Monday, August 13, 2018
As a result of the Tax Cuts and Jobs Act (TCJA), for tax years beginning after 2017 and before 2026, a non C corporate business owner as well as an owner of an interest in a pass-through entity is entitled to a deduction of 20% of the taxpayer’s share of qualified business income (QBI) associated with the conduct of a trade or business in the United States. I.R.C. 199A. The QBID replaces the DPAD, which applied for tax years beginning after 2004. The TCJA repealed the DPAD for tax years beginning after 2017.
The basic idea behind the provision was to provide a benefit to pass-through businesses and sole proprietorships that can’t take advantage of the lower 21 percent corporate tax rate under the TCJA that took effect for tax years beginning after 2017 (on a permanent basis). The QBID also applies to agricultural/horticultural cooperatives and their patrons.
Last week, the Treasury issued proposed regulations on the QBID except as applied to agricultural/horticultural cooperatives. That guidance is to come later this fall. The proposed regulations did not address how the QBID applies to cooper
The proposed regulations for the QBID – that the topic of today’s post.
The QBI deduction (QBID) is subject to various limitations based on whether the entity is engaged manufacturing, producing, growing or extracting qualified property, or engaged in certain specified services (known as a specified service trade or business (SSSB)), or based on the amount of wages paid or “qualified property” (QP) that the business holds. These limitations apply once the taxpayer’s taxable income exceeds a threshold based on filing status. Once the applicable threshold is exceeded the business must clear a wages threshold or a wages and qualified property threshold.
Note: If the wages or wages/QP threshold isn’t satisfied for such higher-income businesses, the QBID could be diminished or eliminated.
What is the wage or wage/QP hurdle? For farmers and ranchers (and other taxpayers) with taxable income over $315,000 (MFJ) or $157,500 (other filing statuses), the QBID is capped at 50 percent of W-2 wages or 25 percent of W-2 wages associated with the business plus 2.5 percent of the “unadjusted basis immediately after acquisition” (UBIA) of all QP. But those limitations don’t apply if the applicable taxable income threshold is not met. In addition, the QBID is phased out once taxable income reaches $415,000 (MFJ) or $207,500 (all others).
On August 8, the Treasury issued proposed regulations on the QBID. Guidance was needed in many areas. For example, questions existed with respect to the treatment of rents; aggregation of multiple business activities; the impact on trusts; and the definition of a trade or business, among other issues. The proposed regulations answered some questions, left some unanswered and raised other questions.
Rental activities. One of the big issues for farmers and ranchers operating as sole proprietorships or as a pass-through entity is whether land rental income constitutes QBI. The proposed regulations do confirm that real estate leasing activities can qualify for the QBID without regard to whether the lessor participates significantly in the activity. That’s the case if the rental is between “commonly controlled” entities – defined as common ownership of 50 percent or more in each entity (e.g., between related parties). This part of the proposed regulations is generous to taxpayers, and will be useful for many rental activities. It’s also aided by the use of I.R.C. §162 for the definition of a “trade or business” as opposed to, for example, the passive loss rules of I.R.C. §469.
But, the proposed regulations may also mean that the income a landlord receives from leasing land to an unrelated party (or parties) under a cash lease or non-material participation share lease may not qualify for the QBID. If that latter situation is correct it could mean that the landlord must pay self-employment tax on the lease income associated with a lease to an unrelated party (or parties) to qualify the lease income for the QBID.
The proposed regulations use an example or a rental of bare land that doesn’t require any cost on the landlord’s part. This seems to imply that the rental of bare land to an unrelated third party qualifies as a trade or business. There is another example in the proposed regulations that also seems to support this conclusion. Apparently, this means that a landlord’s income from passive triple net leases (a lease where the lessee agrees to pay all real estate taxes, building insurance, and maintenance on the property in addition to any normal fees that are expected under the agreement) should qualify for the QBID. But, existing caselaw is generally not friendly to triple net leases being a business under I.R.C. §162. That means it may be crucial to be able to aggregate (group) those activities together.
Unfortunately, the existing caselaw doesn’t discuss the issue of ownership when it is through separate entities and, on this point, the Preamble to the proposed regulations creates confusion. The Preamble says that it's common for a taxpayer to conduct a trade or business through multiple entities for legal or other non-tax reasons, and also states that if the taxpayer meets the common ownership test that activity will be deemed to be a trade or business in accordance with I.R.C. §162. But, the Preamble also states that "in most cases, a trade or business cannot be conducted through more than one entity.” So, if a taxpayer has several rental activities that the taxpayer manages, does that mean that those separate rental activities can’t be aggregated (discussed below) unless each rental activity is a trade or business? If the Treasury is going to be making the trade or business determination on an entity-by-entity basis, triple net leases might be problematic.
Perhaps the final regulations will clarify whether rentals, regardless of the lease terms, will be treated as a trade or business (and can be aggregated).
Aggregation of activities. Farmers and ranchers often utilize more than a single entity for tax as well as estate and business planning reasons. The common technique is to place land into some form of non C corporate entity (or own it individually) and lease that land to the operating entity. For example, many large farming and ranching operations have been structured to have multiple limited liability companies (LLCs) with each LLC owning different tracts of land. These operations typically have an S corporation or some other type of business entity that owns the operating assets that are used in the farming operation. It appears that these entities can be grouped under the aggregation rule. For QBID purposes (specifically, for purposes of the wages and qualified property limitations) the proposed regulations allow an election to be made to aggregate (group) those separate entities. Thus, the rental income can be combined with the income from the farming/ranching operation for purposes of the QBID computation. Grouping allows wages and QP to also be aggregated and a single computation used for purposes of the QBID (eligibility and amount). In addition, taxpayers can allocate W2 wages to the appropriate entity that employs the employee under common law.
Note: The wages and QP from any trade or business that produces net negative QBI is not taken into account and is not carried over to a later year. The taxpayer has to offset the QBI attributable to each trade or business that produced net positive QBI.
Without aggregation, the taxpayer must compute W-2 wages for each trade or business, even if there is more than one within a single corporation or partnership. That means a taxpayer must find a way to allocate a single payroll across different lines.
To be able to aggregate businesses, they must meet several requirements, but the primary one is that the same person or group of persons must either directly or indirectly own 50 percent or more of each trade or business. For purposes of the 50 percent test, a family attribution rule applies that includes a spouse, children, grandchildren and parents of the taxpayer. However, siblings, uncles, and aunts, etc., are not within the family attribution rule. To illustrate the rule, for example, the parents and a child could own a majority interest in three separate businesses and all three of those businesses could be aggregated. But, the bar on siblings, etc., counting as "family" is a harsh rule for agricultural operations in particular. Perhaps the final regulations will modify the definition of "family."
Note: A ”group of persons” can consist of unrelated persons. It is important that the “group” meet the 50 percent test. It is immaterial that no person in the group meets the 50 percent test individually.
Common ownership is not all that is necessary to be able to group separate trade or business activities. The businesses to be grouped must provide goods or services that are the same or are customarily offered together; there must be significant centralized business elements; and the businesses must operate in coordination with or reliance upon one another. Meeting this three-part test should not be problematic for most farming/ranching operations, but there is enough "wiggle room" in those definitions for the IRS to create potential issues.
Once a taxpayer chooses to aggregate multiple businesses, the businesses must be aggregated for all subsequent tax years and must be consistently reported. The only exception is if there is a change in the facts and circumstances such that the aggregation no longer qualifies under the rules. So, disaggregation is generally not allowed, unless the facts and circumstances changes such that the aggregation rules no longer apply.
Losses. If a taxpayer’s business shows a loss for the tax year, the taxpayer cannot claim a QBID and the loss carries forward to the next tax year where it becomes a separate item of QBI. If the taxpayer has multiple businesses (such as a multiple entity farming operation, for example), the proposed regulations require a loss from one entity (or multiple entities) to be netted against the income from the other entity (or entities). If the taxpayer’s income is over the applicable threshold, the netting works in an interesting way. For example, if a farmer shows positive income on Schedule F and a Schedule C loss, the Schedule C loss will reduce the Schedule F income. The farmer’s QBID will be 20 percent of the resulting Schedule F income limited by the qualified wages, or qualified wages and the QP limitation. Of course, the farmer may be able to aggregate the Schedule F and Schedule C businesses and would want to do so if it would result in a greater QBID.
Note: A QBI loss must be taken and allocated against the other QBI income even if the loss entity is not aggregated. However, wages and QP are not aggregated.
If the taxpayer had a carryover loss from a pre-2018 tax year, that loss is not taken into account when computing income that qualifies for the QBID. This can be a big issue if a taxpayer had a passive loss in a prior year that is suspended. That's another taxpayer unfriendly aspect of the proposed regulations.
Trusts. For trusts and their beneficiaries, the QBID can apply if the $157,500 threshold is not exceeded irrespective of whether the trust pays qualified wages or has QP. But, that threshold appears to apply cumulatively to all trust income, including the trust income that is distributed to trust beneficiaries. In other words, the proposed regulations limit the effectiveness of utilizing trusts by including trust distributions in the trust’s taxable income for the year for purposes of the $157,500 limitation. Prop. Treas. Reg. §1.199A-6(d)(3)(iii). This is another taxpayer unfriendly aspect of the proposed regulations.
Based on the Treasury's position, it will likely be more beneficial for parents, for example, for estate planning purposes, to create multiple trusts for their children rather than a single trust that names each of them as beneficiaries. The separate trusts will be separately taxed. The use of trusts can be of particular use when the parents can't utilize the QBID due to the income limitation (in other words, their income exceeds $415,000). The trusts can be structured to qualify for the QBID, even though the parents would not be eligible for the QBID because of their high income. However, the proposed regulations state that, “Trusts formed or funded with a significant purpose of receiving a deduction under I.R.C. §199A will not be respected for purposes of I.R.C. §199A.” Again, that's a harsh, anti-taxpayer position that the proposed regulations take.
Under I.R.C. §643(f) the IRS can treat two or more trusts as a single trust if they are formed by substantially the same grantor and have substantially the same primary beneficiaries, and are formed for the principle purpose of avoiding income taxes. Does the statement in the proposed regulations referenced above mean that the Treasury is ignoring the three-part test of the statute? By itself, that would seem to be the case. However, near the end of the proposed regulations, there is a statement reciting the three-part test of I.R.C. §643(f). Prop. Treas. Reg. §1.643(f)-1). Hopefully, that means that any trust that has a reasonable estate/business planning purpose will be respected for QBID purposes, and that multiple trusts will not be aggregated that satisfy I.R.C. §643(f). Time will tell what the IRS position on this will be.
Unfortunately, the proposed regulations do not address how the QBID is to apply (or not apply) to charitable remainder trusts.
Here are a few other observations from the proposed regulations:
- Guaranteed payments in a partnership and reasonable compensation in an S corporation are not qualified wages for QBID purposes.
- Inherited property that the heir immediately places in service gets a fair market value as of date of death basis, but the proposed regulations don’t mention whether this resets the property’s depreciation period for QP purposes (as part of the 2.5 percent computation).
- For purposes of the QP computation, the 2.5 percent is multiplied by the depreciated basis of the asset on the day it is transferred to an S corporation, for example, but it’s holding period starts on the day it was first used for the business before it is transferred.
- A partnership’s I.R.C. §743(b) adjustment does not count for QP purposes. In other words, the adjustment does not add to UBIA. Thus, the inheritance of a fully depreciated building does not result in having any QP against which the 2.5 percent computation can be applied. That's a harsh rule from a taxpayer's standpoint.
- R.C. §1231 gains are not QBI. But, any portion of an I.R.C. §1231 gain that is taxed as ordinary income will qualify as QBI.
- Preferred allocations of partnership income will not qualify as QBI to the extent the allocation is for services. This forecloses a planning opportunity that could have been achieved by modifying a partnership agreement to provide for such allocations.
The proposed regulations are now subject to a 45-day comment period with a public hearing to occur in mid-October. The proposed rules do not have the force of law, but they can be relied on as guidance until final regulations are issued. From a practice standpoint, rely on the statutory language when it is more favorable to a client than the position the Treasury has taken in the proposed regulations.
Numerous questions remain and will need to be clarified in the final regulations. The Treasury will be hearing from the tax section of the American Bar Association, the American Institute of CPAs, other tax professionals and other interested parties. Hopefully, some of the taxpayer unfavorable positions taken in the proposed regulations can be softened a bit in the final regulations. In addition, it would be nice to get some guidance on how the rules will apply to cooperatives and their patrons.
Also, this post did not exhaust all of the issues addressed in the proposed regulations, just the one that are most likely to apply to farming and ranching businesses. For example, a separate dimension of the proposed regulations deals with “specialized service businesses.” That was not addressed.
Tuesday, July 24, 2018
For many people, the most important estate planning document is the will (or trust) that disposes of property at the time of death. Assets that pass by will are subject to probate and are known as “probate assets.” But, a decedent’s estate may also have “non-probate assets.” Those are assets that are not subject to the probate court’s jurisdiction and pass by a contractual beneficiary designation. These contractual arrangements include life insurance, pensions, IRAs and annuities.
For married couples, one spouse typically names the other spouse as the beneficiary of these non-probate assets. But, what if one spouse names the other as the beneficiary of a non-probate contractual arrangement and divorce occurs and the beneficiary designation is not changed? Does the beneficiary-spouse remain the beneficiary, or is that designation automatically revoked? Can the law automatically remove the former spouse as beneficiary? How does the Constitution’s Contracts Clause factor into this?
That’s the topic of today’s post – beneficiary changes upon divorce.
The Contracts Clause
Article I, Section 10, Clause 1 of the U.S. Constitution specifies that a state cannot enact legislation that disrupts contractual arrangements. That provision says that, “[n]o state shall…pass any…Law impairing the Obligation of Contracts.” Thus, while citizens have the right to enter into contracts that don’t violate “public policy,” the government cannot impair otherwise permissible contracts. But, what does that mean? Does it mean that a state can enact a law that changes the contractual beneficiary designation on a life insurance policy, for example? The issue recently came up in a case that made it all of the to the U.S. Supreme Court.
In Sveen v. Melin, 138 S. Ct. 1815 (2018), a couple married in 1997. In 1998, the husband bought a life insurance policy that named his wife as the primary beneficiary and his two children from a prior marriage as the contingent beneficiaries. In 2002, a new Minnesota law took effect providing that “the dissolution or annulment of a marriage revokes any revocable…beneficiary designation…made by an individual to the individual’s former spouse.” Minn. Stat. §524.2-804, subd.1. Thus, divorce automatically revokes the designation of a spouse as the beneficiary. That would cause the insurance proceeds to go to the contingent beneficiary or the policyholder’s estate upon death of the policyholder. If the policyholder does not want this result, the former spouse can be named as beneficiary (again). In 2007, the couple divorced and the former husband died in 2011 without changing the beneficiary designation. The deceased ex-husband’s children claimed that they were the beneficiaries of the life insurance proceeds. But, the surviving ex-spouse claimed that she was the beneficiary because the law did not exist at the time the policy was purchased and she was named the primary beneficiary. Her core argument was that the retroactive application of the law violated the Contracts Clause.
The U.S. Court of Appeals for the Eighth Circuit agreed with the surviving ex-spouse (Metro Life Insurance Co. v. Melin, 853 F.3d 410 (8th Cir. 2017), but the U.S. Supreme Court reversed. The Supreme Court noted that the Contracts Clause did not establish a complete prohibition against states from enacting laws that impacted pre-existing contracts. The Court noted that a two-step test existed form determining the constitutionality of such a law. Step one involves the question of whether the law “operated as a substantial impairment of a contractual relationship” based on the extent to which the law undermined the parties’ bargain, interfered with the parties’ reasonable expectations, and barred the parties from safeguarding their rights. If a contractual impairment is determined under step one, then the second step examines the means and ends of the legislation to determine whether the state law advances a significant and legitimate public purpose.
In Sveen, the Court held that the law did not substantially impair pre-existing contractual arrangements. The Court reasoned that the law was designed to reflect a policyholder’s intent based on an assumption that an ex-spouse would not be the desired primary beneficiary. In addition, the Court stated that an insured cannot reasonably rely on a beneficiary designation staying in place after a divorce – noting that divorce courts have wide discretion to divide property, including the revocation of spousal beneficiary designations in life insurance policies (or mandating that they remain). Accordingly, the Court concluded that a policyholder had no reliance interest in the policy in the event of divorce, and could undo the impact of the law by again naming the (now) ex-spouse as the primary beneficiary. The decedent’s children were held to be the primary beneficiaries of the policy.
Kansas, like other states, has an automatic revocation provision for wills upon divorce. Kan. Stat. Ann. §59-610. For non-probate assets with a beneficiary designation, in divorce actions judges are to include changes in beneficiary status as part of the property division between the spouses and note any change in the divorce decree. Kan. Stat. Ann. §2-2602(d). The policyholder remains responsible for actually changing the beneficiary designation. Id.
