Another Court Finds Failure to Check Off Foreign Account on Income Tax Return Is Enough to Find Willfulness For FBAR Penalty

As discussed on numerous occasions in this blog, a substantial penalty applies if a foreign account is not reported on an annual FBAR filing and the failure to report was willful. As more attention has been focused on FBAR filing failures over the last 10 years or so, more courts are addressing when a failure to file is willful.

Problematic for taxpayers who claim a lack of knowledge of the FBAR filing requirement is the question on Schedule B of their federal income tax return that asks if they have an interest in or authority over an account in a foreign country, such as a bank account, securities account, or other financial account. The question, along with the instructions as to that question, is interpreted by the government as cluing in the taxpayer to the FBAR filing requirement. Whether the taxpayer answers ‘yes’ or ‘no’ to the question, since a taxpayer is deemed to know what is in a tax return that the taxpayer signs, they are deemed to have knowledge of the filing requirement. Thus, absent other contrary facts, the lack of filing is treated as willful. This is the case even if the taxpayer did not read the return - especially with the trend to treat the term ‘willful’ in a civil penalty context as including either reckless disregard of a filing requirement or willful blindness to the filing requirement.

While not completely clear, a recent Claims Court case accepted this approach and held on summary judgment that a taxpayer who had checked ‘no’ to the foreign account question on her income tax return and who knew she had a foreign account was subject to the willfulness penalty for failing to report the account on an FBAR regardless of actual knowledge of the FBAR filing requirement. While there were other bad facts for the taxpayer, the Court appears to hold that it would have ruled the same way without those other bad facts.

This trend risks most FBAR failures to report as being automatically willful when the taxpayer otherwise filed an income tax report, absent special facts such as lack of knowledge of the account itself or perhaps contrary tax advice - a highly unfavorable trend for taxpayers.

Kimble v. U.S., U.S. Court of Federal Claims, No. 17-421 (December 27, 2018).

FBAR “Willfulness” Decision

A substantial penalty applies for those who willfully fail to report a foreign account on an FBAR. A recent 2nd Circuit Court of Appeals opinion weighed in on two uncertainties regarding willfulness in context of FBAR violations.

First, the Court held that the definition of willfulness is not particular to FBAR violations but should involve the definition applied in other civil contexts. Particularly, the Court said:

In assessing the inquiry performed by the District Court, we first consider its holding that the proper standard for willfulness is“the one used in other civil contexts—that is, a defendant has willfully violated [31 U.S.C. §5314] when he either knowingly or recklessly fails to file [a]FBAR.” (Op. at 7.) We agree. Though “willfulness” may have many meanings, general consensus among courts is that, in the civil context, the term “often denotes that which is intentional, or knowing, or voluntary, as distinguished from accidental, and that it is employed to characterize conduct marked by careless disregard whether or not one has the right so to act.” Wehr v. Burroughs Corp., 619 F.2d 276, 281 (3d Cir. 1980) (quoting United States v. Illinois Central R.R., 303 U.S. 239, 242–43 (1938)) (internal quotation marks omitted).  In particular, where “willfulness” is an element of civil liability, “we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.” Fuges v. Sw. Fin. Servs., Ltd., 707 F.3d 241, 248 (3d Cir. 2012) (quoting Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 57 (2007)). We thus join our District  Court colleague in  holding  that  the  usual  civil standard of willfulness applies for civil penalties under the FBAR statute.

Then, the Court held that knowledge of the filing requirement is not a necessary element - recklessness (i.e., reckless disregard) is enough. Here, the Court said:

This holds true as well for recklessness in the context of a civil FBAR penalty. That is, a person commits a reckless violation of the FBAR statute by engaging in conduct that violates “an objective standard:  action entailing ‘an unjustifiably high risk of harm that is either known or so obvious that it should be known.’” Safeco, 551 U.S. at 68 (quoting Farmer v. Brennan, 511 U.S. 825, 836 (1994)). This holding is in line with other courts that have addressed civil FBAR penalties, see, e.g., United States v. Williams, 489 F.App’x 655, 658 (4th Cir. 2012), as well as our prior cases addressing civil penalties assessed by the IRS under the tax laws, see, e.g., United States v. Carrigan, 31 F.3d 130, 134 (3d Cir. 1994). 

The Court then gave a definition for recklessness with respect to IRS filings, providing that:

[A] person “recklessly” fails to comply  with  an  IRS  filing requirement when he or she “(1) clearly ought to have known that (2)there was a grave risk that [the filing requirement was not being met] and if (3) he [or she] was in a position to find out for certain very easily.” Id. (quoting United States v. Vespe, 868 F.2d 1328, 1335 (3d Cir. 1989) (internal quotation omitted)).

Bedrosian v. U.S., 3rd Cir., Case No. 17-3525, December 21, 2018

Applicable Federal Rates - January 2019

Interesting Modifications in FATCA Proposed Regulations

New Proposed Regulations modify withholding and other misc. requirements under FATCA and chapter 3. Some of the more interesting changes include:

1. No Withholding on Gross Proceeds. Under Code §§471(a) and 1472, withholdable payments made to certain FFIs and certain NFFEs are subject to withholding under chapter 4. Under Code §1473(1)  the term “withholdable payment” means: (i) any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the U.S.; and (ii) any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the U.S. Because of the extensive network of agreements that have developed, the IRS has determined that the current chapter 4 withholding requirements already serve as a significant incentive for FFIs investing in U.S. securities to avoid status as nonparticipating FFIs. Therefore, withholding under (ii) above on gross proceeds will no longer be required.
2. Extension of Implementation of Withholding on Foreign Passthru Payments. The Proposed Regulations will further extend the time for withholding on foreign passthru payments. Thus, a participating FFI will not be required to withhold tax on a foreign passthru payment made to a recalcitrant account holder or nonparticipating FFI before the date that is two years after the date of publication in the Federal Register of final regulations defining the term “foreign passthru payment.”
3. Insurance Premiums. Premiums for insurance contracts that do not have cash value will be excluded nonfinancial payments and, therefore, not withholdable payments.
4. “Investment Entity” Definition. An entity is an investment entity (and therefore a financial institution) if the entity’s gross income is primarily attributable to investing, reinvesting, or trading in financial assets and the entity is “managed by” another entity that is a depository institution, custodial institution, insurance company, or an investment entity described in Reg. §1.1471-5(e)(4)(i)(A). The preamble to the proposed regulations clarify that an entity would not be “managed by” another entity solely because the first-mentioned entity invests all or a portion of its assets in such other entity, and such other entity is a mutual fund, an exchange traded fund, or a collective investment entity that is widely held and is subject to investor-protection regulation. However, in an investor in a “discretionary mandate” will be considered as managed by the financial institution. A “discretionary mandate” is an investment product or solution offered by a financial institution to certain clients where the financial institution manages and invests the client’s funds directly (rather than the client investing in a separate entity) in accordance with the client’s investment goals.

Generally, taxpayers may rely on the Proposed Regulations until final regulations are issued.

Preamble to Prop Reg REG-132881-17; Proposed Regulations §1.1441-1, Proposed Regulations §1.1441-6, Proposed Regulations §1.1461-1, Proposed Regulations §1.1461-2, Proposed Regulations §1.1471-1, Proposed Regulations §1.1471-2, Proposed Regulations 1.1471-3, Proposed Regulations §1.1471-4, Proposed Regulations §1.1471-5, Proposed Regulations §1.1473-1, Proposed Regulations §1.1474-1, Proposed Regulations 1.1474-2

Applicable Federal Rates Chart - Through December 2018

Federal Tax Overpayment & Underpayment Interest Rates

COMMENT: These rates are on the way up. This is helpful for taxpayers who are due a refund, and painful for those that have tax deficiencies.

A Chart to Help You in Planning Homestead Dispositions

I’ve been giving some recent seminars on Florida homestead law. One of the topics I discussed are the limitations on devise of homestead, and some of the obvious and/or hidden planning problems that result when the limitations apply (and how to deal with them when they do arise).

I thought a table that can be used as a quick reference of these problems would be useful. I think this is especially so for attorneys during client discussions or drafting to make sure there is not a hidden problem that was not or is not being considered in planning.

I’ll be inserting this as a new practice aid in new editions of my treatise, Rubin on Florida Homestead. The treatise has an extended discussion of the principal planning that can be done to avoid most of these problems.

I developed some other charts and checklists in these seminars, which I will be rolling out here and in the treatise in the coming weeks.

You can download a PDF of the new table from Dropbox here. Since this is newly developed, if anyone sees any errors or omissions or has other comments, please send me an email at crubin@floridatax.com.

