Improper Decanting [Florida]

In a case of first impression, Florida’s 5^th District Court of Appeals interpreted Fla.Stats. §736.04117 relating to the ability of a trustee to decant a trust into a new trust arrangement. A trustee transferred the funds of a trust held for the current beneficiary (the settlor’s son) into a special needs trust also held for the current beneficiary of that same beneficiary. The trustee could do this since the trustee had the right under the first trust agreement to distribute all or part of the principal to the son in his absolute discretion.

The appellate court found two deficiencies with the decanting. First, Fla.Stats. §736.04117(1)(a)1. requires that the “beneficiaries of the second trust may include only beneficiaries of the first trust.” Under the special needs trust the remaindermen after the death of the son were other beneficiaries of the pooled trust. Such other beneficiaries were not beneficiaries of the first trust – instead, the remaindermen under the first trust were other relatives of the settlor. So the new trust arrangement included beneficiaries that were not beneficiaries of the first trust. While not explicitly addressed, this finding implies that the focus on same beneficiaries includes both current beneficiaries, and future beneficiaries such as remaindermen.

The second deficiency was that the trustee did not provide the 60 days adanced notice of the intent to decant to the qualified beneficiaries, as required by Fla.Stats. §736.04117(4).

Pursuant to these violations, the appellate court ordered the funds of the special trust returned to the original trust.

An interesting question is whether failing to give the requisite 60 days notice is enough to void the new trust funding in all events – the statute does not explicitly provide what the penalty is for a violation of that notice provision. This case will not answer that question, since there was also the other violation of including new beneficiaries so we don’t know if the 60 day notice violation would have been enough by itself to void the new trust funding.

Harrell and Dake v. Badger, 5^th DCA, Case Nos. 5D14-1145 and 5D14-3469 (2015)

2013 Gift Tax Assessment for 1972 Gift Upheld by Tax Court - 41 Years of Separation

The IRS has 3 years to assess gift taxes for gifts disclosed in a gift tax return. If a gift tax return is not filed, the statute of limitations never begins to run. Nonetheless, it is rare for the IRS to assess gift taxes relating to gifts that occurred many years in the past.

A recent Tax Court case confirms that the IRS is not legally barred from assessing gift taxes many, many years after the gift when no gift tax return is filed, if it so desires. Here, Sumner Redstone gifted shares of stock in a closely held entity to two trusts for his children in 1972. Due to litigation commencing in 2006, the IRS became knowledgeable of the gifts, and ultimately assessed gift taxes in 2013 for the 1972 tax year.

The Tax Court found that such assessment was valid, despite the 41 year spread between the taxable gift and the tax assessment.

Mr. Redstone argued that the doctrine of laches should bar the assessment. Laches is an equitable concept that will bar actions after an extended period of time, even if a legal statute of limitations is still open. The Tax Court noted that the U.S. is not subject to the defense of laches in enforcing its rights. Further, it found the facts supporting the application of laches are not present here - it would have required that the IRS had been aware of the 1972 gifts but sat on its rights and that the taxpayer suffered undue prejudice as a result. Here, the IRS did not become aware of the gift transfers until 2010.

Interestingly, back in the 1970's the IRS made inquiries of Mr. Redstone relating to gifts made in 1972 in context of political contributions that Congress was investingating. Mr. Redstone argued that this review was an examination, so that a second examination in 2011-2013 violated the one examination rule of Section 7605(b). The Tax Court rejected this, finding that the review in the 1970's did not give rise to an examination. Further, a violation's effect is limited to giving rise to procedural obstacles to the conduct of the second examination, such as blocking the exam or the enforcement of summons. Such a violation does not invalidate a deficiency coming from that second examination.

Note that we first discussed these issues in a posting here back in 2013.

