Stretch IRAs to be Hit?

Presently, if an IRA owner does not fully withdraw the balance of his IRA during lifetime, his or her heirs may be able to spread the withdrawal of the inherited IRA over the life expectancy of the recipient. By being able to slow down the required distributions, the taxation of the income that has been deferred from income tax within the IRA will be deferred further and spread over an extended period of time. Such IRAs are referred to as “stretch IRAs.”

A provision of the Retirement Enhancement and Savings Act of 2016, which cleared the Senate Finance Committee in September by a vote of 26-0 and which was introduced to Congress in November, seeks to limit stretch IRAs. Under the proposed legislation, IRA balances of an individual that aggregate over $450,000 will need to be distributed within 5 years of the death of the account owner, except in regard to distributions to the surviving spouse of the owner, disabled or chronically ill individuals, individuals who are not more than 10 years younger than the owner, or children of the owner who have not yet reached the age of majority. The proposed Act has other provisions, some of which are taxpayer friendly – you can review a summary here.

Will this make it into law next year? Historically, there is a strong likelihood of passage when a bill clears the Senate Finance Committee by unanimous vote.

Applicable Federal Rates - January 2017

New Reporting Requirements for U.S. Disregarded Entities Owned by Foreign Persons

Code § 6038A imposes reporting and recordkeeping requirements on domestic corporations that are at least 25% foreign-owned. They are required to file an annual return on Form 5472 with respect to each related party with which the reporting corporation has had any reportable transactions.

In newly issued regulations, the IRS will treat U.S. disregarded entities, such as single member LLCs not electing to be taxed as a corporation, as U.S. corporations for this purpose. Thus, their foreign owners will now have to file a Form 5472 if the U.S. disregarded entity has any reportable transactions with related persons and entities.

To add insult to injury, a number of exceptions to some of these obligations for smaller reporting corporations and for de minimis transactions will NOT apply to these entities.

Bear in mind that financial transactions between the owner of the U.S. disregarded entity and the entity itself will constitute reportable transactions and trigger this reporting. For example, the regulations provide this example:

(i) In year 1, W, a foreign corporation, forms and contributes assets to X, a domestic limited liability company that does not elect to be treated as a corporation under §301.7701-3(c) of this chapter. In year 2, W contributes funds to X. In year 3, X makes a payment to W. In year 4, X, in liquidation, distributes its assets to W.

(ii) In accordance with §301.7701-3(b)(1)(ii) of this chapter, X is disregarded as an entity separate from W. In accordance with §301.7701-2(c)(2)(vi) of this chapter, X is treated as an entity separate from W and classified as a domestic corporation for purposes of section 6038A. In accordance with paragraphs (a)(2) and (b)(3) of this section, each of the transactions in years 1 through 4 is a reportable transaction with respect to X. Therefore, X has a section 6038A reporting and record maintenance requirement for each of those years.

Failing to file results in a $10,000 penalty, so failures to file will be painful. And yes, there will be plenty of failures to file. First, it will be awhile until the new filing obligation is disseminated and absorbed by accountants performing international tax compliance, Second, for taxpayers using tax preparers who are not well-versed in international tax compliance, a lot of those preparers will not be knowledgeable of this filing requirement. Lastly, there will undoubtedly be owners of disregarded entities who will not use third party tax preparers and thus will oftentimes remain in the dark about these filing requirements.

The new rules apply to tax years of entities beginning on or after January 1, 2017 and ending on or after December 13 (31??), 2017.

T.D. 9796, 12/12/2016; Reg. § 1.6038A-1, Reg. § 1.6038A-2, Reg. § 301.7701-2

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IRS FINALIZES REGULATIONS THAT LIMIT NONRECOGNITION ON CERTAIN OUTBOUND SECTION 367(a) TRANSFERS & OTHER OUTBOUND RULE CHANGES

U.S. persons transferring appreciated property to foreign corporations may be eligible for nonrecognition of gain using Section 351 or the corporate reorganization provisions. However, Code §367(a) and its regulations provide exceptions to nonrecognition for transfers of certain property based on the policy that it is appropriate for the U.S. to tax the gain in such items at the time they move to foreign corporate taxpayers.

Previously, foreign goodwill and going concern value were excepted from gain recognition under Code §367(a), based on legislative history that allowing such items to escape gain recognition would not adversely impact the U.S. Per more recent Treasury determinations that this exception was being abused, Proposed Regulations eliminated this exception, and now final Regulations have adopted such a rule.

Another change involves outbound transfers of intangible property in nonrecognition transfers. Under Code §367(d), the U.S. transferor is treated as having sold the property in exchange for payments that are contingent upon the productivity, use or disposition of the property, and as receiving amounts that reasonably reflect what would have been received annually in the form of such payment over the shorter of the property’s useful life or 20 years. Under the final regulations, when the useful life of the property is indefinite or more than 20 years, taxpayers can still apply the 20 year period - but the taxpayer has to include during the 20 year amounts that would have been required to be included over the useful life of the transferred property following the end of the 20 year period.

T.D. 9803

RECKLESS INDIFFERENCE IS ENOUGH FOR WILFULLNESS FINDING FOR PURPOSES OF FBAR NONFILING PENALTIES

A husband and wife had an accounting in Switzerland at UBS AG, into which they deposited commissions from camera sales and also directed some of their international customers to make deposits. In 2007, the tax year at issue, the taxpayers did not file the required Form TD F 90-22.1 (FBAR) form with the Department of Treasury which they should have filed to disclose their interest in the UBS account (such FBAR reporting now occurs on FinCen Form 114). They also did not file FBARs, nor U.S. income tax returns, for other tax years. In 2010, the taxpayers applied to participate in the Offshore Voluntary Disclosure Program (OVDP), and filed delinquent income tax returns and FBARs. The FBARs failed to report other non-U.S. accounts of the taxpayers, and the income tax returns failed to report certain commission income. The taxpayers were ultimately rejected from the OVDP program.

At issue was whether the 2007 failure to timely file an FBAR was “willful,” and the meaning of willfulness in this context. The civil penalties for failure to file an FBAR are substantially higher for a willful failure than a nonwillful failure. The willful failure penalty can be as high as the greater of $100,000 or 50% of the balance of the unreported account for each year.

31 USC §5321(a)(5), which imposes the willful penalty, does not provide a definition of willfulness. The taxpayers argued that willfulness means only intentional violations of known legal duties. The Government sought to expand the definition to include reckless disregard of statutory duties. The U.S. District Court noted that the position of the taxpayers was based on case law involving criminal liability, not civil liability. Regarding civil liability, it is true that that the IRS Chief Counsel, in Chief Counsel Advice 200603026, opined that the willfulness standard for purposes of 31 USC §5321 is the same as the criminal standard. But the U.S. District Court noted that IRS Chief Counsel Advice may not be cited as precedent. Noting that other cases have found reckless disregard to be enough to constitute willfulness under 31 USC §5321, the court joined the chorus and reached the same conclusion.

Upon analysis of the facts, the court went on to find that the taxpayers’ failure to file was willful per their reckless disregard of their statutory duties.

Note that the court also addressed the issue whether the government’s burden of proof on willfulness was a mere preponderance of evidence standard, or a higher clear and convincing burden of proof. The court determined that a mere preponderance of evidence was all that the government needed to meet.