The Court’s conclusion expands the reach of the government into private contractual arrangements. It also assumes that all divorces are acrimonious and that a divorced policyholder would never want to benefit a former spouse. That's simply not true. What's more is that the Court upheld the Minnesota law even though it retroactively applied in the case at bar. If a statute that changes (rewrites) the primary beneficiary designation of a contract on a retroactive basis doesn’t substantially impair that contract, I don’t know what does. Judge Gorsuch seems to agree with that last point in his dissent.
How does your state law treat the issue?
Wednesday, July 18, 2018
Next month, Washburn Law School and Kansas State University (KSU) will team up for its annual symposium on agricultural law and the business of agriculture. The event will be held in Manhattan at the Kansas Farm Bureau headquarters. The symposium will be the first day of three days of continuing education on matters involving agricultural law and economics. The other two days will be the annual Risk and Profit Conference conducted by the KSU Department of Agricultural Economics. That event will be on the KSU campus in Manhattan. The three days provide an excellent opportunity for lawyers, CPAs, farmers and ranchers, agribusiness professionals and rural landowners to obtain continuing education on matters regarding agricultural law and economics.
This year’s symposium on August 15 will feature discussion and analysis of the new tax law, the Tax Cuts and Jobs Act, and its impact on individuals and businesses engaged in agriculture; farm and ranch financial distress legal issues and the procedures involved in resolving debtor/creditor disputes, including the use of mediation and Chapter 12 bankruptcy; farm policy issues at the state and federal level (including a discussion of the status of the 2018 Farm Bill); the leasing of water rights; an update on significant legal (and tax) developments in agricultural law (both federal and state); and an hour of ethics that will test participant’s negotiation skills.
The symposium can also be attended online. For a complete description of the sessions and how to register for either in-person or online attendance, click here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
Risk and Profit Conference
On August 16 and 17, the KSU Department of Agricultural Economics will conduct its annual Risk and Profit campus. The event will be held at the alumni center on the KSU campus, and will involve a day and a half of discussion of various topics related to the economics of the business of agriculture. One of the keynote speakers at the conference will be Ambassador Richard T. Crowder, an ag negotiator on a worldwide basis. The conference includes 22 breakout sessions on a wide range of topics, including two separate breakout sessions that I will be doing with Mark Dikeman of the KSU Farm Management Association on the new tax law. For a complete run down of the conference, click here: https://www.agmanager.info/risk-and-profit-conference
The two and one-half days of instruction is an opportunity is a great chance to gain insight into making your ag-related business more profitable from various aspects – legal, tax and economic. If you are a producer, agribusiness professional, or a professional in a service business (lawyer; tax professional; financial planner; or other related service business) you won’t want to miss these events in Manhattan. See you there, or online for Day 1.
July 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Tuesday, June 12, 2018
Normally, property is valued in a decedent's estate at its fair market value as of the date of the decedent's death. The Code and Treasury Regulations bear this our. See I.R.C. §1014). But, neither the Code nor the regulations rule out the possibility that post-death events can have a bearing on the value for assets in a decedent’s estate. The real question is what post-death events are relevant for determining the actual date-of-death value of property for estate tax purposes.
Post-death events and their impact on valuation, that’s the topic of today’s post.
Cases on the Valuation Issue
The cases reveal that consideration may be given to subsequent events that are reasonably foreseeable at the date of death. Those events have a bearing on date-of-death value.
Numerous cases illustrate that it is simply not true that, except for the alternate valuation election under I.R.C. §2032, changes in valuation after death are immaterial. The following cases are illustrative:
- In Gettysburg National Bank v. United States, 1:CV-90-1607, 1992 U.S. Dist. LEXIS 12152 (D. M.D. Pa. Jul. 17, 1992), property was sold to a third party in an arm’s length transaction 16 months after the decedent’s death (13 months after its appraisal for estate tax purposes) for less than 75 percent of the value at which it was included in the gross estate. The court allowed the estate to reduce its value, stating that the subsequent sale may be relevant evidence that the appraised fair market value was incorrect.
- In Estate of Scull v. Comr., C. Memo. 1994-211, sales of artwork at auction 10 months after the valuation date were the best indicators of fair market value for federal estate tax purposes notwithstanding that the market had changed in the interim, and the court applied a 15 percent discount to reflect appreciation in the market between the date of the decedent’s death and the auction.
- In Rubenstein v. United States, 826 F. Supp. 448 (S.D. Fla. 1993), the court determined that the best evidence of a claim’s value is the amount for which the claim was settled after the decedent’s death.
- In Estate of Andrews v. United States, 850 F. Supp. 1279 (E.D. Va. 1994), the court reasoned that reasonably foreseeable post-death facts relating to a publication contract under negotiation when the decedent died were germane to the determination of what a willing buyer would pay for the right to use the decedent’s name.
- In Estate of Necastro v. Comr., C. Memo. 1994-352, environmental contamination was discovered five years after the decedent’s death and the court allowed the estate to file a claim for refund, reducing the value from the value as reported, which was based on facts known at the date of death; the revaluation resulted in a reduction of over 33 percent from the value of the property determined before the contamination was discovered. The court’s opinion did not, however, address the substantive issue whether facts discovered after death may influence valuation if willing buyers and sellers would not have known the relevant facts as of the valuation date.
- In Estate of Jephson v. Comr., 81 T.C. 999 (1983), the court concluded that “[e]vents subsequent to the valuation date may, in certain circumstances, be considered in determining the value as of the valuation date.”
- In Estate of Keller v. Comr., C. Memo. 1980-450, the court stated that a “sale of property to an unrelated party shortly after date of death tends to establish such value at date of death. The property sold involved a farm and growing crop where both the sale of the farm and the harvesting of the crop occurred post-death.
- In Estate of Stanton, C. Memo. 1989-341, the court stated that the sale of the property shortly after death is the best evidence of fair market value. Under the facts of the case, the selling price of comparable property sold six months after the decedent’s death was also considered with a downward adjustment to reflect the greater development potential of the comparable property and the 10 months of appreciation that occurred after the decedent’s death in the actual estate property owned and sold.
- In Estate of Trompeter v. Comr., 279 F.3d 767 (9th Cir. 2002), the Tax Court was reversed for failing to sufficiently articulate the basis for its decision regarding omitted assets and the rationale for the valuation discount selected, but the court nevertheless considered the value of assets using post-death developments, including redemption for $1,000 per share of stock valued at $10 per share 16 months earlier, and a coin collection returned at roughly half the value subsequently assigned to it by the taxpayer’s estate in an effort to enjoin auction of that asset.
- In Morris v. Comr., 761 F.2d 1195 (6th Cir. 1985), the court considered speculative post-death commercial development events for purposes of valuing farmland in the decedent’s estate as of the date of the decedent’s death. The decedent’s farmland was approximately 15 miles north of downtown Kansas City and approximately five miles west of the Kansas City International Airport. At the time of death, plans were in place for a sewer line to service the larger of the two tracts the decedent owned. Also, residential development was planned within two miles of the same tract. In addition, significant roadways and the site for the planned construction of a major interstate were located close to the property. While none of these events had occurred as of the date of death, the court found them probative for determining the value of the farmland as of the date the decedent died. The decedent’s son, the owner of the farmland as surviving joint tenant, tried to introduce evidence of the failed closing of some post-death sales to support his claim that the post-death events were speculative. But, the court disagreed, establishing the value of the farmland at $990,000 rather than the estate’s valuation of $332,151.
The court’s opinion makes it look like that evidence to confirm an appraiser’s date-of-death prediction of future events is more likely to be received than evidence adduced to prove wrong an appraiser’s prediction concerning future events. In any event, however, the case stands for the proposition that post-death events are relevant for establishing death-time value – even if they are somewhat speculative.
- In Okerlund v. United States, 365 F.3d 1044 (Fed. Cir. 2004), the court dealt with the issue of stock valuation in a closely held company for stock that was gifted shortly before the company founder died and the company (a milk processing operation) suffered a salmonella outbreak. The taxpayers argued that these events should result in a lower gift tax value of the stock, with the issue being the relevance of post-death events on the value of the gifts. The court stated that “[i]t would be absurd to rule an arms-length stock sale made moments after a gift of that same stock inadmissible as post-valuation date data….The key to use of any data in a valuation remains that all evidence must be proffered in support of finding the value of the stock on the donative date.” The court ultimately affirmed the trial court’s denial of a lower gift tax valuation based on the reality that the risk factors (the founder’s death and matters that could materially affect the business) had already been accounted for in the valuation of the stock.
Clearly, post-death events and other facts that are reasonably predictable as of the date of death or otherwise relevant to the date of death value can serve as helpful evidence of value and allow either an increase (to obtain a higher income tax basis) or decrease (to reduce federal estate tax) in value as a matter or record. For farmland (and other real estate) the market is not static as of the date of death. Thus, appraisers can reasonably look to the arc of sales extending from pre-death dates to post-death dates in arriving at the date-of-death value.
Wednesday, May 23, 2018
The Tax Cuts and Jobs Act (TCJA) that was signed into law on December 22, 2017, represents a major change to many provisions of the tax Code that impact individuals and business entities. I have discussed of the major changes impacting farm and ranch taxpayers and businesses in prior posts. But, the TCJA also makes substantial changes with respect to the income taxation of trusts and estates. Those changes could have an impact on the use of trusts as an estate planning/wealth transfer device. Likewise, the TCJA changes that impact decedent’s estate must also be noted.
The TCJA’s changes that impact trusts and estates – that’s the focus of today’s post.
While the media has largely focused on the TCJA’s rate reductions for individuals and C corporations, the rates and bracket amounts were also modified for trusts and estates. The new rate structure for trusts and estates are located in I.R.C. §1(j)(2)(E) and are as follows: 10%: $0: $2,550; 24%: $2,551-$9,150; 35%: $9,151-$12,500; 37% - over $12,500. As can be noted, the bracket structure for trusts and estates remains very compressed. Thus, the pre-TCJA planning approach of not trapping income or gains inside a trust or an estate remains the standard advice. That’s because the TCJA did not change the tax rates for qualified dividends and long-term capital gains, although the bracket cut-offs are modified slightly as follows: 0%: $0-$2,600; 15%: $2,601-$12,700; 20%: Over $12,700. Those rates and brackets remain advantageous compared to having the income or gain taxed at the trust or estate level.
Other Aspects of Trust/Estate Taxation
Post-TCJA, it remains true that an estate or trust’s taxable income is computed in the same manner as is income for an individual. I.R.C. §641(b). However, the TCJA amends I.R.C. §164(b) to limit the aggregate deduction for state and local real property taxes and income taxes to a $10,000 maximum annually. But, this limit does not apply to any real estate taxes or personal property taxes that a trust or an estate incurs in the conduct of a trade or business (or an activity that is defined under I.R.C. §212). Thus, an active farm business conducted by a trust or an estate will not be subject to the limitation.
The TCJA also suspends miscellaneous itemized deductions for a trust or an estate. That means, for example, that investment fees and expenses as well as unreimbursed business expenses are not deductible. This will generally cause an increased tax liability at the trust or estate level as compared to prior law. Why? With fewer deductions, the adjusted taxable income (ATI) of a trust or an estate will be higher. For simple trusts, this is also a function of distributable net income (DNI) which, in turn, is a function of the income distribution deduction (IDD). I.R.C. §651(b) allows a simple trust to claim an IDD limited to the lesser of fiduciary accounting income (FAI) or DNI. Under prior law, all trust expenses could be claimed when determining DNI, but only some of those expenses were allocated to principal for purposes of calculating FAI. Now, post-TCJA, ATI for a trust or an estate will be higher due to the loss of various miscellaneous itemized deductions (such as investment management fees). As ATI rises, DNI will decline but FAI won’t change (the allocation of expenses is determined by the trust language or state law). The more common result is likely to be that FAI will be the actual limitation on the IDD, and more income will be trapped inside the estate or the trust. That’s what will cause the trust or the estate to pay more tax post-TCJA compared to prior years.
But, guidance is needed concerning the deductibility of administrative expenses such as trustee fees. It’s not clear whether the TCJA impacts I.R.C. §67. That Code section does not apply the two percent limitation to administrative expenses that are incurred solely because the property is held inside a trust or an estate. There is some support for continuing to deduct these amounts. I.R.C. §67(g) applies to miscellaneous itemized deductions, but trustee fees and similar expenses are above-the-line deductions for a trust or an estate that impact the trust or estate’s AGI. Thus, I.R.C. §67 may not apply. I am told that guidance will be forthcoming on that issue during the summer of 2018. We shall see.
A trust as well as an estate can still claim a $600 personal exemption (with the amount unchanged) under I.R.C. §642. Don’t confuse that with the TCJA’s suspension of the personal exemption for individuals. Also, don’t confuse the removal of the alternative minimum tax (AMT) for corporations or the increased exemption and phaseout range for individuals with the application of the AMT to trusts and estates. No change was made concerning how the AMT applies to a trust or an estate. See I.R.C. §55.(d)(3). The exemption stays at $24,600 with a phaseout threshold of $82,050. Those amounts apply for 2018 and they will be subsequently adjusted for inflation (in accordance with the “chained” CPI).
Other TCJA Impacts on Trusts and Estates
The new 20 percent deduction for pass-through entities under I.R.C. §199A can be claimed by an estate or a trust with non-C corporate business income. The deduction is claimed at the trust or the estate level, with the $157,500 threshold that applies to a taxpayer filing as a single person applying to a trust or an estate. The rules under the now-repealed I.R.C. §199 apply for apportioning between fiduciaries and beneficiaries any W-2 wages and unadjusted basis of qualified property under the limitation based on W-2 wages and capital. There is no separate computation required for alternative minimum tax purposes.
The eligibility of a trust or an estate for the I.R.C. §199A deduction may provide some planning opportunities to route pass-through income from a business that is otherwise limited or barred from claiming the deduction through a non-grantor trust so that the deduction can be claimed or claimed to a greater extent. For example, assume that a sole proprietorship farming operation nets $1,000,000 annually, but pays no qualified wages and has no qualifying property (both factors that result in an elimination of the deduction for the business). If business income is routed through a trust (or multiple truss) with the amount of trust income not exceeding the $157,500 threshold, then an I.R.C. §199A deduction can be generated. However, before this strategy is utilized, there are numerous factors to consider including overall family estate planning/succession planning goals and the economics of the business activity at issue.
Clarification is needed with respect to a charitable remainder trust (CRT) that has unrelated business taxable income (UBIT). UBIT is income of the CRT that comes from an unrelated trade or business less deductions “allowed by Chapter 1 of the Code” that are “directly connected” with the conduct of a trade or business. Treas. Reg. §1.512(a)-1(a). Is the new I.R.C. §199A deduction a directly connected deduction? It would seem to me that it is because it is tied to business activity conducted by the trust. If that construction is correct, I.R.C. §199A would reduce the impact of the UBIT on a CRT. Certainly, guidance is needed from the Treasury on this point.
Related to the CRT issue, the TCJA would appear to allow an electing small business trust (ESBT) to claim the I.R.C. §199A deduction on S corporate income. But, again, guidance is needed. An ESBT calculates the tax on S corporate income separately from all other trust income via a separate schedule. The result is then added to the total tax calculated for the trust’s non-S corporate income. Thus, the ESBT pays tax on all S corporate income. It makes no difference whether the income has been distributed to the ESBT beneficiaries. Also, in computing its tax, the deductions that an ESBT can claim are set forth in I.R.C. §641(c)(2). However, the TCJA does not include the I.R.C. §199A deduction in that list. Was that intentional? Was that an oversight? Your guess is as good as mine.
Another limiting factor for an ESBT is that an ESBT can no longer (post-2017 and on a permanent basis) deduct 100 percent of charitable contributions made from the S corporation’s gross income. Instead, the same limitations that apply to individuals apply to an ESBT – at least as to the “S portion” of the ESBT. But, the charitable contribution need not be made from the gross income of the ESBT. In addition, the charitable contribution must be made by the S corporation for the ESBT to claim the deduction. If the ESBT makes the contribution, it is reported on the non-ESBT portion of the return. It is not allocated to the ESBT portion.
Under the TCJA, an ESBT can have a nonresident alien as a potential current beneficiary.
If a trust or an estate incurs a business-related loss, the TCJA caps the loss at $250,000 for 2018 (inflation-adjust for future years). The $250,000 amount is in the aggregate – it applies at the trust or estate level rather than the entity level (if the trust or estate is a partner of a partnership or an S corporation shareholder). I.R.C. §461(l)(2). Amounts over the threshold can be carried over and used in a future year.
The TCJA impacts a broad array of taxpayers. Its impacts are not limited to individuals and corporate taxpayers. Trusts and estates are also affected. For those with trusts or involved with an estate, make sure to consult tax counsel to make sure the changes are being dealt with appropriately.
Monday, May 21, 2018
In Part One last Thursday, I examined the basics of valuation discounting in the context of a family limited partnership (FLP). In Part Two today, I dig deeper on the I.R.C. §2036 issue, recent cases that have involved IRS challenges to valuation discounts under that Code section, and possible techniques for avoiding IRS challenges.
I.R.C. §2036 – The Basics
Historically, the most litigated issues involving valuation discounts surround I.R.C. §2036. Section 2036(a) specifies as follows:
(a) General rule. The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death—
(1) the possession or enjoyment of, or the right to the income from, the property, or
(2) the right, either alone or in conjunction with any person, to designate the persons who shall
possess or enjoy the property or the income therefrom.