Sumner Redstone v. Commissioner, TC Memo 2015-237

FIRPTA WITHHOLDING RATE BUMPED UP TO 15%

The Protecting Americans from Tax Hikes Act of 2015 was recently signed into law. Section 324 of the Act modifies Code Section 1445 to increase the required withholding amount on dispositions by nonresident aliens and foreign entities of U.S. real property interests from 10% to 15%.

Nonetheless, the prior 10% rate will continue to apply dispositions of a residence if (a) the amount realized is $1 million or less, (b) the transferee will use the property as a residence, and  (c) the $300,000 or less exemption from withholding does not apply.

I guess since the withholding tax is imposed on non-U.S. persons, this provision does not contradict the title of the Act which reads "protecting Americans from tax hikes" (emphasis added), at least if one reads the term "American" as only including tax residents of the USA and excluding tax residents of other countries in the Americas. Technically, this is not a tax hike anyway - just a withholding tax that is subject to refund if the seller's U.S. income taxes are less than the 15% withholding.

Deeds to Trustees [Florida]

One statute that most Florida real estate and trust lawyers have to deal with at some time is Fla.Stats. Section 689.07(1). Let’s read it together:

(1) Every deed or conveyance of real estate heretofore or hereafter made or executed in which the words “trustee” or “as trustee” are added to the name of the grantee, and in which no beneficiaries are named, the nature and purposes of the trust, if any, are not set forth, and the trust is not identified by title or date, shall grant and is hereby declared to have granted a fee simple estate with full power and authority in and to the grantee in such deed to sell, convey, and grant and encumber both the legal and beneficial interest in the real estate conveyed, unless a contrary intention shall appear in the deed or conveyance; provided, that there shall not appear of record among the public records of the county in which the real property is situate at the time of recording of such deed or conveyance, a declaration of trust by the grantee so described declaring the purposes of such trust, if any, declaring that the real estate is held other than for the benefit of the grantee.

Thus, the statute appears to grant fee simple title to the grantees in a deed, even though they are designated takers “as trustee” if no other information regarding the trust is included and the trust was not previously recorded in the public records. And so concluded a Florida Circuit Court judge, in ruling that two co-trustees owned real property conveyed to them “as trustee” in fee simple without further description and without a recorded trust instrument. In so ruling, the court was providing that the two trustees could partition the property, sell it, and keep the proceeds for themselves.

This was the case, even though the two trustees were siblings holding the trust property for over 30 years for 6 siblings under an unrecorded trust agreement. During those 30 years, the trust property was operated as a trust asset for the benefit of all the beneficiaries. Further, the trust agreement was recorded in June 2013. Thus, the Circuit Court ruling, if upheld, would provide a windfall to the trustees to the detriment of the beneficiaries.

Fortunately for the beneficiaries, the 1st District Court of Appeals reversed the Circuit Court, on two theories.

First, the DCA noted that Section 689.07(1) (and its predecessors going back 100 years) was enacted to protect innocent third parties from “secret” trusts, and not to provide a windfall to trustees. More particularly, the statute allows third parties to deal with the trustees as fee simple owners in regard to title, conveyancing and mortgages, and need not be concerned about contrary provisions in trust agreements that may restrict the trustee or vest beneficial ownership in others – that is, the third parties are entitled to rely on the public record as to ownership rights even though there is a suggestion of a trust by the trustee language in the deed. Clearly, in this case the trustees do not fall within the class of “uninformed outsiders” that are protected by this statute.

Second, the legislature attempted to put this issue to bed fifty years ago when it enacted Section 689.07(4), which reads:

(4) Nothing herein contained shall prevent any person from causing any declaration of trust to be recorded before or after the recordation of the instrument evidencing title or ownership of property in a trustee; nor shall this section be construed as preventing any beneficiary under an unrecorded declaration of trust from enforcing the terms thereof against the trustee; provided, however, that any grantee, transferee, assignee, or mortgagee, or person obtaining a release or satisfaction of mortgage from such trustee for value prior to the placing of record of such declaration of trust among the public records of the county in which such real property is situate, shall take such interest or hold such previously mortgaged property free and clear of the claims of the beneficiaries of such declaration of trust and of anyone claiming by, through or under such beneficiaries, and such person need not see to the application of funds furnished to obtain such transfer of interest in property or assignment or release or satisfaction of mortgage thereon.