The lack of a definition of willfulness has been problematic in this area. The District Court’s expansive reading to include reckless disregard is not favorable for taxpayers. A review of the facts leading to the finding of reckless disregard will be instructive to taxpayers and advisors looking for guidance in this area. No single fact was determinative here – a conglomeration of the following was enough to tip the scale in the government’s favor:

1. The taxpayers were found to be reasonably sophisticated business people.
2. The taxpayers failed to provide a home address to UBS, and kept the UBS account hidden from everyone (including their tax preparers) except their children.
3. The taxpayers made no inquiries of any lawyer, accountant, or banker about their reporting requirements as to the account.
4. On the Form 1040, there is a question that asks if taxpayers have an interest in or signatory authority over a financial account in a foreign country, and that question directs them to see instructions for the exceptions and filing requirements for Form TD F 90-22.1. In the opinion of the court, this provision rendered the taxpayers’ statements that they were unaware of, or did not understand, their reporting obligations as not credible. Other statements by the taxpayers that they believed no reporting was required because they intended to use the accounts for retirement were similarly held to be not credible.
5. The taxpayers’ bad behavior regarding their OVDP application was problematic, including misrepresenting that all the funds in the UBS account were after-tax proceeds from their camera business, their failure to disclose other foreign accounts, and their filing of false income tax returns that excluded taxable income earned by them.

Thus, there were a number of bad facts here. Whether the court would have found reckless indifference if less than these facts were present is unknown. Nonetheless, the listed items are useful as examples of facts that the government and the courts will take notice of in making the willfulness determination.

U.S. v. Bohanec, 118 AFTR 2d 2016-XXXX (DC CA 12/8/16)

Existence of Unpaid Tax Claim in Bankruptcy Opens the Door to Expanded Statute of Limitations on Fraudulent Conveyances

In bankruptcy proceedings, if the bankruptcy trustee seeks to gain access to assets that the debtor transferred prior to bankruptcy under fraudulent conveyance law, the trustee must act within the applicable state fraudulent conveyance law statute of limitations. For example, in Florida, this would mean transfers occurring more than 4 years prior to the bankruptcy could not be challenged by the trustee.

A recent Bankruptcy Court case demonstrates a large loophole in this limitation, In that case, the debtor owed a substantial sum to the IRS. Section 544(b) of the Bankruptcy Code provides that:

the trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title or that is not allowable only under section 502(e) of this title.

What this means for the benefit of those who do not deal much with bankruptcy is that if the debtor owes money to a creditor for an unsecured claim, and the statute of limitations on collection for that claim has not yet expired, the bankruptcy trustee can effectively step into the shoes of the creditor and seek to collect on that claim using the statute of limitations that the creditor could use. Since the IRS generally has 10 years to collect on a tax assessment under Code §6502(a)(1), a statute of limitations far longer than most state statutes involving fraudulent conveyances, the issue in the recent case was whether the bankruptcy trustee could avail himself of the 10 year statute of limitations instead of the 4 years allowable under state law to proceed on a fraudulent conveyance claim. The bankruptcy court held the extended 10 year statute applied, noting that most of the other bankruptcy courts that have taken on the issue have similarly ruled for the extended statute.

The court noted that this use of Section 544(b) has not been widely availed of. It did note that “[the IRS is a creditor in a significant percentage of bankruptcy cases. . . If so, widespread use of § 544(b) to avoid state statutes of limitations may occur and this would be a major change in existing practice.”

For debtors with this issue, consideration should be given to paying the IRS before bankruptcy (without running afoul of applicable voidable payment rules), if that is a viable option.

Thanks to Elizabeth Bowers for reporting on this case at the recent RPPTL Florida Bar meeting (Asset Protection Committee).

In re Kipnis, ---- B.R. ----, 2016 WL 4543772, 118 A.F.T.R.2d 2016-5639 (S.D. Fla. 2016)

 

3 Strikes Against the IRS in Attempting to Impose Fiduciary and Beneficiary Liability for Estate Taxes

During her lifetime, Anna Smith established the Anna Smith Family Trust, a revocable trust administered for her benefit. Initially, Anna was initially a co-trustee with two of her children, but eventually became sole trustee. A significant asset of the trust was stock of a closely held company that owned a gaming license.

Anna later died, and her estate filed an estate tax return showing $15.958 million in gross estate assets, showing $6.631 million in estate tax, and the estate paid $4 million in taxes with the return. The estate made a Section 6166 election to pay the remaining taxes in installments. The trust provided for distributions of trust assets to limited partnerships owned by the heirs, and for direct distributions to heirs, after Anna’s death.

An additional $1 million was paid in estate taxes. Eventually, the closely-held stock was distributed to the beneficiaries due to issues with state law restrictions on a gaming license being owned by a trust – at that time, $1.46 million in estate taxes remained due. In conjunction with the distribution, the beneficiaries entered into an agreement to pay all unpaid estate taxes.

After an estate tax audit and settlement, the estate taxes were increased by an additional $240,381. The following year, an IRS agent sent a letter to the executor advising her of an alternative to continued personal liability for the deferred estate tax, which would be to provide a special lien under Code §6324A. Thereafter, the estate provided the IRS with an executed Agreement to Special Lien Under Section 6324A signed by all four children of the decedent, an agreement restricting the sale of the stock while the lien on the stock was in effect, and the additional information about the stock requested by the IRS.

Thereafter, the IRS agent advised that District Counsel had informed her that closely held stock should not be accepted as collateral because the IRS cannot publicly sell it without violating securities regulations. The parties agreed to revisit the issue in two years, but the IRS never contacted the fiduciaries.

Four years later the company filed for bankruptcy. As shareholders, the heirs never received any value for their stock ownership in the bankruptcy.

A year after that the IRS sent delinquent billing notices to the fiduciaries for the deferred estate taxes. Four years later, the IRS brought suit to collect the outstanding estate taxes against the fiduciaries and beneficiaries, asserting fiduciary liability under Code §6324(a)(2), fiduciary liability under 31 U.S.C. §3713, and beneficiary liability as transferees and to enforce the obligation of the beneficiaries to pay taxes under their promise to pay all unpaid estate taxes. The District Court initially ruled in favor of the government for partial summary judgment. Upon reconsideration, the IRS lost on all of its arguments.

A review of the avenues of liability and how the U.S. lost reveals some interesting aspects to these avenues. So how did the IRS lose on all of its attempts?

Code §6324 liability of trustees. Code §6324(a)(1) imposes a ten year general lien against all assets included in the gross estate for payment of estate taxes. Code §6324(a)(2) imposes personal liability on a trustee or transferee for taxes not paid when due for “property included in the gross estate under sections 2034 to 2042.” The trustees argued that the trust property was included under Code §2033 and thus did not come within this liability provision. The IRS claimed the trust property was included under Code §2036 and/or §2038 as a transfer with a retained life estate or because of the decedent’s ability to alter, amend, revoke or terminate the revocable trust. To resolve this, the court noted it must first analyze whether the trust assets were ever "given away" such that decedent lost the beneficial ownership of them during her lifetime, or in other words, whether a "transfer" for purposes of §§2036 and 2038 did or did not occur prior to decedent's death. The court found that while legal title did transfer to the trustee, there was no change in beneficial ownership of trust assets during the decedent’s lifetime. Thus, gross estate inclusion was under §2033 and thus no fiduciary liability under Code §6324(a)(2) arose. That the decedent was also sole trustee of the trust was a helpful, but not necessarily determinative, fact.

31 U.S.C. §3713 liability of fiduciaries. The federal claims statute will impose liability for taxes on a fiduciary who distributes assets under administration while there is an outstanding tax liability if that liability goes unpaid. A discharge of liability under Code §2204 will eliminate §3713 liability. Code §2204 relieves a fiduciary from liability for estate taxes if the fiduciary makes written application and posts bond – the granting of a special lien under Code §6324A qualifies as a bond for this purpose.

