Still Undefeated Against Department of Justice

June 27, 2015 in Tax News

In most court cases concerning federal tax matters, the Department of Justice does not represent the Government. That’s because those cases take place in Tax Court, where the IRS represents itself. Only when a taxpayer first pays up, then sues for a refund, or when a case goes up on appeal, does DOJ take over. Those situations don’t arise very frequently. So I may not be alone as a tax lawyer having only had a few cases against DOJ, and even fewer resulting in an actual court opinion.

And, happy to say, I’m still undefeated, a proud 2-0 after a recent victory. In May v. United States, 115 AFTR 2d 2015-827 (D.C. Ariz. 2015), the Federal District Court for the District of Arizona ruled that the assessment of a penalty against the taxpayer was untimely under the applicable statute of limitations. The case was one of first impression. It was decided on a motion for summary judgment

In my humble opinion, the court got this one exactly right, and it would have been a travesty had it gone the other way. The statute of limitation in question, Internal Revenue Code Section 6501(c)(10), extends the otherwise applicable statute of limitations with respect to liabilities arising from certain transactions until one year from the date information related to the transaction is furnished to the IRS. In this case, the IRS agent auditing the taxpayer’s return asked for and received all the necessary information and was fully prepared to make the assessment, but the IRS nonetheless waited about two years to actually assess the penalty. In defending against the suit for a refund, the Department of Justice claimed that the information the IRS requested, received and acted upon should not be considered “furnished” to it because it was not placed on a certain IRS form. Thus, according to DOJ, the one-year period of Section 6501(c)(10) never commenced to run. It was a hollow argument, and the court appropriately rejected it.

When In Doubt Regarding the IRS, Don’t Sign

July 13, 2014 in Tax News

I’ve recently had three different clients ask me for a second opinion on an IRS situation because they had doubts about their tax position. Turned out in all cases their doubts were well founded. In two of the cases, the clients signed with the IRS first, then consulted me. In the third, the client consulted first. Check out how much better the third client fared:

Client 1 had been audited by the IRS. The agent proposed a tax increase of several hundred thousand dollars. Under pressure from a tax return preparer he had hired to assist him in the audit, the client signed off on the changes made by the agent. Did he give up his rights completely? No. He could still seek a refund. But he would have to pay the tax first, which he has not been able to do. Until he can, the IRS can exercise its enforcement power to collect the tax, even though a large portion of it likely isn’t owed. Had he not signed off on the audit, he could be fighting the issue in Tax Court, before having to pay the tax.

Client 2 signed her tax return, as prepared by her return preparer, and filed, even though she was not comfortable with the tax liability reflected. When she mentioned this to me at a meeting on an entirely different matter, I ultimately concluded that she’d failed to claim a substantial loss. She amended her tax return to claim the loss. But amended returns are scrutinized more closely than original returns. Her amended return was audited. Although the IRS allowed the loss, it made unfavorable changes to other items on the return.

Client 3 thought her tax return wasn’t quite correct. Before filing, she asked me to take a look. I found a mistake in the treatment of the foreclosure on her house. The return was corrected, with a substantial tax savings.

The bottom line: If you are in doubt regarding an IRS matter, get your questions answered before you sign.

2012: A Challenging Year for Year-End Tax Planning

November 15, 2012 in Tax News

Year-end tax planning in 2012 will be more difficult than in prior years. Ordinarily, the objective at year-end is to accelerate deductions and postpone income, with the idea being to defer, but probably not avoid, tax.

But 2012 is different, for several reasons. First, there is a likelihood at this point that income tax rates will increase for high-income taxpayers. Second, the preferential rate on long-term capital gains likely will increase and the preferential rate on dividends may disappear entirely. Third, there are tax provisions in the Affordable Care Act that will subject additional income to the Medicare tax. Specifically, wages in excess of $250,000 for a married couple will be subject to an additional .9% Medicare tax and investment income will be subject to a 3.8% Medicare tax to the extent it causes adjusted gross income to exceed a specified threshold ($250,000 for married taxpayers filing jointly).