(b) Voting rights
(1) In general. For purposes of subsection (a)(1), the retention of the right to vote (directly or indirectly) shares of stock of a controlled shall be considered to be a retention of the enjoyment of transferred property.
Retained interest. As you can imagine, a big issue under I.R.C. §2036 is whether assets that are contributed to an FLP (or an LLC) are pulled back into the transferor’s estate at death without any discount without the application of any discount on account of the restrictions that apply to the decedent’s FLP interest. The basic argument of the IRS is that the assets should be included in the decedent’s estate due to an implied agreement of retained enjoyment, even where the decedent had transferred the assets before death. See, e.g., Estate of Harper v. Comr., T.C. Memo. 2002-121; Estate of Korby v. Comr., 471 F.3d 848 (8th Cir. 2006).
In the statutory language laid out above, the parenthetical language of subsection (a) is important. That’s the language that estate planners use to circumvent the application of I.R.C. §2036. The drafting of the FLP agreement and the associated planning and implementation of the entity should ensure that there are legitimate and significant non-tax reasons for the use of the FLP/LLC. That doesn’t mean that a tax reason creating the entity cannot be present, but there must be a major non-tax reason present also.
If the IRS denies a valuation discount in the context of an FLP/LLC and the taxpayer cannot rely on the parenthetical language, the focus then becomes whether there existed an implied agreement of retained enjoyment in the transferred assets. There aren’t many cases that taxpayer’s win where the taxpayer’s argument is outside of the parenthetical exception and is based on the lack of retained enjoyment in the transferred assets, but there are some. See, e.g., Estate of Mirowski v. Comr., T.C. Memo. 2008-74; Estate of Kelley v. Comr., T.C. Memo. 2005-235.
Designating possession or enjoyment. What about the retained right to designate the persons who will possess or enjoy the transferred property or its income? In other words, what about the potential problem of subsection (a)(2)? A basic issue with the application of this subsection is whether the taxpayer can be a general partner of the FLP (or manager of an LLC). There is some caselaw on this question, but those cases involve unique facts. In both cases, the court determined that I.R.C. §2036(a)(2) applied to cause inclusion of the transferred property in the decedent’s gross estate. See, e.g., Estate of Strangi v. Comr., T.C. Memo. 2003-145, aff’d., 417 F.3d 468 (5th Cir. 2005); Estate of Turner v. Comr., T.C. Memo. 2011-209. In an earlier case in 1982, the Tax Court determined that co-trustee status does not trigger inclusion under (a)(2) if there are clearly identifiable limits on distributions. Estate of Cohen v. Comr., 79 T.C. 1015 (1982). That Tax Court opinion has generally led to the conclusion that (a)(2) also does not apply to investment powers.
While the Strangi litigation indicates that (a)(2) can apply if the decedent is a co-general partner or co-manager, the IRS appears to focus almost solely on situations where the decedent was a sole general partner or manager. The presence of a co-partner or co-manager is similar to a co-trustee situation and also can help build the argument that the entity was created with a significant non-tax reason.
Succession planning. From a succession planning perspective, it may be best for one parent to be the transferor of the limited partnership interests and the other to be the general partner. For example, both parents could make contributions to the partnership in the necessary amounts so that one parent receives a 1 percent general partnership interest and the other parent receives the 99 percent limited partnership interest. The parent holding the limited partnership interest then could make gifts of the limited partnership interests to the children (or their trusts). The other parent is able to retain control of the “family assets” while the parent holding the limited partnership interest is the transferor of the interests. Unlike IRC §672(e), which treats the grantor as holding the powers of the grantor’s spouse, IRC §2036 does not have a similar provision. Thus, if one spouse is able to retain control of the partnership and the other spouse is the transferor of the limited partnership interests, then IRC §2036 should not be applicable.
I.R.C. §2703 and Indirect Gifts
The IRS may also take an audit position against an FLP/LLC that certain built-in restrictions in partnership agreements should be ignored for tax purposes. This argument invokes I.R.C. §2703. That Code section reads as follows:
(a) General rule. For purposes of this subtitle, the value of any property shall be determined without regard to—
(1) any option, agreement, or other right to acquire or use the property at a price less than the fair market value of the property (without regard to such option, agreement, or right), or
(2) any restriction on the right to sell or use such property.
(b) Exceptions. Subsection (a) shall not apply to any option, agreement, right, or restriction which meets each of the following requirements:
(1) It is a bona fide business arrangement.
(2) It is not a device to transfer such property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth.
(3) Its terms are comparable to similar arrangements entered into by persons in an arms’ length transaction.
In both Holman v. Comr., 601 F.3d 763 (8th Cir. 2010) and Fisher v. United States, 1:08-cv-0908-LJM-TAB, 2010 U.S. Dist. LEXIS 91423 (S.D. Ind. Sept. 1, 2010), the IRS claimed that restrictions in a partnership agreement should be ignored in accordance with I.R.C. §2703. In Holman, the restrictions were not a bona fide business arrangement and were disregarded in valuing the gifts at issue. In Fisher, transfer restrictions were likewise ignored.
Several valuation discounting cases have been decided recently that provide further instruction on the pitfalls to avoid in creating an FLP/LLC to derive valuation discounts. Conversely, the cases also provide further detail on the proper roadmap to follow when trying to create valuation discounts via entities.
• Estate of Purdue v. Comr., T.C. Memo. 2015-249. In this case, the decedent and her husband transferred marketable securities, an interest in a building and other assets to an LLC. The decedent also made gifts annually to a Crummey-type trust from 2002 until death in 2007. Post-death, the beneficiaries made a loan to the decedent’s estate to pay the estate taxes. The estate deducted the interest payments as an administration expense. The court concluded that I.R.C. §2036 did not apply because the transfers to the LLC were bona fide and for full consideration. There was also a significant, non-tax reason present for forming the LLC and there was no commingling of the decedent’s personal assets with those of the LLC. In addition, both the decedent and her husband were in good health at that time the LLC was formed and the assets were transferred to it.
• Estate of Holliday v. Comr., T.C. Memo. 2016-51. The decedent’s predeceased husband established trusts and a family limited partnership (FLP). The FLP agreement stated that, “To the extent that the General Partner determines that the Partnership has sufficient funds in excess of its current operating needs to make distributions to the Partners, periodic distributions of Distributable Cash shall be made to the partners on a regular basis according to their respective Partnership Interests.” The decedent, who was living in a nursing home at the time the FLP was formed, contributed approximately $6 million of marketable securities to the FLP and held a 99.9 percent limited partner interest. Before death, the decedent received one check from the FLP (a pro-rata distribution of $35,000). At trial, the General Partner testified that he believed that the FLP language was merely boilerplate and that distributions weren’t made because “no one needed a distribution.” The court viewed the FLP language and the General Partner’s testimony as indicating that the decedent retained an implied right to the possession or enjoyment of the right to income from the property she had transferred to the FLP. The decedent also retained a large amount of valuable assets personally, thus defeating the General Partners’ arguments that distributions were not made to prevent theft and caregiver abuse. The court also noted that the FLP was not necessary for the stated purposes to protect the surviving spouse from others and for centralized management because trusts would have accomplished the same result. The decedent was also not involved in the decision whether to form an FLP or some other structure, indicating that she didn’t really express any desire to insure family assets remained in the family. The court also noted that there was no meaningful bargaining involved in establishing the FLP, with the family simply acquiescing to what the attorney suggested. The FLP also ignored the FLP agreement – no books and records were maintained, and no formal meetings were maintained.
Accordingly, the court determined that there was no non-tax purpose for the formation of the FLP, there was no bona fide sale of assets to the FLP and the decedent had retained an implied right to income from the FLP assets for life under I.R.C. §2036(c) causing inclusion of the FLP assets in the decedent’s estate.
• Estate of Beyer v. Comr., T.C. Memo. 2016-183. In this case, the decedent was in his upper 90s at the time of his death. He had never married and had no children, but he did have four sisters. The decedent had been the CFA of Abbott Lab and had acquired stock options from the company, starting exercising them in 1962 and had accumulated a great deal of Abbott stock. He formed a trust in 1999 and put 800,000 shares of Abbott stock into the trust. He amended the trust in 2001 and again in 2002. Ultimately, the decedent created another trust, and irrevocable trust, and it eventually ended up owning a limited partnership. Within three years of his death, the decedent made substantial gifts to family members from his living trust. Significant gifts were also made to the partnership.
The IRS claimed that the value of the assets that the decedent transferred via the trust were includable in the value of his gross estate under I.R.C. §2036(a). The estate claimed that the transfers to the partnership were designed to keep the Abbott stock in a block and keep his investment portfolio intact, and wanted to transition a family member into managing his assets. The IRS claimed that the sole purpose of the transfers to the partnership were to generate transfer tax savings. The partnership agreement contained a list of the purposes the decedent wanted to accomplish by forming the partnership. None of the decedent’s stated reasons for the transfers were in the list.
The court determined that the facts did not support the decedent’s claims and the transfers were properly included in his estate. The decedent also continued to use assets that he transferred to the partnership and did not retain sufficient assets outside of the partnership to pay his anticipated financial obligations. On the valuation issue, the court disallowed valuation discounts because the partnership held assets in a restricted management account where distributions of principal were prohibited.
As the cases point out, valuation discounts can be achieved even if asset management is consolidated. Also, it is important that the decedent/transferor is not financially dependent on distributions from the FLP/LLC, retains substantial assets outside of the entity to pay living expenses, does not commingle personal and entity funds, is in good health at the time of the transfers, and the entity follows all formalities of the entity structure. For gifted interests, it is important that the donees receive income from the interests. Their rights cannot be overly restricted. See, e.g., Estate of Wimmer v. Comr., T.C. Memo. 2012-157.
Appropriate drafting and planning are critical to preserve valuation discounts. Now that the onerous valuation regulations have been removed, they are planning opportunities. But, care must be taken.
Tuesday, April 17, 2018
Trusts are a popular part of an estate plan for many people. Trusts also come in different forms. Some take effect during life and can be changed whenever the trust grantor (creator or settlor) desires. These are revocable trusts. Other trusts, known as irrevocable trusts, also take effect during life but can’t be changed when desired. Or, at least not as easily. That’s an issue that comes up often. People often change their minds and circumstances also can change. In addition, the tax laws surrounding estates and trust are frequently modified by the Congress as well as the courts. Also, sometimes drafting errors occur and aren’t caught until after the irrevocable trust has been executed.
So how can a grantor of an irrevocable accomplish a “do over” when circumstances change? It involves the concept of “decanting” and it’s the topic of today’s post.
Trying to change the terms of an irrevocable trust is not a new concept. “Decanting” involves pouring one trust into another trust with more favorable terms. To state it a different way, decanting involves distributing the assets of one trust to another trust that has the terms that the grantor desires with the terms that the grantor no longer wants remaining in the old trust.
The ability to “decant” comes from either an express provision in the trust, or a state statute or judicial opinions (common law). Presently, approximately 20 states have adopted “decanting” statutes, and a handful of others (such as Iowa and Kansas) allow trust modification under common law. In some of the common law jurisdictions, courts have determined that decanting is allowed based upon the notion that the trustee’s authority to distribute trust corpus means that the trustee has a special power of appointment which allows the trustee to transfer all (or part) of the trust assets to another irrevocable trust for the same beneficiaries.
In terms of a step-by-step approach to decanting, the first step is to determine whether an applicable state statute applies. If there is a statute, a key question is whether it allows for decanting. Some statutes don’t so provide. If it does, the statutory process must be followed. Does the statute allow the trustee to make the changes that the grantor desires? That is a necessary requirement to being able to decant the trust. If there is no governing statute, or there is a statute but it doesn’t allow the changes that the grantor desires, a determination must be made as to what the state courts have said on the matter, if anything. But, that could mean that litigation involving the changes is a more likely possibility with a less than certain outcome.
If conditions are not favorable for decanting in a particular jurisdiction, it may be possible under the trust’s terms (or something known as a “trust protector”) to shift the trust to a different jurisdiction where the desired changes will be allowed. Absent favorable trust terms, it might be possible to petition a local court for authority to modify the trust to allow the governing jurisdiction of the trust to be changed.
If decanting can be done, the process of changing the trust terms means that documents are prepared that will result in the pouring of the assets of the trust into another trust with different terms. Throughout the process, it is important to follow all applicable statutory rules. Care must be taken when preparing deeds, beneficiary forms, establishing new accounts and conducting any other related business to complete the change.
IRS Private Ruling
In the fall of 2015, the IRS released a Private Letter Ruling that dealt with the need to change an error in the drafting of an irrevocable trust in order to repair tax issues with the trust. Priv. Ltr. Rul. 201544005 (Jun. 19, 2015). The private ruling involved an irrevocable trust that had a couple of flaws. The settlors (a married couple) created the trust for their children, naming themselves as trustees. One problem was that the trust terms gave the settlors a retained power to change the beneficial interests of the trust. That resulted in an incomplete gift of the transfer of the property to the trust. In addition, the retained power meant that I.R.C. §2036 came into play and would cause inclusion of the property subject to the power in the settlors’ estates. The couple intended that their transfers to the trust be completed gifts that would not be included in their gross estates, so they filed a state court petition for reformation of the trust to correct the drafting errors. The drafting attorney submitted an affidavit that the couple’s intent was that their transfers of property to the trust be treated as completed gifts and that the trust was intended to optimize their applicable exclusion amount. The couple also sought to resign as trustees. The court allowed reformation of the trust. That fixed the tax problems. The IRS determined that the court reformation would be respected because the reformation carried out the settlors’ intent.
When to Decant
So, it is possible that an irrevocable trust can be changed to fix a drafting error and for other reasons if the law and facts allow.
What are common reasons decant an irrevocable trust? Some of the most common ones include the following:
- To achieve greater creditor protection by changing, for example, a support trust to a discretionary trust (this can be a big issue, for example, with respect to long-term health care planning);
- To change the situs (jurisdiction where the trust is administered) to a location with greater pro-trust laws;
- To adjust the terms of the trust to take into account the relatively larger federal estate exemption applicable exclusion and include power of appointment language that causes inclusion of the trust property in the settlor’s estate to achieve an income tax basis “step-up” at death (this has become a bigger issue as the federal estate tax exemption has risen substantially in recent years);
- To provide for a successor trustee and modify the trustee powers;
- To either combine multiple trusts or separate one trust into a trust for each beneficiary;
- To create a special needs trust for a beneficiary with a disability;
- To permit the trust to be qualified to hold stock in an S corporation and, of course;
- To correct drafting errors that create tax problems and, perhaps, in the process of doing so create a fundamentally different trust.
The ability to modify an irrevocable trust is critical. This is particularly true with the dramatic change in the federal estate and gift tax systems in recent years. Modification may also be necessary when desires and goals change or to correct an error in drafting. Fortunately, in many instances, it is possible to make changes even though the trust is “irrevocable.” If you need to “decant” a trust, see an estate planning professional for help.
Friday, April 13, 2018
Many readers of this blog are tax preparers. Many focus specifically on returns for clients engaged in agricultural production activities. As tax season winds down, at least for the time being, another season is about to begin. For me, that means that tax seminar season is just around the corner. Whether it’s at a national conference, state conference, in-house training for CPAs or more informal meetings, I am about to begin the journey which will take me until just about Christmas of providing CPE training for CPAs and lawyers across the country.
CPAs and lawyers are always looking for high-quality and relevant tax and legal education events. In today’s post I highlight some upcoming events that you might want to attend.
Calendar of Events
Shortly after tax preparers come back from a well-deserved break from the long hours and weekends of preparing returns and dealing with tax client issues, many will be ready to continue accumulating the necessary CPE credits for the year. This is an important year for CPE tax training with many provisions of the Tax Cuts and Jobs Act taking effect for tax years beginning after 2017.
If you are looking for CPE training the is related to agricultural taxation and agricultural estate and business planning below is a run-down of the major events I will be speaking at in the coming months. Washburn Law School is a major player in agricultural law and taxation, and more details on many of these events can be found from the homepage of WALTR, my law school website – www.washburnlaw.edu/waltr.