HOLIDAY GIFT FROM THE IRS - NO CLAWBACK WORRIES

Similar to concerns in 2012 when there were concerns about a reduction in the unified credit, the 2026 sunset of the $5 million increase in the unified credit basic exclusion amount for gift and estate taxes under the 2017 Tax Cuts and Jobs Act (TCJA) has created concerns about what happens to taxpayers who use all or part of the $5 million increase in the period after the 2026 sunset. In a holiday gift to taxpayers, the Treasury Department has issued a notice of proposed rulemaking that should ameliorate most, if not all, concerns of clawback and related adverse impacts on gift and estate tax computations and amounts.

The Treasury Department announcement indicates four areas of concern. It then notes that three of these areas are nonissues under current law requiring no regulatory attention, and then provides proposed modifications to the regulations to address the fourth area.

First Area - If Pre-2018 Gift Tax Was Paid, Will Those Gifts Absorb Some or All of the 2018-2025 Available Increase in the Basic Exclusion Amount So As To Reduce the Amount of Credit Available for Offsetting Gift Taxes on Gifts Between 2018 and 2025 (i.e., applying the increase to prior gifts on which gift tax was paid)? The Treasury Department’s analysis is that this does not occur under current law, and no regulatory fix is thus needed to avoid such a reduction. Readers interested in the technical reasons why this is the case should review the notice - this posting will be long enough without covering those details (this also applies to the other 3 areas of concern below).

Second Area - The Same as Area One, But as to Estate Taxes on Persons Dying Between 2018 and 2025? The same conclusion here - pre-2018 gift taxes do not act to reduce the Basic Exclusion Amount increase available for estate tax purposes between 2018 and 2015, without the need for a regulatory fix.

Third Area - Will Gift Tax on Gifts Made After 2025 Be Increased By Including in the Tax Computation a Tax on Gifts Made Between 2018 and 2025 that Were Sheltered When Made by the Increase in the Basic Exclusion Amount? The Treasury Department’s analysis is that this does not occur under current law, and no regulatory fix is thus needed to avoid such a threated result.

Fourth Area -  Will Gifts Made Between 2018 and 2025 that are Sheltered by the Increased Basic Exclusion Amount Be Subject to Estate Tax for Decedents Dying in 2026 and After When the Increase Disappears? Treasury determined that this increase in estate tax will occur under current law. Deeming this to be inappropriate, new proposed regulations will amend Treas. Regs. §20.2010-1 to avoid this result. More particularly, the revisions will allow for a basic exclusion amount at death available to be applied against the hypothetical gift tax portion of the estate tax computation equal to the higher of (a) the otherwise applicable basic exclusion amount, and (b) the basic exclusion amount applied against prior gifts.

These new provisions should remove a cloud hovering over taxpayers that desire to use the increased exemption before it disappears in 2026. So the general planning advice to use those increases before 2026 before they are lost (if otherwise practical in a given taxpayer’s situation) remains in effect. At first reading, it would appear that if there is a political change in Washington D.C. that reduces the exemption before 2026, the new regulations would also cover that situation. Of course, if such a change was made, Congress could also write the change in a manner that revises the methods of computation so as to void the foregoing conclusions and changes or to create other problems.

Regarding questions whether Treasury has the authority to make these changes, the announcement points to Code §2001(g)(2) which was added in the TCJA and authorizes regulations in this area.

Of course, these regulations are only proposed, so cautious taxpayers may want to wait until they are actually adopted before relying on them.

It would have been nice if the announcement had also addressed the GST exemption and its temporary increase and 2026 rollback to confirm no adverse consequences from the rollback after it occurs.

REG-106706-18, Notice of Proposed Rulemaking

LL.M. Degree Not Deductible

A taxpayer went to law school in Spain and practiced law there for several years as an international attorney. He then moved to New York City and enrolled in an LL.M. program at NYU. He paid tuition expenses of $27,435. After obtaining his degree, he obtained a visiting attorney position in the U.S. at an international law firm, doing similar work to what he did in Spain. He then  took and passed the New York State bar exam - he was eligible because of his LL.M. degree. He passed and was admitted to practice in New York and continued working at the law firm.

The issue is whether he could deduct his tuition expenses. Code §162(a) allows a deduction for education expenses if (1) made by a taxpayer to maintain or improve skills required in the taxpayer's business or employment, or (2) to meet the express requirements of the taxpayer's employer, or the requirements of law or regulations, imposed as a condition to retaining his or her salary, status or employment. See also Treas. Regs. §1.162-5. However, no deductions are allowed if the education is part of a program of study that will lead to qualifying the individual in a new trade or business, or are needed to meet the minimum education requirements for qualification in the taxpayer’s employment. Treas. Regs.§ 1.162-5(b)(3)(i).

The Tax Court ruled that the deductions were nondeductible. While the taxpayer did perform similar job functions before and after the LL.M., and the LL.M. related to those functions, that the LL.M. allowed him to seek admission to the New York Bar sunk his boat by leading to qualifying him in a new trade or business. Also relevant was that he did not need the degree for his visiting attorney job.

Note that under the 2017 Tax Act, unreimbursed education expenses of employees are miscellaneous itemized deductions that are presently suspended through 2025.

Enrique Fernando Dancausa Valle, TC Summary Opinion 2018-51

Filing a Claim against Estate Grants IRS More Than 10 Years to Collect

Code §6502(a)(1) provides a 10 year collection period to the IRS, measured from the assessment date. The particular language reads: “Where the assessment of any tax imposed by this title has been made within the period of limitation properly applicable thereto, such tax may be collected by levy or by a proceeding in court, but only if the levy is made or the proceeding begun. . . (1) within 10 years after the assessment of the tax. . .”

In U.S. v. Estate of Albert Chicorel, 122 AFTR 2d 2018-XXXX (CA6 2018), the IRS sought to collect on an income tax assessment more than 10 years old. The Estate sought to bar the collection under the above language. The IRS countered that since it had timely filed a claim in the probate proceedings against the Estate, then it had begun a “proceeding” within the above statute within 10 years and thus could complete the collection process outside the 10 year period. The Sixth Circuit Court of Appeals sided with the IRS.

The court found a claim filing constituted a proceeding because filing a proof of claim in Michigan has significant legal consequences for the creditor, the estate, and for Michigan law generally. For example, if the estate does not provide notice that a claim is not allowed, it is automatically allowed. Further, Michigan law specifically equates presentation of the claim with a proceeding. The court noted that the Code §6502(a)(1) extension does not require a “judgment” to be reached in the applicable proceeding.

Once the timely proceeding is undertaken, the collection period does not expire until the liability for the tax (or a judgment against the taxpayer arising from such liability) is satisfied or becomes unenforceable. Code §6502(a) [flush language]. However, the government doesn’t have forever - the court notes that “the statute does not permit the government to allow an assessment to lie dormant and then to attempt collection long after the assessment has passed from reasonable memory.”

Would this case apply in Florida? I could not locate similar language in the Florida Probate Code that equates presentation of a claim with a proceeding. However, the effect of filing a claim and the procedures for the estate to object or be bound by the claim are substantially similar to the Michigan effect, so I would speculate that is enough for the same principles to apply in Florida.

Note the claim here was timely filed in the estate proceeding. The flush language in Code §6502(a) describes a “timely proceeding in court for the collection of a tax...” The appellate court expressly declined to rule on what would happen if the claim had been untimely. I would speculate that a different result may arise, per the statutory use of the word “timely.”

An unrelated issue is whether the personal representative/executor of the estate has personal liability for the unpaid income tax. Code §6905(a) provides a procedure for an executor to make application for a discharge of personal liability (which does not impact estate liability).

Another unrelated issue is whether the IRS is barred by state law limitations periods if they do not timely file a claim against the estate. The answer to this is no.  Board of Comm'rs of Jackson County v. United States, 308 US 343 (1939) ; United States v. Summerlin, 310 US 414 (1940) .

U.S. v. Estate of Albert Chicorel, 122 AFTR 2d 2018-XXXX (CA6 2018)

New Inbound Investment Reporting Requirements for Certain Industries

Regulations have been recently issued under the recently passed Foreign Investment Risk Review Modernization Act (FIRRMA) to implement a pilot program that expands the jurisdiction of the Committee on Foreign Investment in the United States (CFIUS) and imposes filing requirements on certain transactions in the U.S. technology sector.

Parties must file a declaration with CFIUS at least 45 days in advance of certain foreign-person investments in unaffiliated U.S. businesses if involved with critical technologies used in specified industry sectors. 27 U.S. industry sectors are involved.

