Sunday, April 23, 2017

IRS Issues Guidance Regarding Estate Tax Lien Discharge Process

When an individual dies, an estate tax lien attaches automatically to all of the property included in the gross estate. It arises prior to tax assessment, and is not recorded.

Persons inheriting property, or purchasers of property, are interested in having the lien released. As to real property that an estate seeks to sell, a discharge of the lien can be applied for with a Form 4422. A Form 792 is issued to discharge particular property.

In the past, if accepted the IRS would release the lien within a few days. Starting in 2016, the procedures changed, and all applications are now processed through Specialty Collection, Offers, Liens and Advisory. Once the IRS accepts the Form 4422, if the IRS requires it the net proceeds of the sale are deposited with the IRS or in escrow, to be held (less amounts used to pay estate taxes) until after a closing letter is issued or the IRS determines the return will not be audited.

The IRS' Small Business/Self Employed Division has issued interim guidance to its Special Advisory group regarding procedures for handling lien discharge requests. The guidance addresses:

  • Consultation with and requesting assistance from other IRS departments, including Estate & Gift Tax Examinations
  • What Code Sections and Regulations should be consulted for guidance;;
  • The issuance of Letter 1352 when there is no estate tax return filing requirement;
  • Procedures to substantiate facts when an estate tax return will be nontaxable (such as the viability of asserted deductions); and
  • Circumstances when an escrow/payment will or will not be required (for example, one will not be required if an adequate estimated or actual tax payment has been made.

Practitioners who administer estates and/or are involved with lien releases should review this guidance.

IRS Small Business/Self Employed Division Memo “Interim Guidance for Responsibility to Process all Requests for Discharge of the Estate Tax Lien”

Saturday, April 15, 2017

Two Important New International Tax Filings

While not the only international reporting changes that are occurring, there are two significant ones that apply for the current filing season for 2016 returns.

First is the FBAR, which reports interests in foreign accounts. This used to be due on June 30, but is now due by April 18.

Second is the expansion of Form 5472 reporting - now to nonresidents with interests in U.S. single member limited liability companies that are otherwise treated as disregarded entities and that have transactions between the LLC and related people. Such LLCs are now treated as a domestic corporation for purposes of Section 6038A and Form 5472 reporting. Treas. Regs. §1.6038A-1(c)(1)’ Treas. Regs. §301.7701-(a)(2)(vi).

De minimis transfers of assets to or from such an LLC can trigger the reporting. The safe harbor de minimis reporting exceptions applicable to Form 5472 do NOT apply to this single member LLCs. Treas. Regs. §1.6038A-1(i)(1); T.D. 9796 (January 17, 2017). Thus it is likely that single member LLCs used in a U.S. real property holding structure with foreign owners (including foreign trusts) will be subject to this reporting.

Sunday, April 09, 2017

Asserting Reasonable Cause Defense to Penalties in a Pleading Does Not Automatically Waive Attorney-Client Privilege

Reliance on a tax professional can constitute reasonable cause, and thus avoid the application of an accuracy-related penalty under Code §6662 or a fraud penalty under Code §6663. When the professional is an attorney, case law indicates that this reliance waives the attorney-client privilege so that the government can determine if such reliance occurred and met the reasonable cause exception. See New Phoenix Sunrise Corp. v. C.I.R., 106 AFTR 2d 2010-7116 (CA 6 2010) and Ad Investment 2000 Fund, LLC, 142 TC 248 (2014).

So will the mere assertion of a reasonable cause defense result in waiver of the privilege? Not according to the U.S. District Court in a recent case. There, the court noted:

the “reasonable cause” defense in a pleading does not lead to the automatic disclosure of privileged documents. Ad Investment 2000, 142 T.C. at 258-59. It merely gives the Commissioner grounds to compel the production of documents subject to the attorney-client privilege. Id.; see also Tax Court Rules 70, 72. Even when such a motion to compel is well-taken, case law suggests that disclosure may not result. For example, in Ad Investment 2000, the Tax Court found that the petitioners had waived their attorney-client privilege by putting protected communications at issue, and ordered the petitioners to produce the privileged documents. Id. However, the Tax Court simultaneously indicated that the petitioners could still protect their documents from disclosure by abandoning their “reasonable cause” defense.... (stating that, if the petitioners “persist, they sacrifice the privilege to withhold the contents of the opinions”).

While the case involved the circumstance of the pleading being filed in a separate case, the reasoning should equally apply when the pleading is within the instant case.

U.S. v. Micro Cap Ky Insurance Company, Inc., 119 AFTR2d 2017-XXXX (DC Ky 3/27/17)

Saturday, April 01, 2017

Discretionary Trust Beneficiary Had No Standing to Challenge Adoption [Florida]

Since many estates and trusts define beneficiaries by description (e.g., “child” or “lineal descendant”) and it is a natural propensity for persons to gift or leave property to lineal descendants, the adoption of an individual can have a major impact on who benefits under a last will or a trust. Well drafted wills and trusts will typically contain provisions regarding adopting - such as whether an adopted person should be treated as a child or lineal descendant, and perhaps excluding persons who are adopted over a certain age from coming into those classes (so as minimize the risk of adoption being intentionally used to upset a dispositive scheme).

