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Monday, March 19, 2018

JD Supra Readers Choice Award 2018

I’m happy to announce that I have been issued a JD Supra Readers Choice Award for 2018 for the articles I write for you here. You can read more about the award here.

Thank you to those of you that voted for me!


Applicable Federal Rates - April 2018



Sunday, March 11, 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.

Thursday, March 08, 2018

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)

Friday, February 23, 2018

High Tax Kickout from GILTI Inclusion for CFC's May Be Too Restrictive

The new Tax Act added new Code Section 951A. This provision creates a new class of income of a CFC that is taxed currently to U.S. shareholders. That class is "global intangible low-taxed income" or "GILTI." 

GILTI starts broad - it is all gross income of the CFC, and then is cut back with certain exclusions (and is also reduced by certain deductions and an amount equal to 10% of all depreciable tangible assets). One of those exclusions is for high taxed income per Code §951A(c)(2)(A)(i)(III), which reads:
"any gross income excluded from the foreign base company income (as defined in section 954) and the insurance income (as defined in section 953) of such corporation by reason of section 954(b)(4)."
Code §954(b)(4) is an exception from Subpart F income for foreign base income and insurance income that is highly taxed by a foreign jurisdiction. It reads:
 "For purposes of subsection (a) and section 953, foreign base company income and insurance income shall not include any item of income received by a controlled foreign corporation if the taxpayer establishes to the satisfaction of the Secretary that such income was subject to an effective rate of income tax imposed by a foreign country greater than 90 percent of the maximum rate of tax specified in section 11."
So here is the question - does the high tax kickout from GILTI include all of the CFC's income that is subject to a high foreign tax, or is it limited to removing from GILTI only foreign base company income and insurance income that would otherwise be included as Subpart F income (but for being highly taxed)?

Tracking the above provisions, the better interpretation appears to be that the high tax kickout from GILTI only covers income that comes within the definitions of foreign base company income and insurance income.

This borders on the nonsensical, and leaves one wondering whether this is a technical error by Congress that is in need of correction. Why should income that is NOT foreign base company income or insurance income lose out on being excluded from current taxation, when income that is far closer to disfavored Subpart F character obtains the exclusion? If there is a policy reason for this, it is pretty obscure. This suggests that the exclusion of non-FBCI and non-insurance income is an error and not an intended effect. This is belied by the committee reports which do not acknowledge that there should be a distinction based on classes of income along these lines. Further, the pass-through taxation of highly taxed income is adverse to the title of the label for the income that is subjected to pass through treatment - i.e., "globably intangible low-taxed income." 

Here is my proposed statutory fix - modify Code §951A(c)(2)(A)(i)(III) to instead read: "any gross income that would be excluded from the foreign base company income (as defined in section 954) and the insurance income (as defined in section 953) of such corporation by reason of section 954(b)(4) regardless of whether that gross income actually is foreign base company income or insurance income."

Hopefully, this will be brought to the attention of Congress and dealt with in a technical correctons bill. 

Good News on Florida Homestead Protections

I had previously written that as part of the 20 year revision process, a proposal to reduce Florida's constitutional homestead protection against claims for creditors was advancing. That posting can be read here.

The good news (if you are in favor of vigorous homestead protections - not so good news if you are opposed to them) is that this provision was voted down before a subcommittee of the Constitution Review Commission and is now a dead item. The deadline for new items has not yet expired so another or a revised proposal could surface, so the door is not yet fully closed, however.

Sunday, February 18, 2018

Updated Historical Federal Transfer Tax Rates, Exemptions, and Related Information Table

I have updated this table to include 2018 data based on inflation adjustments and changes in the 2017 Tax Act. The $11,180,000 exemption and exemption equivalent amounts for estate, gift and GST tax are not yet out, so estimates are used - final figures usually match these estimates but if the estimates are off, they shouldn’t be off by much. I will update the table to show the final values when they come out.

You can download the table here, and you can also access it any time from the link in the right-hand column under LINKS AND RESOURCES.

Sunday, February 11, 2018

No Homestead Treatment for Property Owned by a Corporation [Florida]

In a recent case, residential property was owned by a corporation. The sole shareholder and president of the corporation resided on the property, and the corporation had attempted to convey the residence to the shareholder, but its deed was effective and ineffective. In attempting to fend off a creditor, it was argued that the property qualified as homestead property and was thus beyond the reach of creditors, and the trial court agreed.

