2014 Statistics of Income

The IRS regularly releases information garnered from tax filings. For those with an interest in this sort of information, based on individual income tax returns for 2014:

• Taxpayers filed 148.7 million U.S. individual income tax returns, an increase of 0.6% from 2013;
• There were significant increases in adjusted gross income (AGI), which rose to $9.7 trillion (an increase of 6.1% compared to 2013);
• Taxable income increased to $6.9 trillion (an increase of 8% compared to 2013); and
• Total income tax rose to $1.4 trillion (an increase of 10% compared to 2013).

Florida Sales Taxes on Internet Sales Outside of Florida [Florida]

Question: A Florida corporation, with a physical location and principal address in Florida, sells flowers, gift baskets, and other items of tangible personal property over the Internet. The company does not maintain any inventory and instead uses the inventory of florists in the delivery location to deliver purchased products. Are deliveries outside of Florida subject to Florida sales tax?

Answer: Reversing the lower appeals court, the Florida Supreme Court says yes.

The florist mounted two challenges. First was a Due Process argument. The Due Process Clause requires some type of physical presence within the taxing State. Quill Corp. v. North Dakota, 504 U.S. 298 (1992). That presence existed here.

The second challenge was a dormant Commerce Clause claim. Such claims are based on State activity that impairs interstate commerce. To survive a dormant Commerce Clause claim, a tax must meet the four requirements of Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977). These four requirements are that the tax is applied to an [1] activity with a substantial nexus with the taxing State, [2] is fairly apportioned, [3] does not discriminate against interstate commerce, and [4] is fairly related to the services provided by the State.

The Court reviewed all four requirements and found them to be met, in large part due to the physical presence and formation in Florida. While not directly relevant, the Court also noted that Florida would not tax an out-of-state Florida that delivers through a Florida florist.

In regard to being “fairly apportioned,” an internal consistency test applies the legal fiction of all States having the same law as Florida and asks if more than one state could then impose tax. In this case, there would be no such double tax. This test has always been bothersome to me since it doesn’t ask whether the same transaction is actually being taxed in two jurisdictions due to the taxing regime in the other jurisdiction.

Implications: Sellers situated in Florida conducting Internet sales will not be able to raise constitutional objections to Florida sales taxes on sales out-of-state, even if the goods come from non-Florida sources or suppliers.

Florida Department of Revenue v. American Business USA Corp., 41 Fla.L.Weekly S237a (Florida Supreme Court, May 26, 2016)

Tax Treaty Savings Clause Question

Facts: A U.S. citizen and permanent resident of Israel incurs capital gains from the sale of stock of a U.S. corporation.

U.S. - Israel Income Tax Treaty Provisions:

Article 15, Paragraph 1: “[a] resident of one of the Contracting States shall be exempt from tax by the other Contracting State on gains from the sale, exchange, or other disposition of capital assets.”

Article 6, Paragraph 3: ““[n]otwithstanding any provisions of this Convention except paragraph (4), a Contracting State may tax its residents and its citizens as if this Convention had not come into effect.”

Question: Can the U.S. subject the taxpayer’s gain to U.S. income tax?

Answer: Yes. The Article 6 savings clause overrides the exclusion from tax in Article 15.

One has to wonder why the taxpayer took this all the way to the Tax Court. Nonetheless, the case is illustrative of a basic principle for U.S. citizens and residents - treaty provisions will often provide benefits for them vis-a-vis the taxes of the OTHER country, but not as to their U.S. taxes. Still, each treaty and fact pattern must be looked at, since sometimes the applicable savings clause that allows the U.S. to tax its citizens and residents without regard to the treaty will not always apply to all provisions of the treaty.

Cole, TC Summary Opinion 2016-22

Applicable Federal Rates - June 2016

Form 5472 Reporting by Foreign Owned Disregarded Entities Established in the U.S. - Coming Soon!

Presently, a domestic single member LLC, and other similar single owner entities, absent a check-the-box election to the contrary, are disregarded for almost all U.S. tax purposes.