The principal issue here was that the fiduciaries never formally applied to the IRS for discharge under Code §2204 – at least not in the manner most practitioners are familiar with relating to such requests for relief when the estate tax return is filed. The court found that there are no authorities or regulations requiring a specific format, form, or working to make an application for discharge. It held “the government has only identified that the application should be made to ‘the applicable internal revenue officer with whom the estate tax return is required to be filed.’ 26 C.F.R. § 20-2204-1. The purpose of the application, according to the text of the statute and regulations, is for the government to provide the fiduciary with a determination of the amount owed.” Since the parties were aware of the tax due when the special lien was filed, the court did not believe a separate written application beyond the lien paperwork was required (and even if it was, the written correspondence between the parties would meet that requirement). Thus, the fiduciaries were protected by Code §2204 in regard to federal claims statute liability even without a formal application for discharge.

Third Party Beneficiary Theory. The government was on the right track with its argument that as a third party beneficiary of the agreement by the beneficiaries to pay the estate taxes, it could enforce that agreement. The problem, however, was that it sat on its hands and allowed the six year state statute of limitations on contract claims to expire. The court did not buy into the government’s argument that the 10 year federal tax collection statute of limitation applied, and not the state statute.

United States v. Mary Carol S. Johnson et al. (U.S District Court for Utah Central Division - Case No. 2:11-cv-00087)

Burden of Proof Issues in Gift Tax Matter

A recent case illustrates 3 important burden of proof issues.

The general facts of the case involved a merger of a company owned by parents with a company owned by children. The gift tax issue involved the relative value of the two companies to determine how much, if anything, was transferred to the children by the merger due to their resulting stock ownership in the merged company.

A rebuttable presumption of correctness cloaks an IRS notice of deficiency. Thus, the taxpayer typically bears the burden of proving by a preponderance of the evidence that the Commissioner's assessment is erroneous. However, there are some circumstances where the burden of proof shifts to the IRS.

One of these is if the deficiency notice is excessive and arbitrary - i.e., that the notice bears no factual relationship to the taxpayer's liability. In the case, the original deficiency notices assumed that the parents' company had no value. The IRS later conceded a portion of the original deficiency, allowing some value to the parents' company. The taxpayers argued that this backtracking from the original deficiency notice shifted the burden of proof to the IRS since the deficiency notice was thus excessive and arbitrary. The appeals court determined that the value shifting intent of the taxpayers, along with other associated documents, gave enough support to the IRS at the time it issued the deficiency notice so that its notice was not arbitrary and excessive. The issue here was a question of degree of a value shift, and not a lack of a rational foundation for the deficiency notice. The court noted that a finding of excessive and arbitrary usually arises when the IRS makes no evidentiary showing at all to support the deficiency notice.

The second burden of proof issue related to Rule 142(a) which allows a burden shift when a "new matter" is raised at trial. The taxpayers argued that the original theory in the notice of deficiency was that the parents' company was a worthless sham, and then the IRS later shifted to a theory that the taxpayers overvalued the parents' company - and thus, this involved a new matter. The notices of deficiency provided: "[U]nder IRC Section 2511[,] donor's merger of Knight Tool Co. into Camelot Systems, Inc. in return for 19% of the stock of Camelot Systems, Inc. resulted in a gift of $23,085,000.00 to the other shareholders of Camelot Systems, Inc. Accordingly, taxable gifts are increased $23,085,000.00." The appellate court did not read a sham argument into the notice of deficiency - instead, the issue originally was, and remained, the value of the parents' company - the taxpayers were on notice that the theory of liability was the valuation of the entities.

The last burden of proof issue involved a battle of the experts, and what a taxpayer must prove in challenging the government's expert. In the trial, the reports of the taxpayers' experts were rejected because they were based on the erroneous assumption (as determined by the Tax Court) that the childrens' corporation owned key business technology that the Tax Court determined to be owned by the parents' corporation. This left the only supported expert report with the government, which report treated the technology as owned by the parents' corporation.

Since the taxpayers had the burden of proof, the Tax Court placed on them the burden to show the proper amount of their tax liability. Since they had no valuations left standing to do so, the Tax Court did not allow the taxpayers to challenge the correctness of the government's expert and report, and adopted the valuation of that report in full, even while remarking on its arguably flawed analysis.

The appellate court found that the taxpayers did not have the obligation to prove the correct amount of their tax liability. Thus, they should have been allowed to challenge the government's expert report, and if successful, then the Tax Court should have determined for itself the correct tax liability rather than simply adopting the government's position. Thus, the appellate court remanded the case to the Tax Court to determine if the government's valuation has methodological flaws that makes it arbitrary and excessive, and if it does, the Tax Court should then determine the proper tax liability. In making that determination, it need not precisely establish the correct amount but can use reasonable approximations.

Cavallaro v. Comm., 118 AFTR 2d 2016-XXXX (CA1), 11/18/16

Gift Tax Statute of Limitations if Prior Gifts Omitted from Return

The IRS only has three years after a Form 709 is filed to assess gift taxes on a gift, so long as the gift is adequately disclosed on the return. If a gift is not disclosed, the statute of limitations does not begin to run on that gift.

The Form 709 requires disclosures of prior gifts, so that the tax on the current gifts can be properly calculated (since prior gifts can impact the rate of tax and available unified credit applicable to the current year computations).

So what happens if a gift is reported on the return, but the prior gifts are improperly reported, resulting in an underpayment of gift tax? Does the IRS have only 3 years to assess the underpayment, or does the failure to properly report the prior gifts extend the statute of limitations?

A recent Chief Counsel Advice concludes that the Code does not support an extended statute of limitations in this circumstance.

Chief Counsel Advice 201643020

IRS on the Hunt for Bitcoin Users

Bitcoin is the most popular of the virtual currencies. In Notice 2014-21, the IRS advised that such currencies are not money, but property, for tax purposes. Two implications of this are that persons who use Bitcoins to purchase things are treated as having sold the Bitcoin on the purchase date for the value of what they purchased – this will usually generate gain or loss to the buyer, and persons who receive Bitcoins are treated as receiving property worth the daily exchange value of Bitcoins on the date of receipt.

Likely suspecting that many taxpayers dealing in Bitcoins may inadvertently not be reporting their transactions as described above, or indeed are intentionally using Bitcoins to not report income, the IRS has issued a John Doe summons to Coinbase, the largest Bitcoin exchange firm in the U.S. seeking the records of all customers who bought virtual currenty from the company from 2013 to 2015. This is a warning that the IRS is enhancing its enforcement efforts in regard to Bitcoin transactions.

Of Course You Should Trust the IRS with Your Financial Information

The income tax provides justification for massive government intrusion into the financial privacy of its taxpayers. Its information gathering capacity and demands run wide and deep, and expand with almost every piece of enacted major tax legislation.

We would like to think that the government can be trusted with our financial data - but is that really justified? Data breaches are not limited to the private sector, the government is not too concerned about being sued like a private company if its servers are breached given sovereign immunity, and political motivations and abuse of access are also real risks.

Am I crying wolf here? You be the judge:

Recent Inspector General Report Excerpt: “TIGTA found the IRS did not ensure that encryption requirements are being enforced and ensure that nonsecure protocols are not being used in order to fully protect information during transmission. These protocols include File Transfer Protocol and Telnet, which are known insecure transfer protocols. The IRS also did not remediate high- risk vulnerabilities or install security patches on file transfer servers in a timely manner.  For example, TIGTA found 6 1 servers with high -risk vulnerabilities, 10 servers with outdated versions of Windows and UNIX operating systems still in operation, and 32 servers missing 18 unique security patches, of which four were deemed as critical. Lastly , the IRS did not ensure that corrective action plans for correcting security control weaknesses, including some of the weaknesses previously mentioned, met IRS standards.  This reduced the assurance that the weaknesses would be corrected timely”.