May 9 – CoBank, Wichita KS
May 10 – Kansas Society of CPAs, Salina, KS
May 14 - Lorman, Co. Webinar
May 16 – Quincy Estate Planning Council, Quincy, IL
May 18 – Iowa Bar, Spring Tax Institute, Des Moines, IA
May 22 – In-House CPA Firm CPE training, Indianapolis, IN
June 7-8 – Summer Tax/Estate & Business Planning Conference, Shippensburg, PA
June 14-15 – In-House CPA Firm CPE training, Cedar Rapids, IA
June 22 - Washburn University School of Law CLE Event, Topeka, KS
June 26 - Washburn University School of Law/Southwest KS Bar Assoc, Dodge City, KS
June 27 – Kansas Society of CPAs, Topeka, KS
July 10 – Univ. of Missouri Summer Tax School, Columbia, MO
July 16-17 – AICPA Farm Tax Conference, Las Vegas, NV
July 19 – Western Kansas Estate Planning Council, Hays, KS
July 26 – Mississippi Farm Bureau Commodity Conference, Natchez, MS
August 14 – In-House training, Kansas Farm Bureau, Manhattan, KS
August 15 - Washburn University School of Law/KSU Ag Law Symposium, Manhattan, Kansas
August 16-17 – Kansas St. Univ. Dept. of Ag Econ. Risk and Profit Conference, Manhattan, KS
September 17-18 – North Dakota Society of CPAs, Grand Forks, ND
September 19 – North Dakota Society of CPAs, Bismarck, ND
September 21 – University of Illinois, Moline, IL
September 24 – University of Illinois, Champaign-Urbana, IL
September 26-27 – Montana Society of CPAs, Great Falls, MT
October 3 – CoBank, Wichita, KS
October 11-12 – Notre Dame Estate Planning Institute, South Bend, IN
The events listed above are the major events geared for practitioners as of this moment. I am continuing to add others, so keep watching WALTR for an event near you. Of course, I am doing numerous other events geared for other audiences that can also be found on WALTR’s homepage. Once I get into mid-late October, then the annual run of tax schools begins with venues set for Kansas, North Dakota, Iowa and South Dakota. Added in there will also be the Iowa Bar Tax School in early December.
Special Attention – Summer Seminar
I would encourage you to pay particular attention to the upcoming summer seminar in Shippensburg, PA. This two-day conference is sponsored by Washburn University School of Law and is co-sponsored by the Pennsylvania Institute of CPAs and the Kansas State University Department of Agricultural Economics. I will be joined for those two days by Paul Neiffer, Principal with CliftonLarsonAllen, LLP. On-site seating for that event is limited to 100 and the seminar is filling up fast. After those seats are taken, the only way to attend will be via the simultaneous webcast. More information concerning the topics we will cover and how to register can be found at: http://washburnlaw.edu/employers/cle/farmandranchincometax.html. We will be spending the first four hours on the first day of that conference on the new tax legislation, with particular emphasis on how it impacts agricultural clients. We will also take a look at the determination of whether a C corporation is now a favored entity in light of the new, lower 21 percent rate. On Day 2 of the conference, we will take a detailed look at various estate and business planning topics for farm and ranch operators. The rules that apply to farmers and ranchers are often uniquely different from non-farmers, and those different rules mean that different planning approaches must often be utilized.
If your state association has interest in ag-tax CPE topics please feel free to have them contact me. I have some open dates remaining for 2018, and am already booking into 2019 and beyond. The same goes for your firm’s in-house CPE needs. In any event, I hope to see you down the road in the coming months at an event. Push through the next few days and take that well-deserved break. When you get back at it, get signed up for one of the events listed above.
Thursday, February 22, 2018
Leasing is of primary importance to agriculture. Leasing permits farmers and ranchers to operate larger farm businesses with the same amount of capital, and it can assist beginning farmers and ranchers in establishing a farming or ranching business.
Today’s post takes a brief look at some of the issues surrounding farmland leases – economic; estate planning; and federal farm program payment limitation planning.
Common Types of Leases
Different types of agricultural land leasing arrangements exist. The differences are generally best understood from a risk/return standpoint. Cash leases involve the periodic payment of a rental amount that is either a fixed number of dollars per acre, or a fixed amount for the entire farm. Typically, such amounts are payable in installments or in a lump sum. A flexible cash lease specifies that the amount of cash rent fluctuates with production conditions and/or crop or livestock prices. A hybrid cash lease contains elements similar to those found in crop-share leases. For example, a hybrid cash lease usually specifies that the rental amount is to be determined by multiplying a set number of bushels by a price determined according to terms of the lease, but at a later date. The tenant will market the entire crop. The landlord benefits from price increases, while requiring no management or selling decisions or capital outlay. However, the rental amount is adversely affected by a decline in price. The tenant, conversely, will not bear the entire risk of low commodity prices, as would be the case if a straight-cash lease were used, but does bear all of the production risk and must pay all of the production costs.
Under a hybrid-cash lease, known as the guaranteed bushel lease, the tenant delivers a set amount of a certain type of grain to a buyer by a specified date. The landlord determines when to sell the grain, and is given an opportunity to take advantage of price rises and to make his or her own marketing decisions. However, the landlord must make marketing decisions, and also is subject to price decreases and the risk of crop failure. For tenants, the required capital outlay will likely be less, and the tenant should have greater flexibility as to cropping patterns. While the rental amount may be less than under a straight-cash lease, the tenant will continue to bear the risk of crop failure.
Another form of the hybrid-cash lease, referred to as the minimum cash or crop share lease, involves a guaranteed cash minimum. However, the landlord has the opportunity to share in crop production from a good year (high price or high yield) without incurring out-of-pocket costs. For a tenant, the minimum cash payment likely will be less than under a straight-cash lease because the landlord will receive a share of production in good years. The tenant, however, still retains much of the production risk. In addition, the tenant typically does not know until harvest whether the tenant will receive all or only part of the crop. This may make forward cash contracting more difficult.
Under a crop-share leasing arrangement, the rent is paid on the basis of a specified proportion of the crops. The landlord may or may not agree to pay part of certain expenses. There are several variations to the traditional crop-share arrangement. For example, with a crop share/cash lease, rent is paid with a certain proportion of the crops, but a fixed sum is charged for selected acreage such as pasture or buildings, or both. Under a livestock-share leasing arrangement, specified shares of livestock, livestock products and crops are paid as rent, with the landlord normally sharing in the expenses. For irrigation crop-share leases, rent is a certain proportion of the crops produced, but the landlord shares part of the irrigation expenses. Under labor-share leases, family members are typically involved and the family member owning the assets has most of the managerial responsibility and bears most of the expenses and receives most of the crops. The other family members receive a share of yield proportionate to their respective labor and management inputs.
Estate Planning Implications
Leasing is also important in terms of its relation to a particular farm or ranch family's estate plan. For example, with respect to Social Security benefits for retired farm-landlords, pre-death material participation under a lease can cause problems. A retired farm-landlord who has not reached full retirement age (66 in 2018) may be unable to receive full Social Security benefits if the landlord and tenant have an agreement that the landlord shall have “material participation” in the production of, or the managing of, agricultural products.
While material participation can cause problems with respect to Social Security benefits, material participation is required for five of the last eight years before the earlier of retirement, disability or death if a special use valuation election is going to be made for the agricultural real estate included in the decedent-to-be's estate. I.R.C. §2032A. A special use valuation election permits the agricultural real estate contained in a decedent's estate to be valued for federal estate tax purposes at its value for agricultural purposes rather than at fair market value. The solution, if a family member is present, may be to have a nonretired landlord not materially participate, but rent the elected land to a materially participating family member or to hire a family member as a farm manager. Cash leasing of elected land to family members is permitted before death, but generally not after death. The solution, if a family member is not present, is to have the landlord retire at age 65 or older, materially participate during five of the eight years immediately preceding retirement, and then during retirement rent out the farm on a nonmaterial participation crop-share or livestock-share lease.
Farm Program Payments
Leases can also have an impact on a producer's eligibility for farm program payments. In general, to qualify for farm program payments, an individual must be “actively engaged in farming.” For example, each “person” who is actively engaged in farming is eligible for up to $125,000 in federal farm program payments each crop year. A tenant qualifies as actively engaged in farming through the contribution of capital, equipment, active personal labor, or active personal management. Likewise, a landlord qualifies as actively engaged in farming by the contribution of the owned land if the rent or income for the operation's use of the land is based on the land's production or the operation's operating results (not cash rent or rent based on a guaranteed share of the crop). In addition, the landlord's contribution must be “significant,” must be “at risk,” and must be commensurate with the landlord's share of the profits and losses from the farming operation.
A landowner who cash leases land is considered a landlord under the payment limitation rules and may not be considered actively engaged in farming. In this situation, only the tenant is considered eligible. Under the payment limitation rules, there are technical requirements that restrict the cash-rent tenant's eligibility to receive payments to situations in which the tenant makes a “significant contribution” of (1) active personal labor and capital, land or equipment; or (2) active personal management and equipment. Leases in which the rental amount fluctuates with price and/or production (so-called “flex” leases) can raise a question as to whether or not the lease is really a crop-share lease which thereby entitles the landlord to a proportionate share of the government payments attributable to the leased land.
Under Farm Service Agency (FSA) regulations (7 C.F.R. §1412.504(a)(2)), a lease is a “cash lease” if it provides for only a guaranteed sum certain cash payment, or a fixed quantity of the crop (for example, cash, pounds, or bushels per acre).” All other types of leases are share leases. In April 2007, FSA issued a Notice stating that if any portion of the rental payment is based on gross revenue, the lease is a share lease. Notice DCP-172 (April 2, 2007). However, according to FSA, if a flex or variable lease pegs rental payments to a set amount of production based on future market value that is not associated with the farm’s specific production, it’s a cash lease. Id. That was the FSA’s position through the 2008 crop year. Beginning, with the 2009 crop year, FSA has taken the position that a tenant and landlord may reach any agreement they wish concerning “flexing” the cash rent payment and the agreement will not convert the cash lease into a share-rent arrangement.
There are many issues that surround farmland leasing. Today’s post just scratches the surface with a few. Of course, many detailed tax rules also come into play when farmland is leased. The bottom line is that the type of lease matters, for many reasons. Give your leasing arrangement careful consideration and get it in writing.
Tuesday, February 20, 2018
For over the past decade I have conducted at least one summer tax conference addressing farm income tax and farm estate and business planning. The seminars have been held from coast-to-coast in choice locations – from North Carolina and New York in the East to California and Alaska in the West, and also from Michigan and Minnesota in the North to New Mexico in the South. This summer’s conference will be in Shippensburg, Pennsylvania on June 7-8 and is sponsored by the Washburn University School of Law. Our co-sponsors are the Kansas State University Department of Agricultural Economics and the Pennsylvania Institute of CPAs. My teaching partner again this year will be Paul Neiffer, the author of the Farm CPA Today blog. If you represent farm clients or are engaged in agricultural production and are interested in ag tax and estate/succession planning topics, this is a must-attend conference.
Today’s post details the seminar agenda and other key details of the conference.
The first day of the seminar will focus on ag income tax topics. Obviously, a major focus will be centered on the new tax law and how that law, the “Tax Cuts and Jobs Act” (TCJA), impacts agricultural producers, agribusinesses and lenders. One of points of emphasis will be on providing practical examples of the application of the TCJA to common client situations. Of course, a large part of that discussion will be on the qualified business income (QBI) deduction. Perhaps by the time of the seminar we will know for sure how that QBI deduction applies to sales of ag products to cooperatives and non-cooperatives.
Of course, we will go through all of the relevant court cases and IRS developments in addition to the TCJA. There have been many important court ag tax court decisions over the past year, as those of your who follow my annotations page on the “Washburn Agricultural Law and Tax Report” know first-hand.
Many agricultural producers are presently having a tough time economically. As a result, we will devote time to financial distress and associated tax issues – discharged debt; insolvency; bankruptcy tax; assets sales, etc.
We will also get into other issues such as tax deferral issues; a detailed discussion of self-employment tax planning strategies; and provide an update on the repair/capitalization regulations.
On Day 2, the focus shifts to estate and business planning issues for the farm client. Of course, we will go through how the TCJA impacts estate planning and will cover the key court and IRS developments that bear on estate and business planning. We will also get into tax planning strategies for the “retiring” farmer and farm program payment eligibility planning.
The TCJA also impacts estate and business succession planning, particularly when it comes to entity choice. Should a C corporation be formed? What are the pros and cons of entity selection under the TCJA? What are the options for structuring a farm client’s business? We will get into all of these issues.
On the second day we will also get into long-term care planning options and strategies, special use valuation, payment federal estate tax in installments, and the income taxation of trusts and estates.
The seminar will be held at the Shippensburg University Conference Center. There is an adjacent hotel that has established a room block for conference attendees at a special rate. Shippensburg is close to the historic Gettysburg Battlefield and is not too far from Lancaster County and other prime ag production areas. Early June will be a great time of the year to be in Pennsylvania.
Attend In-Person or Via the Web
The conference will be simulcast over the web via Adobe Connect. If you attend over the web, the presentation will be both video and audio. You will be able to interact with Paul and I as well as the in-person attendees. On site seating is limited to the first 100 registrants, so if you are planning on attending in-person, make sure to get your spot reserved.
You can find additional information about the seminar and register here: http://washburnlaw.edu/employers/cle/farmandranchincometax.html
If you have ag clients, you will find this conference well worth your time. We look forward to seeing you at the seminar either in-person or via the web.
Friday, February 16, 2018
I am often asked the questions at lay-level seminars whether a person can write their own will. While the answer is “yes,” it probably isn’t the best idea. Why? One of the primary reasons is because unclear language might be inadvertently used. Some words have multiple meanings in different contexts. Other words may simply be imprecise and not really require the executor or trustee to take any particular action concerning the decedent’s assets. The result could be that the decedent’s property ends up being disposed of in a way that the decedent hadn’t really intended.
Sometimes these problems can still occur when a will or trust is professionally prepared. A recent Texas case involving the disposition of ranch land illustrates the problem. Because of the imprecise language in a will and trust, a ranch ended up being sold without the decedent’s heirs having an option to purchase the property so that the land would stay in the family.
Imprecise language in wills and trusts and the problems that can be created - that’s the topic of today’s post.
The Peril of Precatory Language
In the law of wills and trusts, precatory words are words of wish, hope or desire or similar language that implores an executor or trustee of the decedent’s estate to dispose of property in some particular way. These types of words are not legally binding on the executor or trustee. They are merely “advisory.” However, words such as “shall” or “must” or some similar mandatory-type words are legally binding. Other words such as “money,” “funds,” or “personal property” are broad terms that can mean various things unless they are specifically defined elsewhere in the will or trust. Litigation involving wills and trusts most often involves ambiguous terms.
In Estate of Rodriguez, No. 04-17-00005-CV, 2018 Tex. App. LEXIS 254 (Tex. Ct. App. Jan. 10, 2018), a beneficiary of a trust sued the trustee to prevent the sale of ranchland that was owned by the decedent’s testamentary trust. The decedent died in early 2015 leaving a will benefitting his four children and a daughter-in-law. A son was named as executor and the trustee of a testamentary trust created by the decedent’s will. The primary property of the decedent’s residuary estate (after specific bequests had been satisfied) was the decedent’s ranchland. The residuary estate passed to the testamentary trust. Three of the children and the daughter-in-law were named as beneficiaries of the trust.
The trustee decided to sell the ranchland, and the daughter-in-law attempted to buy the ranch to no avail. She sued, seeking a temporary restraining order and an injunction that would prevent the trustee from selling the ranch to a third party that the trustee had accepted an offer to purchase from. The third party also got involved in the lawsuit, seeking specific performance of the purchase contract. The daughter-in-law claimed that the contract between the trustee and the third party violated a right-of-first-refusal that the trust language created in favor of the trust beneficiaries. The trial court disagreed and ordered the trustee to perform the contract. The daughter-in-law appealed.
The appellate court noted the following will language: “I hereby grant unto my…Executor…full power and authority over any and al of my estate and they are hereby authorized to sell…any part thereof…”. The trust created by the will also gave the trustee the specific power to sell the corpus of the trust, but the language was imprecise. The pertinent trust language stated, “My Trustee can sell the corpus of this Trust, but it [is] my desire my ranch stay intact as long as it is reasonable.” Another portion of the trust stated, “If any of the four beneficiaries of his estate wants to sell their portion of the properties they can only sell it to the remaining beneficiaries.” The daughter-in-law claimed the trust language was mandatory rather than precatory, and the mandatory language granted the trust beneficiaries the right-of-first-refusal to buy the ranchland. She claimed that the decedent desired that the ranchland stay intact, and had mentioned that intent to others during his life.
The appellate court disagreed with the daughter-in-law. Neither of the trust clauses, the court noted, required the trustee to offer to anyone, much less the beneficiaries, the chance to buy the ranchland on the same terms offered to another potential buyer. While the language limited a beneficiary’s power to sell to anyone other than another beneficiary, it didn’t restrict the trustee’s power to sell. There was simply nothing in the will or trust that limited the trustee’s power to sell by creating a right-of-first-refusal in favor of the trust beneficiaries. The decedent’s “desire” to keep the ranchland intact was precatory language that didn’t bar the trustee from selling it to a third party. In addition, there was no right-of-first-refusal created for the beneficiaries. The contract to sell the ranchland to the third party was upheld.
For many farm or ranch families, a major objective is to keep the farmland/ranchland in the family. That might be the case regardless of whether the family members will be the actual operators down through subsequent generations. However, the recent Texas case points out how important precise language in wills and trusts is in preserving that intent.
Tuesday, February 6, 2018
Some spousal business ventures can elect out of the partnership rules for federal tax purposes as a qualified joint venture (QJV). I.R.C. §761(f). While the election will ease the tax reporting requirements for husband-wife joint ventures that can take advantage of the election, the Act also makes an important change to I.R.C. §1402 as applied to rental real estate activities that can lay a trap for the unwary.
