Friday, May 24, 2019
During life, many farmers and ranchers are focused on building their asset base, making sure that the business transitions successfully to the next generation, and preserving enough assets for the next generation’s success. Historically, farm and ranch families haven’t widely used life insurance, but it can play an important role in estate, business and succession planning. It can also help protect a spouse (and dependents, if any) against a substantial drop in income upon the death of the farm operator. It can also provide post-death liquidity and fund the buy-out of non-farm heirs.
Planning with life insurance for farmers and ranchers – that’s the topic of today’s post.
A primary purpose of life insurance during the life of the insured farm operator is to provide for the family in the event of death. In that sense, life insurance can provide the necessary capital to build an estate. But, it can also protect income and capital of the farming or ranching business which could be threatened by the operator’s death. Selling off farm assets, including land, to pay debts after the operator’s death will threaten continuity of the business. Life insurance is a means of providing the necessary liquidity to protect against the liquidation of operating assets.
Unfortunately, my experience has been that many legal and tax professionals often overlook the usefulness of insurance as part of the overall plan. This can leave a gaping hole in the estate and business plan that otherwise need not be there. The result is that many farm and ranch families may feel that “the land is my life insurance.” But, what if funds are needed to be unexpected expenses at death? What about debt levels that have increased in recent years? Is it really good to have to liquidate a tract or tracts of land to pay off expenses associated with death and retire burdensome debt?
So how can life insurance be utilized effectively during life? That depends on the economic position of the operator, the asset value of the operation and the legal and tax rules surrounding the ownership of life insurance. Of course, the cost of life insurance must be weighed against options for accumulating funds for use post-death. Also, consideration must be given to the amount of insurance needed, the type of life insurance that will fit the particular situation, and who the insured(s) will be.
From an economic standpoint, life insurance tends to provide a lower return on investment than other alternative capital investments for a farmer or rancher. It’s also susceptible to inflation (not much of an issue in recent years) because of the potentially long time before there is a payout under the policy. But, also from an economic standpoint, life insurance proceeds are generally not included in the beneficiary’s gross income. I.R.C. §101(a)(1).
For younger farmers and ranchers, premium payments can be reduced by putting a term policy in place to cover the beneficiary’s premature death. The term policy can later be converted to a permanent policy. That’s a key point. The use of and plan for life insurance is not static. Life insurance wanes in importance as a mechanism to help build wealth as the farm operation matures and becomes more financially successful and stable. The usage and type of life insurance will change over the life cycle of the farm or ranch business.
From a tax standpoint, life insurance proceeds are included in the insured’s gross estate if the proceeds are received by or for the benefit of the estate. As such, they are potentially subject to federal estate tax. However, the current $11.4 million exemption equivalent of the unified credit (per person) takes federal estate tax off the table for the vast majority of farming and ranching estates. In addition, if the proceeds are payable to the estate, they also become subject to creditors’ claims as well as probate and estate administration costs. If the beneficiary is legally obligated to use the proceeds for the benefit of the estate, the proceeds are included in the estate regardless of whether the estate is the named beneficiary. It makes no difference who took the policy out or who paid the premiums. But, the proceeds are included in the decedent’s gross estate only to the extent they are actually used to discharge claims. See, e.g., Hooper v. Comr., 41 B.T.A. 114 (1940); Estate of Rohnert v. Comr., 40 B.T.A. 1319 (1939); Prichard v. United States, 255 F. Supp. 552 (5th Cir. 1966).
But, there is a possible way to have the funds available to cover the obligations of the decedent’s estate without having the insurance proceeds being included in the estate. That can be accomplished by authorizing the beneficiary to pay charges against the estate or by authorizing the trustee of a life insurance trust to use the proceeds to pay the estate’s obligations, buy the assets of the estate at their fair market value, or make loans to the estate. Treas. Reg. §20.2042-1(b)(1). In that situation, the proceeds aren’t included in the decedent’s estate because there is no legal obligation (i.e., duty) of the beneficiary (or trustee if the policy is held in trust) to use the proceeds to pay the claims of the decedent’s estate. See, e.g., Estate of Wade v. Comr., 47 B.T.A. 21 (1942). However, achieving this result requires careful drafting of policy ownership language along with the description of how the policy proceeds can be used to avoid an IRS claim that the decedent retained “incidents of ownership” over the policy at the time of death. I.R.C. §2042. In addition, the policy holder’s death within three years of transferring the policy can cause inclusion of the policy proceeds in the decedent’s estate. I.R.C. §2035.
Other Uses of Life Insurance
Loan security. Life insurance can be pledged as security for a loan. This means that a farmer or rancher can use it as collateral for buying additional assets to be used in the business. In this event, the full amount of the policy proceeds will be included in the decedent’s gross estate, but the estate can deduct any outstanding amount that is owed to the creditor, including accrued interest. It makes no difference whether the creditor actually uses the insurance proceeds to pay the outstanding debt.
Funding a buy-sell agreement. For those farming and ranching operations where the desire is that the business continue into subsequent generations as a viable economic unit, ensuring that sufficient liquid funds are available to pay costs associated with death is vitally important to help ease the transition from one generation to the next. Having liquid funds can also be key to buying out non-farm heirs so that they do not acquire ownership interests in the daily operational aspects of the business. Few things can destroy a successful generational transition of a farming or ranching business more effectively than a sharing of managerial control of the business between the on-farm and off-farm heirs. Life insurance proceeds can be used fund a buy-out of the off-farm heirs. How is this accomplished? For example, an on-farm heir of the farm operator could buy a life insurance policy on the life of the operator. The policy could name the on-farm heir as the beneficiary such that when the operator dies the proceeds would be payable to the on-farm heir. The on-farm can then use the proceeds to buy-out the interests of the off-farm heirs. In addition, the policy proceeds would be excluded from the operator’s estate.
There are other approaches to the addressing the transition of the farming/ranching business. Of course, one way to approach the on-farm/off-farm heir situation is for the parents’ estate plans to favor the on-farm heirs as the successor-operators. But, this can lead to family conflict if the younger generation perceives the parents’ estate plans as unfair. Whether this point matters to the parents is up to them to decide. Another approach is to leave property equally to the on-farm and the off-farm heirs. But, this approach splits farm ownership between multiple children and their families and can result in none of the families being able to derive sufficient income from their particular ownership interest. This causes the ownership interest to be viewed as a “dead” asset. Remember, off-farm heirs often prefer cash as their inheritance. Sentimental ownership of part of the family farming or ranching operation may last for a while, but it tends to not to be a long-term feeling for various reasons. Sooner or later a sale of the interest will be desired, real estate will be partitioned and the future of the family farming operation will be destroyed. A life insurance funded buy-out can be a means to avoiding these problems.
Today’s post merely introduced the concept of integrating life insurance in the estate/business plan of a farmer or rancher. Other considerations involving life insurance include a determination of the appropriate type of life insurance to be purchased, the provisions to be included in a life insurance contract, and the estate tax treatment of life insurance. Ownership planning is also necessary. As you can see, it gets complex rather quickly. However, the use of life insurance as part of an estate plan can be quite beneficial.
Wednesday, May 22, 2019
The question often arises with farm and ranch clients that engage in estate, business or succession planning as to what the optimal entity structure is for the business? There’s no easy, one-size-fits-all answer to that question. It simply depends on numerous factors. In fact, the question is best answered by asking a question in return – what do you want the farming or ranching business to look like after you and your spouse are gone? What are your goals and objectives. If planning starts from that standpoint, then it is often much easier to get set on a path for creating an “optimal” entity structure.
Some thoughts on structuring the farming or ranching business – that’s the topic of today’s post
Food For Thought
In many planning scenarios it is useful to create a checklist of points to consider that are relevant in the entity selection decisionmaking process. The next step would then be to apply those points to the goals and objectives of the parties. For starters, consider the following:
C corporations. The following are relevant to C corporations:
- A C corporation can be formed tax free if property is exchanged for stock; the transferors (as a group) hold 80 percent or more of the stock immediately after the exchange of property for stock; and the formation is for a business purpose.
- C corporate income is subject to tax at a flat rate of 21 percent.
- A C corporation is not eligible for the 20 percent qualified business income deduction of I.R.C. §199A that is available to a sole proprietor or the member of a pass-through entity (such as a partnership or S corporation).
- While gain that is realized on the sale of stock of a farming corporation can’t be excluded under the special rules that apply to qualified small business stock (I.R.C. §1202), if the stock is that of a corporation engaged in processing activities, the gain can be excluded. There are other rules that can limit (or eliminate) this capital gain exclusion.
- When a C corporation converts to S corporation status, the built-in gains (BIG) tax applies to the built-in gains on income items. I.R.C. §1374(a). The Tax Cuts and Jobs Act (TCJA) didn’t eliminate the BIG tax, but it did lower it to 21 percent.
- A C corporation has good flexibility in establishing its capitalization structure as well as how it allocates income, losses, deductions and credits.
- A C corporation is potentially subject to additional penalty taxes if too much earnings are accumulated without legitimate, well documented business reasons, or If too much income is passive.
- The alternative minimum tax presently doesn’t apply to C corporate income.
- A corporation for the farming operating entity will limit farm program payment limitations to a single $125,000 limit at the entity level. That amount will then be divided by the number of shareholders. If a pass-through entity is the operating entity, the number of payment limits will be determined by the number of members of the entity.
- A C corporation can deduct state income tax. This should be contrasted with the TCJA limitation on the deduction of such taxes for individuals that is pegged at $10,000 (including real property taxes on property that is not used in the conduct of the taxpayer’s trade or business). I.R.C. §164(b)(6).
- A C corporation can provide employees with the tax-free fringe benefits of meals (limited to 50 percent by I.R.C. §274(n)) and lodging that are supported by legitimate business reasons (and satisfy other conditions). This benefit is not available to sole proprietors and partners in a partnership. See, e.g., Rev. Rul. 69-184, 1969-1 C.B. 256. That is also the result for S corporation employees who own, directly or indirectly, more than 2% of the outstanding stock of the S corporation may not receive certain otherwise tax-free fringe benefits (including meals and lodging). See I.R.C. §1372. Attribution rules apply for determining who is considered to be an S corporation shareholder. I.R.C. §318.
- A farming or ranching C corporation can generally use the cash method of accounting.
- In some states, a C corporation cannot own or operate agricultural land unless members of the same family own a majority of the corporate stock. State laws differ on the specific rules barring C corporations from being involved in agriculture, and some states don’t have such rules.
- A C corporation faces the potential of a double layer of tax upon liquidation.
- The C corporation generally does provide good estate planning opportunities. In other words, it tends to be a good organizational vehicle for transitioning ownership from one generation to the next.
What About Income Tax Basis?
