FREIREICH L.L.C.

August 20, 2010

The Tax Court had held that a decedent retained a lifetime interest in a 49% share of real estate that she transferred to her son. Estate of Margot Stewart v. Comm., T.C. Memo 2006-225 (T.C.M. 2006).  The Second Circuit in Estate of Margot Stewart v. Comm., 106 AFTR 2d 2010-5183, 2010 WL 3078783 (2d Cir. 2010) held that the Tax Court clearly erred in finding that there was an implied agreement which provided that the decedent retained enjoyment of the entire 49% share, thereby finding the entire interest in her estate pursuant to Sec. 2036 of the Code.

Under Sec. 2036, a taxable estate includes transfers under which a taxpayer retains the possession or enjoyment of, or the right to the income from property transferred under an expressed or implied agreement.  This section does not apply where the property is sold for full and adequate consideration.

This Code section had been applied previously in Rev Rul 79-109, 1979-1 CB 297.  In that Revenue Ruling, the IRS determined that if a decedent transferred property but reserved the right to the use of (or the income from) the property for life, the value of the property is included in her estate.

The Tax Court had found that the full value of the  property was includible in her estate by concluding that Decedent and her son had an implied agreement that Decedent would retain the economic benefits of the property. The Second Circuit vacated and remanded as clearly erroneous the Tax Court's finding that the terms of the implied agreement provided that Decedent would enjoy 100% of the substantial economic benefit of the son's 49% undivided interest in the property.  The Second Circuit concluded that it wasn't clearly erroneous for the Tax Court to find an implied agreement, but it was clearly erroneous for the Tax Court to find that the terms of the agreement were such that Decedent would enjoy the substantial economic benefit of 100% of the son's 49% interest in the property.

The Second Circuit left for the Tax Court the question that remained which was: what part of the 49% interest should be included in the estate.

8/3/10

Pursuant to Sec. 9006 of the Patient Protection and Affordable Care Act  (the "Act"), businesses that pay $600 or more during the year to non-tax-exempt corporate providers of property and services will have to supply an information report to each provider and to the IRS; and businesses will have to file information returns with respect to any person (including corporations) that receives $600 or more from the business in exchange for property and merchandise.

On July 30, a bill (H.R. 5982) to repeal this onerous section of the Act was presented to the House of Representatives.  H.R. 5982, the “Small Business Tax Relief Act of 2010,” would repeal Sec. 9006 of the Act thus repealing the aforesaid Act requirements before they take effect.

To offset the $19.206 billion in revenue that the Government estimates would be lost by repealing Sec. 9006 of the Act, H.R. 5982 “borrows” from revenue raisers that were included in other House legislation. Other perceived revenue raisers include requiring a minimum 10–year term for grantor retained annuity trusts, an exclusion from the definition of cellulosic biofuel for the cellulosic biofuel producer credit for certain processed fuels, clarification of gain recognized in certain spin-off transactions, and increased penalties for failure to file information returns.

8/2/10

An amendment to the June 15, 2010 House Bill (H.R. 5297, 111th Cong., 2d Sess. (2010)) was proposed on July 13 by Senators Kyl (R-Ariz.) and Lincoln (D-Ark.). The proposal, which was rejected by the Senate would have made the following changes:

Reinstate the estate tax with a top rate of 35 percent, reinstate the GST tax with a flat rate of 35 percent, set the estate tax and GST exemptions at $5 million, all phased in over ten years.  It would also reinstate the estate tax value basis for property received from a decedent; and grant the personal representative of the estate of a decedent who dies in 2010 an election to apply the new rules or the existing 2010 rules. 

Then on July 20, Senator Sen. DeMint (R S.C.) proposed an amendment to the Bill that would have permanently repealed the estate and GST taxes.  It, too, failed to be added to the bill.

July 22, 2010

The family limited partnership (FLP) can be used as an effective method to protect assets from potential creditors.  Asset protection planning is helpful to ensure that assets are not lost in litigation.