When is making a QJV election a good planning move? When should it be avoided? Are their implications for spousal farming operations with respect to farm program payment limitation planning? Is there any impact on self-employment tax? This week I am taking a look at the QJV. Today’s post looks at the basics of the election. On Thursday, I will look at its implications for farm program payment limitation planning as well as its impact on self-employment tax.
The QJV election is the topic of today’s post.
Joint Ventures and Partnership Returns
A joint venture is simply an undertaking of a business activity by two or more persons where the parties involved agree to share in the profits and loss of the activity. That is similar to the Uniform Partnership Act’s definition of a partnership. UPA §101(6). The Internal Revenue Code defines a partnership in a negative manner by describing what is not a partnership (I.R.C. §§761(a) and 7701(a)(2)), and the IRS follows the UPA definition of a partnership by specifying that a business activity conducted in a form jointly owned by spouses (including a husband-wife limited liability company (LLC)) creates a partnership that requires the filing of an IRS Form 1065 and the issuance to each spouse of separate Schedules K-1 and SE, followed by the aggregation of the K-1s on the 1040 Schedule E, page 2. The Act does not change the historic IRS position.
Note: Thus, for a spousal general partnership, each spouse’s share of partnership income is subject to self-employment tax. See, e.g., Norwood v. Comr., T.C. Memo. 2000-84.
While the IRS position creates a tax compliance hardship, in reality, a partnership return does not have to be filed for every husband-wife operation. For example, if the enterprise does not meet the basic requirements to be a partnership under the Code (such as not carrying on a business, financial operation or venture, as required by I.R.C. §7701(a)(2)), no partnership return is required. Also, a spousal joint venture can elect out of partnership treatment if it is formed for “investment purposes only” and not for the active conduct of business if the income of the couple can be determined without the need for a partnership calculation. I.R.C. §761(a).
A spousal business activity (in which both spouses are materially participating in accordance with I.R.C. §469(f)) can elect to be treated as a QJV which will not be treated for tax purposes as a partnership. In essence, the provision equates the treatment of spousal LLCs in common-law property states with that of community property states. In Rev. Proc. 2002-69, 2002-2 C.B. 831, IRS specified that husband-wife LLCs in community property states can disregard the entity.
Note: The IRS claims on its website that a qualified joint venture, includes only those businesses that are owned and operated by spouses as co-owners, and not those that are in the name of a state law entity (including a general or limited partnership or limited liability company). So, according to the IRS website, spousal LLCs, for example, would not be eligible for the election. However, this assertion is not made in Rev. Proc. 2002-69. There doesn’t appear to be any authority that bars a spousal LLC from making the QJV election.
With a QJV election in place, each spouse is to file as a sole proprietor to report that spouse’s proportionate share of the income and deduction items of the business activity. To elect QJV status, five criteria must be satisfied: (1) the activity must involve the conduct of a trade or business; (2) the only members of the joint venture are spouses; (3) both spouses elect the application of the QJV rule; (4) both spouses materially participate in the business; and (5) the spouses file a joint tax return for the year I.R.C. §761(f)(1).
Note: “Material participation” is defined in accordance with the passive activity loss rules of I.R.C. §469(h), except I.R.C. §469(h)(5). Thus, whether a spouse is materially participating in the business is to be determined independently of the other spouse.
The IRS instructions to Form 1065 (the form, of course, is not filed by reason of the election) provide guidance on the election. Those instructions specify that the election is made simply by not filing a Form 1065 and dividing all income, gain, loss, deduction and credit between the spouses in accordance with each spouse’s interest in the venture. Each spouse must file a separate Schedule C, C-EZ or F reporting that spouse’s share of income, deduction or loss. Each spouse also must file a separate Schedule SE to report their respective shares of self-employment income from the activity with each spouse then receiving credit for their share of the net self-employment income for Social Security benefit eligibility purposes. For spousal rental activities where income is reported on Schedule E, a QJV election may not be possible. That’s because the reporting of the income on Schedule E constitutes an election out of Subchapter K, and a taxpayer can only come back within Subchapter K (and, therefore, I.R.C. §761(f)) with IRS permission that is requested within the first 30 days of the tax year.
In general, electing QJV status won’t change a married couple’s total federal income tax liability or total self-employment tax liability, but it will eliminate the need to file Form 1065 and the related Schedules K-1. In that regard, the QJV election can provide a simplified filing method for spousal businesses. It can also remove a potential penalty for failure to file a partnership return from applying. That penalty is presently $200 per partner for each month (or fraction thereof) the partnership return is late, capped at 12 months.
Friday, January 19, 2018
Normally, the computation of a tax deduction for a gift to charity is simple – it’s the fair market value of the donated property limited by basis. That’s why, for example raised grain gifted to charity by a farmer doesn’t generate an income tax deduction. The farmer that gifts the grain doesn’t have a basis in the grain. But, special rules apply to a trust from which property is gifted to charity.
Today’s post looks at the issue of the tax deduction for property gifted to charity from a trust. Those special rules came up in a recent case involving a multi-million-dollar gift.
Rule Applicable to Trusts
I.R.C. §642(c)(1) says that a trust can claim a deduction in computing its taxable income for any amount of gross income, without limitation, that under the terms of the governing instrument is, during the tax year, paid for a charitable purpose. Note the requirement of “gross income.” A trust only gets a charitable deduction if the source of the contribution is gross income. That means that tracing the contribution is required to determine its source. See, e.g., Van Buren v. Comr., 89 T.C. 1101 (1987); Rev. Rul. 2003-123, 2003-150 I.R.B. 1200. Does the tracing have to be to the trust’s gross income earned in years before the year of the contribution? Or, does the trust just have to show that the charitable contribution was made out of gross income received by the trust in the year the contribution was made? According to the U.S. Supreme Court, the trustee does not have to prove that the charitable gift was made from the current year’s income, just that the gift was made out of trust income. Old Colony Trust Company v. Comr., 301 U.S. 379 (1937).
But, does trust income include unrealized gains on appreciated property donated to charity? That’s an interesting question that was answered by a recent federal appellate court.
A recent case involving a charitable donation by a trust raised the issue of the amount of the claimed deduction. Is it the fair market value of the property or is it the basis of the donated property if that amount is less than the fair market value? Under the facts of Green v. United States, 144 F. Supp. 3d 1254 (W.D. Okla. 2015), the settlors created a dynasty trust in 1993 with terms authorizing the trustee to make charitable distributions out of the trust's gross income at the trustee's discretion. The trust wholly owned a single-member LLC and in 2004, the LLC donated properties that it had purchased to three charities. Each property had a fair market value that exceeded basis. The LLC received the funds to buy the properties from a limited partnership's distribution to the trust in which the trust was a 99 percent limited partner. The limited partnership owned and operated most of the Hobby-Lobby stores in the United States.
The IRS initially claimed that the trust could not take a charitable deduction, but then decided that a deduction could be claimed if it were limited to the trust's basis in each property. The trust claimed a charitable deduction in excess of $20 million on Form 1041 for 2004, and later filed an amended Form 1041 increasing the claimed charitable deduction to just shy of $30 million, and seeking a tax refund of over $3 million. The IRS denied the refund, claiming that the charitable deduction was limited to cost basis. The trust paid the deficiency and sued for a refund.
On the trust's motion for summary judgment, the parties agreed that the donated properties were acquired by the trust with funds coming from gross income from a pre-2004 tax year. Thus, according to the trust, I.R.C. Sec. 642(c)(1) allowed the charitable deduction to be computed based on the donated property's fair market value. The court agreed, noting that I.R.C. § 642(c)(1) allowed a deduction without limitation contrary to the basis limitation contained in I.R.C. §170, and that charitable deduction provisions are to be construed liberally in the taxpayer's favor.
The trial court noted that the donated properties were all acquired with distributions from the limited partnership to the trust, and each distribution was part of the LLC's gross income for the year of distribution. Thus, the donated properties were clearly bought with funds traceable to the trust's gross income and were donated under the terms of the trust. The court noted that the IRS admitted that there was no caselaw or other substantial authority that supported the government's position. The court granted summary judgment for the trust.
On appeal, the U.S. Court of Appeals for the Tenth Circuit reversed. Green v. United States, No. 16-6371, 2018 U.S. App. LEXIS 885 (10th Cir. Jan. 12, 2018). The appellate court noted that the parties agreed that the trust had acquired the donated properties with gross income and that the charitable donation was made out of gross income. However, the IRS claimed that only the basis of the properties was traceable to an amount paid out of gross income. It was that amount of gross income, according to the IRS, that was utilized to acquire each property. The appellate court agreed. There was no realization of gross income on the appreciation of the properties because the underlying properties had not been sold. So, because the trust had not sold or exchanged the properties, the gains tied to the increases in market value were not subject to tax. The appellate court reasoned that if the deduction of I.R.C. §642(c)(1) extended to unrealized gains, that would not be consistent with how the tax Code treats gross income. The appellate court tossed the “ball” back to the Congress to make it clear that the deduction under I.R.C. §642(c)(1) extends to unrealized gains associated with real property originally purchased with gross income
The charitable donation rules associated with trusts are complicated. The income tax deduction is tied to the trust’s gross income. Now we have greater certainty that the deduction is limited to realized gains, not unrealized gains. Maybe the Congress will clarify that unrealized gains should count in the computation. But, then again, maybe not.
Wednesday, January 17, 2018
Much of the focus on the new tax law (TCJA) has been on its impact on the rate changes for individuals along with the increase in the standard deduction, and the lower tax rate for C corporations. Also receiving a great deal of attention has been the qualified business income (QBI) deduction of new I.R.C. §199A.
But, what about the impact of the changes set forth in the TCJA on estate planning? That’s the focus of today’s post.
Estate Planning Implications
Existing planning concepts reinforced. The TCJA reinforces what the last major tax act (the American Taxpayer Relief Act (ATRA) of 2012) put in motion – an emphasis on income tax basis planning, and the elimination of any concern about the federal estate tax for the vast majority of estates. Indeed, the Joint Committee on Taxation (JCT) estimates that in 2018 the federal estate tax will impact only 1,800 estates. Given an approximate 2.6 million deaths in the U.S. every year, the federal estate tax will now impact about one in every 1,400 estates. Because of this minimal impact, estate planning will rarely involve estate tax planning, but it will involve income tax basis planning. In other words, the basic idea is to ensure that property is included in a decedent’s estate at death for tax purposes so that a “stepped-up” basis at death is achieved (via I.R.C. §1014).
Increase in the exemption. Why did the JCT estimate that so few estates will be impacted by the federal estate tax in 2018? It’s because the TCJA substantially increases the value of assets that can be included in a decedent’s estate without any federal estate tax applying – doubling the exempt amount from what it would have been in 2018 without the change in the law ($5.6 million) to $11.2 million per decedent. That amount can be transferred tax-free during life via gift or at death through an estate. In addition, for gifts, the present interest annual exclusion is set at $15,000 per donee. That means that a person can make cumulative gifts of up to $15,000 per donee in 2018 without any gift tax consequences (and no gift tax return filing requirement) and without using up any of the $11.2 million applicable exclusion that offsets taxable gifts – it will be fully retained to offset taxable estate value at death. In addition, the $15,000 amount can be doubled by spouses via a special election. But, if the $15,000 (or $30,000) amount is exceeded, Form 709 must be filed by April 15 of the year following the year of the gift.
Marital deduction and portability. For large estates that exceed the applicable exclusion amount of $11.2 million, the tax rate is 40 percent. The TCJA didn’t change the estate tax rate. Another aspect of estate tax/planning that didn’t change involves the marital deduction. For spouses that are U.S. citizens, the TCJA retains the unlimited deduction from federal estate and gift tax that delays the imposition of estate tax on assets one spouse inherits from a prior deceased spouse until the death of the surviving spouse. Thus, assets can be gifted to a spouse with no tax complications at the death of the first spouse, and the first spouse can simply leave everything to a surviving spouse without any tax effect until the surviving spouse dies. This, of course, may not be a very good overall estate plan depending on the value of the assets transferred to the surviving spouse.
The “portability” concept of prior law was retained. That means that a surviving spouse can carry over any unused exemption of the surviving spouse’s “last deceased spouse” (a phrase that has meaning if the surviving spouse remarries). Portability allows married couples to transfer up to $22.4 million without any federal transfer tax consequences, and without any need to have complicated estate planning documents drafted to achieve the no-tax result. But, portability is not “automatic.” The estate executor must “elect” portability by filing a federal estate tax return (Form 706) within nine months of death (unless a six-month extension is granted). That requirement applies even if the estate is beneath the applicable exclusion amount such that no tax is due.
Remember the “Alamo” – state transfer taxes. A minority of states (presently 17 of them) tax transfers at death, either via an estate tax or an inheritance tax. The number of states that do is dwindling - two more states repealed their estate tax as of the beginning of 2018. A key point to remember is that in the states where an estate tax is retained, the exemption is often much less than the federal exemption. Only three states that retain an estate tax tie the state exemption to the federal amount. This all means that for persons in these states, taxes at death are a real possibility. This point must be remembered by persons in these states – CT, HI, IL, IA, KY, ME, MD, MA, MN, NE, NJ, NY, OR, PA, RI, VT, WA and the District of Columbia.
Generation-skipping transfer tax. The TCJA does retain the generation-skipping transfer (GSTT) tax. Thus, for assets transferred to certain individuals more than a generation younger than the decedent (that’s an oversimplification of the rule), the “generation-skipping” transfer tax (GSTT) applies. The GSTT is an addition to the federal estate or gift tax, but it does come with an exemption of $11.2 million (for 2018) for GSTT transfers made either during life (via gift) or at death. Above that exemption, a 40 percent tax rate applies. Portability does not apply to the GSTT.
Income tax basis. As noted above, the TCJA retains the rule that for income tax purposes, the cost basis of inherited assets gets adjusted to the fair market value on the date of the owner’s death. This is commonly referred to as “stepped-up” basis, but that may not always be the case. Sometimes, basis can go down. When “stepped-up” basis applies, the rule works to significantly limit (or eliminate) capital gains tax upon subsequent sale of the asset by the heir(s). This can be a very important rule for ag estates where the heirs desire to sell the inherited assets. Ag estates are commonly comprised of low-basis assets. So, while the federal estate tax won’t impact very many ag estates, the basis issue is important to just about all of them. That’s why, as mentioned above, the basic estate plan for most estates is to cause inclusion of the property in the estate at death. Achieving that basis increase is essential.
Estate planning still remains important. While the federal estate tax is not a concern for most people, there are still other aspects of estate planning that must be addressed. This includes having a basic will prepared and a financial power of attorney as well as a health care power of attorney. In certain situations, it may also include a pre-marital/post-marital agreement. If a family business is involved, then succession planning must be incorporated into the overall estate plan. That could mean, in many situations, a well-drafted buy-sell agreement. In addition, a major concern for some people involves planning for long-term health care.
Also, it’s a good idea to always revisit your estate plan whenever there is a change in the law to make sure that the drafting language used in key documents (e.g., a will or a trust) doesn’t result in any unintended consequences.
Oh…remember that the changes in the federal estate tax contained in the TCJA mentioned above are only temporary. If nothing changes as we go forward, the law reverts to what the law was in 2017 starting in 2026. That means the exemption goes back down to the 2017 level, adjusted for inflation. That also means estate planning is still on the table. The federal estate tax hasn’t been killed, just temporarily buried a bit deeper.
Monday, January 1, 2018
This week I will be writing about what I view as the most significant developments in agricultural law and agricultural taxation during 2017. There were many important happenings in the courts, the IRS and with administrative agencies that have an impact on farm and ranch operations, rural landowners and agribusinesses. What I am writing about this week are those developments that will have the biggest impact nationally. Certainly, there were significant state developments, but they typically will not have the national impact of those that result from federal courts, the IRS and federal agencies.
It's tough to get it down to the ten biggest developments of the year, and I do spend considerable time sorting through the cases and rulings get to the final cut. Today’s post examines those developments that I felt were close to the top ten, but didn’t quite make the list. Later this week we will look at those that I feel were worthy of the top ten. Again, the measuring stick is the impact that the development has on the U.S. ag sector as a whole.
Almost, But Not Quite
Those developments that were the last ones on the chopping block before the final “top ten” are always the most difficult to determine. But, as I see it, here they are (in no particular order):
- Withdrawal of Proposed I.R.C. §2704 Regulations. In the fall of 2016, the Treasury Department issued proposed regulations (REG-16113-02) involving valuation issues under I.R.C. §2704. The proposed regulations would have established serious limitations on the ability to establish valuation discounts (e.g., minority interest and lack of marketability) for estate, gift and generation-skipping transfer tax purposes via estate and business planning techniques. In early December of 2016, a public hearing was held concerning the proposed regulations. However, the proposed regulations were not finalized before President Trump took office. In early October of 2017, the Treasury Department announced that it was pulling several tax regulations identified as burdensome under President Trump’s Executive Order 13789, including the proposed I.R.C. §2704 regulations. Second Report to the President on Identifying and Reducing Tax Regulatory Burdens (Oct. 4, 2017).