Ryan was a beneficiary of a trust established by his great-grandparents. His interest was discretionary only - distributions to him as a descendant were to be made only at the sole discretion of the trustees.

Ryan’s father adopted Brindley in 2004. This had the effect of making Brindley a beneficiary of the trust. When he was adopted, no notice was provided to Ryan. Ryan did not learn of the adoption until later, and in 2014 sought to challenge it, alleging fraud on the court because he did not receive notice and the opportunity to challenge it. After his adoption, Brindley received thousands of dollars from the trust as a beneficiary.

Under Stefanos v. Rivera-Berrios, 673 So.2d 12 (Fla. 1996) and the Florida Adoption Act, a person must show a direct, financial, and immediate interest in an adoption to be entitled to notice, or to have legal standing to vacate an adoption order. Applying this standard, the trial court ruled in favor of Ryan in allowing him to challenge the adoption order.

The 1st DCA reversed the trial court. Because Ryan’s interest as a beneficiary was only “contingent” since subject to the discretion of the trustee, Ryan was found not to possess a direct, financial and immediate interest in the trusts and thus in the adoption. Presumably, if Ryan’s interest was based on an ascertainable standard or provided for mandatory distributions that could be diluted by the addition of a new beneficiary, the Court would have ruled differently.

The Court distinguished Rickard v. McKesson, 774 So.2d 838 (Fla. 4th DCA 2000) from this case. In that case a contingent beneficiary of a trust was entitled to notice of an adoption proceeding because the adoption would divest the beneficiary of her interest in the trust. Since the adoption here would not result in divestment, Rickard did not mandate notice under the current facts, at least according to the 1st DCA.

Edwards and Kuiper v. Maxwell, 42 Fla.L.Weekly D742a (1st DCA, March 31, 2017)

Friday, March 24, 2017

Article Abstract: Government Wins Fourth Straight FBAR Penalty Case: Analyzing Bohanec and the Evolution of 'Willfulness'

I wrote about the Bohanec case here in December 2016. Hale E. Sheppard recently published an article analyzing this case, along with the other 3 key cases and other authority dealing with willfulness in context of civil FBAR penalties. It is a detailed article, and also somewhat long, so I have provided some of the highlights here:

A. United States v. Williams, 489 Fed. Appx. 655 110 AFTR2d 2012-5298 (CA-4, 2012)

1. Key Facts

a) Used an accountant - did not discuss foreign accounts with accountant - indicated he did not have reportable interest in a foreign account on accountant's questionnaire.

b) Accounts received funds from foreign sources.

c) Did not report substantial interest income from the accounts.

d) When pleading guilty to criminal violations, he admitted he knew he had the obligation to report, but chose not to so as to hide income.

e) Taxpayer did not check off on his income tax returns the existence of the foreign accounts.

2. Key holdings

a) Willfulness can be inferred from taxpayer conduct designed to conceal financial information.

b) Willfulness can also be inferred from a taxpayer's conscious effort to avoid learning about reporting requirements, i.e., “willful blindness” exists where a taxpayer knew of a high probability of a tax liability yet intentionally avoided the pertinent facts. When willfulness is a condition for civil liability, the Fourth Circuit indicated that this covers both knowing violations and reckless violations of a standard.

c) Failure to make the foreign account check off on the Form 1040, with its reference to the FBAR, constitutes a conscious effort to avoid learning about reporting requirements and constitutes willfulblindness.

d) Burden of proof is on the U.S. government with a preponderance of the evidence standard (Williams II).

3. Misc.

a) Limited precedential appeal as an unpublished decision.

B. CCA 200603026

1. Civil and criminal definitions of willfulness for FBAR violations are the same.

2. "[I]n order for there to be a voluntary intentional violation of a known legal duty, the accountholder would just have to have knowledge that he had a duty to file an FBAR, since knowledge of the duty to file an FBAR would entail knowledge that it is illegal not to file the FBAR. A corollary of this principle is that there is no willfulness if the accountholder has no knowledge of the duty to file the FBAR."

C. IRM section (7/1/08); IRM section (11/6/15).

1. The test is whether “there was a voluntary, intentional violation of a known legal duty” and “willfulness is shown by the person's knowledge of the [FBAR] reporting requirements and the person's conscious choice not to comply with the requirements.”

