Saturday, November 21, 2020

When Is Transferred Property Pulled Back Into the Estate At Death? Be on Your Bongard!

Overview

When the federal estate tax exemption was much lower than it is now, gifting property played a much greater role in estate planning than it does now.  That gifting could consist of either an outright gift of property or a gift of an interest in an entity.  In either situation, the basic idea was to transfer value away, typically to other family members to keep the transferor’s estate at death beneath the level of the available estate tax exemption at death so that federal estate tax could be avoided. 

However, if a transfer isn’t done correctly, it runs the risk of being pulled back into the decedent’s estate and subjected to federal estate tax at death. 

Avoiding transferred property being included in a decedent’s estate at death – it’s the topic of today’s post.

Tax Code Provision and Tax Court Test

Under I.R.C. §2036, the value of a decedent’s gross estate includes the value of all property to the extent that the decedent had an interest in the property at the time of death.  That includes property that the decedent transferred but retained for life, or for any period of time tied to the decedent’s death the possession or enjoyment of the property.  I.R.C. §2036 also catches a retained right to receive income from the property or the right to designate who possesses the property or the income from the property.  The same is true for a retained right to vote stock of a corporation the decedent controls. 

When will a transfer be respected so that the transferred property will not be included in the transferor’s estate at death?  In Estate of Bongard v. Comr., 124 T.C. 95 (2005), the Tax Court set forth the standard concerning how to determine whether I.R.C. §2036 pulls property back into a decedent's estate. According to the Tax Court, transferred property will be pulled back into the decedent’s estate if the decedent made a transfer of property during life that was not a bona fide sale for adequate and full consideration, and the decedent retained an interest or right in the transferred property.  A sale is bona fide only if the evidence establishes the existence of a legitimate and significant nontax reason exists for the transfer.

Recent Case

The Tax Court’s Bongard standard was at issue in another Tax Court case decided earlier this year.  In Estate of Moore, T.C. Memo. 2020-40, the decedent, at age 88 in late 2004, started negotiations with prospective buyers for the sale of his farm.  However, before he could get the farm sold, he suffered a heart attack and was diagnosed with congestive heath failure.  Doctors told him that he wouldn’t live longer than six months.  Within a week after being discharged from the hospital, and while in in-home hospice care, the decedent worked with an attorney to formalize an estate plan – something he really hadn’t done up to this point in time.  His primary goal was to eliminate potential estate tax.  However, he also wanted to maintain control.  Those two goals can prove difficult to satisfy simultaneously. 

Ultimately, the attorney created various trust for the decedent – a revocable living trust; a charitable lead annuity trust; a trust for his children; a management trust; an irrevocable trust (also for the benefit of his children); and a family limited partnership (FLP).  The management trust (which made a nominal contribution to the FLP upon its formation) held a 1 percent general partner interest in the FLP.  The decedent held a 95 percent limited partnership interest in the FLP.  Each of his four children held a 1 percent limited partner interest. Purportedly, the purpose of the FLP was to provide protection against liability; protection against creditors; bad marriages; and to bring together a dysfunctional family.  Under the terms of the FLP agreement, no single partner could transfer any interest unless all partners agreed.

The decedent transferred all of his property (the farmland and his personal property) to the revocable living trust.  The trust contained a formula that transferred a part of the trust assets to the charitable trust with the goal of causing the least amount of federal estate tax to the estate.  Everything else, after payment of taxes and claims and distributions of specific bequests were specified to pass to the trust for the children.  The management trust held a 1 percent interest as a general partner in the FLP and, upon the decedent’s death, that interest was to be distributed to the trust for his children.  The decedent then transferred (via the revocable living trust) an 80 percent interest in his farmland and $1.8 million worth of assets to the FLP. 

Five days after forming the FLP, and within two months of his death, the decedent sold the farm for almost $17 million.  The FLP and the revocable trust transferred their respective interests in the farmland to the buyer.  The terms of sale allowed the decedent to continue to live on the farm and operate it (in accordance with his capability) until his death. 

After the sale, the decedent directed the FLP to transfer $500,000 to each of his four children in return for a five-year promissory note at a 3.6 percent interest rate per annum.  However, there was no amortization schedule for any of the notes, and none of the children made any payments.  Also, the FLP never attempted to collect on the notes, and the attorney that prepared the estate plan told the children that they didn’t have to pay on the notes.  The FLP then distributed (purportedly a loan) $2 million to the revocable living trust, that the decedent used to pay expenses, including the balance of the $320,000 attorney fee charged to set up all of the trusts and the FLP, and the tax obligation on the sale of the farm. 

Additionally, in late February 2005, the living trust transferred $500,000 to the irrevocable trust, which was treated as a $125,000 gift to each of the four children. Lastly, in early March 2005, the living trust transferred its entire limited interest in the FLP to the irrevocable trust in return for $500,000 cash and a note for $4.8 million. The decedent died in late March of 2005.

The decedent's federal estate tax return reported $53,875 for the management trust's 1% general partnership interest in the FLP; $4.8 million for the note receivable from the irrevocable trust; claimed a $2 million deduction for the debt owed to the FLP and a $4.8 million deduction for a charitable contribution to the charitable trust.  It also reported $1.5 million in taxable gifts; and $475,000 deduction for attorneys' fees associated with the administration of the decedent's estate (reported on Schedule J (the form where estate administration deductions are claimed), which was in addition to the $320,000 charged for establishing the estate plan).

The estate also filed a federal gift tax return for 2005. The return reported gifts of $125,000 for each of the decedent's children in the form of the $500,000 transfer to the irrevocable trust earlier that year.

The IRS issued a notice of deficiency to the estate determining a deficiency of nearly $6.4 million. Additionally, the IRS issued a notice of deficiency determining a gift tax liability of more than $1.3 million for the 2005 tax year.  While the Tax Court was tasked with addressing numerous legal/tax issues, a primary one was whether the value of the farm should be included in the decedent’s estate for tax purposes. 

The Bongard Application

Business purpose.  As noted above, one of the tests established by the Bongard decision is whether a transfer was made for a nontax business purpose.  That is usually evidenced by active management of the transferred asset(s).  But here, the Tax Court noted, the decedent sold the farm days after he transferred it to the FLP.  That meant that there was no business for the children to manage.  Only liquid assets remained in the FLP that the children did not manage.  Instead, and investment advisor was hired to manage the liquid assets.  Also, based on the evidence, there was no legitimate concern about creditor claims (another legitimate purpose for creating the FLP). In addition, the entire estate plan (including the formation of the FLP) was done in the imminence of death as part of a scheme to avoid tax.  The whole plan reeked of being testamentary in nature.

Retained interest.  Also, part of the Bongard test is that the decedent must not retain an interest in the transferred property.  But the Tax Court determined that the decedent had at least an implied agreement to retain possession or enjoyment of the farm property.  Indeed, he continued to live at the farm and made management decisions up to his death and treated the other FLP assets as his own by paying personal expenses (including attorney fees) with them and using FLP assets for making loans to his children.  In essence, he treated the FLP as his pocketbook. 

The retained possession or enjoyment of the transferred property along with the lack of a substantial nontax purpose caused inclusion of the farm property in the decedent’s gross estate at death.  The amount included in the estate was calculated as the value of the farm as of the date of death less the funds that left the estate between the time of the sale and the date of death.  I.R.C. §2043.

Other Issues

The Tax Court also determined that the “loan” from the FLP to the revocable living trust was not really a loan, thereby wiping out an estate tax deduction for the $2 million loan. There was nothing that indicated that it was a loan – no note; no interest; no collateral; no maturity date specified; and no payments were made or demanded. 

The Tax Court also agreed with the IRS that the “loans” to the children were gifts.  Again, like the purported loan from the FLP to the revocable living trust, there was nothing to indicate that the transfers to the children were anything other than gifts.  Those total gifts of about $2 million caused the additional gift tax to be included in the decedent’s estate as gifts within three years of death.  I.R.C. §2035(b). 

Conclusion

The Moore case is an illustration of what not to do.  Of course, the emphasis on avoiding federal estate tax was bigger at the time the planning was engaged in than it is now.  The federal estate tax exemption equivalent of the unified credit was only $1,500,000.  That’s a far cry from the current level of the exemption.  But, for those with large estates that face the potential of federal estate tax, the case clearly points out the peril that unplanned estates face in a rush to tidy matters up before time is up.

In addition, “death bed” estate planning is particularly not good when the planning tries to get too “cute.”  Formalities of entities and transfers must be followed and, when an FLP is involved, the transferor must retain sufficient assets personally to pay living expenses, etc.  Any use of the FLP assets after transfer to the FLP, must be via an agreement that clearly denotes that the assets belong to the FLP and that an appropriate amount is paid for the assets’ usage.  Retained possession and enjoyment of transferred assets is a big “no-no.” 

November 21, 2020 in Business Planning, Estate Planning | Permalink | Comments (0)

Monday, November 16, 2020

Merging a Revocable Trust at Death With an Estate – Tax Consequences

Overview

A revocable trust is a popular estate planning tool that is utilized as a will substitute.  Some people view it as a good alternative to a will for several reasons, including privacy and probate avoidance.  Unfortunately, some believe that a revocable trust will also save estate taxes compared to a properly drafted will.  It will not.  The very nature of the revocability of the trust means that the trust property is included in the decedent’s estate at death. 

While estate tax savings are not an issue with a revocable trust, it’s important to understand the income tax issues that can occur when the grantor of the trust dies and the trust assets become part of the grantor’s estate.  There’s a special tax election involved for a “qualified revocable trust” (QRT) and it has particular accounting and income tax consequences.  It can also provide some tax planning opportunities.

The tax and accounting rules surrounding the election to treat a QRT as an estate – it’s the topic of today’s post.

The I.R.C. §645 Election

The issue.  When the grantor of a revocable trust dies, the trust becomes irrevocable.  For tax purposes, the trust will have a calendar year – a short tax year from the date of death through December 31.  In addition, the trust will be a complex trust if the trustee is not required to make immediate distributions.  In that case, depending on the assets in the trust, the trust may earn income that will be taxed in accordance with the rate brackets applicable to a trust.  For 2020, the top rate of 37 percent is reached at $12,951 of trust income.  Of course, one possible solution to this problem is for the trustee to distribute the trust income to the beneficiaries so that it can be taxed at their (likely lower) tax rates.  But, if that additional income has not been planned for it could create tax issues for the beneficiaries such as underpayment penalties. 

Another option may be for the trustee/executor to make the I.R.C. §645 election for a QRT.

Mechanics.  A QRT is a domestic trust (or portion thereof) that is treated as owned by a decedent (a grantor trust) on the date of the decedent’s death by reason of a power to revoke that was exercisable by the decedent or with the consent of the decedent’s spouse.  I.R.C. §645(b)(1)For a QRT, the executor of the decedent’s estate, along with the trustee, can make an election to have the QRT taxed as part of the decedent’s estate for income tax purposes instead of as a separate trust.  I.R.C. §645(a).  In other words, a joint election by both the trust and the estate’s executor is required. 

Without the election, the revocable trust becomes irrevocable upon the decedent’s death and requires a separate income tax return (Form 1041) to report trust income (using a calendar year-end) that is earned post-death.  The merger of the trust and the estate for income tax purposes applies only to tax years that end before the date six months after the final determination of estate tax, or, if there is no estate tax return that is filed (Form 706), two years after the date of death.  I.R.C. §645(b)(2). 

If an executor is not appointed for the estate, the trustee files the election with an explanatory statement that no executor is being appointed for the estate.  The election is made by completing Form 8855 and attaching a statement to Form 1041 providing the name of the QRT, its taxpayer identification number and the name and address of the trustee of the QRT.

Once made, the election causes the trust to be treated for income tax purposes as part of the decedent’s estate for all applicable tax years of the estate ending after the date of the decedent’s death.  Id.  The electing QRT need not file an income tax return for the short year after the date of the decedent’s death.  Instead, the trustee of the electing QRT only need file one Form 1041 for the combined trust and estate under the estate’s TIN, and all income, deductions and credits are combined. 

The election allows a fiscal year-end to be utilized, ending at the end of a month not to exceed one-year after the decedent’s death.  The utilization of a fiscal year for income tax purposes can allow the estate executor to more effectively time the reporting of income and expense to achieve a more advantageous tax result.  For example, assume that an election is made for a QRT resulting in a tax year of December 1, 2020 through November 30, 2021.  A beneficiary receives a distribution on December 23, 2020.  As a result of the election, the beneficiary won’t have to report any income triggered by the distribution until 2021 and will have until April 15, 2022 to file the return that reports the income from the distribution.  Without the election, the distribution would have been taxed to the beneficiary in 2020 and reported on the 2020 return filed on or before April 15, 2021.   

The election can also allow for the loss recognition when a pecuniary bequest is satisfied with property having a fair market value less than basis.  I.R.C. §267(b).  One $600 personal exemption is allowed; the QRT can deduct amount paid to, or permanently set aside for charity; and up to $25,000 in passive real estate losses can be deducted.  I.R.C. §§642(b); 642(c); 469(i)(4).

Once the election is made, it is irrevocable.

Implications.  The I.R.C. §645 election, while resulting in one tax return for purposes of reporting income and expense on Form 1041, the trust and the estate are still treated as separate shares for purposes of calculating the distributable net income (DNI) deduction.  Treas. Reg. §1.645-1(e)(2)(iii).  The election does not combine the estate and trust for purposes of computing the DNI deduction. Thus, distributions can result in different allocation to beneficiaries and different amounts of income tax paid by the estate/trust. 

To illustrate, assume that an estate has $20,000 of income with no distributions made to the trust which, as typical, is the estate’s sole beneficiary.  The trust has $40,000 of income and made a $60,000 distribution to a beneficiary.  The income reported on Form 1041 is $60,000.  Under the Treas. Reg., the estate’s DNI is calculated separately from that of the trust.  In the example, the estate’s share of DNI is $20,000, but it gets no DNI deduction due to the lack of distributions during the tax year.  Conversely, the trust’s share of DNI is $40,000 and the trust’s DNI deduction is the lesser of the total cash distributed or the DNI.  Here, the DNI was less than the actual cash distributed resulting in a DNI deduction of $40,000.  The filed Form 1041 recognizes the $20,000 of taxable income and the beneficiary has $40,000 of income reported on the beneficiary’s individual return. 

Now assume that the estate distributes $20,000 to the trust, the trust’s share of income is $60,000 ($40,000 plus the $20,000 from the estate).  The full $60,000 of income is DNI of the trust, and the $60,000 distribution to the beneficiary causes the full $60,000 to be taxed at the beneficiary’s level.  There is no tax at the trust level to be taxed at the compressed bracket rates applicable to trusts and estates.  This all means that separate accounting for the trust and the estate must be done while the estate is being administered. 

When the election period ends or when the assets of the original trust are distributed to another trust, the new trust will file returns on a calendar year basis.  Thus, a filing will be required for the timeframe from the end of the fiscal year to the end of the calendar year after the termination.  In that instance, the beneficiaries could end up with two K-1s and the benefit of income deferral could be eliminated depending  on the tax bracket that the beneficiary is in.

Conclusion

Clearly there are several things to consider before making an I.R.C. §645 election.  For individuals that die late in the year, the election can allow estate administration to perhaps be completed before a tax return must be filed.  Thus, the first tax return could end up being the final tax return for the estate if the estate is fully administered by the time the return is due.  That would save administrative costs.  Also, the election can provide the ability to shift income into a later tax year; allow funds to be set aside for charity and receive a deduction but not have to distribute the funds until a later time; eliminate the need for estimated tax payments; and hold S corporate stock during the period of estate administration – an advantage over a trust if administration extends beyond two years.  But the separate share rule can complicate the accounting.  The trust and the estate are not combined for calculating the DNI deduction.  Separate accounting for the trust and estate is needed while the estate is being administered.

More things to think about when a decedent dies with a revocable trust.

November 16, 2020 in Estate Planning, Income Tax | Permalink | Comments (0)

Saturday, October 17, 2020

Income Taxation of Trusts - New Regulations

Overview

On May 7, 2020, the IRS issued proposed regulations providing guidance on the deductibility of expenses that estates and non-grantor trusts incur.  REG-113295-18. The reason for the proposed regulations is that the Tax Cuts and Jobs Act (TCJA), effective for tax years beginning after 2017 and before 2026, bars individual taxpayers from claiming miscellaneous itemized deductions.  I.R.C. §67(g).  This TCJA suspension of miscellaneous itemized deductions for individuals raised questions as to whether and/or how estates and non-grantor trusts are impacted.  In late September, the IRS finalized the regulations.  TD 9918 (Sept. 21, 2020).

New guidance on handling deductions of a non-grantor trust or estate and those that flow to beneficiaries – it’s the topic of today’s post.

Computing Trust/Estate AGI

In general, a trust’s or estate’s AGI is computed in the same manner as is AGI for an individual. I.R.C. §67(e).  However, when computing AGI for trust or an estate, deductions are allowed for administration costs that are incurred in connection with a trust or an estate if those costs would not have been incurred if the property were held individually instead of in a trust or in the context of a decedent’s estateI.R.C. §67(e)(1).  In addition, an estate or trust is entitled to a personal exemption (I.R.C. §642(b)), a deduction for current income distributed from a trust (I.R.C. §651), and a deduction for the distribution of income from an estate or a trust for accumulated income as well as the distribution of corpus (I.R.C. §661). 

But, the TCJA added I.R.C. §67(g) which states, “…no miscellaneous itemized deduction shall be allowed for any taxable year beginning after December 31, 2017, and before January 1, 2026.”  That raised a question of whether the IRS would take the position that the new I.R.C. §67(g) caused the I.R.C. §67(e) expenses to be miscellaneous itemized deductions that a non-grantor trust or estate could no longer deduct.   In 2018, however, the IRS issued Notice 2018-61 to announce pending regulations and stated that I.R.C. §67(e) expenses would remain deductible by virtue of removing them from the itemized deduction category.   

