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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.