And another:

Recent Inspector General Report Excerpt: “taxpayers whose PII/tax return information was sent unencrypted in either internal or external e -mails during four weeks; this equates to 28,200,857 taxpayers for the full year”

Corporate Tax Reform on the Front Burner?

There is a clue out there that President-elect Trump may first want to tackle corporate tax reform, before moving on to individual tax reform (both of which involve rate reductions). This is because Stephen Moore, a Heritage Foundation fellow and co-author of President-elect Donald Trump's tax plan, is calling on Congress to pursue corporate tax reform as part of a bipartisan jobs bill that could finance a massive new infrastructure program while cutting tax rates for businesses, while suggesting separately that individual tax reform be addressed at a later time.

Of course this is only speculation, but given Mr. Moore’s involvement with the Donald’s tax plan, it may be indicative of the Donald’s thoughts as well.

Applicable Federal Rates - December 2016

New Regulations Issued Regarding CFCs and Investment in U.S. Property

Income earned abroad by U.S. controlled foreign corporations can often qualify for deferral of U.S. income tax. If the foreign corporation is a controlled foreign corporation (CFC), its U.S. shareholders may be taxable on such untaxed income if the corporation converts the property to U.S. property (Code §956).

The U.S. has now issued new and revised regulations relating to such investments in U.S. property. The regulations are technical, but here are some highlights:

a. Treas. Regs. §1.956-1T(b)(4) revises the anti-avoidance rule as to the definition of “funding” in regard to treating U.S. property held in a non-U.S. corporation controlled by the CFC if there is a principal purpose to avoid §956 (i.e., when U.S. property held in a controlled subsidiary foreign corporation will be attributed to the CFC under these rules).

b. Also under the anti-abuse rule, that rule was expanded in prior proposed regulations, and now in final regulations, to cover property that is held in controlled partnerships, too. The new rules also address how to compute these amounts, adopting a deemed liquidation rule but with special exceptions for property subject to special allocations.

c. The proposed regulations that applied §956 to property acquired by a CFC in certain related party factoring transactions were finalized.

TC 9792 (11/2/1)

What Kind of Tax Changes Can We Expect From Trump's Presidency?

The tears have not yet dried for some, and the celebrating is not yet over for others, but let's turn our attention to taxes. With a Republican Congress and a Republican president, some measure of tax relief is a given. What can we expect?

A good place to start is Trump's platform. Here are the key elements:

1. Cut in half the number of individual income tax brackets and bring rates down to 12%, 25% and 33%.

2. Elimination of the 3.8% Obamacare tax.

3. Lower the business tax rate for corporations and small businesses alike to 15%, but with elimination of many deductions.

4. Tax carried interest gains as ordinary income.

5. Retain 20% capital gains rate for noncorporations.

6. Increase the standard deduction for joint filers to $30,000 from $12,600, while eliminating personal exemptions.

7. $200,000 cap for itemized deductions for joint filers.

8. Repeal of the estate tax (what about the gift tax?). No basis step-up at death, except on first $10 million of assets.

9. Elimination of corporate alternative minimum tax.

10. 10% one-time tax on repatriation of corporate profits held offshore.

11. U.S. manufacturers may elect to expense capital investment and lose the deductibility of corporate interest expense.

How much of this will make it into law, and with what changes? What happens with the new Section 2704 regulations? Will the IRS try to push them through before the inauguration? Will it matter, since Trump is proposing eliminating the estate tax? Will the life insurance lobby influence Congress so as to retain the estate tax at some level?

As the expression goes, "may you live in interesting times." Well, that has been true for the last few months, and in the tax world will be true for at least the next few months. By the way, that expression is often attributed as an anonymous Chinese curse - however, others claim it is in fact an American expression (see the discussion here).

$100 Million FBAR Penalty - Ouch

Taxpayers who fail to file Reports of Foreign Bank and Financial Accounts (FBARs) disclosing their non-U.S. accounts can suffer a 50% penalty on the balance of the unreported accounts. In one of the largest penalties I have seen, a New York professor of business administration has been subjected to a $100 million civil FBAR penalty for failing to report a $200 million account.

Clients often enquire whether the IRS would really impose a 50% penalty - this case provides an unequivocal yes. They also ask what bad facts will bring about such a penalty. Here, the nonreporting was clearly intentional and egregious. For more facts, feel free to read the press release of the Department of Justice here.

Emeritus Professor Pleads Guilty to Conspiring to Defraud the United States and to Submitting False Expatriation Statement (DOJ Release, November 4, 2016)

Exceptions to Limited Liability for LLC Members [Florida]

Fla.Stats. §605.0304(1) provides for the limited liability of LLC members - it provides: "A debt, obligation, or other liability of a limited liability company is solely the debt, obligation, or other liability of the company. A member or manager is not personally liable, directly or indirectly, by way of contribution or otherwise, for a debt, obligation, or other liability of the company solely by reason of being or acting as a member or manager."

Nonetheless, there are other routes to liability for members, arising in their capacity as members. A recent article in the Florida Bar Journal provides details on many of these. These routes include;

• A  member's written obligation to make future contributions. Sometimes, these are not obvious to unsophisticated members - for example, a provision in an operating agreement requiring members to be responsible for deficit capital account balances.
• Provisions in an agreement for an LLC to be formed prior to organization.
• The 2 year clawback for improper distributions, which can be imposed on the transferee, and members and managers consenting to the distribution (Fla.Stats. §§605.0405 and .0406). Thus, this liability can be imposed on members and managers who did not receive the distribution.
• Responsible person liability for U.S. taxes (Code §6672), and for Florida sales or use taxes.
• Tortious conduct individually committed by a member or manager.
• Violation of officer or director fiduciary duties to the creditors of a company that operates in the "vicinity of insolvency" (See In Re Trafford Distribution Center, Inc., 431 D.R. 263 (Bankr. S.D. Fla. 2010); In re Sol, LLC, 2010 Bankr. LEXIS 2047 (S.D. Fla 2012))
• Theories expanding fiduciary duties to persons affiliated with owning entities, based on expansive case law, such as In re USACafes, L.P. Litigation, 600 A.2d  43 (Del. Ch. 1991) (expanded fiduciary duties of directors of general partner of limited partnership towards a limited partnership) and Beaubien v. Cambridge Consol., 652 So.2d 936, (Fla. 5th DCA 1995) (individual managers of corporate trustee owed fiduciary duties individually to the beneficiaries of the trust), and similar expansion of control person liability as applied in context of tortious conduct (Quail Cruises Ship Mgmt., 2011 U.S. Dist. LEXIS 122830 (S.D. Fla. Oct. 24, 2011).
• Potential for expanded duty of loyalty under Fla.Stats. §605.04091(2) which has a nonexclusive list of bad acts.

Judicial Exceptions to Limited Liability Protection Provided by Florida LLCs, by Thomas O. Wells and Diane Noller Wells, The Florida Bar Journal, November 2016

2017 Inflation Adjustments

Rev. Proc. 2016-55 has provided adjusted figures for 2017 for tax items subject to inflation adjustments. Here are some highlights:

Standard deduction - married filing jointly	$12,700
Standard deduction - single persons	$6,350
Standard deduction for a dependent	$1,050
Standard deduction for aged or blind person	$1,250
Overall Limitation on itemized deductions (Section 68(b))	$313,800 (Married person)
Personal exemption	$4,050
Covered expatriate threshold based on average annual net income tax for preceding five years	$162,000
Covered expatriate gross income exclusion	$699,000
Foreign earned income exclusion	$102,100
Unified credit against estate tax and gift tax	$5,490,000
Maximum §2032A value reduction	$1,120,000
Gift tax annual exclusion	$14,000 (no change)
Gift tax annual exclusion for gifts to noncitizen spouse	$149,000
Tax on arrow shafts (my favorite tax)	$0.50 per shaft
Notice of large gifts received from foreign persons	$15,797
2% interest rate portion on estate tax payable in installments	$1,490,000
Penalty for failure to file a partnership return or S corporation return	$200

Overview of New Section 385 Regulations

The IRS has issued final and temporary regulations under Code Section 385. These provisions, intended to limit earnings stripping, will enhance the IRS' ability to characterize related party ownership arrangements, purportedly established as debt, as equity instead.