Excess Deductions

Another aspect of non-grantor trust/estate taxation involves “excess deductions.”  When an estate or trust terminates, a beneficiary gets to deduct any carryover (excess) amount of a net operating loss or capital lossI.R.C. §642(h)(1).  The beneficiary can also deduct the trust’s or estate’s deductions for its last tax year that are in excess of the trust’s or estate’s gross income for the year.  I.R.C. §642(h)(2).  These deductions are allowed in computing the beneficiary’s taxable income.  While they must be taken into account in computing the beneficiary’s tax preference items, they cannot be used to compute gross income.  Treas. Reg. §1.642(h)-2(a).  In addition, the character of the deductions remains the same in the hands of a beneficiary upon the termination of an estate or a trust. 

But, the TCJA suspension of miscellaneous itemized deductions clouded the tax treatment of how excess deductions were to be handled.  When a trust or estate terminates with excess deductions they could be treated in the hands of a beneficiary as a miscellaneous itemized deduction that I.R.C. §67(g) disallows.  I say “could be” because an excess deduction could take one of three forms.  It is either comprised of deductions that are allowed when computing AGI under I.R.C. §§62 and 67(e); or it is an itemized deduction under I.R.C. §63(d) that is allowed when computing taxable income; or it is a miscellaneous itemized deduction that the TCJA disallows (through 2025). 

Proposed Regulations

The Proposed Regulations specify that certain deductions of an estate or trust are allowed in computing adjusted gross income (AGI) and are not miscellaneous itemized deductions and, thus, are not disallowed by I.R.C. §67(g). Instead, they are treated at above-the-line deductions that are allowed in determining AGI . The Proposed Regulations also provide guidance on determining the character, amount and manner for allocating excess deductions that beneficiaries succeeding to the property of a terminated estate or non-grantor trust may claim on their individual income tax returns.

Specifically, the Proposed Regulations amend Treas. Reg. §1.67-4 to clarify that I.R.C. §67(g) doesn’t disallow an estate or non-grantor trust from claiming deductions:  (1) for costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in the trust or estate; and (2) for deductions that are allowed under I.R.C. §§642(b), 651 and 661 (personal exemption for an estate or trust; income distributed currently; and distributions for accumulated income and corpus).

As for excess deductions of an estate or trust, prior Proposed Regulations treated excess deductions upon termination of an estate or non-grantor trust as a single miscellaneous itemized deduction.  The new Proposed Regulations, however, segregate excess deductions when determining their character, amount, and how they are to be allocated to beneficiaries.  The new Proposed Regulations specified that the excess amount retains its separate character as either an amount that is used to arrive at AGI; a non-miscellaneous itemized deduction; or a miscellaneous deduction.  That character doesn’t change in the hands of the beneficiary.  The fiduciary is to separately identify deductions that may be limited when the beneficiary claims the deductions. 

The Proposed Regulations utilize Treas. Reg. §1.652(b)-3 such that, in the year that a trust or estate terminates, excess deductions that are directly attributable to a particular class of income are allocated to that income.  The Preamble to the Proposed Regulations states that excess deductions are allocated to beneficiaries under the rules set forth in Treas. Reg. §1.642(h)-4.  After allocation, the amount and character of any remaining deductions are treated as excess deductions in a beneficiary’s hands in accordance with I.R.C. §642(h)(2).  This accords with the legislative history of I.R.C. §642(h) in seeking to avoid “wasted” deductions. 

The bifurcation of excess deductions into three categories by the Proposed Regulations rather than lumping them altogether miscellaneous itemized deductions disallowed by the TCJA is pro-taxpayer. 

The IRS says that the Proposed Regulations can be relied on for tax years beginning after 2017, and on or before the proposed regulations are published as final regulations.   

Final Regulations

I.R.C. §67(g) doesn’t control.  The Final Regulations affirm that deductions for costs which are paid or incurred in connection with the administration of an estate or trust and which would not have been incurred if the property were not held in such trust or estate remain deductible in computing AGI.  In other words, I.R.C. §67(e) overrides I.R.C. §67(g).  However, the Final Regulations do not provide any guidance on whether these deductions (including those under I.R.C. §§642(b), 651 and 661) are deductible in computing alternative minimum tax for an estate or trust.  That point was deemed to be outside the scope of the Final Regulations. 

Excess deductions.  As for excess deductions, the Final Regulations confirm the position of the Proposed Regulations that excess deductions retain their nature in the hands of the beneficiary.  Treas. Reg. §1.642(h)-2(a)(2).  How is that nature determined?  Excess deductions passing from a trust or an estate have their nature pegged by Treas. Reg. §1.652(b)-3. The nature of excess deductions of a trust or an estate is determined by a three-step process:  1) direct expenses are allocated first (e.g., real estate taxes offset real estate rental income); 2) the trustee can exercise discretion when allocating remaining deductions – in essence, offsetting less favored deductions for individuals by using them against remaining trust/estate income (also, if direct expenses exceed the associated income, the excess can be offset at this step); 3) once all of the trust/estate income has been offset any remaining deductions constitute excess deductions when the trust/estate is terminated that are allocated to the beneficiaries in accordance with Treas. Reg. §1.642(h)-4.  Treas. Reg. 1.642(h)-2(b)(2).   

Example 2 of the Proposed Regulations was modified in the Final Regulations to permit allocation of personal property tax to income, with any I.R.C. §67(e) expenses distributed to the beneficiary.  Thus, the fiduciary has discretion to selectively allocate deductions to income or distribute them to a beneficiary.  Those excess deductions that are, in a beneficiary’s hands, allowed at arriving at AGI on Form 1040 are to be deducted as a negative item on Schedule 1. 

As the Proposed Regulations required and the Preamble to the Final Regulations confirm, the information concerning excess deductions must be reported to the beneficiaries when a trust or an estate terminates.  Deduction items must be separately stated when, in the beneficiary’s hands, the deduction would be limited under the Code.  The Preamble states that the Treasury Department and the IRS “plan to update the instructions for Form 1041, Schedule K-1 (Form 1041) and Form 1040…for 2020 and subsequent tax years to provide for the reporting of excess deductions that are section 67(e) expenses or non-miscellaneous itemized deductions.”   

Because excess deductions retain their nature in a beneficiary’s hands, any individual-level tax limitations still apply.  Thus, for example, if an excess deduction results from state and local taxes (SALT) that a non-grantor trust or estate pays, is still limited at the beneficiary’s level to the $10,000 maximum amount under the TCJA.  The Final Regulations addressed this issue, but the Treasury determined that it lacked the authority to exempt a beneficiary from the SALT limitation.

The Preamble also notes that beneficiaries subject to tax in states that don’t conform to I.R.C. §67(g) may need access to miscellaneous itemized deduction excess deduction information for state tax purposes.  This burden apparently rests with the fiduciary of the estate/trust and the pertinent state taxing authority.  The IRS declined to modify federal income tax forms to require or accommodate the collection of this information because it is a state tax issue and not a federal one.    

The Final Regulations clarify that a beneficiary cannot carry back a net operating loss carryover that is passed out of a trust/estate in its final year.  Treas. Reg. §1.642(h)-5(a), Ex. 1.  A net operating loss carryover from an estate/trust can only be carried forward by the beneficiary. 

Applicability

The Final Regulations apply to tax years beginning after their publication in the Federal Register.  They do not apply to all open tax years.  Thus, it is not possible to file an amended return to take advantage of the position of the Final Regulations with respect to excess deductions for a tax year predating the effective date of the Final Regulations. 

Conclusion

The Proposed and Final Regulations are, in general, taxpayer friendly.  Tax planning will likely focus on the allocation of deductions in accordance with classes of income over which the fiduciary can exercise discretion (amounts allowed in arriving at AGI; non-miscellaneous itemized deductions; and miscellaneous itemized deductions).  To the extent that the fiduciary can have excess deductions on termination of an estate or non-grantor trust reduce AGI, that is likely to produce the best tax result for the beneficiary or beneficiaries (with consideration given, of course, to possible TCJA-imposed limitations).  Given the compressed tax brackets applicable to trusts and estates, the position taken in the Proposed and Final Regulations on deduction items and the flexibility given to fiduciaries is welcome news. 

October 17, 2020 in Estate Planning, Income Tax | Permalink | Comments (0)

Thursday, October 15, 2020

Can I Write My Own Will? Should I?

Overview

Statistics show that most people do not have a will in place to dispose of their property upon death.  In that event the state where a person is domiciled has a set of rules that will specify who gets the decedent’s property.  If a taker can’t be found under those rules, the state will receive the property. 

Some people don’t get around to executing a will during life.  The reasons for not doing so vary – from not wanting to hire a lawyer; to simply not getting it done.  Other’s may try to write their own will?  Can that be done?  If so, is it a good idea?

Writing one’s own will – it’s the topic of today’s post.

Legal Requirements for a Valid Will

Every state has statutory requirements that a will must satisfy in order to be recognized as valid in that particular jurisdiction.  For example, in all jurisdictions, a person making a will (known as a “testator”) must be of sound mind, generally must know the extent and nature of his or her property, must know who would be the natural recipients of the assets, must know who his or her relatives are, and must know who is to receive the property passing under the will.  A testator lacking these traits does not have testamentary capacity and is not competent to make a will.  Such persons are more susceptible to being influenced by family members and others desirous of increasing their share of the estate of the decedent-to-be. 

Cases involving challenges to wills are common where the testator is borderline competent or is susceptible to influence by others.  However, the fact that the testator was old or in poor health does not, absent other evidence, give rise to a presumption that the testator lacked testamentary capacity or was subject to undue influence.  See, e.g., Lasen v. Anderson, et al., 187 P.3d 857 (Wyo. 2008); In re Estate of Hedke, 278 Neb. 727 (2009)A person that challenges a will on undue influence and lack of testamentary capacity grounds must establish undue influence by clear and convincing proof and that the decedent possessed testamentary capacity despite being unable to comprehend the purchasing power of her estate.  See, e.g., In re Estate of Bennett, 19 Kan. App. 2d 154, 865 P.2d 1062 (1993). 

Generally, a person making a will must be of “full age.” However, in some states persons not yet of the age of majority who are or have been married can execute a will as if they are of full age.

In addition, the will must be in writing and signed at the end by the testator or by someone else in the presence and at the direction of the testator.  In most states, the will must be witnessed by at least two competent and disinterested witnesses who saw the testator sign the will or heard the testator acknowledge it.  A devise or bequest of property in a will to a subscribing witness is void, with narrow exceptions in the law. 

Handwritten Will

In some states, holographic wills (wills that are in the testator’s handwriting but not witnessed) are not admissible.  Other states treat as valid a handwritten will if it meets certain statutory requirements such as being left with the decedent’s other valuable papers or with another person for safekeeping.  See, e.g., In re Church, 466 S.E.2d 297 (N.C. App. 1996).   In Nebraska, for example, a handwritten will is valid if it is signed and dated (in some manner).  The signature can be the testator’s initials.  In re Estate of Foxley, 254 Neb. 204, 575 N.W.2d 150 (1998).  The date can consist of only the month and year.  In re Estate of Wells, 243 Neb. 152, 497 N.W.2d 683 (1993)

Recent Case

In In re Estate of Blikre, 934 N.W.2d 867 (N.D. Sup. Ct. 2019), the decedent’s will devised her estate to her sister, the plaintiff’s wife. The estate consisted of real property and mineral rights. The plaintiff’s wife was originally named the representative of the decedent’s estate, but she died soon after the decedent died. The plaintiff petitioned for appointment as successor personal representative, as did the defendant, who was the decedent’s other sister who had been excluded from the will. Upon the decedent’s death, the plaintiff sought formal probate of the will by attaching a copy of the will to the petition. The defendant argued that the decedent’s will should be considered revoked because the original was missing.

The trial court ordered formal probate of the will, finding that there was insufficient evidence to show the decedent intended to revoke her will. The defendant appealed, arguing that the decedent had a handwritten will that should be formally probated. The defendant claimed the handwritten will revoked the original will and distributed the decedent’s estate to the defendant and her nieces. The appellate court remanded to the trial court to decide this issue. The trial court held that the decedent’s handwritten documents did not express her testamentary intent to distribute her estate and did not revoke her original will.

On appeal, the defendant argued the decedent’s will was invalid because it was not executed in front of two witnesses, and that even if the will were valid, it was replaced by the handwritten will. The appellate court held that the lawyer who notarized the will gave credible evidence that the two witnesses who signed the original will were physically present when it was executed. Further, the appellate court held that although the handwritten documents were written by the decedent, the documents did not amount to a valid handwritten will under North Dakota law. For a handwritten will to be valid, it must express donative and testamentary intent. The appellate court held that the handwritten documents did not clearly express donative intent, but merely listed desires and concerns the decedent had. As for the missing original will, the appellate court noted that the defendant was the only person who accessed a security box that the decedent kept important documents in upon the decedent’s death. Additionally, before the decedent had died, she told the plaintiff to convey mineral deeds to both the plaintiff’s wife and the defendant. At that time, the decedent did not indicate that she had revoked her will. The appellate court determined the combination of the plaintiff’s testimony and defendant’s untrustworthy testimony was able to overcome the presumption that the decedent had revoked the will. 

Conclusion

While an individual may write their own will, it is usually advisable to have an attorney prepare the will.  One reason is because words can mean different things in different contexts.  For example, in Cameron, et. al. v. Bissette, et al., 661 S.E.2d 32 (N.C. 2008), the decedent’s holographic will was ruled void for vagueness because the decedent left “this Land” to certain beneficiaries, but with no explanation of what “this Land” referred to.   In situations where uncertainty is present because of the words used, a court will try to determine the testator’s intent in light of the testator’s lack of skill in will drafting.  See, e.g., In re Estate of Matthews, 13 Neb. App. 812, 702 N.W.2d 821 (2005).

So, to answer the question of whether you can write your own will, the answer is that you can.  Perhaps the better question is whether you should.  That answer is less clear.  But, if you have a farm or ranch or other small business or otherwise have substantial assets, writing your own will is probably not the best idea. Definitely not.

October 15, 2020 in Estate Planning | Permalink | Comments (0)

Monday, October 12, 2020

Principles of Agricultural Law

PrinciplesForBlog2020Fall-cropped

Overview

The fields of agricultural law and agricultural taxation are dynamic.  Law and tax impacts the daily life of a farmer, rancher, agribusiness and rural landowner practically on a daily basis.  Whether that is good or bad is not really the question.  The point is that it’s the reality.  Lack of familiarity with the basic fundamental and applicable rules and principles can turn out to be very costly.  As a result of these numerous intersections, and the fact that the rules applicable to those engaged in farming are often different from non-farmers, I started out just over 25 years ago to develop a textbook that addressed the major issues that a farmer or rancher and their legal and tax counsel should be aware of.  After three years, the book was complete – Principles of Agricultural Law - and it’s been updated twice annually since that time. 

The 47th edition is now complete, and it’s the topic of today’s post – Principles of Agricultural Law.

Subject Areas

The text is designed to be useful to farmers and ranchers; agribusiness professionals; ag lenders; educational professionals; lawyers, CPAs and other tax preparers; undergraduate and law students; and those that simply want to learn more about legal and tax issues.  The text covers a wide range of topics.  Here’s just a sample of what is covered:

Ag contracts.  Farmers and ranchers engage in many contractual situations, including ag leases, to purchase contracts.  The potential perils of verbal contracts are numerous and can lead to unnecessary litigation. What if a commodity is sold under forward contract and a weather event destroys the crop before it is harvested?  When does the law require a contract to be in writing?  For purchases of goods, do any warranties apply?  What remedies are available upon breach? If a lawsuit needs to be brought to enforce a contract, how soon must it be filed? Is a liability release form necessary?  Is it valid?  What happens when a contract breach occurs?  What is the remedy? 

Ag financing.  Farmers and ranchers are often quite dependent on borrowing money for keeping their operations running.  What are the rules surrounding ag finance?  This is a big issue for lenders also?  What about dealing with an ag cooperative and the issue of liens?  What are the priority rules with respect to the various types of liens that a farmer might have to deal with? 

Ag bankruptcy.  A unique set of rules can apply to farmers that file bankruptcy.  Chapter 12 bankruptcy allows farmers to de-prioritize taxes.  That can be a huge benefit.  Knowing how best to utilize those rules is very beneficial.  That’s especially true with the unsettled issue of whether Payment Protection Program (PPP) funds can be utilized by a farmer in bankruptcy.  The courts are split on that issue.

Income tax.  Tax and tax planning permeate daily life.  Deferral contracts; depreciation; installment sales; like-kind exchanges; credits; losses; income averaging; reporting government payments; etc.  The list could go on and on.  Having a basic understanding of the rules and the opportunities available can add a lot to the bottom line of the farming or ranching operation as well as help minimize the bleeding when times are tough.

Real property.  Of course, land is typically the biggest asset in terms of value for a farming and ranching operation.  But, land ownership brings with it many potential legal issues.  Where is the property line?  How is a dispute over a boundary resolved?  Who is responsible for building and maintaining a fence?  What if there is an easement over part of the farm?  Does an abandoned rail line create an issue?  What if land is bought or sold under an installment contract?  How do the like-kind exchange rules work when farmland is traded? 

Estate planning.  While the federal estate tax is not a concern for most people and the vast majority of farming and ranching operations, when it does apply it’s a major issue that requires planning.  What are the rules governing property passage at death?  Should property be gifted during life?  What happens to property passage at death if there is no will?  How can family conflicts be minimized post-death?  Does the manner in which property is owned matter?  What are the applicable tax rules?  These are all important questions.

Business planning.  One of the biggest issues for many farm and ranch families is how to properly structure the business so that it can be passed on to subsequent generations and remain viable economically.  What’s the best entity choice?  What are the options?  Of course, tax planning is a critical part of the business transition process.

Cooperatives.  Many ag producers are patrons of cooperatives.  That relationship creates unique legal and tax issues.  Of course, the tax law enacted near the end of 2017 modified an existing deduction for patrons of ag cooperatives.  Those rules are very complex.  What are the responsibilities of cooperative board members? 