Given the currently high level of the federal estate tax exemption equivalent of the unified credit (11.4 million per decedent for deaths in 2019), income tax basis planning is high on the priority list. Thus, when federal estate tax is not a potential concern, planning generally focuses on making sure that property is included in a decedent’s estate. This raises some basic planning rules that must be considered:
- For property that is included in a decedent’s estate for purposes of federal estate tax, the basis of that property in the hands of the person inherits the property is generally the fair market value (FMV) as of the date of the decedent’s death. I.R.C. §Sec. 1014(a)(1)).
- But, the “stepped-up” basis rule (to the date-of-death value) doesn’t apply to property that is income in respect of a decedent (IRD) under §691. R.C. §1014(c). An item is IRD something that decedent was entitled to as gross income but wasn’t’ included in income due to death in accordance with the decedent’s method of accounting. See Treas. Reg. §1.691(a)-1(b). Farmers and ranchers have some common occurrences of IRD such as…
- Deferred gain to be reported from installment sales and deferred sales of crops and livestock;
- The portion (on a pro rata) basis or crop-share rentals due at the time of death;
- Receivables for a cash basis farmer;
- Unpaid wages;
- The value of commodities stored at an elevator (cooperative). Reg. §1.691(a)-2(b), Example 5 (canning factory and processing cooperative).
- Accrued interest income on Series E/EE bonds;
- When a decedent’s estate makes an election under I.R.C. §2032A to value ag land in the estate at its value as ag property (known as the “special use” value) rather than at its fair market value, the basis of the land in the hands of the heir is the special use value. There is no basis “step-up” to fair market value at the time of death. Treas. Reg. §§1014(a)(3); 1.1014-3(a).
- While the income of a pass-through entity is taxed only at the owner level, and the pass-through income increases the owner’s tax basis in the owner’s interest in the pass-through entity, a C corporation pays tax at the corporate level and then tax is also paid at the shareholder level on dividends or proceeds of liquidation. In addition, C corporate income does not increase the shareholder’s stock basis.
Just Starting Out – Creating a New Entity
If an organizational structure is initially being put into place, again there are numerous factors to consider in determining whether the farming or ranching business should operate as a C corporation or a pass-through entity. In addition, to those factors pointed out above, the following factors should also be considered:
- Is it anticipated that the primary or sole shareholder will hold the corporate stock until death?
- Where will the business be incorporated and do business? If the business will be a C corporation, does the state of incorporation or other states in which the corporation will do business have a state income tax?
- What tax bracket(s) will apply to the shareholders?
- If the underlying business of the corporation would qualify for the 20 percent qualified business income deduction of I.R.C. §199A, what’s the differential between the corporate tax rate of 21 percent and the individual rate less the 20 percent deduction? Will that full 20 percent deduction be available if the entity weren’t a C corporation? This can involve a rather complex analysis.
- What type of assets are involved? Will they appreciate in value? If so, the corporate tax rate of 21 percent plus the second layer of tax on gain of the appreciated asset value at the shareholder level upon liquidation (or on a qualified dividend) will exceed the maximum 23.8 percent capital gain rate that applies to an individual (20 percent rate plus an additional 3.8 percent on passive gain under Obamacare. I.R.C. §1411.
- Is it anticipated that the business will retain earnings or pay it out in the form of compensation, rents or other expenses? Growing businesses tend to retain earnings. Paid-out earnings of a C corporation are taxed again at the shareholder level.
- Is income expected to fluctuate widely? If so, remember that the C corporate tax rate is a flat 21 percent.
- Will there be sufficient funds to pay consistent income to the owners of the business? If so, that can mean that (if a C corporation structure is utilized) shareholder-employees can receive tax benefits at the individual level. If a corporate-level loss is incurred in doing so, that loss can be used to offset future taxable income.
- Under the TCJA, losses can offset up to 80 percent of pre-NOL taxable income.
- The loss (for a farming corporation) can be carried back two years. I.R.C. §172(b)(1)(B).
- From an accounting and tax planning standpoint, is a fiscal year desired? A C corporation can have a fiscal year-end and the individual shareholders can have a calendar year-end.
So, what is the best entity structure for your farming or ranching operation? The discussion above merely scratches the surface of a very complex matter. However, if you clearly articulate your goals and objectives for the future of your business to your planners, and provide complete information on assets, liabilities, land ownership, current arrangements, family data and dynamics, cropping and livestock history and tax history, then a good plan can be put in place that can, at least in the short-term satisfy your objectives. Then, there must be a commitment to routinely review and update the plan as necessary. There is no “one-size-fits-all” business plan, and plans aren’t static. There is cost involved, of course, but the successful operations realize that the cost is a small compared to the benefits.
Tuesday, May 14, 2019
This summer Washburn Law School is sponsoring its summer national ag tax and estate and business planning conference in Steamboat Springs, Colorado on August 13-14. The event will be held at the beautiful Steamboat Grand Hotel, and is co-sponsored by the Department of Agricultural Economics at Kansas State University and WealthCounsel. Registration is now open for the two-day event, and onsite seating is limited to the first 100 registrants. However, the event will be live streamed over the web for those who can’t make it to Steamboat.
Key Ag Tax and Planning Topics
The QBID. As we historically have done at this summer event, we devote an entire day to ag income tax topics and an entire second day to planning concepts critical to farm and ranch families. Indeed, on Aug. 13, myself and Paul Neiffer will begin the day with a dive back into the qualified business income deduction (QBID) of I.R.C. §199A and take a look at the experience of the past filing season (that largely continues uninterrupted this year). For many clients, returns were put on extension in hopes that issues surrounding the QBID, or the DPAD/QBID for patrons of cooperatives would get resolved. Plus, software issues abounded, and the IRS issued conflicting (and some incorrect) information concerning the QBID. In addition, the season began with errors in Pub. 225, the Farmers’ Tax Guide. Some states even piggy-backed the IRS errors for state income tax purposes and coupling. That made matters very frustrating.
On the QBID discussion, we will take a close look at the rental issue. That seems to be a rather confusing matter for many practitioners. Is there an easy way to separate rental situations so that they can be easily analyzed? We will break it down as simply as possible and explain when to use the safe-harbor – it’s probably not nearly as often as you think. What is an I.R.C. §162 trade or business activity? How do the passive loss rules interact with the QBID?
For farmers that are patrons of ag cooperatives, how is the DPAD/QBID to be calculated? What information is needed to properly complete the return? Where does what get reported? My experience so far this tax season in seminars is that it is taking me about three hours just to recap and review the QBID and go through practitioner questions that came in during tax season and share how they were answered. The discussion has been great, and at the end of the discussion, you will have a better handle on how the QBID works for your clients. Is it really as complicated as it seems?
Selected ag topics. After a brief break following the QBID discussion, we will get into various ag-related tax topics and how the changes brought about by the TCJA impact ag returns. What were the problem areas of applying the new rules during the filing season? What are the key tax issues that farm and ranch clients are presently facing. Currently, disaster issues loom large in parts of the Midwest and Plains. Also, Farm Bill-related issues associated with CCC loans and the impact on the PLC/ARC decision are important. What about how losses are to be treated and reported? Those rules have changed. Depreciation rules have also been modified. But, is it always in a client’s best interests to maximize the depreciation deduction? What about trades? The reporting of personal property trades has changed dramatically. How do those get reported now? What are the implications for clients?
Cases and Rulings
Of course, the day wouldn’t be complete without going through the key rulings and cases from the prior year. There are always many important developments in the courts and with the IRS. Some are even amusing! It’s always insightful to learn from the mistakes of others, and from others that are blazing the trail for others to follow. We will work through all of the key ag-related cases and rulings from the past 12-18 months.
We will have specific session focusing on depreciation, the passive loss rules (and how to report on the return); ag disasters; and the 2018 Farm Bill. Day 1 will be a full day.
Ag Estate and Business Planning
On August 14, we turn our attention to planning concepts for the farm and ranch family. Joining me on Day 2 will be Stan Miller, the founder of WealthCounsel, LLC. In addition to providing estate and business planning education, WealthCounsel, LLC also provides drafting software. In addition, Timothy O’Sullivan joins the Day 2 teaching team. Tim has a longstanding practice in Wichita, Kansas, where he focuses on estate planning and the administration of trusts and estates.
Recent developments. Day 2 begins with a rapid summary of the development that impact estate and business planning. For most clients, the issue is not tax avoidance given the presently high levels of the applicable exclusion. Rather, the issue is including property in the estate to achieve a stepped-up basis. I will go through recent developments impacting the basis planning issue and other developments impacting charitable giving as well as retirement planning.
Other issues. Tim O’Sullivan will devote a session to dealing with family disharmony and how to keep it from cratering a good estate plan. Tim will also have a separate session on incorporating good long-term care planning into the overall family estate and business plan. This is a very important topic for many farm and ranch families – particularly those that want to keep the family business in tact for future generations. I will have separate sessions on charitable giving; planning for second (and subsequent) marriages; and common estate planning mistakes. To round out Day 2, Stan Miller will devote a session to techniques that can professionals can implement to preserve family held farms and ranches for future generations. This will be a timely topic given the many variables that farmers and ranchers must handle to help their operations continue to be successful.
For more information about the event and to register, click here: http://washburnlaw.edu/employers/cle/farmandranchtax.html
A room block for the conference is available at the Steamboat Grand Hotel and is accessible from the page at the link provide above or here: https://group.steamboatgrand.com/v2/lodging-offers/promo-code?package=49164&code=WASH19_BLK
If you can’t attend, the conference is live streamed. Information about signing up for the live streaming is also available on the first link provided above.
Conservation Easement Seminar
I will also be presenting at another CLE/CPE event in Steamboat on Monday, August 12 immediately preceding our two-day conference. That event is sponsored by the Colorado Cattlemen’s Agricultural Land Trust, the Eagle Valley Land Trust, and the Yampa Valley Land Trust, and focuses on the legal, real estate and tax issues associated with conservation easement donations. I will provide more information about that event as it becomes available.
This two-day seminar is a high-quality event this summer in a beautiful location. If you are in need of training on ag tax and planning related issues, this is the event for you. In addition, the full day on conservation easements preceding the two-day conference is an excellent opportunity to dig into a topic that IRS is looking at closely. It’s important to complete these transactions properly and this conference will lay out the details as to how to do it properly.
I hope to see you either in-person in Steamboat Springs later this summer or via the web. It will be a great event for your practice!
Wednesday, May 8, 2019
In recent months, several court decisions have involved the issues of executors and beneficiaries of an estate being held personally liable for the unpaid taxes of the estate. Sometimes a statute of limitations defense can be raised to fend off personal liability. Sometimes it cannot be raised. The matter can also be complicated when the estate makes an election to pay the estate tax in installment over (essentially) 15 years rather than filing the return and paying the federal estate tax nine months after the decedent’s death.
