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Saturday, July 06, 2019

Update: Appellate Court Upholds Denial of Charitable Deduction for Reporting Omission

Back in 2017, I discussed the case of Reri Holdings I, LLC here. There, the Tax Court denied a charitable deduction of over $33 million since the taxpayer did not include the adjusted basis information for the property in its Form 8283 filing. The Tax Court concluded that the substantial compliance doctrine could not be used by the taxpayer to salvage the deduction since the reporting of the basis, while not directly relevant to a charitable deduction, would have assisted the IRS in evaluating the contribution without an audit since a large disparity between basis and the value of the deduction would alert the IRS to potential issues.

The case was affirmed by the D.C. Court of Appeals in May of this year.

RERI Holdings I, LLC, 149 TC 1 (2017), aff’d, D.C. Court of Appeals, No. 17-1266 (May 24, 2019)

Employers Can Truncate Employee Social Security Numbers on Forms W-2

In an effort to reduce identity theft, the IRS has issued final regulations that permit employers to truncate the social security numbers of employees on Forms W-2. Thus, the employer can elect to report the number in the format of XXX-XX-1234 or ***-**-1234 instead of providing the whole number. It is not a mandatory provision – the employer can choose to do it if it wants.

Full taxpayer identification numbers are still required on the copies of the Forms W-2 that are filed with the Social Security Administration, and on those of payers of third-party sick pay to employers.

The regulations are effective for items filed or furnished after December 31, 2020.

TD 9861

Sunday, June 30, 2019

Good News/Bad News on GILTI Exclusion for Highly Taxed Income

I noted in my February 23, 2018 posting that the taxation of GILTI under Code §951A does not apply to foreign base company income and insurance income that is excluded from Subpart F by reason of being highly taxed by a foreign country. The way the statute was drafted, income that was NOT foreign base company income or insurance income, but otherwise would be GILTI and subject to pass-through tax, could NOT use the high tax kickout to avoid tax. I noted that this appeared to me to be a statutory glitch and was inconsistent with the policy of allowing a high tax kickout and the overall purpose of the GILTI provisions.

Others have brought this issue to the attention of Treasury in regard to comments to the GILTI proposed regulations. The bad news is that while Treasury did take those comments under consideration, in enacting final regulations it declined to extend the high tax kickout to income other than foreign base company income and insurance income under Subpart F. See Treasury Decision 9866 (6/19/2019).

The good news is that Treasury also released a proposed regulation that allows a CFC to make an election to have gross income items qualify for exclusion from GILTI if such income is subject to foreign income taxes at an effective rate that is greater than 90% of the §11 maximum tax rate. Prop. Treas. Regs.§1.951A-2(c)(6). While not entirely clear from the language of the proposed regulation (at least to me), the Preamble to the proposed regulation confirms this intent:

For the foregoing reasons, the proposed regulations provide that an election may be made for a CFC to exclude under section 954(b)(4), and thus to exclude from gross tested income, gross income subject to foreign income tax at an effective rate that is greater than 90 percent of the rate that would apply if the income were subject to the maximum rate of tax specified in section 11 (18.9 percent based on the current rate of 21 percent). See proposed §1.951A-2(c)(6)(i). . .If an election is made with respect to a CFC, the election applies to exclude from gross tested income all the CFC's items of income for the taxable year that meet the effective rate test in proposed § 1.951A-2(c)(6)(iii). Preamble to Prop Regs., Fed. Reg. Vol. 84, No. 120 at p. 29114 [REG-101828-19]. 

Back to some bad news. The proposed regulations “are proposed to apply to taxable years of foreign corporations beginning on or after the date that final regulations are published in the Federal Register, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end.” Preamble to Prop Regs. If there is any doubt as to not being able to use the proposed regulations before they are finalized, the Preamble to the final and temporary regulations provides: “until the regulations described in the separate notice of proposed rulemaking are effective, a taxpayer may not exclude any item of income from gross tested income under section 951A(c)(2)(A)(i)(III) unless the income would be FBCI or insurance income but for the application of section 954(b)(4) and § 1.954-1(d).

Sunday, June 23, 2019

Due Process Limitations Apply to Limit State Tax of Trust Beneficiaries

States with income taxes have varying rules on when they assert authority to tax income of trusts, based on combinations of contacts with their state of settlors, trustees, beneficiaries, assets, and management activities. In one of the more aggressive assertions of authority to tax, several states assert that they can tax the income of a trust merely because a beneficiary resides in the state. In a challenge to North Carolina’s scheme, the U.S. Supreme Court ruled that the presence of in-state beneficiaries alone does not empower a state to tax undistributed trust income when the beneficiaries have no right to demand that income and are uncertain to receive it.

In the case, the settlor formed a trust for his children in his home state of New York. The trustee of the trust was a New York resident. Trust documents and records were kept in New York, and the asset custodians were in Massachusetts.The trust granted the trustee absolute discretion to distribute assets to the beneficiaries. One of the children moved to North Carolina, and North Carolina sought to tax all the income of a subtrust because that child was a North Carolina resident. The child had no right to, and did not receive, any distributions from the trust.

The Court based its decision on the requirements of the Due Process Clause of the U.S. Constitution, which limits states to imposing only taxes that bear fiscal relation to protection, opportunities and benefits given by the state. Some definite link, some minimum connection, is required so that the income attributed to the state for tax purposes be rationally related to values connected with the taxing state. Applied to beneficiaries, this results in taxation turning on the extent of the in-state beneficiary’s right to control, possess, enjoy, or receive trust assets.

A key aspect was that the beneficiary could not count on necessarily receiving any specific amount of the income in the future. The Court noted that the assets of the trust could end up with others, and that the beneficiary had no power to assign her interest.