Article X, section 4 of the Florida Constitution, which provides protection against forced sale for homestead property, reads in relevant part:

There shall be exempt from forced sale under process of any court, and no judgment, decree or execution shall be a lien thereon, except for the payment of taxes and assessments thereon, obligations contracted for the purchase, improvement or repair thereof, or obligations contracted for house, field or other labor performed on the realty, the following property owned by a natural person. . . (emphasis added).

Since a corporation is not a natural person, that would seem to be the end of the argument that the property was homestead property. However, in Callava v. Feinberg, 864 So.2d 429, 431 (3rd DCA 2004), and other cases similar to it, property owned by a trust qualified as homestead property. Since a trust is not a natural person, why should ownership be a corporation be treated differently than a trust for this purpose?

In reversing the trial court, the 2nd DCA noted the crucial difference. In Callava, an individual beneficiary of the trust was found to hold an equitable interest in the subject property. Legal ownership was in the trust. Equitable ownership in a natural person is sufficient for these purposes – legal ownership is not required.

The problem for the shareholder in the instant case is that the shareholder had neither legal nor equitable/beneficial ownership, and thus the property did not qualify for homestead protection.

DeJesus v. A.M.J.R.K., 43 Fla. L. Weekly D331a (2nd DCA 2018).

Saturday, February 03, 2018

When a Nightclub is Not a Business

Under Code §183(b), a taxpayer’s activity that is not engaged in for profit gives rise to deductions only to the extent of income. No excess deductions arise that can be used to offset other income, and no net operating losses are produced.

Joy Ford, a country music recording artist and promoter, owned and operating the Bell Cove Club, a lakeside music venue in Hendersonville, Tennessee. The club featured live country music on Friday and Saturday nights. Joy devoted most of her time to the club and paid all of its expenses. The club charged a $5 admission fee and a nominal amount for snacks and beverages.

The club operated at a loss, reporting losses in 2012-14 of $39,285, $74,120, and $96,893. Joy used the losses to offset other income she had. The club’s recordkeeping was atrocious and didn’t match up to the tax filings. Joy had opportunities to make the club profitable, including a possible television show and converting it into a restaurant. Joy declined these opportunities.

Upon review, the Tax Court concluded that the club was not engaged in for profit, and applied Code §183(b) to eliminate Joy’s use of the losses against other income. Key factors cited by the court were that Joy had no expertise in club ownership, maintained inadequate records, disregarded expert business advice, nonchalantly accepted Bell Cove's perpetual losses, and made no attempt to reduce expenses, increase revenue, or improve Bell Cove's overall performance.

Why was Joy operating this way? Owning Bell Cove elevated her status in the country music community, allowed her to further the careers of young performers, offered her weekly opportunities to interact with country music fans, and satiated her love for promoting country music. She earnestly devoted time and energy to Bell Cove but was primarily motivated by personal pleasure, not profit.

One would think that a night club would always qualify as a business for these purposes, but there you go. The lesson here is that what looks like a business, smells like a business, and in many ways operates like a business, may not be one for purposes of the Code §183(b) limitations.

Joy Ford, TC Memo 2018-8

Sunday, January 28, 2018

The U.S. Will Now Bar Tax Delinquents from Travelling Abroad

I wrote back in 2015 here about new legislation that gave power to the Secretary of State to deny, revoke or limit the passport of persons with delinquent taxes. Code §7345 provides that the Commissioner of the IRS will provide notice to the Secretary of the Treasury, who will then transmit that notice to the Secretary of State, in regard to a taxpayer’s delinquent tax debt. Generally, it applies to delinquent tax debt over $50,000 (adjusted for inflation), for which a notice of lien has been filed or a levy has been made. Upon receipt of a Code §7345 certification, §32101(e) of the 2015 FAST Act provides that the State Department will generally deny an application for issuance or renewal of a passport from such individual, and may revoke or limit a passport previously issued to such individual.

In Notice 2018-01, the Treasury Department announced that the IRS and the State Department will begin implementing these provisions in January, 2018. The Notice provides information about the implementation of the rules.

The National Taxpayer Advocate in its annual report to Congress noted the right to travel internationally is a fundamental right of citizenship. Many civil libertarians would assert that the right to travel is more than this - it is a natural right of individuals that is not bestowed by governments, and should be restricted only for security purposes (including immigration and criminal enforcement). Restricting a fundamental and natural human right for the enforcement of civil debt obligations is a new chapter in U.S. tax law, and one that can be expected to give rise to constitutional challenges.