D. McBride, 908 F. Supp. 2d 1186 110 AFTR2d 2012-6600 (DC Utah, 2012)

1. Key Facts

a) Taxpayer received information from planning organization about general reporting requirements for foreign company interests, trusts, and bank accounts.

b) Taxpayer did not check off on his income tax returns the existence of the foreign accounts

2. Key Holdings

a) Burden of proof is on the U.S. government with a preponderance of the evidence standard.

b) "Willfulness" in this context includes not only knowing FBAR violations, but also recklessness. Wwillful blindness" satisfies the willfulness standard in both criminal and civil contexts.

c) Willful intent can be proven by circumstantial evidence, and reasonable inferences can be drawn from the facts because direct proof of a taxpayer's intent is rarely available.

d) As to knowledge of the law, the taxpayer was deemed to have knowledge of the FBAR requirements per his signature on his Form1040 and the reference to FBAR requirements therein (although the taxpayer was also found to have actual knowledge of the requirements based on materials he received and his admissions and evasive conduct.

e) Interest on the penalty was allowed from the date of assessment pursuant to 31 U.S.C. section 3717(e)(2)31 U.S.C. section 3717(e)(2).

f) Reasonable reliance on a professional defense is not workable when professional is not given all relevant facts.

g) There are whiffs of strict liability in this case - i.e., that a taxpayer is responsible if they know of the FBAR filing requirements even if they reasonably believed they were not subject to them.

E. Bussell, 117 AFTR 2d 2016-439 (DC Calif., 2015)

1. Key Holdings

a) Willfulness encompasses "reckless disregard of a statutory duty."

F. Bohanec, 118 AFTR2d 2016-5537 (DC Calif., 2016)

1. Key Facts

a) Taxpayers did not provide their U.S. address to the foreign bank, did not tell anyone about the foreign account (other than their two children), did not keep any records or use a bookkeeper, did not discuss the potential implications of the non-U.S. account with an accountant, attorney, or banker, and did not file Forms 1040.

b) Taxpayers submitted erroneous OVDP application, along with inaccurate Forms 1040 and inaccurate FBARs.

2. Key Holdings

a) The concept of "willfulness" for civil FBAR penalty purposes extends to reckless disregard of a statutory duty (notwithstanding CCA 200603026 and the Internal Revenue Manual), including reckless indiference.

b) Burden of proof is on the U.S. government with a preponderance of the evidence standard.

c) Part III of Schedule B of their Form 1040 from 1998 put them on notice that they needed to file an FBAR

Sunday, March 12, 2017

Receiver Put in the Same Shoes as Underlying Taxpayer under Claim of Right Claim

At times, a taxpayer may receive and report income, and then in a later year have to return the income item. Depending on the circumstances, this could give rise to a deduction in the later year under Code §§162 or 165 under the Claim of Right Doctrine.

If the taxpayer does not have significant income in the year of repayment (or in the NOL carryback or carryforward periods if the deduction is under Code §162), the taxpayer not get much mileage from the deduction due to a lack of income to offset by the deduction. To remedy this situation, Code §1341, when operable, will allow the taxpayer a refund in the year of repayment equal to the tax savings that would have resulted if the initial income reporting was not required, regardless of the amount of income arising in the year of repayment.

A requirement to use Code §1341 is that at the time of the original receipt of money, the taxpayer must have subjectively believed it had an unrestricted right to the money in that year. This is problematic for taxpayers who received the money fraudulently or as the result of criminal activity, since they would lack this subjective belief - thus, they cannot use Code §1341. As an aside, note that repayments as the result of fines or forfeitures may be denied deductibility anyway under Code §§162 and 165.

In a recent appellate decision, the taxpayer had obtained funds through fraud, and through the actions of a receiver, had to disgorge some of those funds. Because those funds were obtained through fraud, Code §1341 cannot apply. Nonetheless, the receiver, on behalf of the taxpayer, made a Code §1341 refund claim so as to increase funds available to the victims of the taxpayer. When challenged by the IRS, the receiver was able to convince the trial court that this Code §1341 limitation regarding subjective belief of an unrestricted right to the money was not applicable when the refund claim was made by the receiver and not the taxpayer, based on the equitable purposes of Code §1341 and the equitable actions of the receiver.

The federal First District Court of Appeals recently acted to reverse the trial court, and to deny the refund claim to the receiver. The attempted use of Code §1341 by the receiver was not an equitable purpose that Congress intended to remedy under Code §1341, and thus receiver could not escape its intent limitations.

Robb Evans & Associations, LLC v. U.S., 119 AFTR 2d 2017-XXXX, (CA1), 03/03/2017

Tuesday, March 07, 2017

IRS Limiting GST Private Letter Rulings and Presubmission Conferences

At a recent Federal Bar Association Tax Law Conference, an IRS Chief Counsel branch chief advised that due to budget cuts:

a. The IRS has temporarily suspended issuing private letter rulings regarding modifications to generation-skipping transfer exempt trusts, and

b. The IRS has temporarily suspended pre-submission conferences in regard to estate, gift and generation-skipping transfer tax issues before the submission of a private letter ruling. This procedure allowed taxpayers to have a preliminary, nonbinding discussion with IRS personnel before submitting a private letter ruling request.