Civil liabilities.  The legal issues are enormous in this category.  Nuisance law; liability to trespassers and others on the property; rules governing conduct in a multitude of situations; liability for the spread of noxious weeds; liability for an employee’s on-the-job injuries; livestock trespass; and on and on the issues go.  Agritourism is a very big thing for some farmers, but does it increase liability potential?  Nuisance issues are also important in agriculture.  It’s useful to know how the courts handle these various situations.

Criminal liabilities.  This topic is not one that is often thought of, but the implications can be monstrous.  Often, for a farmer or rancher or rural landowner, the possibility of criminal allegations can arise upon (sometimes) inadvertent violation of environmental laws.  Even protecting livestock from predators can give rise to unexpected criminal liability.  Mail fraud can also arise with respect to the participation in federal farm programs.  The areas of life potentially impacted with criminal penalties are worth knowing, as well as knowing how to avoid tripping into them.

Water law.  Of course, water is essential to agricultural production.  Water issues vary across the country, but they tend to focus around being able to have rights to water in the time of shortage and moving the diversion point of water.  Also, water quality issues are important.  In essence, knowing whether a tract of land has a water right associated with it, how to acquire a water right, and the relative strength of that water rights are critical to understand.

Environmental law.  It seems that agricultural and the environment are constantly in the news.  The Clean Water Act, Endangered Species Act and other federal (and state) laws and regulations can have a big impact on a farming or ranching operation.  Just think of the issues with the USDA’s Swampbuster rules that have arisen over the past 30-plus years.  What constitutes a regulatory taking of property that requires the payment of compensation under the Constitution?  It’s good to know where the lines are drawn and how to stay out of (expensive) trouble.

Regulatory law.  Agriculture is a very heavily regulated industry.  Animals and plants, commodities and food products are all subject to a great deal of regulation at both the federal and state level.  Antitrust laws are also important to agriculture because of the highly concentrated markets that farmers buy inputs from and sell commodities into.  Where are the lines drawn?  How can an ag operation best position itself to negotiate the myriad of rules?   

Conclusion

It is always encouraging to me to see students, farmers and ranchers, agribusiness and tax professionals get interested in the subject matter and see the relevance of material to their personal and business lives. Agricultural law and taxation is reality.  It’s not merely academic.  The Principles text is one that can be very helpful to not only those engaged in agriculture, but also for those advising agricultural producers.  It’s also a great reference tool for Extension educators. It’s also a great investment for any farmer – and it’s updated twice annually to keep the reader on top of current developments that impact agriculture.

If you are interested in obtaining a copy, perhaps even as a Christmas gift, you can visit the link here:  http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html.  Instructors that adopt the text for a course are entitled to a free copy.  The book is available in print and CD versions.  Also, for instructors, a complete set of Powerpoint slides is available via separate purchase.  Sample exams and work problems are also available.  You may also contact me directly to obtain a copy.

If you are interested in obtaining a copy, you can visit the link here:  http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html.  You may also contact me directly. 

October 12, 2020 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)

Monday, October 5, 2020

Does A Discretionary Trust Remove Fiduciary Duties A Trustee Owes Beneficiaries?

Overview

Trusts are often used as part of an estate plan for various reasons.  They can be established to take effect during life or be included as part of a will to take effect at death.  They can be revocable or irrevocable.  They can also be established as a “support” trust or as a “discretionary” trust.  A support trust is a trust where the trustee’s responsibility is to provide for the beneficiary’s support such as food, clothing, and shelter.  A discretionary trust, on the other hand, is a trust that has been set up to benefit one or more beneficiaries, but the trustee is given full discretion as to when, if any, trust principal and/or income, are given to the beneficiaries.  With a discretionary trust, the trust beneficiaries have no rights to trust funds.  But, can the trustee of a discretionary trust simply ignore the other beneficiaries?  Is the trustee still accountable for the way the trust assets and income are handled?

The issue of the responsibility of a trustee to other beneficiaries of a discretionary trust – it’s the topic of today’s post.

Recent Kansas Case

Basic facts.  The question of how a trustee relates to other beneficiaries of a discretionary trust came up in a recent Kansas case involving farmland and oil and gas interests.  In Roenne v. Miller, No. 120,054, 2020 Kan. App. LEXIS 72 (Kan. Ct. App. Oct. 2, 2020), the decedent, at the time of her death, had five children and owned royalty interests in oil leases, farmland, a home, as well as cattle, farm equipment and other personal property.  Her will devised a one-half interest in the farmland to a son that was named as trustee of her testamentary trust.  The other one-half interest in the farmland was devised to another son for life with a remainder to his children.  Upon this son dying childless, the remainder would pass to the trustee-son.  All of her livestock and farm machinery along with certain personal property was bequeathed to these two sons equally.  The non-trustee son then assigned his one-half interest in the farm assets and farmland to the trustee-son. 

The decedent’s will clearly specified that the other children were to have no interest in her farmland.  The will directed that the balance of her estate, consisting solely of interests in oil royalties, passed to the testamentary trust.  The trust gave the trustee “uncontrolled” or “exclusive” discretion over trust net income and principal, and provided specifics authorizations for the use of the trust income and principal.  The trust also specified that the trustee was to “only act in a fiduciary capacity” and that the trustee “shall each year render an account of his administration of the trust funds hereunder that the same shall be available for inspection by any of the beneficiaries at any reasonable time.”  In addition, the trust specified that the trustee was liable for any failure to exercise reasonable care, prudence and diligence in the discharge of trustee duties. 

At the time of the decedent’s death, the farmland was encumbered by substantial debt.  The trustee sold the decedent’s home and used the proceeds to pay down debt on some of the farmland.  Other of the farmland was foreclosed upon and the trustee’s wife bought part of it at the foreclosure auction with the trustee’s name later added to the title.  The trustee did pay off a mortgage on one of the oil leases, but also distributed oil lease income to himself over a 19-year period in the amount of $1,300,000.  No bank account was established for the trust and the trustee deposited the oil lease income directly into his personal account that he owned jointly with his wife.  The oil lease income was used to pay down the substantial debt on the farmland and to pay farming expenses.  While the trustee testified that his use of the oil income in such manner did not benefit the trust, he asserted that the would not have taken on the responsibility of executor and trustee unless he could use the oil income to service the debt on to pay off the farm debt and farming expenses.  He testified at trial that he promised the decedent that he “would keep the farm intact whatever way I could.”  In 2013 and 2014, the trustee conveyed the mineral rights from the trust to himself personally as a beneficiary which effectively emptied the trust of assets. 

Trial court.  The other beneficiaries sued the trustee for negligently and fraudulently breaching his fiduciary duties as trustee by converting for his own use the trust income mineral interests. The trial court construed the will and trust together and determined that the decedent’s intent was to give the trustee-son as much power as possible to use trust principal for the benefit of any beneficiary in any amount without limitation.  Additionally, the trial court held that the trustee did not violate his fiduciary duty he owed as a trustee or commit fraud because he relied upon the terms of the trust and had sought out advice from an attorney that advised him that oil income could be used to service debt. He testified that accountants and bankers relied on the trust’s terms in dealing with him and told him that he could use trust income in the manner that he did.  In other words, because the trustee had uncontrolled or exclusive discretion over the trust, the trustee could not be held accountable to the other beneficiaries for his conduct.

Appellate court.  On appeal, the plaintiffs contended that the trial court erred in ruling that the trust language granting the trustee uncontrolled discretion relieved the trustee of his fiduciary duties as a trustee on the basis that such a determination did not square with the law of trusts. The trustee maintained his argument that the trust was a discretionary trust and not a support trust. Consequently, the trust did not require the trustee to make disbursements to the other beneficiaries.  Specifically, the trustee claimed that his conduct conformed to the “prudent investor rule” of Kan. Stat. Ann. §58-24a01, and did not violate his duty of loyalty under Kan. Stat. Ann. §58a-802 because the trust authorized him to transfer trust property to himself. 

The appellate court reversed and remanded.  The appellate court noted that the decedent’s intent in creating the trust was paramount and that the language of the trust was unambiguous in creating a discretionary, as opposed to a support, trust.  No single beneficiary had the right to a distribution.  The trustee had the freedom to act in his capacity as trustee.  As such, the appellate court noted that it could only interfere with that freedom in cases where the trustee abuses discretion, acts in bad faith or acts in a manner that is arbitrary and unreasonable as to amount to bad faith.  A good faith reliance on the express provisions of a trust does not result in trustee liability for breach of trust.  However, even with a fully discretionary trust, the trustee still has fiduciary duties to the beneficiaries of loyalty, impartiality and prudence in accordance with Kan. Stat. Ann. §58a-101 et seq.  These statutory duties, the appellate court noted, cannot be superseded by trust language purporting to give the trustee “uncontrolled” discretion.  A trustee, must still act in good faith and administer the trust for the benefit of the beneficiaries.  While a grantor’s intent is paramount, the law places limits on trustee conduct even in the context of a fully discretionary trust. 

Concerning the duty of loyalty, the appellate court noted that Kan. Stat. Ann. §58a-802(a) requires the trustee to “administer the trust consistent with the terms of the trust and solely in the interests of the beneficiaries.”  The duty preserves the character of the fiduciary relationship between the trustee and the beneficiaries.  The duty of impartiality is an extension of the duty of loyalty and is contained in Kan. Stat. Ann. 58a-803 which specifies that, “If a trust has two or more beneficiaries, the trustee shall act impartially in investing, managing, and distributing the trust property, giving all due regard to the beneficiaries’ respective interests.”  Here, the trustee was one of the five beneficiaries and had a duty to act impartially with respect to the other beneficiaries.  Depositing trust income in the trustee’s personal account, the appellate court held, violated the duty of impartiality. The trust was intended to be for the benefit of all of the decedent’s children, and the trustee’s actions were inconsistent with that intent.

Concerning the duty of prudent administration, Kan. Stat. Ann. §58a-804 states that, “A trustee shall administer the trust as a prudent person would, by considering the purposes, terms, distributional requirements, and other circumstances of the trust.  In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.” 

The trust stated that the trustee could use trust income to pay farming expenses, convey mineral rights, and execute oil and gas leases.  But, it gave such authorization to the trustee only in his role as a fiduciary and not as a beneficiary. The trust instrument was clear in stating, “All powers given to the trustee or trustees by this instrument are exercisable by the trustees only in a fiduciary capacity.  No power given to the trustees hereunder shall be construed to enable any person to purchase, exchange, or otherwise deal with or dispose of the principal [or] the income therefrom for less than adequate consideration in money or money’s worth.”   This is a key point.  There was no indication in the trust language that the trustee could transfer all of the trust assets to his personal account as a beneficiary to operate his own personal farming operation.  Doing so overrode his duties of loyalty and impartiality.  Although the trustee argued he was relying on an oral promise to maintain the farm, the appellate court noted the mother could have given him all of the royalty interest income, like she did with the farm, in her will.  There was no express trust language allowing the trustee to transfer everything to himself and his wife.  

The appellate court held that despite language in the trust granting the trustee uncontrolled discretion to act, the trustee still had fiduciary duties to all of the beneficiaries.  Those duties, the appellate court determined, had been breached.  The trial court’s focus solely on the discretionary language was in error.  On remand, the trial court must address the trustee’s statute of limitations defense, or any other equitable defenses, and remedies for a breach of trust including a money judgment or a specific sum for restitution.

Conclusion

The recent Kansas decision is a case study in what can go wrong with an estate plan.  It illustrates the classic situation in the farm setting where the parent wants to benefit all of the children equally, but have the farm assets end up in the hands of a particular child.  It’s debatable whether the structure chosen to implement that plan was appropriate.  However, when a trust is utilized, clients and potential trustees should be advised of the basics of trust law, the fiduciary duties that a trustee owes to the beneficiaries and that those statutory duties can’t be extinguished by trust language.  Apparently, some judges need to learn those basics also.  In the Kansas case, voters have already turned the first-term trial court judge out of office when his present term is up.     

October 5, 2020 in Estate Planning | Permalink | Comments (0)

Saturday, June 27, 2020

Is It A Gift or Not a Gift? That is the Question

Overview

Either as part of an estate plan or for purposes of setting up another person in business or for other reasons, a gift might be made.  But when is a transfer of funds really a gift?  Why does it matter?  The recipient doesn’t have to report into income gifted amounts.  If the amount transferred is not really a gift, then it’s income to the recipient.  When large amounts are involved, the distinction is of utmost importance.

When is a transfer of funds a gift?  It’s the topic of today’s blog article

Definition of a “Gift”

Under the Internal Revenue Code (“Code”), gross income is income from whatever source derived unless otherwise excluded.  I.R.C. §61(a)However, gross income does not include the value of property that is acquired by gift.  I.R.C. §102(a).  In Comr. v. Duberstein, 363 U.S. 278 (1960), the U.S. Supreme Court defined a gift under I.R.C. §102 as a transfer that proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity or like impulses.  As a result, the Supreme Court concluded that the most important consideration in determining whether a gift has been made is the donor’s intent.  That’s a broader inquiry than simply looking at how the donor characterizes a particular transaction.  A court will examine objectively whether a gift occurs based on the facts and if those facts support a donor that intended a transfer based on affection, etc.  Detached and disinterested generosity is the key.  If the transfer was made out of a moral duty or some sort of expectation on the recipient’s part, it is not a gift under I.R.C. §102 because it did not arise out of a detached and disinterred generosity.  Similarly, when the recipient has rendered services to a donor, a payment for services is not a gift even if the transferor had no legal obligation to pay the remuneration for the services.   

Apart from the Court’s analysis in Duberstein, a particular transaction may amount to a “common law” gift.  A common law gift requires only a voluntary transfer without consideration.  If the donor had no legal obligation to make the payment, the transfer is a gift under the common law standard.  That’s an easier standard to satisfy than the Code definition set forth in Duberstein

Recent Case

The recent Tax Court case of Kroner v. Comr., T.C. Memo. 2020-73 illustrates how the courts examine whether a particular transfer constitutes a gift and the consequences of misreporting the transaction(s) for tax purposes.  The petitioner was the CEO of a business that bought and sold structured settlement payments and lottery winnings.  The company would buy structured payments from lottery winners and resell the payments to investors.  The petitioner had historically worked in the discounted cashflow industry and, as a result, met a Mr. Haring, a wealthy British citizen, sometime in the 1990s.  Their business relationship lasted until 2007.

In 2003 and 2004, the petitioner was interested in protecting his assets and an attorney recommended the use of an “offshore” trust to hold the petitioner’s assets.  An offshore trust is often associated with tax scams, but I reserve that discussion for another post in the future.  In any event, the petitioner established the “Kroner Family Trust” in a small island in the Caribbean.  The petitioner was the beneficiary of the trust along with his son.  In 2007, the petitioner established another trust in the Bahamas to hold business assets.  From 2005-2007, the petitioner received wire transfers from Mr. Haring totaling $24,775,000.  Some of the transferred funds went directly to the petitioner, but others went to the trust in the Caribbean island and still others went to the petitioner’s business.  The lawyer that set up the offshore trusts “advised” the petitioner that the transfers were gifts that the petitioner didn’t have to report as taxable income.  The attorney’s legal “analysis” which led him to this conclusion was a conversation he had with the petitioner and a note that he drafted for Mr. Haring stating that the transfers were gifts.  The attorney also advised the petitioner of the requirements to file Form 3520 every year that he received a transfer from Mr. Haring to report the gifts from a foreign person.  A CPA prepared the Form 3520 for the necessary years.  The petitioner never reported any of the transfers from Mr. Haring as taxable income. 

The petitioner was audited for tax years 2005-2007.  The IRS took the position that the transfers were not gifts, should have been reported as taxable income, and assessed accuracy-related penalties on top of the tax deficiency. 

The Tax Court agreed that the transfers should have been included in the petitioner’s taxable income.  They were not gifts.  The Tax Court noted that Mr. Haring’s intention was the most critical factor in determining the status of the transfers.  The petitioner bore the burden to establish Mr. Haring’s intent by a preponderance of the evidence.  However, Mr. Haring never appeared at trial and didn’t provide testimony.  Instead, the petitioner tried to establish the gift nature of the transfers by his own testimony.  The petitioner and Mr. Haring had operated some business interests together in the 1990s, and the petitioner acted as a nominee for Mr. Haring for certain of Mr. Haring financial interests.  He even formed a trust in Liechtenstein for Mr. Haring in 2000.  Mr. Haring also provided a loan for the petitioner’s credit counseling business in 2000.  That loan was paid off in 2007.  Mr. Haring also held about a 70 percent equity interest in the petitioner’s cashflow industry business in exchange for providing funding and loan guarantees.  He later liquidated his interest for $255 million. 

The petitioner last saw Mr. Haring in 2002 and testified at trial that he didn’t know where he lived and that he didn’t know his telephone number.  He did, however, receive a telephone call from Mr. Haring in 2005 that lasted no more than three minutes.  The petitioner claimed that Mr. Haring told him during the call that Mr. Haring had a “surprise” for the petitioner.  The petitioner later met with Mr. Haring’s associate and they set up the ability to receive wire transfers from Mr. Haring into the petitioner’s bank account.  That’s when the attorney drafted a note to the petitioner from Mr. Haring stating that the transfers would be gifts. 

The Tax Court didn’t buy the petitioner’s story, finding that neither the petitioner nor the attorney were credible witnesses.  The Tax Court stated that the petitioner’s testimony was self-serving and that the attorney’s testimony was “simply not credible.”  There was no supporting documentary evidence.  In addition, the attorney represented both Mr. Haring and the petitioner.  The Tax Court also noted that the attorney was “evasive in his answers and in his selective invocation of the attorney-client privilege with regard to the legal advice provided to Mr. Haring about the transfers.”  The Tax Court also doubted the authenticity and credibility of the 2005 note allegedly from Mr. Haring but drafted by the attorney regarding his desire to gift funds to the petitioner.  Thus, the note carried little weight in determining whether the transfers were gifts.     

