Conversion of Charitable Lead Trust from Nongrantor Trust to Grantor Trust Does Not Provide a Charitable Deduction to the Grantor

In PLR 201730012, a charitable lead trust was converted from a nongrantor trust to a grantor trust by adding a power of substitution to the trust provisions. The taxpayer sought a charitable deduction for the deemed distribution from the trust to the grantor and transfer from the grantor to the trust, under the recognized principal that a grantor transferring property a charitable lead trust that is a grantor trust can receive a charitable deduction for the transfer.

Treasury declined to allow the deduction because in its view the conversion of a trust from a nongrantor trust to a grantor trust is not a transfer of property held by the trust for income tax purposes. Although I have not researched the issue, I am not aware of any clear authority on this issue, one way or the other, so taxpayers will have to make their own judgment call as to the proper answer to this question. Another PLR that addresses conversion of a nongrantor trust to a grantor trust is PLR 200923024. 

PLR 201730012 (July 28, 2017)

Disposition of U.S. Partnership Interest Will Not Result in Effectively Connected Income to Foreign Partner

What happens when a foreign individual or corporation sells an interest in a partnership that is engaged in a U.S. trade or business? The Internal Revenue Code does not directly answer this question - the answer lies at the intersection of several provisions and principles:

a. Foreign persons are subject to U.S. income taxes on their income effectively connected with a U.S. trade or business (ECI);

b. Foreign persons are usually not subject to tax on their capital gains (with exceptions for gains arising from disposition of U.S. real property interests and for individuals present too long in the U.S.);

c. Subject to some exceptions, the disposition of a partnership interest for a profit results in capital gain; and

d. The business character of the income of a partnership flows through to a partner, with the effect that a partner of a partnership with ECI treats its share of the income of the partnership as ECI (thus typically resulting in U.S. income taxation of that partner on its share of the partnership ECI.

In 1991, the IRS put those principles into a bag, shook them up, and issued Rev.Rul. 91-32 which held that a partner with capital gain from the disposition of a partnership that is engaged in a U.S. trade or business will be treated as incurring ECI on the portion of the gain attributable to the business assets of the partnership.

In Grecian Magnesite Mining v. Comm., the Tax Court recently disregarded Rev.Rul. 91-32 and held that a foreign partner with capital gain from the redemption of its partnership interest in a partnership conducting a U.S. trade or business was NOT subject to U.S income tax on that gain (other than the portion attributable to U.S. real property of the partnership) - that is, the gain would not be treated as ECI. In so doing, the Tax Court adopted an entity theory of taxation for partnerships when interests in the partnerships are sold, instead of a look-through or aggregate approach.

Foreign taxpayers who are in the unusual circumstance of being in the U.S. trade or business of trading in partnership interests will not benefit from this holding since their gains on such trading would likely still be ECI.

The court did not address the taxation of the portion of the gain taxable as ordinary income - particularly under Code Section 751 as to the portion of the gain attributable to inventory and receivables of the partnership.

The holding has a major impact on inbound business structuring, since it allows foreign partners to obtain pass-through treatment on the business income of the partnership, but will be able to sell their interests later and not be subject to U.S. income tax on its capital gain.Thus it provides a new incentive to operating U.S. businesses through U.S. partnerships and limited liability companies (although of course there may be other tax and business reasons not to conduct business in such a form).

Perhaps the result may be reversed on appeal, or the IRS attempts to change the result by regulation or new legislation. If not, this taxpayer-favorable ruling will be of benefit in many circumstances.

Grecian Magnesite Mining, v. Commissionr, 149 T.C. No. 3 (July 13, 2017)

IRS Regulations on the Chopping Block

Tax practitioners have complained for years about the ever-expanding scope and complexity of both the Internal Revenue Code and Treasury Regulations. A possible shrinkage in the Treasury Regulations may soon occur.

On April 21, 2017, President Trump issued Executive Order 13789, a directive designed to reduce tax regulatory burdens. The order instructed the Secretary to submit a 60-day interim report identifying regulations that (i) impose an undue financial burden on U.S. taxpayers; (ii) add undue complexity to the Federal tax laws; or (iii) exceed the statutory authority of the Internal Revenue Service (IRS). The order further instructs the Secretary to submit a final report to the President by September 18, 2017, recommending “specific actions to mitigate the burden imposed by regulations identified in the interim report.”

Treasury has identified numerous regulations that meet the criteria, It remains to be seen what Treasury will recommend as to the subject regulations, be it simplification or repeal.

Some of the key provisions that are targeted include:

• Proposed Regulations under Section 2704 on Restrictions on Liquidation of an Interest for Estate, Gift and Generation-Skipping Transfer Taxes.
• Temporary Regulations under Section 752 on Liabilities Recognized as Recourse Partnership Liabilities.
• Final and Temporary Regulations under Section 385 on the Treatment of Certain Interests in Corporations as Stock or Indebtedness.
• Final Regulations under Section 367 on the Treatment of Certain Transfers of Property to Foreign Corporations.

Notice 2017-38

Update to Guide on U.S. Taxation of Nonresident Aliens

I first wrote a simplified guide to U.S. taxation of nonresident aliens before the Internet and emails. The first few editions were printed and mailed out to persons on our firm's mailing list. Eventually, I circulated it by email, and then put it on our firm's website. It now resides on this blog, in the publication list to the right. It has been a few years since I updated it, so I gave it an update today and uploaded the new version. You can get to it from the list on the right, or you can click here.

IRS Provides Automatic Extension to Make Portability Election (Under Some Circumstances)

A portability election by the estate of a first spouse to die allows the unused unified credit of the first spouse to be used by the surviving spouse for estate and gift tax purposes. Since Code §2010(c)(5)(A) requires the election be made on an estate tax return, the portability election is effective only if made on an estate tax return that is timely filed (including extensions).

Because of numerous requests for extensions of the timing period, and the administrative burden placed on the IRS, the IRS has issued a Revenue Procedure to allow for the filing of a late portability election. The key provisions of this extension are:

1. The portability election must be submitted with a complete and properly filed Form 706 by the later of (a) January 2, 2018, and (b) the second anniversary of the decedent’s death. Once January 2, 2018 is reached, this effectively becomes a two year extension. The January 2, 2018 date allows for late filings by those estates that are already past the two year period.
2. The extension is ONLY AVAILABLE TO ESTATES THAT ARE NOT OTHERWISE REQUIRED TO FILE AN ESTATE TAX RETURN. Thus, if an estate is required to file a return due to the size of the gross estate (including prior taxable gifts), then this automatic extension procedure cannot be used (although the estate can still seek an extension under Treas. Regs. § 301.9100-3).
3. The Form 706 must state at the top that the return is “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER § 2010(c)(5)(A).”
4. An estate that does not comply with the requirements of the Revenue Procedure can still seek an extension under Treas. Regs. § 301.9100-3.
5. An estate that files late but within the deadlines of the Revenue Procedure and later learns that it should have filed a Form 706 because the estate exceeded the gross estate filing thresholds cannot rely on the late election - it is treated as null and void.
6. If a valid late election is made and this results in a refund of estate and/or gift taxes of the surviving spouse, the time period for filing for a refund is not extended from the normal statutory periods.
7. A claim for credit or refund of tax filed within the time prescribed in Code § 6511(a) by the surviving spouse or the estate of the surviving spouse in anticipation of a Form 706 being filed to elect portability under the Revenue Procedure will be considered a protective claim for credit or refund of tax.

Rev. Proc. 2017-34, 2017-26 IRB 1282