Out of State Homestead Exemption Voids Florida Exemption [Florida]

Florida exempts a portion of a Florida homestead from ad valorem tax. This could save a taxpayer a few hundred dollars a year. The real economic value to such an exemption is that under Florida's Save our Homes provision, ad valorem tax value increases are limited to 3% per year even though the value of the residence increases more.

A husband owned a residence in Indiana. He received a residency-based property tax exemption from Indiana on that property. His wife owned a Florida residence and received a Florida homestead ad valorem tax exemption. In August 2006, the Broward County Property Appraiser caught wind of the dual exemption filings. It trotted out Article VII, Section 6(b) of the Florida Constitution, which reads "[n]ot more than one exemption shall be allowed any individual or family unit or with respect to any residential unit." Based on that provision, the appraiser sought to remove the homestead exemption from the wife's property for 1996 through 2006 - this uncapped the value for ad valorem tax purposes by removing the 3% Save our Homes protection.

Does the Constitution provision apply if the second exemption property is in another state? Yes, says the appeals court.

Is it unconstitutional to deny the wife her exemption because her husband sought exemption in another state? No, says the appeals court

A cautionary tale for Florida homeowners.

VENICE L. ENDSLEY, Appellant, v. BROWARD COUNTY, FINANCE AND ADMINISTRATIVE SERVICES DEPARTMENT, REVENUE COLLECTIONS DIVISION; LORI PARRISH, as Broward County Property Appraiser, et al., Appellees. 4th District. Case No. 4D14-3997. March 23, 2016

Form 8971 Filing Date Extended

The new Form relating to reporting to beneficiaries of estates and the IRS on the tax basis of distributed assets has had its first filing due date extended to June 30, 2016. The IRS has taken notice of the scrambling around imposed on estates to meet the end of March deadline, and is giving more time for compliance.

Notice 2016-27

Applicable Federal Rates - April 2016

Income Tax Assessment on Beneficiary Allowed Even Though the Statute of Limitations Had Expired

A recent Tax Court case illustrates how the IRS was able to assess income taxes against two trust beneficiaries even though the statute of limitations for assessment had expired, via the mitigation provisions of the Internal Revenue Code.

FACTS: A father established a revocable trust during his lifetime. Several IRAs of father named the trust as beneficiary. Father then died on June 21, 1998. In 2001, $228,530.44 was distributed to the trust from the IRAs. In the same year, the trust distributed the same amount to two beneficiaries of the trust (who were children of the father).

On its timely Form 1041 for 2001, the trust reported $228,530 in gross income, and also deducted that amount as an income distribution, so that it had no net income. It reported the distributions to the beneficiaries on Schedules K-1. The two beneficiaries each reported $114,265 in income from the distributions on their Forms 1040 for 2001.

The Form 1041 was selected for audit, and in 2004 the IRS disallowed the income distribution deductions, and determined an $80,302 deficiency for the trust for 2001. The IRS also adjusted the beneficiaries’ Forms 1040 by removing the trust distributions from gross income. The beneficiaries paid the additional tax due that the trust owed 2001, and they received refunds for their 2001 taxes.

In 2006, the trust amended its 2001 Form 1041 and sought a refund of the taxes paid under the audit by again claiming a distribution deduction. In 2008, the IRS accepted the refund claim, and refunded the taxes that had been paid on behalf of the trust based on the 2004 disallowance. In 2008, the IRS sent notices of deficiency to the beneficiaries for 2001 that included the distributed amounts in the gross income of the beneficiaries.

The 2008 assessments against the beneficiaries were barred by the statute of limitations, which expired for the 2001 tax years of the beneficiaries on April 15, 2005. The IRS sought to uphold their assessments using the mitigation provisions of the Code (Sections 1311 through 1314). If applicable, the provisions allow for the correction of an error made in a closed tax year by effectively extending the limitations period up to one year from the date a final determination is made. Their intent is to take "the profit out of inconsistency, whether exhibited by taxpayers or revenue officials, and whether fortuitous or the result of design", and their purpose is to prevent the Government or a taxpayer from obtaining "an unfair benefit *** by assuming an inconsistent position and then taking shelter behind the protective barrier of the *** [period] of limitations." S. Rept. No. 75-1567, at 49 (1938), 1939-1 C.B. (Part 2) 779, 815.