So, if you’re a high income taxpayer, is the game plan in 2012 to accelerate income and delay deductions? Yes, but not entirely yes. Remember the rules that limited itemized deductions? Those may be returning. In addition, Congress is looking at limitations on the total amount of itemized deductions. Thus, itemized deduction may be worth more in 2012 than it will be in 2013.

As if all that were not complicated enough, there are looming changes in the estate and gift tax rules, the details of which are less predictable than the changes to the income tax rules. Currently, a married couple may pass up to $10 Million free of estate tax to the next generation, with the excess subject to tax at a 35% rate. In the absence of new legislation, the so-called exemption will decrease to $2 Million for a married couple, with the excess subject to tax at a maximum rate of 55%. Ultimately, the exemption amount could land anywhere in between. My guess is that it will land at $7 Million for a married couple, with the excess taxable at 45%. How does all this translate? First, if you have a large estate, see your estate planner immediately to determine whether any action should be taken before 2013.

Second, if you’re not a high income taxpayer ($250,000 of adjusted gross income for a married couple filing jointly, $200,000 of adjusted gross income for a single person), relax. There’s probably just not that much at stake. Yes, there’s a chance that total gridlock in Congress will cause your rates to increase back to pre-2001 levels, but there’s no way to quantify that risk and the effect would not be overwhelming. If you expect to make substantially more in 2013 than 2012, you may want to accelerate income into 2012 to even things out, but going beyond that point could prove to be a bad play. These general rules don’t apply to everyone. For example, if you’re considering converting a traditional IRA to a Roth IRA, 2012 may be the optimal time. If you have unrealized gains in investment assets, it may make sense to accelerate those gains. Even though the increased rates largely are limited to high income taxpayers, the increased rates on capital gains likely will apply to all taxpayers.

Third, if you are a high income taxpayer, you should get together with your tax advisor and consider whether there are opportunities to accelerate income. For example, if you have appreciated stocks, you could sell them and buy them back, thereby triggering the gain (the wash sale rules do not apply to gains). This could you save you 8.8% in tax (15% capital gains rate, as compared to 20% capital gains rate plus 3.8% Medicare tax). There may be various other opportunities to accelerate income (or delay deductions). Among the most common are:

  • Accelerating January bonus compensation to December
  • Maximizing retirement distributions
  • Converting Roth IRAs
  • Triggering unrecognized installment sale income
  • Accelerate billing and collection of business income
  • Declaring special dividends from closely held corporations
  • Postponing mortgage payments
  • Postponing state income tax payments

If your income in 2013 is likely to exceed $380,000, this planning may be especially important. At that level, your marginal income tax rate in 2013 could be 4.6 percentage points higher, and you will be subject to the additional Medicare tax as well. At a minimum, your overall rate increase will exceed 5 percentage points and, on some types of income, it could be exceed 8 percentage points.

This post only touches upon some of the tax law changes that will occur at the end of the year. There are others, and it is quite possible new legislation may be enacted late this year or early next. Thus, the analysis in this post is not intended to be exhaustive. It is general in nature and is not intended as legal advice.

Positive Developments in the Tax World

July 12, 2012 in Tax News

New IRS Fresh Start Program a Huge Help to Struggling Taxpayers

In May, the IRS rolled out new features to its “Fresh Start” program that will allow thousands of taxpayers to clear up their tax problems and move on. Under the new program, taxpayers who previously could not qualify for relief will be able to resolve their tax debts in two years or less, and often for a fraction of the outstanding liability.

This is an outstanding development for taxpayers struggling with back tax liabilities.