Some preliminary thoughts/observations:

     a. The use of a purely discretionary trust to avoid state income tax when a beneficiary resides in a state with an income tax is a valid planning mechanism, so long as no other ties and connections with the taxing state exist. It would appear that a spendthrift clause that prevents a beneficiary from assigning his or her beneficial interest is a necessary aspect of such planning. Of course, such planning has real world consequences, such as limited access to, and rights over, trust assets by the beneficiary.

     b. Would a power of appointment over trust assets in a discretionary trust by the in-state beneficiary give rise to taxing jurisdiction? This was not discussed in the case. If presently exercisable in the subject tax year, then probably yes. If not presently exercisable, maybe not.

     c. Would a right to receive all or a share of trust assets at a given future age give the requisite taxing nexus for an in-state beneficiary? This fact was present in the case. However, in the case there were facts that made this future right contingent which appear to have influenced the court, such as the ability for the trust to be re-written to exclude such a right under decanting provisions of law (which power was actually exercised after the tax years in issue) and that the trustee could exclude one beneficiary to the benefit of another.

     d. The Court noted that tests of nexus are different as to rights of settlors, trustees and beneficiaries. For example, prior precedent confirms that a resident trustee is enough nexus for state income tax, as well as residence of a settlor (at least where the settlor retains rights over the trust assets, such as a power of revocation). I believe there is at least one state that asserts continuing taxing jurisdiction over a trust with no contacts with the state other than the settlor was a resident of the trust at creation – perhaps a challenge to that nexus authority may be forthcoming based on the principles elucidated in this case.

     e. For practitioners in states without a state income tax on individuals, the case is still relevant, since in preparing or advising on a trust in your state you should still be planning for the circumstance of beneficiaries who reside in other states.

NORTH CAROLINA DEPT. OF REVENUE v. KIMBERLEY RICE KAESTNER 1992 FAMILY TRUST (U.S. Supreme Court 2019)

Tuesday, June 18, 2019

Limits on Effects of Order Determining Homestead on Title [Florida]

A recent appellate decision addresses the effect of an order determining homestead vis-à-vis title to the homestead. In the case, a decedent left her homestead by will to her three children. The will also provided a life estate in the property to two of the children. The probate court entered an order determining homestead, which determined that the homestead property was divided in equal shares to the children, but did not mention the life estate provided for in the will. The trial court determined the order determining homestead divested the life tenants from their life estate per the absence of any mention of the life estate (thus allowing partition of the property to proceed on petition of two of the children). Florida’s 5th DCA reversed the trial court, and held that the order determining homestead did not terminate the life estate provided for in the decedent’s will.[1] The appellate court noted that the homestead order did not create new rights, but only explained or clarified the rights that already existed by operation of law.

The appellate court rejected arguments that the children’s consents to the homestead order altered the parties’ individual interests in the estate. It also ruled that the order was not a title transaction within the meaning of Fla.Stats. §712.01(3) noting:

the Homestead Order in this case does not constitute a title transaction, as defined by section 712.01(3), Florida Statutes (2011), extinguishing the life estates in the property. ‘A title transaction within the meaning of this act is defined in section 712.01(3), Florida Statutes, and means any recorded instrument or court proceeding which affects title to any estate or interest in land and which describes the land affected with legal sufficiency.’ Cunningham v. Haley, 501 So. 2d 649, 652 (Fla. 5th DCA 1986). Although the probate and recording of a will constitutes a title transaction within the meaning of section 712.01(3), see Mayo v. Owens, 367 So. 2d 1054, 1057 (Fla. 1st DCA 1979); Kittrell v. Clark, 363 So. 2d 373 (Fla. 1st DCA 1978), Kenneth and Carla point to no authority holding or suggesting that an order determining homestead property constitutes the same.

Mullins v. Mullins, No. 5D18-1672, 2019 WL 2396753, at *4 (Fla. Dist. Ct. App. June 7, 2019)noting

Sunday, June 09, 2019

Electronic Notarization Comes Alive in Florida, and Electronic Notarization and Witnessing of Wills and Trusts Comes Along for the Ride [Florida]

A 78 page bill on the subject of electronic and remote notarization and witnessing of documents was approved by the governor two days ago. Here is some info to start to get you up to speed.

General Provisions:

  • In addition to the statute, the Florida Department of State will adopt rules that online notaries will need to follow.
  • Online notarization is conducted through and requires audio-video communication technology.
  • Notarial certificates should indicate whether they are notarizing in person or online. Sample certificates are in the new statute.
  • The online notary must confirm the identify of the principal, either by personal knowledge or all of the following: remote presentation of identification, credential analysis of identification provided, and identity proofing based on knowledge-based authentication or similar method. Credential analysis involves a third party aiding the notary in affirming the validity of government-issued identification credentials. Identify proofing involves a a third party affirming the identity of an individual through use of public or proprietary data sources, including knowledge-based authentication (question and answer systems) or biometric verification.
  • Errors and omissions insurance is required by the notary, his or her employer, or a remote online notarization (RON) service provider.
  • A notary can notarize even if the principal or any witnesses are located outside of Florida.
  • A notary can serve as an online notary only after taking a course of study.
  • A notary will need to work with a RON services provider to use their communication technology and processes for credential analysis and identity proofing.
  • A notary will need to provide a $25,000 bond.
  • A notary will have to keep an electronic journal of online notarizations, and keep them secured and backed up. The record will have to record various information about the notarization.
  • The notary will have to retain an copy of the recording of the audio-video communication relating to the notarization.
  • The notary may not charge more than $25. It may also charge for copies provided of electronic records, subject to caps and restrictions.
  • The notary can also supervise the witnessing of documents online in a similar manner to notarizing the signature of the principal signor. The witness need not be in the physical presence of the signor or notary. A remote witness must be a resident of and physically located within the U.S. or a territory of the U.S., presumably to make them available to court proceedings if necessary.