One set of rules provides prerequisite requirements that must be met before the IRS will entertain debt characterization. The second set challenges the debt treatment of debt instruments that are not issued for new capital.

The good news is that the new rules will only apply to large or publicly traded entities.

I have done a short summary mind map of the basics of the regulations. You can download it from http://gutterchaves.d.pr/DwHW and when you run the download it should be viewable in your browser.

T.D. 9790

Section 385 Regulations Issued - Not as Harsh as The Proposed Regulations

Earlier this year, the IRS issued proposed regulations on the conversion of purported related party debt to equity - see the discussion here. The IRS has now issued temporary and final regulations on the subject.

Taking into consideration the negative comments that came out against the proposed regulations, the IRS has eliminated or softened some of the more negative aspects of the proposed regulations.

The regulations are quite lengthy - the Treasury Decision is over 500 pages. More to follow, once I have given them a read through.

T.D. 9790

Executor Loses Out on Fees Due to Section 6166 Lien

A personal representative/executor for an estate granted a special estate tax lien under Code §6324A to the U.S. as part of a Section 6166 election to defer payment of federal estate tax. At the time, the executor had been paid only been part of his fees, leaving $486,265 unpaid. The IRS has the ability to demand a lien before allowing a Section 6166 election if adequate bond is not posted.

During the course of the lien period, the value of the liened property fell below the amounts still due to the IRS. The executor asserted his claim to fees was superior to the tax lien, and thus that he could use the liened property as a source of funds for his unpaid fee. The U.S. District Court granted  the executor’s motion for summary judgment on this issue. Because the statute was silent as to priority of administrative expenses, the court gave priority to the administrative expenses based on a “first in time is first in right” theory. On review, the 11th Circuit Court of Appeals overturned the lower court and ruled that the IRS lien has priority. Since the executor’s claim for commissions was not a lien, the “first in time is first in right” common law theory was found not to apply.

Note that under the general estate tax lien of Code §6324, administrative expenses take priority over the government lien. This is due to the express exception under Code §6324(a) that excepts out “such part of the gross estate as is used for the payment of charges against the estate and expenses of its administration.” The appellate court noted no such explicit exception under Code §6324A, and reasoned that if Congress had wanted one, it would have written one in.

The executor argued that his expenses should have superiority - otherwise, it may be difficult to obtain executors to serve. The appellate court rejected this. Their thought process was that the executor has the opportunity to make arrangements for payment of his fees before putting on the §6324A lien, and/or can leave other property for fee payment free of the lien (or not make the Section 6166 election).

The appellate court also noted that allowing the lien to be subject to administrative expenses could lead to partially unsecured deferred payment obligations. Also, since such administrative expenses would not take superiority in regard to any bond posted to secure the deferred tax, they likewise should not be granted superiority in regard to this alternate method for securing the tax.

Hopefully for the executor, he will be able to recoup his unpaid fees from distributions previously made to beneficiaries.

This decision is a trap for the unwary, and “make arrangement for payment of estate administrative expenses, including professional and executor fees outside of liened property” should be added to every practitioner’s checklist when making a Code §6166 election and related §6124A lien.

U.S. v. Spoor, 118 AFTR 2d 2016-xxxx (11th Cir 10/4/16)

Failure to Make Check-Off on Gift Tax Return Bars 5 Year Ratable Treatment for contribution to 529 Accounts

Contributions made to an education Section 529 plan are taxable gifts. However, such a gift will qualify for exclusion as an annual exclusion gift to the extent of the available exclusion for the donee in the year of the gift.

If the amount contributed exceeds the available annual exclusion, Code §529(c)(2) allows that gift to be spread ratably over a five year period for gift tax purposes, if the taxpayer so elects. The Form 709 provides a check box for electing such ratable treatment.

In a recent Tax Court case, the taxpayer made contributions that exceeded the available annual exclusion amounts, but did not make the ratable election on a gift tax return (in one year, he did not file a gift tax return, and in another year he filed but did not make the election). It appears that the taxpayer did not report these amounts as taxable gifts.

Would the taxpayer’s treatment of the gifts as nontaxable constitute a 5 year ratable election, even though the election was not checked on a gift tax return?

No, says the Tax Court. The legislative history to Code §529(c)(2) and the Form 709 instructions require a return to be filed and an election to be checked off. So, since there was no checkoff, the fundings constituted taxable gifts in the year made (less available annual exclusion).

Estate of Edward G. Beyer, et al., TC Memo 2016-183

Filing an Entity Income Tax Return Does Not Constitute a Check-the-Box Election

A single member limited liability company (SMLLC) is treated by default under the check-the-box rules as a disregarded entity. If a Form 8832 is filed, the owner can elect to treat it as a corporation/association.

A single owner corporation was merged into an SMLLC owned by the same person. The surviving SMLLC filed Forms 1120 as a 'c' corporation thereafter. The IRS processed the Forms 1120. No Form 8832 election was ever made to treated the SMLLC as a corporation.

The IRS sought to impose employment tax liabilities on the member of the SMLLC, asserting he was responsible as sole member of a disregarded entity. The member argued that the IRS should respect the SMLLC as a corporation, and not treat it as a disregarded entity. The case ended up in Tax Court.

The member made three arguments. First, he argued that the merger of the two entities was a reorganization under Code §368(a)(1)(F) and thus the SMLLC should be treated as a corporation for Federal tax purposes. The Tax Court determined that absent the filing of a Form 8832, the SMLLC could not be a corporation, regardless of the reorganization status.

The member then argued that the filing of Forms 1120 for the first year after the merger constituted a valid election to be taxed as a corporation. The Tax Court held that a taxpayer can't make a check-the-box election by filing any form it wishes - it must use the Form 8832.

Lastly, the member argued that the doctrine of equitable estoppel prevented the IRS from contending that the SMLLC was not a corporation. The Tax Court described the four requirements of equitable estoppel as (1) a false representation or wrongful misleading silence; (2) the error must be in a statement of fact and not in an opinion or a statement of law; (3) the person claiming the benefits of estoppel must be ignorant of the true facts; and (4) he must be adversely affected by the acts or statements of the person against whom an estoppel is claimed. The Tax Court rejected the equitable estoppel claim since the IRS made no false statement to the member, and it did not agree that the IRS' lack of rejection of the Forms 1120 was a wrongful misleading silence. Further, court advised the the member knew the SMLLC had never filed a Form 8832 to elect to be treated as anything other than a disregarded entity.

Heber E. Costello, LLC, et al., TC Memo 2016-184

U.S. Tax Competitiveness is Abysmal (and Economic Freedom is Trending Downward)

Capital, and all the benefits it provides (investment, innovation, jobs, creation of wealth), flows to where it is treated best. An important element of treatment is how it is taxed. So how does U.S. tax competitiveness measure up against the other OECD countries?

It comes in at a solid 5th worst  - way to go USA! An important contributing factor, according to Center for Federal Tax Policy that issued the rankings, is that the U.S has a " combined federal, state, and local corporate tax rate of 39 percent [that] is significantly higher than the average rate of 25 percent among OECD nations."