The program will end by March 5, 2020, but permanent reporting requirements may have been put in place by then. It applies to transactions completed on November 10, 2018 or later, although there are other effective date provisions that may apply.

After filing, CFIUS has 30 days to review the declaration and then undertake certain requests for a long-form notice form, initiate a unilateral review, or clear the transaction – or the parties can file the long-form notice initially.

Parties failing to file a required declaration may be subject to a civil penalty up to the amount of the transaction value.

Businesses and professionals involved in assisting with and/or the reporting of inbound investments should add these new reporting requirements to their checklists and lists of reporting requirements.

FIRRMA PILOT PROGRAM REGULATIONS AND OTHER INFORMATION

The New “Newlywed” Exception to Documentary Stamp Taxes

Florida imposes documentary stamp taxes on transfers of Florida real property. The tax is based on the consideration paid for the property. Generally, if real property that is transferred is encumbered by a mortgage and the purchase price is less than the mortgage amount (or there is nothing otherwise paid), the mortgage amount is treated as consideration for purposes of calculating the tax.

This tax arises on transfers of encumbered real property, even if the transferor and transferee are married to each other. Given other exemptions for intra-spousal transfers under law (e.g., as to the federal estate tax, and under the Save Our Homes cap on ad valorem taxes), this is surprising and somewhat disheartening. Oddly enough, Florida law will NOT impose the tax on transfers of a marital home between spouses or former spouses when the transfer is incidental to a divorce. Fla.Stats. §201.02(7)(a). Of course, if there is no mortgage on the property and nothing is paid for the property, an intra-spousal transfer will not be subject to stamp taxes.

Under a new provision of law that came into effect in July, spouses can now transfer encumbered homestead property between themselves without incurring documentary stamp taxes, if no other consideration is paid. However, this new provision applies only to transfers within one year of marriage. Therefore, newlyweds can use it – spouses who have been married over a year cannot. This one year limit is also a trap for unwary newlyweds – if they take more than a year to reorganize their real property holdings, the tax will apply.

As noted, the transferred property must be homestead property. The applicable definition of “homestead” for this purpose is the ad valorem tax definition under Fla.Stats. §192.001 and the ad valorem tax provisions of s. 6(a), Art. VII of the Florida Constitution.

Any tax exemption is a good exemption (from the perspective of taxpayers), but the limitation of this new exception to newlyweds seems unduly restrictive. It appears to allow newlyweds to add a spouse to the title as part of new marriage restructuring, but why not open it up to other transfers? For example, spouses that desire to transfer homestead property owned by one spouse to TBE so as to allow for an automatic transfer at death to the surviving spouse should be able to do so without the tax. As matters stand now, if there is a large mortgage on the property, the stamp taxes can make such transfers and planning cost prohibitive.

Fla.Stats. §201.02(7)(b)

New Homestead Diagram

Many years ago I prepared a diagram in table format that simplified the restrictions on transfers of Florida homestead property. This has been downloaded thousands of times and I hear is used by many legal and real estate professionals. You can download a copy here.

I have re-worked the analysis into a flow chart type approach, for those that prefer that type of analysis. The new chart also reflects when an item is “protected homestead” for Florida law purposes. You can download a copy here.

Either one will help get you to the right result. I actually like the flow chart approach since after you use it a few times, it will burn much of itself into your memory so many times you will no longer need to consult it.

Future editions of my treatise, Rubin on Florida Homestead, will include both diagrams. Prior purchasers, whose versions do not include the new chart, can use these download links to gain access to it.

RESTRICTIONS ON TRANSFERS OF FLORIDA HOMESTEAD PROPERTY - FLOWCHART VERSION

The Transitory Nature of the Estate Tax Exemption Amount

With $11.18 million of cover under the unified credit under the 2017 tax act, more estates than ever are exempt from federal estate tax. This is especially so for married individuals, who have double this amount and the benefits of portability to help make effective use of both spouse’s exemption amounts.

Clients need to be reminded that this exemption amount is NOT permanent. Come 2026, the exemption will return to pre-2017 tax act levels, adjusted for inflation. So the exemption will be cut in half (approximately). But it is not just the built-in changes that need attention – it is the political reality that if there is a change in power in Washington, there is a substantial likelihood that the Democrats would seek to lower exemptions even farther (and/or increase estate tax rates).

This was brought home recently via proposed legislation of Elizabeth Warren, a possible 2020 presidential candidate. A recent article notes:

Warren’s office says her bill would lower the exemption to what it was at the end of President George W. Bush’s administration in 2009 — $3.5 million for individuals or $7 million for couples — and tax the value above that threshold beginning at a rate of 55 percent. Warren’s bill also includes progressive, marginal estate tax rates with higher thresholds: 60 percent on anything over $10 million for an individual or $20 million for a couple and then 65 percent on anything over $50 million for an individual or $100 million for a couple. For estates worth more than $1 billion, all of those rates would be increased 10 percent across the board to 65 percent, 70 percent, and 75 percent, respectively.

Even if Congress and President Trump can make the 2017 tax act provisions “permanent,” there really is no such thing as permanent. A willing Congress and President can pass whatever changes they want in the future.

Planners and taxpayers alike ignore the of possibility of a reduced exemption at their own peril. At a minimum, consideration should be given in marital planning to what would be the best disposition plan at the death of the first spouse based both under current exemption amounts and what would be best if exemption amounts are materially lowered. Consideration should also be given to using the higher exemption amounts before they are rescinded (for those that can afford to do so).

3 things to know about Elizabeth Warren’s new housing bill

Federal Overpayment and Underpayment of Tax Interest Rates - Third Quarter 2018

Avoiding Drafting Errors in Estate Planning Documents

As a member of a law firm with a substantial practice in estate and trust litigation, I have the opportunity to see numerous cases of poor drafting that end up in dispute or litigation. In the best of circumstances, it can be difficult to draft a 20-30 page trust or other instrument 100% free of all drafting errors. But there are many circumstances that are more likely to create, or not catch, drafting errors.

A recent article by L. Paul Hood, Jr. addresses many of these circumstances, and provides suggestions to minimize errors. I highly recommend it. Below is a list of several of these circumstances and/or suggestions, as paraphrased and commented on by me, but you should read the whole article:

a. Do your best to avoid the need to rush. Easier said than done when under client pressure or senior attorney pressure, but one source of time pressure is within your control: procrastination. Also, resist pressure to draft to immediately implement a settlement solution or with a client waiting in your office for a revision to sign. I tell our litigators when they are drafting a complex settlement agreement at the end of a day and night of mediation that what they are trying to do in a few hours would probably take several days of drafting, review, and rewriting  to properly prepare and that the risk of drafting (or analysis) errors is obviously higher in those circumstances.

b. Take good notes at your client meetings, and review drafts with the client. For clients with little interest in reading your legalese, a diagram illustrating key dispositive provisions goes a long way to make sure everyone is on the same page. Doing the diagram will also reveal to you, the draftsperson, contingencies, circumstances and planning alternatives you may not have considered. Of course, this can increase your time investment in the project and thus your or client costs, but it sure beats a malpractice action.

c. Confirm that procedures included in the document can be reasonably implemented in the real world, such as how to prove a trustee has become disabled or incapacitated.

d. Be especially vigilant when cutting and pasting provisions from one document to another.

e. Review the execution version for blanks, and make sure the printed version is the latest draft on your computer.

f. Review other documents that will affect the drafted document or will be affected by it, to assure they are consistent with each other.

My favorite is to set aside a document and come back to it for final review the next day with fresh eyes. I can’t tell you how many times I see things on such a fresh read through that were not obvious when drafting.

Hood, Jr., L. Paul, How to Avoid Common Sources of Drafting Errors, Estate Planning Journal (WG&L), August 2018

Multiple Trusts and the Section 199A 20% Deduction

Section 199A Background

The Tax Cuts and Jobs Act of 2017 created a 20% deduction for noncorporate taxpayers against their qualified business income. For taxpayers in the highest bracket, this would reduce their tax on such income from 37% to 29.6%.

There are limits on the use of the deduction for higher income taxpayers. One set of limits is the exclusion of service income (subject to some exceptions) from the deduction, and another requires significant wages or depreciable business property to benefit from the deduction. Therefore, higher income taxpayers are incentivized to reduce their taxable income to avoid these limitations.

The deduction is available to trusts and estates and their beneficiaries.

Using Trusts to Reduce Income

Since trusts can take the deduction, it has been suggested that income from qualified businesses be split among numerous nongrantor trusts. By splitting the income among numerous trusts, the trust can stay below the limitation thresholds and take full advantage of the deduction.