Personal liability of heirs for unpaid federal estate tax – that’s the topic of today’s post
Family trust. In United States v. Johnson, No. 17-4083, 2019 U.S. App. LEXIS 9317 (10th Cir. Mar. 29, 2019), the decedent died in 1991, survived by her four children. Before death, the decedent had established a trust that named two of her children as the successor trustees of her trust and the personal representatives of her estate. The decedent funded the trust with stock in a closely-held corporation that operated a hotel with a Nevada gambling license. Her will directed that the residue of her estate after payment of expenses and claims be transferred to the trust and administered in accordance with the trust’s terms. The children were also the beneficiaries of the decedent’s life insurance policies value at approximately $370,000. The decedent died on September 2, 1991.
Installment payment election. As reported on a timely filed federal estate tax return, the gross estate was valued at almost $16 million and the estate tax liability was approximately $6.9 million. The federal estate tax paid with the estate tax return was $4 million. An installment payment election was made in accordance with I.R.C. §6166 for the balance of the estate tax liability which allowed that portion of the tax to be paid in 10 annual installments starting in 1997 (after five years of interest-only payments) and ending in 2006. Upon receiving the filed estate tax return, the IRS took note of the election and assessed the estate for unpaid estate tax on July 13, 1992. In late 1992, all of the remaining trust assets (primarily hotel stock) were distributed to the children. The hotel stock was distributed to the trust beneficiaries because Nevada law governing casino ownership via trust required it. All of the children entered into a distribution agreement (governed by Utah law) acknowledging that they were equally responsible for the unpaid federal estate tax as it became due and equally liable for any additional tax that might result from an audit.
IRS lien. In 1995, the IRS took the position that the estate’s gross value had been underreported by approximately $3.5 million. Ultimately, a settlement was reached whereby the estate agreed to pay additional federal estate tax of $240,381. In 1997, shortly before the due date of the first estate tax installment, the IRS informed the personal representatives of alternatives to personal liability for unpaid deferred estate tax. As a result, the personal representatives executed an I.R.C. §6324A lien which all four children signed along with an agreement restricting the sale of stock in a hotel which comprised the largest asset of the decedent’s estate. That restriction was to be in effect while the lien was in effect. In 2002, the hotel filed bankruptcy and a sale of all hotel assets was approved. In 2003, the IRS informed the personal representatives that if they defaulted, the entire balance of estate tax would be immediately due. Shortly thereafter the estate defaulted on its federal estate tax liability after having paid a total of $5 million of the amount due. After attempting to collect via levies against the estate, trust and the children, and learned of the distribution agreements in mid-2005. The IRS filed suit in 2011 naming all of the children as defendants and seeking to recover over $1.5 million in unpaid federal estate tax from them personally.
Litigation. The trial court held that the heirs who received trust distributions were not liable as beneficiaries or transferees under I.R.C. §6324(a)(2). However, the trial court also determined that the personal representatives could be liable under 31 U.S.C. §3713 and I.R.C. §2036(a) as successor trustees up to the value of the trust assets that were included in the decedent’s gross estate via I.R.C. §2034-2042. The personal representatives claimed that the assets were included in the estate via I.R.C. §2033. The trial court determined that the assets were included in the estate via I.R.C. §2033 because the decedent never lost the beneficial ownership of them during her lifetime (i.e., the assets had not been transferred as required by I.R.C. §2036). Thus, the personal representatives were not personally liable for the unpaid estate tax as trustees. In addition, the court determined that the personal representatives were not liable under 31 U.S.C. §3713 because liability was discharged upon execution of the I.R.C. §6324 lien. The IRS also claimed it had rights as a third-party beneficiary of the 1992 distribution agreement whereby they agreed to be equally liable for any additional taxes resulting from an audit. The trial court determined this claim was untimely under Utah law (6-year statute of limitations) and rejected the IRS claim that federal law should apply.
Tenth Circuit decision. On appeal, the appellate court held that federal law applied on the contract-based claim and was governed by the 10-year statute of limitations of I.R.C. §6502. That’s because the court concluded that the government was acting in its sovereign capacity. Accordingly, the 10-year statute of limitations applied. When the federal government is enforcing its rights, it is not bound by a state’s statute of limitations even with respect to lawsuits that are brought in state courts. It makes no difference whether the claim at issue arose under federal or state statutes or the common law.
Likewise, the transferee liability claim was timely because the limitations period applicable to the I.R.C. §6324(a) transferees was the same as the limitations period that applied to the estate. Because the 10-year limitations period that normally applies to the collection of estate tax was suspended by the installment payment election, the government’s claim was timely. See, e.g., §6503(d); United States v. Botefuhr, 309 F.3d 1263 (10th Cir. 2002). The appellate court also held that the children were liable for unpaid estate tax to the extent of any life insurance proceeds they received from the estate. United States v. Johnson, No. 17-4083, 2019 U.S. App. LEXIS 9317 (10th Cir. Mar. 29, 2019). The appellate court also held, reversing the trial court, that the beneficiaries weren’t entitled to attorney fees and costs because the government’s position was “substantially justified under I.R.C. §7430(c)(4)(B). Indeed, the government received a judgment for the full amount of the estate tax liability asserted.
It’s worth noting that the decedent in Johnson died in 1991. The Tenth Circuit’s decision was in 2019. That show’s how long matters can get drawn out if an installment payment election is made and there is unpaid tax liability. The government is not simply going to go away.
Friday, April 26, 2019
This summer, Washburn University School of Law will be sponsoring a two-day Farm and Ranch Tax and Estate/Business Planning Seminar in Steamboat Springs, CO. The event will be on August 13-14 at the Steamboat Grand Hotel. This seminar presents an extensive, in-depth coverage and analysis of tax and estate/business problems and issues involving farm and ranch clients over two-days. Attendance can either be in-person or via online over the web.
In today’s post, I outline the coverage of the topics at the seminar and the presenters as well as related information about registering. Steamboat Springs – Summer of 2019!
Topics and Speakers
On Day 1 (August 13), Paul Neiffer (CPA with CliftonLarsonAllen and author of the FarmCPA blog) will be presenting with me. We will start the day with a discussion of the I.R.C. §199A (QBI) deduction. Many issues surfaced during the 2018 tax filing season concerning the QBI deduction. The IRS produced contradictory statements concerning the deduction and the tax software companies also struggled to keep the software up with the developments. During this opening session, Paul and I will walk through QBI deduction issues as applied to farm and ranch clients and address many questions with detailed answers – a very real “hands-on” approach that is practitioner-friendly.
During the next session on Day 1, I Paul and I will take two hours to cover a potpourri of selected farm income tax topics. Those issues that are the present “biggies” will be addressed as well as current issues that practitioners are having with the IRS involving ag clients.
After lunch on Day 1, I will highlight some of the most important recent cases and rulings for farm and ranch taxpayers, and what those developments mean as applied on the farm and in the farm economy. Any new legislation will also be addressed, whether it’s income tax or other areas of the law (such as bankruptcy) that impact ag clients.
We will then devote an hour to common depreciation issues and how the rules have changed and are to be applied post-TCJA. What are the best depreciation planning techniques? We will work through the answers.
Following the afternoon break, I will dive into the passive loss rules. What do they mean? How do they apply to a farm client? How do they interact with the QBI deduction? What is a real estate professional? How to the grouping rules work? These questions (and more) will be answered and numerous examples will show how the rules work in various contexts.
Day 1 finishes out with Paul covering tax and planning issues associated with the 2018 Farm Bill and the choices farm clients have and how the new rules work. I will then cover the tax rules associated with ag disasters and casualties. There are many of those issues for clients that will show up during the 2019 tax filing season, especially for farm/ranch clients in the Midwest and Plains states.
On Day 2, our focus turns to farm and ranch estate and business planning. I will begin the day with an update of the key recent developments that impact the estate and succession planning process. What were the key cases of the past year? What about IRS rulings and pronouncements? I will cover those and show you how they apply to your clients.
Day 2 then continues with a key session on how to use estate planning concepts to minimize family disharmony. This session is presented by Tim O’Sullivan with Foulston Siefken LLP in Wichita, KS. Tim has a broad level of experience in estate planning and the handling of decedent’s estates. This is a “must attend” session for estate planners and deals with a topic that is often overlooked as an element in putting together a successful estate and business transition plan.
After the morning break on Day 2, I will cover the tax and legal issues associated with the use of trusts. Trusts are an often-used tool for farm and ranch clients, but what is the correct type for your client? The answer to that question is tied to the facts. Also, can a state tax a trust beneficiary or the trust itself if there isn’t any physical connection with the state? It’s an issue presently before the U.S. Supreme Court. By the time of the seminar, we will likely have an answer to that question.
How does the TCJA impact charitable giving? What are the new charitable planning techniques? What factors are important? I will address these questions and more in the session leading up to lunch.
After the lunch break on Day 2, I will deal with an unfortunate, but important topic- what is appropriate estate and business planning in second marriage situations? If the plan doesn’t account for this issue, significant disruptions can occur, and expectations may not be met. This is an important session dealing with a topic that tends to be overlooked.
I will then provide a breather from some heavy topics with a lighter (and fun) one – what are common estate and business planning mistakes? What classic situations have you dealt with in your practice over the years? Mistakes are frequent, but some seem to occur over and over. Can they be identified and prevented? That’s the goal of this session.
Tim O’Sullivan then returns for another session. This time, Tim does a deep dig into long-term health care planning. How can farm and ranch assets and resources be preserved? What are the applicable rules? What if only one spouse needs long-term care? Should assets be transferred? If so, to whom? This is a very important session designed to give you the tools you need for your long-term care planning toolbox.
Day 2 finishes with a key session by Stan Miller on how estate and business planning concepts can be used to help make sure the family farm survives for families that want it to survive as a viable economic unit. Stan is a founder of WealthCounsel, LLC and a principal in the company. Stan has a long background in estate and business planning. He is also a partner with ILP + McChain Miller Nissman in Little Rock, Arkansas. This session is a great capstone session for the day that will bring the day’s discussion together and get down to how the concepts discuss throughout the day can be used to help the farming and ranching business of a client survive the ups and downs of the economy, as well as family situations.
The seminar will be held on Tuesday and Wednesday, August 13-14 at the Steamboat Grand Hotel, in Steamboat, Colorado. It is co-sponsored by the Kansas State University Department of Agricultural Economics and WealthCounsel, LLC. You can find more registration information here: http://washburnlaw.edu/employers/cle/farmandranchtax.html
On another note, on Monday, August 12, also in Steamboat, I will be participating in another seminar (also in Steamboat Springs) sponsored by the Colorado Cattlemen’s Agricultural Land Trust, the Eagle Valley Land Trust, and the Yampa Valley Land Trust. Half of the day will concern legal issues associated with conservation land trusts. The other half of the day will address real estate issues associated with conservation land trusts. These issues are very important in many parts of the country in addition to Colorado. As further details are provided, I will pass those along. This all means that there will be three full days of tax and legal information available this coming August in Steamboat Springs.