Special provisions for wills, trusts with testamentary aspects, health care advance directives, waivers of spousal rights, or powers of attorney authorizing certain types of acts:

  • The notary must ask certain questions of the principal signor relating to impairment or disability if the witnesses are not in the physical presence of the principal signor. If they are not properly answered, then remote witnessing is ineffective.
  • If the principal signor is a “vulnerable adult” as defined in Fla.Stats. §415.102, the witnesses must be in the presence of the principal signor. If they are not, the witnessing is invalid.
  • If witnesses are not in the physical presence of the signor, then additional questions are asked of the principal signor for thelvideo/audio record are undertaken by the notary.
  • An electronic will or codicil is revoked by deleting or obliterating an electronic record, with the intent to revoke, as provided by clear and convincing evidence.
  • Remote witnessing requires that the witness hear the signer acknowledging the signer’s signature.
  • Self-proof affidavits for wills can be electronically witnessed and notarized, if the electronic record that contains the will is held by a qualified custodian at all times before being offered to probate.
  • The electronic will can be admitted to probate if filed through the e-filing portal, and is deemed to be an original of the electronic will. A paper copy of an electronic will which is certified by a notary public to be a true and correct copy can also be admitted to probate as an original will.

Some preliminary thoughts/questions of mine:

  • How much will RON service providers charge?
  • How many notaries will go through the hassle of qualifying to be an online notary and meeting all the requirements for qualification and online notarizations (including the storage and delivery of recordings and the electronic documents that are notarized) – or will such services end up being provided almost exclusively by companies engaged in the business of providing online notarization? The Act has 70+ pages of rules and requirements, and of course more will be coming by regulation.
  • What happens when electronic records are inadvertently destroyed or are not available? Of course, paper records can suffer the same fate – but think about ransomware and other electronic hacking that the has the potential to void and destroy hundreds of thousands of electronic documents at one time.
  • If remote witnessing is not available for a will or similar document (e.g., the signor is a vulnerable adult), testators and signors of such documents may think they have a valid document when they in fact do not.

Good thing? Bad thing? Probably both, but it doesn’t really matter since it is now the law of the land (subject to a delayed effective date). The old way of doing things is still valid – it remains to be seen how widespread the use of electronic notarization and witnessing (and how widespread any resulting fraud and other problems)  will be. My gut instinct is that taking a process that is fairly straightforward (notarization) and subjecting it to a multitude of rules, regulations, costs, and new business interests suggests that perhaps the old ways may be the better way, especially as to testamentary documents.

The foregoing is based on a preliminary read of the new law only. There will be a lot of real ink and electronic ink spilled on this subject for sure. Let the articles, seminars, books, and litigation commence!

Read the new law here.

Monday, May 27, 2019

This is Just Plain Wrong

Alva and Alberta Pilliod recently were awarded $2 billion in punitive damages from Monsanto, related to claims of cancer from using Roundup weed killer. Unfortunately, the big winners here are not the Pilliods, but the U.S., the State of California, and their attorneys, due to changes in the deductibility of legal fees in the 2017 Tax Act.

The big change was the elimination of miscellaneous itemized deductions through 2025, even for those taxpayers that itemize their deductions. Attorney’s fees generally are miscellaneous itemized deductions, so taxpayers that obtain a judgment and pay their attorneys from the judgment cannot deduct those fees.

So let’s review the math for the Pilliods (let’s assume the judgment remains the same after appeals and is paid). They have $2 billion of income from the judgment. With maximum federal tax rates of 37% and California income taxes of 13.3%, and with no deduction for the attorney’s fees and costs they pay, their combined income taxes should be around $1 billion. Their is speculation that their attorney’s fees and costs could total $1 billion. Net left for the Pilliods: $0.

Their attorneys will be taxed on the fee portion of what they receive. If we assume $200,000 in costs, the attorney’s fees will be $800,000. Since we don’t know where they live or what type of entities they practice in, we don’t know their tax bill. But let’s assume 50% - their after-tax receipts are $400,000.

Totals for the tax authorities under this scenario is $1.4 billion.

SOMETHING IS VERY WRONG WITH THIS RESULT, OBVIOUSLY.

When an income tax rises to 100% due to the disallowance of costs to obtain the income, does it cease to be an income tax? And what about the effective double taxation of the attorney’s fees - both the plaintiff and the attorneys are effectively taxed on the same payment?

As these results filter out in the world, it is going to impact the economics of litigation, and may work to the benefit of defendants where the financial incentives to plaintiffs are substantially diminished.

The Pilliods problems are exacerbated by living in a state with high income taxes, such as California, so residents of other states might be able to pocket more from such recoveries. The Pilliods were awarded an additional $55 million in compensatory damages. If qualifying as damages for physical injuries, the $55 million is not subject to income tax. After paying their lawyers, they would end up with $27.5 million. However, the physical injury exception will not be available to plaintiffs in lawsuits where the award is not for physical injury.

Note that there are some exceptions to nondeductibility. Costs involving discrimination suits and attorney’s fees relating to whistleblower awards are above-the-line deductions that were not chopped by the 2017 Tax Act. The same applies to recoveries relating to a taxpayer’s trade or business (other than sexual harassment and abuse cases where there is a nondisclosure agreement). Also, attorney’s fees that are court awarded or statutory are not included in income.