Code §643(f) provides that under regulations, the Service can treat two or more trusts as 1 trust if (1) the 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 federal income tax. If applicable, it would defeat the above planning by combining multiple trusts into one trust – thus, the income would be combined and would then likely push the income of that trust up above the Code §199A income thresholds.

Proposed Regulations Weigh In

Treasury seeks to implement the authority under Code §643(f) and has issued Proposed Regulation §1.643(f)-1. The proposed regulation starts by parroting the above language of Code §643(f). It then indicates a “principal purpose” of avoidance will be presumed as to the establishment or funding of multiple trusts if it results in a significant income tax benefit unless there is a significant non-tax (or non-income tax) purpose that could not have been achieved without the creation of the separate trusts. It gives an example (Example 1) of a “principal purpose” problem where interests of a business are split among nongrantor trusts for the purpose of qualifying for the Code §199A deduction when an owner reads about the idea in an article. Spouses are treated as one person (as to being a grantor or beneficiary).

As to the question of substantially same beneficiaries, that Example 1 holds that the following trusts with substantially the same terms and established by the same grantor will be aggregated as one trust:

Trust 1 – Beneficiaries B, C, D

Trust 2 – Beneficiaries E, C, D

Trust 3 – Beneficiary E.

Example 2 has one grantor and these beneficiaries:

Trust 1 – G as to mandatory income, with H as remainder beneficiary

Trust 2 – H is discretionary income beneficiary for health, support and maintenance, and G is discretionary income beneficiary for medical expenses. He is the remainder beneficiary upon G’s death.

The example concludes that the trusts will not be aggregated due to the significant non-tax differences between the terms of the two trusts.

Conclusions

One conclusion is that multiple nongrantor trusts are viable for Code §199A planning purposes, if there is sufficient differentiation as to beneficiaries and trust terms. It is not viable without that differentiation.

Another conclusion is that the examples do not provide a clear demarcation or explanation of when trusts will be aggregated when there is some level of overlap in beneficiaries and terms. So taxpayers using trusts with some level of overlap will need to proceed at their own risk.

The preamble to the regulations notes that the proposed regulations are not limited to Code §199A avoidance.

The new rules are proposed to apply to taxable years ending after August 16, 2018. The preamble indicates they will apply to trusts entered into or modified after that date, but trusts existing or modified prior to that date will be governed under Code §643(f) on the bases of the statute and legislative history guidance.

Spouse Not Removed from Will by Reason of Divorce

This is an interesting case, although the issue probably does not come up that often.

While unmarried, Mr. Priever executed a will leaving his property to his then fiancée, Ms. Gordon. The two then married, and later divorced. Mr. Priever then died.

Mr. Priever’s father, through his guardian,  petitioned to have the will construed as if Ms. Gordon predeceased Mr. Priever pursuant to Fla.Stats. §732.507(2). This statute reads:

Any provision of a will executed by a married person that affects the spouse of that person shall become void upon the divorce of that person or upon the dissolution or annulment of the marriage. After the dissolution, divorce, or annulment, the will shall be administered and construed as if the former spouse had died at the time of the dissolution, divorce, or annulment of the marriage, unless the will or the dissolution or divorce judgment expressly provides otherwise.

Clearly, if Mr. Priever executed this will AFTER he married Ms. Gordon, she would be removed as a beneficiary. Mr. Priever signed the will BEFORE marriage, however.

The trial court held that the statute removed Ms. Gordon as a beneficiary. The appellate court reversed the decision, and held the statute did not apply and she should not be removed as a beneficiary by the statute.

The court relied on the “married person” language of the statute (“Any provision of a will executed by a married person that affects the spouse. . .). Since Mr. Priever was not a married person when he signed his will, that was enough for the appellate court to find the statute did not apply.

Policy-wise, the statute exists based on a legislative judgment that a spouse who divorces but does not change his or her will did so because of inadvertence and not an intent to leave the ex-spouse in the will. While this reasoning probably holds to a pre-marriage will, one can come up with circumstances where it shouldn’t. Perhaps the Florida Bar or the Florida legislature might take on a project to expand the statute to also cover pre-marriage wills.

SILVIA GORDON, Appellant, v. ROBERT FISHMAN, as personal representative of the Estate of Ron Priever, deceased; ROBERT FISHMAN, as Guardian of Bernard Priever; SAMUEL GORDON; and REBECCA GORDON, Appellees. 2nd District. Case No. 2D17-1488. August 24, 2018

GOT HOMESTEAD? www.rubinonfloridahomestead.com

August 2018 Applicable Federal Rates

Revisions to Partnership Representative Rules

The IRS has issued final regulations under the new centralized partnership audit regime. This audit regime was enacted in 2015. The rules provide for a partnership to appoint a “partnership representative” to participate in the audit process.

The final regulations generally adopt previously temporary and proposed regulations. Some of the key changes made in the final regulations from the temporary and proposed regulations relating to the partnership representative include:

• According to the Preamble, a partnership that has elected out of the centralized partnership audit regime is not required to designate a representative – if it does, that representative has no authority with respect to the partnership.
• A partnership may designate itself as the representative if it meets the substantial presence in the U.S. requirement and designates an individual that has such substantial presence to act on behalf of the partnership.
• A disregarded entity can serve as partnership representative. The entity must comply with the general entity representative rules to appoint a designated individual to act on its behalf. Both the entity and the designated individual must meet the U.S. substantial presence requirements.
• The representative need not be an employee of the entity, per the Preamble. Similarly, an entity representative need not have employees.
• Numerous modifications were made in regard to the changing the the partnership representative, including resignations and appointment of successors.

Remember that LLC’s taxable as partnerships (i.e., most multi-member LLC’s other than those electing to be taxed as a corporation or deemed to be corporations) must also comply with these rules.

T.D. 9839

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Final Charitable Contribution Reporting Regulations Issued

The Code imposes various reporting and substantiation requirements in order for a donor to claim a charitable contribution. More than once I have seen the IRS adopt a strict approach with taxpayers and have sought to disallow deductions for substantial contributions due to technical failures to comply with the rules.

The IRS has promulgated revisions to the rules, which in large part adopt the 2008 proposed regulations. Some key modifications include:

• All donors must keep records of their contributions. Code §170(f)(17). For money contributions, the donor must retain a canceled check, or other reliable written records showing the name of the donee, the date of contribution and the amount. Some organizations provide a blank pledge card to their donors. The Preamble to the new regulations provide that such a card is insufficient for these record keeping requirements since they it will not include all the information required.
• For contributions over $250, the donee organization must provide a contemporaneous written acknowledgment of the gift. Code §170(f)(8). A donor may be required to complete and submit a Form 8283, depending on the type of gift and the amount. The Preamble to the new rules provide that the Form 8283 itself does not meet the contemporaneous written acknowledgment requirement - a separate written acknowledgment is required.
• Appraisals are required for non-money contributions over $5,000. The new rules provide some technical modifications on what appraisers are qualified to issue the appraiser. For example, an appraiser can meet the requisite education and experience requirements by successfully completing professional or college-level coursework. The Preamble notes that mere attendance is not sufficient, and evidence of successful completion is required.
• If the contributed property is over $500,000 in value, the appraisal must be attached to the donor’s income tax return. Under the new rules, the appraisal is not attached just for the return of the contribution year, but must also be attached for future carryover years.

TD 9836. Substantiation and Reporting Requirements for Cash and Noncash Charitable Contribution Deductions

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Kiddie Tax Summary

The 2017 Tax Act reworked the Kiddie Tax. The Kiddie Tax acted to increase the rate of tax on the unearned income of children so that their family could not benefit from diverting investment income to children who are taxed in a lower tax bracket.

Below is an overview of the new provision that should bring you up to speed on the revisions in 3 minutes or less. A larger, more readable PDF version can be download by clicking THIS LINK.

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IRS ACTS TO REDUCE INFORMATION PROVIDED TO IT FOR EXEMPT ORGANIZATIONS

I have previously noted and complained about the relentless expansion of information reporting required to the IRS. Like an unexpected cool breeze on a hot summer day, an unexpected reduction in such reporting has been promulgated for many tax-exempt organizations. This is favorable since it reduces the compliance burden on taxpayers, protects the privacy of donors, and limits the ability of the IRS to injure donors by inadvertently disclosing donor information (as has happened in the past) or inappropriately targeting groups and individuals for disparate treatment when their politics is not in accord with the current ruling party (i.e., the inappropriate screening of conservative groups).