More particularly, Code Section 1311(a) provides that if (1) there is a determination of tax (as defined in Section 1313), (2) that determination causes an error described in Section 1312, and (3) on the determination date an adjustment to correct the error is barred by operation of law, then mitigation applies. Code Section 1311(b) generally also requires, in the case of an allowed refund, an inconsistent treatment as to the erroneous income exclusion.

Requirement 1 was met with the IRS’ determination to allow the refund claim of the trust. Requirement 2 was met per Section 1312(5) which provides as one of the Section 1312 errors the circumstance when “[t]he determination allows... deductions allowable in computing the taxable income of...trusts...and the correlative inclusion...has been erroneously excluded...in respect of the related taxpayer.” Here, the refund claim determination allowed a deduction to the trust but the correlative inclusion of income of the distribution income was erroneously excluded from the gross income of the beneficiaries (the related taxpayers). Requirement 3 was met per the statute of limitations bar that prevented the income from being assessed to the beneficiaries. Lastly, there existed an inconsistency between the allowed deduction/refund to the trust and the erroneous non-taxation of the beneficiaries. Thus, the Tax Court applied the mitigation provisions to allow for the assessment of the beneficiaries.

COMMENT: This case is interesting for at least two reasons. First, it illustrates the application of the mitigation provision of the Code to a mismatching of income and deduction between a trust and its beneficiaries. Such cases are rare, and often difficult to imagine how they can come about. Second, it reminds practitioners that in examining statute of limitation issues, if it appears the statute has run one still has to ask the question whether the mitigation provisions may act to extend the statute. I would venture to say that there are likely many practitioners who have little, if any, passing knowledge or awareness of the mitigation provisions.

As a personal aside, when I earned my Masters in Tax Law many years ago, our tax procedure professor was enamored with terrorizing our class with the mitigation provisions. These provisions are difficult to follow and employ, especially for students first learning the basics of tax procedure. That experience left me with a special non-fondness for the mitigation provisions.

A key preliminary question to ask in determining whether one should look further at the mitigation provisions is whether the IRS and the taxpayer have adopted inconsistent positions that injure (or provide a windfall to) one or the other, and are typically reliant on a closed statute of limitations. Examples include multiple deductions for the same item, multiple income inclusions for the same item, or mismatched income and deduction between trusts and beneficiaries like in this case. An alternate phraseology is to ask whether the result is too good to be true for either the IRS or the taxpayer, and arises in part from statute of limitations provisions.

As the case illustrates, the mitigation provisions apply even if the problem arose from government behavior or error. The provisions can operate to the benefit of the IRS or the taxpayer, depending on the circumstances.

CITES: Sally M. Costello, et vir. v. Commissioner, TC Memo 2016-33; Code Sections 1311-13

IRS Audit Instructions for Outbound Section 482 Transactions

Code Section 482 requires taxpayers that conduct related party sales and transactions to use arms-length pricing. Section 482 particularly applies to international transactions given the possibility to shift taxable income out of the United States by overcharging or undercharging in these transactions.

Taxpayers who violate these pricing rules can be subject to a 20% adjustment penalty, or at times a 40% adjustment penalty. However, if taxpayers at the time of the transaction make a good-faith effort to compute a fair arms-length price and properly document their efforts, even if the IRS later adjusts the pricing, the 40% penalty will not apply. Treasury regulations provide what documentation and analysis is required of the taxpayer. Generally, this documentation and analysis must be provided to the IRS within 30 days of an IRS request.

In a recent International Practice Unit (IPU) advice, the IRS provides steps for its auditors to take in regard to outbound Section 482 transactions. Taxpayers and advisers involved in Section 482 transactions should review it, both as to planning to avoid penalties and in dealing with an audit.

The IPU instructs the examiner to request the 10 documentary and analysis items that the regulations require to avoid the 40% penalty. The IPU notes that just because the taxpayer produces all 10 items does not mean they are automatically off the hook for a 40% penalty.