Note: While it is possible that the regulations could be reintroduced in the future with revisions, it is not likely that the present version will ultimately be finalized under the current Administration.
- IRS Says There Is No Exception From Filing a Partnership Return. The IRS Chief Counsel’s Office, in response to a question raised by an IRS Senior Technician Reviewer, has stated that Rev. Prov. 84-35, 1984-2 C.B. 488, does not provide an automatic exemption from the requirement to file Form 1065 (U.S. Return of Partnership Income) for partnerships with 10 or fewer partners. Instead, the IRS noted that such partnerships can be deemed to meet a reasonable cause test and are not liable for the I.R.C. §6698 penalty. IRS explained that I.R.C. §6031 requires partnerships to file Form 1065 each tax year and that failing to file is subject to penalties under I.R.C. §6698 unless the failure to file if due to reasonable cause. Neither I.R.C. §6031 nor I.R.C. §6698 contain an automatic exception to the general filing requirement of I.R.C. §6031(a) for a partnership as defined in I.R.C. §761(a). IRS noted that it cannot determine whether a partnership meets the reasonable cause criteria or qualifies for relief under Rev. Proc. 84-35 unless the partnership files Form 1065 or some other document. Reasonable cause under Rev. Proc. 84-35 is determined on a case-by-case basis and I.R.M. Section 184.108.40.206.3.1 sets forth the procedures for applying the guidance of Rev. Proc. 84-35. C.C.A. 201733013 (Jul. 12, 2017); see also Roger A. McEowen, The Small Partnership 'Exception,' Tax Notes, April 17, 2017, pp. 357-361.
- “Qualified Farmer” Definition Not Satisfied; 100 Percent Deductibility of Conservation Easement Not Allowed. A “qualified farmer” can receive a 100 percent deduction for the contribution of a permanent easement to a qualified organization in accordance with I.R.C. §170(b)(1)(E). However, to be a “qualified farmer,” the taxpayer must have gross income from the trade or business of farming that exceeds 50 percent of total gross income for the tax year. In a 2017, the U.S. Tax Court decided a case where the petitioners claimed that the proceeds from the sale of the property and the proceeds from the sale of the development rights constituted income from the trade or business of farming that got them over the 50 percent threshold. The IRS disagreed, and limited the charitable deduction to 50 percent of each petitioner’s contribution base with respect to the conservation easement. The court agreed with the IRS. The court noted that the income from the sale of the conservation easement and the sale of the land did not meet the definition of income from farming as set forth in I.R.C. §2032A(e)(5) by virtue of I.R.C. §170(b)(1)(E)(v). The court noted that the statute was clear and that neither income from the sale of land nor income from the sale of development rights was included in the list of income from farming. While the court pointed out that there was no question that the petitioners were farmers and continued to be after the conveyance of the easement, they were not “qualified farmers” for purposes of I.R.C. §170(b)(1)(E)(iv)(I). Rutkoske v. Comr., 149 T.C. No. 6 (2017).
- Corporate-Provided Meals In Leased Facility Fully Deductible. While the facts of the case have nothing to do with agriculture, the issues involved are the same ones that the IRS has been aggressively auditing with respect to farming and ranching operations – namely, that the 100 percent deduction for meals provided to corporate employees for the employer’s convenience cannot be achieved if the premises where the meals are provided is not corporate-owned. In a case involving an NHL hockey team, the corporate owner contracted with visiting city hotels where the players stayed while on road trips to provide the players and team personnel pre-game meals. The petitioner deducted the full cost of the meals, and the IRS limited the deduction in accordance with the 50 percent limitation of I.R.C. §274(n)(1). The court noted that the 50 percent limitation is inapplicable if the meals qualify as a de minimis fringe benefit and are provided in a nondiscriminatory manner. The court determined that the nondiscriminatory requirement was satisfied because all of the staff that traveled with the team were entitled to use the meal rooms. The court also determined that the de minimis rule was satisfied if the eating facility (meal rooms) was owned or leased by the petitioner, operated by the petitioner, located on or near the petitioner’s business premises, and the meals were furnished during or immediately before or after the workday. In addition, the court determined that the rules can be satisfied via contract with a third party to operate an eating facility for the petitioner’s employees. As for the business purpose requirement, the court noted that the hotels where the team stayed at while traveling for road games constituted a significant portion of the employees’ responsibilities and where the team conducted a significant portion of its business. Thus, the cost of the meals qualified as a fully deductible de minimis fringe benefit. Jacobs v. Comr., 148 T.C. No. 24 (2017).
Note: The petitioner’s victory in the case was short-lived. The tax bill enacted into law on December 22, 2017, changes the provision allowing 100 percent deductibility of employer-provided meals to 50 percent effective Jan. 1, 2018, through 2025. After 2025, no deduction is allowed.
- Settlement Reached In EPA Data-Gathering CAFO Case. In 2008, the Government Accounting Office (GAO) issued a report stating that the Environmental Protection Agency (EPA) had inconsistent and inaccurate information about confined animal feeding operations (CAFOs), and recommended that EPA compile a national inventory of CAFO’s with NPDES permits. Also, as a result of a settlement reached with environmental activist groups, the EPA agreed to propose a rule requiring all CAFOs to submit information to the EPA as to whether an operation had an NPDES permit. The information required to be submitted had to provide contact information of the owner, the location of the CAFO production area, and whether a permit had been applied for. Upon objection by industry groups, the proposed rule was withdrawn and EPA decided to collect the information from federal, state and local government sources. Subsequent litigation determined that farm groups had standing to challenge the EPA’s conduct and that the EPA action had made it much easier for activist groups to identify and target particular confined animal feeding operations (CAFOs). On March 27, 2017, the court approved a settlement agreement ending the litigation between the parties. Under the terms of the settlement, only the city, county, zip code and permit status of an operation will be released. EPA is also required to conduct training on FOIA, personal information and the Privacy Act. The underlying case is American Farm Bureau Federation v. United States Environmental Protection Agency, 836 F.3d 963 (8th Cir. 2016).
- Developments Involving State Trespass Laws Designed to Protect Livestock Facilities.
- Challenge to North Carolina law dismissed for lack of standing. The plaintiffs, numerous animal rights activist groups, brought a pre-enforcement challenge to the North Carolina Property Protection Act (Act). The Act creates a civil cause of action for a NC employer against an employee who “captures or removes” documents from the employer’s premises or records images or sound on the employer’s premises and uses the documents or recordings to breach the employee’s duty of loyalty to the employer. The plaintiffs claimed that the Act stifled their ability to investigate NC employers for illegal or unethical conduct and restricted the flow of information those investigations provide in violation of the First and Fourteenth Amendments of the U.S. Constitution and various provisions of the NC Constitution. The court dismissed the case for lack of standing. People for the Ethical Treatment of Animals v. Stein, 259 F. Supp. 3d 369 (M.D. N.C. 2017).
- Utah law deemed unconstitutional. Utah law (Code §76-6-112) (hereinafter Act) criminalizes entering private agricultural livestock facilities under false pretenses or via trespass to photograph, audiotape or videotape practices inside the facility. Anti-livestock activist groups sued on behalf of the citizen-activist claiming that the Act amounted to an unconstitutional restriction on speech in violation of the First Amendment. While the state claimed that lying, which the statute regulates, is not protected free speech, the court determined that only lying that causes “legally cognizable harm” falls outside First Amendment protection. The state also argued that the act of recording is not speech that is protected by the First Amendment. However, the court determined that the act of recording is protectable First Amendment speech. The court also concluded that the fact that the speech occurred on a private agricultural facility did not render it outside First Amendment protection. The court determined that both the lying and the recording provisions of the Act were content-based provisions subject to strict scrutiny. To survive strict scrutiny the state had to demonstrate that the restriction furthered a compelling state interest. The court determined that “the state has provided no evidence that animal and employee safety were the actual reasons for enacting the Act, nor that animal and employee safety are endangered by those targeted by the Act, nor that the Act would actually do anything to remedy those dangers to the extent that they exist”. For those reasons, the court determined that the act was unconstitutional. Animal Legal Defense Fund v. Herbert, 263 F. Supp. 3d 1193 (D. Utah 2017).
- Wyoming law struck down. In 2015, two new Wyoming laws went into effect that imposed civil and criminal liability upon any person who "[c]rosses private land to access adjacent or proximate land where he collects resource data." Wyo. Stat. §§6-3-414(c); 40-27-101(c). The appellate court, reversing the trial court, determined that because of the broad definitions provided in the statutes, the phrase "collects resource data" includes numerous activities on public lands (such as writing notes on habitat conditions, photographing wildlife, or taking water samples), so long as an individual also records the location from which the data was collected. Accordingly, the court held that the statutes regulated protected speech under the First Amendment in spite of the fact that they also governed access to private property. While trespassing is not protected by the First Amendment, the court determined that the statutes targeted the “creation” of speech by penalizing the collection or resource data. Western Watersheds Project v. Michael, 869 F.3d 1189 (10th Cir. 2017), rev’g., 196 F. Supp. 3d 1231 (D. Wyo. 2016).
- Challenge to North Carolina law dismissed for lack of standing. The plaintiffs, numerous animal rights activist groups, brought a pre-enforcement challenge to the North Carolina Property Protection Act (Act). The Act creates a civil cause of action for a NC employer against an employee who “captures or removes” documents from the employer’s premises or records images or sound on the employer’s premises and uses the documents or recordings to breach the employee’s duty of loyalty to the employer. The plaintiffs claimed that the Act stifled their ability to investigate NC employers for illegal or unethical conduct and restricted the flow of information those investigations provide in violation of the First and Fourteenth Amendments of the U.S. Constitution and various provisions of the NC Constitution. The court dismissed the case for lack of standing. People for the Ethical Treatment of Animals v. Stein, 259 F. Supp. 3d 369 (M.D. N.C. 2017).
- GIPSA Interim Final Rule on Marketing of Livestock and Poultry Delayed and Withdrawn.In the fall of 2016, the USDA sent to the Office of Management and Budget (OMB) interim final rules that provide the agency’s interpretation of certain aspects of the Packers and Stockyards Act (PSA) involving the buying and selling of livestock and poultry. The interim final rules concern Section 202 of the PSA (7 U.S.C. §§ 192 (a) and (e)) which makes it unlawful for any packer who inspects livestock, meat products or livestock products to engage in or use any unfair, unjustly discriminatory or deceptive practice or device, or engage in any course of business or do any act for the purpose or with the effect of manipulating or controlling prices or creating a monopoly in the buying, selling or dealing any article in restraint of commerce. The “effect” language of the statute would seem to eliminate any requirement that the producer show that the packer acted with the intent to control or manipulate prices. However, the federal courts have largely interpreted the provision to require a plaintiff to show an anti-competitive effect in order to have an actionable claim. Under the proposed regulations, "likelihood of competitive injury" is defined as "a reasonable basis to believe that a competitive injury is likely to occur in the market channel or marketplace.” It includes, but is not limited to, situations in which a packer, swine contractor, or live poultry dealer raises rivals' costs, improperly forecloses competition in a large share of the market through exclusive dealing, restrains competition, or represents a misuse of market power to distort competition among other packers, swine contractors, or live poultry dealers. It also includes situations “in which a packer, swine contractor, or live poultry dealer wrongfully depresses prices paid to a producer or grower below market value, or impairs a producer's or grower's ability to compete with other producers or growers or to impair a producer's or grower's ability to receive the reasonably expected full economic value from a transaction in the market channel or marketplace." According to the proposed regulations, a “competitive injury” under the PSA occurs when conduct distorts competition in the market channel or marketplace. The scope of PSA §202(a) and (b) is stated to depend on the nature and circumstances of the challenged conduct. The proposed regulations specifically note that a finding that a challenged act or practice adversely affects or is likely to affect competition is not necessary in all cases. The proposed regulations also note that a PSA violation can occur without a finding of harm or likely harm to competition, but as noted above, that is contrary to numerous court opinions that have decided the issue. On April 11, 2017, the USDA announced that it was delaying the effective date of the interim final rule for 180 days, until October 19, 2017. However, on October 18, 2017, GIPSA officially withdrew the proposed rule. Related to, but not part of, the GIPSA Interim Final Rule, a poultry grower ranking system proposed rule was not formally withdrawn.
- Syngenta Settlement. In late 2017, Syngenta publicly announced that it was settling farmers’ claims surrounding the alleged early release of Viptera and Duracade genetically modified corn. While there are numerous cases and aspects of the litigation involving Syngenta, the settlement involves what is known as the “MIR 162 Corn Litigation” and a Minnesota state court class action. The public announcement of the settlement indicated that Syngenta would pay $1.5 billion.
- IRS To Finalize Regulations on the Tax Status of LLC and LLP Members. In its 2017-2018 Priority Guidance Plan, the IRS states that it plans to finalize regulations under I.R.C. §469(h)(2) – the passive loss rules that were initially proposes in 2011. That provision creates a per se rule of non-material participation for limited partner interests in a limited partnership unless the Treasury specifies differently in regulations. Those regulations were initially issued in temporary form and became proposed regulations in 2011. Is the IRS preparing to take a move to finalize regulations taking the position that they the Tax Court refused to sanction? Only time will tell, but the issue is important for LLC and LLP members. The issue boils down to the particular provisions of a state’s LLC statute and whether there are sufficient factors under the state statute that distinguish an LLC from a limited partnership. That will be the case until IRS issues regulations dealing specifically with LLCs and similar entities. The proposed definition would make it easier for LLC members and some limited partners to satisfy the material participation requirements for passive loss purposes, consistent with the court opinions that IRS has recently lost on the issue. Specifically, the proposed regulations require that two conditions have to be satisfied for an individual to be classified as a limited partner under I.R.C. §469(h)(2): (1) the entity must be classified as a partnership for federal income tax purposes; and (2) the holder of the interest must not have management rights at any time during the entity’s tax year under local law and the entity’s governing agreement. Thus, LLC members of member-managed LLCs would be able to use all seven of the material participation tests, as would limited partners that have at least some rights to participate in managerial control or management of a partnership.
- Fourth Circuit Develops New Test for Joint Employment Under the FLSA. The Fair Labor Standards Act of 1938 (FLSA) (29 U.S.C. §§ 201 et seq.) as originally enacted, was intended to raise the wages and shorten the working hours of the nation's workers. The FLSA is very complex, and not all of it is pertinent to agriculture and agricultural processing, but the aspect of it that concerns “joint employment” is of major relevance to agriculture. Most courts that have considered the issue have utilized an “economic realities” or “control” test to determine if one company’s workers are attributable to another employer for purposes of the FLSA. But, in a 2017 case, the U.S. Court of Appeals for the Fourth Circuit, created a new test for joint employment under the FLSA that appears to expand the definition of “joint employment” and may create a split of authority in the Circuit Courts of Appeal on the issue. The court held that the test under the FLSA for joint employment involved two steps. The first step involved a determination as to whether two or more persons or entities share or agree to allocate responsibility for, whether formally or informally, directly or indirectly, the essential terms and conditions of a worker’s employment. The second step involves a determination of whether the combined influence of the parties over the essential terms and conditions of the employment made the worker an employee rather than an independent contractor. If, under this standard, the multiple employers were not completely disassociated, a joint employment situation existed. The court also said that it was immaterial that the subcontractor and general contractor engaged in a traditional business relationship. In other words, the fact that general contractors and subcontractor typically structure their business relationship in this manner didn’t matter. The Salinas court then went on to reason that separate employment exists only where the employers are “acting entirely independent of each other and are completely disassociated with respect to” the employees. The court’s “complete disassociation” test appears that it could result in a greater likelihood that joint employment will result in the FLSA context than would be the case under the “economic realities” or “control” test. While the control issue is part of the “complete disassociation” test, joint determination in hiring or firing, the duration of the relationship between the employers, where the work is performed and responsibility over work functions are key factors that are also to be considered. Salinas v. Commercial Interiors, Inc., 848 F.3d 125 (4th Cir. 2017), rev’g, No. JFM-12-1973, 2014 U.S. Dist. LEXIS 160956 (D. Md. Nov. 17, 2014).
- Electronic Logs For Truckers. On December 18, 2017, the U.S. Department of Transportation (USDOT) Final Rule on Electronic Logging Devices (ELD) and Hours of Service (HOS) was set to go into effect. 80 Fed. Reg. 78292 (Dec.16, 2015). The final rule, which was issued in late 2015, could have a significant impact on the livestock industry and livestock haulers. The new rule will require truck drivers to use electronic logging devices instead of paper logs to track their driving hours starting December 18. The devices connect to the vehicle's engine and automatically record driving hours. The Obama Administration pushed for the change to electronic logs purportedly out of safety concerns. The Trump Administration has instructed the FMCSA (and state law enforcement officials) to delay the December 18 enforcement of the final rule by delaying out-of-service orders for ELD violations until April 1, 2018, and not count ELD violations against a carrier’s Compliance, Accountability, Safety Score. Thus, from December 18, 2017 to April 1, 2018, any truck drivers who are caught without an electronic logging device will be cited and allowed to continue driving, as long as they are in compliance with hours-of-service rules. In addition, the FMCSA has granted a 90-day waiver for all vehicles carrying agricultural commodities. Other general exceptions to the final rule exist for vehicles built before 2000, vehicles that operate under the farm exemption (a “MAP 21” covered farm vehicle; 49 C.F.R. §395.1(s)), drivers coming within the 100/150 air-mile radius short haul log exemption (49 CFR §395.1(k)), and drivers who maintain HOS logs for no more than eight days during any 30-day period. One rule that is of particular concern is an HOS requirement that restricts drive time to 11 hours. This rule change occurred in 2003 and restricts truck drivers to 11 hours of driving within a 14-hour period. Ten hours of rest is required. That is a tough rule as applied to long-haul cattle transports. Unloading and reloading cattle can be detrimental to the health of livestock.