The Treasury Department and the IRS have announced that they will no longer require many tax-exempt organizations to file personally-identifiable information about their donors as part of their annual tax return (Forms 990). This will apply to all tax-exempt groups under Code §501(c), other than those organized under Code §501(c)(3) or Code §527. The reporting left in place was deemed necessary so that the IRS can confirm charitable deductions claimed by owners were actually made.

Organizations covered by the new exclusion include labor unions, volunteer fire departments, issue-advocacy groups, local chambers of commerce, veterans groups, and community service clubs.

Thumbs up to the IRS and Treasury for this reporting relief.

Press Release, July 16, 2018

GOT HOMESTEAD? - Rubin on Florida Homestead

A Safe Harbor for Waiver-by-Deed of Spousal Homestead Interests [Florida]

Under the Florida Constitution, a decedent owner of Florida homestead property with a surviving spouse can only devise that property to the surviving spouse (although if there are surviving minor children then no devise can be made at all). Fla.Stats. §732.702 allows for written waivers of homestead rights by spouses. That statute requires “fair disclosure” of assets be made if the waiver occurs after marriage.

Recent case law, most notably Stone v. Stone, 157 So.3d 295 (4th DCA 2014) allowed a deed from a spouse to constitute a waiver for this purpose. The correctness and scope of this decision have been debated by practitioners.

By reason of Stone and other decisions, Florida has enacted Fla.Stats. §732.7025 (effective on July 1 of this year) that provides a safe harbor method of having a spousal waiver-by-deed. If a spouse enters into a deed that has specific statutory language, then the deed will constitute a valid waiver of spousal homestead rights for descent and distribution purposes (but not for creditor protection purposes or for purposes of avoiding spousal joinder on inter vivos transfers of homestead).

For those with an interest, I have a more extended commentary in the Waiver section of my treatise, Rubin on Florida Homestead (www.rubinonfloridahomestead.com). This commentary addresses whether fair disclosure is still needed, the “safe harbor” nature of the new provision, the effect of such a waiver, and the question whether the new statute applies if the deeding spouse has no legal or equitable interest in the homestead. If of interest, you can download a copy of that Section from Microsoft OneDrive at this link: https://1drv.ms/b/s!AvIWUWY7Se4ogaUrVjPseSkvCL9yvQ

Supreme Court Upholds Changes to Beneficiaries Upon Divorce

Married persons often name the other spouse as beneficiaries of their estate, life insurance, pensions, IRA’s, annuities and other contractual arrangements upon the death of the first spouse. Upon divorce, they often do not get around to changing these beneficiary designations, either intentionally or unintentionally. Many state legislatures have reached the conclusion that the spouse that died would likely have wanted to change the beneficiary from the former spouse, but just never got around to it (whether intentionally via procrastination or unintentionally). They have enacted revocation-on-divorce statutes that treat a divorce as voiding one or more of testamentary bequests and beneficiary designations. In 2002, Minnesota adopted such a statute that applied to will and various will substitutes, including life insurance and annuity contracts.

The Contracts Clause of the U.S. Constitution restricts the power of States to disrupt contractual arrangements. It provides that “[n]o state shall . . . pass any . . . Law impairing the Obligation of Contracts.”  U. S. Const., Art. I, §10, cl. 1. In a recent case, the U.S. Supreme Court addressed the issue whether Minnesota’s revocation-on-divorce statute was unconstitutional as violative of the Contract Clause. The dispute arose between the claims of a divorced spouse, and alternative beneficiaries, as to entitlement to life insurance proceeds when a former spouse died and did not remove the surviving spouse as beneficiary of the insurance policy.

The Supreme Court ruled against the surviving spouse and held these types of laws do not violate the Contracts Clause. That Clause restricts the power of States to disrupt contractual arrangements, but it does not prohibit all laws affecting pre-existing contracts. The two-step test for determining when such a law crosses the constitutional line first asks whether the state law has “operated as a substantial impairment of a contractual relationship.” In analyzing that question, the Court has considered the extent to which the law undermines the contractual bargain, interferes with a party’s reasonable expectations, and prevents the party from safeguarding or reinstating his rights. If such factors show a substantial impairment, the inquiry turns to whether the state law is drawn in an “appropriate” and “reasonable” way to advance “a significant and legitimate public purpose.”

The Supreme Court ruled based on the first step, and never had to address the second step. The Court noted that the law is designed to reflect a policyholder’s intent—and so to support, rather than impair, the contractual scheme. It applies a prevalent legislative presumption that a divorcee would not want his or her former partner to benefit from a life insurance policy and other will substitutes. Thus the law often honors, not undermines, the intent of the only contracting party to care about the beneficiary designation. Also, the Court reasoned that the law is unlikely to disturb any policyholder’s expectations at the time of contracting, because an insured cannot reasonably rely on a beneficiary designation staying in place after a divorce.This is because divorce courts have wide discretion to divide property upon dissolution of a marriage, including by revoking spousal beneficiary designations in life insurance policies or by mandating that such designations remain. Because a life insurance purchaser cannot know what will happen to that policy in the event of a divorce, his reliance interests are next to nil. Further, the law supplies a mere default rule, which the policyholder can undo in a moment by redesignating the divorced spouse as beneficiary through a change-in-beneficiary form.The Court noted it has long held that laws imposing such minimal paper-work burdens (like recording statutes) do not violate the Contracts Clause.

The decision threatened to have a substantial impact if the Court had ruled these laws to be a violation of the Contracts Law, but that has dissipated with the conclusion that such laws are not a Contracts Clause violation.

Sveen v. Melin, 584 U.S. ____ (2018)

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Taxpayers Could Not Rely on IRS Correspondence Waiving Penalties

In a recent U.S. District Court decision, the taxpayers were audited, and ultimately received a letter from the auditing agent that “the penalties had been waived.” The taxpayers signed a Form 4549 document which did not assess penalties.

Subsequently, the IRS sent a Form 4549-A assessing a civil penalty under §6707A for failure to disclose a listed transaction. The taxpayers argued that the IRS had waived penalties and could not assess this new penalty, or alternatively the IRS was equitably estopped from asserting the penalty. The court ruled in favor of the IRS and allowed the penalty.

Code §7121(a) authorizes the IRS to enter into agreements in writing as to tax liabilities of a taxpayer. Treas. Regs. § 301.7121-1(d)(1) provides that closing agreements must be executed on forms prescribed by the IRS. Rev.Proc. 68-16, Section 6 provides that the appropriate forms are Form 866 or Form 906. Since neither of those Forms were issued by the IRS, the court held that there was no binding closing agreement as to penalties, and thus allowed the new penalties. The court noted that a Form 4549 is not an authorized closing agreement.

The court also noted that since the IRS had not asserted a §6707A penalty at the time of its waiver offer, that penalty was not waived.

While there is case law allowing valid closing agreements to arise outside of a Form 866 or Form 906, the court noted that the precedent in this area applies only to settlement of pending litigation in docketed cases, which was not the case for the taxpayers.

The court also disposed of the equitable estoppel claim by finding a lack of “affirmative misconduct” on behalf of the IRS.

Hinkle, 121 AFTR2d Para. 2018-861( DC New Mexico)

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Likely That Not All Internet/Web Sales Into a State will be Subject to State and Local Sales Taxes

In South Dakota v Wayfair, Inc., the U.S. Supreme Court overruled its prior precedent regarding sales tax on interstate sales and imposed state sales tax on sellers of merchandise who had no physical location or presence in South Dakota into South Dakota via the Internet .

OLD LAW. National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992) had previously held that an out-of-state seller’s liability to collect and remit the tax to the consumer’s State depended on whether the seller had a physical presence in that State, and that mere shipment of goods into the consumer’s State, following an order from a cata­log, did not satisfy the physical presence requirement.

GENERAL COMMERCE CLAUSE LIMITATIONS ON TAXATION OF INTERSTATE SALES. State regulations may not discriminate against interstate commerce, and may not impose undue burdens on interstate commerce. State laws that “regulat[e] even-handedly to effectuate a legitimate local public interest . . . will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefit". In Complete Auto Transit, Inc. v. Brady, 430 U. S. 274 (1977), the Court held it would sustain a tax so long as it (1) applies to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the State provides. The Quill requirement for physical presence was based on "substantial nexus" requirement.

COURT DETERMINATIONS. The Supreme Court found that the physical presence test is flawed and abrogated it, and thus overruled Quill and National Bellas Hess. So now, the mere selling into a state via the Internet can subject the seller to sales taxes in the location of the purchaser.