The centerpiece of the new program is a dramatic change in the evaluation of offers in compromise, which essentially are offers by taxpayers to satisfy their tax liabilities in full for an amount based on the income they’ll have available after payment of necessary living expenses. Previously, the IRS sought a payment based on four or five years’ worth of available income. Under the new rules, however, the IRS will seek payments based on only two years’ worth of available income and, if a taxpayer can obtain the funds to pay immediately, only one year’s worth of available income. The new program also increases the amounts allowable for various living expenses in determining a taxpayer’s income available to pay tax, and also allows delinquent state tax liabilities to be taken into account.

Anybody struggling to pay back taxes should explore the possibility of filing an offer in compromise under the IRS Fresh Start program.

All-Time Low IRS Minimum Interest Rates Create Rare Planning Opportunities

Many tax planning strategies, especially estate tax planning strategies, involve loans between family members or trusts for their benefit. Such loans typically must carry an interest rate at least equal to the “applicable federal rate,” or AFR, to be respected for tax purposes. Often, the benefit the strategy offers increases as the AFR decreases.

The AFR just reached an all-time low. For example, on a nine year loan, the minimum interest rate is less than one percent per year — .92%.

Because the AFR currently is so low, several estate tax planning strategies could work exceptionally well if you’re concerned about the future of the estate tax after the 2012 election. If you’re seeking to fulfill charitable objectives in a tax-advantaged manner, this might be your golden opportunity to do so.

Welcome

November 13, 2010 in Tax News

As a business and tax attorney serving Arizona for over 30 years, the philosophy behind my legal practice has remained constant. I maintain the highest level of responsiveness to my clients’ needs, solve legal problems in the most cost-effective, yet creative manner and take on no more work than I can do well.

My practice emphasizes:

  • Tax Disputes
  • Estate Planning
  • Business Planning and Transactions
  • Business succession planning
  • Formations of corporations, partnerships and limited liability companies
  • Business acquisitions and sales
  • Taxation of real estate transactions
  • Probate
  • Individual, partnership, limited liability company and corporate taxation
  • Tax exempt organizations

Although I’m a solo practitioner, my network of lawyers with complimentary areas of expertise is extensive. Through those affiliations, my clients often are able to obtain the same breadth of expertise as they would with a large firm, but with the personal touch and attentiveness of a small firm with a client-centered environment.

Lawyer Robert Lord | Lawyer Tax

Coping with Changes and Uncertainty in the Estate Tax

November 3, 2010 in Tax News

As most people have heard, the Federal Estate and Gift Tax Code is scheduled to change dramatically over the next several years. Under current law, each individual may pass up to $1,000,000 of wealth free of federal estate or gift tax to the next generation. That amount, the “exemption equivalent,” is scheduled to increase to $1,500,000 in 2004, then gradually increase further to $3,500,000 in 2009. In the year 2010, the estate tax is scheduled to be repealed, only to return in 2011, with an exemption equivalent of only $1,000,000. Undoubtedly, further changes will be made. Without further changes, the dilemma facing wealthy octogenarians in the year 2010 would be too unpleasant even for Congress to tolerate.

In light of the recent changes, and the uncertainties regarding the future direction of the federal estate and gift tax system, the question arises which estate and gift tax planning vehicles should you still consider and which vehicles no longer are viable? Do irrevocable life insurance trusts still make sense? How about family limited partnerships and limited liability companies? Are charitable remainder trusts as tax efficient as they used to be? This article discusses the ongoing viability of the traditional various tools used in the estate and gift tax planning process. As discussed below, the viability of some of those tools is unchanged by modifications in the tax law. The effectiveness of some of those tools, however, has been reduced sharply. In some circumstances, tools used for years by estate planners actually could result in increased tax liability.

The Traditional “A-B” or “Credit Shelter” Trust. The good news here is that the A-B or credit shelter trust generally still works, although it could prove unnecessary if the repeal of the estate tax scheduled for the year 2010 is made permanent. Prior to repeal of the estate tax, however, your use of an A-B trust to allow you to double up on your and your spouse’s exemption equivalents remains an important objective in the estate planning process.