As I noted above, the seminar can be attended either in-person on online via the web. Registration will open up soon, so get your seat reserved. Steamboat Springs, CO is a beautiful area on the western slope of the Colorado Rockies.
Hope to see you there!!
Tuesday, April 2, 2019
To be valid a will must satisfy certain requirements. One of those requirements is that the will is the product of the decedent’s intent. No one else can be allowed to unduly influence the decedent’s intent.
In ag settings, challenges to wills sometimes arise. The battles frequently involve the disposition of farmland that has been held in the family for many years or perhaps generations. As a result, tensions and emotions run high because the future of the family farm may be at stake. But, what does “undue influence” mean? In what situations may it be present?
Will challenges and undue influence – that’s the topic of today’s post.
Basic Will Requirements
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 must be of sound mind; generally must know the extent and nature of their property; must know who would be the natural recipients of the assets; must know who their relatives are; and must know who is to receive the property passing under the will. A testator lacking these traits is deemed to not have testamentary capacity and is not competent to make a will. These 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. If that influence rises to the level of being “undue,” the will resulting from such influence will not be validated.
Testamentary Capacity and Undue Influence
Cases involving will challenges 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. For example, in a 2008 Wyoming case, Lasen v. Andersen, et al., 187 P.3d 857 (Wyo. 2008), the decedent’s daughter and her husband sued to quiet title to the decedent’s farm. Other family members asserted various defenses and also claimed an interest in the farm. A bank was also involved in the litigation. The trial court ruled against the daughter and granted the bank’s counterclaim. The trial court determined that the daughter and her husband had unduly influenced the decedent by continually pressing the decedent to change his will in their favor. The trial court also determined that the daughter and her husband had improperly pressured the decedent to change his power-of-attorney and execute the deed to the farm at issue in the case. The appellate court agreed, noting that the daughter was the party that executed the second deed involving the farm and that her husband did not obviate the first deed that had been executed and delivered.
But, undue influence was not established in In re Estate of Rutland, 24 So. 3d 347 (Miss. Ct. App. 2009). In this case, the court held that the trial court improperly set aside the decedent’s 2002 will which devised an 88-acre farm. The court determined that the decedent had testamentary capacity based on the evidence presented and that the evidence was insufficient to support a finding of undue influence and there was no abuse of a confidential relationship. If a confidential relationship had been present, a presumption of undue influence would have arisen.
In a 1993 Kansas case, In re Estate of Bennett, 19 Kan. App. 2d 154, 865 P.2d 1062 (1993), the court held that a person challenging the will 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. The surviving widow received approximately $50 million from her husband’s estate after they had lived as near paupers for many years. She changed her will after inheriting the vast sum and the disaffected family members sued on the basis that the subsequent will was the product of undue influence. It was not.
Recent case. In In re Estate of Caldwell, No. E2017-02297-COA-R3-CV, 2019 Tenn. App. LEXIS 114 (Tenn. Ct. App. Mar. 7, 2019), the decedent executed a will in 1999 that named the plaintiff, his son, as a devisee of his farm along with his nephew. At the time the will was executed, the plaintiff and nephew lived on the farm. Approximately nine years later the defendant, the decedent’s daughter, began to reestablish a relationship with the decedent and the plaintiff. The defendant did not learn that the decedent was her biological father until she was 35 years old and that she was a half-sister of the plaintiff by virtue of having the same father – the decedent.
In 2012 the decedent suffered a stroke that slowed his speech and resulted in limited mobility in one arm. The plaintiff took care of the decedent during the evenings and farmed during the day. The defendant often prepared meals and cleaned for the decedent. In November of 2012 the decedent executed a second will. The 2012 will revoked the 1999 will and devised the farm to the defendant. The 2012 will also named the defendant the executor of the estate. The defendant would drive the decedent to the attorney’s office but did not stay for the meetings. The attorney noted that the decedent spoke slower, but had no issue expressing his intent. The decedent wished to keep the property in the family and wanted the defendant and nephew to always have a place to live. The decedent also desired to make amends with the defendant for not playing a role in the first 35 years of her life. The 2012 will was properly witnessed and executed in late November. In January of 2013 the decedent quitclaim deeded the farm to the defendant. Again, at this time the attorney did not believe that the decedent had any mental capacity issues.
The decedent died in 2015 and the plaintiff submitted the 1999 will to probate. The defendant submitted the 2012 will to probate, and the plaintiff responded by bringing legal action for conversion; fraud; misrepresentation and deceit; unjust enrichment; and breach of fiduciary duty. The plaintiff sought punitive damages and injunctive relief that would prevent the defendant from taking any action against the estate. After a three-day bench trial, the trial court determined that the decedent had the requisite testamentary capacity and that the 2012 will was not a product of undue influence.
On appeal, the appellate court affirmed. The appellate court found that the evidence showed that decedent was of sound mind and had testamentary capacity at the time the 2012 will was executed – he knew what property he owned and understood how he wanted to dispose of it at his death. On the plaintiff’s undue influence claim, the appellate court determined that a confidential relationship did not exist between the defendant and the decedent based on a clear and convincing standard. As such, undue influence would not be presumed and the evidence demonstrated that the decedent received independent advice and was not unduly influenced in executing the 2012 will.
Family fights over the family farm are never a good thing. Sometimes the matter may involve claims of undue influence or lack of testamentary capacity to execute a will that is the linchpin of the estate plan. Care should be taken to avoid situations that can give rise to such claims.
Friday, March 29, 2019
The developments in agricultural law and taxation keep rolling in. Many of you have requested more frequent posts on recent developments, so today’s post is devoted to just a handful that are important to farmers, ranchers and the professionals that represent them. In today’s post I take a look at a couple of recent farm bankruptcy cases, the use of a trust to hold farm and ranch property, and the rights of grazing permit holders on federal land.
Selected recent developments in agricultural law and tax – it’s the topic of today’s post.
Times continue to be difficult in agriculture with bankruptcy matters unfortunately taking on increased significance. In one recent case, In re Wulff, No. 17-31982-bhl, 2019 Bankr. LEXIS 388 (Bankr. E.D. Wis. Feb. 11, 2019), the debtor filed Chapter 12 bankruptcy and submitted a complete list of creditors. One of the creditors did not receive notice of the bankruptcy because of a bad address but became aware of the debtor’s bankruptcy upon attempting to collect on their account after the proof of claim deadline had passed. There were multiple plans submitted to the court that were rejected for various reasons, but every plan submitted accounted for the creditor that did not have notice. Ultimately, the debtor’s plan was confirmed. After confirmation, the creditor attempted to file a proof of claim and the trustee objected. The creditor maintained that it filed as soon as receiving notice of the proceedings. The court allowed the claim, but that the creditor had not established grounds for an extended timeframe to file the proof of claim. Even so, the court noted that the debtor’s initial plan and amended plans all accounted for the creditor’s claim. All the plans were consistent with the creditor’s late-filed proof of claim. Thus, the court confirmed the debtor’s reorganization plan with the late-filed proof of claim upon a finding that it was consistent with the plan.
In another bankruptcy case, In re Smith, Nos. 17-11591-WRS, 18-1068-WRS, 2019 Bankr. LEXIS 234 (Bankr. M.D. Ala. Jan. 29, 2019), the debtor filed bankruptcy in 2017. At the time of filing, the debtor had a 2006 loan secured by his farmland that had matured. Instead of foreclosing, the creditor bank and the debtor negotiated a renewal in 2012. Another creditor, an agricultural cooperative, held a 2009 lien. In determining priority, the court held that the bank’s liens were prior to the cooperative’s liens. The court determined that the 2012 renewal of the bank note, even if the bank new of the cooperative’s lien, did not cause the bank to lose priority. While the court noted that sometimes an advancement on an existing mortgage causes the underlying mortgage to lose priority over subsequent liens, the court determined that the 2012 renewal was not an advancement. There was no evidence that additional funds were loaned to the debtor by the bank. In addition, the court determined that the bank’s lowering of the interest rate on the obligation did not cause the creditor to lose priority.
Trusts and Estate Planning
Trusts are a popular tool in estate planning for various reasons. One reason is that a trust can help consolidate farming and ranching interests and aid in the succession planning process. The benefit of consolidating farm and ranch property in trust was the issue of a recent Wyoming case. In re Redland Family Trust, 2019 WY 17 (2019), involved a family that has been involved in contentious litigation over a family trust. The case had been before the Wyoming Supreme Court on multiple occasions. The trust was created in 1989 and amended in 1995. The amendment provided for the appointment of a successor trustee; always required the service of two trustees; created a marital trust for the survivor of the settlors; and revised the buyout provision. The grantors and their five children made contributions to the trust. Upon the death of one of the grantors in 2007 one of the children was appointed as co-trustee. Ligation arose when the surviving grantor’s property was not conveyed to the trust and then again involving removal of the trustees, and an appointed trustee moved to have the trust terminated due to the administrative difficulties to administer, family dysfunction, and because the trust no longer served its purpose. The defendants, (including the co-trustee that resigned) asserted that termination was moot and moved to have the new co-trustee removed.
The trial court did not remove the co-trustee and found that the trust was still valid. The trial court found that the co-trustee did not violate any fiduciary duties and that the defendants failed to show gross and willful misconduct to justify her removal. Further the trial court found that the co-trustee’s claims that the trust was invalid should have been raised in the original trust challenge. The trial court determined that the primary reason for the trust (to keep the lands and leases together for the Redland family) had not been frustrated and that the trust remained administratively functional and was not "unlawful, contrary to public policy, or impossible.
On appeal, the Wyoming Supreme Court affirmed. The Court determined that the trust still had a purpose - to keep the ranch holdings together to conduct business. Even though the other purpose of minimizing tax consequences had failed, consolidation of ranch holdings remained a legitimate purpose. The Court also determined that the co-trustee did not violate her fiduciary duties, her duties of impartiality or loyalty, and that her actions did not amount to gross and willful misconduct. In addition, the Court found that the duty of impartiality did not require the trustee to treat all beneficiaries fairly, but simply to act in the best interest of the beneficiaries and equally defend the intentions of the settlors. While the Court could find no precedent with respect to the duty of loyalty the Court held that merely seeking termination of the trust was not a breach of loyalty. In addition, the Court determined that hostility between parties did not warrant removal.