SCOPE OF THE RULING. The substantial nexus test remains, as do the other Brady requirements and the requirement not to unduly burden interstate commerce. These requirements were found to be met in this case, in part based on several aspects of South Dakota law and the taxpayers: (a) the tax applies only to sellers that, on an annual basis, deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State, (b) there was no retroactive application of the tax, (c)  South Dakota is a party to the Streamlined Sales and Use Tax Agreement which reduces administrative and compliance costs per a single, state level tax administration, uniform definitions of products and services, simplified rate structures, and other uniform rules, (d)  the sellers were large, national companies with an extensive virtual presence, and (e) the State provided sales tax administration software.

Unduly complex collection mechanisms, lack of exceptions for small businesses or those with minimal sales in the locality, and other fact-specific questions may make the collection of sales taxes illegitimate in other jurisdictions based on the facts applicable to the applicable sales and taxing jurisdiction. While regimes with similar rules to South Dakota will likely pass constitutional muster, other broader or more burdensome regimes may not.

South Dakota v Wayfair, Inc., 585 U. S. ____ (2018).

The Good and Bad News on Charitable Deductions under the 2017 Act

The good news first:

a. The 50% of adjusted AGI limitation maximum deduction amounts in any one year is increased to 60% as to cash contributions.

b. The Section 68 3% “Pease limitation” phase-out of itemized deductions is out of the law (through 2015).

These changes can significantly increase available deductions, but mostly for higher income persons and/or persons making significant gifts. Thus, one has to wonder whether the loss of deductions under the “bad news” below for many taxpayers will be offset by these increases.

The bad news:

a. The standard deduction is significantly increased to $12,000 for single people and $24,000 for married taxpayers.

b. Many formerly deductible expenses are no longer deductible,or deductions are limited (e.g., $10,000 limit for state and local taxes).

This means that for taxpayers making smaller gifts, it will be harder for them to have aggregate deductions above the standard deduction threshold. If deductions are not above that threshold, it will make more sense for those taxpayers to not itemize and take the standard deduction. This means that their charitable gifts may not be significant enough to garner a tax deduction. The prediction is that for lower and middle income taxpayers without a lot of deductions, their charitable giving will be reduced without the incentive of an income tax deduction.

There is an obvious planning mechanism for these taxpayers - to aggregate and save up their their charitable gifts and make them in fewer tax years (but to have a higher gifting amount in those years they do gift). The plan would be to take them above the standard deduction limits in their gift years and thus obtain a tax benefit for their gifting. Still, for many taxpayers, even with aggregation (also referred to as “stacking”), their gifts may not be high enough to materially get past the standard deduction thresholds.

Taxpayers who do not want to put large lump sums into the hands of charities but desire a charitable deduction in a current year can avail themselves of existing planning mechanisms that allows a deduction now and money going out to the charity later. These include gifts to private foundations, donor advised funds, and charitable trusts. Note that there are various limitations on deductions and rules on how to operate such vehicles, and some of them are not cost-effective absent large gifts. Before using them, taxpayers should consult with their tax advisors.

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Updated Florida Irrevocable Trust Amendment Mechanisms [Florida]

By Charles (Chuck) Rubin & Jenna Rubin

Florida practitioners will tell you that it is difficult to aggregate and analyze all the potential legal avenues to amending or terminating an irrevocable trust. We have previously created a map/chart that summarizes the principal methods available.

We have recently updated that map/chart, and added another delivery method. The two methods to view the map/chart are now:

a. An HTML file that after you download to your computer should open in a browser to view the information in an expandable/collapsible mindmap format. Click HERE to download the file. You must download it first and save it, and then you can open it. Some computer systems block the file or will not run it, presumably based on security settings. If that is the case for you, see alternative b. below.

b. This is a PDF file that contains all the information from the map/diagram, but in a text document layout, including copies of the relevant statutes. Click HERE to download it.

We have received a lot of favorable feedback from prior versions, so we are keeping this project going and will continue to update these items as the law evolves.

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IRS Warns on State Charitable Deduction Schemes to Allow Property Taxes Deduction

The Tax Cuts and Jobs Act of 2017 limits the Code §164 deduction of individuals for state and local taxes to $10,000 per year ($5,000 for married individuals filing a separate return). Thus, many taxpayers in states with high state taxes have lost a federal income tax subsidy of their state and local taxes.

Several states have adopted or are proposing arrangements to convert tax payments to deductible charitable deductions. These work by allowing taxpayers to make their tax payments to state-established or sanctioned charitable organizationS and then receive a credit against their state taxes for these payments. Voila - a state tax payment (subject to the $10,000 limit) is converted to a deductible charitable payment (not subject to the $10,000 limit).

The IRS has issued Notice 2018-54 warning taxpayers of proposed regulations that will be coming out that will address these payments. The Notice does not explicitly provide that the above charitable deduction arrangement will be ineffective - no such level of detail is provided. It does, however, specifically describe those arrangements and also references the “substance-over-form” doctrine, so it is highly likely that the regulations will disallow the charitable deduction under these arrangements.

Note that in the past, the IRS has provided that such charitable contribution/state tax credit arrangements allowed for a charitable deduction. Such was the conclusion in Office of Chief Counsel Internal Revenue Service Memorandum 201105010. However, that memorandum implies that the taxpayers did not receive a disqualifying quid pro quo in receiving the state tax credit for the charitable deduction, at least in part because a federal income tax deduction was allowable both for charitable deductions and state and local tax payments. Now that the state and local tax deduction is limited, I would expect the IRS to hold that by receiving the state tax credit the taxpayers are receiving a valuable quid pro quo - a federal tax deduction that would not otherwise be available for a direct tax payment. Thus, the charitable deduction would not be available. Alternatively, or also, the IRS may rely on the substance-over-form doctrine it mentions in its Notice to challenge the charitable deduction.

Notice 2018-54, Guidance on Certain Payments Made in Exchange for State and Local Tax Credits

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Court Stops Beneficiaries From Commuting Trust [Florida]

By Chuck Rubin & Jenna Rubin

EXECUTIVE SUMMARY: An income beneficiary of a trust and the trust remaindermen were unable to successfully commute and terminate a trust.

FACTS: A revocable trust became irrevocable at the death of the settlor. The settlor provided for an income interest for her son for his life, with the remainder to pass to three educational institutions at the son’s later death.

The son and the remaindermen entered into an agreement to terminate the trust, and divide the $3 million of trust assets between them based on their actuarial interests. The trustee of the trust was not a party to the agreement, and did not agree to the early termination.

The son filed a complaint against the trustee to terminate the trust in accordance with the agreement, citing Fla.Stats. §§736.04113 and 736.04115. Fla.Stats. §736.04113 allows for judicial modification of an irrevocable trust on petition of a trustee or a qualified beneficiary if: (a) the purposes of the trust have been fulfilled or have become illegal, impossible, wasteful, or impracticable to fulfill; (b) because of circumstances not anticipated by the settlor, compliance with the terms of the trust would defeat or substantially impair the accomplishment of a material purpose of the trust; or (c) a material purpose of the trust no longer exists. Fla.Stats. §736.04115 similarly allows judicial modification if compliance with the terms of a trust is in the best interests of the beneficiaries, taking into account the intent of the settlor and the current circumstances and best interests of the beneficiaries.

Both parties moved for summary judgment, and the trial court ruled in favor of the son, allowing termination of the trust. The trial court held that the termination was in the best interests of the beneficiaries since it would preserve trust assets by eliminating unnecessary expenses relating to trust administration. On appeal, the appellate court reversed the trial court and directed that summary judgment be entered in favor of the trustee barring the termination of the trust.

COMMENTS: There are few income beneficiaries and remaindermen who would not want to commute their trusts and receive direct and immediate access and ownership over trust assets if given the opportunity. And in fact, this can be accomplished in Florida if the beneficiaries can satisfy a court that it would be in their best interests (for post-2000 trusts) or that trust purposes no longer exis,. have been fulfilled, or have become illegal, impossible, wasteful, or impracticable to fulfill. Fla.Stats. §§736.04113 and 736.04115. Before this decision, the desires of settlors to retain assets in trust for beneficiaries to avoid vesting of significant assets in their hands, to protect them from creditor claims, to have third party or professional asset management, and to achieve the other benefits of trust ownership could be easily thwarted if courts are lenient in applying those statutory provisions... Here though, the appellate court recognized that the settlor’s intent is the polestar of trust interpretation and that early termination of the trust based on common circumstances applicable to many trust administrations would thwart that intent.