If you have an A-B living trust from several years ago, it likely still works. It is important, however, to review the language of older A-B trusts. Some of those trusts refer to the dollar amount of the exemption equivalent at the time the trust was drafted. Trusts drafted in that manner may be deficient and they may prevent you from fully using the recent increase in the exemption equivalent.

Note also that the increase in the exemption equivalent could interfere with your non-tax concerns. For example, if you have structured your plan to allow children from a prior marriage to inherit the exemption equivalent immediately from you upon your death, rather than at the time of your spouse’s death, the scheduled increase in the exemption equivalent could cause a much larger share of your estate to pass to those children and a correspondingly smaller share of your estate to your spouse.

Charitable Remainder Trusts. The attractiveness of charitable remainder trusts certainly has diminished as a result of recent changes in the tax law. In the typical charitable remainder trust, you would contribute appreciated assets to a trust, retaining a lifetime interest in the trust and assigning the remainder interest in the trust to your children. The principal tax advantage to you would be the avoidance of capital gains tax upon the sale of appreciated assets contributed to the trust. The economic disadvantage of the charitable remainder trust to you would be the gifting of a remainder interest in the contributed assets to charity. Under current law, that disadvantage would be mitigated by the reduction in your estate tax liability resulting from the removal of the contributed assets from your estate.

Recent changes in the tax law have reduced the tax advantage of the charitable remainder trust and, at the same time, increased, or at least potentially increased, the economic disadvantage. Because the maximum rate for long-term capital gains has decreased, the value of avoiding tax on the sale of appreciated assets by a charitable remainder trust also has decreased. Because the exemption equivalent is scheduled to increase in future years and because the estate tax may be repealed entirely, the after tax “cost” of leaving a remainder interest to charity has increased.

Prior to the changes in the tax law, the tax benefit would be sufficient to warrant your consideration of a charitable remainder trust even if you had only modest charitable intent. In other words, the decision to establish a charitable remainder trust often had both a tax avoidance and a philanthropic component. Now, the charitable remainder trust should be considered only if philanthropy is your overriding objective. In other words, if you plan to leave money to charity anyhow, the charitable remainder trust may still be worthy of consideration. Otherwise, it probably is not.

Irrevocable Life Insurance Trusts. The irrevocable life insurance trust remains a viable tax planning vehicle. By having a life insurance policy held in an irrevocable trust, you are able to exclude the death benefit on the policy from your taxable estate. If the estate tax remains in place, the irrevocable life insurance trust may serve to reduce your ultimate estate tax liability. If the estate tax is repealed or if the exemption equivalent is raised to the point where your estate will not be taxable, the irrevocable life insurance trust would prove unnecessary. However, it would not result in any detriment to your situation. Thus, the only real factor to consider before establishing an irrevocable life insurance trust is cost. Any potential tax savings, however, is likely to outweigh the cost of establishing an irrevocable life insurance trust.

Qualified Personal Residence Trusts and Grantor Retained Annuity Trusts. The qualified personal residence trust and the grantor retained annuity trust both involve the use of the time value of money to generate a tax benefit. In a qualified personal residence trust, you contribute your personal residence to a trust and retain the right to use the residence for a period of years, with the remainder interest in the trust ultimately passing to your children. The grantor retained annuity trust is similarly structured except the asset contributed to the trust is something other than your personal residence and, instead of the right to use a residence, you retain an annuity payout over a term of years, with the remainder interest passing to your children after the expiration of that term. Under both structures, you are treated as having made a gift of the present value of the remainder interest. So, for example, if your house were worth $500,000 and you retained the right to live in the house for twenty years, the value of the amount of the gift would be the amount which, if invested for twenty years at the current market rate of return, would be worth $500,000.

Prior to the recent change in the tax law, the principal disadvantage of charitable remainder trusts and grantor retained annuity trusts was their complexity. Otherwise, if your estate were large enough, they represented powerful estate tax planning vehicles, with limited downside risk.

