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Monday, March 30, 2015

Minority Shareholders Liable as Transferees for Unpaid Corporate Taxes Due to Wrongdoing of Majority Shareholders

The Tax Court has found two minority shareholders liable to return several million of dividends they received from a corporation when the corporation failed to pay federal income taxes at the direction of majority shareholders, which majority shareholders also drove the company into insolvency by siphoning off corporate funds. The minority shareholders were found liable under the Internal Revenue Code transferee liability statute (Code Section 6901). Since the application of that statute is predicated under the applicable state law, the fraudulent conveyance aspects of the case would likewise apply to create similar liabilities for the minority shareholders as to amounts due to creditors by the corporation other than the IRS. Here, the state at issue was Florida.

Besides the somewhat “unfair” result of the minority shareholders suffering for the sins of the bad actor majority shareholders, some other interesting aspects of this case include:

   1. The shareholders did not have to return amounts “advanced” to them under a bonus program in years before the corporation became insolvent. Such amounts related to a continuation of a prior bonus compensation plan, that converted to loans when the company was not doing so well. Even those these amounts were initially treated as loans, and then later recast by the IRS as taxable dividends under audit, the Tax Court nonetheless treated them as compensation for services provided. As such, the corporation was treated as having received fair value for its payments – in that circumstance, a fraudulent conveyance does not arise.

2. In trying to force a repayment of the above advances, the IRS also tried to argue that the minority shareholders comitted actual fraud in receiving those payments. The Tax Court ran through a “badges of fraud” analysis, and ultimately concluded that there was not enough indicia of fraud to support a finding of actual fraud.

3. The Tax Court found that dividends received by the minority shareholders in the years that the corporation was insolvent did constitute fraudulent conveyances subject to repayment. Keep in mind that a constructive fraudulent conveyance does not require actual fraud or intent to defraud. It can be enough that the payor is insolvent at the time of payment, and the payor did not receive fair value for its payment. A dividend from a corporation does not involve an exchange for fair value. And in determining whether the corporation is insolvent, the funds inappropriately taken from the corporation must be deducted from the balance sheet, making it easier for the creditor to show insolvency.

4. In accordance with Florida law, the creditor (here, the IRS) was not obligated to exhaust its collection efforts first against the corporation, or the majority shareholders, before seeking to collect from the minority shareholders. Perhaps the minority shareholders have a cause of action against those other persons for any amounts paid to the IRS, but I suspect collectibility against them may be a big issue.

William J. Kardash, Sr., et al., TC Memo 2015-51

Sunday, March 29, 2015

Direct vs. Indirect Probate Court Jurisdiction Over Foreign Realty

[This is a Florida case, but presumably the same principle may apply in other states.]

A state probate court generally does not have jurisdiction over real property situated in another state or country that was owned by the decedent. Generally, such property must be administered in those local jurisdictions, and local law will apply to its disposition (although such foreign jurisdictions may be bound to follow the decedent’s last will if that is what the law of that jurisdiction requires).

In a recent Florida case, a Florida court ordered that the Florida personal representative should hold the share of a beneficiary in an intestate Florida estate in a restricted account until that beneficiary “has fulfilled her obligation to ensure legal title to the Romanian properties is properly vested in the persons entitled to receive those properties under Romanian law.” After issuing the order the Florida court was persuaded to vacate it since it did not have jurisdiction over the Romania property nor the legal authority to compel administration of the decedent’s estate in the country of Romania.

The appellate court reversed the vacating of the order. It noted:

“It has long been established . . . that a court which has obtained in personam jurisdiction over a defendant may order that defendant to act on property that is outside of the court's jurisdiction, provided that the court does not directly affect the title to the property while it remains in the foreign jurisdiction.” General Electric Capital Corp. v. Advance Petroleum, Inc., 660 So. 2d 1139, 1142 (Fla. 3d DCA 1995) (emphasis in original).

It also noted that the probate court had personal jurisdiction over the beneficiary and thus had authority to direct her to effect distribution of the Romanian property, even though the property lay outside the court’s geographic jurisdiction since the probate court was doing “nothing to directly affect the title to the properties.”

Do you agree? The court clearly “indirectly” affected title to the Romanian property – it was twisting the arm of the beneficiary to have title transferred in Romania (albeit in accordance with Romanian law) by holding her inheritance hostage. Is this different enough from a direct order to transfer the property or a an order directly transferring property so as to justify the court’s jurisdictional reach?

See also Rubin on Probate Litigation for another write-up of this case.

