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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