy provisions that apply to homestead property. Interestingly, even though the new wife received this interest (here, a life estate), she took that interest subject to the rights of use granted to the former spouse and required sale provisions under the marital settlement agreement. It was argued that the marital settlement agreement removed the property from homestead status – the court instead allowed the homestead status and the resulting dictated ownership at death, but left the successor owners subject to the limitations and terms of the marital settlement agreement as to the use and disposition of the homestead.

Estate of Friscia v. Friscia, 39 Fla. L. Weekly D1810a (August 27, 2014)

Saturday, September 06, 2014


The IRS has announced the interest rates that will be imposed on late taxes, and paid on tax refunds, for the 4th quarter of 2014.


Wednesday, September 03, 2014


JPMorgan Chase Bank , N.A. receiving a notice of levy against the assets of one of its depositors. Two hours later, the taxpayer went to the bank and withdrew $40,000, before the bank froze the account (it actually took the bank 2 days to fully process the levy).

The IRS sought to hold the bank liable for the $40,000. The bank countered that it only had to act to freeze the account within a reasonable period of time – and two hours is not reasonable. The District Court found for the IRS.

The Court noted there are only two statutory defenses for the bank under Code Section 6332. The first is that the defendant “did not possess any property or rights to property of the taxpayer,” and second, that “the property was subject to a prior attachment or execution.” Neither applied here, so the bank had to raise equitable defenses such as reasonableness.

The Court could find no “reasonableness” exception under Code Section 6332. While there is one as to the imposition of an ADDITIONAL 50% penalty that the IRS could apply, the statute does not provide one for the base liability of the property holder.

There were other issues here, such as whether the IRS improperly tipped off the taxpayer of its intent to levy, to the prejudice of the bank, but they do not appear to have impacted the Court’s analysis of the bank’s statutory obligations.

So…failing to act within 2 hours was too long a wait for the bank. Under the reasoning of the opinion, a 1 minute delay in freezing the account may likewise have imposed liability on the bank, as ridiculous as that may be. This is very dangerous precedent for those that receive notices of levy – unless they act to protect the levied property instantaneously, they suffer risk of being guarantors of the tax liabilities of their customers.

U.S. v. JPMORGAN CHASE BANK, 114 AFTR 2d 2014-XXXX, (DC CA), 08/15/2014

Saturday, August 30, 2014


Code §501(c)(7) provides an exemption from federal income tax for clubs organized substantially for pleasure, recreation, and other nonprofitable purposes if no part its net earnings inures to the benefit of a private shareholder. Thus, social clubs, sororities, and fraternities, for example, can often qualify for income tax exemption.

In a recent private letter ruling, the IRS was asked to rule that an "online sorority" qualified as an exempt social club.

The sorority was organized to operate a national online sorority for students of an online for-profit university. Its purpose was to encourage members to succeed academically and professionally. Its members communicate among each other over the Internet via email, blog posts, and online classes, and by telephone. When new members are added, there is an online ceremony for admission. Most of the activities of the sorority occur online, including meetings and seminars. However, members who live near each other may meet to perform activities for nonprofit organizations, and there is an annual meeting held each year at 3 locations throughout the U.S. where organizational activities are discussed and addressed.

The IRS concluded that the sorority did not qualify. The ruling stated that "[f]ace-to-face interaction is important for members of a social club. Organizations that do not afford opportunities for this personal contact among members are not entitled to exemption." The ruling also provided that the club operates "primarily to advance the individual interests of your members. You do not engage in meetings and gatherings as a primary activity that involves personal contact among or between your members." The lack of a fixed facility where members could meet to engage in fellowship was also found relevant, as was the lack of expenditure of funds for social or recreational purposes, and that the face-to-face annual meetings were not social meetings but organizational meetings.

It is true that prior precedent emphasizes face-to-face interaction. For example, Rev.Rul. 58-589 provides that there must be an established membership of individuals, personal contacts, and fellowship, and that a commingling of the members must play a material part in the life of the organization. However, such parameters were developed well before there were electronic methods of meeting that provided for immediate communication and feedback (including instant messaging and email), online group meetings, and online seminars. It is possible today to engage in extensive social activities and commingling online that were not possible even a few years ago. Thus, one can legitimately argue that an online social organization can have the same practical camaraderie and interaction as a more traditional organization that meets in person, and that perhaps the IRS should loosen (i.e., modernize) its standards in this regard.

It is also true that a social organization needs to focus on social and recreational activities, and not be an organization that is simply providing personal growth or other benefits to its members. Thus, for example, a flying club that provides economical flying facilities for its members but had no organized social or recreational program, was not recognized as exempt in Revenue Ruling 70-32. This was appropriately contrasted in the subject private letter ruling with another such club in Revenue Ruling 74-30, where the flying club members constantly commingled in informal meetings and had regular person-to-person association. The club in Revenue Ruling 70-32 was problematic because it was open to all persons interested in flying, the members did not participate as a group in the hobby for recreation, and the members had no expectation of a personal relationship with other members.

It may be that the subject sorority was more focused on providing a benefit to its members than providing a social interaction environment, in which case exempt status may be inappropriate. However, one can image other online organizations that are there just for social interaction purposes. Applying the explanations provided in this ruling, they would not qualify for exempt status. Is it appropriate that they be barred from social club status just because the contact and interaction is electronic and not in person?

PLR 201434022, August 22, 2014

Thursday, August 28, 2014


Code Section 871(h) provides non-U.S. persons with a valuable exemption from U.S. income taxes on interest paid on registered U.S. obligations, commonly referred to as the portfolio interest exemption. Before a payor is authorized to make an interest payment without withholding taxes under the exemption, the payor must have received a W-8BEN form within the last 3 years establishing the foreign residency of the interest recipient.

In the real world, payors often fail to have the required Form W-8BEN before a payment is made. Treas. Reg. § 1.871-14(c)(3)(i) provides protection against liability for the withholding tax to such a payor that did not withhold, if the required documentation “is furnished before expiration of the beneficial owner's period of limitation for claiming a refund of tax with respect to such interest.” This raises interesting issues relating to that period of limitation, such as when or whether the recipient filed an income tax return, and whether the nonpayment of withholding tax or other payment of tax starts this statute of limitations period.

In a Chief Counsel Advice, the IRS addresses two common factual circumstances and discusses what the statute of limitations is for providing the required documentation. Under both examples, the payor paid the interest without withholding any tax from the payment.

Under the first example, the payee did not file a U.S. tax return or pay any U.S  tax for the taxable year. The CCA concludes that in this circumstance no tax has been paid that starts the statute of limitations for refund, nor is there a filing of a tax return that starts the statute. Thus, there essentially is no statute of limitations that applies for purposes of obtaining the required documentation.

Under the second example, the payee timely filed a U.S. tax return reporting taxable income unrelated to the interest payments and paid the tax due on such income. In this circumstance, both the payment of tax and the filing of the return start the limitations period. Thus, either one of them triggers a limitations that expires after the later of 3 years from the time the return was filed or 2 years from the time the tax was paid.

Note, however, that in both circumstances, the payor may be required under Treas. Reg. § 1.1441-1(b)(7)(ii), to provide additional proof to support its claim for a reduced rate of withholding.

CCA 201434021 (08/22/2014)