Taxes Slash $2 Billion Roundup Weedkiller Verdit to $27.5 Million, Forbes.com (May 14, 2019)


Thursday, May 23, 2019

Documentary Stamp Tax Newlywed Exception Now Applies to All Married Persons [Florida]

Generally, transfers of real property in Florida are subject to documentary stamp taxes based on the consideration paid. If the real property is subject to a mortgage when transferred, the unpaid balance of the mortgage is counted as consideration for this purpose.

There is no general exception to this rule for transfers between spouses. However, Fla.Stats. §201.02(7)(b) does provide that no documentary stamp taxes will apply to a transfer of homestead property between spouses (a) if the only consideration is the mortgage debt, and (b) the deed or other instrument of transfer is recorded within 1 year of the marriage. Many questioned why this exception was limited to newlyweds.

Effective July 1, 2019, requirement (b) above no longer will apply, per Florida House Bill No. 7123 which has been enacted into law. Thus, spouses can transfer homestead property between themselves, even if encumbered by a mortgage, without documentary stamp taxes – so long as there is no other consideration for the transfer other than the mortgage.

Sunday, May 05, 2019

Economic Substance Requirements and Tax Haven Jurisdictions

Not receiving much attention are new economic substance requirements that have recently been enacted in several tax haven jurisdictions, including the Cayman Islands, Bermuda, and the British Virgin Islands.

Tax planning structures often involve the use of corporations and other entities formed in tax haven jurisdictions. To give one example, tax haven companies are often used as blocker holding companies to insulate foreign persons from U.S. estate taxes on their U.S. assets. These new economic substance requirements threaten to complicate such planning structures.

The new requirements are an outgrowth of pressure from the EU and OECD to limit the use of tax haven companies for tax planning and base erosion purposes, especially where the companies have little or no activity, assets, or staff in the subject jurisdiction. When applicable, such companies will require adequate local premises, employees, activities, income, and expenses. Companies that do not comply are subject to civil penalties in the hundreds of thousands of dollars, criminal penalties if not properly reported, and being struck-off the register as a company in good standing. Thus, applicable companies will have to increase their local activities (and concomitant costs) to be compliant – many times this may not be practical or cost-effective.

Companies will be subject to these rules if they engage in “relevant activities.” These typically include banking, insurance, shipping, fund management, finance/leasing, holding company activities, IP holding activities, and service center or distribution center activities. The scope of what is required to comply may be reduced for pure equity holding companies, so this may allow continued use of pure holding companies, but it remains to be seen exactly how those reduced requirements will play out.

Companies already situated in these jurisdictions should review the application of these new rules to them – the use of companies in the future should include a review of the impact of these rules on their circumstances.

Sunday, April 28, 2019

Does a Disclaimer of Real Property Require a Legal Description in Florida?

In a recent case, a disclaimant signed a disclaimer that purported to include real property owned by a decedent, but did not provide a legal description for the real property. After entering into the disclaimer, the disclaimant apparently had a change of heart and desired to retain the disclaimed real property, claiming the disclaimer was invalid.

Here are the key statutory provisions (emphasis added):

Fla.Stats. §739.104(3): “To be effective, a disclaimer must be in writing, declare the writing as a disclaimer, describe the interest or power disclaimed, and be signed by the person making the disclaimer and witnessed and acknowledged in the manner provided for deeds of real estate to be recorded in this state. In addition, for a disclaimer to be effective, an original of the disclaimer must be delivered or filed in the manner provided in s. 739.301.”

Fla.Stats. §739.601:

     “(1) A disclaimer of an interest in or relating to real estate does not provide constructive notice to all persons unless the disclaimer contains a legal description of the real estate to which the disclaimer relates and unless the disclaimer is filed for recording in the office of the clerk of the court in the county or counties where the real estate is located.

      (2) An effective disclaimer meeting the requirements of subsection (1) constitutes constructive notice to all persons from the time of filing. Failure to record the disclaimer does not affect its validity as between the disclaimant and persons to whom the property interest or power passes by reason of the disclaimer.

As noted, Fla.Stats. §739.104(3) does not require a legal description. Fla.Stats. §739.601 does require it. The trial court held that the disclaimer was ineffective without a legal description.

Reversing the trial court, the 3rd DCA determined that a legal description is required for constructive notice purposes only via recording. As between the disclaimant and the persons who would receive the real property if there is a valid disclaimer, a legal description for real property is NOT required to enforce the disclaimer.

As an aside, the disclaimer was also rejected by the trial court as failing to meet the writing requirements of the statute of frauds. The appellate court noted that the disclaimer was in writing and signed by the disclaimant, and thus the statute of frauds was met.

Lee v. Lee, 44 Fla.L.Weekly D284 (3rd DCA 2019)

Friday, April 12, 2019

NFL Draft Day and Federal Income Tax

Two concepts that you don’t often see together!

While only of direct interest to a few taxpayers, a Revenue Procedure addressing draft picks and player contracts issued this week does make for interesting reading.

Tax professionals know that the sale or exchange of property gives rise to taxable gain or loss if the amount received is more or less than the taxpayer’s basis in the property, absent the application of a nonrecognition provision of the Internal Revenue Code. Player contracts and draft picks are property. Therefore, when they are exchanged or traded between teams, gain or loss can result. Gain is the excess of the amount realized from the exchange over the tax basis of the property given up. Loss occurs if the amount realized is less than the basis.

In Revenue Procedure 2019-18, the IRS has provided a safe harbor for professional sports teams to avoid gain on such trades. It provides that teams can assign a zero value to player contracts and draft picks. Thus, a team receiving a contract or draft pick has an amount realized of $0 and will not recognize any gain on the transaction. They will also obtain a $0 basis in the received contract or draft pick.