Presently, a foreign owner of such disregarded entity need not file a Form 5472 regarding that entity, since it is a non-entity for tax purposes. The Form 5472 form (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business) is authorized under Code Sections 6038A and 6038C, with respect to each related party with which the reporting corporation has had any “reportable transactions.” These corporations must also keep permanent books of account or records as required by section 6001 that are sufficient to establish the accuracy of the federal income tax return of the corporation, including information, documents, or records to the extent they may be relevant to determine the correct U.S. tax treatment of transactions with related parties. Failure to report can result in significant penalties.

New proposed regulations will treat such entities as a corporation for purposes of Section 6038A, thus giving rise to the above reporting requirement. Transactions between the disregarded entity and its owner will now be reportable transactions. Interestingly, safe harbors from reporting for entities of less than $10M in U.S. gross receipts or whose related party transactions do not exceed certain thresholds will NOT apply.

Let’s be clear - this reporting has NOTHING to do with enforcing the collection of taxes due the U.S. Transactions between such a disregarded entity and its owner are disregarded for U.S. tax purposes - that is why the IRS does not presently require information about them.

This reporting has EVERYTHING to do with the political judgment by some in the U.S. that the U.S. is not adequately disclosing the ultimate beneficial ownership of U.S. entities, and that is impeding the tax collection of other countries.

The costs and burdens of information reporting have increased exponentially in recent years. Here is a new filing, with new costs and burdens, that won’t raise a penny of U.S. tax collection, to add to the burden.

Perhaps a reasonable middle ground would be a requirement for filing a short form report by these entities reporting their beneficial ownership, and leave it at that. Alternatively, the $10M U.S. gross receipts and small related party receipts exceptions should be made applicable, so at least smaller entities will not be subject to these expanded rules. Requiring reporting of transactions that are utterly disregarded for U.S. tax purposes, for the sake of non-U.S. government interests, is not surprising in today’s day and age, but is it appropriate?

The new regulations are only proposed, and will not go into effect until 12 months after they are adopted as temporary or final regulations.

REG-127199-15. Treatment of Certain Domestic Entities Disregarded as Separate From Their Owners as Corporations for Purposes of Section 6038A (5/10/2016), amending regulations Sections 1.6038A-1, 1.6038A-2, and 301.7701-2.

Marital Deduction Trusts and Expatriates – More Questions Than Answers

If an expatriate dies and leaves property to a U.S. citizen or resident spouse, can a marital trust be used to defer or avoid the transfer tax imposed under Section 2801? Both the Code and the Regulations seem to say yes, but a closer reading suggests that absent further regulatory relief, the answer is uncertain. And will the surviving spouse be taxable on the marital trust assets at his or her later death?

FACTS: Code Section 2801 imposes a transfer tax at the highest estate tax rate of estate tax on a covered gift or bequest to a U.S. citizen or resident. In the circumstances of death of an individual, a covered bequest is any property acquired directly or indirectly by reason of the death of an individual who, immediately before such death, was a covered expatriate. Code Section 2801(e)(1)(B). A covered expatriate is an individual who expatriated from the U.S. and met or exceeded certain asset or income thresholds at the time of expatriation. This tax is not a Chapter 11 estate tax (nor a Chapter 12 gift tax) – this will be an important fact.

Code Section 2801 should only apply to decedents who are nonresidents of the U.S. and noncitizens, since it does not apply to Chapter 11 gross estate assets of a decedent. Expatriates who nonetheless are U.S. residents or citizens at the time of death will have all of their assets included in their Chapter 11 gross estate, and thus will not be subject to Code Section 2801. Further, Code Section 2801 should only apply to non-U.S. situs assets of an expatriate decedent. This is because under Code Section 2101, U.S. situs assets of nonresident/noncitizen are included in his or her Chapter 11 gross estate – as noted Code Section 2801 does not apply to Chapter 11 gross estate assets.

So assume we have a nonresident/noncitizen qualified expatriate who owns $20 million of common stock in a non-U.S. corporation, and at his death he leaves it to a trust meeting the QTIP requirements of Code Section 2056(b)(7). As a threshold matter, this a transfer of non-Chapter 11 gross estate property from a qualified expatriate to a U.S. citizen – this is a covered bequest and is subject to Code Section 2801 tax. Can the tax be deferred or avoided under the estate tax marital deduction?