The Tax Court also determined that the petitioner failed to prove that the transfers were made with disinterested generosity.  The record was simply devoid of any credible evidence to prove that Mr. Haring transferred the funds to the petitioner with detached and disinterested generosity.  The Tax Court noted that timing of some of the transfers with liquidity events of the petitioner’s business of which Mr. Haring was an investor.  That raised a question as to whether Mr. Haring was acting as the petitioner’s nominee. 

The Tax Court determined that the petitioner need not pay the 20 percent accuracy-related penalty because the IRS failed to satisfy its burden of production under I.R.C. §6751(b)

Conclusion

The Kroner case is a textbook lesson on what constitutes a gift – detached and disinterested generosity.  The burden of establishing that a transfer is a nontaxable gift is on the party asserting that the transfer amounted to a gift.  The case is also a lesson into the messes that sloppiness and questionable lawyering can get a client into.  When the amount of the gift (or gifts) is as large as that involved in the Kroner case, attention to detail is a must.  The income tax consequences from being wrong are enormous. 

June 27, 2020 in Estate Planning, Income Tax | Permalink | Comments (0)

Wednesday, June 24, 2020

Valuing Farm Chattels and Marketing Rights of Farmers

Overview

When a farmer or rancher dies, often left behind are assets that are unique to agriculture.  For tax purposes, these assets present unique valuation issues.  For practitioners handling ag estates, it’s important to get values correct for federal estate tax purposes and/or a county inheritance tax worksheet.  What are the basics tenets of valuing these unique farm and ranch items?  This was an issue that Don Kelley, who I started out my practice career out with in North Platte, NE, wrote about in his two-volume treatise, Estate Planning for Farmers and Ranchers, and his other two-volume set, Farm Business Organizations.  Don recently turned over the editorship of those treatises to me.  In working on updating those volumes recently, I thought it would be a useful topic for today's article.  

Valuing farm chattels and marketing rights of a farmer at death – it’s the topic of today’s post

Valuing Chattels

There is no specific Treasury Regulation that addresses the valuation of tangible chattel property (personal property) beyond Treas. Reg. §20.2031-6 (addressing household goods/personal effects) and Treas. Reg. §20.2031-1 which addresses general valuation concepts. 

Treas. Reg. §20.2031-1(b) states:

“Livestock, farm machinery, harvested and growing crops must generally be itemized and the value of each item separately returned.  Property shall not be returned at the value at which it is assessed for local property tax purposes unless that value represents the fair market value as of the applicable valuation date.  All relevant facts and elements of value as of the applicable valuation date shall be considered in every case.”

It’s often easier to value chattels and inventory them than it is to value farm/ranch real estate.  Most farm machinery has an established market.  As a result, appraisals of farm machinery and equipment usually are not controversial.  If there is an established retail market for chattel property, it is to be value at retail.  Treas. Reg. §20.2031-1(b).  As the regulation states, “For example, the fair market value of an automobile (an article generally obtained by the public in the retail market) includible in the decedent's gross estate is the price for which an automobile of the same or approximately the same description, make, model, age, condition, etc., could be purchased by a member of the general public and not the price for which the particular automobile of the decedent would be purchased by a dealer in used automobiles.  Examples of items of property which are generally sold to the public at retail may be found in §§ 20.2031-6 and 20.2031-8.”  Id.

This same approach is to be used with respect to farm machinery and equipment and also farm vehicles.  For example, in Estate of Love v. Comr., T.C. Memo. 1989-470, the decedent was in the business of breeding and racing thoroughbred horses and died 11 days after a brood mare mated.  It was not possible as of the date of the decedent’s death (the valuation date) to determine whether the mare was pregnant at the time the decedent died, but the IRS went ahead and assumed that the mare was pregnant on the date of the decedent’s death for valuation purposes.  Doing so greatly increased the value of the mare.  The Tax Court determined that that post-death pregnancy of the mare was not to be taken into account when valuing the mare for estate tax purposes.  There was no way that a hypothetical willing buyer would have known that the mare was pregnant, and the Tax Court determined that the assumption by the IRS of the mare’s pregnancy was not in accord with Treas. Reg. §20.2031-1(b).  The Tax Court also excluded post-death sales of horses in the determination of the mare’s value and relied on comparable sales of horses near the date of the decedent’s death.  The Tax Court’s opinion was upheld on appeal.  923 F.2d 335 (4th Cir. 1991).  

Valuating Fixtures

Farm buildings, fences, water wells and similar items are customarily appraised as part of the farm real estate.  But, if a fixture (and associated chattel equipment) is linked with crop production, valuation is more problematic.  An example of such an item would be an irrigation well used to pump water for crop irrigation.  At least in the areas of the Great Plains and the western Midwest, IRS offices have historically valued detachable chattel items as farm machinery.  Such items of property include aboveground pivot irrigation systems, motors and pumps.  The associated land on which the irrigated crops are grown is typically appraised along with any immovable fixtures (i.e., wells; well casings; pivot stanchions) in place. 

Inventory

Harvested grain in inventory of a farmer usually doesn’t present a valuation issue.  The grain is valued in accordance with trading exchanges for the type of crop involved as of the date of death.  For example, in Willging v. United States, 474 F.2d 12 (9th Cir. 1973), the plaintiff was a wheat farmer that reported income on the accrual basis.  The value of the 1966 opening grain inventory increased by over $36,000 from January 1, 1966 until the date of the farmer’s death in November.  The estate claimed that the increase in the inventory values escaped taxation because of the basis step-up rule of I.R.C. §1014.  The appellate court disagreed, reversing the trial court.  The court noted that the farmer determined income annually by adding to the sales price of products sold during the year the value of his closing inventory, and then subtracting from that amount the value of the opening inventory.  Inventories were valued under the “farm price” method (market price less direct costs of disposition).  The farmer deducted expenses in the year incurred.  Because the farmer elected to be taxed under the accrual method, the court noted that the value of the grain was realized when it increased the inventory value.  It wasn’t realized when it was later sold.  Thus, his death didn’t have the effect of accruing items which would not otherwise have been accrued, but his death closed the tax year for his last tax year for the income he had received that year. 

Marketing Rights

Many farmers are members of agricultural cooperatives and may hold cooperative marketing rights as of the time of death.  This is particularly true with respect to dairy farmers and is also common among beekeepers.  How are such rights valued?  In Cordeiro’s Estate v. Comr., 51 T.C. 195 (1968), the petitioner acquired a herd of dairy cows from the decedent.  The decedent was a member of a cooperative marketing association and had been required to market all of his milk from the herd through the cooperative.  The decedent had been allocated “base” as a measure of his share in the proceeds of the cooperative’s milk sales.  The decedent’s membership and base expired upon the decedent’s death and the petitioner succeeded to it and membership in the cooperative.  The Tax Court determined that the base was separate from the dairy herd and that the petitioner’s cost basis in the dairy cows was to be determined without any value attributed to the base.  A milk base is an intangible right to sell a certain amount of milk at a particular price.  See, Priv. Ltr. Rul. 7818002 (Jan. 6, 1978).  See also, Vander Hoek v. Comr., 51 T.C. 203 (1968), acq., 1969 A.O.C. LEXIS 210 (May 9, 1969). 

Similarly, a rice allotment has been held to be a right this is devisable, descendible, transferable and salable.  First Victoria National Bank v. United States, 620 F.2d 1096 (5th Cir. 1980).  The court said that the allotment was similar to business goodwill.  That reasoning could support an IRS argument that other USDA program benefits that a decedent had applied for have value for tax purposes associated with death. 

Conclusion

Valuation issues for farmers and ranchers can be unique.  When particular items of chattel property are involved, specific valuation guidance is often lacking, and the existing guidance is dated.  While the courts have addressed some of the issues, the general advice of not being greedy holds true.  If a valuation amount looks reasonable to an IRS examining agent, chances are IRS won’t push the issue.

This is just one of the issues that will be addressed at the 2020 Farm & Ranch Income Tax/Estate and Business Planning national conference in Deadwood, South Dakota on July 20-21.  You may attend either in-person or online.  For more information on the conference and how to registration information click here:  https://washburnlaw.edu/employers/cle/deadwoodcle.html

June 24, 2020 in Estate Planning | Permalink | Comments (0)

Wednesday, June 17, 2020

Tax Issues Associated With Options In Wills and Trusts

Overview

As part of an estate plan, an heir may be given an option to buy certain assets of the decedent at a specified price.  In agricultural estates, such an option is typically associated with farmland of the decedent, and often gives the optionee (the person named in the will with the right to exercise the option) a very good deal for the property upon exercise of the option. 

Often the question arises as to the basis of the property in the hands of the optionee when the option is exercised and the resulting tax consequences when the property is later sold. 

Tax issues associated with the exercise of an option – it’s the topic of today’s post.

Options – The Basics

There is no question that an option can be included in a will.  A testator has the right to dispose of their property as desired.  The only significant limitation on testamentary freedom involves the inability to completely disinherit a spouse.  Even if the will leaves nothing for the surviving spouse, under state law the surviving spouse has a right to an elective share entitling the surviving spouse to “elect” to take a portion of the estate regardless of what the deceased spouse’s will says (except, of course, if a valid prenuptial agreement was executed).   Under most state laws, a surviving spouse’s elective share comprises anywhere from between one-third to one-half of the decedent’s estate.  In addition, in some states, the spousal elective share can include retirement assets or life insurance. 

Tax Issues

What are the tax consequences when an optionee exercises an option?  Does the exercise result in tax consequences to the decedent’s estate?  What are the tax consequences if the optionee later sells the property that was acquired by the exercise of the option? 

Decedent’s estate.  The exercise of an option results in no tax consequence to the decedent’s estate.   The exercise of the option, followed by the sale of the property by the estate to the holder of the option does not result in gain or loss to the estate.   In Priv. Ltr. Rul. 8210074, Dec. 10, 1981, the decedent's son was given an option under the terms of the parent’s will to purchase some of the parent’s farmland at $350/acre. The son exercised the option and paid the estate $26,668 for the land. At the time the option was exercised, the farmland was worth $114,293 (as valued on the parent’s estate tax return). The IRS determined that the combined basis of the option and the real estate subject to the option was $114,293 with $26,668 of that allocable to the land. Thus, when the real estate was sold to the son for $26,668, it equaled the basis in the land in the hands of the estate resulting in neither gain nor loss to the estate.

Optionee’s basis. 

When the optionee exercises the option in a will or trust, the primary question is what the income tax basis of the property received under the option is in the optionee’s hands.  I.R.C. §1014 is the applicable basis provision for property acquired from a decedent.  The provision states in pertinent part, “(a)In general Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be— (1) the fair market value of the property at the date of the decedent’s death,… (b)Property acquired from the decedent For purposes of subsection (a), the following property shall be considered to have been acquired from or to have passed from the decedent: (1) Property acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent….

This ‘”stepped-up” basis rule applies to property required to be included in the decedent’s gross estate, including property that is subject to an option in a will (or trust) that grants the beneficiary an option to purchase the property at a beneficial price from the estate.  The option is treated as property acquired from the decedent and receives an income tax basis equal to its fair market value as of the date of the decedent’s death.  Its basis is the estate tax value of the property subject to the option less the price the beneficiary must pay to exercise the option.  A beneficiary who exercises an option under a will may add the basis of the option to the cost of the property (the option amount) to determine the optionee’s basis in the property. 

In Cadby v. Comr., 24 T.C. 899 (1955), acq., 1956-2 C.B. 5, the decedent died in 1942.  His will included a provision directing the executor and trustee to sell some of the decedent’s stock to a family member and another person for $25,000 upon proof that the family member had purchased from the decedent’s surviving spouse preferred stock in the same company for $6,000 if payment were made within two years of the decedent’s death.  If payment wasn’t made within the specified timeframe, disposition of the stock was left to the discretion of the executor and trustee. Shortly after the decedent’s death, the family member sold his rights under the will to a third party for $13,000.

In determining the tax consequence of the transaction to the family member, the Tax Court noted that the fair market value of the decedent’s stock interest subject to the option was $55,243 as of the date of death as denoted on the decedent’s federal estate tax return.  In addition, the family member paid $6,000 for the stock he purchased from the decedent’s surviving spouse.  Thus, the family member’s income tax basis in the stock was $61,243.40.  From that amount, the Tax Court subtracted the option price of $25,000 and the payment to the surviving spouse of $6,000.  The result, $30,243.40, was the option price.  Because the family member held a one-half interest in the option, that one-half interest was worth $15,121.70.  Thus, the sale for $13,000 did not trigger any taxable income to the family member. 

IRS Position

Twelve years after the Tax Court’s ruling in Cadby, the IRS issued a Revenue Ruling formally stating its position that a beneficiary who exercises an option under a will may add the basis of the option to the cost of the property (the option amount) to determine the beneficiary’s basis in the property.  Rev. Rul. 67-96, 1967-1 C.B. 195.  In 2003, the IRS issued a private letter ruling again confirming the Tax Court’s approach in Cadby.  Priv. Ltr. Rul. 200340019 (Jun. 25, 2003).  Under the facts of the ruling, under the terms of Mother's will, the taxpayer was given the right to purchase the Mother’s home upon the Mother’s death at an amount less than fair market value.  The basis in the option and in the home upon exercise of the option was determined in accordance with Rev. Rul. 67-96.  Thus, the basis in the option upon its exercise was measured by the difference between the value of the home for federal estate tax purposes and the option price.  In addition, as a result of exercising the option, the taxpayer’s basis in the home was the sum of the basis of the option and the actual option price paid. 

Conclusion

Options can play an important role in transitioning a farming or ranching business to the next generation.  Not only must thought be given to the financial ability of the optionee to exercise the option, the income tax issues triggered upon exercise of the option and, when applicable, the subsequent sale of the property acquired by exercising the option must also be considered.

June 17, 2020 in Estate Planning, Income Tax | Permalink | Comments (0)

Tuesday, June 9, 2020

Are Advances to Children Loans or Gifts?

Overview

Often a parent (or parents) will advance money to a child.  The reasons for doing so are varied, such as making a large loan but then forgiving the payments each year consistent with the federal gift tax present interest annual exclusion (currently $15,000), but a significant question is whether such an advance of funds is a loan or a gift.  The proper classification makes a difference from a tax standpoint.

Is an advance of funds to a child a loan or a gift – that’s the topic of today’s post.

IRS Factors

The IRS presumption is that an advance is a gift when a transfer between family members is involved.  The taxpayer can overcome the presumption by showing that repayment was expected and that the taxpayer actually intended to enforce the debt.  In making that determination, the IRS utilizes a set of factors to evaluate whether an advance of funds amounts to a loan or a gift.  Those factors include whether the borrower signed a promissory note; whether interest was charged; whether collateral secured the indebtedness; whether payment was actually made; whether demand for repayment occurred when a payment was missed; whether there was a fixed due date for the loan; whether the borrower had the ability to repay the debt; how the parties characterized the transaction, and; whether the transaction was reported for federal tax purposes as a loan.  In essence, the question boils down to whether there is a bona fide debtor-creditor relationship. 

Illustrative Cases

In Miller v. Comr., T.C. Memo. 1996-3, the petitioners (a married couple) operated a ranch and employed their two sons to manage it.  One of the boys also managed his parents’ commercial property business in Georgia and that one of the sons helped manage.  The Mother transferred $100,000 to a son by giving him two $50,000 checks in the summer and fall of 1982.  She wrote the word “loan” on the check register and the check stub for each check and the checks were recorded in an account labeled “Notes Receivable – S. Miller” in the Mother’s general ledger.  She was trying to help him pay off a $56,000 mortgage on a house he and his wife bought in 1980 for $300,000 that became due in 1982.  In November of 1982, he used $56,000 of the $100,000 that he received from his Mother to retire the mortgage. The son signed a non-interest-bearing noted in the principal amount of $100,000 that was payable to his Mother.  The note was not secured by any collateral.   The note specified that the son was to pay his Mother on demand or three years after it was executed if no demand was made.  However, the Mother didn’t consider the three-year-later date to be a fixed date on which the son had to pay her, and she had no intention of demanding payment on that date, or any other date.  She also never discussed with her son any consequences of his failing to make payment.  In late 1982, the son made a $15,000 payment on the note, but didn’t make any more over the next three years.  The Mother never sought to enforce repayment, instead writing a “forgiveness” letter to him each year.  The IRS took the position (based on the multiple factors) that the loans were gifts.  The Tax Court agreed, which meant that the Mother had gift tax liability.  

In Estate of Bolles v. Comr., T.C. Memo. 2020-71, the decedent had five children and expressed a desire to treat them equally upon her death. She kept a personal record of advances to each child and any repayment that a child made. She treated the original advances as loans and forgave the “debt” account of each child annually in the amount of the federal gift tax present interest annual exclusion. The decedent and her spouse established a trust to hold some of their jointly owned property, including a substantial art collection and office building in San Francisco. At the time of her death she and her five children were among the beneficiaries of the trust. Her oldest child encountered financial difficulties and entered into an agreement with the trust to use trust property as security for $600,000 in bank loans. The son also owed the trust back-rent from his architecture practice. The son failed to meet the loan obligations and the trust was liable for the bank loan. The decedent transferred over $1 million to the son from 1985 through 2007. The son did not make any repayments after 1988. The decedent also had a revocable trust created in 1989. That trust specifically excluded the son from any distribution from her estate. It was later amended to include a formula to account for the “loans” made to the son during her lifetime.

Upon her death, another son filed a federal estate tax return and the IRS determined a deficiency of $1,152,356, arguing that the decedent’s advances to the oldest child were taxable gifts and not loans. The Tax Court determined that the amounts were gifts based on a non-exclusive, nine-factor analysis used in determining the status of advances: (1) whether there was a promissory note or other evidence of indebtedness; (2) whether interest was charged; (3) whether there was security or collateral; (4) whether there was a fixed maturity date; (5) whether a demand for repayment was made; (6) whether actual repayment was made; (7) whether the transferee had the ability to repay; (8) whether records maintained by the transferor and/or the transferee reflect the transaction as a loan; and (9) whether the manner in which the transaction was reported for Federal tax purposes is consistent with a loan.