A loss is possible, if the exchanging team has more than a $0 basis in the contract or draft pick that is being disposed of. Also, if there is cash being paid or received in the transaction, then those amounts WILL enter into the amount realized or the basis of an acquired asset.

To use the safe harbor, the following requirements must be met:

1. The parties to the trade that are subject to federal income tax must treat the trade on their respective federal income tax returns consistent with the Revenue Procedure;

2. Each team that is a party to the trade must transfer and receive a personnel contract or draft pick. In the trade, no team may transfer property other than a personnel contract, draft pick, or cash;

3. In the trade, no personnel contract or draft pick may be an amortizable Code Sec. 197 intangible; and

4. The financial statements of teams that are parties to the trade must not reflect assets or liabilities resulting from the trade other than cash.

Why the special treatment for the teams? Is it the special love that Treasury officials have for professional sports? Or is it because the value of player contracts and draft picks is extremely difficult to value, is subjective to the particular team,  and is subject to constant fluctuation? The IRS says it is the latter.

Who says tax law can’t be fun?

Revenue Procedure 2019-18

Friday, March 29, 2019

The End to Agency Deference in Florida Tax Disputes [Florida]

Many a Florida taxpayer has disagreed with the Department of Revenue’s interpretation of a tax statute. I recently was involved in an audit where it was clear to us that the Florida Administrative Code provisions were not supported by the statutory provisions.

A taxpayer seeking to challenge the DOR’s interpretation in court have had the deck stacked against them under the concept of agency deference. This gives the DOR the benefit of the doubt in its interpretation of the law – court’s will typically defer to the DOR’s interpretation on the theory that the DOR is an “expert” in tax matters.

In great news for taxpayers, those days are now over. Recently approved Amendment 6 to the Florida Constitution adds new Section 21 to Article V of the Florida Constitution. This provision reads:

Judicial interpretation of statutes and rules.—In interpreting a state statute or rule, a state court or an officer hearing an administrative action pursuant to general law may not defer to an administrative agency’s interpretation of such statute or rule, and must instead interpret such statute or rule de novo.

In other words, agency deference is now dead in Florida. This will assist taxpayers in deciding whether to comply with an administrative code provision, in negotiating with the DOR during an audit, and in litigating with the DOR in court, if they believe a DOR pronouncement or interpretation of the law is erroneous.

This new provision also has important implications outside of the tax arena, but of course that is not our interest here.

The fate of agency deference at the federal level is also under fire in federal courts these days – it will be interesting to see what develops there, including in the U.S. Supreme Court. If only we could get a similar amendment into the U.S. Constitution!

Saturday, March 23, 2019

Qualified Beneficiaries–Recent Case is Puzzling in its Logic and Scope [Florida]

A recent 4th DCA opinion on who is a “qualified beneficiary” under Florida’s Trust Code is a puzzler, at least to me. Status as a qualified beneficiary is important – it determines who is entitled to receive an accounting for a trust.

To simplify the facts, 3 separate trusts were held for 3 daughters – each daughter was the current income and principal beneficiary of their own separate trust. At the death of a daughter, the assets of her trust would be transferred to the trusts of her surviving siblings. At the death of the last daughter, the trust assets would go outright to 3 named charities.

Fla.Stats. §736.0103(16) provides general rules on when a living beneficiary is a qualified beneficiary. Generally, the rules include the current beneficiaries, and the next level of persons who would take if the trust then terminated or the current beneficiaries then ceased to be beneficiaries. Because a charitable organization is not a “living beneficiary,” Fla.Stats. §736.0110 applies similar rules when the beneficiary is a charitable organization. Relevant to the above facts, the statute provides “A charitable organization expressly designated to receive distributions under the terms of a charitable trust has the rights of a qualified beneficiary under this code if the charitable organization, on the date the charitable organization’s qualification is being determined:. . .  (b) Would be a distributee or permissible distributee of trust income or principal on termination of the interests of other distributees or permissible distributees then receiving or eligible to receive distributions.”

The trial court held that the charities were not qualified beneficiaries, since if a current trust terminates, they do not become a current distributee – instead it passes to the trusts for the other daughters. Presumably, the trial court would have ruled differently as to the last of these trusts after the other 2 daughters passed away, since then the charities would be next in line to benefit.

The 4th DCA reversed and found the charities were qualified beneficiaries. The court held that all the trusts should be viewed together and the rules should be applied as if all the individual beneficial interests terminated at the same time (and not sequentially). This is questionable to me, since it seems to disregard the word “then” in the statute. That is, the statute says call the new distributee a qualified beneficiary if the interests of a distributee THEN receiving or eligible to receive distributions has her interest terminated. The charities take only if the other non-beneficiary daughters have their interests terminated by death – but on the testing date they are not THEN receiving distributions from the subject trust because the current beneficiary of the trust is still living.

It is difficult to decipher what the court is saying. It appears to me that they are instead saying that the phrase “then receiving” is not applied just in the present moment, but also to future moments. That is, if the list of beneficiaries is A, then B, then C, then outright to D, the court appears to be saying that D is a qualified beneficiary under the above rules because D “would be a distributee. . . on termination of the interests of other distributees [our C]. . . then receiving” if we apply the rules prospectively to the point in time where C would be a current distributee even though C is not presently a current distributee. Under this logic, C would also be a qualified beneficiary. If this is the court’s theory, then I think it is nonsensical since effectively it makes everybody in the line of succession as a present OR FUTURE distributee a qualified beneficiary which is clearly not the purpose of the statute.