IOAN CIUNGU, BENEFICIARY, Appellant, v. MELANIA BULEA, BENEFICIARY IN RE: ESTATE OF VICTORIA CIUNGU, ET AL., Appellee. 40 Fla. L. Weekly D689c, 1st District. Case No. 1D13-5392

Sunday, March 22, 2015

Article Abstract: Can Post-Valuation Events Impact Estate Tax valuation?



Use  of Foreseeable Postmortem  Events  In Valuing  Estate


Audrey G. Young


Estate Planning Journal, April 2015



ABSTRACT (Key Points & Discussions)

    • There is disparate case law on whether post-death events are admissible in determining value at death for estate tax purposes. Examples of relevant cases include:
      • Estate of Gilford (Tax Court): “In general, property is valued as of the valuation date on the basis of market conditions and facts available on that date without regard to hindsight. However, we have held that postmortem events can be considered by the Court for the limited purpose of establishing what the willing buyer and seller's expectations were on the valuation date and whether these expectations were reasonable and intelligent.”
      • Bank of Kenosha (7th Cir.): Subsequent sales prices relevant to what a hypothetical buyer might have agreed to, absent any exogenous shocks.
      • Saltzman (2nd Cir): Sales price 7 months after valuation not admissible since sale was not foreseeable on the valuation date.
      • Trust Services of America, Inc. (9th Cir.): "reasonably foreseeable" analysis applied to exclude evidence of postmortem merger.
      • Okerlund (Federal Circuit): Subsequent events may be admissible even when of low probative value due to intervening events if the possibility of such events would have affected the price. “Valuation must always be made as of the donative date relying primarily on ex ante information; ex post data should be used sparingly. As with all evidentiary submissions, however, the critical question is relevance.”
    • There is a mismatch in allowing the IRS to consider post-death events for gross estate valuation purposes, but to disregard contingent or uncertain deduction amounts under Section 2053 regulations.
    • These issues are being raised in the estate administration of Michael Jackson, and involve some very big tax numbers - so litigation and new case law may be coming.




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Friday, March 20, 2015

Saturday, March 14, 2015

Temporary Investment of Homestead Sale Proceeds in Marketable Securities Does Not Jeopardize Protected Status [Florida]

In 2010, Patrick Sill had a $740,487.22 judgment entered against him. In October 2013, he sold his homestead and deposited his $458,696.67 share of the sale proceeds into a Wells Fargo investment account entitled “FL Homestead Account.” He did not deposit other assets into this account.

More than 1/2 of the account was invested in mutual funds and unit investment trusts. The judgment creditor sought access to the proceeds of the account. The trial court denied the creditor, and the 4th DCA has now affirmed that.

Key points:

     a. A debtor is permitted to sell a homestead and hold the proceeds for reinvestment for a reasonable time without losing the homestead creditor protection for those funds. The opinion quoted Orange Brevard Plumbing & Heating Co. v. La Croix, 137 So. 2d 201 (Fla. 1962) for the outlines of this continuing exemption:

“the proceeds of a voluntary sale of a homestead [are] exempt from the claims of creditors just as the homestead itself is exempt if, and only if, the vendor shows, by a preponderance of the evidence an abiding good faith intention prior to and at the time of the sale of the homestead to reinvest the proceeds thereof in another homestead within a reasonable time. Moreover, only so much of the proceeds of the sale as are intended to be reinvested in another homestead may be exempt under this holding. Any surplus over and above that amount should be treated as general assets of the debtor. We further hold that in order to satisfy the requirements of the exemption the funds must not be commingled with other monies of the vendor but must be kept separate and apart and held for the sole purpose of acquiring another home. The proceeds of the sale are not exempt if they are not reinvested in another homestead in a reasonable time or if they are held for the general purposes of the vendor.”

b. Noncash proceeds, such as a brokerage account, can be used for this purpose. The court noted “[n]o constitutional provision or statute limits how the proceeds of a sale must be held. Given the nature of homestead protection, a court should not apply the exemption in a way that encourages excessive speculation with the proceeds of a sale. There was no evidence that the securities in Sill's account were particularly risky and the funds were kept “separate and apart” from Sill's other funds.“

c. The court’s opinion did not address whether the time period between sale and this action was “unreasonable” for this purpose.

d. The court explicitly refrained from addressing whether any gains and profits from the brokerage account would also qualify for homestead protection.