Aside from review of the 10 items, examiners are instructed to pull certain schedules from Forms 5471, 8858, and 8865 to locate missing controlled transactions. Since the IRS is going to do this, tax preparers and advisers should do the same, preferably before filing the Form 5472 and other tax return filings for the applicable year to make sure nothing is omitted.

Examiners are also instructed to review the taxpayer's financial statements to make sure they line up with the transfer price documentation being provided. Again, this is something that should be done by the tax preparers and advisers.

A hidden trap for taxpayers is the requirement under Treasury Regulations Section 1.6038A-3 to maintain certain backup records. These records are in addition to the 10 documentary items taxpayers are required to maintain for penalty avoidance. Since the examiner is directed to specifically ask for these items under the IPU, taxpayers and their advisors should establish procedures to maintain those records during the applicable statute of limitations period. These records include original entry books and transaction records, profit and loss statements, pricing documents, foreign country and third-party filings, ownership and capital structure records, records of loans, services, and other non-sales transactions, and records relating to conduit financing arrangements.

The IPU also points the examiner to other IRS guidance as to particular Section 482 issues and compliance.

The IPU provides specific analysis questions that the auditor should examine. Knowing these questions in advance will assist the taxpayer in preparing for an audit.

Review of Transfer Pricing Documentation by Outbound Taxpayers (ISO/PUO/P_1.7_02(2014)) (Mar. 4, 2016)

Expatriation Case

Cases on the new expatriation regime under Code Section 877A are few and far between. The Tax Court has now issued an opinion involving a U.S. resident who gave up his green card and the resulting consequences under Code Section 877A.

The case has two interesting points. The first goes to the issue whether one can be a covered expatriate solely by not filing a Form 8854 that certifies five years of tax compliance at the time of expatriation. Remember that Code Section 877A applies to persons giving up their citizenship or U.S. residency only if they are a “covered expatriate.” This generally means the expatriate has income or assets in excess of statutory thresholds, or does not certify the five years of compliance.

Here, the taxpayer did not file a Form 8854 when he surrendered his green card. Further, the taxpayer in fact had not fully complied with required filings for the preceding five years.

Do these provisions really mean that even if a taxpayer falls below the income or asset thresholds, he will still be a covered expatriate solely because of the failure to certify tax compliance? This case does not squarely answer that question, because the taxpayer could not have made the certification due to his noncompliance. However, the Code tells us that such failure to certify effectively makes one a covered expatriate (Code Section 877(a)(2)(C), which is part of the definition of a covered expatriate under Code Section 877A(g)(1)). So it appears clear that failing to certify is enough be a covered expatriate.

Okay, but Code Section 877(a)(2)(C) does not tell us WHEN the certification has to be given. So if the certification is given late, can one avoid covered expatriate status (assuming the income and asset thresholds are not exceeded)? This case does not answer that question because a late certification was not made.

What if a certification is given, but it is false or erroneous? That should not keep one out of covered expatriate status, per the Code’s other criteria of “fails to submit such evidence of such compliance [of five years of tax compliance] as the Secretary may require.”

The second issue involves whether the deemed sale of assets rule of Code Section 877A that applies to expatriates (and this particular expatriate) triggers the deferred gain on an installment sale obligation held by the expatriate under Code Section 453B. Yes, says the Tax Court, with the deemed selling of the price of the obligation being its face amount.

Gerd Topsnik, 146 TC No. 1 (January 20, 2016)

New Basis Consistency and Reporting Proposed Regulations - Did the IRS Go Too Far?

The IRS has issued proposed regulations under new Code Sections 1014(f) (relating to requirements that the initial income tax basis of an asset received from a decedent cannot exceed the estate tax basis of that asset) and Section 6035 (relating to the reporting of basis on property acquired from a decedent). You can read those regulations here and here.

The proposed regulations have two requirements which are eyebrow raising (to say the least), and of questionable validity.

Zero Basis for Assets Not Reported on an Estate Tax Return. The regulations provide that if an asset is required to be reported on an estate tax return, is otherwise subject to the basis consistency rules of Section 1014(f) (e.g., assets that do not increase the estate tax after credits are not subject to the rules), and is NOT reported on a return before the expiration of the estate tax statute of limitations, the basis of the asset in the hands of the recipient is adjusted to ZERO!