Note that if correct the analysis may apply equally to determining whether living persons are qualified beneficiaries – that is, the case may expand beyond the limited charitable beneficiary scenario and impact all trusts. If one compares the above language in Fla.Stats. §736.0110 with the general rules of Fla.Stats. §736.0103(16), there is little difference. The 4th DCA’s decision would seem to apply equally to that statute, and thus allow contingent beneficiaries who are more than one death away from becoming an active beneficiary (either by reason of transfers to different trusts at the death of a beneficiary or perhaps are in line of succession in one trust) may be qualified beneficiaries.

Hadassah, The Women’s Zionist Organization of America, Inc. v. Stephen G. Melcer, Trustee, et al, 2019 WL 141039 (4th DCA 2019)

Saturday, March 09, 2019

Bernie Sanders’ Tax Proposals

We all know that come 2025 the aggregate transfers covered by the unified credit for estate and gift taxes will revert to pre-Trump levels (subject to adjustments for inflation), thus ensnaring more taxpayers in the estate and gift tax web. Of course, should a Democrat be re-elected in 2020, changes in taxes to the higher side may occur even sooner than 2025.

A recent tax bill filed by Senator Bernie Sanders, a candidate for President, gives some insight about what tax legislation might look like if a Democrat is elected – more so if he is elected, but perhaps also as to other Democratic candidates.

Some key changes he would make to the high side include:

a. Increases in estate, gift and GST rates, to a maximum of 77% for members of the billionaire’s club;

b reduction in the unified credit exclusion amount to $3,500,000;

c. elimination of entity valuation discounts as to entity assets that are not business assets;

d. imposing a 10 year minimum term for grantor retained annuity trusts;

e. subjecting grantor trusts to estate tax inclusion at the death of the deemed owner;

f. limiting the GST exemption to a 50 year term; and

g. reduction in the annual gift tax exclusion.

These changes would be good news for tax planners, and bad news for those of moderate or higher wealth.

The old Chinese curse says – may you live in interesting times. I think most of us can agree, at least from a tax perspective if not a political perspective, we are all cursed under that measure.

S.309 — 116th Congress (2019-2020)

Sunday, March 03, 2019

Beneficiaries Hit with Transferee Liability Suit for Estate Taxes 19 Years After Date of Death

A recent case illustrates how beneficiaries and recipients of property from a decedent do not receive the property free and clear from estate tax liabilities. If estate taxes are not paid, the IRS can seek collection of the taxes from such beneficiaries and recipients as transferees under Code §6324(a)(2). And it may be a long, long time before the IRS ‘comes a knocking.’

The case illustrates to us that:

a. Transferee liability is not limited to those who receive a gift or bequest pursuant to a last will or disposition of property being administered under a revocable trust. Instead, it extends to recipients of all property included in the gross estate including:

     1. Transferees who received lifetime gifts that are included in the gross estate under Section 2035 because made within 3 years of death;

     2. Gift recipients whose gift was a discharge of indebtedness to the decedent;

     3. Transferees who receive the property as surviving joint tenants;

     4. Property passing to remaindermen when the decedent had a life tenancy in the property;

     5. Life insurance proceeds on the life of the decedent;

b. The IRS may take a long time before asserting transferee liability. The statute of limitations is 10 years from the date the assessment of tax is made against the estate. Here, the IRS filed suit in the 9th year of that 10 year period (and 19 years after the date of death).

c. The IRS will pursue transferee liability even when the estate tax liability is not that significant. Here, the unpaid tax was $28,939 (but with interest and penalties the amount sought was $65,874.80.

There are numerous Code provisions and procedures for relieving a fiduciary from liability for such taxes - but this is not the case for beneficiaries. Conservative recipients of property may not want to spend their inheritances or received property until they know the 3 year assessment period has expired without an assessment.

U.S. v. Ringling, 123 AFTR2d 2019-XXXX (DC SD 2/21/19)

Monday, February 18, 2019

IRS Blesses 2nd Marriage Planning Technique for IRA

A common issue in planning for marriages with prior children is how to provide for the surviving spouse, while also making provision for children of a prior marriage or relationship. A regularly used planning arrangement is to designate as successor owner at death of the original owner a marital trust that provides for assets to be expended for the surviving spouse during his or her lifetime, with a remainder to the children and lineal descendants of the first spouse to die. This avoids the problem of leaving the assets outright to the surviving spouse, who then can leave the assets to other beneficiaries at his or her death.

If the asset at issue is an IRA or qualified plan interest, the owning spouse may have similar concerns. However, income tax issues complicate the planning. For income tax planning purposes, it is usually desirable that the owning spouse have the option to “stretch” the payouts over the life expectancy of the surviving spouse (or of the decedent spouse) and thus defer income taxes by having the beneficiary be a “qualified beneficiary” of the IRA/qualified plan assets. This can be done via an outright beneficiary designation to the surviving spouse, but presents the same issues with prior children of the decedent spouse as discussed above. Unfortunately, in regard to an IRA or qualified plan asset, the use of trusts to receive the interests faces planning obstacles per the provisions of the Regulations that limit the ability to have the trust beneficiary(ies) be treated as "qualified beneficiaries.”

A recent private letter ruling confirms a fairly straightforward planning mechanism to obtain stretch status for an IRA via a trust under these circumstances. The blessed methodology is for the IRA owner’s revocable trust to be named as beneficiary of the IRA at the owner’s death. The revocable trust provides that a separate trust will be created to hold all IRA and qualified plan assets received. The spouse is named as the sole lifetime beneficiary of the trust, and the owner’s children are named as remaindermen. The IRS ruled that this arrangement passes muster under the Regulations, and the surviving spouse is treated as a qualified beneficiary of the IRA,and the sole one at that.

