Treasury Provides Relief for Late 60-Day Rollovers

The Internal Revenue Code allows qualified plan participants and IRA owners to withdraw assets from a plan or IRA and contribute them to another (or the same) plan or IRA without being taxed on the distribution, if the rollover occurs within 60 days. If the deposit occurs after 60 days, the taxpayer can seek a Private Letter Ruling that avoids taxation if the taxpayer has good cause. Unfortunately, such a route is expensive, requiring a $10,000 user fee.

In Rev.Proc. 2016 – 47, Treasury is now allowing taxpayers that make a late rollover to avoid tax without having to seek a Private Letter Ruling if the lateness is attributable to certain listed circumstances. If a taxpayer qualifies, he or she sends a certification letter to the recipient plan or IRA administrator or custodian. The taxpayer is then off the hook for being taxed, unless the IRS audits and finds that the taxpayer really did not meet the criteria for avoiding taxation.

To qualify to use the procedure, the taxpayer must not have previously been denied a waiver by the IRS for the particular distribution at issue. The taxpayer must also complete the rollover as soon as practicable once the reason for not rolling over timely has ended (with a 30 day safe harbor applying to this requirement).

Here are the 11 reasons for a late rollover that will allow use of the procedure:

(a) an error was committed by the financial institution receiving the contribution or making the distribution to which the contribution relates; (b) the distribution, having been made in the form of a check, was misplaced and never cashed; (c) the distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan; (d) the taxpayer’s principal residence was severely damaged; (e) a member of the taxpayer’s family died; (f) the taxpayer or a member of the taxpayer’s family was seriously ill; (g) the taxpayer was incarcerated; (h) restrictions were imposed by a foreign country; (i) a postal error occurred; (j) the distribution was made on account of a levy under § 6331 and the proceeds of the levy have been returned to the taxpayer; or (k) the party making the distribution to which the roll over relates delayed providing information that the receiving plan or IRA required to complete the rollover despite the taxpayer’s reasonable efforts to obtain the information.

Rev.Proc. 2016 – 47

Spouses Need to Exercise Care in Transferring Property between Them When Subject to a Marital Agreement [Florida]

Many prenuptial and postnuptial agreements provide for a class of property known as Separate Property. Such Separate Property will often not be subject to claim by or transfer to the non-owning spouse upon death or divorce. When Separate Property is provided for in the agreement, the participants need to exercise care in transferring property between and among them to avoid unintended consequences.

This was illustrated in a recent case when a Separate Property provision was included in a prenuptial agreement. The agreement also contained a paragraph that provided if a party acquires real property in his or her own name it shall be that party's Separate Property.

What occurred is that the husband transferred funds from his own separate account to a separate account of his wife. The wife then acquired real property in her name with those funds. Eight months later, she transferred the property by quitclaim deed to the husband, where it remained until divorce.

The trial court found the property to be the Separate Property of the wife at the time of divorce, and thus belonged to her. This was based on the above-described provision that if a party acquires real property in her own name it shall be her Separate Property.

The appellate court reversed the trial court and found the property to be the Separate Property of the husband. It determined that when the property was first acquired, it was the wife's Separate Property because it was in her name. However, since the agreement also allowed a party to gift away his or her Separate Property, when she quit claimed that property to her husband it was then titled in his name and became his Separate Property.

The fact pattern here is pretty specific. However, there is a general lesson here. Transfers of property between and among spouses can have unintended consequences when there is a marital agreement in place. If some type of erroneous transfer occurs, and the parties seek to correct it, they should consider an amendment to the agreement so as to clarify the treatment of the correction. Further, such transfers may invoke difficult contractual interpretations, as evidenced by this case with the trial court and the appellate court reach different conclusions, again suggesting care in such transfers.

Colino v. Volino, 41 Fla. L. weekly D1990b (5th DCA, August 26, 2016)

Applicable Federal Rates - September 2016

Practice Aid – A Redlined Version of the Proposed Section 2701 and 2704 Regulations

These proposed regulations are difficult enough in substance to deal with, without having to piece together the changes that they make to the existing regulations. Maybe there is a redlined version out there already, but I could not find one, so I created a redlined comparison of the recently proposed regulations that show the current full regulation as redlined to show the new proposed changes. I did it myself so I don’t attest to total accuracy -  use with caution and if anyone locates any errors, let me know and I will correct and release a revised version. The redlined versions can be downloaded from http://gutterchaves.d.pr/14Bdk.