This statute was intended to prevent trustees from using 689.07(1) as a sword against beneficiaries to cut off their beneficial interests – the trustees are still bound by their fiduciary obligations under the trust agreement. Further, this statute expressly allows for recording of the trust instrument AFTER the recording of the deed.

The case provides an interesting history lesson regarding this statute, and how it is intended to operate. It does not appear that the 2013 breakout of these provisions out of Section 689.071 to their new home in Section 689.07 changes the analysis.

Heiskell and Morris v. Morris, 1st DCA, Case Nos. 1D15-364 & 1D15-365. Opinion filed December 18, 2015

Applicable Federal Rates - January 2016

Are Income Tax Refunds Due to a Decedent Subject to Estate Taxes?

I've always thought so, but apparently at least one estate thought not, and took the issue to the Tax Court.

A decedent died before filing his income tax return for the prior calendar tax year. Once the return was prepared after death, it showed the decedent was due a refund of $429,315. A smaller refund was also later determined to be due for the short year of the decedent's death.

The decedent's estate did not include the refund amounts on the estate tax return. The estate argued that the overpayment as of the date of death was not a property interest of the decedent – it was only a mere possibility or expectancy which would not be a property interest under applicable state law. It argued that there is no property interest until the refund has been declared by the Government.
 

The Tax Court determined that there were other cases acknowledging that tax refunds are part of the gross estate. Further, it noted that the IRS by law "shall" refund any balance due to the taxpayer – this mandatory obligation was clearly relevant. Thus, it included the refunds in the gross estate.
 

The Tax Court did note that if the refund could be subject to offset by the IRS for other tax liabilities of the decedent, then case law would permit excluding the refund. That was not the case here, however.
 

Estate of Russell Badgett, Jr. v. Comm., T.C. Memo 2015-226 (November 24, 2015)

IRS Suggests Using Transcripts in Lieu of Estate Tax Closing Letter

A federal estate tax closing letter shows that the IRS has either accepted an estate tax return as filed, or after audit final adjustments have been agreed to. They do not close the statute of limitations, but provide comfort to executors that they can make distributions or pay creditors with little likelihood of IRS review of the estate tax computations.

In the past, closing letters were automatically issued. Earlier this year the IRS indicated that would no longer happen – taxpayers now need to specifically request a closing letter, and must wait at least 4 months from filing of the estate tax return before making the request.

The IRS has now indicated on its website that an estate tax transcript can be used as an alternative method for taxpayers to determine that the IRS has accepted an estate tax return or closed an audit. More particularly, the IRS provides:

“Transaction Code 421 [on a transcript] indicates an Estate Tax Return (Form 706) has been accepted as filed or that the examination is complete. Please note that the Transaction Code 421 explanation will display "Closed examination of tax return" in all instances. If Transaction Code 421 is not present, the tax return remains under review.”

The IRS goes on to provide how taxpayers or their representatives can request a tax transcript from the IRS (either online or via the mail). It also notes that “[t]he decision to audit a Form 706 is typically made four to six months after the filing date. Please wait four to six months after filing Form 706 before submitting a request for an account transcript.”

Since many probate courts require an estate tax closing letter before closing an estate when an estate tax return is filed, it remains to be seen whether an IRS estate tax transcript will be accepted as a valid substitute for those returns.

Transcripts in Lieu of Estate Tax Closing Letters. See also Frequently Asked Questions on Estate Taxes

Gulag America

A few years back, Congress passed FATCA. While purportedly aimed at reaching money of tax evaders hidden offshore, a practical effect has been it is nearly impossible for U.S. persons to hold or open bank or brokerage accounts outside of the U.S. That is, for a tax policy objective, the freedom enjoyed by U.S. persons to hold their liquid assets wherever they want in the world has been substantially curtailed.