The appellate court noted that the trustees’ fees were customary, there were no unusual administrative expenses, and there had been no invasion of principal. It also indicated that market fluctuations did not create a real risk that the settlor’s intent would be thwarted. The court noted “[i]f we were to affirm the trial court's ruling, beneficiaries could have trusts terminated simply by stating that they did not want to pay trustees' fees, administrative expenses, or be concerned with market fluctuations.”

The case is instructive since there is little case law that interprets the specific requirements for judicial modification in the subject statutes. It makes terminating a trust more difficult by holding that barring other circumstances, mere savings on future administrative expenses, and the risk of market fluctuations will not be not enough to meet the requirements for judicial modification or termination.

The case also illustrates the benefits of having the trustee on board when petitioning to terminate a trust. If the trustee and all the beneficiaries reach an agreement, it is more likely than not that a trial court will approve termination when presented with a petition invoking the modification statutes and an agreed order to sign. However, the case also suggests that even with the trustee’s participation, an activist trial court may decline to sign off on the termination based merely on the grounds put forth by the beneficiaries in this case.

If the trustee agrees with the beneficiaries, and the Florida statutory requirements relating to date of the trust and the applicable rule against perpetuities allow it, another route to terminate a trust might be through nonjudicial modification under Fla.Stats. §736.0412. Alternatively, if the settlor is still living, common law modification or termination (judicial or nonjudicial) may be allowable by agreement between the settlor and beneficiaries, without regard to the trustee’s consent.

There are other avenues in Florida that can allow, under proper circumstances, for the modification or termination of a trust. A chart previously prepared by the authors of this posting that summarizes the various approaches (and updated for this case) is available for download here [follow the download instructions to save the file on your computer and then click the file to open it in a browser - it will not open unless you first download it].

Horgan v. Cosden, 2018 WL 2374443 (Fla. 2^nd DCA 2018)

I Forgot to Mention . . .

That to help get the word out, the publisher of Rubin on Florida Homestead is offering a 15% discount for purchases through this opening weekend. When checking out at www.rubinonfloridahomestead.com, use the coupon code “Introduction”. For those of you that already ordered, a credit back for the 15% is being applied to your orders.

Soft Opening – Rubin on Florida Homestead

As I teased a few days ago, I’ve been working on a challenging writing project these past 2-3  years. Today is the day of its release!

As you can tell by the title, it is a book/treatise on Florida homestead law. I took on the project because there are no comprehensive one-stop reference sources out there that cover all aspects of homestead law. There are many excellent sources of information and analysis, but they are scattered among various articles, chapters in books on larger subjects, and other miscellaneous places. Most of them are limited to one aspect of Florida homestead law – but Florida homestead law generally covers three large areas: creditor protection, limitations on gifting and testamentary transfers, and ad valorem taxes (and its corollary Save Our Homes cap on valuation limitations). As anyone who has had to deal with these areas, they involve concepts and planning that is quite challenging to both understand and practically apply. So I have sought to make the book a one-stop resource for all things related to Florida homestead law.

I’ve endeavored to make the book accessible to those who need an introduction to an area, to answer quick questions, or to assist with a detailed analysis. While of interest to those in Florida, it should also be of interest to those outside of Florida who have occasional need to deal with Florida homestead issues for themselves or their clients.

If this is something that interests you, and I sure hope it does, feel free to visit www.rubinonfloridahomestead.com for more information on the book (and of course, how to buy it!).

The book is in PDF format, for viewing on computers and other devices. Perhaps a paper edition may come in the future, but the ability to search contents, access links to cited sources, and my ability to update the book as the law evolves,  makes an electronic version the better way to go in my mind.

This is the first public announcement – I am going to wait a little while until all the kinks are worked out before going wide. If you have any problems with the website or ordering, please email me at crubin@floridatax.com. Comments on the book itself, whether general, suggestions for future coverage areas, or otherwise, are also welcome.

Teaser - New Publication Coming

A heads-up to readers that I will shortly be publishing a treatise that should be of interest to many of you. I have been hard at work on this project for the last 2-3 years, and hope to have it out in the next few weeks. Frankly, if I had known it would take me so long to write I probably would never have started, but I believe it is unique in what it covers and fills a need.

Some of you have asked me about the reduced volume of posting by me in Rubin on Tax (especially in recent weeks), and this is the reason why - there are only so many non-working hours in the day so something had to give. I intend to get the volume back up again, once this project is behind me.

More details to follow soon!

Possible Fix Coming to Charitable Gifting Problem

For many taxpayers, the 2017 tax law changes removed an incentive to many taxpayers to make charitable contributions. As an itemized deduction, charitable contributions provide a deduction only to taxpayers who itemize their deductions. With a much larger standard deduction, and reductions in available deductions for state and local taxes and mortgage interest, many taxpayers who used to itemize will no longer do so. This is especially true for lower and middle income taxpayers. Thus, many charities expect reductions in gifting to them do to the loss of income tax benefits to donors.

A bipartisan bill, the Charitable Giving Tax Deduction Act, has been introduced into the House of Representatives that would address this issue. The Act would make charitable deductions an “above-the-line” deduction. This means that taxpayers can deduct contributions against their income, whether or not they itemize their deductions. The income tax incentive to make charitable gifts would thus be restored, and even enhanced from the pre-2017 tax law changes.

Whether the bill will pass is anyone’s guess at this time. Its bipartisan support and its charitable nature probably gives it more of a shot to pass than most bills.

Takeaway from Recent Decision on Florida Attorney Extraordinary Attorney Fees For Ordinary Administrative Work in an Estate [Florida]

In this case, the Personal Representative sought fees for serving as both PR and attorney for the estate - while not totally clear from the opinion, it appears the PR sought those fees using the presumptively correct fee Florida statutory fee schedule schedule.

The PR also engaged outside counsel to assist with some matters. It is the fees for that outside counsel that the court was principally concerned with. The court ended up substantially reducing the fees sought by the outside counsel either outright, or deferring the consideration of some of those fees until later since some of them were too premature for the court to rule on. Some of the conclusions of the court were:

a. Work by the office of the outside attorney to determine addresses of 53 interested persons for purposes of receiving formal notice regarding a determination of beneficiaries and pertaining to the sale of property and determination of homestead did not constitute “extraordinary” services entitling an attorney for compensation. Instead, such work was of the “ordinary” services character. The court did note that proceedings for determination of beneficiaries can be considered extraordinary in appropriate circumstances.

b. Work by outside attorneys to strike a late claim upon failure of a claimant to file an independent action were similarly not “extraordinary” services of the attorneys.

c. Review by outside attorneys of prepared estate income tax return was determined to be duplicative of the Personal Representative’s and CPA’s efforts.

d. Paralegal time of outside attorney’s office relating to preparing addresses and Fed Ex mailers, processing paperwork to the computer, scheduling hearings, coordinating phone conferences, and similar services were found to be administrative and secretarial in nature and not legal services.

e. In regard to the employment by the estate of multiple attorneys, the court noted: “While parties have the right to employ as many lawyers as they choose, the Court will not assess lawyer fees for or against any party for more than one lawyer for a matter in which no more than one lawyer is required. . .As such, duplicative time charges by multiple attorneys working on the case are generally non-compensable and the Court cannot award compensation for various extensive conferences between lawyers without any indication of how those conferences advanced the case. . .. Finally, “excessive time spent on simple ministerial tasks such as reviewing documents or filing notices of appearance” is normally not compensable. . . Nor are duplicative reviews and consultations by numerous attorneys.

It appears that most of the problems here would not be problems as to compensating the PR or the attorney for the estate under ordinary fee arrangements - instead, the delegation of ordinary administrative tasks to another attorney while the PR and estate attorney were charging for ordinary services was a problem.

Note, that this opinion was issued by the Circuit Court, and is not an appellate decision. Thus, its precedential value in other cases may be limited

RE: ESTATE OF GINGER ECKERT ROBERTS, 15th Judicial Circuit in and for Palm Beach County, Probate Division, Case No. 50-2016-CP-004272. January 4, 2018.

IRS Provides Some Relief for Post-Divorce Grantor Trust Rule Issues

During happy days, one spouse (call him or her the “Donor Spouse”) sets up an irrevocable trust for the benefit of the other spouse (call him or her the “Donee Spouse”). Under Code §672(e)(1)(A), a grantor of a trust is treated as holding any power or interest in a trust that is held by an individual who was the spouse of the grantor at the time of the creation of such power or interest. This typically results in grantor trust status for the trust since the Donor Spouse is treated as having retained rights to income and principal in the trust - with the Donor Spouse being taxable on some or all of the trust income.