If there is a creditor of the limited partnership, a limited partner's liability is limited to his or her capital contribution.   Limited Partners are not liable for the debts of the limited partnership.  If the creditor is the creditor of the individual (the “debtor”), the remedies a judgment creditor has against the debtor's partnership interest are limited.  Generally, a creditor who has a judgment against a limited partner debtor cannot attach the limited partnership interest but rather, must obtain a “charging order.”  A charging order entitles the creditor to receive any distributions made by the partnership to the charged partner.

Since family members control the FLP, once a judgment creditor obtains such a charging order, the general partner will typically cease making distributions and therefore nothing is paid to the creditor.  A judgment creditor who obtains a charging order is not a partner of the FLP and does not have any right to withdraw from the partnership or the right to vote or acquire the judgment debtor's FLP interest or demand distributions.   A charging order can often not only be of little value to the creditor, but pursuant to an IRS ruling, Rev. Rul. 77-137 (1977), the creditor with a charging order is treated as a substituted limited partner and thus must pay tax on the debtor’s share of partnership profits for federal income tax purposes.   Thus, a judgment creditor with a charging order could, therefore, possibly wind up with a tax liability that exceeds the value of the interest severely limiting the value of the order. This potential tax liability often discourages judgment creditors from seeking charging orders.

July 15, 2010

A bill was introduced in the House today similar to the bill introduced in the Senate on June 24 which extends the applicable exclusion amount (unified credit equivalent) of $3,500,000 indefinitely retroactive to 1/1/2010.  Under existing law there is no federal estate tax in 2010 but beginning in 2011, estates valued in excess of $1,000,000 would be subject to tax at rates starting at 41%.  The House Bill HR 5764 and the Senate Bill S 3533 (the new Bils") also would repeal the carryover basis provisions which took effect in 2010.  The new Bills would have rates of 45% for estates up to $10,000,000, 50% for estates between $10,000,000 and $50,000,000 and 55% for estates over $50,000,000 with a 10% surtax for estates in excess of $500,000,000. 

The constitutionality of the bill might be challenged on the retroactive aspect of it.  These bills have not been voted on as yet.

7/14/10

The Tax Court in Intermountain Ins. Serv. of Vail LLC v. Comm’r, 134 TC No. 11 (2010) held that temporary regulations issued by the IRS were invalid. There is a general three-year limitations period in Sections 6229(a) and 6501(a) for assessing tax against a taxpayer or a partner in a partnership. Treasury Regulations were issued by the Internal Revenue Service in an attempt to extend the general three-year limitations to six years where there are basis overstatments.

The six-year limitations period is triggered when a taxpayer or partnership "omits from gross income an amount properly included therein which is in excess of 25% of the amount of gross income stated in the return." Sections 6229(c)(2) and 6501(e)(1)(A). The temporary regulations provide that "an understated amount of income resulting from an overstatement of unrecovered cost or other basis constitutes an omission from gross income for the purposes of..." [Sections 301.6229(c)(2) and 6501(e)(1)(A)]."

The Tax Court, however, ruled that the general three-year limitations period of Section 6501(a) was the applicable period for assessing tax.

The meaning of the three year statutory limit was unambiguous—a basis misstatement was not an omission from gross income. Therefore, the Tax Court held that the temporary regulations were invalid.

7/8/10

The Tax Court has held in Gates v. Comm’r, 135 TC No. 1 (U.S. Tax Ct. 2010) that taxpayers, who voluntarily demolished and reconstructed a new home on their land to enlarge and remodel their home, could not exclude the gain on the sale of the new house under Code Sec. 121.

Background: Pursuant to Sec. 121, a taxpayer can exclude from income up to $250,000 of gain from the sale of a home owned and used by the taxpayer as a principal residence for at least two of the five years prior to its sale. Married taxpayers filing jointly for the year of sale may exclude up to $500,000 of such gain if (1) either spouse owned the home for at least two of the five years before the sale, (2) both spouses used the home as a principal residence for at least two of the five years before the sale, and (3) neither spouse is ineligible for the full exclusion because of the once-every-two-year limit.