Another important international ranking was also recently released - the Index of Economic Freedom. Here, the U.S. ranks number 11. Not bad, but not great for a country touted as the land of the free. More bad news is that the U.S. scored declined by over 1% since 2015, while the world as a whole improved. The long term trend in the U.S. is depressing - in 2008, the U.S. was ranked 5th. You can see the full rankings here.

Business Protection from Payroll Provider Fraud

Many businesses rely on third parties to handle their payroll, including making withholding deposits with the IRS on behalf of the business. Way too often, the payroll provider will embezzle the funds and not pay them over to the IRS.

In this circumstance, the business is still on the hook for the unpaid employment taxes. To add insult to injury, if the IRS takes a hard line it will usually be successful in obtaining interest and penalties from the business. This is based on the view of the courts that a taxpayer's duty to file returns and pay taxes is nondelegable. For a recent example where the employer was held responsible for interest and penalties, see Kimdun, Inc. v. U.S., 118 AFTR 2d 2016-5508 (DC CA 2016).

So what can employers do to protect themselves? One thing that should be done is to check online with the IRS through the FTPS system on a regular basis to confirm that deposits are being made. While doing this may or may not help in a penalty dispute with the IRS, it will alert the business to problems before the tax and penalty liability builds up.

Here is an excerpt from the Internal Revenue Manual on this subject:

5.1.24.5.3  (08-15-2012)
Use of Electronic Federal Tax Payment System (EFTPS) for Payment Verification

An employer should ensure its PSPs are using EFTPS so the employer can confirm payments are being made on its behalf. An employer can register on the EFTPS system to get its own PIN and use this PIN to periodically verify payments. A "red flag" should arise the first time a payroll service provider misses or makes a late payment.

When an employer registers on EFTPS, it will have on-line access to its payment history for 16 months. In addition, EFTPS allows an employer to make any additional tax payments its third-party payer is not making on its behalf, such as estimated tax payments.

Updated Historical Transfer Tax Rates & Exemptions

I have updated this table (last updated in 2013) – you can download it from here.

No Later Voiding of Unnecessary QTIP Elections if Portability Elected

CITE	Rev. Proc. 2016-49
RELEVANT LAW	A QTIP election, once made, is irrevocable. The election has various implications, including: GOOD: Allowance of the marital deduction. ADVERSE: §2044 includes the QTIP trust property in the gross estate of the surviving spouse, and §2519 will take dispositions of the QTIP trust property. ADVERSE: Absent a "reverse QTIP" election under §2652(a)(3), the surviving spouse is treated as the transferor of the property for GST purposes under §2652(a). A decedent's estate should be able to make a QTIP election even though one is not needed (e.g., adequate unified credit would allow for no estate tax even without the election). See the discussion on this below. If unneeded, the above adverse consequences still apply. Rev. Proc. 2001-38 provides that the election will be void and the above adverse consequences will NOT apply if the election was not needed to reduce the estate tax liability to zero, and the procedures of the Revenue Procedure are followed. Note that the procedure does describe various circumstances when it will nonetheless not apply.
RULING PRONOUNCEMENTS	The voiding procedures of Rev. Proc. 2001-38 are not available if a portability election is made (unless the DSUE amount is zero, or in other limited circumstances). In estates in which the estate makes the portability election, QTIP elections will not be treated as void.
COMMENTS	The premise of Rev. Proc. 2001-38 was that no one would intentionally make an unneeded QTIP election, since the adverse effects are significant. With portability, this is not the case. For example, the adverse effects may be mitigated or eliminated - the surviving spouse may have an enhanced gross estate but is also now receiving the DSUE amount to reduce or eliminate future transfer tax on it. Therefore, with portability the adverse effects are ameliorated or eliminated, so it is no longer appropriate to allow for automatic voiding of the QTIP election when it was unneeded to reduce estate tax at the first spouse's death. With portability, at times it may be advantageous to make an unnecessary QTIP election for what would otherwise be an exempt credit shelter trust. For example, by including the bypass trust in the gross estate of the surviving spouse, its assets can now receive a basis step-up at the death of the second spouse - that would not be the case if the trust was an exempt bypass trust. This is more the case for lower value estates where growth in the QTIP trust is not projected to put the surviving spouse's estate into a taxable situation. The estate tax cost of inclusion under §2044 is offset, at least in part,  by the DSUE amount coming over. Thus, this ruling may be a boon to some taxpayers. By affirmatively making an unnecessary election in combination with portability, can the IRS nonetheless void the election of its own accord if it provides an advantage to the surviving spouse's estate, like the above basis step-up? Clearly, the IRS may want to void it, since it provides a basis step-up for what would otherwise have been a by-pass trust. Both the old and the new procedures are relief provisions for taxpayers, and require them to undertake steps to come within them to void the election - they really don't address what the IRS can do on its own motion. The procedures imply that if the taxpayer takes no action, then the QTIP election remains in force. Rev. Proc. 2001-38 was silent on the issue whether the IRS could void the election on its initiative  - that makes sense since there was little reason for it to do so. Now, however, the IRS may want to do so to remove the above basis step-up effect.  Can it do so, even though the taxpayer cannot? The 2016 procedure contains the language "In estates in which the executor made the portability election, QTIP elections will not be treated as void." Clearly, this means the taxpayers cannot use the voiding procedures to later take a second look at the situation and decide to void the prior QTIP election, and that makes sense. But should this be read as a commitment by the IRS that it won't void the election as unnecessary on its own initiative and motion - or just that the taxpayer cannot gain the relief of voiding an election in these circumstances? There are many who think the procedure is a statement by the IRS to not act on its own motion to void, but perhaps that quoted sentence applies only in context of the procedure - i.e., TAXPAYER requests for relief - since the IRS would not need to use the procedure to void then that statement may have no applicability? If the IRS does challenge such a QTIP election, could it prevail in its challenge? It would be difficult, since there are only 3 requirements to make a QTIP election, and none of them relate to whether it is needed to reduce estate tax. For more on this question see the article of Austin Bramwell, Brad Dillon and Lisi Mullen here. Note that taxpayers can still get the same basis step-up and transfer of DSUE without these issues by leaving the assets of the first spouse outright to the surviving spouse.  But they cannot do so when a trust for the surviving spouse is desired (e.g., for asset protection, spendthrift, or remarriage purposes), so the procedure is valuable for supporting this tax planning opportunity when a trust is desirable.  Of course, making a QTIP trust election for the bypass trust comes with other potential adverse consequences, and thus may not often be desirable. For example, if the bypass trust is expected to materially appreciate in value, making the QTIP election exposes that appreciation to estate tax at the second spouse's death if available unified credit amounts are exceeded, as well as potential generation skipping tax.
RESEARCH TAGS	QTIP, portability, marital deduction

Hillary Clinton Advises of Changes She Would Make to the Estate Tax Rate

And its not downward – surprise!

Last week, Hillary advised that she would like to move the highest estate tax rate from its current 40% to 65%. She would also implement a 50% and 55% bracket.

Mission Near Impossible - Reliance on Professionals Defense to Late Filing and Payment Penalties

An estate sought relief for $1.189 million in penalties for the late filing of a Form 706 and the late payment of estate taxes when the filing and payment were over a year late. The U.S. District Court granted the government's motion for summary judgment upholding the penalties, and the 6th Circuit Court of Appeals affirmed the lower court. The late filing and payment were principally attributable to the estate attorney who was responsible for the filings. The courts ruled for the government notwithstanding the following favorable facts supporting reasonable cause: (1) the executor was elderly, (2) he only had a high school diploma, (3) he had never interacted with attorneys before serving as executor, (4) he had never served as an executor, (5) the attorney was suffering from brain cancer and her competency was deteriorating during the applicable period, (6) the attorney told the executor that extensions had been obtained whenever questioned about the filing status, but this was a lie, (7) the State of Ohio refunded the penalties as to state estate taxes for reasonable cause, and (8) the government conceded that the executor heavily relied on the attorney.