To reach this result, the general provisions for qualifying trust beneficiaries as qualified beneficiaries must be met. These include the requirements under section 1.401(a)(9)-4, Q&A-5:  (1) the trust is valid under state law, or would be but for the fact there is no corpus; (2) the trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee; (3) the beneficiaries of the trust who are beneficiaries with respect to the trust's interest in the employee's benefit are identifiable within the meaning of section 1.401(a)(9)-4, Q&A-1, from the trust instrument; and (4) the documentation described in section 1.401(a)(9)-4, Q&A-6, has been provided to the plan administrator. Further, for the spouse to be sole designated beneficiary, the trust must be a conduit trust - it must contain provisions requiring the immediate distribution of all retirement plan or RIA distributions by the trustee to the beneficiary.

The payment to two trusts (first the revocable trust, and then onto the separate trust for IRA/retirement plan assets), is permitted under section 1.401(a)(9)-4, Q&A-5(d). That provision states that if the beneficiary of the trust named as beneficiary of an employee's interest is another trust, the beneficiaries of the other trust will be treated as having been designated as beneficiaries of the first trust, and thus, as having been designated by the employee under the plan for purposes of determining the distribution period under section 401(a)(9)(A)(ii), provided that the requirements of section 1.401(a)(9)-4, Q&A-5(b), are satisfied with respect to such other trust in addition to the trust named as beneficiary.

PLR 201902023

Sunday, February 10, 2019

Court Order Enjoining Occupancy or Residence by Owners Did Not Terminate Homestead Status [Florida]

A recent case addressed whether owners who had to cease living on homestead property by reason of a court order to vacate the property and enjoining them from residing thereon due to unsafe conditions and code violations, should automatically be treated as having abandoned their homestead. Homestead status was relevant because the husband deeded the property away without joinder of his wife – such a transfer is void under Florida’s Constitution if the property remained homestead property. Here, the husband and wife had moved off the property and been living in a rented residences or stayed with friends for five years after the court order.

The trial court found that the property ceased to be homestead property. Reversing the trial court, the 4th District Court of Appeal ruled that abandonment of homestead status under these circumstances was not automatic, and denied the buyer’s request (who was seeking to enforce the transfer) for summary judgment on the issue. While homestead status can be lost through abandonment, a finding of abandonment requires a strong showing of intent not to return to the homestead. Such a determination requires a review of the totality of circumstances to determine such intent. Case law supports that an involuntary cessation of residency on the homestead does not alone constitute abandonment. Based on the foregoing, the appeals court remanded the case for further proceedings, including resolving the question of fact of the wife’s intent (or absence of intent) to abandon the subject property.

Yost-Rudge v. A-to-Z Properties, Inc., 2019 WL 459015 (4th DCA, February 6, 2019)

Saturday, January 26, 2019

Real Property Rental Safe Harbor under Code §199A

Code §199A allows taxpayers up to a 20% income tax deduction for business income earned through a sole proprietorship or pass-through entity. There are numerous requirements to meet, and one of these is that the business constitute a trade or business under Code §162.

Unfortunately, for rental real estate activities it is not often clear whether the activity constitutes a trade or business. To assist taxpayers, the IRS has published Notice 2019-07 which provides a safe harbor to obtain trade or business status for rental real estate activities. Note that if a taxpayer does not meet the requirements, they can still claim trade or business status – they just do not have the benefit of automatic IRS approval of that conclusion via the safe harbor.

I have summarized in this link a mind map summary of the safe harbor requirements, so those with an interest can get quickly up to speed on them. It is possible that these requirements may be tinkered with by the IRS when it issues a final Revenue Procedure, so readers should check whether such a procedure has been issued before relying on the Notice. Of course this is a summary only – check the Notice provisions directly instead of relying on this summary alone.

Notice 2019-07 – LINK TO MAP SUMMARY

Sunday, January 20, 2019

U.S. Supreme Court to Decide Whether a State Can Tax a Trust Solely Based on Residence of a Beneficiary

The Due Process Clause of the U.S. Constitution requires a taxpayer have sufficient contacts with a state before the taxpayer can be subject to income taxes in that state. This has led to disparate results on when the income of a trust is subject to the taxing jurisdiction of a state.

One common fact pattern is a trust where a state seeks to tax a trust on its income because a beneficiary of the trust resides in the state, even though the trust was formed out of state, the trustee resides out of state and administers the trust from out of state, and the assets are situated outside of that trust. Under such a facts, the State of North Carolina has asserted it can tax the income of the trust. Eleven states tax trust income when a trust’s beneficiaries are state residents.

The Supreme Court has granted certiorari in that case, so much needed guidance should soon be coming on this important issue!

NORTH CAROLINA DEPT. OF REVENUE V. KAESTNER FAMILY TRUST

Wednesday, January 09, 2019

Mandatory Restricted Depository Arrangements in Probate Questioned [Florida]

Fla.Stats. §69.031(1) authorizes a probate court to direct the financial assets of a probate estate be deposited into a restricted depository account held by a financial institution. This is a protective mechanism, since assets may be disbursed from that account only upon court order, instead of mere direction by the personal representative. Thus, it acts a mechanism to reduce the risk of improper use, dissipation, or disbursement of estate assets by the personal representative.

Fla.Stats. §69.031(1) reads as follows:

(1) When it is expedient in the judgment of any court having jurisdiction of any estate in process of administration by any guardian, curator, executor, administrator, trustee, receiver, or other officer, because the size of the bond required of the officer is burdensome or for other cause, the court may order part or all of the personal assets of the estate placed with a bank, trust company, or savings and loan association (which savings and loan association is a member of the Federal Savings and Loan Insurance Corporation and doing business in this state) designated by the court, consideration being given to any bank, trust company or savings and loan association proposed by the officer. When the assets are placed with the designated financial institution, it shall file a receipt therefor in the name of the estate and give the officer a copy. Such receipt shall acknowledge the assets received by the financial institution. All interest, dividends, principal and other debts collected by the financial institution on account thereof shall be held by the financial institution in safekeeping, subject to the instructions of the officer authorized by order of the court directed to the financial institution. (emphasis added)

Some counties have opted to impose restricted depository accounts for all estates, raising the issue whether a blanket prohibition is appropriate, or whether the above highlighted language of the statute first requires either a determinization that the size of a bond would be burdensome or there is other good cause in each estate.