The construction of Gulag America under the guise of tax policy continues apace with the passage and signing of the Fixing America’s Surface Transportation (FAST) Act in the last few days. The Act adds new Section 7345 to the Internal Revenue Code. This provision provides that if the IRS Commissioner certifies that a taxpayer is delinquent in his her federal taxes to the tune of $50,000 or more, the Secretary of State can take action to deny, revoke or limit the taxpayer’s passport. That is, persons with delinquent taxes may now be barred from leaving the U.S.

The U.S. has enforced its taxes for over one hundred years with civil and criminal enforcement mechanisms. Apparently, that enforcement arsenal is no longer sufficient, and U.S. citizens in financial straits will now lose their travel “privileges.” I wonder how many federal government employees, including members of Congress, will feel the heat of this provision (Federal employees owe $3.3B in back taxes).

An Illustration of How NOT to Do an Related Party Loan

While the Internal Revenue Code does have provisions that may impact the tax consequences of related party loans, conceptually there is nothing wrong with a related party loan. Loans can have favorable tax aspects, including deductibility of interest payments, principal repayments by entities being treated as such instead of taxable distributions, and bad debt deductions if the obligations cannot be repaid. Since the IRS will often seek to recast related party loans as gifts, capital contributions, or something other than a loan, taxpayers must observe all proper formalities and meet the criteria for both a “loan,” and when a bad debt deduction is sought that the loan became “worthless.”

On the “loan” side, the lender generally must show at the time of the funds advance, there was a real expectation of repayment and an intent to enforce collection. On the “worthless” side, the lender must be able to show that the debt was truly worthless in the year a deduction for worthlessness is sought.

A recent appellate decision shows the IRS will use bad facts to void loan treatment when a shareholder loans funds to a related corporation. The shareholder sought to write off $800,000 that she loaned to the corporation and that was not repaid.

Here is a list of the bad facts in the case. They are an education on what to AVOID in these situations:

• Generally speaking, the loan was not made on terms that an outsider would have undertaken.
• The loan was unsecured.
• The loan was funded over a period of time as a line of credit. During that period of time, the finances of the borrowing corporation declined – nonetheless, the lender continued to fund the loan.
• No payments of interest or principal ever were made.
• The borrowing corporation did not enter bankruptcy, and continued to operate two years after the year a worthless debt deduction was sought.
• The borrowing corporation did not recognize any cancellation of indebtedness income.
• The lender’s only effort to enforce the debt was to make a demand for repayment of $5,000 in the year of the write off. No legal action was ever commenced.
• There were no opinions of accountants or financial consultants that the note was worthless.
• There was no evidence of borrower creditworthiness at the time of the loan was advanced (a loan to an insolvent entity will often not be characterized as a loan).
• The loan was a line of credit loan, but it had no covenants that advances could be suspended if certain income or other benchmarks were not attained or maintained.
• No event of default occurred in the year that worthlessness was claimed.

SHAW v. COMM., 116 AFTR 2d 2015-XXXX, (CA9), 11/18/2015

Private Foundation Can Limit Grant Scholarships to Students Attending Specific Schools

A private foundation that makes a grant to an individual for travel, study, or other similar purposes makes a “taxable expenditure” that is subject to a penalty excise tax under Code Section 4945. However, if the grant is made on an objective and nondiscriminatory basis for a scholarship or fellowship to be used to study at qualified educational organizations, and the IRS approves the grant process and criteria, then that grant will not be a taxable expenditure.

What if scholarships are funded, but only for students meeting qualification criteria at a few named schools? Is this “nondiscriminatory” for this purpose?

In Private Letter Ruling 201548023 the IRS approved the taxpayer’s grant making procedures, even though the scholarships were limited to students attending three named schools. And in Private Letter Ruling 201548022, the IRS also approved procedures limiting scholarships to students attending one named school.