The court determined that the decedent did not have a reasonable expectation of repayment due to the son’s financial situation and employment history. However, a small portion of the advances made to the son while his financial situation was more favorable were loans because the decedent could expect repayment based on the son’s improved financial condition. The Tax Court noted that with respect to situations involving loans to family members, an actual expectation of repayment and an intent to enforce the debt are critical to sustaining the tax characterization of the transaction as a loan. 

Conclusion

Be careful when making loans or gifts to children.  Take care to document the transaction(s) carefully and make sure to structure it with the factors listed above in mind to achieve the desired result.  Also, be mindful of another weapon the IRS might utilize in certain transactions, including those involving family members – the “step-transaction” doctrine.  This is another potential problem that can arise when the gift/loan distinction is not in issue.  For example, in Estate of Cidulka v. Comr., T.C. Memo. 1996-149, the IRS successfully utilized the doctrine to trigger gift tax liability.  The decedent had made annual gifts of stock during his life to his son, daughter-in-law and grandchildren.  He treated the transfers as gifts for gift tax purposes and kept each one at or under the applicable gift tax present interest annual exclusion (currently $15,000) so that he wouldn’t have to pay gift tax on the transfers.  Over a 14-year period, the daughter-in-law dutifully transferred her gift each year to her husband (the decedent’s son) on the exact same day her father-in-law transferred the stock to her.  The IRS didn’t have trouble picking that one apart.  It took the position that the annual gifts to her were really for her son, exceeded the annual exclusion amount and were subject to gift tax. 

Transferring funds to children can be full of traps.  Be advised.

June 9, 2020 in Estate Planning | Permalink | Comments (0)

Thursday, June 4, 2020

Summer 2020 – National Farm Income Tax/Estate and Business Planning Conference

Overview

On July 20-21, Washburn Law School will be conducting a national conference on farm income tax and farm estate and business planning in Deadwood South Dakota.  Also occurring nearly simultaneously will be the law school’s first “CLE Excursion.”  In today’s post I provide a preview of the conference and the excursion.

Farm Income Tax/Estate and Business Planning Conference

If you represent ag clients in handling tax issues and or work with them on estate and business plans, this conference is a focused event on issues tailored to the farm clientele that will be useful to your business.  Numerous tax rules as well as the rules surrounding estate and business planning for the ag client are unique.  The unique rules and the planning challenges and opportunities they present will be discussed.

The conference will be held at the Lodge at Deadwood, a premier conference facility in just outside Deadwood, South Dakota in the beautiful Black Hills with proximity to Mount Rushmore, Devils Tower, Spearfish Canyon and other beautiful locations. 

Day 1 (July 20) – Farm Income Tax

On Monday, July 20, the discussion will focus on various farm income tax topics.  Speakers for the day include myself, Paul Neiffer, and U.S. Tax Court Judge Elizabeth Crewson Paris   The topics for the day include:

  • Caselaw and IRS update (including tax provisions in the CARES Act)
  • CARES Act Update (PPP and EIDL)
  • GAAP Accounting Update
  • Restructuring Credit Lines
  • Deducting Bad Debts
  • Forgiving Installment Sale Obligations
  • Passive Losses
  • R.C. §199A Advanced Planning
  • Practicing Before the U.S. Tax Court
  • NOLs and EBLs
  • FSA Advanced Planning
  • CFAP Update (including payment limitation planning)
  • Like-Kind Exchanges and I.R.C. §1245 property

Day 2 (July 21) – Farm Estate and Business Planning

On Tuesday, July 21, the focus will shift to farm estate and business planning.  Speakers for the day along with myself will be Prof. Jeff Jackson, Brandon Ruopp, Marc Vianello and Prof. Shawn Leisinger

  • Caselaw and IRS update
  • Incorporating a Gun Trust Into an Estate Plan
  • Retirement Planning
  • Common Estate Planning Mistakes of Farmers and Ranchers
  • Post-Death Management of the Family Farm and Ranch Business
  • Estate and Gift Tax Discounts for Lack of Marketability
  • Valuation of Farm Chattels and Marketing Rights
  • Ethical Issues Related to Risk

You can learn more about the conference and find registration information here:  http://washburnlaw.edu/employers/cle/farmandranchtax.html

CLE Excursion

Corresponding with the farm income tax and estate/business planning conference will be Washburn Law School’s “CLE Excursion.  While this event is primarily for Washburn Law Alumni, others are welcome to register.  An informal gathering will be on Friday evening, July 17.  On Saturday, July 18, with two hours of CLE that day.  A day of sightseeing is planned for Sunday, July 19 with a CLE conference also at the Lodge at Deadwood.  CLE topics for July 20 will be: 

  • Ethics
  • Gun Trusts
  • Law and Technology

On July 20 an excursion will also take place to Mount Rushmore and Crazy Horse mountain.  You can learn more about this event and register here: http://washburnlaw.edu/employers/cle/deadwoodcle.html

Virus Concerns?

If you are unable to attend due to the virus or concerns over the virus, the two-day conference will be live-streamed.  We use a superior streaming technology that allows you to participate in the conference from the comfort and safety of your own office.  

Room Block

A room block has been established for the tax/planning conference.  When you call the Lodge at Deadwood, just mention that you will be attending Washburn Law School’s summer conference.  A special rate has been negotiated for the room block.

Conclusion

This conference will take place shortly after the end of the filing season (assuming it isn’t postponed again) at a time when many will also be ready for a nice place to vacation at and also take in a continuing education conference.  It is also possible to register for both events and pick and choose the topics you would like to attend.  In addition, as noted the farm income tax/farm estate and business planning conference can also be attended online as it will be broadcast live online. 

I hope to see you in Deadwood this summer.  If you can’t be there, I hope you can attend online.

June 4, 2020 in Business Planning, Estate Planning | Permalink | Comments (0)

Friday, April 24, 2020

Summer 2020 – National Farm Income Tax/Estate and Business Planning Conference

Overview

This coming July, Washburn Law School will be conducting a national conference on farm income tax and farm estate and business planning in Deadwood South Dakota.  Also occurring nearly simultaneously will be the law school’s first “CLE Excursion.”  In today’s post I provide a preview of the conference and the excursion.

Farm Income Tax/Estate and Business Planning Conference

If you represent ag clients in handling tax issues and or work with them on estate and business plans, this conference is a focused event on issues tailored to the farm clientele that will be useful to your business.  Numerous tax rules as well as the rules surrounding estate and business planning for the ag client are unique.  The unique rules and the planning challenges and opportunities they present will be discussed.

The conference will be held at the Lodge at Deadwood, a premier conference facility just outside Deadwood, South Dakota in the beautiful Black Hills with proximity to Mount Rushmore, Devils Tower, Spearfish Canyon and other beautiful locations. 

Day 1 (July 20) – Farm Income Tax

On Monday, July 20, the discussion will focus on various farm income tax topics.  Speakers for the day include myself, Paul Neiffer, and U.S. Tax Court Judge Elizabeth Crewson Paris   The topics for the day include:

  • Caselaw and IRS update
  • GAAP Accounting Update
  • Restructuring Credit Lines
  • Deducting Bad Debts
  • Forgiving Installment Sale Obligations
  • Passive Losses
  • R.C. §199A Advanced Planning
  • Practicing Before the U.S. Tax Court
  • NOLs and EBLs
  • FSA Advanced Planning
  • Like-Kind Exchanged and I.R.C. §1245 property

Day 2 (July 21) – Farm Estate and Business Planning

On Tuesday, July 21, the focus will shift to farm estate and business planning.  Speakers for the day along with myself will be Prof. Jeff Jackson, Brandon Ruopp, Marc Vianello and Prof. Shawn Leisinger

  • Caselaw and IRS update
  • Incorporating a Gun Trust Into an Estate Plan
  • Retirement Planning
  • Common Estate Planning Mistakes of Farmers and Ranchers
  • Post-Death Management of the Family Farm and Ranch Business
  • Estate and Gift Tax Discounts for Lack of Marketability
  • Valuation of Farm Chattels and Marketing Rights
  • Ethical Issues Related to Risk

You can learn more about the conference and find registration information here:  http://washburnlaw.edu/employers/cle/farmandranchtax.html

CLE Excursion

Corresponding with the farm income tax and estate/business planning conference will be Washburn Law School’s “CLE Excursion.  While this event is primarily for Washburn Law Alumni, others are welcome to register.  An informal gathering will be on Friday evening, July 17.  On Saturday, July 18, with two hours of CLE that day.  A day of sightseeing is planned for Sunday, July 19 and a couple of hours of CLE are also available that day as well as a reception that evening preceding the two-day tax and estate/business planning conference that begins the next day.  All of the CLE events and the reception will be held at the Lodge at Deadwood.  Additional CLE topics for this July 20 event will be: 

  • Ethics
  • Gun Trusts
  • Law and Technology

Also on July 20 an excursion will also take place to Mount Rushmore and Crazy Horse mountain.  You can learn more about this event and register here: http://washburnlaw.edu/employers/cle/deadwoodcle.html

Conclusion

This conference will take place shortly after the end of the filing season at a time when many will also be ready for a nice place to vacation at and also take in a continuing education conference.  It is also possible to register for both events and pick and choose the topics you would like to attend.  In addition, the farm income tax/farm estate and business planning conference can also be attended online as it will be broadcast live online.  A room block has been established for the tax/planning conference.  When you call the Lodge at Deadwood, just mention that you will be attending Washburn Law School’s summer conference.  A special rate has been negotiated for the room block.

I hope to see you in Deadwood this summer.  If you can’t be there, I hope you can attend online.

April 24, 2020 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Wednesday, April 15, 2020

Court Developments of Interest

Overview

In recent articles on this blog, I have taken a look at the various parts of recently enacted legislation as a consequence of the economic trauma the federal and state governments have imposed on businesses and individuals as a recent of the virus.  Today, I step away from virus related developments and focus on recent court opinions of relevance to agricultural law and taxation. 

Ag law and tax in the courts – it’s the topic of today’s post.

Valuation Discounting – Assignee Interests

Streightoff v. Comr., T.C. Memo. 2018-178, aff’d., No. 19-60244, 2020 U.S. App. LEXIS 10070 (5th Cir. Mar. 31, 2020).

Limited partnerships (and their variant – the family limited partnership), emerged as an important estate and business planning tool in the early 1990s.  They can be useful for farming and ranching operations of relatively higher net worth as a vehicle to transfer interests in the farming or ranching business to a succeeding generation at a discounted value.  That discounted value is often achieved by working the transferor into a minority position before death and the creation of multiple types of partnership interests, and also holding those partnership interests in different types of entities.  Discounted value can also be achieved (under the laws of some states) by transferring an assignee interest rather than the actual interest in the partnership.  Assignee interests are, in essence, limited partnership interests with economic participation equal to that of limited partnership interests but typically without the same rights.  They typically do not carry the right to vote, inspect partnership books or transfer their interests.  Thus, the claim is, they should be valued less than a general partnership interest and even less than a limited partnership interest for both federal gift tax as well as estate tax purposes - if they are established and transferred properly.  That was the issue in a recent case.

In Streightoff, the decedent had created a limited partnership under Texas law before death. The decedent held a one percent general partner interest and an 88.99 percent limited partner interest. Eight of the decedent’s family members owned the balance of the limited partner interests. The partnership didn’t conduct any meetings and held cash, equities, bonds and mutual funds. The decedent had the power to approve the sale of partnership interests and had a right of first refusal on all sales. The partnership agreement described persons who acquired partnership interests as “assignees.”

A few years before death, the decedent purported to create an “assignee” interest in his revocable trust with respect to his 88.99 percent limited partnership interest. The decedent’s estate tax return reported the decedent’s limited partnership interest as an “assignee” of the revocable trust and claimed a 37.2 percent discount for lack of marketability discount and lack of control. The estate based the level of the discount on the notion that the trust only held an assignee interest consistent with the partnership agreement which stated that, “A transferee who was not admitted as a substituted limited partner would hold the right to allocations and distributions with respect to the transferred interest, but would have no right to information or accounting or to inspect the books or records of the partnership and would not have any of the rights of a general or limited partner (including the right to vote on partnership matters)."

The IRS reduced the extent of the discount and asserted a deficiency of about $500,000. While the estate claimed that the lack of marketability discount should be 27.5 percent based on a possible holding period until 2075, the Tax Court determined that the decedent’s assignee interest was essentially the same thing as a limited partnership interest. Accordingly, the Tax Court settled on an 18 percent discount for lack of marketability. No discount for lack of control was allowed because the Tax Court found that the partnership interest was significant and carried with it the power to remove the general partner. The appellate court affirmed on appeal, concluding that the Tax Court properly determined that the assignment was essentially a transfer of the decedent’s partnership interest. The “assignment” clearly conveyed more than an assignee interest. 

 

Petition to Quiet Title Over Disputed Boundary Denied

Liddiard v. Mikesh, No. 19-0143, 2020 Iowa App. LEXIS 267 (Iowa Ct. App. March 18, 2020)

If an individual possesses someone else's land in an open and notorious fashion with an intent to take it away from them, such person (known as an adverse possessor) can become the true property owner after the statutory time period has expired via a quiet title action.  Adverse possession statutes vary by jurisdiction in terms of the requirements a person claiming title by adverse possession must satisfy and the length of time property must be adversely possessed.  A boundary between two properties can also be established by acquiescence.  This theory applies when neither of the adjacent owners knows the location of the true boundary.  Instead, the parties treat a particular marker or line as the boundary for a prescribed period of time.  Both parties simply agree (acquiesce) to treat that particular line or marker as the boundary.  Both of these concepts were involved in a recent Iowa case.

The parties had been adjoining rural landowners since 1988. When the defendant bought his tract, a survey was conducted.  That survey was relied on in litigation between the parties concerning a dispute over logged timber on a five-acre parcel where ownership between the parties was not clear via the respective deeds. A few years later the plaintiff sued to quiet title to the disputed area claiming that the true boundary was the existing fence line based on either the theory of adverse possession or boundary by acquiescence.

The trial court determined that the plaintiff had failed to establish the requirements for either theory, and refused to quiet title in the plaintiff. On appeal, the appellate court agreed. Based on the evidence, the appellate court determined that the plaintiff failed to establish exclusive use of the disputed area for the statutory period and did not substantially maintain or improve the area.  Thus not all of the elements of adverse possession were satisfied.  In addition, the plaintiff did not bring the quiet title action for six years after the initial dispute over timber. The appellate court also determined that the defendant did not treat the fence line as the boundary. Thus, no boundary by acquiescence was established because both parties did not assume the fence line was the boundary. 

Court Addresses Direct and Indirect Discharges Under CWA – Awaiting Supreme Court Guidance

Conservation Law Foundation v. New Hampshire Fish & Game Department, No. 18-CV-996-PB, 2020 U.S. Dist. LEXIS 59608 (D. N.H. Apr. 6, 2020).

The plaintiff claimed that the defendant had violated the Clean Water Act (CWA) by allowing a hatchery that the defendant owned and operated to discharge pollutants into a river in violation of the hatchery’s National Pollutant Discharge Elimination System (NPDES) permit. The plaintiff claimed that the defendant was making both direct and indirect discharges in violation of its NPDES permit. The direct discharge claims were based on current and anticipated future discharges directly from the hatchery into the river. The indirect discharge claims stemmed from past releases of phosphorus by the hatchery that became sediment at the bottom of the river.  Those discharges continued to leach phosphorus into the water.

The trial court dismissed the direct discharge claims and directed the parties to submit additional arguments with respect to the indirect discharge claims. The direct discharge claims were dismissed because in late 2019, the EPA released a new NPDES permit for the hatchery which ultimately may allow the discharges that the plaintiffs claim violate the CWA. Because the anticipated 2020 permit may moot some or all of the plaintiffs’ direct discharge claims, the court dismissed those claims. As for the indirect discharge claims, the court noted that the plaintiffs’ arguments that the defendants have violated the CWA by allowing pollutants to enter a water of the United States through a conduit is similar to an issue that is presently before the United States Supreme Court.  See Hawaii Wildlife Fund v. County of Maui, 881 F.3d 754 (9th Cir. 2018), pet. for cert. granted, County of Maui v. Hawaii Wildlife Fund, 139 S. Ct. 1164 (2019)Because how the Supreme Court rules on the indirect discharge claim could impact the court’s decision in this case, the court requested that the parties file additional briefing on whether the Maui case should influence the court’s decision. 

Alimony Payments Not Deductible

Biddle v. Comr., T.C. Memo. 2020-39

In divorce situations, it’s fairly common for one ex-spouse to become legally obligated to make payments to the other ex-spouse.  Before 2018, the ex-spouse making alimony payments could deduct them for federal income tax purposes.  To be deductible alimony, a payment could not be classified as fixed or deemed to be child support under a set of complex rules, as evidenced in a recent Tax Court case.

Under the facts of the case, the petitioner and his wife were married for 14 years and had four children together before divorcing in 2010. The divorce decree included provisions for “child support” and “alimony.” The decree ordered the petitioner to pay monthly child support of $1,795.63 per month until each child reached age 18, died, married, entered military school or became self-sufficient. The decree also ordered the petitioner to pay “permanent periodic alimony” of $1,592.50 for at least five years until either the youngest child reached age 18, the ex-wife or petitioner died, the ex-wife remarried at the five-year point or later, or the wife became self-supporting. The decree also specified that if the husband received a pay raise that half of the net increase would increase the alimony payment. The decree was later modified to reduce the monthly child support amount because the petitioner took custody of an additional child. No change was made to the alimony payment.