Although the taxpayers in Gates owned and used their old house as a principal residence for at least two of the five years before the sale, the Code Sec. 121 exclusion didn't apply because they never lived in the new house and it was never used as their principal residence. The Tax Court determined to narrowly construe the exclusion from income.

Issues remain as to whether a person who demolishes a house (but not the foundation) and constructs a larger house using the old foundation has remodeled (Sec.121 exclusion is available) versus completely rebuilt (Sec. 121 exclusion fails).

6/30/10

On June 29, the House of Representatives approved H.R. 5623, the Homebuyer Assistance Improvement Act of 2010 (the "Bill"). The Bill provides credit relief to first-time homebuyers who are unable to close title by June 30, 2010.  Under current law, both the regular Code Section 36 first-time homebuyer credit of $8,000 and the reduced credit for long-term residents of $6,500 expired for homes purchased after Apr. 30, 2010. However, if a written binding contract to purchase a principal residence was entered into on or before April 30, 2010, the credit may be claimed if the purchase is closed on or before June 30, 2010.  The Bill would amend Section 36(h)(2) to provide that if a written binding contract to purchase a principal residence was entered into on or before April 30, 2010, the credit may be claimed if the purchase is closed on or before September 30, 2010. Thus, this extension would allow homebuyers who signed a contract no later than the end of April to complete their closing by the end of September.

This three-month extension will give time for all the new mortgages to be processed and not punish those homeowners who have been delayed through no fault of their own.

6/24/2010

The withholding tax provisions of Code Sec. 3401 et seq. define “wages” as all remuneration from employment.   In 2008, the Court of Appeals for the Federal Circuit held that severance pay was subject to FICA.  CSX Corp. v. U.S., 518 F.3d 1328 (Fed. Cir. 2008)   Then, In February of 2010, the a federal district court in U.S. v. Quality Stores, Inc., 105 AFTR 2d 2010-1110 (D. Mi. 2010) ruled that payments made to involuntarily terminated workers should not be classified as “wages” for FICA tax purposes.  

An I.R.S. spokesperson, Mary Gorman, Assistant Division Counsel, Office of Chief Counsel, for the IRS Small Business/Self-Employed Division, recently stated that the IRS will continue to follow a prior decision of the Court of Appeals for the Federal Circuit which held that payments made to fired employees should be classified as “wages” for FICA tax purposes.  The IRS will not follow a recent pro-taxpayer district court decision to the contrary.  She further stated that the IRS will continue to deny claims that seek a refund of FICA tax paid on severance payments.

Taxpayers are therefore encouraged to file protective claims to preserve their opportunity to receive a refund if the courts were ultimately to decide that severance payments are not subject to FICA tax.

6/23/10 

On June 23, 2010, the "Responsible Estate Tax Act of 2010," was introduced to the Senate by Senators Bernard Sanders (I-Vermont), Tom Harkin (D-Iowa) and Sheldon Whitehouse (D-R.I.) as S. 3533, 111th Cong., 2d Sess. (June 23, 2010). If it gets passed and approved by Congress and the President its highlights include:

Adopt an applicable exclusion amount and GST exemption amount of $3.5 million per person;

Adopt a tax rate structure of 45% for taxable estates up to $10 million, 50% on the taxable estate above $10 million and below $50 million, and 55% on taxable estates above $50 million, and a 10% surtax on estates above $500 million;

Require consistent valuation for transfer and income tax purposes, and require a 10-year minimum term for Grantor Retained Annuity Trusts a/k/a GRATs;

Eliminate the use of valuation discounts for entities (such as FLPs or FLLCs) that do not operate an active trade or business;

Allow reduction in the gross estate under Code Sec. 2032A , special use valuation for family farms and certain closely held business real estate, by up to $3 million.

6/21/10 

Under current law, companies are allowed an income tax deduction for ordinary and necessary business expenses, which includes expenses such as the payment of compensatory and punitive damages.