Rights of Grazing Permittees
In the U.S. West, the ability to graze on federally owned land is essential to economic success. An understanding of those rights is essential, and many legal battles in the West involve associated rights and responsibilities on federal land. One of those issues involves the erection of improvements. In Johnson v. Almida Land & Cattle Co., LLC, 2019 Ariz. App. Unpub. LEXIS 140 (Ariz. App. Ct. Jan. 31, 2019), the defendant owned a grazing allotment and was permitted to graze cattle on the allotted Forest Service land in Arizona. Consistent with the grazing permit, the defendant erected an electric fence on the allotment. In June 2011, the plaintiff collided with the fence while riding an off-road motorcycle, when he turned off a Forest Service road onto an unmarked, unimproved “two-track route” which the fence crossed. The plaintiff brought sued for negligence and the defendant moved for summary judgment on the basis that it owed no duty of care to the plaintiff. The trial court granted the motion, agreeing that there was no duty of care under the Restatement (Second) of Torts.
On appeal, the appellate court determined that the issue was whether a federal permittee owes a duty of care to the public with respect to construction of improvements on the land. Determination of that issue, the appellate court reasoned, was dependent on state law. On that point, the appellate court found that a criminal statute will establish a tort duty if the statute is designed to protect the class of persons in which the plaintiff is included, against the risk of the type of harm which has in fact occurred as a result of its violation, regardless of whether the statute mentions civil liability. The relevant AZ criminal statute held that a person commits a misdemeanor of public nuisance if that person knowingly and unlawfully obstructs a “public highway,” “public thoroughfare,” “roadway” or “highway.” The appellate court held that this public nuisance statute prohibiting the obstruction of certain types of pathways, also created a tort duty in those who erect improvements that impact those paths. Based on this interpretation, the court held that AZ law establishes a public policy giving rise to a tort duty with respect to the obstruction of certain types of public pathways. Consequently, a permittee on federal land owes a duty of care to the public when it erects an improvement across a publicly accessible route. However, the appellate court held that the facts were insufficient to determine, as a matter of law, whether the route at issue qualified as a “public highway,” “public thoroughfare,” “roadway” or “highway.” Consequently, the appellate court reversed on the duty of care issue and remanded to determine if the route fell within the scope of the relevant statutes.
Agricultural law is a “goldmine” of issues that landowners, producers and their legal and tax counsel must stay on top of. It’s a dynamic field. In a few more weeks, I will dig back into the caselaw for additional key recent developments.
Monday, March 25, 2019
Upon death, particularly the death of the surviving spouse, the estate executor may need to dispose of the decedent’s personal residence. When that happens, numerous tax considerations come into play. There are also some planning aspects to handling the personal residence.
The sale of the personal residence after death – that’s the topic of today’s post.
Income Tax Basis Issues
Upon death, the executor may face the need to dispose of the decedent’s personal residence. The starting point to determining any tax consequences of the disposition involves a determination of income tax basis. If the residence was included in the decedent’s gross estate, the tax basis will be determined in accordance with fair market value as of the date of the decedent’s death under the willing buyer-willing seller test. I.R.C. §1014. That is based largely on sales of comparable properties, and requires more than a simple market analysis by a real estate agent.
If the decedent was the first of the two spouses to die, a determination of how the residence was titled at death will need to be made. For a residence held in joint tenancy or tenancy in common, only the value of the decedent’s share of the residence will be included in the decedent’s estate and receive a basis step-up to fair market value. Id. In common-law property states where the residence is owned in joint tenancy between the spouses, the property is treated at the first death as belonging 50 percent to each spouse for federal estate tax purposes. I.R.C. § 2040(b). This is known as the “fractional share” rule. Thus, one-half of the value is taxed at the death of the first spouse to die and one-half receives a new income tax basis. However, in 1992 the Sixth Circuit Court of Appeals applied the “consideration furnished rule” to a husband-wife joint tenancy involving farmland. Gallenstein v. United States, 975 F.2d 286 (6th Cir. 1992). The result was that the entire value of the land acquired before 1977 was included in the estate of the first spouse to die. That meant that the full value was subject to federal estate tax, but was covered by the 100 percent federal estate tax marital deduction. The entire property received a new income tax basis which was the objective of the surviving spouse. Other federal courts have reached the same conclusion.
If the residence is community property, the decedent’s entire interest will receive a basis step-up to fair market value. If the residence is held in joint tenancy with rights of survivorship, the decedent’s interest passed by the survivorship designation to the designated survivor.
If a surviving spouse sells the marital home shortly after the first spouse’s death, the survivor will often realize a loss largely due to the expenses incurred with respect to the sale. If the survivor realizes a gain, then, the survivor is eligible for the $250,000 exclusion of gain. I.R.C. §121. That exclusion is a maximum of $500,000 if the sale occurs within two years of the first spouse’s death.
Residence Held in Trust
A revocable trust is a common estate planning tool. If the decedent’s personal residence was held in a revocable trust and passed to the surviving spouse upon the first spouse’s death under the terms of the trust to continue to be held in trust, the house receives a full step-up (or down) in basis to the current fair market value at the death of the surviving spouse. If the house is distributed outright to a beneficiary (or beneficiaries) and then the beneficiary immediately sells the home, a loss generally will be a nondeductible personal loss unless the home is first converted to a rental property before it is sold. This is a key point that may require some planning to allow for rental use for a period of time before sale.
If the residence must be sold by the estate or trust to pay debts or to satisfy cash distributions to beneficiaries, any loss on the sale might be deductible. That loss could potentially offset other income of the trust or estate, or it could flow through to the beneficiaries. However, the IRS position is that an estate or a trust cannot claim such a loss unless the residence is a rental property or is converted to a rental property before it is sold. This position has not been widely supported by the courts which have determined that a trust or estate can claim such a loss if no beneficiaries use the home as a residence after the decedent’s death and before it is sold. It is important to get good tax counsel on this issue. It’s an issue that comes up not infrequently.
The sale of the personal residence after death presents numerous tax issues. With a modest level of planning, negative tax consequences can be avoided and helpful tax provisions can be taken advantage of.
Friday, March 15, 2019
If the federal estate tax isn’t paid when due nine months after the date of the decedent’s death, is a person that receives property from the decedent’s estate personally liable for the unpaid tax? Does it matter how the person received the property - either by gift, as a surviving joint tenant or as a beneficiary of the estate? How long does the IRS have to collect the tax? These are all important questions, especially with respect to a farmer’s estate where present economic and financial conditions may have dissipated estate property such that the estate no longer has assets and funds with which to pay the tax, or where the assets have already been distributed.
The personal liability of estate beneficiaries for federal estate tax – that’s the topic of today’s post.
With the present level of the exemption from federal estate tax pegged at $11.4 million for deaths in 2019, it’s very unlikely that any particular estate will have to worry about federal estate tax. But, this enhanced level of exemption (it was, in essence, doubled by the late 2017 tax legislation) is set to expire at the end of 2025 and go back to the pre-2018 level of $5 million (adjusted for inflation). Also, it is possible that a change in the political winds come 2020, could reduce the exemption below $5 million. That would make it far more relevant again for many farm and ranch families.
When a decedent’s estate has a federal estate tax liability, it is due nine-months after the date of death. I.R.C. §6075(a). A six-month extension is available. But, if the tax is not paid when it is due, any transferee, surviving tenant or beneficiary of the estate is personally liable for the unpaid estate tax to the extent the property they received was included in the decedent’s gross estate under I.R.C. §2034 through I.R.C. §2042. I.R.C. §6324(a)(2). The IRS also has a special lien for any unpaid gift tax. I.R.C. §6324(b). These liens arise automatically – no assessment, notice or demand for payment or filing is required. The lien attaches to the gross estate and lasts for the earlier of ten years from the date of the decedent’s death or until the tax is paid. I.R.C. §6324(a). The lien attaches to the extent of tax shown to be due by the return and of any deficiency in tax found to be due. Treas. Reg. §301.6324-1(a)(1).
The IRS must prove that an unpaid tax exists at the time of death and that a beneficiary received property that was included in the decedent’s gross estate at death. I.R.C. §§ 2035-2042 list the various types of property and the rules governing how those types of property are included in the decedent’s gross estate for estate tax purposes. Each beneficiary of estate property is personally liable for any unpaid estate tax based on the property they received from the estate and to the extent of the property’s value at the time of the decedent’s death. I.R.C. 6324(a)(2). See also Baptiste v. Comr., 29 F.3d 433 (8th Cir. 1994), aff’g. in part and rev’g. in part 100 T.C. 52 (1993); Baptiste v. Comr., 29 F.3d 1533 (11th Cir. 1194), aff’g., 100 T.C. 252 (1993).
Procedurally, the IRS is not required to follow the normal process for collecting a deficiency when it moves to assert the lien against a transferee of estate property. See, e.g., United States v. Geniviva, 16 F.3d 522 (3rd Cir. 1994). The special estate tax lien is also not subject to the filing and notice requirements of the general IRS lien of I.R.C. §6321. I.R.C. §6323(a). Thus, buyers, holders of security interests, other lien holders and judgment lien creditors may not be protected unless I.R.C. §6324 provides protection. Rev. Rul. 69-23, 1969-1 CB 302.
Some property is exempt from the IRS lien. Included in the exempt list is any part of the decedent’s gross estate that is used to pay charges against the estate or pay administrative costs. I.R.C. §6324(a)(1). The lien also doesn’t apply to any part of the decedent’s property that is transferred to a bona fide buyer or holder of a security interest, except that the lien attaches to any consideration received. I.R.C. §§6324(a)(2)-(3). Also, any property that is released via certificate is exempt. I.R.C. §6325; Treas. Reg. §301.6324-1(a)(2)(iv).
The issue of liability of estate beneficiaries for unpaid estate tax came up in a recent case from South Dakota. In United States v. Ringling, No. 4:17-cv-04006-KES, 2019 U.S. Dist. LEXIS 28146 (D. S.D. Feb. 21, 2019), the defendants were the daughters and one grandson of the decedent. The decedent died in late 1999 leaving his estate equally to his daughters and providing a specific bequest of farmland to one of the daughters as part of her co-equal share of the estate. The will named the daughters as co-personal representatives of his estate. The estate included farmland and crops among other assets. In 1999, the federal estate tax exemption equivalent of the unified credit was $650,000 and the top rate was 55 percent.
In 1996, the decedent entered into an agreement with his grandson to buy additional farmland. Under that agreement, the decedent bought the land and the grandson was to pay the decedent $32,000 via an installment contract. Ten days before his death in 1999, the decedent forgave the remaining balance due on the contract of $27,600.96. Also, in 1996 the decedent conveyed a warranty deed to his grandson for the family farm along with irrigation equipment and permits, retaining a life estate and the right to receive the rent income and profits from the farm during his life. After death, the farm was appraised at $345,700. Six days before death, the decedent and his grandson entered into a contract for deed of additional farmland. This contract called for the grandson to pay $90,000 to the decedent, with $10,000 to be paid before or at the time of deed execution and the balance to be paid in 20 equal installments. The grandson would not take possession until March 1, 2000. At the time of the decedent’s death in late 1999, the unpaid balance on the contract was $80,093.30.