On petitioner’s 2015 return, he claimed a $28,000 alimony deduction. The IRS disallowed the deduction as nondeductible child support because of one of the contingencies terminating payment was petitioner’s youngest child turning 18. The Tax Court upheld the IRS position. The Tax Court noted that under I.R.C. §71(c)(2)(A), the payments would count as child support until the child turned 18. Here, the decree clearly stated that the designated alimony payments would terminate on the contingency that the petitioner’s youngest child turn 18. That was a contingency relating to a child that qualifies a payment as nondeductible child support. This is the result, the court noted, even though the decree designated separate amounts for child support and alimony. The parties’ intent also was immaterial. 

Conclusion

Even though the focus of much present thought and discussion is on the virus and the economic wreckage that (primarily) state governmental policies are causing, the courts continue to crank out important cases.  Make sure you are still paying attention to what is going on.

April 15, 2020 in Business Planning, Civil Liabilities, Environmental Law, Estate Planning | Permalink | Comments (0)

Monday, April 6, 2020

Retirement-Related Provisions of the CARES Act

Overview

The government’s response to the virus that originated in China and has spread to the United States has, in turn, precipitated Congressional legislation designed to provide economic relief from that government response.  Last week, I devoted a blog article to the small business and bankruptcy provisions.  In today’s post, I examine the retirement-related provisions.  Later this week, I will provide a run-down of the individual and business income tax-related provisions.

Retirement-related provisions of recent legislation – it’s the topic of today’s post.

Change In Early Distribution Penalty Rule

I.R.C. §72(t) provides for a 10 percent additional tax on an early distribution from a qualified retirement plan as defined in I.R.C. §4974(c)I.R.C. §72(t)(1).  The penalty tax does not apply if the distribution is made on or after the date the taxpayer turns age 59 and ½.  I.R.C. §72(t)(2).  It also doesn’t apply to post-death distributions and distributions made on account of disability, among other things.  See I.R.C. §72(t)(2)(A)(i)-(viii). 

Section 2202 of H.R. 748, the Coronavirus Aid Relief and Economic Security (CARES) Act (Act), Pub. L. No. 116-136, amends I.R.C. §72(t) such that the 10 percent penalty does not apply to any coronavirus-related distribution of $100,000 or less during the tax year from an eligible retirement plan.  Act, §2202(a)(1)-(2).  An “eligible retirement plan” is one listed in I.R.C. §402(c)(8)(B).  That means that IRAs, individual retirement annuities, qualified trusts, annuity plans, governmental deferred compensation plans, qualified pension, profit sharing or stock bonus plans (including I.R.C. §401(k) plans), annuity plans and contracts, as well as custodial accounts.

The distribution must occur on or after January 1, 2020 and before December 31, 2020.  Act, §2202(a)(4)(A)(i).  It is not available for distributions made on December 31, 2020.  Id.   The distribution must also be made to a “qualified person” – a person or the person’s spouse or dependent (as defined in I.R.C. §152) that is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test that the Centers for Disease Control and Prevention has approved.  Act, §2202(a)(4)(A)(ii)(I)-II).  A qualified person is also one who experiences adverse financial consequences as a result of being quarantined, furloughed or laid off or as a result of reduced work hours due to the virus or disease.  Act, §2202(4)(A)(III).  A qualified person is also one who is unable to work due to lack of child-care due to the virus or disease, as well as an owner (undefined) of a business (undefined) who either closed the business or reduced business hours due to the virus or disease.  Id.  The Act also gives the Secretary of the Treasury the ability to determine other factors via regulation.  Id. 

The administrator of an eligible retirement plan (as defined by I.R.C. §402(c)(8)(B)) can rely on an employee’s certification that the employee is a qualified individual when determining whether a distribution is a qualified distribution.  Act, §2202(a)(4)(B). 

The amount distributed may be repaid at any time during the three-year period beginning on the day after the date on which the distribution was received via one or more contributions to an eligible retirement plan of which the taxpayer is a beneficiary and to which a rollover contribution could be made.  Act §2202(3)(A).  If the amount repaid is attributable to a distribution from an eligible retirement plan other than an IRA, the taxpayer is treated as having received the distribution in an eligible rollover distribution (as defined by I.R.C. §402(c)(4)) and as having transferred the amount to the eligible retirement plan in a direct trustee to trustee transfer within 60 days of the distribution.  Act, §2202(3)(B).  The same result is obtained if the amount repaid traces to a distribution from an IRA.  Act, §2202(3)(C).

While the 10 percent penalty is waived for such virus or disease-related early distributions, the amount withdrawn must still be included in income.  However, the Act provides that distributed amounts are to be included in income ratably over the three-year period beginning with 2020.  Act, §2202(a)(5)(A).  An election out of the three-year rule can be made.  Id.    Qualified distributions are also exempt from the normal trustee to trustee and withholding rules.  In other words, virus/disease-related distributions are not treated as eligible rollover distributions.  Act, §2202(a)(6)(A).  But, the distributions are treated as satisfying plan distribution requirements.  Act, §2202(a)(6)(B). 

Loans

Loans from a qualified employer plan can be made up to $100,000 (up from $50,000) for the first 180 days of the Act (180 days from March 27, 2020).  The loan is capped at 100 percent of the vested account balance and must be to a qualified individual.  Act, §2202(b)(1)A).  If repayment of the loan occurs in 2020, the due date is delayed for one year.  Act, §2202(b)(2).  In other words, for an outstanding loan or after March 27, 2020 from an eligible retirement plan that must be repaid between March 27 and the end of 2020, the due date is extended for one year.  

Modified Required Minimum Distribution Rule

In late December of 2019, the Congress passed Omnibus spending bills containing multiple parts that impact retirement provisions and disaster relief tax rules.  One of those bills, the “Setting Every Community Up for Retirement Enhancement Act” (SECURE Act), increased the required minimum distribution (RMD) age for distributions from a traditional IRA from the year in which an individual turns 70.5 to the year the individual turns 72. This provision matches the existing rules for 401(k)s and Roth IRAs. The provision is applicable to persons that did not reach age 70.5 by the end of 2019.  SECURE Act §114(a), amending I.R.C. §401(a)(9(C)(i)(I). 

The Act amends I.R.C. §401(a)(9) to waive the required minimum distribution rule for calendar year 2020 for an IRA, I.R.C. §401(k) plan I.R.C. §403(b) plan or other defined contribution plan, that is in effect by the end of 2020.  Act, §2203(a).  The waiver applies to any distribution required to be made in 2020 due to a required beginning date occurring in 2020 as well as because of the distribution not having been made by the end of 2019.  Id.

Conclusion

The virus has generated a great deal of activity on Capitol Hill, some of which applies to retirement plans.  The big changes apply to the possibility of having the early withdrawal penalty eliminated, plan loans and a change to the required minimum distribution rule. 

April 6, 2020 in Estate Planning, Income Tax | Permalink | Comments (0)

Wednesday, March 25, 2020

Farm and Ranch Estate And Business Planning In 2020 (Through 2025)

Overview

The Tax Cuts and Jobs Act (TCJA) has made estate and business planning much easier for most farm and ranch families.  Much easier, that is, with respect to avoiding the federal estate tax.  Indeed, under the TCJA, the exemption equivalent of the unified credit is set at $11.58 million per decedent for deaths in 2020, and with an unlimited marital deduction and the ability to “port” over the unused exclusion (if any) at the death of the first spouse to the surviving spouse, very few estates will incur federal estate tax.   The TCJA also retains the basis “step-up” rule.  That means that property that is included in the decedent’s estate at death for tax purposes gets an income tax basis in the hands of the recipient equal to the property’s fair market value as of the date of death.

But, with the slim chance that federal estate tax will apply, should estate and business planning be ignored?  The answer is “no” if the desire is to keep the farming or ranching business in the family. 

The basic estate planning strategies for 2020 and for the life of the TCJA (presently, through 2025) – that’s the topic of today’s post.

Basic Considerations

Existing plans should focus on avoiding common errors and look to modify outdated language in existing wills and trusts.  For example, many estate plans utilize "formula clause" language.  That language divides assets upon the death of the first spouse (regardless of whether it is the husband or the wife) between a "credit shelter trust," which utilizes the remaining federal estate tax exemption amount, and a "marital trust," which qualifies for the (unlimited) federal estate tax marital deduction.  The intended result of the language is to cause the “credit shelter” trust’s value to be taxed in the first spouse’s estate where it will be covered by the exemption, and create a life estate in the trust property for the surviving spouse that will “bypass” the surviving spouse’s estate upon the surviving spouse’s subsequent death.  As for the martial trust assets, tax on those assets is postponed (if it is taxed at all) until the surviving spouse dies.

It’s also important to have any existing formula clauses in current estate plans reviewed to ensure the language is still appropriate given the increase in the federal exemption amount.  It may be necessary to have an existing will or trust redrafted to account for the change in the law and utilize language that allows for flexibility in planning.   

In addition, for some people, divorce planning/protection is necessary.  Also, a determination will need to be made as to whether asset control is necessary as well as creditor protection.  Likewise, consideration may need to be made of the income tax benefits of family entities to shift income (subject to family partnership rules of I.R.C. §704(e)) and create qualifying deductions for the entity.  The entity may have been created for estate and gift tax discount purposes, but now could provide income tax benefits.  In any event, family entities (such as family limited partnerships (FLPs) and limited liability companies (LLCs)) will continue to be valuable estate planning tools for farmers and ranchers with wealth that is potentially subject to federal estate (and gift) tax.

For the vast majority of family farming and ranching operations, it is not beneficial from a tax standpoint to make gifts during life.  Gifted property provides the donee with a “carryover” income tax basis.  I.R.C. §1015(a).  A partial basis increase can result if the donor pays gift tax on the gift.  I.R.C. §1015(d).   If the property is not gifted, but is retained until death the heirs will receive a income tax basis equal to the date of death value.  I.R.C. §1014.  That means income tax basis planning is far more important than avoiding federal estate tax for most people.  But, some states tax transfers at death with exemptions that are often much lower than the federal exemption.  In those situations, planning to avoid or minimize the impact of state estate/inheritance tax should not be ignored.  Also, consideration should be made to determine whether insurance is still necessary to fund any potential estate tax liability  

Other estate planning points to consider include:

  • For life insurance, it’s probably not a good idea to cancel the policy before having that move professionally evaluated. That’s particularly the case for trust-owned life insurance.  For pension-owned life insurance, for those persons that are safely below the exemption, adverse tax consequences can likely be avoided.
  • Evaluate irrevocable trusts and consider the possibility of “decanting.” Decanting is the process of pouring the assets of one irrevocable trust into another irrevocable trust that contains more desirable terms.  The rules surrounding trust decanting are complex concerning the process of decanting, but it can be a valuable option when unforeseen circumstances arise during trust administration.
  • For durable powers of attorney, examine the document to see whether there are caps on gifted amounts (the annual exclusion is now $15,000) and make sure to not have inflation adjusting references to the annual exclusion.
  • For qualified personal residence trusts (QPRTs) that were created when the estate tax exemption was $2 million, the conventional advice was to deed the house from the QPRT to the children or a remainder trust (which might have been a grantor trust), with a written lease agreement in favor of the parent/donor who would continue to live in the house. Now, it may be desired to have the home included in the estate for basis step-up purposes and the elimination of gain on sale.
  • While FLPs and LLCs may have been created to deal with an estate tax value-inclusion issue, it may not be wise to simply dismantle them because estate tax is no longer a problem for the client. Indeed, it may be a good idea to actually cause inclusion of the FLP interest in the estate.  This can be accomplished by revising the partnership or operating agreement and having a parent document control over the FLP.  Then, an I.R.C. §754 election can be made which can allow the heirs to get a basis step-up.
  • At least through 2025, the choice of entity for the operational side of the farm/ranch business should be reevaluated in light of the 20 percent qualified business income deduction for non-C corporate businesses and the 21 percent income tax rate for C corporations.

Other Planning Issues

While income tax basis planning (using techniques to cause inclusion of asset value in the estate at death) is now of primary importance for most people, asset protection may also be a major concern.  Pre-nuptial agreements have become more common in recent decades, and marital trusts are also used to ultimately pass assets to the heirs of the first spouse to die (who may not be the surviving spouse’s heirs) at the death of the surviving spouse. 

Powers of attorney for both financial and health care remain a crucial part of any estate plan.  For a farm family, the financial power should be in addition to the FSA Form 211, and give the designated agent the authority to deal with any financial-related matter that the principal otherwise could. 

For farms and ranches concerning about the business remaining viable into subsequent generations, the building of a management team is essential.  This involves the development of management skills in the next generation, communication and recognizing various strengths and weaknesses of the persons involved.  It’s also critical to ensure fair compensation for the inputs of labor and/or capital involved and adjust compensation arrangements over time as the changes in the inputs occur.  Also, valuing ownership interests in a closely-held farming/ranching business is important.  This can be largely achieved by a well thought-out and drafted buy-sell agreement as well as a first-option agreement.

Conclusion

While estate planning has been made easier by the TCJA, that doesn’t mean that it is no longer necessary.  Reviewing existing plans with an estate planning professional is important.  Also, the TCJA is only temporary.  The estate and gift tax provisions expire at the end of 2025. When that happens, the exemption reverts to what it was under prior law and then is adjusted for inflation.  If current law is not extended, it is estimated that the federal estate and gift tax exemption will somewhere between $6.5 and $7.5 million.  While those numbers are still high enough to cover the vast majority of people, they are a far cry from the present $11.58 million amount. 

One thing is for sure – a great deal of wealth is going to transfer in the coming decades.  One estimate I have seen is that approximately $30 trillion in asset value will transfer over the next 30-40 years.  That’s about a trillion per year over that timeframe.  A chunk of that will involve farm and ranch real estate, livestock, equipment and other personal property.

These topics will be addressed in detail at the Summer Ag Tax and Ag Estate/Business Conference in Deadwood, South Dakota on July 20-21.  You can learn more about the conference and register here:  http://washburnlaw.edu/employers/cle/farmandranchtax.html

March 25, 2020 in Business Planning, Estate Planning | Permalink | Comments (0)

Tuesday, March 17, 2020

Alternate Valuation – Useful Estate Tax Valuation Provision

Overview

The dramatic drop in the stock market over the last month has taken its toll on investments intended for use during retirement years.  For example, the Dow Jones peaked at 29,551.42 on February 12, 2020, but had dropped to 20,188.52 at the close on March 16, 2020.  This can cause a difficult tax issue for a decedent’s estate that faces federal estate tax liability by having the potential to trigger a higher than anticipated tax burden.  But, there’s a valuation provision in the tax Code that can be beneficial – alternate valuation of I.R.C. §2032.

The alternate valuation provision for a federally taxable estate – it’s the topic of today’s post.

Valuation Basics

In general, property is valued for federal estate tax purposes as of the date of death.  I.R.C. §2031(a).  Unless an extension is filed, a federal estate tax return is due nine months after the date of the decedent’s death.   However, the executor can make an election to value the estate within six months after death if the value of the property in the gross estate and the estate’s federal estate tax liability (including any generation-skipping transfers payable by reason of the decedent’s death – Treas. Reg. §20.2032-1(b)(1)) are both reduced by making the election.  I.R.C. §2032(c); C.C.A. 201926013 (May 30, 2019).  This is known as an alternate valuation election, and the election causes the estate’s property to be valued at six months after death or earlier if the property is disposed of before the end of the six-month period.  I.R.C. §2032(a).  In other words, property distributed, sold, exchanged or otherwise disposed of within six months of the decedent’s death is valued as of the date of the distribution, sale, exchange or other distribution.  I.R.C. §2032(a)(1); Treas. Reg. §20.2032-1(a)(1).  Any property not so disposed of is valued as of six months after death.  I.R.C. §2032(a)(2).  Post-death value changes due merely to a lapse of time are ignored and the date-of-death value is used.  I.R.C. §2032(a)(3).  If there is no numerically corresponding date six months after the decedent’s death, the alternate valuation date is the last day of the sixth month after death.  Rev. Rul. 74-260, 1974-1 CB 275.  For example, if the date of the decedent’s death was August 31, the correct alternate valuation date would be February 28 (or 29). 

The election doesn’t create a direct issue with filing the federal estate tax return – it’s not due until nine months after the date of death.  The only issue involved might be the shorter timeframe to get the estate assets valued if the election to use the alternate valuation date is made.  Also, if the election is made, it is irrevocable (with a limited exception) and applies to all of the property included in the decedent’s gross estate.  I.R.C. §2032(d)(1); Treas. Reg. §20.2032-1(b)(1).  The election cannot be used as to only a portion of the property in the decedent’s estate.  Id.

Income tax basis issues.  If an alternate valuation election is made, the income tax basis of property that is acquired from the decedent is its value as of the applicable valuation date under the alternate valuation rules.  I.R.C. §1014(a)(2); Treas. Reg. §1.1014-3(e).  The adjusted basis of the property is the value as of the alternate valuation date, less any depreciation allowed or allowable from the time of the decedent’s death.  Rev. Rul. 63-223, 1963-2 CB 100.  If the estate extracts minerals and sells them during the alternate valuation period, gain or loss on sale is tied to their “in place” value on the date of sale (i.e., the alternate valuation date) without any reduction for depletion.  Rev. Rul. 66-348, 1966-2 CB 433, as clarified by Rev. Rul. 71-317 CB 328.  The “in place” value pegs the adjusted income tax basis. 

Valuing deductions.  With an alternate valuation election in place, the decedent’s estate is not entitled to an estate tax loss deduction for the amount by which an item of property included in the estate was reduced by virtue of the election.  Form 706 instructions, p. 34 (Aug. 2019 version).  If a set percentage of the decedent’s adjusted gross estate is bequeathed to charity, the estate’s charitable deduction is determined by using the value of the decedent’s adjusted gross estate as of the alternate valuation date.  Rev. Rul. 70-527, 1970-2 CB 193.  The same rule (in terms of using the alternate valuation date) applies to determining the amount of any marital deduction.  I.R.C. §2032(b); Treas. Reg. §§20.2032-1(g); 20.2056(b)-4(a). 

An alternate valuation election can be coupled with a special use valuation election.  Rev. Rul. 83-31, 1983-1 CB 225. 