The Senate  just  voted 60-37, to approve an amendment to the American Jobs and Closing Tax Loopholes Act of 2010.  When signed by the President, this vote will end the deduction for companies paying punitive damage awards paid or incurred after Dec. 31, 2011.  President  Obama had proposed eliminating this deduction in his fiscal 2010 budget so this amendment is sure to pass. The Obama administration had explained that "the deductibility of punitive damage payments undermines the role of such damages in discouraging and penalizing certain undesirable actions or activities."

In a June 16 letter to senators, R. Bruce Josten, executive vice president of the U.S. Chamber of Commerce, warned that "plaintiffs' lawyers would use this provision to force the hand of business to settle frivolous or speculative cases, so that companies might deduct the amounts of those settlements rather than risking incurring non-deductible punitive damage awards."

The deduction for punitive damages awards has been controversial over the years and still divides tax scholars and practitioners.

Some, such as Dan Markel and Gregg Polsky of Florida State University College of Law, have argued that, lacking a punitive damages deduction, defendants will simply disguise those damages as compensatory damages in lawsuit settlements. Others say it is disingenuous to "punish" a company with a punitive award and then allow it to deduct the amount to lower its tax bill.

The Senate amendment, sponsored by Majority Leader Harry Reid, D-Nev., would apply to damages paid or incurred after Dec. 31, 2011. The provision is estimated to raise $315 million over 10 years.

6/15/10

On June 15, 2010, the House passed H.R. 5486, 111th Cong., 2nd Sess (2010), and on June 17, 2010, H.R. 5297. These bills, which are combined in the Senate as H.R. 5297, provide small business tax relief.   The bills limit the use of grantor retained annuity trusts (GRATs) to those of at least ten years, which require a minimum remainder interest, (no indication of the size and eliminates the use of GRATs whose annuity payments decrease over the years.  The anti-GRAT provisions of both bills would apply to transfers after the date of enactment.

6/10/10

Tax Court was wrong to invalidate reg imposing time limit on request for spousal relief.

Lantz v. Comm., 105 AFTR 2d ¶ 2010-935 (7th Cir. 06/08/2010)

The Seventh Circuit Court of Appeals has just reversed a Tax Court decision that invalidated Reg. § 1.6015-5(b)(1) .  That regulation section provides that a spouse must request equitable relief under Code Sec. 6015(f) no later than two years from the first collection activity against the spouse.

Background.  When filing a joint income tax return, each spouse is jointly and severally liable for the tax, interest, and most penalties arising therefrom.  Code Sec. 6015(f) allows relief to a requesting spouse if, among other conditions, taking into account all the facts and circumstances, it is inequitable to hold the "innocent spouse" liable.

Reg. § 1.6015-5(b)(1) provides that a spouse requesting relief under Code Sec. 6015(f) must do so no later than two years from the date of the first collection activity against the innocent spouse.

The Tax Court concluded that Reg. § 1.6015-5(b)(1) was an invalid interpretation of Code Sec. 6015(f)  but the Seventh Circuit reversed stressing that agencies may make deadlines and the fact that Congress designated a deadline in two provisions of the same statute and not in a third is not a compelling argument that it meant to preclude IRS from imposing a deadline applicable to cases governed by that third provision.

Even after this decision, there may still be remedies such as Code Sec. 6343(a)(1)(D) authorizes IRS to release a levy if it determines that the levy is creating an economic hardship due to the financial condition of an individual taxpayer. Also, the IRS could exercise its discretion to grant a reasonable extension of time under Reg. § 301.9100-3 . 

The case is only precedent in the Seventh Circuit (comprised of Illinois, Indiana and Wisconsin)but may be looked to by other Circuits. 

6/10/10

For much of the past two years, President Obama has included a proposal in his budget to require that to be a valid GRAT under the statute, a minimum term of ten years must be used. Recently, that provision was inserted as part of the recent jobs act.  H.R. 4849 passed the House on 3/24/2010, but has yet to be taken up by the Senate.

Therefore, clients who are interested in short-term GRATs should consider funding them sooner rather than later.