Sunday, March 05, 2017

Strict Charitable Contribution Substantiation Requirements Trip Up Another Taxpayer

Taxpayers making contributions to charities that seek a charitable deduction have a myriad of reporting and receipt requirements to comply with. Code §170(f)(12) imposes additional requirements as to contributions of motor vehicles, boats, and airplanes. These various requirements are a major trap for taxpayers, as the IRS will often assert the most harmless errors or omissions in compliance as grounds for denying the deduction.

In a recent Tax Court case, a taxpayer lost a $338,080 charitable deduction for the contribution of an aircraft. One of the failures of the taxpayer was the failure to obtain a required contemporaneous written acknowledgment (CWA) from the donee that included all of the following required information:

(1) the name and taxpayer identification number of the donor;

(2) the vehicle identification number or similar number;

(3) a certification of the intended use or material improvement of the vehicle and the intended duration of such use;

(4) a certification that the item would not be transferred in exchange for money, property, or services before completion of such use or improvement;

(5) whether the donee organization provided any goods or services in exchange for the vehicle; and, if so,

(6) a description and good-faith estimate of the value of such goods or services.

The taxpayer also failed to meet the requirement of submitting a copy of the CWA to the IRS with his tax return. Note that the donee organization is also required to submit the CWA to the IRS (using Form1098-C).

The Tax Court declined to allow the taxpayer to apply the substantial compliance doctrine in regard to the CWA failure, based on case law that such doctrine does not apply to Code §170(f)(8) requirements, quoting other case law to the effect “The doctrine of substantial compliance does not apply to excuse the failure to obtain a CWA meeting the statutory requirements. . .The deterrence value of section 170(f)(8)'s total denial of a deduction comports with the effective administration of a self-assessment and self-reporting system.” It similarly did not allow the use of an Aircraft Donation Agreement to meet the CWA requirements when that agreement did not have all the required disclosures listed above and was unsigned.

A big problem with CWAs for vehicles is that the taxpayer must receive the CWA from the donee organization within 30 days of the contribution. So, if the taxpayer makes the contribution, and then his accountant advises him of the need for a CWA when preparing the income tax return for the contribution year, it will most likely be TOO LATE to obtain the CWA in a timely manner. This is a big trap, and an unfair one - taxpayers should be allowed time to obtain the CWA at least through the return due date.

Joe A. Izen, Jr. v. Commissioner, 148 T.C. No. 5, 03/1/2017

Sunday, February 26, 2017

Taxpayers Will Not Need to Report Obamacare Compliance to Avoid Tax Return Rejection

On January 20, 2017, President Trump issued an executive order directing federal agencies to exercise authority and discretion available to the to reduce the potential burdens of the Affordable Care Act (Obamacare). In accordance with that order, the IRS is now indicating that it will not automatically reject 2016 income tax returns of individuals for failing to provide required information on whether they had health insurance, an exemption from coverage or made a shared responsibility payment. Such rejections were slated to commence for the 2016 filing season.

This does not mean individuals are off the hook for failing to follow the law, including being subject to penalty for failing to have proper coverage.


Sunday, February 19, 2017

Michael Jackson Estate Tax Case Moving Forward

Most estate tax practitioners will tell you estate tax it is all about valuation when assets are other than cash and marketable securities. The estate tax case of the Michael Jackson estate is an ideal demonstration. Tax Court proceedings are presently underway in that case.

The fiduciaries of Michael Jackson’s estate filed an estate tax return showing a value of $7 million. The IRS issued a notice of deficiency claiming a value of $1.32 billion, and demanded additional estate taxes of $505.1 million and $196.9 million in penalties and interest. Wow!

A large issue in the case, and one that is relevant to other celebrities, is the value at death of Jackson’s name and likeness. The estate reported the value at $2,105.00, claiming his reputation was tainted by child-abuse allegations and strange behavior. The IRS pegs that value at $434 million. At the time of his death, he was rehearsing for a comeback tour.

The valuation at death is not supposed to look at post-death events, but there is usually leakage on this issue that informs a court’s judgment. The question for any asset is what a willing buyer would pay for the asset from a willing seller on the date of death (or on a date that is 6 months later if alternate valuation is elected). That Jackson’s estate did a phenomenal job of exploiting his name and likeness after his death is not a favorable circumstance for it in this dispute. Nonetheless, allowing a substantial value for name and likeness can create significant difficulties for an estate since this is an intangible asset, and can result in a tax bill far in excess of available assets for payment if these assets cannot be sold. In large celebrity estates, the existence of this issue may prompt a quick sale of these assets to help establish value for estate tax purposes.

Note that a lot of the above information is from third party reporting on the estate and case, so don’t hold me to the accuracy of these figures.

Saturday, February 18, 2017

IRS is Getting More Info About Your Home Mortgage

Below is a copy of the 2017 Form 1098:


The items with the green arrows are new - previously, the IRS did not obtain this information from the mortgage lender. Key items now being disclosed include the principal balance at the beginning of the year, the origination date, and the address of the home securing the loan.