Fast forward, and the happy couple is not so happy. They divorce, but the trust lives on. Since the testing under Code §672(e)(1)(A) of the spousal relationship that gives rise to the grantor trust status looks to the time of the creation of the trust, not the status in any later tax year, the Donor Spouse continues to be taxable to the Donor Spouse after the divorce. This is typically an unexpected and unwanted surprise to the Donor Spouse.

Previously, Code §682 remedied this circumstance by providing the Donee Spouse would be taxable on the income. Even then, it was not a perfect solution, with some income potentially remaining taxable to the Donor Spouse, such as capital gains.

In the 2017 Tax Act, special rules allowing shift of alimony tax consequences to a payee spouse were repealed. As part of that repeal, Code §682 was removed from the Code. This presents at least two major issues.

First, what happens to trusts that were formed prior to the repeal of Code §682? Notice 2018-37 has answered this question. It indicates that regulations will be issued to provide that former Code §682 will continue to apply to those older trusts, so the Donee Spouses will remain taxable thereunder. However, this applies only to spouses divorced or legally separated under a divorce or separation instrument executed on or before December 31, 2018, unless that instrument is modified after that date and the modification provides that the changes made by the 2017 tax act apply to the modification.

The second major issue is what happens to trusts for spouses whose divorce or separation occurs after December 31, 2018? Without Code §682, Donor Spouses should remain taxable on those trusts under the grantor trust rules because Code §672(e)(1) continues to apply. Ramifications for persons setting up spousal trusts, either during the marriage or providing for them in prenuptial or postnuptial agreements, is to consider these issues and perhaps to come up with a way to terminate the grantor trust treatment to the Donor Spouse upon divorce if that is the desired arrangement. One way perhaps may be to terminate the trust upon divorce - as to who the assets will be payable can be worked out with regard to the other tax and planning consequences to such a termination or having such a termination provision in existence (e.g., provisions relating to the qualification for and termination of QTIP trust status). Another might be to trigger a mandatory reimbursement provision for the taxes to the Donor Spouse from the trust, or other Donee Spouse assets (again, subject to other applicable tax and planning considerations).

The Notice does request comments on whether guidance is needed regarding the continued application of the grantor trust provisions after divorce or separation. Perhaps Treasury is thinking about instituting its own regulatory relief to the application of the grantor trust rules after divorce or separation, but the Notice provides no indication that is on the table.

Notice 2018-37 (4/12/2018)

IRS Guidance Issued on New Interest Stripping Rules

The Tax Cuts and Jobs Act substantially modified the interest stripping rules of Code §163(j). In a recent IRS notice, the IRS provided guidance on some of the provisions of the revised limitation and what new regulations will say. Here are some highlights:

a. The old provision allowed for the carryforward of disallowed interest expense to future years. The notice advises that any disallowed interest expense for the last tax year beginning before 1/1/2018 can be carried over (to be subject to the new provisions in the next year). Such a carryforward does not apply to an “excess limitation carryforward” from such prior year. A similar provision applies to such a carryover in regard to the Code §59A base erosion minimum tax.

b. The new rules allow interest to be deducted to the extent of the taxpayer’s business interest income, plus 30% of adjusted taxable income, plus floor plan financing interest. The notice indicates that any interest paid or accrued by a C corporation on its indebtedness will be business interest income for these purposes. This is based on the premise, noted in the legislative history, that a corporation does not earn investment interest or investment income. This treatment will not apply to S corporations, however. The regulations will also address C corporations that are partners in partnerships paying interest.

c. The notice provides that the new provision applies at the level of a consolidated group, and also that regulations when issued will address other consolidated group issues.

d. The notice provides that the IRS will be issuing regulations to the effect that a disallowance and carryforward of an interest expense deduction under Code §164(j) will not impact the reduction in earnings and profits of a payor C corporation.

e. The notice indicates regulations will be issued regarding the application of Code §163(j) in the partnership scenario.

Notice 2018-28, 2018-16 IRB

Offshore Voluntary Disclosure Program (OVDP) Closing in September

The OVDP commenced in 2009, and provided a mechanism for U.S. taxpayers who had not complied with various non-U.S. information disclosure and tax payments to square up with the IRS without risk of criminal prosecution, but at the cost of fixed penalties, back taxes, and interest. Over 56,000 taxpayers have used one of its programs. With a steady decline in submissions from 18,000 in 2011 to only 600 in 2017, the IRS has determined to close the program on September 28, 2018. Taxpayers who have been on the fence about joining the program will need to do so before that date.

For now, the other special compliance initiatives for the reporting of foreign financial assets remain in place, principally:

a. IRS-Criminal Investigation Voluntary Disclosure Program;
b. Streamlined Filing Compliance Procedures;
c. Delinquent FBAR submission procedures; and
d. Delinquent international information return submission procedures.

IR-2018-52, March 13, 2018

JD Supra Readers Choice Award 2018

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Thank you to those of you that voted for me!

Applicable Federal Rates - April 2018

Key Federal Inflation-Adjusted Amounts for 2018

In Rev.Proc. 2018-18, the IRS has released various tax rates, brackets, and threshold amounts for 2018, incorporating inflation adjustments and the new tax act. Some of the principal figures are as follows:

Alternative Minimum Tax Exemption for Individuals: $109,400 for married individuals filing joint returns and surviving spouses - $70,300 for other unmarried individuals - $24,600 for estates and trusts.

Standard Deduction: $24,000 for married individuals filing joint returns and surviving spouses - $12,000 for unmarried individuals - additional standard deduction for the aged or blind of $1,300.

Election to Expense Certain Depreciable Assets: The aggregate cost of any § 179 property that a taxpayer elects to treat as an expense cannot exceed $1,000,000. The $1,000,000 limitation is reduced (but not below zero) by the amount the cost of § 179 property placed in service during the 2018 taxable year exceeds $2,500,000.

Expatriate Gain Exclusion Amount: $711,000.

Foreign Earned Income Exclusion Amount: $103,900.

Unified Credit Against Estate Tax: $11,180,000.

Notice of Large Gifts Received from Foreign Persons Threshold: $16,076.

Property Exempt from Levy: $4,680.

HSA Contribution for High Deductible Health Plans: $3,450 for individual coverage and $6,850 for family coverage.

State Asset Protection Trusts Take Another Hit

Numerous states have statutes that allow for the creation of self-settled discretionary trusts that are protected from claims of the settlor while allowing the settlor to be a discretionary beneficiary. Such trusts are likely valid for settlors who are residents of the particular state, the property in the trust is located in that state, and no other state has jurisdiction over the parties. While these states seek the trust business of persons outside of their borders seeking these benefits, the validity of these benefits to such person has been an unanswered question.

In a recent Supreme Court of Alaska case (Alaska being one of the states that allow for asset protection trusts), judgment debtors transferred Montana property to an Alaska asset protection trust after judgments were entered against them. The judgment creditors brought an action to void the transfer to the trust as a fraudulent conveyance in Montana applying Montana law, and prevailed. A bankruptcy trustee in a Chapter 7 bankruptcy brought in Alaska also sought to have the transfer voided as a fraudulent transfer in federal court, and prevailed.

The debtors sought to have both of these determinations voided because they should have been heard in Alaska state court. This was based on Alaska law that conferred jurisdiction regarding fraudulent conveyance claims involving Alaska asset protection trusts exclusively to Alaska state courts. The Alaska Supreme Court ultimately ruled:

a. The Full Faith and Credit Clause of the U.S. Constitution does not force states to be bound by another state’s law that exclusive jurisdiction to hear matters based on a cause of action even though that state created the cause of action. The court also noted that a fraudulent transfer action is a “transitory” action so that it may be brought in a court having jurisdiction over the parties without regard to where the transfer took place.

b. The Supremacy Clause of the U.S. Constitution prevents a state from depriving federal courts of their jurisdiction.

The U.S. Constitution has always been a concern regarding the enforceability of the protections of state asset protection trust law when the debtor resides in another state or is exposed to the jurisdiction of another state’s law or courts, but given the relative newness of these statutes there was a dearth of case law resolving whether these concerns would be recognized by courts hearing these cases. This case, along with other similar decisions that are springing up, validate these concerns and cast doubt on the ability of asset protection trust states to offer enforceable protection when the debtors reside outside of the state, have property outside of the state, or are subject to the jurisdiction of courts outside of the asset protection trust state.

Note that these constitutional concerns are not an issue when the trust is situated outside of the U.S. in a non-U.S. asset protection (at least when the assets are situated outside of the U.S).

Toni 1 Trust v. Wacker, 2018 WL 1125033 (Alaska 2018)