5/27/10

As of this date there still has been no Congressional Action to address the repeal of the federal estate and generation-skipping transfer (GST) taxes that applies for individuals dying in 2010 and no action to amend the tax structure in 2011 and beyond.  This has led to great uncertainty in planning and has caused wills using formula clauses that work well when the estate tax is in place to produce unintended consequences when there is no estate tax.  Specifically, how will the terms "the applicable exclusion amount" or "the marital deduction" be construed, if the decedent dies in 2010?  To avoid such issues, wills should be reviewed to determine what action should be taken to amend or add a codicil.

5/27/10 

In planning for transfers of closely held businesses, we typically employ valuation experts to value same for gift tax purposes.  The IRS sometimes disagrees with the expert hired by taxpayer that might otherwise increase the tax burden.   Formula transfers permit a planner to adjust a formula and avoid gift tax even if the valuation by the IRS is upheld. The IRS has challenged the validity of formula transfers.  Bu the IRS has lost three recent cases which has further paved the way for the use of formula transfers. All three opinions validate the use of formula transfer planning.

May 20, 2010

The United States Tax Court in Intermountain Ins. Service of Vail, Ltd. Liability Co. v. C.I.R.,
134 T.C. No. 11, (U.S.Tax Ct. May 06, 2010) has invalidated a tempoarry Treasury Regulation that had attempted to set the statute of limitations for the IRS to impose tax where there is an overstatement of basis to six years.  This Regulation was invalidated therefore reinstating the statute of limitations on basis overstatements at three years.  The full Tax Court came to this holding stating that the United States Supreme Court had already considered this issue and determined that the period of limitation for assessment in such circumstances was three years.  In Colony, Inc. v. Commissioner, 357 U.S. 28, 33, 78 S. Ct. 1033, 2 L. Ed. 2d 1119 (1958),  the Supreme Court was faced with identical language in section 275(c) of the IRC of 1939, the predecessor to section 6501(e)(1)(A) and ruled that a basis overstatement was not the same as an omission of income (which provides for a six year limitation period) and therefore determined the statute of limitations to be three years.  Therefore, Treas. Reg. Secs. 301.6229(c)(2)-1T(b) and 301.6501(e)-1T(b), are invalid. 

5/15/2010
The City of Philadelphia and the State of Pennsylvania are offering a tax amnesty for their taxes.  Philadelphia's program is offered from May 3, 2010 through June 25, 2010.  The State of Pennsylvania's program runs from April 26 through June 18.    The programs are offering interest reduced by 50% and penalties are waived if taxes are paid in full.  This offer is open to New Jersey residents who owe Pennsylvania or Philadelphia taxes.

April 29, 2010

The recent holding in U.S. v. Moskowitz, Passman & Edelman, 603 F.3d 162 (2^nd Cir. 2010), determined that a law firm was required to remit to the U.S. Treasury Department the funds it paid to a partner as "draws" based upon the continuing wage and salary levy served on the firm pursuant to Section 6331(e).

The government brought suit under Section 6332(d) to enforce the levies after the law firm failed to remit the draws to the Treasury. The U.S. District Court for the Southern District of New York found in favor of the government, since the taxpayer’s contention that calling the payments a draw or advance instead of a salary was insufficient to except it from the levy. Therefore, the lower court determined that the law firm violated the levies, and it was therefore liable for the levy amount plus an additional fifty percent Section 6662(d)(2) penalty.

The Second Circuit concurred with the district court ruling that the defenses available to a taxpayer in a levy case are limited; challenging the validity of the levy or making competing claims to the ownership of the funds are not considered valid excuses to fail to honor a levy. While non-possession of the delinquent taxpayer's property would be an available defense, the Second Circuit ruled that claiming payments to be draws did not constitute this defense. While the Code Section 6331(e) does not define "salary or wages," Treas. Reg. 301.6331-1(b)(1) defines "salary and wages" to include "compensation for services paid in the form of fees, commissions, bonuses, and similar items."

The Second Circuit ruled that the draws constituted "compensation for services" under the Regulation. Thus the law firm was liable for the levy and the 50% penalty for failing to comply with the levy.