Code Section 2081(e)(3) provides: “[A covered bequest] shall not include any property with respect to which a deduction would be allowed under section 2055, 2056, 2522, or 2523, whichever is appropriate, if the decedent… were a United States person.” If our decedent is a U.S. person, then the estate tax marital deduction is available under Code Section 2056, so it would seem to allow the marital deduction. The proposed regulations expand upon this and provide: “A transfer from a covered expatriate to the covered expatriate's spouse is not a… covered bequest to the extent a marital deduction under section… 2056 would have been allowed if the covered expatriate had been a U.S. citizen or resident at the time of the transfer. To the extent that a… bequest to a trust (or to a separate share of the trust) would qualify for the marital deduction, the gift or bequest is not a… covered bequest. For purposes of this paragraph (c)(4), a marital deduction is deemed not to be allowed for qualified terminable interest property (QTIP) or for property in a qualified domestic trust (QDOT) unless a valid QTIP and/or QDOT election is made.” (emphasis added) Prop. Regs. Section 28.2801-3(c)(4).

COMMENTS: Let’s examine the proposed regulations first. They require a valid QTIP election, on a Form 706 or Form 706-NA. A Form 706 QTIP election is not possible, since the estate of our decedent will file a Form 706-NA per the decedent’s nonresident/noncitizen status.

The Form 706-NA and its instructions require the inclusion of a Schedule M from the Form 706 to obtain a marital deduction. That Schedule M by default imposes a QTIP election on assets described thereon in the QTIP section. The instructions to Schedule M provide that you can only include property interests that are included in the decedent’s gross estate – non-gross estate assets do not belong on the schedule. So how does one make a “valid QTIP” election for non-U.S. situs assets that are not included in the decedent expatriate’s estate? It would appear that requiring a “valid QTIP election” prevents the estate from meeting the requirements of the proposed regulation.

Does Section 2801(e)(3) allow for the deduction? Likely yes, but maybe no. To get the deduction under Code Section 2056 if we treat our expatriate as a U.S. person, a valid QTIP election on an estate tax return is needed – we now circle back to the question of how one can make a QTIP election on an estate tax return if the assets are not actually included in the gross estate of the decedent. Perhaps a constructive inclusion of the subject assets in the decedent’s gross estate, along with a constructive election with the completion of a Schedule M that includes the foreign situs assets, will suffice. One would suppose that this is the proper result, per the inclusion of Section 2801(e)(3) in the Code. That being the case, at a minimum, the proposed regulations when finalized should remove the requirements for a “valid” QTIP election and allow for a constructive QTIP election that includes the non-U.S. situs assets for which a deduction is sought – otherwise the requirements of the regulation cannot be satisfied.

Here is perhaps a more interesting question – if the marital deduction is allowed, what happens at the subsequent death of the surviving spouse? Will the assets be subject to estate tax in the surviving spouse’s estate under Code Section 2044? That would be a stretch – Code Section 2044 by its terms applies only if there was a deduction taken at the first spouse’s death under Section 2056(b)(7) – “… [t]his section applies to any property if… a deduction was allowed with respect to the transfer of such property to the decedent… under section 2056 by reason of subsection (b)(7). At best, there is no deduction that occurs, only an exclusion of assets from property subject to tax under Code Section 2081. See Code Section 2081(e)(3). Alternatively, can Code Section 2081(e)(3) be read expansively to impose an estate tax on the surviving spouse under Code Section 2044? That, too, would be quite a stretch since all Code Section 2081(e)(3) says is to exclude certain property from a covered bequest – it says nothing about imposing estate taxes on the surviving spouse.

So where are we? Here are the main possibilities:

1. A QTIP election may be allowable, however inartfully allowed under the Code and proposed regulations. An informal discussion with the draftpersons of the proposed regulations indicates this is what was intended. If that is the case, then the next question is whether the surviving spouse will be subject to having the QTIP trust assets included in his or her gross estate at death under Code Section 2044. If not, this strongly suggests the use of QTIP trusts in lieu of outright transfers to U.S. person spouses by expatriates when future estate taxes are an issue! Even if the regulations are issued in final form to provide for such taxation though, one has to question whether the IRS has regulatory authority to impose such a tax.
2. The election may not be allowable, at least until revised proposed or final regulations or a Form 708 are issued that address these issues. In that situation, draftspersons will have to give consideration to an outright bequest to a U.S. person surviving spouse in lieu of a QTIP transfer.