Notice 2018-01, Revocation, Limitation or Denial of Passport in Case of Certain Tax Delinquencies

Monday, January 15, 2018

Obscure Provision of New Tax Act Complicates Testamentary Tax Planning for Nonresidents with U.S. Beneficiaries

Nonresidents with a significant portfolio of U.S. stocks typically use a non-U.S. corporation to hold their portfolio. This is because U.S. stocks are generally subject to U.S. estate taxes at the death of their owner, and absent treaty relief a nonresident owner can only exempt $60,000 in assets from U.S. estate taxes. Since stock of a non-U.S. corporation is not a U.S. situs asset for estate tax purposes, assets held in the corporation, such as U.S. stocks, avoid U.S. estate taxation.

If the nonresident owner has U.S. individual heirs who will succeed to the stocks, the transfer of the shares of stock of the foreign corporation at death can create unpleasant tax consequences for the new U.S. shareholders. If they will own a majority of the shares, in most circumstances the foreign corporation will become a controlled foreign corporation (CFC) for U.S. income tax purposes. This will result in the 10% or more U.S. shareholders becoming taxable on the investment income of the company, including capital gains, on a flow-through basis and at ordinary income rates by reason of such income being characterized as foreign personal holding company income (FPHCI). The U.S. shareholders will also suffer some level of double taxation as to U.S. withholding taxes imposed on the foreign corporation (e.g., on its U.S. source income and dividends), and on any non-U.S. withholding and other taxes - no full U.S. tax credit arises and the individual shareholders only receive in effect a deduction for such taxes. Municipal bond interest also becomes taxable to the U.S. shareholders under the CFC rules.

Until now, these problems were easily resolved by liquidating the foreign corporation within 30 days of the death of the foreign stockholder. If the U.S. shareholders received a stepped-up basis in their shares (which is usually the case, subject to some questions when there is an intervening trust), the liquidation generally would have no adverse U.S. income tax consequences to them. This is because the foreign corporation would not become a CFC if the U.S. shareholders did not own it for 30 days. This could be accomplished either by an actual liquidation within the first 30 days after the death of the stockholder, or a check-the-box election (if the company was eligible) with an effective date within that period. Since a check-the-box election can be retroactive up to 75 days, this effectively provided a 105 day window to take care of things.

The problem today is that the new Act repeals the 30 day window, thus resulting in CFC status immediately as of death of the stockholder. Thus, a liquidation or check-the-box election effective within the first 30 days is taxed as a CFC liquidation, which is not nearly as painless as a non-CFC liquidation. Note that making a check-the-box election with an effective date PRIOR to death of the shareholder may resolve the liquidation problem, but will likely void the estate tax insulation of the foreign corporate ownership of the securities.

What's the problem with liquidating the CFC? Under Code §336, the CFC is treated as having sold its assets on liquidation for their value. If the stocks are appreciated in value, and assuming this results in overall net gain, that gain is treated as FPHCI which flows through to the U.S. shareholders and is taxable to them as ordinary income. The U.S. shareholders do get a basis step-up under Code §961 for this income, and they also likely received a basis step-up at death of the stockholder - this will typically result in a capital loss to the U.S. shareholders equal to the FPHCI they realized on the liquidation. Since the capital loss cannot offset the ordinary income treatment of the FPHCI (beyond $3,000), the loss is of not much help as to the FPHCI, resulting in the burdensome taxation of the passed-through ordinary income.

Thus, the removal of the 30 day exempt period in the new Act makes things difficult for nonresidents with U.S. heirs and their planners who sought to avoid the negative CFC implications of the foreign holding company structure.

The problem is not insurmountable - there are ways to deal with it.

One way is via churning. This involves regular and periodic sale and repurchase of the appreciated stock by the foreign corporation during the lifetime of the nonresident stockholder. Such sales and repurchases will increase the income tax basis of the stocks on a regular basis. In most circumstances any gain from such sales is not subject to U.S. income tax absent the involvement of real property holding companies. It does require some diligence to keep current on the churning, however. Further, if the U.S. stock is not publicly traded, then the sale and repurchase can be more difficult. The step transaction doctrine and attempts by the IRS to disregard the churning are always an issue. Note that this is not a "new" technique - many practitioners in the past have been leery of their clients taking immediate action upon death of the stockholder within the 30 day/105 day windows discussed above, so churning was recommended to avoid the need for such immediate action.