This information will allow the IRS computers and personnel to make some judgments on whether a mortgage interest deduction was properly taken on an income tax return. Without this information, the IRS would have had to audit or otherwise inquire to obtain relevant information about the mortgage. This information will help the IRS determine whether deducted mortgage interest is within the $1 million limit on home acquisition debt and $100,000 of home equity debt, and whether the mortgage is on a permitted residence of the taxpayer.

As an aside, this is a small demonstration of how the existence of an income tax entitles the government to broad information regarding its citizens - information for which there would otherwise be no compelling justification for it to demand.

Saturday, February 11, 2017

Birds-Eye View of New Gain Recognition Rules on Transfers of Appreciated Property to Partnerships with Related Foreign Partners

The IRS recently issued extensive regulations under the authority of Section 721(c) that denies nonrecognition treatment for transfer of appreciated property to a controlled partnership (domestic or foreign) by a U.S. person if there are related foreign partners.

I have a prepared a map diagram (viewable in any browser) that provides an overview of the new provisions. Its purpose is to generally familiarize you with the new rules - you will need to review the rules themselves for full detail (translation: do not rely on the diagram since it is an abbreviated summary only).

Here is the link to download the map diagram - again, open it with any browser program. When you have it open, click the ovals with numbers in them wherever you see them to fully expand each map section - they look like this:


Treasury Decision 9814

Wednesday, February 08, 2017

IRA Owner Taxed on Distribution, Even Though Funds Were Improperly Rolled into IRA

A deceased husband's IRA was incorrectly rolled over into an IRA of his widow, instead of being paid to his estate. The widow then distributed funds from the IRA to her stepson.

The Tax Court held that the widow was taxable on the funds distributed from the IRA under normal IRA distribution rules, even though the funds appear to have come from the erroneously rolled over IRA of her deceased husband.  The court noted "[a]lthough the Court finds that Wachovia incorrectly rolled over Mr. Ozimkoski, Sr.'s IRA to petitioner's IRA, the Court has no jurisdiction to unwind that transaction and must decide petitioner's tax liability on the basis of Wachovia's erroneous transfer of Mr. Ozimkoski, Sr.'s IRA assets to her IRA and the subsequent distributions from her IRA." Further, the widow was subject to the 10% tax of Code §72(t) as an early distribution from an IRA.

Suzanne D. Oster Ozimkoski, TC Memo 2016-228

Sunday, February 05, 2017

30% Penalty Is Not an Excessive Fine

So says the Tax Court in the recent decision involving the 30% penalty imposed under Code §6662A(c). The penalty can be imposed if a taxpayer fails to adequately disclose a reportable transaction giving rise to an understatement of tax. The penalty is 30% of the tax understatement. When the penalty applies, there are no defenses allowed.

The Eighth Amendment to the United States Constitution provides "excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted." To avoid a problem under this clause, the amount of the fine must bear some relationship to the gravity of the offense that it is designed to punish.

Since the penalty applies only to listed transactions (essentially, transactions deem to be abusive), and to reportable transactions with a significant purpose of avoiding or evading federal income tax, the court found measurable harm to the government from violations and that the penalty is proportional to the harm caused.

Thompson, (2017) 148 TC No. 3

Tuesday, January 31, 2017

IRS Permits Trust Division Without Adverse Federal Tax Consequences

In Private Letter Rulings 201702005 and 201702006, the IRS favorably ruled on federal tax consequences of a proposed trust division. But for a minor change in facts, the two rulings are identical, so we will focus only on 201702005. Two trusts are involved in the rulng – with each trust to be divided pursuant to state statute and court approval. The trusts involved are irrevocable trusts established for the benefit of the descendants of a child of the settlor (A). A has three adult children (B, C & D) and four minor grandchildren. Income is distributable to A’s children and the descendants of any deceased child of A (although in one trust such descendants are not included). The trustee has authority to withhold income and accumulate it or later pay it out. The trustee may also distribute principal if needed for care, eduation and support beyond what is being satisfied by income distributions. One year after A’s death the trust principal and accumulated income is to be distributed to A’s lineal descendants per stirpes. Proposed new subtrusts will be funded by fractionally dividing the existing trust assets of each trust into 3 new subtrusts, one for each of B, C & D. Trust provisions for the subjtrusts are similar, but not identical to the existing trusts, subject to the siloing of the interests of B, C & D and their descendants into separate trusts so as not to be directly impacted by the exercise of trustee discretion outside of their respective silo. The PLR sought rulings to the effect that (a) the new subtrusts will maintain the “grandfathered” trust status of the predecessor trust for GST purposes, (b) each subtrust will be treated as a separate trust for federal income tax purposes, (c) the division will not cause the predecessor trusts nor any new subtrust to recognize gain or loss from a sale or other disposition of property under Code §§61, 662, or 1001, (d) the subtrusts will inherit the tax basis and holding periods of the predecessor trust as to assets received, (e) the division will not result in any assets of the subtrusts being included in the gross estate of their beneficiaries, and (f) the divisions will not result in transfers subject to gift tax. The IRS favorably ruled on all of the requested rulings.