Application of the Alternate Valuation Election

As indicated above, the decedent’s gross estate must be a taxable estate.  Treas. Reg. § 20.2032-1(b)(1) (1958); Tax Reform Act of 1984, Sec. 1923(a), 98th Cong., 2d Sess. (1984). The purpose of making an alternate valuation election is to lessen the federal estate tax burden if values decline in the six-month period immediately following death.  Consider the following example:

Example:  Marcia, a widow, died on September 16, 2019, with a taxable estate of $15 million.  At the time of her death she had an available estate tax exclusion of $11.40 million.  Assume that the federal estate tax liability of Marcia’s estate, if her estate were valued as of the date of death, would be $1,440,000.  Marcia’s estate consisted largely of publicly traded stock and, given the stock market plunge, was valued at $12 million on March 16, 2020 – six months after the date of her death.  If the executor of Marcia’s estate elected alternate valuation, the resulting federal estate tax would be approximately $240,000.  The election save’s Marcia’s estate $1,200,000 in federal estate tax.

As noted above, non-taxable estates cannot make an alternate valuation election.  If an estate would not be subject to federal estate tax, an alternate valuation election could allow the estate’s heirs to obtain a higher income tax basis on property included in the gross estate if values had risen after death.  That’s because of the income tax basis rule specifying that an asset included in a decedent’s estate receives an income tax basis equal to the asset’s fair market value in the recipient’s hands as of the date of death.  Eligibility for an alternate valuation election requires that both the taxable value of the estate decline by making the election and the estate tax liability decline.  If the value of the taxable estate drops during the six-month post-death period due to expenses being paid, no separate deduction is allowed for the expenses in computing the taxable estate.  I.R.C. §2032(b).   

The election is made by checking “Yes” on line 1 of Part 3 of Form 706 (the federal estate tax return) that is filed within one year after its due date (including extensions).  I.R.C. §2032(d)(2); Estate of Eddy v. Comr., 115 T.C. 135 (2000).  Thus, the election may only be made on the last estate tax return filed on or before the due date of the return (including extensions of time to file actually granted) or, if a timely return is not filed, the first estate tax return filed after the due date, provided the return is filed no later than one year after the due date (including extensions of time to file actually granted).  Treas. Reg. §20.2032-1(b)(1).  Application for an extension of time to make the election, or a protective election, can be made after the expiration of the one-year period from the return’s due date if the return is filed no later than one year after the due date (including extensions).  Preamble to TD 9172, Jan. 3, 2005.  A protective election allows the alternate valuation date to be used if it is subsequently determined that the transfer taxes upon death will be lower based on the alternate valuation rather than based on the date of death value of the gross estate.  See, e.g., C.C.A. 201926013 (May 30, 2019).   

When an alternate valuation election is made, the Form 706 must include: (1) an itemized description of all property in the estate on the date of death and the value of each item on that date; (2) an itemized disclosure of all distributions, sales, exchanges and other dispositions of property, and the date of each, during the six month period after the date of death; and (3) the value of each item of property on the valuation date under the election.  Interest and rents accrued as of death and dividends declared on or before death that aren’t collected as of the date of death are to be separately stated.  Treas. Reg. §20.6018-3(c)(6).  Dispositions of estate property during the six-month post-death period must be substantiated.  See, e.g., Treas. Reg. §20.6018-4(e). 

The Matter of “Included” and “Excluded” Property

For most businesses, alternate valuation is straightforward.  There is one value as of the date of death and a different value six months after death.  However, in an agricultural estate many things occur during the six-month period immediately following the decedent’s death.  For example, a decedent may have planted a crop shortly before death, which was harvested and sold within six months after death.  Or perhaps the decedent had cows that were bred before the date of death and calved after death and were sold after the six-month period following death.  When an alternate valuation election is made, not included in the estate’s valuation are any items that are income that the estate’s assets produce after the decedent’s death.   

Help in determining whether these types of property are subject to alternate valuation invokes the concepts of “included” and “excluded” property.  Included property is all property that is in existence at death that is part of the decedent’s gross estate.  Included property is valued six months after death or as of the date of sale, whichever comes first.  Treas. Reg. §20.2032-1(d).  Thus, crops that are growing as of the date of death and are harvested and sold after death are valued as of the earlier of six months after death or the date of sale.  Likewise, leased real estate or personal property and rents accrued to the date of the decedent’s death are included property.  The underlying property and the accrued rents are to be valued separately.  Rental amounts that accrue post-death and before the alternate valuation date are excluded property.  If rent is paid in advance, it is to be treated similarly to advance payment of interest on obligations.  Treas. Reg. §20.2032-1(d)(2). 

Excluded property is property that is excluded from the gross value of the decedent’s estate under the alternate valuation election.  Thus, income that is earned or accrued (whether received or not) after the date of the decedent’s death and during the alternate valuation period with respect to any property interest existing at the date of death is excluded property.  This is the result unless such property is a form of included property itself or it represents the receipt of included property.  Treas. Reg. §20.2032-1(d).  For example, crops that are planted after death are ignored for purposes of alternate valuation.  For property that exists as of the date of death and is disposed of gradually during the six-month period after death (such as silage that is fed during the six-month period following death), every day’s feeding is a disposition.  Thus, a calculation must be made not only as to the value, but as to how much disappeared.  The same is true of shelled corn, hay, or similar items.  The inventory must show the disappearance over that time period, and some value must be attached to it.

Conclusion

The recent and dramatic decline in the stock market provides an opportunity for substantial estate tax savings for estate with the “right” set of facts.  It’s all a matter of timing.  For the time being, alternate valuation is “in vogue.”

March 17, 2020 in Estate Planning | Permalink | Comments (0)

Friday, March 13, 2020

More Selected Caselaw Developments of Relevance to Ag Producers

Overview

Periodically on this blog I write about recent caselaw and IRS developments that farmers, ranchers and others should be aware about.  The courts are constantly churning out cases that are important to agriculture and tax developments are always non-stop.  It’s amazing how broad the reach is of the issues the courts and IRS address that touches agriculture in one way or another.  Many of these issues may not be given much thought on a daily basis, but perhaps they should.

In today’s post, I look at a few more recent developments of relevance to agriculture – it’s the focus of today’s post.

IRS Loses Valuation Case

Grieve v. Comr., T.C. Memo. 2020-28

When interests in closely-held businesses are transferred, either by death or gift, and either federal estate or gift tax is involved, the valuation issue becomes highly relevant.  For farms and ranches, blocks of non-controlling stock may be involved and the IRS may seek to apply a premium to the value of the stock to increase estate or gift taxes owed.  Recently, the U.S. Tax Court shot down an IRS attempt to attach a premium to a gift of non-controlling stock among family members. 

In the case, after the petitioner’s wife died, he formed two LLCs (Rabbit and Angus) for financial management and estate planning purposes. He then transferred some of the Class B shares of Rabbit to a grantor-retained annuity trust (GRAT) and the Class B shares of Angus to an irrevocable trust. The petitioner filed a 2013 gift tax return (Form 709) and attached appraisal reports that reported a taxable gift of nearly $10 million. The IRS rejected that valuation, claiming that the proper valuation was $17.8 million, and issued a notice of deficiency.

The Tax Court examined both appraisal reports, noting that the petitioner’s appraisal reports included independent analysis of the LLC shares using a combination of market and income approaches to determine the total value. Conversely, the Tax Court noted that the IRS included an assumption that selling the Class B share would encourage the petitioner’s daughter (who solely owned the Class A shares) to sell her 0.2 percent interest in the entities, which would increase the petitioner’s interests. However, the daughter testified that she would not be inclined to sell her interest, and if she were to sell, would seek a much higher premium that the IRS estimated. The Tax Court also determined that the IRS appraisal also relied on additional hypothetical scenarios that were inconsistent and insufficient to consider a change to the petitioner’s appraisal and the discounts concluded in the report. In addition, the Tax Court noted that the IRS appraiser failed to provide support for the valuations, and also did not provide evidence that his appraisal methodology was subject to peer review.

The Tax Court concluded that the IRS failed to provide sufficient evident to support its expert appraiser’s conclusion that the interests of the LLCs were undervalued and that the petitioner’s gifts of the assets to the two trusts were likewise undervalued. The Tax Court rejected the IRS position that the petitioner had underreported gift tax by $4.4 million and also rejected the IRS penalties of $600,000. 

IRAs and the Constitution

Conard v. Comr., 154 T.C. No. 6 (2020)

So that people are disincentivized from using their retirement savings for things other than retirement, the IRS hits withdrawals before age 59-1/2 with a 10 percent penalty.  Exceptions to the penalty apply, but even if a taxpayer fits within an exception the amount withdrawn still must be reported into income.  Exemptions include distributions made post-death; because the account owner is total and permanently disabled, to cover qualified post-secondary education expenses; distributions made after being called to active military duty for 180 days; or within a year of a child’s birth or adoption. 

The U.S. Tax Court recently dealt with a constitutional challenge to such penalty exemptions.  In the case, the petitioner had not yet reached age 59-1/2 at the time the she received a distribution from a qualified retirement plan. Consequently, the IRS assessed the 10 percent early withdrawal penalty of I.R.C. §72(t). She sought review of the asserted tax deficiency and challenged the additional tax on the basis that the application of the tax to her early distribution violated the Constitution’s Fifth Amendment Due Process Clause because exceptions exist to the penalty that are applicable to taxpayers that haven’t reached age 59-1/2, such as for disability, etc.

The Tax Court disagreed, applying the rational basis test (low-level scrutiny) to evaluate the constitutionality of the Code provision. The Tax Court determined that test applied because the provision did not invade a substantive constitutional right or freedom or involve a suspect classification. As a result, the constitutionality of the provision could only be overcome by an explicit demonstration that the statute established hostile and oppressive discrimination against particular persons and classes. The Tax Court noted that the petitioner did not claim that the penalty provision concerned a substantive constitutional right or freedom or involved a suspect classification. Age is not a suspect classification for purposes of equal protection. Thus, the provision was presumed constitutional if it had a legitimate governmental purpose. The Tax Court noted that Committee Reports concerning the provision provided that the statute aimed “to provide means for financing retirement” and that penalties for early withdrawals were “designed to insure that retirement plans will not be used for other purposes.” An exemption from the penalty for disability, for example, satisfied a legitimate objective of encouraging taxpayers to provide for times of inability to work. 

Huge FBAR Penalty Imposed

United States v. Ott, No. 18-cv-12174, 2020 U.S. Dist. LEXIS 32514 (E.D. Mich. Feb. 26, 2020)

In recent years, some farmers and ranchers have started operations in locations other than the United States.  Others may have bank accounts in foreign jurisdictions.  Still others may serve as an agent under a power of attorney for someone that has a bank account in a foreign jurisdiction.  In that event, every year, under the Bank Secrecy Act, anyone that owns or has an interest in or signature authority over certain foreign accounts such as bank accounts, brokerage accounts and mutual funds, must report the account(s) by filing a Report of Foreign Bank and Financial Accounts (FBAR) on FinCEN Form 114.  The proper box must also be checked on Schedule B of Form 1040.  Failure to do so can trigger a penalty.  Willful failure to do so can result in a monstrous penalty.  A recent case points out how bad the penalty can be for misreporting.

In the case, the taxpayer had a foreign bank account with aggregate highest balance of $1.9 million, $770,000 and $1.76 million for the three tax years at issue. Form 1040, Schedule B contains a question with a box to be checked asking whether the taxpayer had a financial interest in or signature authority over a financial account located in a foreign country. The box on Schedule B was checked “No” which was the default in the software that the return preparer used. The taxpayer also did not file an FBAR Form for any of the three years. The FBAR Form is required to be filed when the aggregate account balance exceeds $10,000.

The IRS claimed that the taxpayer had constructive knowledge of his reporting requirements by signing his tax returns which included a reference to the FBAR on Schedule B, and that the naming his sister's Canadian address on the accounts was an act of concealment. The taxpayer argued that he was simply negligent and there was no will failure to file the FBARs. The Court examined the definition of willfulness for purposes of FBAR filing and concluded that the taxpayer could have easily determined the need to file the FBAR. Accordingly, the court held that the taxpayer willfully failed to file the FBAR Form and assessed penalties for the years at issue in the amount of $988,245. 

Lakes Have Constitutional Rights?

Drewes Farms Partnership v. City of Toledo, No. 3:19 CV 434, 2020 WL 966628 (N.D. Ohio Feb. 27, 2020) No. 3:19 CV 434 2020 U.S. Dist. LEXIS 36427 (N.D. Ohio Feb. 27, 2020)

The genesis of this case actually began in a bar in Toledo (no word on whether the bar was across from the depot).  Apparently, the inebriated were commiserating over the pollution of Lake Erie.  Ultimately, the ideas of that night got formulated into a ballot question at a special election for the citizens of Toledo concerning whether Lake Erie should be granted legal rights that people have.  It was the first rights-based legislation in the U.S. aimed at protecting an ecosystem – Lake Erie, its tributaries and the species that live there. 

When election time came, sufficient Toledo citizens voted to add the “Lake Erie Bill of Rights” (LEBOR) to the city’s charter in early 2019. The LEBOR prohibited any infringement of the “rights” of Lake Erie to “exist, flourish, and naturally evolve” without explaining the kind of conduct that would infringe those “rights.” The plaintiff, a farming operation that grows crops in four counties near Toledo and Lake Erie, sued to invalidate the LEBOR on constitutional grounds for lack of due process as being void for vagueness. The court agreed and vacated the LEBOR in its entirety. 

Conclusion

There are always developments involving agriculture.  It’s good to stay informed. 

March 13, 2020 in Business Planning, Estate Planning, Income Tax, Regulatory Law | Permalink | Comments (0)

Wednesday, March 11, 2020

What Is a “Trade or Business” For Purposes of Installment Payment of Federal Estate Tax?

Overview

Normally, federal estate tax is due nine months after death.  For estates that are illiquid, such as many taxable farm and ranch estates, there is a useful option.  Upon satisfying two requirements, the estate executor can elect under I.R.C. §6166 to pay the federal estate tax attributable to the decedent’s interest in a closely-held business in installments over (approximately) fifteen years. 

The two eligibility tests that must be satisfied for an estate to qualify for installment payment of federal estate tax are: (1) the decedent must have an interest in a closely-held business (I.R.C. §6166(a)(1)); and (2) the interest in the closely held business must exceed 35 percent of the value of the decedent’s adjusted gross estate. I.R.C. §6166(a)(1). An “interest in a closely-held business” means an interest as a proprietor in a trade or business carried on by a proprietorship; an interest as a partner in a partnership carrying on a trade or business; or stock in a corporation carrying on a trade or business.  I.R.C. §6166(b)(1).  Only those assets actually utilized in the trade or business are to be included in the decedent's interest in the closely held business.  Treas. Reg. §20.6166A-2(c).  

Does ownership of real property constitute a trade or business?  That’s an important question for farmers and ranchers.  Real estate (and associated real property structures) often is the largest asset (in terms of value) of the gross estate. 

Owning real property as a “trade or business” for purposes of deferring federal estate tax – it’s the topic of today’s post.

Farming Activities, I.R.C. §6166 and “Trade or Business”

Real estate that the decedent holds passively will not qualify for deferral under I.R.C. §6166.  For example, a mere royalty interest in oil and gas property is insufficient to constitute a trade or business.  Rev. Rul. 61-55, 1961-1 C.B. 713.  The real estate must be used by the decedent in the active conduct of a trade or business.  Over the years, the IRS has provided guidance on where the line is drawn between the passive holding of real estate and the use of it in the trade or business of farming.  In addition, the determination of whether the decedent had an interest in a closely-held business is made immediately before the decedent’s death.  I.R.C. §6166(b)(2)(A). 

1975 IRS Ruling.  In 1975, the IRS laid out its position on the determination of a trade or business in a farm context under I.R.C. §6166.  Rev. Rul. 75-366, 1975-2 C.B. 472.  The ruling, is still applicable for determining the existence of a trade or business in the I.R.C. §6166 context.  The facts of Rev. Rul. 75-366 involved a crop-share lease where the decedent as landlord paid 40 percent of the expenses incurred under the lease and received 40 percent of the crops.  The IRS found it critical that the decedent’s income under the lease was based on the farm’s productivity rather than simply being a fixed rental amount. The decedent had also actively participated in farm management decisionmaking concerning the crops to plant and how the farming operation should participate in federal farm programs.  The decedent also made trips to the farm on almost a daily basis to inspect the crops and discuss farming operations with the tenant farmers.  He also sometimes delivered supplies to the farm.  Based on these facts, the decedent’s involvement was deemed sufficient to constitute an interest in a closely held business for purposes of I.R.C. §6166 because the decedent was engaged in the trade or business of farming.  The ruling also pointed out that a “plain vanilla” cash rent lease would be unlikely to constitute an interest in a trade or business.   

1980s private rulings.  The IRS followed-up its 1975 Revenue Ruling with several private letter rulings in the early 1980s.  In Priv. Ltr. Rul. 8020101 (Feb. 25, 1980), the IRS concluded that a 97-year old farmer did not use his farmland in the trade or business of farming where he had given his livestock to his children less than a year before he died and then “leased” his land to them.  He was not actively farming at the time of his death due to his health. The IRS based its conclusion on the basis that the livestock had been gifted before death and the children were not required to make rental payments for the land (in return for paying the real estate taxes and operating costs).  They also didn’t manage the farm as the decedent’s agents.  It’s interesting to note that for the year of the decedent’s death, the federal estate tax exemption was $134,000 and the maximum estate tax rate was 70 percent.

Contrast that private letter ruling with Priv. Ltr. Rul. 8020143 (Feb. 26, 1980).  Here, the IRS determined that a decedent was engaged in the trade or business of farming where he cultivated, operated and managed farms for profit, either as the owner or tenant, and the rental income that he received was based on production (crop-share) rather than being a fixed amount.  The decedent paid all of the property taxes, paid for maintaining fences and structures on the farm, and also paid for ditching, draining and general farmland maintenance.  He also paid a share of farm input costs and other operating costs.  He was also engaged in management decisions by determining what crops would be planted, the timing of planting and how the crops would be marketed.  His decisionmaking involvement directly affected his economic return. 