The potential repeal of the estate tax dramatically alters the equation regarding qualified personal residence trusts and grantor retained annuity trusts. If the estate tax is repealed, qualified personal residence trusts and grantor retained annuity trusts will not give rise to any tax benefit. However, they may give rise to an income tax detriment. Generally, your children may sell assets you leave to them in your estate without paying capital gains tax on the appreciation that occurred prior to the date of your death. That is because the cost basis of those assets is “stepped-up” to their fair market values as of the date of your death. If assets are contributed to a qualified personal residence trust or a grantor retained annuity trust, however, your death will not eliminate the capital gains tax to be paid upon the sale of those assets. Thus, qualified personal residence trusts and grantor retained annuity trusts have an income tax disadvantage associated with them. Prior to the recent changes in the tax law, that income tax disadvantage was more than overcome by an estate tax savings. With the possibility that the estate tax will be repealed entirely, however, that no longer is the case. Thus, it is quite possible that the establishment of a qualified personal residence trust or grantor retained annuity trust ultimately could result in a net tax disadvantage to you.

This is not to suggest that there will be no situations that warrant the use of a qualified personal residence trust or grantor retained annuity trust. However, there now is a real risk that such a trust could cost you tax-wise depending on how the estate tax ultimately is resolved. Thus, you should carefully consider this before going forward.

Family Limited Partnerships and Limited Liability Companies. The family limited partnership or limited liability company uses the illiquidity and lack of control associated with a limited partnership or limited liability company interest to create a discount in the value of stated assets, thereby reducing the ultimate estate tax liability. For example, if you contribute $1,000,000 worth of real estate to a family limited partnership and take back a 99% limited partnership interest along with a 1% general partnership interest, the limited partnership may be valued as low as $500,000 for estate tax purposes. Recently, however, the IRS has had several court victories in which they have challenged the tax treatment of family limited partnerships and limited liability companies. Nevertheless, they remain as viable planning vehicles under today’s tax law.

Family limited partnerships and limited liability companies have the same potential disadvantage associated with them as qualified personal residence trusts and grantor retained annuity trusts. That is, if the estate tax is repealed, the estate tax benefit associated with family limited partnerships and limited liability companies will be lost. At that point, it will be the IRS that will be arguing for a discount in the value of family limited partnership and limited liability company interests, in order to limit the step up in basis. The greater the discount, the more capital gains tax that ultimately will be paid upon the sale of assets contributed to a family limited partnership or limited liability company.

The downside risk associated with the family limited partnership or limited liability company, however, is not nearly as great as the downside risk associated with the qualified personal residence trust or grantor retained annuity trust. That is because the establishment of a family limited partnership or a limited liability company essentially can be reversed simply by liquidating the entity, whereas the qualified personal residence trust or grantor retained annuity trust, once created, cannot easily be undone. Thus, if a family limited partnership or limited liability company could save you significant estate tax dollars under today’s law, it still makes sense to move forward with your planning. If the repeal of the estate tax is made permanent, you may have to liquidate the partnership or limited liability company. You will have been inconvenienced and have paid some unnecessary costs, but will not have lost out tax-wise.

This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.

Choosing You Real Estate Ownership Vehicle

August 19, 2004 in Tax News

On too many occasions, I have been asked by clients to help them solve problems attributable to the vehicle through which they chose to acquire real estate. Although sometimes such problems can be mitigated, there certainly is no substitute for good front-end planning. This article discusses a few of the many situations where choosing the right ownership vehicle at the time of purchase can prove beneficial when real estate is sold.

Ownership of Real Estate Used in a Business. With the recent rise in the popularity of office condominiums, ownership of real estate by business owners certainly has increased, perhaps dramatically. It is important, therefore, to be aware of a very common tax planning mistake often made by business owners who acquire real estate.