A problem with “pot” trusts is the justifiable concern by beneficiaries that discretionary distributions or other actions by a trustee that benefit a member of one beneficiary or family group injure the interests of other beneficiaries or family groups. The easiest solution is to divide the trust into separate trust or trust shares, divided along family group lines in a manner similar to the division in the proposed ruling request.

Such a division raises questions of GST exemption allocations, GST trust grandfathering, estate taxes, gift taxes, and income taxes. There is no Internal Revenue Code provision that addresses or facilitates such divisions, such as, by analogy, the corporate reorganization provisions that permit corporations to reorganize themselves without triggering adverse income tax consequences. Instead, these issues must be resolved either by Private Letter Ruling requests and/or reliance on case law where these issues have been litigated.

In this ruling, there is little that has not been favorably addressed in other prior rulings – typically in piece meal fashion. The ruling is nonetheless of interest since it (a) reflects a continued leniency by the IRS in allowing such pro rata divisions to occur without adverse consequences, and (b) provides a list of key tax issues and the IRS’ thoughts on why such divisions will not trigger negative answers in plain vanilla divisions. The following provides a short overview of the issues raised and the IRS justification for ruling favorably on each.

(a) GST Grandfathering Preserved. The subject trusts will involve generation skipping distributions to grandchildren (and possibly more remote generations) of the settlor. Presently, the trusts are exempt from the GST because they were irrevocable on September 25, 1985, and no additions were made to them after that date. Modifications, judicial constructions, settlement agreements, and other trustee action involving such “grandfathered” trusts run the risk of losing this grandfathered status. Treas. Regs. §26.2601-1(b)(4)(i)(D)(1) generally protects such actions from ending grandfathering status if the action does not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation than the person who held that interest before the modification, and the modification does not extend the time for vesting of any beneficial interest beyond the period of the original trust. Treas. Regs. §26.2601-1(b)(4)(i)(D)(2) provides that a shift of beneficial interest to a lower generation can occur if the modification results in either an increase in the amount of a GST transfer or a new GST transfer. Treas. Regs. §26.2601-1(b)(4)(i)(E), Example 5, provides an example of a pro rata trust division that preserves grandfathered status for the successor trusts. Based principally on the current trust divisions being substantially similar to Example 5, the ruling allowed for the continuation of grandfathered status.

Oftentimes, the trust being divided is not a grandfathered trust, but a trust that is wholly or partly exempt due to the prior allocation of generation skipping tax exemption of the settlor(s). Unlike grandfathered trusts, there are no regulatory provisions that provide a safe harbor for the continuation of whole or partially exempt status. Instead, taxpayers will often seek to rely on the principles of the above-described grandfathering regulations by anaology to adopt a position that the successor trusts inherit the whole or partially exempt status of the predecessor trust.

(b) Separate Trusts. Code §643(f) provides that, for purposes of subchapter J of chapter 1 of subtitle A, under regulations prescribed by the Secretary, two or more trusts shall be treated as one trust if (1) such trusts have substantially the same grantor or grantors and substantially the same primary beneficiary or beneficiaries, and (2) a principal purpose of such trusts is the avoidance of the tax imposed by chapter 1. Code §643(f) does not apply to trusts that were irrevocable on March 1, 1984 except to the extent additions to corpus were made after March 1, 1984. Based on this effective date provision, the ruling provides that Code §643(f) is inapplicable.

(c) No Gain. Non-pro rata distributions from trusts have the potential for being treated as pro rata distributions to beneficiaries and then an exchange of the assets between the trusts which can recognize gain or loss. Rev.Rul. 69-486, 1969-2 CB 159. The corollary to Rev.Rul. 69-486 is that a pro rata didistribution in kind does not constitute a sale or exchange. Treas. Regs. §1.661(a)-2(f) provides that gain or loss is realized by the trust or estate (or the other beneficiaries) by reason of a distribution of property in kind if the distribution is in satisfaction of a right to receive a distribution of a specific dollar amount, of specific property other than that distributed, or of income as defined under Code §643(b) and the applicable regulations, if income is required to be distributed currently. Based on the pro rata division involved, and presumably because the division does not come within the circumstances of Treas. Regs. §1.661(a)-2(f), the PLR provides that no gain recognition resulted.

(d) Carryover Basis and Holding Period. Based on there being no recognition of gain or loss under Code §1001, and the provisions of Treas. Regs. §1.1015-2(a)(1), the PLR determined that a pro rata division into subtrusts allows for carryover basis and holding period of trust assets to the new subtrusts. Treas. Regs. §1.1015-2(a)(1) provides that in the case of property acquired by transfer in trust (other than by transfer in trust by gift, bequest, or devise), the basis of property so acquired is the same as it would be in the hands of the grantor increased in the amount of gain or decreased in the amount of loss recognized to the grantor on the transfer under the law applicable to the year in which the transfer was made. If the taxpayer acquired the property by transfer in trust, this basis applies whether the property is in the hands of the trustee or the beneficiary, and whether acquired prior to termination of the trust and distribution of the property, or thereafter.

