RETURN EXTENSIONS CAN BE FILED ELECTRONICALLY

Federal income tax returns are due for most individuals this April 15th. Taxpayers who cannot complete their return by then can file for an automatic 6 month extension for filing.

Historically, taxpayers (or their return preparers) prepared a Form 4868 to obtain the extension. The IRS is reminding taxpayers that they can also file the extension request electronically using the IRS’ FreeFile online system.

Remember, that an extension to file is not the same as an extension to pay. A payment adequate to meet the tax that is ultimately determined to be due must be paid by April 15 to avoid penalties, or a separate extension to be pay must be applied for and granted by the IRS. Those who owe taxes can make a payment when they file the extension either by mailing a check or by several electronic payment methods, such as electronic funds withdrawals from bank accounts and credit card payments

TAX COURT BENDS OVER BACKWARDS TO IMPOSE EQUITABLE APPORTIONMENT

Many states apportion estate taxes among beneficiaries of an estate and revocable trusts in proportion to the assets received by them that are subject to estate taxes, absent contrary language in the dispositive instruments. This is known as “equitable apportionment.”  Thus, when assets pass to a surviving spouse in a manner that qualify for the marital deduction, equitable apportionment avoids such marital assets being reduced for estate taxes relating to the passage of other assets. This is usually a good thing since it reduces the overall estate tax bill – if the marital deduction property bears estate taxes, an interrelated computation of the tax arises that reduces the marital deduction (since not all the marital deduction property ends up with the surviving spouse).

Oftentimes, surviving spouses receive a residuary interest in estate and trust assets. In such cases, draftsmen must be careful to specifically provide that the marital assets so received do not bear estate taxes – either by allowing a state’s default equitable apportionment statute to apply or via drafting. Oftentimes, standard language (or statutory language) will allocate estate taxes to the residuary assets (and thus the marital deduction assets) by default – so this default language has to be overridden.

For example, if you were reading a revocable trust that left the residuary assets to the surviving spouse, and the trust also contained this language:

The Trustee shall pay from the residue of the trust estate prior to any distributions provided for herein, all of the Settlor's debts, expenses of last illness, expenses of disposal of remains, all expenses of administration and trust termination, including attorneys' fees, and shall pay all estate taxes, if any, attributable to Settlor's entire taxable estate,

you would assume there is a problem here – estate taxes are being allocated to the residuary (and thus the assets passing to the spouse), and that equitable apportionment would not apply. In a recent Tax Court case, the IRS thought the same. However, for some unknown reason, the Tax Court went through a numerous contortions to find that the clause did NOT require that the residuary marital gift bear estate taxes, and that Utah’s equitable apportionment statute applied to allocate the taxes to other gifts. This was done, even though it appears from the case that the other gifts were not other residuary gifts, but were specific gifts to other beneficiaries.

It is true that there were some slight ambiguities and inconsistencies in the trust that could be used to challenge the above express language, but I would not have expected the taxpayer to prevail. For example, the court read the above reference to the “residue of the trust estate” to refer to the residue of the probate estate – quite  a stretch. Further, the Court drew a distinction between allocation and apportionment. That is, the Court believed that even if the testator/settlor intended that the taxes be allocated to and paid out of the residuary, the testator/settlor did not intend to also apportion the taxes among the residuary beneficiaries – that is, the taxes should still nonetheless be apportioned among the beneficiaries in proportion to the TAXABLE assets they received.

What lessons can be learned (other than sometimes, against all odds, the Tax Court will pull the draftsman’s fat out of the fire for him or her)? Depending on which result is desired, be very specific with allocation and apportionment language. For example, if apportionment among taxable assets only is desired, use language such as “with apportionment.” Or if apportionment is not desired so that the entire residuary should bear taxes, use language such as “without apportionment.” When no apportionment is desired, one can go the further step of expressly providing that no right of reimbursement exists – that is, to use language such as “without apportionment and with no right of reimbursement from any recipient of any such property.”

John D. McCoy, et ux. v. Commissioner, TC Memo 2009-61

IRS AMNESTY FOR UNDISCLOSED OFFSHORE ACCOUNTS AND ENTITIES

The Internal Revenue Service ("IRS") recently announced a framework for resolving cases involving previously undisclosed foreign entities and offshore accounts held by or for the benefit of U.S. persons. The protocol set forth by the IRS will remain available to taxpayers up until September 23, 2009, unless sooner extended.

The announced framework requires that a request be submitted to the IRS asking for permission to make a voluntary disclosure. The request will contain a summary of the relevant facts and will initially be considered by the IRS Criminal Investigation Division (CI) which will make a preliminary determination as to whether the taxpayer is eligible to make a voluntary disclosure. That determination will be based in large part on whether the IRS has already commenced an investigation of the taxpayer seeking relief. If not, and if there are no extraordinary aspects whereby the IRS feels compelled to otherwise prosecute (for example, if there is some underlying criminal activity which gave rise to the money on deposit in the offshore account or foreign entity), then the request to proceed with a voluntary disclosure will likely be granted.

Once CI approves the making of a voluntary disclosure , the request will be forwarded to a special IRS unit in Philadelphia for civil processing where it will be worked by examiners who specialize in offshore issues.

If permission is granted to proceed, the IRS will resolve the case based upon the following guidelines:

1.  All taxes and interest going back for a period of six (6) years will be assessed (unless the account or foreign entity is in existence for less than six (6) years, in which case the assessments will go back tot he first year the account or entity was opened). The taxpayer will be required to file or amend all returns for that period, including information returns and Treasury Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (commonly known as as "FBAR").

2.  The IRS will assess either an accuracy or delinquency penalty on all years and there will be no consideration given to any "reasonable cause" exception.

3.  The IRS will also assess a penalty equal to twenty (20%) percent of the amount in foreign bank accounts or entities in the year with the highest aggregate account or asset value.

4.  If (i) the taxpayer did not open or cause any foreign account to be opened or entity formed (for example, if an account or entity is inherited); (ii) there has been no activity during the period the account or entity has been controlled by the taxpayer (that is, there were no deposits or withdrawals, etc.); and (iii) all applicable U.S, taxes have been paid on the original funds deposited into the accounts or entities (that is, other than earnings on the funds while in the account or entity), then the twenty (20%) percent penalty described in the previous paragraph will be reduced to five (5%) percent.

The taxpayer will be required to cooperate both civilly and criminally in order to benefit from the terms outlined above.

Thanks to my partner, Marvin Gutter, for the above summary.