- Dicamba Spray-Drift Issues. Spray-drift issues with respect to dicamba and the use of XtendiMax with VaporGrip (Monsanto) and Engenia (BASF) herbicides for use with Xtend Soybeans and Cotton were on the rise in 2017. , 2017Usage of dicamba has increased recently in an attempt to control weeds in fields planted with crops that are engineered to withstand it. But, Missouri (effective July 7) and Arkansas (as of June 2017) took action to ban dicamba products because of drift-related damage issues. In addition, numerous lawsuits have been filed by farmers against Monsanto, BASF and/or DuPont alleging that companies violated the law by releasing their genetically modified seeds without an accompanying herbicide and that the companies could have reasonably foreseen that seed purchasers would illegally apply off-label, older dicamba formulations, resulting in drift damage. Other lawsuits involve claims that the new herbicide products are unreasonably dangerous and have caused harm even when applicators followed all instructions provided by law. In December of 2017, the Arkansas Plant Board voted to not recommend imposing a cut-off date of April 15 for dicamba applications. Further consideration of the issue will occur in early 2018.
Wednesday, November 8, 2017
Next June, Washburn University School of Law will be sponsoring a two-day seminar in Pennsylvania on farm income tax and farm estate and business planning. I will be one of speakers at the event as will Paul Neiffer, the author of the Farm CPA Today blog. Paul and I have done numerous events together over the past few years and I thoroughly enjoy working with Paul. The K-State Department of Agricultural Economics will be co-sponsoring the event, and we are looking forward to working with the Pennsylvania Society of CPAs and Farm Credit East. The seminar dates will be June 7-8 and the location, while not set at the present time, will be within a couple of hours of Harrisburg, PA.
Our two-day event will precede the 2018 conference in Harrisburg of the National Association of Farm Business Analysis Specialists (NAFBAS) and the National Farm and Ranch Business Management Education Association, Inc. (NFRBMEA) which begins on June 10. We are looking forward to partnering with the two groups to provide technical and practical tax information in an applied manner that the attendees to the NAFBAS/NFRBMEA conference will find to be a beneficial supplement to their conference. Accordingly, we are planning the agenda to supplement the information that will be provided at the NAFBAS/NFRBMEA conference.
We will follow our traditional two-day seminar approach with farm income tax information on Day 1 and farm estate and business planning topics on Day 2. On Day 1, we will provide an update on recent cases and rulings. Of course, if there is new tax legislation, we will cover its application to various client situations. We will also provide farm income averaging planning strategies, farm financial distress tax planning issues, self-employment tax and how to structure leases and entities. Also on Day 1, we will explain how to handle indirect production costs and the application of the repair/capitalization regulations. In addition, we will explain the proper handling of farm losses and planning opportunities with farming C corporations.
On Friday, Day 2, we will cover the most recent developments in farm estate and business planning. Of course, if there is legislation enacted that impacts the transfer tax system, we will cover it in detail. We will also have a session on applicable tax planning strategies for the retiring farmer, and ownership transition strategies. Also discussed on Day 2 will be the procedures and tax planning associated with incorporating the farm business tax-free. We will also get into long-term health care planning, how best to structure the farming business to take maximum advantage of farm program payments, special use valuation as well as installment payment of federal estate tax. Those handling fiduciary returns will also find our session on trust and estate taxation and associated planning opportunities to be of great benefit.
Mark your calendars now for the June7-8 seminar in PA. If flying, depending on the location we settle on, flights into either Pittsburgh, Philadelphia or Baltimore will be relatively close. Be watching www.washburnlaw.edu/waltr for further details as the weeks go by. Until then, upcoming tax seminars will find me next week in North Dakota, and then Kansas in the following two weeks. In early December, I will be leading-off the Iowa Bar’s Bloethe Tax School in Des Moines with a federal tax update. I have also heard from numerous Iowans that will be attending tax school in Overland Park in late November, and I am looking forward to seeing you there along with the other attendees. Next week’s seminar from Fargo will be simulcast over the web in case you can’t attend in-person. Also, the seminar from Pittsburg, KS will be simulcast over the web. In addition, there will be a 2-hour ethics seminar/webinar on Dec. 15. Be watching my CPE calendar on www.washburnlaw.edu/waltr for more details.
I have a new book out, published by West Academic – “Agricultural Law in a Nutshell.” Here’s the link to more information about the book and how to order. http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/agriculturallawnutshell/index.html If you are involved in agriculture or just like to read up on legal issues involving those involved in agricultural production or agribusiness, the book would make a great stocking-stuffer. If you are teaching or taking an agricultural law class in the spring semester of 2018, this is a “must have” book.
There are always plenty of legal issues to write about and current developments to keep up on. Readers of this blog are well aware of that fact.
Monday, October 23, 2017
The death of a family member or other loved-one is often difficult circumstance for the family and other close ones that are left behind. From a financial and tax standpoint, however, proper and thorough estate planning is the key to minimizing and potentially eliminating more distress associated with the decedent’s passing.
One aspect of estate planning that does not involve technical tax planning or entity structuring or other crucial legal aspects involves cataloguing where the decedent’s important documents are located and who has access to them. In the past, that has often involved counseling clients to make sure that they have a filing system for key items such as insurance policies, contact information for utility companies, and contracts and warranty information for equipment and appliances, etc. In addition, a safety deposit box and/or safe has commonly been suggested for the storage of critical documents such as a will, power of attorney, or trust as well as real estate deeds and similar items.
But, in recent years a new issue has arisen in the estate planning realm. This issue involves the decedent’s digital assets such as electronic mail (email) accounts, bank accounts, credit cards, mortgages, and any other type of digital record as well as electronically stored information and social media accounts. Even business assets have become digitized. Depending on the decedent’s type of business, the extent of digitization of business records and information can be quite large.
So, what is the big estate planning issue with digital assets? It involves who has access to those assets upon death and whether appropriate language is included in estate planning documents to provide that access. A recent court decision in Massachusetts brings the issue front and center.
That’s the topic of today post – digital assets and estate planning.
Interestingly, federal law governing privacy rights to electronic communications goes back over 30 years. The Stored Communications Act (SCA) was included as part of the Electronic Communications Privacy Act of 1986. 18 U.S.C. §§2701-2712. That SCA created privacy rights to particular electronic communications and associated files from disclosure by online service providers. However, with the development of the internet and email communication that started in the mid-1990s, the SCA created a significant problem for fiduciaries and family members that needed access to the decedent’s online records and accounts. The SCA bars an online service provider from disclosing the decedent’s files and/or accounts to the estate fiduciaries or others unless the requirements for an exception contained in 18 U.S.C. §2702(b) are satisfied. But, even if an exception is satisfied, the service provider is not required to provide access to or otherwise disclose the contents of the decedent’s digital files or online accounts. Voluntary disclosure is the rule upon “lawful consent” of the “originator” or “subscriber.” 18 U.S.C. §2702(b)(3). In addition, the statute does not clearly state whether an estate fiduciary (e.g., executor or personal representative) can give the required “lawful consent.”
Facts. In a recent decision, the highest court in Massachusetts held that “…the personal representatives may provide lawful consent on the decedent’s behalf to the release of the contents of the Yahoo email account.” Ajemian v. Yahoo!, Inc., 478 Mass. 169 (2017). The facts of the case indicate that the decedent died intestate in 2006 as the result of a bicycle accident. The decedent had, at the time of death, an email account. However, he didn’t leave any instructions regarding how to handle the account after his death. Two of his siblings were appointed the personal representatives of his estate, and sought access to the contents of the email account. But, the service provider refused to provide access on the basis that it was barred from doing so by the SCA. The service provider also claimed that the terms of service that governed the email account gave the service provider the discretion to reject the personal representatives’ request.
Court determinations. The personal representatives sued, and the probate court granted the service provider’s motion to dismiss the case. On appeal, the appellate court vacated that judgment and remanded the case for a determination of whether the SCA barred the service provider from releasing the contents of the decedent’s email account to the personal representatives. On remand, the service provider claimed that the SCA prevented disclosure and, even if it did not, the terms-of-service agreement gave the service provider the right to deny access to (and even delete the contents of) the account. The appellate court granted summary judgment for the service provider on the basis that the SCA prohibited disclosure (but not on the basis of the terms of service contract).
On further review at the Massachusetts Supreme Judicial Court, the personal representatives claimed that they were the decedent’s agents for purposes of the exception of 18 U.S.C. §2702(b)(1) which gave the service provider the ability to disclose the contents of the decedent’s email account to them. However, the Supreme Judicial Court did not buy that argument, determining instead that a person appointed by a court does not fall within the common law meaning of “agent” citing Restatement (Third) of Agency §1.01 comment f. As to whether the personal representatives “stepped into the shoes” of the decedent as the originator of the account and, thus, could lawfully consent to the release of the contents of the email account under 18 U.S.C. §2702(b)(3), the Supreme Judicial Court held that they could, reasoning that there was nothing in the statutory definition or legislative history that indicated an intent to preempt state probate and/or common law allowing personal representatives to provide consent on a decedent’s behalf. The Supreme Judicial Court vacated the appellate court’s judgment and remanded the case to the probate court.
Revised Uniform Fiduciary Access To Digital Assets Act
While the Ajemian decision holds that a personal representative can meet the “lawful consent” exception of the SCA, a service provider is still not required to provide the desired access to digital records. However, under the Revised Uniform Fiduciary Access to Digital Assets Act (RUFADAA), a state law procedure is provided that fiduciaries can use to get access to online accounts (or other digital assets) of a decedent. The RUFADAA defines a “fiduciary” as a person appointed to manage the property of another person in that other’s person’s best interest. In essence, the RUFADAA empowers a fiduciary to manage another person’s “digital assets.” However, under the RUFADAA, the fiduciary must still get consent from the “owner” to be able to manage certain digital assets such as electronic communications and social media accounts unless the original user consented in a will, trust, power of attorney, or other record. Once that consent is obtained for digital assets that require it, if the service provider doesn’t comply with a disclosure request, §16(a) of the RUFADAA allows the personal representative to file a legal action seeking a court order requiring the service provider to comply with the personal representative’s request.
The majority of states have enacted the RUFADAA (or a substantially similar version thereof). Those that haven’t are: CA, DE, GA, KY, LA, MA, ME, MO, NH, OK, PA, RI, WV and the District of Columbia. Some of these states may enact the law in the near future. 2017 saw action in numerous state legislatures. As noted, MA has not enacted the RUFADAA, so a question is raised as to whether the court’s analysis in Ajemian would have differed, as well as how the RUFADAA would have impacted the SCA.
Digital Asset Planning Suggestions
What needs to be considered with respect to digital assets and an estate plan? The access question looms large. Who is to have access to digital assets and information post-death? From a will drafting standpoint, if a specific gift of digital assets is not made, the digital assets will be disposed of under the will’s residuary clause (“all the rest, residue and remainder of my estate”). Also, what type of access is the estate fiduciary to have? The type of access (such as the ability to read the substance of electronic communications) should be clearly specified in the owner’s will or trust. If access to digital assets and information is to be granted to a third party before death, the type and extent of access should be set forth in a power of attorney. On this point, the type of power of attorney matters.
Even with the authority to act as provided in a will, trust or power of attorney, it is likely that a service provider (or similar “custodian”) will require that the fiduciary obtain a court order before the release of any digital information or the granting of access.
While many people do not have estate planning documents in place at death, a very high percentage of decedents have at least some digital assets and/or accounts at the time of death. Some may have significant value. Others may have significant sentimental worth (such as photos). Thus, the ability to deal with and manage those assets post-death is very important. Technology has created additional legal and planning issues that should be accounted for.
The RUFADAA contains many associated comments that answer a lot of questions. To learn more, click on http://www.uniformlaws.org. Under the “Acts” tab, click on “Fiduciary Access To Digital Assets Act.”
Tuesday, October 3, 2017
Estate tax portability allows a surviving spouse to carry over any unused portion of the deceased spouse’s estate tax exclusion (DSUE) to be used to offset estate tax in the surviving spouse’s estate, if necessary. It gets added to the surviving spouse’s own exemption. The DSUE has become a key aspect of post-2012 estate planning, and makes it quite simple for married couple to utilize the full estate tax exclusion over both of their estates. The full estate and gift tax coupled exclusion is $5.49 million per individual for deaths in 2017 and gifts made in 2017.
One of the concerns about portability is the ability of the IRS to audit the estate of the deceased spouse where portability was elected. Does the IRS have an open-ended statute of limitations to go back and examine that estate to determine if the “ported” amount of the unused exclusion was computed properly? A recent Tax Court decision confirms that the IRS does.
The election. To “port” the unused exclusion at the death of the first spouse to the surviving spouse, an election must be made. As noted, the amount available to be “ported” to the estate of the surviving spouse is the deceased spouse’s unused exclusion (DSUE). IRC §2010(c)(4); Treas. Reg. §20.2010-2. The portability election must be made on a timely filed Form 706 for the first spouse to die. I.R.C. §2010(c)(5)(A); Treas. Reg. §20.2010-2(a)(1). This also applies for nontaxable estates, and the return is due by the same deadline (including extensions) as taxable estates. The deadline for filing is nine months after the decedent’s date of death (with a six-month extension possible). The election is revocable until the deadline for filing the return expires.
While an affirmative election is required by statute, part 6 of Form 706 (which is entirely dedicated to the portability election, the DSUE calculation, and roll forward of the DSUE amount) provides that "a decedent with a surviving spouse elects portability of the DSUE amount, if any, by completing and timely-filing the Form 706. No further action is required to elect portability…". This election, therefore, is made by default if there is a DSUE amount and an estate tax return is filed (as long as the box in section A of part 6 is not checked, which affirmatively elects out of portability).
Late election relief. In Rev. Proc. 2014-18, 2014-7 IRB 513, the IRS provided a simplified method for certain estates to obtain an extended time to make the portability election. That relief has now expired and has been extended by Rev. Proc. 2017-34, 2017-26 IRB 1282. The portability election must be submitted with a complete and properly filed Form 706 by the later of January 2, 2018, or the second anniversary of the decedent's death. After January 2, 2018, the extension is, effectively, for two years. The extension is only available to estates that are not otherwise required to file an estate tax return. Other estates can only obtain an extension under Treas. Reg. §301.9100-3. Form 706 must state at the top that the return is "FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER §2010(c)(5)(A)."
An estate that files late, but within the extended deadlines of Rev. Proc. 2017-34, cannot rely on the revenue procedure if it later learns that it should have filed a Form 706. If a valid late election is made and results in a refund of estate or gift taxes for the surviving spouse, the time period for filing for a refund is not extended from the normal statutory periods. In addition, a claim for a tax refund or credit is treated as a protective claim for a tax credit or refund if it is filed within the time period of §6511(a) by the surviving spouse or the surviving spouse's estate in anticipation of Form 706 being filed to elect portability under Rev. Proc. 2017-34.
Election requirements. Treas. Reg. §20.2010-2 requires that the DSUE election be made by filing a complete and properly prepared Form 706. Treas. Reg. §20.2010-2(a)(7)(ii)(A) permits the “appointed” executor who is not otherwise required to file an estate tax return to use the executor's "best estimate" of the value of certain property and then report on Form 706 the gross amount in aggregate, rounded up to the nearest $250,000.
Treas. Reg. §20.2010-2(a)(7)(ii) sets forth simplified reporting for particular assets on Form 706, which allows for good faith estimates. The simplified reporting rules apply to estates that do not otherwise have a filing requirement under IRC §6018(a). This means that if the gross estate exceeds the basic exclusion amount ($5.49 million in 2017), simplified reporting is not applicable.
Simplified reporting is only available for marital and charitable deduction property (under IRC §§2056, 2056A, and 2055) but not to such property if certain conditions apply. Treas. Reg. §20.2010-2(a)(7)(ii)(A).
Assets reported under the simplified method are to be listed on the applicable Form 706 schedule without any value entered in the column for "Value at date of death." The sum of the asset values included in the return under the simplified method are rounded up to the next $250,000 increment and reported on lines 10 and 23 of part 5 of Form 706 (as assets subject to the special rule of Treas. Reg. §20.2010-2(a)(7)(ii)).
In addition to listing the assets on the appropriate schedules, the regulations require that certain additional information must be provided for each asset. Treas. Reg. §20.2010-2(a)(7)(ii)(A).