(e) No Gross Estate Inclusion. Presumably, the assets of the existing trusts are not subject to gross estate inclusion at the deaths of their beneficiaries. The ruling holds that no inclusion results for the subtrusts under Code §§2035-38 since “the distribution, management, and termination provisions of the [s]ubtrusts will be substantially similar to the current distribution, management, and distribution provisions of the respective [t]rust.”

(f) No Taxable Gifts. The PLR provides that because the beneficial interests, rights, and expectancies of the beneficiaries are substantially the same, both before and after the proposed division, no transfer of property will be deemed to occur as a result of the division.

Monday, January 23, 2017

Reminder: FBARs Due in April Starting This Year

Until now, the Reports of Foreign Bank and Financial Accounts (FBAR) for foreign financial accounts was due on June 30 of each year, for purposes of reporting accounts for the preceding calendar year.

An announcement by FinCen reminds preparers and account holders that starting this year, the due date has been moved, starting for 2016 accounts, to April 15 (actually, April 18 for 2017). Here is the text of the announcement:


New FBAR Due Date Announcement

Wednesday, January 18, 2017

IRS Formalizes Transcripts as Substitute for Estate Tax Closing Letters

In 2005, I discussed here how the IRS had posted information on its website that an account transcript notation bearing transaction code “421” could be used to determine that the IRS had concluded its review of a filed estate tax return and has accepted the return as filed (or after an adjustment by the IRS to which the estate agreed to), in lieu of obtaining a closing letter. The IRS indicated that closing letters would no longer be automatically issued, but could be requested 4 months or later after the return was filed.

The IRS has now formalized this information into a Notice. The Notice is helpful, and presumably was promulgated, to educate probate courts that have relied on closing letters in the probate process that they can now rely on an IRS estate tax transcript if it bears the ‘421’ transaction code.

The Revenue Procedure indicates that the estate tax closing letters can still be requested. It also notes that an account transcript can be obtained by estates and their authorized representatives by filing Form 4506-Request for Transcript of Tax Return with the IRS via mail or fax.

It would seem that the transcript request process can be more cumbersome than a request for a closing letter, since if the closing code is not shown on the transcript then the request process will need to be repeated until the IRS concludes its review and enters the closing code on its computer system.

The Revenue Procedure points out that after such a closing of review, the IRS can still reopen the review if there is (1) evidence of fraud, malfeasance, collusion, concealment, or misrepresentation of a material fact, (2) a clearly-defined, substantial error based upon an established IRS position, or (3) another circumstance indicating that a failure to reopen the case would be a serious administrative omission. Further, if portability of a decedent’s DSUE (deceased spousal unused exclusion) amount is elected on the estate tax return, the IRS may later review the return as to whether a proper DSUE amount was reported.

Notice 2017-12

Monday, January 16, 2017

Grant to Public Charity Qualifies as “Unusual Grant” for Public Support Test

Publicly supported charities provide favorable benefits under the Code for both the organization and donors, in contrast with non-publicly supported private foundations. To qualify, the organization must receive a substantial part of its support from either governmental bodies or from direct or indirect contributions from the public. The regulations provide tests for public support (the 1/3-of-support test and the 10% facts and circumstances test (Treas. Regs. §1.170A-9(f)). Under these tests, large grants from any individual (namely, grants exceeding 2% of the organization’s total support), can make it difficult to pass these tests. However, if a greater than 2% grant qualifies as an “unusual grant” under Treas. Regs. §1.170a-9(f)(6)(i), they are disregarded under the tests.

A recent private letter ruling determined that a large grant at the time a new organization had begun operations qualified as an unusual grant. The contributor was a foundation that was informed about the organization through a mutual acquaintance, and had no prior affiliation with the organization. The following facts and circumstances are the types of things the IRS likes to see in testing for an unusual grant, and were present here:

The contributor did not create the recipient organization;

The contributor has not previously contributed to the recipient organization;

The contributor does not stand in a position of authority with respect to the recipient organization;

The contributor does not directly or indirectly exercise control over the recipient organization;

The contributor was not in a relationship described in Code Sec. 4946(a)(1)(C) through Code Sec. 4946(a)(1)(G) with someone listed in the above items;

The contribution was in the form of cash, or equivalent, which furthers the recipient organization’s exempt purposes;

The recipient organization is a new organization and has been actively engaged in seeking sources of public support and funding in order to implement the recipient organization’s charitable programs;

The recipient organization reasonably expects to attract a significant amount of public support after the grant;

The recipient organization has a representative governing body as described in Reg. § 1.509(a)-3(d)(3)(i); and

The contributor imposed no material restrictions or conditions within the meaning of Reg. § 1.507-2(a)(7).

