IRS PROVIDES MORE GUIDANCE ON UNREPORTED OFFSHORE INCOME

Last month, the IRS announced that it was adopting consistent guidelines for voluntary disclosure requests of taxpayers that relate to offshore undisclosed accounts and foreign entities. Disclosure issues would be settled, with the taxpayer being subject to the imposition of taxes and interest for the prior 6 years, with the taxpayer filing or amending all returns for that period, including required FBAR returns. Late tax payments will still be subject to accuracy or delinquency penalties, and no reasonable cause exception will be allowed. However, all other penalties will be waived, and no criminal prosecutions will apply, other than a 20% penalty based on the highest aggregate foreign account or foreign asset value (or 5% in some circumstances).

The IRS has now issued written FAQ responses that flesh out the details of these offers. Highlights of the FAQs include:

A. The time limit for the offer is for six months only – through September 23, 2009;

B. The offer is open to all taxpayers that comply with IRS's terms, including corporations, partnerships and trusts. The offer does not apply if IRS has initiated a civil examination of the taxpayer, regardless of whether it relates to undisclosed foreign accounts or undisclosed foreign entities.

C. The settlement offer should not be used by taxpayers that have properly reported all of their taxable income but have not been filing FBARs in prior years to report a personal foreign bank account or to report the fact that taxpayers have signature authority over bank accounts owned by their employers. These taxpayers are advised to file the delinquent FBAR reports and attach an explanation of why the reports are being filed late. The FAQ indicates that no penalties will be imposed for the failure to file the FBAR.

The IRS has indicated that it will attempt to identify taxpayers that do not submit a voluntary disclosure offer, but instead simply file amended returns and pay related tax and interest under a “quiet" disclosure. Such taxpayers who follow the “quiet" disclosure route are at risk for civil examination and criminal prosecution. Taxpayers who have already taken the "quiet" disclosure route can still make a voluntary disclosure under the above guidelines.

SALE OR SURRENDER OF LIFE INSURANCE CONTRACTS

In today’s difficult financial times, more taxpayers than usual are cashing in or selling their life insurance policies. A recent Revenue Ruling addresses the IRS’ view of the income tax consequences of such transactions. The salient points are summarized below. Note that these rules apply to non-modified endowment policies (non-MEC) policies – results can differ for MEC policies.

A. SURRENDER OF POLICY TO THE INSURANCE COMPANY. In this circumstance the policy holder has income if and to the extent that the amount received on surrender exceeds his or her “investment in the contract.” Section 72(e)(5). The “investment in the contract” is the aggregate amount of premiums or other consideration paid for the contract before that date, less the aggregate amount received under the contract before that date to the extent that amount was excludable from gross income. It is the position of the IRS that any such income is ordinary income, and not capital gain.

B. SALE OF INSURANCE POLICY. While seemingly the same economic transaction occurs in a sale as under a surrender, different tax results obtain because a sale is taxed under the sale or exchange provisions of the Code, including Section 1001, while the above surrender treatment is addressed under the insurance – annuity rules of Section 72. In the case of a sale of a policy, the seller incurs a gain to the extent that the amount received exceeds his or her adjusted basis in the contract. Note that “adjusted basis” is not the same as “investment in the contract,” although premium payments are credited towards both. A key difference is that to the extent premium payments are allocable strictly to the cost of life insurance (and not the build-up of cash value to pay future premiums or benefits), that portion of the premium payment reduces basis, and will thus increase gain (or reduce loss) on the sale. In the case of a sale of term life insurance, the monthly premium amount is treated as the cost of life insurance through the date of sale. Not all practitioners are willing to concede that such a reduction in basis is proper. Notwithstanding sale or exchange treatment under Section 1001, the IRS nonetheless applies the “substitute for ordinary income” doctrine to tax the gain as ordinary income and not capital gain, to the extent the sales price is attributable to the inside build-up in the contract, with any remaining portion of the gain eligible for capital gain treatment.

Rev. Rul. 2009-13, 2009-21 IRB

DOCUMENTARY STAMP TAX LOOPHOLE ABOUT TO BE CLOSED [FLORIDA]

Florida imposes documentary stamp taxes on the transfer of real property. Since the tax typically applies only to transfers of real property and not interests in corporations and LLC’s that own real property, one planning method to eliminate the tax is for the seller to first transfer the real property to an LLC, and then sell the LLC interests to the buyer, free of documentary stamp taxes.

This planning was facilitated by case law and Department of Revenue concessions that transfers of real property could be made to a wholly owned entity without documentary stamp taxes being imposed.  Absent this change (or “clarification”) of the law, the first step of the above planning (the transfer of the real property to the LLC) could not be accomplished tax-free.

Likely in response to publicity regarding the planning technique, the Florida Senate has passed legislation that will impose documentary stamp taxes on such LLC transactions. The Florida House also passed legislation, but exempted from tax situations when the property was owned by the entity for at least 3 years prior to the transfer. Therefore, the Senate and House versions will need to be reconciled. We will also be interested to see the final language of the new law, to determine if and how it applies to entities other than LLC’s and whether any planning opportunities remain.