When the surviving spouse is a resident of the U.S. but not a citizen, similar considerations should apply in regard to a QDOT trust..

Breach of Trust Statute of Limitations Held Open for 10 Years - With New Summary Chart [Florida]

The concepts of statute of limitations and repose, and laches, exist to bring finality after the passage of time as to liability risks. Claims for breach of trust against a trustee can be subject to a confusing array of rules as to when the statute expires, especially when the concept of fiduciary accountings, and different rules for a continuing trust versus a terminating trust, are thrown into the mix. A recent Florida case demonstrates these complexities.

A short summary of the facts: (a) in 2002, the assets of the subject trust are moved into two trusts, (b) on October 11, 2011, accountings for the old trust and the two new trusts are given to a beneficiary who was a beneficiary of the old trust but not the two new trusts, which accountings included a limitations notice that warned that an action for breach of trust for matters disclosed in the accountings may be barred unless an action is commenced within 6 months, (c) on April 9, 2012, the above beneficiary sued the trustee of the old trust regarding the termination of the 2002 trust, (d) the trustee sought to dismiss the action, alleging that the beneficiary knew of the transfer by January 2003 and did not bring an action within 4 years of that date under the applicable statute of limitations, and (e) the trial court agreed and ruled in favor the trustee.

The appellate court reversed, finding that laches did not bar the lawsuit. The court found that Gregor did not have knowledge of being excluded from the new trusts until 2011. In a circumstance when adequate disclosure is not given to a beneficiary, the statute of limitations does not begin to run, unless a final trust accounting is given and a notice is given of the availability of the trust records for examination, or disclosure is later made. Since the final trust accounting procedure was not followed, the statute did not start to run until October 2011 when the accountings were issued. Since the beneficiary first obtained knowledge via an accounting with a limitations notice, a six month statute applied and not the usual four year statute of limitations from the October 2011 date. Since the beneficiary filed suit within those six months, his claim was not barred.

Florida Statutes section 736.1008 codifies the rules in this area. Nonetheless, the permutations and combinations of facts and the resulting periods of limitation that can apply under that statute are not immediately obvious. To assist practitioners in applying the statute, I have prepared a chart that should help - you can download a copy here. Since I have created this from scratch, if anyone thinks thinks any corrections are needed to it, please email me at crubin@floridatax.com.

Woodward v. Woodward, 41 Fla. L. Weekly D1073a (4th DCA, May 4, 2016)

Brokerage Account is a Safe Account to Temporarily Hold Homestead Sale Proceeds for Reinvestment [Florida]

An individual sold his interest in a Florida homestead, and put a portion of the proceeds in two Wells Fargo brokerage investment accounts entitled “Fl. homestead account..” The account was invested in mutual funds and unit investment trusts.

The Florida constitution protects a Florida homestead from claims of creditors of the owner. This has been extended to the proceeds from sale of a homestead if (1) there is  a good faith intention, prior to and at the time of the sale, to reinvest the proceeds in another homestead within a reasonable time; (2) the funds are  not commingled with other monies; (3) the proceeds are kept separate and apart and held for the sole purpose of acquiring another home.

The creditor in the instant case claimed that the owner lost homestead protection due to the investment in securities. The trial court accepted the creditor’s argument, but the district court of appeal rejected it. The Florida Supreme Court took on the case and sided with the owner of the property, holding that the accounts maintained protection as homestead property.

Some particular elements that were helpful to the owner were: (a) the court believed the securities investments were still relatively safe, (b) to hold otherwise would require the taxpayer to hold the funds in a noninterest bearing account, at least in a low interest rate environment, and (c) the owner actually used the funds to purchase a new residence.

By commenting on the safety of the securities investments, the door is still open that more speculative investment of sale proceeds could jeopardize the homestead protection.

JBK Associates, Inc. v. Sill Bros., Inc., Florida Supreme Court (April 28, 2016)