No Obligation to File Inaccurate Return to Avoid Failure to File Penalty

A partnership was a partner in a Cayman Islands partnership - that investment made up most of its assets. The Cayman Islands partnership did not file a Form 1065 income tax return and did not give a Form K-1 to the taxpayer partnership, because it was determined that the partnership accounting records were such a mess that it would cost several million dollars to put them in good shape and meanwhile the Cayman Islands partnership was liquidating.

Thus, the taxpayer partnership did not have the information it needed to file its own Form 1065, and did not file one.  The IRS sought to impose a failure to file penalty under Section 6698. This penalty is only $195 multiplied by the number of partners - but this partnership had about 1600 partners. That would put the penalty at $312,000! And this went on for 3 years.

The taxpayer partnership claimed reasonable cause. The partnership tried, but failed, to obtain information it needed.

The government claimed that the partnership should have obtained the inaccurate data from the Cayman Islands partnership, prepared a return based on that, and included a disclosure. The court was not convinced that filing an clearly erroneous return was the required course of action.

In the end, the bankrutpcy court hearing the tax penalty issue determined that the partnership had done enough to escape the penalty.

Interestingly, the court included consideration of Section 6721 and 6724 - they should not have applied here since those sections relate to information return and a Form 1065 is not an information return.

In re: Refco Public Commodity Pool LP, 118 AFTR 2d ¶ 2016-5085 (Bktcy Ct DE 8/2/2016)

Updated ITIN Procedures

Foreign individuals who are ineligible to obtain a social security number but who require a U.S. taxpayer identification number can apply for a an Individual Taxpayer Identification Number (ITIN) using Form W-7. The process is cumbersome since it requires the provision of original identity documents.

Treasury recently released Notice 2016-48 which provides some changes to the procedures, arising principally from 2015 legislation. Highlights of the Notice include:

• The basis methodology of the Form W-7 and the provision of original identity documents remains in place, principally through certified acceptance agents (CAAs)who have received certification from the IRS or through some IRS Taxpayer Assistance Centers.
• Taxpayers should check https://www.irs.gov/uac/tac-locations-where-in-person-document-verification-is-provided to find IRS Taxpayer Assistance Centers that can perform these functions, and to make appointments.
• Provides provisions for renewing ITINs that expire for lack of use on a federal tax return for three consecutive years.
• An individual whose expired ITIN is used only on information returns filed and furnished by third parties, such as Forms 1099, need not renew the ITIN. ITINs may continue to be used for information return purposes regardless of whether they have expired for individual income tax return filing purposes. If the individual is later required to file a tax return, however, the individual's ITIN will have to be renewed at that time.
• Some individuals may not be aware that their ITIN has expired or that they must renew an expired ITIN. The IRS will still accept their returns, but there may be a delay in processing and certain credits may not be allowed unless the ITIN is renewed. This could result in a reduced refund or additional penalties and interest. IRS will notify these filers about the need to file Form W-7 to renew their ITIN.

Notice 2016-48

Some Food for Thought - Code Section 2704 Proposed Regulations

As the proposed regulations are digested by practitioners, here is some food for thought:

a. Will GRATs be underwater from the start - that is, nondiscounted values for the funding transactions, and discounted values for distributions back to the grantor?

b. Nondiscounted values required for sales to IDGTs?

c. Silver lining - assuming the higher Section 2704 values allow for higher basis for interests held at death, this will allow for income tax savings. For estates within annual exclusion amounts (and thus no estate tax) such basis step-ups could make this a revenue loser for the IRS.

d. For interests in corporations, perhaps the disregard of liquidation restrictions under state law are not going to fly, unlike in the partnership and LLC areas. If true, this may bring about more use of corporations for those with taxable estate situations.

e. How do the new valuation rules interface with swaps of assets between a grantor and his/her grantor trust?

IRS Issues Long-Awaiting Section 2704 Proposed Regulations

In case you haven’t heard, these proposed regulations were issued on August 2. The particular focus is to substantially reduce valuation discounts for transfer tax purposes on minority interests, nonvoting, and limited control interests that are transferred to family members. Some of the restrictions will only apply if a transfer is made within 3 years of death – others will apply more broadly. The definition of “control” is expanded to catch more circumstances within its net. The use of non-family owners of interests in entities to avoid Section 2704 will be made more difficult.

The regulations are only in proposed form. With hearings set for early December, they should not be finalized until at least 30 days after that (if ever). Parts of them are subject to legal attack, as Treasury appears to be writing the law contrary to the statutory language (such as disregarding restrictions on liquidation that are not more onerous than otherwise applicable state law).