In an opinion released today, the Fourth District Court of Appeal ruled against local rules requiring the mandatory use of restricted depositories. The Court nonetheless allowed the restricted depository order under appeal in that case to stand, since there was otherwise good cause for the court to order the account under the facts. The case is not final, pending the possibility of a motion for rehearing and the outcome of such a rehearing if it is granted, but interested persons should monitor its status.

Assuming the Court’s opinion becomes final, it is difficult to know how counties with such mandatory requirements will react, both within and without the counties making up the Fourth DCA (such as whether they will remove such mandatory requirement, otherwise attempt to re-work their rules in light of the opinion, or await appellate decisions in their own circuit).

DISCLOSURE: Our firm, through Jenna Rubin, Esq., represents the appellees in this case.

STEVEN GOODSTEIN, as Personal Representative of the Estate of Andrew Scott Goodstein v. SHELLEY GOODSTEIN, as Conservator for BLAKE GOODSTEIN and CHANDLER GOODSTEIN, and GRANT GOODSTEIN, 4th DCA, Case No. 4D18-2382 (January 9, 2019)

Sunday, January 06, 2019

Rules Issued on Excess Remuneration Paid by Exempt Organizations

The 2017 Tax Act imposed a penalty on excess compensation paid to employees of an applicable exempt organizations (“ATEO”). Code §4960 imposes an excise tax of 21 percent on compensation paid to a covered employee in excess of $1 million and on any excess parachute payments paid to a covered employee.  A “covered employee” is any employee (or former employee) who is one of the five highest - compensated employees of the organization for the taxable year or was a covered employee of the organization (or any predecessor) for any preceding taxable year.

The IRS has issued Notice 2019-9, which contains interim rules on how the excise tax will apply. Some interesting aspects of the new statute and rules are summarized below:

  • Related Entity Aspects:
    • Any remuneration paid to a covered employee by a related entity is included in the calculation of the covered employee’s total remuneration for the year.
    • A payment from a related entity, including a related entity that is an ATEO, for services rendered to the common-law employer, is considered a payment to the employee from the common-law employer. Calculation of the excise tax is separate from any arrangement that an ATEO and any related organization may have for bearing the cost of the excise tax.
    • Remuneration paid by a separate organization on behalf of the ATEO, whether related to the ATEO or not, for services performed as an employee of the ATEO is treated as remuneration paid by the ATEO.
    • An employee may be a covered employee of more than one ATEO and that each ATEO employer calculates its liability under Code Sec. 4960(a)(1) taking into account the organizations to which it is related. However, an employer is liable only for the greater of the excise tax it would owe as an ATEO or the excise tax it would owe as a related organization with respect to that covered employee.
  • Determining Compensation Aspects:
    • Wages include all remuneration for services performed by an employee for the employer, except for fees paid to a public official, and other specifically excluded types of remuneration.
    • Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to such remuneration (i.e., when the compensation is vested). Remuneration in which the covered employee vested before the effective date of Code §4960 is treated as paid before that effective date. The definition of substantial risk of forfeiture under Prop Reg § 1.457-12(e)(1) is the definition of substantial risk of forfeiture within the meaning of Code §457(f)(3)(B) for purposes of Code §4960(a). Under Prop Reg § 1.457-12(e)(1), an amount of compensation is subject to a substantial risk of forfeiture only if entitlement to the amount is conditioned on the future performance of substantial services, or upon the occurrence of a condition that is related to a purpose of the compensation if the possibility of forfeiture is substantial.
    • For purposes of determining when remuneration is treated as paid, the timing rule in Code Sec. 4960(a) applies,and the timing rule for wage inclusion under Reg § 31.3402(a)-1(b) is not relevant. Under Notice 2019-9, Q/A-13, the amount of remuneration treated as paid at vesting is the present value of the remuneration in which the covered employee vests.
  • Who Is a Covered Employee:
    • Once an employee is a covered employee, he or she continues to be a covered employee for all subsequent tax years. There is no minimum dollar threshold for an employee to be a covered employee.
    • Remuneration paid for medical services is not taken into account for purposes of identifying the five highest-compensated employees.
    • Whether an employee is one of the five highest-compensated employees is determined separately for each ATEO, and not for the entire group of related organizations. Therefore, each ATEO has its five highest-compensated employees. Thus, a related group of entities may have more than five covered employees.
    • Only an ATEO’s common law employees (including officers) can be one of an ATEO’s five highest compensated employees. There is a limited services exception from highest compensated employee status under which, unless an ATEO pays at least 10% of the total remuneration paid by the ATEO and all related organizations to an employee during the calendar year, the employee is not treated as one of the ATEO’s five highest compensated employees.
  • Misc.:
    • Certain governmental entities are not ATEOs. A governmental entity (including a state college or university) that is not recognized as exempt from taxation under Code §501(a) and does not exclude income from gross income under Code §115(1) is not an ATEO described in Code §4960(c)(1). A governmental entity that sought and received a determination letter recognizing its tax-exempt status under Code §501(c)(3) may relinquish this status pursuant to the procedures described in Rev Proc 2018-5.
    • For purposes of calculating the remuneration upon which the tax is calculated, remuneration does not include certain retirement benefits or certain directors' fees.