In the context of I.R.C. §6166, the management activities of an employee or agent are imputed to the owner of the land.  For example, in Priv. Ltr. Rul. 8133015 (Apr. 29, 1981), the decedent operated two farms until becoming incapacitated by a stroke almost five years before he died.  At that time, the decedent’s wife began actively managing the farms, but neither the decedent nor the decedent’s spouse performed any physical labor on the farms.  The farms were crop-share leased to different tenants.  The IRS determined that the decedent owned an interest in the farms via his wife (she was deemed to be managing the farms on his behalf) and was deemed to be engaged in the trade or business of farming. 

A similar result was reached in Priv. Ltr. Rul. 8244003 (May 1, 1981), where the farm was operated by the decedent’s daughter and son-in-law on a crop-share basis.  The decedent was elderly and infirm.  The IRS concluded that it was immaterial that the decedent didn’t pay self-employment tax on her income from the farm.  For purposes of I.R.C. §6166, payment of self-employment tax was determined to be irrelevant on the issue of whether the decedent was engaged in the trade or business of farming.  See also Priv. Ltr. Rul. 8432007 (Apr. 9, 1984). 

In Priv. Ltr. Rul. 8515010 (Jan. 8, 1985), the IRS concluded that the cash rental of a pasture and barn failed did not constitute the trade or business of farming and, thus, did not qualify as interests in a closely-held business.  The decedent’s only involvement with respect to the pasture and barn was to provide routine maintenance.  Conversely, where a decedent leased an orchard for a fixed rental to a family corporation (of which the decedent was the majority shareholder) that conducted farming operations, the decedent was deemed to be engaged in the trade or business of farming because he was determined to be closely involved in both the leasing of his farm properties and the running of the family corporation.  Gettysburg National Bank v. United States, No. 1:CV-90-1607, 1992 U.S. Dist. LEXIS 12152 (M.D. Pa. Jul. 17, 1992).

More private rulings.  In Tech. Adv. Memo. 9403004 (Oct. 8, 1993), the IRS concluded that the decedent was not engaged in the trade or business of farming where he received a fixed rental amount for leasing land.  It was deemed to be a passive income-producing investment asset.  In Tech. Adv. Memo. 9635004 (May 15, 1996), the decedent operated a cattle ranch at the time of his death with his son via a partnership owned two-thirds by the decedent and one-third by the son.  There was no question that the cattle ranch was an active trade or business or that the decedent actively participated in all aspects of the ranch’s management and operation.  Both the decedent and his son owned land individually that was used in the ranching business.  The partnership paid the real estate taxes on the land as well as the cost of maintaining fences and insurance.  No rent was paid to either the decedent or his son.  The IRS determined that the land the decedent owned that the partnership used in the cattle ranching business was used in the trade or business of farming for purposes of I.R.C. §6166.  The IRS based its conclusion on the fact that the decedent’s activities were conducted in the overall scope of his income-producing cattle ranching business and the real estate was a fundamental part of the overall ranching business.  The IRS also noted that the decedent owned the land at the time of his death.  These were all important key factors and persuaded the IRS even though the partnership didn’t own the land.      

The multi-factor test.  In 2006, IRS clarified that, to be an interest in a trade or business under I.R.C. §6166, a decedent must conduct an active trade or business or must hold an interest in a partnership, LLC or corporation that itself carries on an active trade or business.   Rev. Rul. 2006-34, 2006-1 C.B. 1171. In the ruling, IRS set forth a list of non-exclusive factors to determine whether a decedent’s interest is an active trade or business. The factors are:  (1) the amount of time the decedent (or agents or employees) spent in the business; (2) whether an office was maintained from which the activities were conducted or coordinated and whether regular office hours are maintained; (3) the extent to which the decedent was actively involved in finding new tenants and negotiating and executing leases; (4) the extent to which the decedent provided landscaping, grounds care or other services beyond the furnishing of the leased premises; (5) the extent to which the decedent personally made, arranged for or supervised repairs and maintenance on the property; and (6) the extent to which the decedent handled tenant requests for repairs and complaints. 

In addition, the IRS stated in Rev. Rul. 2006-34 that an independent contractor (or other third-party) can conduct some of the activities and the underlying activity can still constitute a trade or business unless the third-party activities simply constitute holding investment property.   

Conclusion

The present $11.58 million exemption for federal estate tax means that very few farms and ranches will be subject to the tax.  That makes installment payment of federal estate tax largely irrelevant.  But, for those that do face federal estate tax liability, the opportunity to pay the tax over time rather than in full within nine months after death can be very important.  In addition, if the political winds change and the exemption collapses, many family farms and ranches could be subject to the tax.  It’s also important to remember that under present law, the exemption automatically drops significantly for deaths after 2025.

The closely-held business requirement as applied to real estate and as defined by use in the active conduct of a trade or business, is a large component of eligibility for land in a farming or ranching operation.  Land leases should be something other than a straightforward cash lease with at least active involvement in decision making by the decedent-to-be, or an agent or employee of the decedent-to-be.  Self-employment tax is not a crucial factor, but passive rental arrangements such as cash rent leases, are not eligible.  For assets leased to business entities, the test is applied separately to the business entity and the leased assets.  Land held in a revocable living trust is eligible for installment payment of federal estate tax if it is a “grantor” trust. 

March 11, 2020 in Estate Planning | Permalink | Comments (0)

Thursday, March 5, 2020

Registration Open For Summer Ag Income Tax/Estate and Business Planning Seminar

Overview

Registration is now open for this summer’s national ag tax and estate/business planning conference in Deadwood, South Dakota.  The conference is set for July 20-21 at The Lodge at Deadwood.  In today’s post I briefly summarize the conference, the featured speakers and registration.

Deadwood, South Dakota - July 20-21, 2020

The conference will be in Deadwood, South Dakota on July 20 and 21.  The event is sponsored by the Washburn University School of Law.  The Kansas State University Department of Agricultural Economics is a co-sponsor. Some of the morning and afternoon breaks are sponsored by SkySon Financial and Safe Harbour Exchange, LLC.  The location is The Lodge at Deadwood.  The Lodge is relatively new, opening in 2009.  It is located just west of Deadwood on a bluff that overlooks the town.  You can learn more about The Lodge here: https://www.deadwoodlodge.com/hotel.  The Lodge has great conference facilities and also contains the Deadwood Grille featuring Western dining.  For families with children, The Lodge contains an indoor water playland.  There is also transportation from The Lodge to Main street in Deadwood where the shops and local attractions are located.  Deadwood is in the Black Hills area of western South Dakota.  Nearby is Mt. Rushmore, Crazy Horse, Custer State Park, Devil’s Tower and Rapid City.  The closest flight connection is via Rapid City.  The Deadwood area is a beautiful area, and the weather in late July should be fabulous. 

Featured Speakers

On Day 1, July 20, joining me on the program will be Paul Neiffer.  Paul has been doing the summer seminars with me for several years now and is affiliated with CliftonLarsonAllen, LLP.  We enjoy working together to provide the best in ag tax education that you can find.  We will discuss new cases and IRS developments; GAAP Accounting; restructuring credit lines; deducting bad debts; forgiving installment sale debt and some passive loss issues.  We will also get into advanced tax planning issues associated with the qualified business income deduction of I.R.C. Sec. 199A as well as net operating loss issues under the new rules; FSA advanced planning and like-kind exchanges when I.R.C. §1245 property is involved. 

Also with us as a Day 1 speaker is the honorable Judge Elizabeth Paris of the U.S. Tax Court.  She will provide an informative session on litigating a case before the U.S. Tax Court and the special rules and procedures of the court – what you need to know before filing a case with the Tax Court.  Judge Paris has issued opinions in several important ag cases during her tenure on the court, including Martin v. Comr., 149 T.C. 293 (2017), and is a great speaker.  You won’t want to miss her session.

I will lead off Day 2, July 21, with coverage of the most recent ag-related cases and rulings impacted farm and ranch estate and business planning.  Also joining me on Day 2 will be Prof. Jeffrey Jackson, a colleague of mine at Washburn University School of Law.  He will present a session on gun trusts for holding firearms and the unique issues that passing firearms at death can present.  Prof. Jackson will discuss what a gun trust is and how it works, what it cannot do, and client counseling with respect to passage of firearms by gift or at death.  Prof. Jackson's presentation will be followed by a session involving a comprehensive review of the new rules surrounding retirement planning after the SECURE act by Brandon Ruopp, an attorney from Marshalltown, Iowa.  

Also making a presentation on Day 2 will be Marc Vianello.  Marc is a CPA and the managing member of Vianello Forensic Consulting, LLC.  He is an experienced financial professional with and intensive 30-year history as a forensic accountant and expert witness regarding damages in highly complex litigation, including breach of contract, intellectual property (patent, Lanham, trade secret, copyright), business valuation, franchise, agriculture, Qui Tam and class action, personal injury, employment, casualties, financial crimes, and all other types of income and valuation damages. Marc also has an extensive background regarding the computation of estate and gift tax discounts for lack of marketability.  Marc’s presentation will focus on how practitioners can utilize forensic accounting techniques and expert testimony to bolster a client’s position against the IRS on audit as well as in court.

Other topics that I will address on Day 2 include the common estate planning mistakes of farmers and ranchers; post-death management of the farm or ranch business; and the valuation of farm chattels and marketing rights.

Day 2 will conclude with an hour session on ethics.  Prof. Shawn Leisinger of Washburn School of Law will present a session on the ethical issues related to risk I the legal context and how to ethically advise clients concerning risk decisions. 

Webcast

If you are unable to join us in-person for the two-day event in Deadwood, the conference will be broadcast live over the web.  The webcast will be handled by Glen McBeth.  Glen handles Instructional Technology at the law library at the law school.  Glen has broadcast the last few summer seminars and does a tremendous job producing a high-quality webcast. 

Room Block

A room block has been established at The Lodge for conference attendees under Washburn University School of Law.  The rate is $169 per night and is valid from July 17 through July 22.  The room block will release on June 19.  The Lodge does not have an online link for reservations, but you may call the front desk at (877) 393-5634 and tell them they need to make reservations under the Washburn University Law School room block.  As noted, the room block begins the weekend before the seminar begins so that you can arrive early and enjoy the weekend in Deadwood and the Black Hills area before conference if you’d like. 

Alumni Event

Washburn’s law school will also be holding an alumni event at The Lodge that corresponds with the summer seminar.  There will be a social event for law school alumni and registrants of the summer seminar on Sunday evening, July 19.  That event will be followed the next day with a CLE seminar focusing on law and technology.  This CLE event will also be at The Lodge and will run simultaneously with Day 1 of the two-day summer seminar on July 20.  The summer seminar will continue on July 21.

Sponsorship

If your business is interested in sponsoring a breakfast, break or lunch, and having vending space at the conference, please let me know.  It’s a great event to interact with practitioners that represent the legal and tax needs of farmers and ranchers from across the country that are involved in many aspects of agriculture.

Conclusion

If you have farm or ranch clients that you work with on tax, estate or business planning, this conference is an outstanding opportunity to receive specialized training in ag tax in these areas and interact with others.  The conference is also appropriate for agribusiness professionals, rural landowners and agricultural producers. 

More detailed information about the conference and registration information is available here:  http://washburnlaw.edu/employers/cle/farmandranchtax.html.  I look forward to seeing you in Deadwood or having you participate via the web.   

March 5, 2020 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Thursday, February 20, 2020

Recent Developments Involving Estates and Trusts

Overview

A key aspect of transitioning assets and family business interests to the next generation is maintaining family harmony.  Often, that is accomplished when an estate plan is properly put together and takes effect seamlessly at death.  When that doesn’t occur is when disharmony among family members can occur and disrupt the transition to the next generation.  Sometimes family dynamics prevent a smooth transition.  Other times, improper planning or technical errors in the estate plan are the cause of unfulfilled expectations. In still other situations, the estate planning techniques utilized don’t end up functioning as planned. Some recent court decisions illustrate just a snippet of the issues that can arise at death.

Some recent estate and trust court decisions – that’s the topic of today’s post.

A TOD Account as a Fraudulent Transfer?

Heritage Properties v. Walt & Lee Keenihan Foundation, 2019 Ark. 371 (2019)

The plaintiff in this case was a creditor in the decedent’s estate. Before death, the decedent created a brokerage account with $500,000 and designated the defendant as the transfer-on-death (TOD) recipient. The decedent died 18 months after establishing the account at a time when the account value was $1.1 million. Upon the decedent’s death, the $1.1 million in the account transferred automatically to the defendant outside of the decedent’s probate estate. The plaintiff filed a claim against the decedent’s estate for $850,000 which made the estate insolvent. The plaintiff sued the estate in the local trial court rather than the probate court, claiming that the TOD account resulting in a transfer of the $1.1 million to the defendant was a fraudulent transfer designed to defeat the plaintiff’s claim.

The trial court dismissed the case for lack of jurisdiction, standing and lack of sufficient evidence. On further review, the state Supreme Court held that the trial court did have jurisdiction as a court of general jurisdiction and that the plaintiff had standing to directly pursue the estate for return of an allegedly fraudulent transfer.  The Court couched its reasoning on the fact that the TOD account was not part of the probate estate. The Court also clarified that the plaintiff didn’t have to show that the decedent had actual intent to defraud the creditor. Instead, the court concluded, the plaintiff only needed to prove that the decedent made the transfer and "intended to incur, or believed or reasonably should have believed that she would incur, debts beyond her ability to pay as they became due."  That’s a rather low standard of proof to overcome.

Trust Failure 

Doll v. Post, 132 N.E.3d 34 (Ind. Ct. App. 2019)

The decedent created a trust in 2010 and amended it before his death in 2018. The trust made specific bequests to the plaintiff, two other individuals, a masonic lodge, and Shriners hospital. The trust contained a residuary clause that stated: “Residue of Trust Property: The Trustee shall hold, distribute and pay the remaining principal and undistributed income in perpetuity; subject, however, to limitations imposed by law. All the powers given by law and the provision[s] of the [T]rust may be exercised in the sole discretion of the Trustee without prior authority above or subsequent approval by any court.”

One of the people who was to receive a specific bequest could not be located. At the time of the decedent’s death, approximately $4,600 remained in the residuary, and the trustee distributed it to charity. The plaintiff moved to intervene arguing that the residuary clause failed, and the remainder should pass to her.

The trial court found that the trust document was ambiguous, and entertained outside evidence. Based on that extrinsic evidence, the court found that the decedent’s intent was to create a charitable trust and that the trustee’s act was proper. On appeal, the appellate court reversed and remanded. The appellate court determined that the trust document did not give the trustee the unfettered authority to distribute the residuary, and that the trustee was bound to follow local law. Local law specified that if the decedent’s intent was not explicit the trustee should select a beneficiary "from an indefinite class," identify a beneficiary with "reasonable certainty," or find a beneficiary capable of being "ascertained." The appellate court determined that the trustee could not find such a beneficiary and that the trust was not purely a charitable trust because some of the named beneficiaries were individuals.

The appellate court also determined that the cy pres doctrine did not apply.  The cy pres doctrine allows a court to amend the terms of a charitable trust as closely as possible to the original intention of the testator or settlor to prevent the trust from failing.  But, the cy pres doctrine did not apply, the appellate court reasoned, because the trust did not not have general granting language stating the trust’s purpose was charitable, and the charitable portions of the trust were fulfilled with the specific bequests.  Consequently, the residuary clause unambiguously failed to designate a beneficiary with reasonable certainty or a beneficiary capable of being ascertained and failed as a matter of law. The appellate court ordered the trustee to hold the residue of the estate and distribute it in accordance with state intestacy law. 

Homestead Provision Applicable in Will Construction Battle

Chambers v. Bockman, 2019 Ohio 3538 (Ohio Ct. App. 2019)

The decedent and surviving spouse plaintiff married in 2009. The couple maintained separate residences for the most part. The decedent owned his home on a 1.08-acre tract.  Adjacent to this tract but separated by a fence was the decedent’s 55-acre tract where he raised cattle and horses. The decedent owned a third tract adjacent to the plaintiffs’ own home that was used as a rental property. The decedent died in June of 2017. The defendant was appointed executor of the estate. One portion of the decedent’s will specifically left the rental property to the plaintiff. The other portion of the will in dispute stated: “All of the rest, residue and remainder of my property, real, personal and/or mixed, of which I shall die seized, or to which I may be entitled, or over which I shall possess any power of appointment by Will at the time of my decease and wheresoever situated, whether acquired before or after the execution of this, my Will, to my friend, [defendant], absolutely and in fee simple.”

The decedent’s home and farm were appraised as one property and valued at $378,000. In mid-2018, the plaintiff filed a complaint in the probate court to purchase the decedent’s home and farm pursuant to state statute. The defendant countered that the home and farm did not qualify as a “mansion house” under applicable state law because the plaintiff never lived there; the will devised the home and the farm to the defendant; and the plaintiff was not entitled to purchase the home. The probate court, holding for the plaintiff, determined that residency was not required for the statute to apply; the bequest to the defendant was a general bequest that was not specific as to the home and farm; and the plaintiff was entitled to purchase the home and farm for $378,000. The appellate court affirmed.

While the appellate court agreed that the plaintiff could purchase the home if it were a “mansion home,” the court determined that it merely had to be a “home of the decedent” rather than the residence of the surviving spouse. It satisfied that requirement. The appellate court also upheld the trial court’s finding that the decedent did not specifically devise the real estate to the defendant. The farm being adjacent to the home meant that the two properties were operated as one and that the plaintiff could buy both the home and the farm. 

Conclusion

Even the best planning can result in unanticipated consequences upon death. 

February 20, 2020 in Estate Planning | Permalink | Comments (0)