Availability. The inherited DSUE amount is available to the surviving spouse as of the date of the deceased spouse's death. It is applied to gifts and the estate of the surviving spouse before their own exemption is used. Accordingly, the surviving spouse may use the DSUE amount to shelter lifetime gifts from gift tax or to reduce the estate tax liability of the surviving spouse's estate at death. Treas. Reg. §20.2010-3(b)(ii).
The regulations allow the surviving spouse to use the DSUE before the deceased spouse’s return is filed (and before the amount of the DSUE is established). Treas. Reg. §20.2010-3(ii). However, the DSUE amount is subject to audit until the statute of limitations expires on the surviving spouse’s estate tax return. Temp. Treas. Regs. §§20.2010-3T(c)(1) and 25.2505-2T(d)(1). However, the regulations do not address whether a presumption of survivorship can be established. Thus, there is no guidance on what happens if both spouses die at the same time and the order of death cannot be determined and it is not known whether the IRS would respect estate planning documents that include a provision for simultaneous deaths.
Statute of Limitations – IRS Audits
The statute of limitations for assessing additional tax on the estate tax return is the later of three years from the date of filing or two years from the date the tax was paid. However, the IRS can examine the DSUE amount at any time during the period of the limitations for the second spouse as it applies to the estate of the first spouse. Treas. Reg. §20.2010-2(d) allows the IRS to examine the estate and gift tax returns of each of the decedent's predeceased spouses. Any materials relevant to the calculation of the DSUE amount, including the estate tax (and gift tax) returns of each deceased spouse, can be examined. Thus, a surviving spouse needs to retain appraisals, work papers, documentation supporting the good-faith estimate, and all intervening estate and gift tax returns to substantiate the DSUE amount.
New Case On The Audit Issue
Facts. In Estate of Sower v. Comr., 149 T.C. No. 11 (2017), the decedent died in August of 2013 as the surviving spouse. Her predeceased spouse died in early 2012. His estate reported no federal estate tax liability on its timely filed Form 706. His estate also reported no taxable gifts although he had made $997,920 in taxable gifts during his life. However, his estate did include $845,420 in taxable gifts on the worksheet provided to calculate taxable gifts to be reported on the return. His estate reported a deceased spouse unused exclusion (DSUE) amount of $1,256,033 and a portability election of the DSUE was made on his estate’s Form 706 to port the DSUE to the surviving spouse.
The decedent’s estate filed a timely Form 706 claiming the ported DSUE of $1,256,033 and paid an estate tax liability of $369,036, and then an additional $386,424 of tax and interest to correct a math error on the original return. The decedent’s estate also did not include lifetime taxable gifts (of which there were $997,921) on the return, simply leaving the entry for them blank. About two months later, the IRS issued an estate tax closing letter to the husband’s estate showing no estate tax liability and noting that that the return had been accepted as filed.
IRS audit. In early 2015, the IRS began its examination of the decedent’s return. In connection with that exam, the IRS opened an exam of the husband’s estate to determine the proper DSUE to be ported to the decedent’s estate. As a result of this exam, the IRS made an adjustment for the amount of the pre-deceased spouse’s lifetime taxable gifts and issued a second closing letter and also reducing the DSUE available to port to the decedent’s estate of $282,690. The IRS also adjusted the decedent’s taxable estate by the amount of her lifetime taxable gifts and reduced it for funeral costs. The end result was an increase in federal estate tax liability for the decedent’s estate of $788,165, and the IRS sent the decedent’s estate a notice of deficiency for that amount and the estate disputed the full amount by filing a petition in Tax Court.
Estate’s arguments. The estate claimed that the IRS was estopped from reopening the estate of the predeceased spouse after the closing letter had been initially issued to that estate. The estate also claimed that the IRS was precluded from adjusting the DSUE for gifts made before 2010. The estate additionally claimed that I.R.C. §2010(c)(5)(B) (allowing IRS to examine an estate tax return to determine the correct DSUE notwithstanding the normal applicable statute of limitations) was unconstitutional for lacking due process because it overrode the statute of limitations on assessment contained in I.R.C. §6501.
Tax Court opinion. The Tax Court disagreed with the estate on all points. The court noted that I.R.C. §2010(c)(5)(B) gave the IRS the power to examine the estate tax return of the predeceased spouse to determine the correct DSUE amount. That power, the court noted, applied regardless of whether the period of limitations on assessment had expired for the predeceased spouse’s estate. This, the Tax Court noted, was bolstered by temporary regulations in place at the time of the predeceased spouse’s (and the decedent’s) death. I.R.C. §7602, the Tax Court noted, also gave the IRS broad discretion to examine a range of materials to determine whether a return was correct, including estate tax returns.
The Tax Court also determined that the closing letter did not amount to a closing document under I.R.C. §7121, which required a Form 866 and Form 906, and there had been no negotiation between the IRS and the estate. The Tax Court also held that the decedent’s estate had not satisfied the elements necessary to establish equitable estoppel against the IRS. The IRS had not made a false statement or had been misleadingly silent that lead to an adverse impact on the estate.
Also, the Tax Court noted that there had not been any second examination. No additional information had been requested from the pre-deceased spouse’s estate and no additional tax was asserted. The effective date of the proposed regulation was for estates of decedent’s dying after 2010 and covered gifts made by such estates irrespective of when those gifts were made.
There was also no due process violation because adjusting the DSUE did not amount to an assessment of tax against the estate of the pre-deceased spouse. Consequently, the Tax Court held that the IRS properly adjusted the DSUE and the decedent’s estate had to include the lifetime taxable gifts in the estate for estate tax liability computation purposes.
Because the election to utilize portability allows the IRS an extended timeframe to question valuations, the use of a bypass/credit shelter trust that accomplishes the same result for many clients may be a preferred approach. However, in those situations, it should be a routine practice for practitioners to obtain a signed acknowledgement and waiver from the executor of the first spouse’s estate that the potential benefit of portability in the surviving spouse’s death has been explained fully and has been waived.
As the Tax Court points out, the IRS has the power to audit the first spouse’s estate tax return and can add any increased tax to the surviving spouse’s estate tax return – no matter how many years have passed since the first spouse’s death. That means it should also be routine practice for practitioners to make sure that Form 706 for the first spouse’s estate is prepared with absolute perfection.
Tuesday, August 22, 2017
On September 18, Washburn School of Law will be having its second annual CLE conference in conjunction with the Agricultural Economics Department at Kansas St. University. The conference, hosted by the Kansas Farm Bureau (KFB) in Manhattan, KS, will explore the legal, economic, tax and regulatory issue confronting agriculture. This year, the conference will also be simulcast over the web.
That’s my focus today – the September 18 conference in Manhattan, for practitioners, agribusiness professionals, agricultural producers, students and others.
Financial situation. Midwest agriculture has faced another difficult year financially. After greetings by Kansas Farm Bureau General Counsel Terry Holdren, Dr. Allen Featherstone, the chair of the ag econ department at KSU will lead off the day with a thorough discussion on the farm financial situation. While his focus will largely be on Kansas, he will also take a look at nationwide trends. What are the numbers for 2017? Where is the sector headed for 2018?
Regulation and the environment. Ryan Flickner, Senior Director, Advocacy Division, at the KFB will then follow up with a discussion on Kansas regulations and environmental laws of key importance to Kansas producers and agribusinesses.
Tax – part one. I will have a session on the tax and legal issues associated with the wildfire in southwest Kansas earlier this year – handling and reporting losses, government payments, gifts and related issues. I will also delve into the big problem in certain parts of Kansas this year with wheat streak mosaic and dicamba spray drift.
Weather. Mary Knapp, the state climatologist for Kansas, will provide her insights on how weather can be understood as an aid to manage on-farm risks. Mary’s discussions are always informative and interesting.
Crop Insurance. Dr. Art Barnaby, with KSU’s ag econ department, certainly one of the nation’s leading experts on crop insurance, will address the specific situations where crop insurance does not cover crop loss. Does that include losses caused by wheat streak mosaic? What about losses from dicamba drift?
Washburn’s Rural Law Program. Prof. Shawn Leisinger, the Executive Director of the Centers for Excellence at the law school (among his other titles) will tell attendees and viewers what the law school is doing (and planning to do) with respect to repopulating rural Kansas with well-trained lawyers to represent the families and businesses of agriculture. He will also explain the law school’s vision concerning agricultural law and the keen focus that the law school has on agricultural legal issues.
Succession Planning. Dr. Gregg Hadley with the KSU ag econ department will discuss the interpersonal issues associated with transitioning the farm business from one generation to the next. While the technical tax and legal issues are important, so are the personal family relationships and how the members of the family interact with each other.
Tax – part two. I will return with a second session on tax issues. This time my focus will be on hot-button issues at both the state and national level. What are the big tax issues for agriculture at the present time? There’s always a lot to talk about for this session.
Water. Prof. Burke Griggs, another member of our “ag law team” at the law school, will share his expertise on water law with a discussion on interstate water disputes, the role of government in managing scarce water supplies, and what the relationship is between the two. What are the implications for Kansas and beyond?
Producer panel. We will close out the day with a panel consisting of ag producers from across the state. They will discuss how they use tax and legal professionals as well as agribusiness professionals in the conduct of their day-to-day business transactions.
The Symposium is a collaborative effort of Washburn law, the ag econ department at KSU and the KFB. For lawyers, CPAs and other tax professionals, application has been sought for continuing education credit. The symposium promises to be a great day to interact with others involved in agriculture, build relationships and connections and learn a bit in the process.
We hope to see you either in-person or online. For more information on the symposium and how to register, check out the following link: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
August 22, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Friday, August 18, 2017
Upon a decedent’s death, any liabilities for deficiencies on the decedent’s tax returns do not disappear. Someone must pay those taxes. In addition, creditors’ claims against the estate must be paid. If one of the creditors is the IRS, there is a federal tax lien that will come in to play. In that situation, the question becomes the priority of the lien. Does the IRS beat out other creditors? What if the estate administrator is entitled to get paid under state law?
Tax liability for deficiencies associated with a decedent’s estate and the IRS as an estate creditor – what are the related issues? That’s the topic of today’s post.
The decedent’s estate, in essence, is liable for the decedent’s tax deficiency at the time of death. Individuals receiving assets from a decedent take the assets subject to the claims of the decedent’s creditors — including the government. Asset transferees (the recipients of those assets) are liable for taxes due from the decedent to the extent of the assets that they receive. In addition, a trust can be liable as a transferee of a transfer under I.R.C. §6901 to the extent provided in state law. See, e.g., Frank Sawyer Trust of May 1992 v. Comr.,, T.C. Memo. 2014-59.
The courts have addressed transferee/executor liability issues in several recent cases. For instance, in United States v. Mangiardi, No. 9:13-cv-80256, 2013 U.S. Dist. LEXIS 102012 (S.D. Fla. Jul. 22, 2013), the court held that the IRS could collect estate tax more than 12 years after taxes were assessed. The decedent died in 2000. At the time of death, his revocable trust was worth approximately $4.58 million and an IRA worth $3.86 million. The estate tax was approximately $2.48 million. Four years of extensions were granted due to a market value decline of publicly traded securities. The estate paid estate taxes of $250,000, and the trust had insufficient assets to pay the balance. The IRS sought payment of tax from the transferee of an IRA under I.R.C. §6324. The court held that the IRS was not bound by the 4-year assessment period of I.R.C.§§6501 and 6901(c) and could proceed under I.R.C. §6324 (10-year provision). The court determined that the 10-year provision was extended by the 4-year extension period previously granted to the estate, and IRA transferee liability was derivative of the estate's liability. The court held that it was immaterial that the transferee may not have known of the unpaid estate tax. The amounts withdrawn from the IRA to pay the estate tax liability were also subject to income tax in the transferee's hands.
In another recent case, United States v. Tyler, No. 12-2034, 2013 U.S. App. LEXIS 11722 (3d Cir. Jun. 11, 2013), a married couple owned real estate as tenants by the entirety (a special form of marital ownership recognized in some states). The husband owed the IRS $436,849 in income taxes. He transferred his interest in the real estate to his wife for $1, and the IRS then placed a lien on the real estate. He died with no distributable assets and there were no other assets with which to pay the tax lien. His surviving wife died within a year of her his death and the property passed to their son, the defendant in the case. The son was named as a co-executor of his mother’s estate. The IRS claimed that the tax lien applied to the real estate before legal title passed to the surviving spouse. Thus, the IRS asserted, the executors had to satisfy the lien out of the assets of her estate. The executors conveyed the real estate to the co-executor son for $1 after receiving letters from the IRS asserting the lien. The son then later sold the real estate and invested the proceeds in the stock market, subsequently losing his investment. The IRS brought a collection action for 50 percent of the sale proceeds of the real estate from the executors. The trial court ruled for the IRS and the appellate court affirmed. Under the federal claims statute, the executor has personal liability for the decedent’s debts and obligations. The rule is that the fiduciary who disposes of the assets of an estate before paying a governmental claim is liable to the extent of payments for unpaid governmental claims if the fiduciary distributes the estate assets, the distribution renders the estate insolvent, and the distribution takes place after the fiduciary had actual or constructive knowledge of the liability for unpaid taxes.
United States. v. Whisenhunt, No. 3:12-CV-0614-B, 2014 U.S. Dist. LEXIS 38969 (N.D. Tex. Mar. 25, 2014), is another case that points out that an executor has personal liability for unpaid federal estate tax when the estate assets are distributed before the estate tax is paid in full. The court determined that the executor was personally liable for $526,507 in delinquent federal estate tax and penalties, which was the amount of the distribution at the time of the decedent's death.
Federal Estate Tax Lien
Another recent case illustrates additional peril for estate executors. In In re Estate of Simmons, No. 1:15-cv-01097-TWP-MPB, 2017 U.S. Dist. LEXIS 120487 (S.D. Ind. Jul. 31, 2017), the decedent died in 2014. He and his wife had one son in 1991 and then divorced in 1998. The decedent remarried, and the second wife was the surviving spouse at the time of the decedent’s death. The primary asset of the estate was the decedent’s home. The claims against the estate amounted to $1.8 million, including those of the decedent’s first wife, two of the decedent’s former employees for unpaid wages and benefits of approximately $800,000, and two noteholders for which the decedent had defaulted on the notes. Those amounted to about $250,000 in total. The state of Indiana also filed a tax lien, and the IRS lien was just shy of $600,000. However, the state court determined that the estate was insolvent. The estate only contained assets of $266,873. A state court order required that the estate assets be sold and be distributed in accordance with the priority stated in Indiana law. The state court order indicated that the IRS lien was in a seventh priority position.
On the motion of the IRS, the case was removed to federal district court. The federal district court determined that the IRS had a first priority lien and ordered that the net proceeds of from the sale of the residence ($245,766) go to the IRS. Neither the surviving spouse nor the executor were pleased with this conclusion. The surviving spouse expended substantial funds to get the home ready to be sold, and the executor (and the attorney for the estate) was entitled to be paid in accordance with state law. That’s the normal course of events – administrative expenses and fees generally have priority over other creditors, including the IRS.
However, there is another principal that can come into play. The Supremacy Clause of the Constitution (Article VI, Clause 2) says that state law is subject to federal preemption if there is a federal law on point that would override state law. That’s where the federal priority statute for governmental claims comes into play. 31 U.S.C. §3713. Under this provision, a federal governmental claim has first priority when a decedent’s estate has insufficient funds/assets to pay all of the decedent’s debts. However, courts have generally held that administrative expenses (e.g., fees of the executor and attorney for the estate) are not actually the decedent’s “expenses” with the result that they take priority over governmental claims. But, the In re Estate of Simmons court said that when the IRS files a federal tax lien I.R.C. §6321 comes into play. Under that statute, the federal government has a blanket priority lien on the assets of the estate. The limited exceptions of I.R.C. §6323 don’t apply to claims involving administrative expenses.
The federal court’s determination would seem to have a chilling effect on person’s assuming administrative tasks, including legal counsel for estate’s that have insufficient funds to pay all outstanding taxes, and it’s not the first time a court has reached the same conclusion. See, e.g., Estate of Friedman v. Cadle Co., 3:08CV488(RNC), 2009 U.S. Dist. LEXIS 130505 (D. Conn. Sept. 8, 2009). But, the In re Estate of Simmons court did note that the Internal Revenue Manual, at Section 220.127.116.11(3) says that the IRS has discretion to not assert its priority position so that reasonable administrative expenses can be paid to the persons entitled to them. In In re Estate of Simmons, the IRS stated that it intended to pay the executor’s unreimbursed expenses. That was enough for the court to go ahead and give the IRS priority on its lien.
The discretion of the IRS to allow the payment of reasonable administrative expenses is not terribly reassuring. It’s also troubling that it’s solely up to the IRS to determine what is “reasonable.” From a practitioner’s standpoint, when considering the representation of an estate with sizable outstanding unpaid federal taxes, it’s probably a good idea to first conduct a search for federal tax liens. Also, there probably is also a duty to advise the executor of the potential impact of a federal tax lien.
Executors (and their counsel) already have a mess on their hands in large estates where Form 706 must be filed and the new basis consistency reporting rules are triggered. Those rules already provide a disincentive to serve as an executor. The federal tax lien statute may create another reason not to handle certain estates.