The penalties for failure to timely file a tax return and pay tax do not apply if the failure is due to reasonable cause and not due to willful neglect. Code §6651(a). Treas. Regs. §301.6651-1(c)(1) requires the taxpayer seeking to avoid the penalties for late filing "to show that the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time." A failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made "a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship  if he paid on the due date."

The principal case on the issue of reliance on a professional to avoid late filing and payment penalties by an estate is United States v. Boyle, 469 U.S. 241 (1985). There, the U.S. Supreme Court intentionally established a bright line that the burden of prompt filing is on the executor, not on an agent or employee of the executor, with exceptions to apply only in a "very narrow range of situations." The executor has the "obligation to ascertain the statutory deadline and then to meet that deadline, except in a very narrow range of situations." Id. at 249-50. The Court explained that "tax returns imply deadlines. Reliance by a lay person on a lawyer is of course common; but that reliance cannot function as a substitute for compliance with an unambiguous statute." Id. at 251. The Court therefore concluded that "Congress has charged the executor with an unambiguous, precisely defined duty to file the return within nine months . . . That the attorney, as the executor's agent, was expected to attend to the matter does not relieve the principal of his duty to comply with the statute." Id. at 250. Thus, executors seeking to avoid responsibility for late filing or late payment based on reliance on a professional begin the process with the weight of the case law against them. A review of the particular facts of this case and the appellate court's treatment of them will illustrate how difficult a burden the executor has.

Boyle leaves open the possibility that an executor's qualifications may impact the reasonableness analysis, with a concurring opinion noting that "senility, mental retardation or other causes" might render an individual incapable of complying with the statutory deadlines. The estate here noted that the executor lacked the sophistication of the executor in Boyle. Nonetheless, the executor in Boyle was not experienced in the field of federal estate taxation and relied on his attorney for instruction and guidance - both of those facts also applied here. Ironically, the actions by the executor in firing the attorney, hiring a new attorney, and then having the return and payment handled, once the failures became known were cited by the appellate court to prove the executor's ability to manage the estate. While not cited in this case, in Baccei v. U.S., 632 F3d 1140 (9th Cir. 2011), trustee was denied relief for late payment of estate taxes when his accountant filed a deficient request for extension of time to pay the estate taxes - citing Boyle and other cases, the court noted that a taxpayer "cannot rely on its employee or agent to escape responsibility for the nonperformance of nondelegable tax duties."

The estate also sought relief based on the attorney's deteriorating medical situation. While sympathetic, the appellate court noted that the question is whether the executor, and not the attorney, was reasonable in missing the deadline. Since the deadline would have been missed whether the attorney acted reasonably or not, that did not impact the reasonableness of the executor in relying on the attorney. The appellate court also relied on Valen Mfg. Co. v. United States, 90 F.3d 1190 (6th Cir. 1996) to demonstrate that the focus is on the taxpayer, and not the agent. There, an employee's active concealment of her failure to file the company's tax return and pay its liabilities was not enough to relieve the taxpayer of late filing and payment penalties. It also cited an unpublished decision in Vaughn v. United States, 635 F. App'x 216 (6th Cir. 2015), where Mo Vaughn, a former Major League baseball player, relied on a wealth-management firm and tax accountant to prepare and file his tax returns and make payments. Rather than pay the taxes, the manager embezzled millions of dollars. The appellate court there found the felonious actions of Mr. Vaughn's agents did not excuse him from the expectation that a taxpayer would know that he must file a return and pay taxes.

This case and the authorities cited therein set a high bar for taxpayers, but not necessarily an impossible one. In this case, the court did note that the executor was aware of the filing deadline, and also had various warnings that the attorney was not properly handling matters. Perhaps the absence of such facts might have resulted in a different finding. The appellate court also noted the case of Brown v. United States, 630 F. Supp. 57 (M.D. Tenn. 1985). While lacking precedential punch since it preceded both Valen and Vaughn, reasonable cause was allowed for an executor when the executor was 78 years old, only had a high school education, lacked experience in tax matters, was in failing health, and relied on an attorney to do the return and the attorney was hospitalized two weeks before the filing deadline. The appellate court noted that in Brown the executor was incapable of replacing the attorney. So, given the right circumstances, reasonable cause for late filing based on reliance on a professional might garner relief - but that will clearly be the exception and not the rule.

Applicable Federal Rates - October 2016

Free Tickets to Jonathan Blattmachr Presentation in Boca Raton on September 28, 2016 on the new Section 2704(b) Regulations

I have 3 tickets to give away to this seminar (the tickets are normally being sold for $50 each) on the afternoon September 28, 2016, and the following cocktail reception. More info is at www.pbcseminar.info. 

If interested, send me an email with your name and contact info ASAP at crubin@floridatax.com. First three responses will get the tickets.

Article Abstract: Carried Interests and Tax Treatment of Fee Waivers: an Attempt at Reform in the Proposed Regulations

TITLE	Carried Interests and Tax Treatment of Fee Waivers: an Attempt at Reform in the Proposed Regulations
AUTHOR(S)	William M. Funk
PUBLICATION	Business Entities, July/August 2016
PUBLISHER	WG&L
ABSTRACT (Key Points & Discussions)	Managers of investment partnerships regularly attempt to structure their carried interests so as to be nontaxable upon issuance, and to avoid ordinary income treatment on partnership allocations and distributions relating to those partner interests. In so doing, they seek treatment as regular partners on distributions under Code §§704/731, and they seek to avoid treatment as interests received by a non-partner under Code §707(a) or as a guaranteed payment under Code §707(c). Fund managers are often paid under a bifurcated regime, such as the 2-and-20 arrangement. Under that arrangement, the manager will receive a fixed fee, such as a 2% of value under management fee, and a share of profits, such as a 20% profits interest. These arrangements sometimes allow the manager to forgo payment of the 2% fixed fee and instead effectively exchange that fee for an additional profits interest beyond the 20%. The article reviews and analyzes Proposed Treas. Regs. §1.707-2, which regulations seek to provide more certainty in regard to whether partnership interests issued for services, such as carried interests, will be taxable under Code §§704/731. The article then addresses the particular question of how the conversion of a 2% fix management fee into an additional share of profits by the manager will be taxed. Its conclusion is that if properly structured  (A) taxation of income allocated to and distributed to the partner on the newly issued profits interest will be treated as regular partnership transactions including under Code §§704/731, and not under Code §§707(a) or §707(c), but nonetheless (B) the exchange of the 2% fixed fee for an additional profits interest is taxable - principally because there is an ascertainable value of the additional profits interest team received (as measured by the fixed fee being foregone), in contrast to what was likely the initial nontaxable issuance of the initial 20% profits interest.
RESEARCH TAGS	Partnerships, carried interest, guaranteed payments, Code §§704, 707(a) & (c), 731.
MY COMMENTS	These new proposed regulations were issued in 2015.

 

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IRS Attempts Collection Against Surviving Spouse and Marital Deduction Property

In a recent U.S. District Court case from the Southern District of California, the court ruled on several motions to dismiss relating to the IRS' attempt to impose liability on a surviving spouse for estate taxes on the estate of her decedent husband, even though the property received by the surviving spouse was eligible for the marital deduction. The IRS attempted various approaches. Some of the more interesting approaches are discussed below, along with the court's resolution.
The facts are somewhat lengthy. Boiling them down to the key aspects, Allen Paulson (the decedent) entered into a prenuptial agreement with his spouse-to-be, Madeleine Pickens. The agreement included obligations for Mr. Paulson to make certain gifts to Ms. Pickens when he died. Mr. Paulson's living trust made provisions for Ms. Pickens, but gave her the ability to elect to receive either under the prenuptial agreement or the living trust provisions. The living trust provided for substantial gifts to a marital trust.