Surely, there will be a lot of real and digital ink spilled over these proposed regulations in the coming days.

Prop Reg § 25.2701-2, Prop Reg § 25.2701-8, Prop Reg § 25.2704-1 , Prop Reg § 25.2704-2, Prop Reg § 25.2704-3, Prop Reg § 25.2704-4

Executrix Held Liable Under Federal Claims Statute For Actions Taken Prior to Appointment as Executrix

A decedent died while owing over $340,000 in unpaid federal income tax liabilities. His estate was insolvent. The assets of his estate consisted almost entirely of a 100% interest in one corporation and 50% of another corporation. Each corporation owned a fishing vessel as its sole asset. Shortly after the decedent died, the decedent’s surviving spouse transferred the shares of the 100% owned company to herself. About six months later, she was appointed executrix of the decedent’s estate, and later transferred the shares of the second corporation to herself. At the time of these transfers, she knew of the unpaid tax liabilities.

The IRS sought to impose liability on the wife for the unpaid tax liabilities per the application of the federal claims statute for the value of the stock she distributed (31 U.S.C. Section 3713). The trial court concurred and entered a judgment against the wife, and the appellate court affirmed the judgment, even though some of the shares were distributed prior to the wife being appointed executrix.

31 U.S.C. Section 3713(a)(1)(B) provides that a claim of the United States government shall be paid first when the estate of a deceased debtor, in the custody of the executor or administrator, is not enough large enough to pay all debts of the debtor. Thus, via the Supremacy Clause of the U.S. Constitution, this federal statute gives the IRS a first priority in collecting taxes against a decedent’s estate (subject to some exceptions), regardless of the priorities provided under state law.

If the representatives of the estate fail to honor the priority claim, they become personally responsible to the government for the taxes. 31 U.S.C. Section 3713(b). For an executor to be responsible under 31 U.S.C. Section 3713(b), three requirements must be met. Interestingly, only the first requirement is statutory. The second and third requirements have evolved to soften what would otherwise be a strict liability regime. The first requirement is that the executor must have transferred assets of the estate before paying a claim of the U.S. The second requirement is that the estate is insolvent, and the third is that the executor have knowledge of the liability.

In the subject case, all three of these requirements were met. The spouse asserted, however, that since she had transferred stock of the first corporation prior to her appointment as executor, the statute should not apply to that transfer. Not a bad argument, given the language of 31 U.S.C. Section 3713(b) which reads: “[a] representative of a person or an estate (except a trustee acting under title 11) paying any part of a debt of the person or estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government (emphasis added).” If one paid out the estate assets before being an official representative, then perhaps the statute should not apply by its own wording.

The appellate court was unimpressed – it held that “whether the appellant had been appointed executrix at the time the assets were transferred is not determinative in the section 3713(b) analysis. What counts is whether the responsible party had control over the transferred assets … and it is nose-on-the-face plain that the appellant had such control from and after the date of Reitano's demise.” Technically, this was only dicta, since the court actually did not rule on this question because it was not raised at the trial court level – but the court provided that even if the issue had not been waived by failure to raise it at the lower court level, the appellate court would have ruled against the taxpayer. The court relied on the U.S. Supreme Court case of King v. U.S., 379 U.S. 329 (1964), which held under a predecessor statute “one need not be a personal representative to come within the coverage … it is the element of control over the assets which is decisive.” Since the wife had control of the stock before she was appointed executrix, that was enough to invoke the statute.

Should one have to deal with similar facts, that the pronouncement on the issue was only dicta still leaves open room to argue on this issue. Note that the statute addressed in King had a broader list of persons who could be held liable – that statute, former 31 U.S.C. Section 192, read: “[e]very executor, administrator, or assignee, or other person, who pays, in whole or in part, any debt due by the person or estate for whom or for which he acts before he satisfies and pays the debts due to the United States from such person or estate, shall become answerable in his own person and estate to the extent of such payments for the debts so due to the United States, or for so much thereof as may remain due and unpaid.” Contrast the language “executor, administrator, or assignee, or other person” (Section 192) with “a representative of a person or an estate” (Section 3713(b)) and ask yourself whether a finding of responsibility under the broader first statute of a non-fiduciary based on factual control should necessarily mean the same finding should be made under a more narrow Section 3713(b). At a minimum, the “or other person” language in Section 192 arguably appears to be broader than a “representative” under Section 3713(b), and thus might be grounds for King to not be strong precedent under these facts.

U.S. v. McNicol, 118 AFTR 2d 2016-5150 (CA1 2016))