An alternative method to deal with the issue would be to domesticate the foreign corporation post-death, make a Subchapter S election to avoid double tax on the appreciation, and wait out the 5 year built-in gains period. This is a possible approach, but clients may be uncomfortable with having to hold the stock for the five year period.

Another approach involves having the foreign holding company owned in turn by two foreign corporation holding companies, with the nonresident owner being the shareholder of those companies. A check-the-box election is made after death, retroactive to prior to death, for the foreign subsidiary holding the U.S. stock. On the deemed predeath liquidation, a deemed sale occurs of the U.S. stock, but since it occurred prior to death there is no CFC or FPHCI flowing through to U.S. shareholders - but a basis step-up still occurs by reason of the liquidation. The two intermediate holding companies then liquidate after death - while they are CFC's, there is no gain on the U.S. stocks they received from the liquidating subsidiary and thus no FPHCI (except perhaps on appreciation occurring after the deemed liquidation date of the subsidiary foreign corporation). This still requires diligent action near the time of death, and issues of tax relevancy of the check-the-box election may apply.

Of course, there are alternate methods of planning for the U.S. securities, such as the use of an irrevocable trust to own the U.S. stocks, dual partnership structures, and tiered foreign corporate structures that can do a post-death check-the-box election retroactive to predeath to enter into a dual partnership structure.

Non-U.S. situs appreciated assets held through a foreign corporation can result in similar problems for the U.S. heirs. However, if those are segregated into their own foreign corporation, a pre-death effective check-the-box election can be conducted to eliminate the taxable gain. This can be done for the non-U.S. situs assets since they will not be subject to U.S. estate taxes even if deemed owned by the nonresident shareholder directly at the time of death.

These problems and resolutions may also apply to other U.S. situs assets other than stock of U.S. corporations. However, U.S. real property interests (including stock of U.S. real property holding companies) are more problematic given that capital gains from disposition are nonetheless subject to U.S. income tax under Code §897.

Giving Credit it Where it is Due Department: As to the dual corporate holding structure described above, to Seth Entin's presentation at the recent Florida Bar International Tax Conference.

Sunday, January 07, 2018

The Stealthy Tax Increase in the Tax Cuts and Jobs Act of 2017

Ever since the Reagan Administrative, tax brackets have been indexed for inflation. This avoids bracket creep when taxpayers move into a higher tax bracket because inflation pushes up their income. The thinking is that inflation increases are not real increases in earnings, so the rate tables should be indexed to avoid tax increases arising solely from inflation. This seems like less of an issue today with relatively tame inflation rates, but remember that inflation went into the teens in some years in the1970’s making bracket creep a big issue.

The new Act changes rate indexing and other Code indexing from the former Consumer Price Index (CPI) to a new creation known as “chained CPI.” Chained CPI is an adjustment to CPI that reduces the inflation rate by attempting to factor in human behavior that when prices rise, some consumers will look for less expensive substitute products, so that the overall inflation is lower than it would first appear when measured by actual spending.

So was chained CPI brought in due to a desire by Congress to more accurately measure inflation? Doubtful. By reducing the inflation rate for tax purposes to what may be less than the actual rate, bracket creep will now increase faster for taxpayers. This will increase taxes, and is thus a hidden revenue raiser. The differences between the two rates are not that significant, but will add up over time. See this table for how the cumulative spread increases over time:

[source: BloombergPolitics]

I have seen estimates that the effective tax increase next year will be $800 million, and is estimated to be $31.5 billion by 2027. Bracket creep tends to burden lower income taxpayers more than higher income taxpayers, because the brackets are smaller and thus will trigger more increases on the low end - further, for taxpayers already at the highest rate there is no higher bracket to creep into.

The wealthy will still be impacted as the unified credit exemption from transfer taxes is now coming under chained CPI adjustments. This means slower increases in such exemptions and thus more potential transfer taxes.

It is interesting that chained CPI was brought in by the Republicans and in a tax cut bill. I assume it was included to help the budget numbers work.

Note that Pres. Obama tried to bring chained CPI to social security increases during his administration which would have the effect of reducing social security payouts, but was beat down by Democrats. Don’t be surprised if we see that before Congress again in the near future.