In early 2008, the estate filed Form 706 reporting a gross estate of $834,336 and a net estate tax due of $28,939. No payment accompanied the filing. On Form 706, the estate reported assets as three pieces of farmland; co-op shares; stocks; bonds; two contracts for deed; cash; bank accounts; certificates of deposit (CDs); two life insurance policies; a corn crop that had been gifted to the grandson; the decedent’s pickup truck; a van; and other miscellaneous property. The Form 706 reported that each of the daughters received $121,988 and that the grandson received $416,116. Later in 2008, the IRS agreed that the estate tax was $28,939, but that a late filing penalty of $6,511.27 and a failure to pay penalty of $7,234.75 should be added on. In addition, the IRS assessed interest of $23,189.78. The total amount the IRS asserted due was $65,874.80. In 2010, the estate requested an abatement of the penalties and interest. The IRS denied the request. In 2013, the IRS sent the defendants Form 10492 Notice of Federal Taxes Due with respect to the estate. Later in 2013, the IRS filed a Notice of Federal Tax Lien on the farmland. The Notice was also sent to the estate. A hearing was not requested. Beginning in 2010, the defendants had made some payments on the estate tax liability, but as of mid-2018 over $63,000 remained due. The IRS then sued seeking payment from the daughters and the grandson personally via I.R.C. §6324(a)(2) and sought summary judgment. Only one daughter filed a response in opposition to summary judgment.
The court noted that each of the daughters and the grandson jointly owned property with the decedent at the time of his death. The jointly owned property also included a checking account on which one of the daughters continued to write checks after the decedent’s death. Under I.R.C. §2040, the court noted, the decedent’s gross estate included all property that he and any other person held as joint tenants with rights of survivorship. The two life insurance policies were included in the estate by virtue of I.R.C. §2042. Various gifts were also included in the gross estate under I.R.C. §2035. These included the decedent’s transfer of the corn crop and CDs to the grandson, as well as the forgiveness of the balance due on the contract for deed. These were all included in the estate because they had been transferred within three years of death. Also included in the decedent’s gross estate was the decedent’s retained life estate in the family farm that he had transferred to his grandson. The retained life estate caused the farm to be included in the gross estate and made it subject to the special estate tax lien as I.R.C. §6324(a)(2) property.
The court held that the defendants were personally liable for the unpaid federal estate tax as transferees of estate property and that they did not receive the property free and clear of estate tax liabilities. The court noted that transferee liability is not limited to those receiving a gift or bequest under a decedent’s will or via the administration of a revocable trust. Rather, liability extends to recipients of all property included in the gross estate including transferees who received lifetime gifts that are included in the gross estate under I.R.C. §2035 because they were made within three years of death; gift recipients whose gift was a discharge of indebtedness to the decedent; transferees who receive the property as surviving join tenants; property passing to remaindermen when the decedent had a life tenancy in the property; and life insurance proceeds on the life of the decedent.
The one daughter that filed a response to the IRS summary judgment motion asserted that the government was barred by the statute of limitations. After all, she noted, the decedent died in 1999 and the IRS didn’t file suit to collect the tax until early 2017. However, under I.R.C. §6324(a)(2), personal liability for unpaid estate tax can be asserted by the IRS ten years from the date the assessment is made against the estate. I.R.C. §6502(a)(1). See also United States v. Botefuhr, 309 F.3d 1263 (10th Cir. 2002). The assessment was made in 2008 (remember the estate didn’t file Form 706 until 2008) and the IRS sued in 2017, nine years into the 10-year timeframe for doing so and 18 years after the decedent’s death. The daughter challenging the government’s motion didn’t dispute these facts. Now, the court’s decision finding the daughters and grandson personally liable for the unpaid estate tax comes just over 19 years after the decedent’s death.
The clear lesson of the case is that federal estate tax liability just doesn’t go away if the estate doesn’t pay it. In addition, the IRS has a lengthy timeframe to collect the tax. Proper pre-death planning can, of course, help to either minimize or eliminate the tax. Also, if the exemption from federal estate tax were to drop in the future, more farms, ranches and small businesses would get caught in its snare. That was certainly the result for the South Dakota farming operation in the recent case.
Wednesday, March 13, 2019
Last April I devoted a post to the general grouping rules under I.R.C. §469. https://lawprofessors.typepad.com/agriculturallaw/2018/04/passive-activities-and-grouping.html Those rules allow the grouping of passive investment activities with other activities in which the taxpayer materially participates. Thus, for example, an investor in an ethanol plant might be able to group the losses from that investment with the taxpayer’s farming activity. Grouping may make it more likely that the taxpayer can avoid the passive loss rules and fully deduct any resulting losses.
But, there’s another grouping rule – one that applies to a taxpayer that has satisfied the tests to be a real estate professional and it’s only for purposes of determining material participation in rental activities. This election is an all-or-nothing election – either all of the taxpayer’s rental activities are aggregated or none of them are.
The aggregation election for real estate professionals – that’s the focus of today’s post.
Real Estate Professional
In last Thursday’s post, https://lawprofessors.typepad.com/agriculturallaw/2019/03/passive-losses-and-real-estate-professionals.html I detailed the rules under I.R.C. §469 pertaining to a real estate professional. To qualify as a “real estate professional” two test must be satisfied: (1) more than 50 percent of the personal services that the taxpayer performs in trades or business for the tax year must be performed in real property trades or businesses in which the taxpayer materially participates; and (2) the taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates. I.R.C. §469(c)(7). If the two tests are satisfied, as noted above, the rental activity is no longer presumed to be passive and, if material participation is present, the rental activity is non-passive. I.R.C. §469(c)(7)(A)(i).Another way of putting is that once the tests of I.R.C. §469(c)(7) are satisfied it doesn’t necessarily mean that rental losses are non-passive and deductible, it just means that the rental losses aren’t per se as passive under I.R.C. §469(c)(2). See, e.g., Gragg v. United States, 831 F.3d 1189 (9th Cir. 2016); Perez v. Comr., T.C. Memo. 2010-232. An additional step remains – the taxpayer must materially participate in each separate rental activity (if there are multiple activities).
Note: The issue of whether a taxpayer is a real estate professional is determined on an annual basis. See, e.g., Bailey v. Comr., T.C. Memo. 2001-296. In addition, when a joint return is filed, the requirements to qualify as a real estate professional are satisfied if either spouse separately satisfies the requirements. I.R.C. §469(c)(7)(B).
Is Separate Really the Rule?
As noted above, if a taxpayer has multiple rental activities, the taxpayer must materially participate in each activity. That can be a rather harsh rule. But, there is an exception. Actually, there are two. If material participation test cannot be satisfied, the taxpayer can use a relaxed rule of active participation. I.R.C. §469(i). That rule allows the deduction of up to $25,000 of losses (subject to an income phase-out). In addition, the taxpayer can make an election to aggregate all of the rental activities that the taxpayer is involved in for purposes of meeting the material participation test. Treas. Reg. §1.469-9(g)(1). This aggregation election is available to a taxpayer that has satisfied the requirements to be a qualified real estate professional under I.R.C. §469(c)(7). See, e.g., C.C.A. 201427016 (Jul 3, 2014).
Points on aggregation. Aggregation only applies to the taxpayer’s rental activities. Activities that aren’t rental activities can’t be grouped with rental activities. In addition, it’s only for purposes of determining whether the material participation test has been met. Because the election only applies to rental activities, time spent on non-rental activities won’t help the taxpayer meet the material participation test for the rental activities. This makes the definition of a “rental activity” important. I highlighted the designated rental activities in last Thursday’s post. One of them is that the real estate must be used in a rental activity rather be realty that is held in the taxpayer’s trade or business where the average period of customer use for the property is seven days or less. Temp. Treas. Reg. §1.469-1T(e)(3)(ii); see also Bailey v. Comr., T.C. Memo. 2001-296.
By election only. Aggregation is accomplished only by election. Treas. Reg. §1.469-9(g)(3). It’s not enough to simply list all of the rental activities of the taxpayer in a single column on Schedule E. In Kosonen v. Comr., T.C. Memo. 2000-107, the petitioner owned seven residential rental properties. As of the beginning of 1994, he had non-deductible suspended losses of $215,860 from his properties. He put in almost 1,000 hours in rental activities in each of 1994 and 1995. On this 1994 return, he listed each rental property and loss separately on Schedule E and reported a combined loss of $56,954 on line 42 of Schedule E – the line where a taxpayer that is materially participating in rental activities reports net income or loss from all rental activities. He also reported the loss on line 17 of Form 1040 and subtracted it from other income to compute his adjusted gross income. He also filed Form 8582 to report the $56,954 loss. However, he didn’t attach an aggregation statement to the return noting that he was electing to treat his rental real estate activities as a single activity. He also didn’t combine his 1994 Schedule E rental real estate losses with his previously suspended losses. The IRS noted that had a proper election been made that the petitioner would have satisfied the material participation requirement. But, the IRS took the position that an election had not been made and as a result the material participation requirement had to be satisfied with respect to each separate activity. Because he could meet the material participation test in any single activity by itself, the IRS asserted, the resulting losses were suspended and couldn’t offset active income. The Tax Court agreed with the IRS. While the form of his entries on the return were consistent with an aggregation election, the Tax Court held that his method of reporting net losses as active income was not clear notice of an aggregation election. The fact that the IRS had not yet issued guidance on how to make an aggregation election didn’t eliminate the statutory requirement to aggregate, the Tax Court concluded.
Attached statement. To satisfy the statutory election requirement, the election statement attached to the return should clearly state that an election to aggregate rental activities is being made via I.R.C. §469(c)(7)(A) and that the taxpayer is a qualifying taxpayer in accordance with I.R.C. §469(c)(7)(B).
Late election relief. It is possible to make a late election via an amended return. In Rev. Proc. 2011-34, 2011-24 I.R.B. 875, the IRS said a late election can be made in situations where the taxpayer has filed returns that are consistent with having made the election. In that event, the late election applies to all tax years for which the taxpayer is seeking relief. The late election is made by making the election in the proper manner as indicated above as an attachment to the amended return for the current tax year. The attachment must identify the tax year(s) for which the late election is to apply, and explain why a timely election wasn’t initially made. The opportunity to make a late election is important. See, e.g., Estate of Ramirez, et al. v. Comr., T.C. Memo. 2018-196.
Binding election. The aggregation election cannot be revoked once it is made – it is binding for the tax year in which it is made and for all future years in which the taxpayer is a qualifying real estate professional. If intervening years exist in which the taxpayer was not a qualified real estate professional, the election has no effect in those years and the taxpayer’s activities will be evaluated under the general grouping rule of Treas. Reg. §1.469-4. Treas. Reg. §1.469-9(g)(1).