Looking back at Section 1014(f), I do not see any authority that authorizes an adjustment of basis to zero for such a failure. Perhaps one can argue that the blanket rule of zero can be based on the statutory language of a "value...specified by the Secretary" under Section 1014(f)(2)(B) and thus being the cap on basis under 1014(f)(1)(A), but that appears to be a very strained reading of the statute [I have cut and pasted the entire statute at the end of this posting for those who want to review these provisions themselves]. Section 1014(f)(2)(B) appears to relate to a specific finding of value by the Secretary, per the subsequent language relating a timely contest of that value by the estate executor, and not a blanket regulatory dictate of zero basis for all affected taxpayers. I have not looked to the legislative history of the statute - if there is language there on the subject of a zero basis, then that might provide support for Treasury on this adjustment to zero.

Note that this will complicate the decision whether to file a supplemental estate tax return to report an asset found after an estate tax return is filed if the estate is taxable and the statute of limitations has not yet closed. The estate will need to file a supplemental return to avoid this zero basis, but is it worth it to file and incur estate tax for an income tax benefit that may be taxed at a lower rate (if ever)?

Endless Form 8971 Filings. Code Section 6035 requires executors to issue a statement using Form 8971 to beneficiaries detailing basis information for assets that they will (or may) receive from the estate. This new requirement is a pain to prepare and deal with, but is required by the new Code Section. Treasury was not satisfied with this - their proposed regulations require that the recipients of such assets issue another statement to the IRS and  their subsequent transferees in carryover basis transfers if related to the transferor. And these new transferees will also have similar statement requirements if they later make a related party carryover basis transfer, and on and on ad nauseum - at least that is how many are reading the proposed regulations, but to me the language is not completely clear on that point.

However, Code section 6035 imposes these requirements ONLY on the persons required to file the estate tax return. Where does Treasury find authority to impose notice obligations on the recipients of property, and their subsequent related party transferees? Treasury advises this comes from its authority to prescribe regulations necessary to carry out the section. I fail to see how subsequent reporting by transferees has anything to do with "carry[ing] out the section," which is the regulatory authorization included in Code Section 6035.  While the new requirements may support the policy of the section, is that enough to justify this requirement by regulation alone? If Treasury wanted to impose this reporting obligation then it should have its inclusion in the original statute, or via a new statutory amendment.

---------------------

Section 1014(f):

(f) Basis must be consistent with estate tax return. For purposes of this section—

    (1) In general. The basis of any property to which subsection (a) applies shall not exceed—

         (A) in the case of property the final value of which has been determined for purposes of the tax imposed by chapter 11 on the estate of such decedent, such value, and

         (B) in the case of property not described in subparagraph (A) and with respect to which a statement has been furnished under section 6035(a) identifying the value of such property, such value.

    (2) Exception

         Paragraph (1) shall only apply to any property whose inclusion in the decedent’s estate increased the liability for the tax imposed by chapter 11 (reduced by credits allowable against such tax) on such estate.

    (3) Determination. For purposes of paragraph (1), the basis of property has been determined for purposes of the tax imposed by chapter 11 if—

         (A) the value of such property is shown on a return under section 6018 and such value is not contested by the Secretary before the expiration of the time for assessing a tax under chapter 11,

         (B) in a case not described in subparagraph (A), the value is specified by the Secretary and such value is not timely contested by the executor of the estate, or

         (C) the value is determined by a court or pursuant to a settlement agreement with the Secretary.

(4) Regulations - The Secretary may by regulations provide exceptions to the application of this subsection.

Guardianship Court Permitted to Annul Marriage [Florida]

An incapacitated  ward had his rights to contract removed by a guardianship court. The ward thereafter married, without court approval. The marriage was then challenged based on FS 744.3215(2)(a) (2013). That statute provides "[i]f the right to enter into a contract has been removed, the right to marry is subject to court approval."

So the statute definitely raises problems for the marriage. The real question turned out to be whether the marriage was absolutely void and subject to annulment, or simply voidable and thus could be approved by the court after the fact. The trial court found it void and annulled it - the Fourth District Court of Appeals has now affirmed the trial court.

Smith v. Smith, 4th DCA (March 2, 2016), Case No. 4D14-1436