Here is the situation: John Smith operates his business through a corporation, Smith, Inc. John locates the ideal building for his business and causes Smith, Inc., to purchase the building. The business thrives and the building triples in value. John allows his key employee, Carl, to become a shareholder in Smith, Inc. At some point, a potential buyer makes a very attractive offer to purchase the building. John and Carl now face a difficult tax situation. Smith, Inc., will be required to pay tax, at regular corporate rates, on the gain from the sale. If, after paying its corporate income tax, Smith, Inc., distributes the remaining sales proceeds, John and Carl will be required to pay tax on the distributions they receive, this time at long-term capital gain rates. The combined corporate and individual tax rate for John and Carl likely will exceed forty percent.

What could John have done differently? If John had purchased the building through a limited liability company, he then could have caused the limited liability company to rent the building to Smith, Inc., with the following advantages: First, and foremost, the effective tax rate upon the sale of the building would be dramatically lower. Second, the rent paid by Smith, Inc., would reduce its taxable income, thereby decreasing the need to pay compensation to John and Carl in order to avoid corporate level tax. Although the rental income received by the LLC would be taxable to John and Carl, rental income, unlike compensation, is not subject to Social Security or Medicare tax. Third, at the time John chose to allow Carl to become an owner in the business, he would have had the flexibility to retain 100% ownership of the building. That could prove especially valuable for retirement planning purposes. Fourth, if the business subsequently floundered, creditors of Smith, Inc., generally would not be able to seize the building in order to satisfy their claims, as they could if the building were owned by Smith, Inc.

Joint Tenancy With Right of Survivorship? In many Arizona real estate transactions, it seems, married couples take title as joint tenants with the right of survivorship. Almost always, that is not the best choice tax wise. When a married couple owns real property as joint tenants, it is assumed that each spouse owns his or her joint tenancy interest as sole and separate property. Under current estate tax law, the cost basis of property owned by an individual is “stepped up” to fair market value upon the individual’s death. In other words, the unrealized gain on the property effectively is eliminated. This gain elimination applies not only to an individual’s sole and separate property, but also to community property in which the individual has an interest. Thus, by titling property in joint tenancy rather than as community property, a married couple may forfeit the ability to achieve complete elimination of capital gain upon the first of their deaths.

Here is an example of how this works: Suppose husband (H) and wife (W) purchase a rental property for $200,000. In the years preceding his death, H and W claim $100,000 of depreciation on the property. At the time H dies, the property has a value of $400,000 and an adjusted cost basis of $100,000. If the property were titled as community property or community property with right of survivorship, the entire $300,000 gain would be eliminated upon H’s death. If H and W took title to the property as joint tenants with right of survivorship, however, only $150,000 of gain would be eliminated upon H’s death.

Anticipating the Future Like-Kind Exchange. Ordinarily, when two or more individuals purchase investment real estate, they choose to own the real estate through a limited liability company or partnership. For the most part, that is perfectly appropriate. There is one potential pitfall to be considered, however. If it is possible that upon the ultimate sale of the investment real estate, some of the owners would desire to enter into like-kind exchanges, whereas others would desire to cash out, the limited liability company or partnership could be problematical. For example, suppose George and Henry each contribute $100,000 to a limited liability company that purchases an investment property for $200,000. After the property has doubled in value to $400,000, George and Henry decide to sell. George desires to reinvest his share of the proceeds through a like-kind exchange, whereas Henry desires to cash out. If the limited liability company sells the property and distributes $200,000 to Henry, however, the entire gain now is taxable, even if the remaining $200,000 is reinvested.

Here’s an alternative: George and Henry simply take title to the property as tenants in common. When it comes time to sell, each can sell his tenancy in common interest to the buyer. George can enter into a like-kind exchange and defer up to 100% of his share of the gain. Henry can cash out and recognize his share of the gain. A word of caution: The IRS may treat tenants in common as having formed a partnership for income tax purposes. You, therefore, should consult your tax advisor before employing this structure.

Conclusion. When purchasing real estate, the choice of ownership vehicle should be considered carefully. The best ownership vehicle is not necessarily the one that is most easily implemented at the time of purchase. Rather, it is the vehicle that will yield the best results while the property is operated and when it ultimately is sold.

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This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.