Years applicable. If the election hasn’t been made in a year during which the taxpayer was a qualified real estate professional, it can still be made in a later year. But, the election is of no effect if it is made in a year that the taxpayer doesn’t satisfy the requirements to be a real estate professional. Treas. Reg. §1.469-9(g)(1). In other words, the election may be made in any year in which the taxpayer is a qualifying taxpayer for any tax year in which the taxpayer is a qualifying taxpayer. In addition, the failure to make the election in one year doesn't bar the taxpayer from making the election in a later year. Treas. Regs. §§1.469-9(g)(1) and (3).
Revocation. While the aggregation election is normally binding, the aggregation election can be revoked for a year during which the taxpayer’s facts and circumstances change in a material way. If that happens, the election can be revoked by filing a statement with the original tax return for that year. According to the regulations, the statement must provide that the I.R.C. §469(c)(7)(A) election is being revoked and describe the material change in the taxpayer’s factual situation that justifies the revocation. Treas. Reg. §1.469-9(g)(3).
Rental real estate activities held in limited partnerships. What happens if the taxpayer makes the election to aggregate all real estate rental activities but not all of the taxpayer’s interests in real estate activities are held individually by the taxpayer? The regulations address this possibility and use an example of an interest in a rental real estate activity held by the taxpayer as a limited partnership interest. Treas. Reg. §1.469-9(f)(1). The result is that the effect of the aggregation election doesn’t necessarily apply in this situation. Instead, the taxpayer’s combined rental activities are deemed to be a limited partnership interest when determining material participation and the taxpayer must establish material participation under one of the tests that apply to determine the material participation of a limited partner contained in Treas. Reg. 1.469-5T(e)(2). Treas. Reg. §1.469-9(f)(1). But, there is a de minimis exception that applies if the taxpayer’s share of gross rental income from all limited partnership interests in rental real estate is less than 10 percent of the taxpayer’s share of gross rental income from all of the taxpayer’s interests in rental real estate for the tax year. In this situation, the taxpayer can determine material participation by using any of the tests for material participation in Treas. Reg. §1.469-5T(a) that apply to rental real estate activities. Treas. Reg. §1.469-9(f)(2). This is also the rule if the taxpayer has an interest in a rental real estate activity via an LLC. An LLC interest is not treated as a limited partnership interest for this purpose. Thus, the taxpayer can use any of the seven tests for material participation contained in Treas. Reg. §1.469-5T(a). See, e.g., Garnett v. Comr., 132 T.C. 368 (2009); Hegarty v. Comr., T.C. Sum. Op. 2009-153; Newell v. Comr., T.C. Memo. 2010-23; Thompson v. Comr., 87 Fed. Cl. 728 (2009), acq. in result only, A.O.D. 2010-002 (Apr. 5, 2010); Chambers v. Comr., T.C. Sum. Op. 2012-91.
It should be noted that in its 2017-2018 Priority Guidance Plan, the IRS stated that it planned to finalize regulations under I.R.C. §469(h)(2). That provision creates a per se rule of non-material participation for limited partner interests in a limited partnership unless the Treasury specifies differently in regulations. Those regulations were initially issued in temporary form and became proposed regulations in 2011. Until the IRS takes action to effectively overturn the Tax Court decisions via regulation, the issue will boil down (as it has in the Tax Court cases referenced above) to an analysis of a particular state’s LLC statute and whether there are sufficient factors under the state statute that distinguish an LLC from a limited partnership.
Effect on losses. The aggregation election also impacts the handling of losses. Once the aggregation election is made, prior year disallowed passive losses from any of the aggregated real estate rental activities can be used to offset current net income from the aggregated activities regardless of which activity produces the income or prior year loss. At least this is the position take in the preamble to the regulations. See Preamble to T.D. 8645 (Dec. 21, 1995). This is the result even if the disallowed prior year losses occurred in tax years before the aggregation election was made. Treas. Reg. §1.469-9(e)(4).
Any suspended losses remain suspended until substantially all of the combined activities (by virtue of the election) are disposed of in a fully taxable transaction. This would be an issue if a rental real estate activity with a suspended loss is aggregated with other rental real estate activities. Those suspended losses would not be deductible until the entire aggregated activity (now treated as a single activity) is disposed of. Thus, depending on the amount of the suspended losses at issue, it may not be a good idea to make the aggregation election in this situation. Likewise, it also may not be a good idea to make the aggregation election if the taxpayer has positive net income from rental real estate activities and passive losses from activities other than rental real estate activities. If the election is made in this situation, the rental activities won’t be passive, and the taxpayer won’t be able to use the losses from the other passive activities to offset the income from the rental real estate activities. The losses could then end up being suspended and non-deductible until the entire (combined) activity is disposed of.
The aggregation election is an election that is available only for real estate professionals and can make satisfying the material participation test easier. That can allow for full deductibility of losses from rental real estate activities. But, the terrain is rocky. Good tax advice and planning is essential.
Friday, March 1, 2019
Donations to charity can provide a tax deduction for the donor. Normally, the tax deduction is tied to the value of the property donated to a qualified charity. That’s an easy determination if the gift is cash. But what if the gift consists of property other than cash? How is that valued for charitable deduction purposes?
Valuing non-cash gifts to charity – that’s the topic of today’s post.
When a charitable contribution of property other than money is made, the amount of the contribution is generally the fair market value (FMV) of the donated property at the time of the donation. Treas. Reg. §1.170A-1(c)(1). What is FMV? It’s “the price at which the property would change hands between a willing buyer and seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.” Treas. Reg. §1.170A-1(c)(2). Sometimes FMV is relatively easy to determine under this standard. Other times, it’s not as easy – especially if the non-cash gift is a unique asset. In that situation, the IRS has two approaches to arrive at FMV: the comparable sales method; and the replacement value of the donated property. In a relatively recent Tax Court case, these valuation approaches to a substantial non-cash donation to charity were on display.
In Gardner v. Comr., T.C. Memo. 2017-165, the petitioner was a big-game hunter that had been on numerous safaris and other big-game hunts around the world. In one two-year period he had been on over 20 safaris. Like many big-game hunters, he provided the meat from his kills to the local community and then had taxidermists prepare the hide for eventual display in the “trophy room” of his home. Some of the displays were full body mounts, others were wall hangings or rugs. These types of displays are the most attractive and desirable in the hunting business. His trophy room was, at one point, featured in a hunting publication, “Trophy Rooms Around the World.”
Ultimately, the petitioner downsized his collection by donating 177 of the “less desirable” pieces in his collection to a charity (an ecological foundation). None of the donated specimens were of “record book” quality. Before making the donation, he had the donated specimens appraised. Based on that FMV appraisal, he claimed a charitable deduction of $1,425,900. That figure was derived from his appraiser’s computation of the replacement cost of each donated item – what it could cost him to replace each item with an item of similar quality. Replacement cost was computed by projecting the out-of-pocket expenses for the petitioner to travel to a hunting site; take part in a safari; kill the animal; remove and preserve the carcass; ship the carcass to the U.S.; and pay for taxidermy services to prepay the specimen for display. The petitioner’s appraiser gave every one of the donated items a quality rating of “excellent” for specimen quality and taxidermy quality. For provenance, the appraiser listed the items as “meager.” The appraiser, however, did not provide any evidence for the rational of why he utilized the replacement cost approach.
On audit, the IRS valued the donated specimens at $163,045 based on their expert’s report. The expert appraiser for the IRS had been a licensed taxidermist for more than 30 years and was a certified appraiser specializing in taxidermy items. He characterized the donated items as mostly “remnants and scraps” of a trophy collection – what’s left over after mounting an animal or “what’s left over when you’re done mounting an animal.” He testified that there was an active market among taxidermists for such items to either complete projects or mount them for their own collections. That market, the IRS expert noted, has been expanded by the internet and allowed a ready determination of market value. Indeed, the IRS expert found 504 comparable sales transactions via traditional auctions and internet auction sites. This wasn’t the situation, the IRS expert asserted, where world-class trophy mounts were involved with a thin to non-existent market (which would support the use of the replacement cost approach). Thus, based on the comparable sale approach, the IRS arrived at the $163,045 value.
The matter ended up in the Tax Court, and the Tax Court first noted that it had previously determined how to value hunting specimens donated to charity in 1992. In Epping v. Comr., T.C. Memo. 1992-279, the Tax Court reasoned that if an active market exists, the general rule is to use comparable sales to arrive at a value of the donated property. The Epping case involved “an assortment of animal mounts, horns, rugs, and antlers.” The Tax Court in that case determined that there was an active market in hunting specimens with substantial comparable sales.” However, the Tax Court also noted that replacement cost is appropriate when the donated property is unique, and no evidence of comparable sales exists. Thus, to be able for a taxpayer to use replacement cost to value the donated items, the taxpayer must show that there is no active market for the comparable items and that there is a correlation between the replacement cost and FMV. That’s a tough hurdle to clear in many situations.
In the present case, the Tax Court, was persuaded by the IRS expert’s testimony that the 177 donated items were neither of “world-class” nor museum quality. Instead, the Tax Court agreed that they were mostly “remnants, leftovers, and scraps” of the petitioner’s collection. In addition, the Tax Court noted that the petitioner’s own testimony indicated that he wanted to “downsize” his collection by getting rid of unwanted items. The Tax Court also noted that photographs of the specimens provided by his expert indicated that the donated specimens were not high quality, and none were of record-book quality. In addition, the Tax Court noted that the IRS expert had established an active market for items similar to those the petitioner donated. Thus, the Tax Court determined that the specimens were commodities rather than collectibles and would be appropriately valued based on the market price for similar items – the IRS approach. To further support the use of the comparable sales approach, the Tax Court concluded that the petitioner did not really attempt to challenge the IRS expert’s data and didn’t introduce any evidence of market prices for comparable items. The petitioner failed to prove that the FMV of the 177 donated items exceeded the $163,045 value that the IRS established.
Valuing non-cash charitable gifts can be tricky. Establishing FMV of the donated property must be backed up with sufficient evidence that supports the valuation approach. Truly unique items that lack a ready market may be able to be valued under the replacement cost approach. A good appraiser goes a long way to making that determination. As the Tax Court stated, “To paraphrase Ernest Hemingway, there is no hunting like the hunting for tax deductions.”
Monday, February 25, 2019
A married couple’s estate planning goals and objectives often dovetail - benefit the surviving spouse for life with the remaining property at the death of the surviving spouse passing to the children. But, estate planning when a second marriage (either as a result of death or divorce) is involved is more complex, especially when each spouse has children from the prior marriage. The estate planning techniques of first marriage situations often don’t work when a second marriage is involved. But, the IRS recently blessed a second marriage estate planning technique.