PLR 201701023

Monday, January 09, 2017

Treasury Department Unofficial Statements on Proposed Section 2704 Regulations

There is a lot of uncertainty whether the Section 2704 proposed regulations will ever be finalized, either due to policy to be set by President-elect Trump, and/or Congressional efforts to block those regulations. Nonetheless, practitioners still need to keep an eye on this project in the event they are finalized.

Kathy Veihmeyer Hughes of the Treasury Department’s Office of Tax Policy, provided some information on the project and what was intended by the proposed regulations in speaking to the Heckerling Institute on Estate Planning today in Orlando, Florida. Some key points (some of which have been previously put out there at other conferences) include:

a. Treasury is working on digesting the comments received at the December hearing on the regulations, and will be revising the regulations. There will not be an attempt to revise them and finalize them before President-elect Trump’s election, as some have feared.

b. The regulations are not intended to do away with minority interest discounts.

c. The regulations do not require valuations always be made in conformity with a deemed put right.

d. The three year rule as to including transfers occurring within 3 years of death in estate tax valuation adjustments will NOT be retroactive to transfers made before the effective date of the final regulations.

e. The regulations will not have an effective date prior to the date of issuance of the final regulations, and for some, prior to 30 days after issuance of the final regulations.

Sunday, January 08, 2017

Some Tax Law Changes That Take Effect in 2017

No new tax legislation has come forth yet, but per tax laws passed in prior years, some changes in the law will occur in 2017. Chief among them:

The floor beneath the itemized deduction for medical expenses of taxpayers who are age 65 or older increases from 7.5% of AGI to 10% of AGI. Thus, fewer medical expense deductions for older taxpayers. Code §213.

Forms W-2, W-3, and returns to report non-employee compensation (e.g., Form 1099-MISC), must be filed on or before January 31 of the year following the calendar year to which such returns relate (formerly, these were due on February 28, and not until March 31 for electronic filings). And, those returns are no longer eligible for the extended filing date for electronically filed returns. Code § 6071(c). Also, there are no more automatic Form W-2 extensions - one 30 day extension can be requested on a Form 8809.

Partnerships now have to file their income tax returns by the 15th day of the third month after the end of their tax year (e.g., March 15 for calendar year entities). Partnerships previously had until the 15th day of the fourth month. C corporations now don’t need to file until the 15th day of the fourth month, instead of the prior 15th day of the third month rule. Extension rules have also been changed for some entities. For a table summarizing all of the new filing deadlines for entities, click here.

Taxpayers who have not used an ITIN at least once in the past three years will no longer be able to use that ITIN on a tax return as of Jan. 1, 2017 and will need to obtain a new one. An ITIN is an individual taxpayer identification number. It is issued to individuals that are not eligible to receive a Social Security number such as noncitizens and nonresidents of the U.S. Code §6109(i)(3).

Large business and international taxpayers that request an examination to resolve specific issues relating to returns that are neither due nor filed must pay a user fee. The fee is being increased from $134,000 to $218,000. Rev. Proc. 2016-30. Nothing like a tax compliance system that is so complex that taxpayers must pay $218,000 out of their own pockets to the government to help resolve uncertainties in how it applies to them.

Sunday, January 01, 2017

Estate Tax Impact of Life Insurance Required by Divorce


Estate Tax Impact of Life Insurance Required by Divorce




Estate Planning



ABSTRACT (Key Points & Discussions)

    • Analysis of estate tax inclusion for life insurance policies that a divorcing spouse is obligated to own or maintain, and for an estate tax deduction if the insurance is includible in the gross estate.
    • One exposure to estate tax inclusion is from the decedent possessing incidents of ownership in the policy per Code §2042(2). However, even if the deceased spouse is owner, lack of actual control over or economic benefits from the policy may result in no incidents of ownership.
    • Estate tax inclusion can also result under Code §2036 via retained economic rights by the decedent  - for example, when the policy is held in a trust and the decedent may benefit from it.
    • Another source of inclusion is a transfer of ownership of the policy within 3 years of death under Code §2035.
    • Deductibility can be available under Code §2053(a)(3) as a claim against the decedent's estate. However, when the obligation is to obtain the policy and name the other spouse as beneficiary (as contrasted with an obligation to pay a fixed amount at death to the surviving spouse), there is no claim remaining after death so this provision may not apply to allow a deduction.
    • Deductibility can also arise under Code §2053(a)(4) as a debt against property (the insurance proceeds).
    • Requirement that obligation be contracted in a bona fide manner and supported by adequate and full consideration can be an obstacle to deductibility. For example, relinquishment of marital rights in decedent's property is not adequate consideration under Code §2043(b)(1) - however, meeting the requirements of Code §2516 will allow for a finding of adequate and full consideration.


Divorce; Estate tax inclusion; Estate tax deductibility for claims and debts against property