After Mr. Paulson's death, the IRS granted an extension of time to file the Form 706 and to pay estate taxes. When filed, the Form 706 reported a total gross estate of $187,729,626, a net taxable estate of $9,234,172, and an estate tax liability of $4,459,051, and this tax amount was assessed on November 26, 2001. The estate elected to pay $706,296 in tax and deferred the remaining tax under Code §6166.

The estate tax return was selected for audit. During the audit, disputes arose between the estate and trust fiduciaries, Ms. Pickens, and some beneficiaries. Under a 2003 settlement, Ms. Pickens gave up the distributions provided under both the prenuptial agreement and the living trust, instead choosing to receive direct distributions from the living trust of two residences and stock in a country club. These amounts were paid to Ms. Pickens as trustee of a trust bearing her name, the Madeleine Anne Paulson Separate Trust (or so it appears, since the trust bears both her first name and her married last name).

The IRS proposed a deficiency of almost $38 million in estate taxes. A Tax Court determination, based on the stipulation of the parties, resulted in an increase in the estate taxes of $6,669,447. The estate elected to add this to its Code §6166 deferred payment obligation.

In 2010, the IRS rescinded Code §6166 treatment due to missed installment obligation payments. This rescission was affirmed by the Tax Court in 2011 after a taxpayer challenge.
Additional litigation between interested parties resulted in the resignation of the executor in 2013. As of 2015, the estate tax liability stood at $10,261,217. The U.S. filed a complaint seeking judgment against the estate and various persons in their fiduciary and individual capacities, including Ms. Pickens. Various cross-claims were also filed between the parties. What follows below are some of the more interesting defenses raised by Ms. Pickens and the court's rulings on them.

Statute of Limitations on Collections. Ms. Pickens claimed that a portion of the tax being sought relates to the 2001 assessment, and is thus time barred by the ten-year statute of limitations. The U.S. argued that the 2001 assessed taxes were previously paid, and that the remaining tax relates to the 2006 post-audit assessment. Thus, applying a first-in, first-out approach to the taxes, this left all of the remaining taxes available for collection within the ten-year window. The court ruled in favor of the U.S.

Liability for Tax as Statutory Executor. The U.S. sought to hold Ms. Pickens responsible, in her representative capacity, for the tax as the executor of the estate under Code §2002. Ms. Pickens was never appointed and never served as the executor of the estate. Recall that the estate had an executor, but he resigned in 2013. The U.S. argued that Ms. Pickens is a statutory executor, subject to this liability, because she now owns property that formerly belonged to the decedent. Code §2203 defines an executor for these purposes as "the executor or administrator of the decedent, or, if there is no executor or administrator appointed, qualified, and acting within the United States, then any person in actual or constructive possession of any property of the decedent." The court noted that since there was no executor at the current time, the Code §2202 claim against her can proceed.

Transferee Liability as a Fiduciary of the Marital Trust. The government sought to impose transferee liability on Ms. Pickens under Code §6324(a)(2) as trustee of the Marital Trust. The court noted "it is unclear how Plaintiff can plausibly articulate a claim for relief against Ms. Pickens based on a role that she never assumed by virtue of the Marital Trust never being funded" and dismissed the Code §6324(a)(2) claim relating to trustee status.

Transferee Liability as a Beneficiary. The government also sought to impose transferee liability on Ms. Pickens under Code §6324(a)(2), this time as a beneficiary of the living trust. Reading the statute alone, one would likely side with the government on this. It reads: "If the estate tax imposed by chapter 11 is not paid when due, then the spouse, transferee, trustee (except the trustee of an employees' trust which meets the requirements of section 401(a)), surviving tenant, person in possession of the property by reason of the exercise, nonexercise, or release of a power of appointment, or beneficiary, who receives, or has on the date of the decedent's death, property included in the gross estate under sections 2034 to 2042, inclusive, to the extent of the value, at the time of the decedent's death, of such property, shall be personally liable for such tax." Here we have a "beneficiary" receiving property includible in the gross estate and there being unpaid estate tax.

However, case law has limited the meaning of the term "beneficiary" in Code §6324(a)(2) to mean only the beneficiary of a life insurance policy. The court declined to depart from that limited interpretation and dismissed the U.S.' Code §6324(a)(2) claim relating to beneficiary status.
Transferee Liability as a Fiduciary of the Madeleine Anne Paulson Separate Trust. The government also sought to impose transferee liability on Ms. Pickens under Code §6324(a)(2) as trustee of the Madeleine Anne Paulson Separate Trust. Noting that the settlement assets were paid to Ms. Pickens as trustee of that trust, the court allowed the claim to proceed against her in her individual capacity.

IRS as Third Party Beneficiary. In the 2003 settlement agreement, Ms. Pickens agreed to indemnify other parties to the agreement for estate taxes attributable to assets she received. The IRS sought to piggy-back on those indemnification provisions to collect from Ms. Pickens based on it being a third party beneficiary of the settlement contract. The court allowed the IRS to proceed on that claim.

COMMENTS:

As to Statutory Executor Argument. One might wonder why the IRS is seeking to hold Ms. Pickens liable in her representative capacity, since if the transfers to her were respected as eligible for the marital deduction (as they opinion indicates they were), one would presume that the tax apportionment provisions of the subject documents and/or state law would direct payment of the estate taxes away from the assets she received.  However, while such apportionment provisions may dictate who can sue who for contribution and indemnification, there is no general bar as to the IRS collecting from assets that are eligible for the marital deduction even if the dispositive documents or state law indicate otherwise.

The IRS also may have had a more hidden motive. There is language in the opinion that the IRS is seeking to obtain a judgment against the estate by naming its executor or administrator in a representative capacity so as to reduce the estate tax liability to a judgment under Code §7402, and to extend the statute of limitations for collection of that tax under Code §6502.

Ms. Pickens argued that the IRS' position would render every beneficiary of an estate a statutory executor when the appointed, qualified, and acting executor resigns. An interesting argument, but one that apparently did not impress the court.

As to Transferee Liability as a Beneficiary. The limitation of the term "beneficiary" to a beneficiary of a life insurance trust is a warning to not always take unambiguous statutory language at its face value.

As to Transferee Liability as a Fiduciary of the Madeleine Anne Paulson Separate Trust. Bad luck for Ms. Pickens on this one. Having ruled that Ms. Pickens has no transferee liability as a beneficiary, if the settlement agreement paid the assets directly to Ms. Pickens instead of a trust for her, there probably would be no transferee liability.

As to IRS as Third Party Beneficiary. Taxpayers often include tax indemnification provisions in their settlement and other agreements. The recognition of third party beneficiary rights in the IRS suggests that such agreements be drafted in a manner (if practical and possible) in a manner that eliminates such a third party beneficiary claim. One has to wonder again where the IRS is going with this, since Ms. Pickens indemnification relates only to taxes on the assets she received. As marital deduction property, there should be no taxes and thus no indemnification. The opinion does give mention of other settlement agreement language that perhaps overcomes this limitation.
Overall, the case also demonstrates that the IRS is not immune from the well-known litigation strategy of throwing it all against the wall to see what sticks.

U.S. v. Paulson, Case No. 3:15-cv-02057, U.S. District Court, Southern District of California (September 6, 2016)