BK ASSOCIATES, INC., f/k/a COASTAL INSULATION, INC., Appellant, v. SILL BROS., INC., PATRICK T. SILL, STEPHEN D. SILL, LISA D. SILL and BARBARA H. SILL, Appellees. 4th District. Case No. 4D14-3049. March 11, 2014

Thursday, March 12, 2015

Article Abstract – Preferred Interest Partnerships to Use DSUE Amounts Received by a Surviving Spouse



Tasty Freeze: Preferred Partnership Tax-Saving Recipe


Michael N. Gooen and Tracy A. Snow


Estate Planning Journal - May 2015



ABSTRACT (Key Points & Discussions)

    • Surviving spouse's can obtain the use of the unused unified credit amounts of their predeceased spouse (DSUE) if a portability election is made. However, if the surviving spouse remarries, and their new spouse dies before them, then the DSUE from the first spouse is lost and the DSUE, if any, from the latest spouse to die applies instead. If this new spouse has a smaller DSUE than the first spouse that died, the surviving spouse's estate ends up with a smaller available DSUE.
    • To avoid this, surviving spouse's will often want to make a gift to use up the DSUE of their first deceased spouse before they remarry. If the DSUE of that first deceased spouse is used by the surviving spouse during lifetime before the death of a new spouse, the surviving spouse does not lose the benefit of that first deceased spouse's DSUE amount.
    • However, often the surviving spouse is not comfortable gifting away significant assets for this purpose - he or she may need those assets for support or for a rainy day fund.
    • The authors suggest that the surviving spouse capitalize a partnership with preferred and common interests, and then gift away the common interests. It is intended that the surviving spouse INTENTIONALLY triggers Section 2701, which results in the surviving spouse making a taxable gift that includes both the value of the transferred common interest, AND the preferred interest retained by the surviving spouse (which preferred interest has the lion's share of the real value). The surviving spouse uses the DSUE amount to avoid gift tax on this transfer.
    • At the surviving spouse's later death, all growth in the partnership in excess of the preferred payments paid to the surviving spouse will have been transferred free of transfer tax to the gift recipients of the common share, based on the nature of the common interest and the frozen upside of the preferred interest. While the retained preferred interest of the surviving spouse will be subject to estate tax inclusion, there will be an offsetting reduction for the amount of that interest that was previously subject to gift tax under Section 2701, thus not creating any additional overall transfer taxes. The surviving spouse has thus (a) been able to use the DSUE to make a gift, even though still retaining cash flow from the gift via the retained preferred interest, and (b) shifted post-formation appreciation to the gift recipients free of transfer taxes. A step-up in basis for the spouse's retained interest may also apply, which can be applied within the partnership via a Section 754 election.
    • Other possible enhancements to this technique include making the transfer to a defective grantor trust (so that the surviving spouse has to pay the income taxes on the transferred interest and thus reduces the size of her estate without taxable gift), and making the preferred interest of the spouse noncumulative (so as to preserve flexibility to limit unnecessary growth in the spouse's estate).


DSUE, Partnership Freeze


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Sunday, March 08, 2015


Florida taxpayers that apply for and receive a homestead exemption receive a reduction on their ad valorem taxes. Perhaps more importantly, the homestead become subject to the "Save Our Homes" annual 3% limit on increases in value of the homestead for ad valorem purposes.

A husband purchased a residence in Martin County in 1985 and applied for and received homestead exemption. In 1985 he married and in 2000 he conveyed the house to himself and his wife as tenants by the entireties. Both the husband and the wife occupy the house as their primary residence. The wife never applied for homestead exemption in her name.

The husband died in 2006. The wife did not notify the property appraiser of his demise, and did not apply for homestead exemption. From 2007 to 2011, the property appraiser allowed a reduced tax for homestead and applied the Save Our Homes assessment cap to the wife. After learning about the husband's death in 2012, the property appraiser sought to collect $283,070.45 for additional taxes due to the reversal of homestead status from 2007 to 2011, plus a 50% penalty and 15% interest per year, since the wife never applied for homestead in her own name.

At first review, one might side with the property appraiser. Florida Statutes Section 196.011(9)(a) provides that a county may allow for automatic renewal of homestead status without the need for an annual application or statement. However, that statute provides "Notwithstanding such waiver, refiling of an application or statement shall be required when any property granted an exemption is sold or otherwise disposed of, when the ownership changes in any manner, when the applicant for homestead exemption ceases to use the property as his or her homestead, or when the status of the owner changes so as to change the exempt status of the property” (emphasis added). Ownership did change when the husband died, although the statute does not define "ownership change" for this purpose. Further, the above statute also applies when one's "ceases to use the property as his or her homestead" - it would seem the husband met that test when he died.

Florida Statutes Section 193.155(3)(a), in addressing assessments under the Save Our Homes assessment cap, also discusses changes of ownership. Unlike Chapter 196, this provision does define "change of ownership" and specifically provides transfers of legal or equitable title between a husband and wife, including a change to a surviving spouse is not a change of ownership. However, since this definition is in a different Chapter than Chapter 196, and that the cited provision says it applies only for purposes of that Section, one would think that provision does not apply for purposes of Section 196.011(9)(a).

Nonetheless, both the trial court and the Fourth DCA have ruled that the definition of change of ownership under the Save Our Homes provision should apply for purposes of defining an ownership change in Section 196.011(9)(a). The Fourth DCA said that “[t]o interpret otherwise would create a conundrum, where a surviving spouse would qualify for renewal of the “Save Our Homes” assessment cap but not for renewal of the homestead exception. Such a result is not consistent with the homestead exemption's purpose of shielding Floridians from undue financial hardship related to a home after a person has experienced one of life's most stressful events, the death of a spouse.”

The Fourth DCA also relied on the legal fiction that because entireties law views the cotenants as one owner, there was no change of ownership when the husband died.

The courts were correct that there would be a conundrum and a disconnect if the wife here obtain the benefit of the Save Our Homes assessment limitations if the property did not otherwise qualify for homestead exemption status, and thus this probably justified its liberal statutory interpretation. The case also serves as a useful reminder that heirs of a decedent that succeed to homestead property need to file their own homestead application if they will use that property as their homestead. Conservatively, even surviving joint tenants by the entireties should do so, unless they reside in the Fourth DCA and thus can rely on this case.

AUREL KELLY, as Martin County Property Appraiser, and RUTH PIETRUSZEWSKI, as Martin County Tax Collector v. MARY JANE SPAIN, 40 Fla. L. Weekly D513a, 4th District. Case No. 4D14-510, February 25, 2015.

Wednesday, March 04, 2015

Threat of Litigation Eliminates Charitable Set Aside Deduction for Estate

Estates and trusts with charitable beneficiaries often seek to employ the Code Section 642(c) charitable set aside deduction for income earned by the estate and trust that will eventually (but not in the current tax year) be distributed to the charity. This deduction is needed when the income cannot be currently distributed, since in that case neither a distribution deduction nor a charitable deduction would otherwise be available. Oftentimes, income cannot be currently distributed because it is too early in the administrative process to distribute to the beneficiary, especially when the beneficiary is a residuary beneficiary.

Code Section 642(c) will allow a deduction to the estate or trust in the year income is earned if the income is permanently set aside for a charitable purpose.  However, Treas. Reg. §1.642(c)-2(d) provides that no amount will be considered permanently set aside  “unless under the terms of the governing instrument and the circumstances of the particular case, the possibility that the amount set aside...will not be devoted to such purpose or use is so remote as to be negligible.”

In a recent Tax Court case, there was a charitable residuary beneficiary, and there was income earned in a year that was not paid out to the charity in that year. Subsequent to the earning of the income, the estate was engaged in litigation with another beneficiary. The charity did not receive all of the previously earned income due to expenses of the litigation.

The IRS asserted, and the Tax Court agreed, that the charging of the set-aside amounts with litigation expenses was not “so remote as to be negligible,” and thus disallowed the charitable set-aside deduction. The Court borrowed from case law in other contexts to equate “so remote as to be negligible” as meaning “a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction” or ““a chance which every dictate of reason would justify an intelligent person in disregarding as so highly improbable and remote as to be lacking in reason and substance.”

Under the facts of the case, the Tax Court found clear indications that at the time of the set-aside, there was a reasonable likelihood of litigation and that the costs of such litigation could impact the funds ultimately passing to the charitable residuary beneficiary. Thus, no set-aside deduction was allowed

It is important to note that the estate did not lose the set-aside deduction only on the set-aside funds actually expended on the litigation, but on the entire set-aside amount even though a large portion of the set-aside was not applied to the litigation expenses. It is not a question of the actual amount of funds applied out of the set-aside that is relevant – what is relevant is how much of the set-aside is at risk of being lost such that the risk of loss is not “so remote as to be negligible.”

It would have been helpful for the court to have specifically ruled that the entire amount was at risk to litigation expenses and the remaining administrative expenses (i.e., that the risk to the whole income amount was more than negligible. By not doing so and disallowing the entire set-aside deduction, it is unclear if the case can be stretched to support an interpretation that the entire set-aside can be lost even if only a PORTION of the income that was set-aside was at risk which risk was more than so remote as to be negligible.

Estate of Eileen S. Belmont, et al.v. Commissioner, 144 T.C. No. 6