Estate planning for second marriages – that’s the topic of today’s post.
Second Marriage Estate Plans
Potential problem areas. Blended families are not uncommon. When I first started practicing law, I was tasked with developing an estate plan for an older married couple. Each one of them had outlived their prior spouse and each of them had children from that prior marriage. They each had a separate farming/ranching operation. It was imperative to them that their respective children carry on the farming/ranching business that was associated with each of them. In this situation, the common estate plan for a married couple wouldn’t work. It was no longer appropriate to balance ownership of all assets equally between the couple and then via reciprocal (i.e., mirror) wills leave a portion of the assets to the surviving spouse outright with the balance in a “credit-shelter” trust and the remainder at the death of the surviving spouse split between all of the kids (from both prior marriages). This standard approach could have resulted in children of one family eventually owning the other family’s farming/ranching operation. That would not have been a good result.
It's also common in first marriages for the spouses to own the home and land as joint tenants with right of survivorship. Upon the death of the first spouse, the jointly held asset automatically passes to the surviving spouse. While that results in the surviving spouse having complete ownership of the asset, that is often not a desirable outcome in a second marriage situation. The survivor could leave the asset at death to their children of the first marriage.
Beneficiary designations can also lead to a similar problem as jointly held property. The spouse is often named as the beneficiary of life insurance, retirement plans/accounts, etc. But, this can become a problem upon death and the subsequent remarriage of the surviving spouse.
Potential solution. One approach that is used in second (and subsequent) situations involves a revocable trust that is funded either during the grantor’s life or at death or via beneficiary designations (or some combination). The grantor can amend or revoke the trust at any time before death, and on death the trust becomes irrevocable and continues for the surviving spouse’s benefit and the benefit of the children of the first marriage. The trust income can be paid to the surviving spouse during life and the trust assets remaining at the surviving spouse’s life pass to the grantor’s children of the first marriage. A “spendthrift” provision can be added to the trust to provide additional assurance that the assets ultimately land in the correct hands, and are not dissipated by creditors, etc. In addition, the trust allows the grantor to maintain post-death control over the assets of the family from the first marriage. The assets are not left outright to the surviving spouse of the second marriage, and the surviving spouse cannot change the estate plan to exclusively benefit the survivor’s own children, for example.
Handling Retirement Plans
In second marriage situations, can an individual retirement account (IRA) also be placed in a trust so that account income benefits the surviving spouse of the second marriage for life with the account balance passing to the children of the pre-deceased spouse’s first marriage? The tax code complicates matters, but a recent IRS private letter ruling shows how it can be accomplished.
In general, annual required minimum distributions must be taken from traditional IRAs at the required beginning date (RBD) – April 1 of the year after the year in which the account owner turns 70 ½. I.R.C. §401(a)(9)(C)(i)(l). Special rules apply when the IRA owner dies after the RBD. In that case, any balance remaining in the account is distributed in accordance with certain rules. For example, if the account owner didn’t designate a beneficiary, the post-death payout period is determined by what the deceased owner’s life expectancy was at the time of death. Treas. Reg. §1.401(a)(9)-(5). If the IRA owner named a non-spouse as the beneficiary, the account balance is paid out over the longer of the remining life expectancy of the designated beneficiary or the remaining life expectancy of the IRA owner. Id.
If the IRA owner designated the spouse as the IRA’s sole designated beneficiary, the required distribution for each year after death is determined by the longer of the remining life expectancy of the surviving spouse or the remaining life expectancy of the deceased spouse based on their age at the time of death. Id. This can allow payouts to be “stretched.” But, naming the surviving spouse as the beneficiary of an IRA also gives the surviving spouse the ability to treat the IRA as their own. That means that the surviving spouse can name their own beneficiaries – not necessarily a good result in second marriage situations where each spouse has children of a prior marriage.
Trust as a beneficiary. Can a trust be named the beneficiary of the retirement plan so that the surviving spouse doesn’t have complete control over the account funds? In general, the answer is “no.” Treas. Reg. §1.401(a)(9)-4, Q&A 3. However, a trust beneficiary (with respect to the trust’s interests in the IRA owner’s benefits) is treated as the designated beneficiary of an IRA if certain conditions are satisfied for the period during which the RMDs are being determined by treating the trust beneficiary as the designated beneficiary of the IRA owner. See Treas. Reg. §1.401(a)(9)-4, Q&A 5(b).
Recent IRS ruling. In Priv. Ltr. Rul. 201902023 (Oct. 15, 2018), the decedent created a revocable living trust during life. The trust contained a subtrust to hold the benefits and distributions from his retirement plans (and other assets). He died after attaining his RBD and after distributions from his IRA had started. The revocable trust and the subtrust became irrevocable upon his death. His IRA named the trust as the beneficiary. The terms of the trust specified that property held by the subtrust were to be “held, administered, and distributed” for the sole benefit of his (younger) surviving spouse. Upon her death, the trust specified that the retirement plan (along with the remaining assets of the subtrust) were to be divided equally between his children or their descendants.
The IRS noted that the trust identified the surviving spouse as the sole beneficiary of the subtrust in accordance with Treas. Reg. §1.401(a)(9)-4, Q&A 5(b)(3). In addition, the trust required the trustee to pay the surviving spouse any and all funds in the subtrust that the trustee withdrew, including RMDs, and there could be no accumulation for any other beneficiary. That satisfied the requirements of Treas. Reg. §1.401(a)(9)-4, Q&A-5 (valid trust under state law; trust is irrevocable or becomes so on death of account owner; the trust identifies the beneficiary; and the plan administrator is given appropriate documentation) and the surviving spouse was treated as the sole designated beneficiary of the IRA. Thus, the IRS concluded that the payment to the two trusts (first to the revocable trust and then to the subtrust) was permitted by Treas. Reg. §1.401(a)(9)-4. Q&A-5(d) which says that if the trust beneficiary is named as the beneficiary of the account owner’s interest in another trust, that beneficiary will be treated as having been designated as the beneficiary of the first trust and, be deemed to be the IRA account owner for distribution purposes.
In addition, the IRS determined that because the surviving spouse had a longer life expectancy that did the decedent, the applicable distribution period for the IRA should be based on her life expectancy. This means that via the trust and the subtrust, the surviving spouse received RMDs as if she were the designated sole beneficiary. Upon her death, any remaining assets of the subtrust will be distributed to the pre-deceased spouse’s children or their descendants.
Unique estate and business planning issues present themselves in second marriage situations. Along with a well-drafted marital agreement, other steps should be taken to ensure the continued viability of separate farming/ranching operations that are brought into the subsequent marriage while simultaneously benefiting each spouse’s children of the prior marriages appropriately at the death of their respective parent. Included in this planning is the treatment of retirement accounts. The recent IRS ruling illustrates one way to leave an IRA to the spouse of a second marriage and avoid negative consequences.
Tuesday, February 5, 2019
Last summer, the U.S. Supreme Court decided South Dakota v. Wayfair, 138 S. Ct. 2080 (2018), where the court upheld South Dakota’s ability to collect taxes from online sales by sellers with no physical presence in the state. That decision was the latest development in the Court’s 50 years of precedent on the issue, and I wrote on the issue here: https://lawprofessors.typepad.com/agriculturallaw/2018/06/state-taxation-of-online-sales.html
Does the Supreme Court’s opinion mean that a state can tax trust income that a beneficiary receives where the only contact with the state is that the beneficiary lives there? It’s an issue that is presently before the U.S. Supreme Court. It’s also the topic of today’s post – the ability of a state to tax trust income when the trust itself has no contact with the taxing state.
The “Nexus” Requirement
Article I, Section 8 of the U.S. Constitution says that, “The Congress shall have the power...to regulate commerce…among the several states…”. That is a rather clear statement – the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States.” As I pointed out in the blog post on the Wayfair decision last summer, a state tax will be upheld when applied to an activity that meets several requirements: the activity must have a substantial nexus with the state; must be fairly apportioned; must not discriminate against interstate commerce, and; must be fairly related to the services that the state provided. Later, the U.S. Supreme Court said that a physical presence was what satisfied the substantial nexus requirement.
The physical presence requirement to establish nexus was at issue in Wayfair and the Court determined that a “substantial nexus” could be present without the party subjected to tax having a physical presence in the taxing jurisdiction. But, the key point is that the “substantial nexus” must be present. Likewise, the other three requirements of prior U.S. Supreme Court precedent remain – the tax must be fairly apportioned; it must not discriminate against interstate commerce, and; it must be fairly related to services that the state provides. In other words, taxing a business without a physical presence in the state cannot unduly burden interstate commerce. The Wayfair majority determined that the South Dakota law satisfied these tests because of the way it was structured – limited application (based on transactions or dollars of sales); not retroactive; the state was a member of the Streamlined Sales and Use Tax Agreement; the sellers at issue were national businesses with a large online presence; and South Dakota provided tax software to ease the administrative burden.
Taxing an Out-Of-State Trust?
The U.S. Supreme Court has now decided to hear a case from North Carolina involving that state’s attempt to tax a trust that has no nexus with the state other than the fact that a trust beneficiary is domiciled there. Kimberley Rice Kaestner Trust 1992 Family Trust v. North Carolina Department of Revenue, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff'd., 814 S.E.2d 43 (N.C. 2018), pet. for cert. granted, No. 18-457, 2019 U.S. LEXIS 574 (U.S. Sup. Ct. Jan. 11, 2019). The trust at issue, a revocable living trust, was created in 1992 with a situs of New York. The primary beneficiaries were the settlor’s descendants. None of the descendants lived in North Carolina at the time of the trust’s creation. The trust was divided into three separate trusts in 2002, one for each of the settlor’s children. The beneficiary of one of the sub-trusts was a North Carolina resident at that time. The trustee was replaced in 2005 with a successor trustee who resided in Connecticut. North Carolina tax returns were filed for tax years 2005-2008 for the accumulated trust income, that was distributed to the beneficiaries, including the non-North Carolina beneficiaries. In 2009, the trust filed a claim for a refund of North Carolina taxes in an amount slightly exceeding $1.3 million. The trust claimed that N.C. Gen. Stat. §105-160.2, which assesses tax on the amount of taxable income of the estate or trust that is for the benefit of a North Carolina resident, was unconstitutional on due process and Commerce Clause grounds. The defendant denied the claim, and the hearing officer later dismissed the case for lack of jurisdiction.
The trial court dismissed the request for injunctive relief with respect to the refund claim, but denied the defendant’s motion to dismiss the constitutional claims. The trial court then granted summary judgment for the trust on the constitutional claim and ordered the defendant to refund the taxes paid on its accumulated income.
On appeal, the appellate court affirmed. The appellate court determined that the trust failed to have sufficient minimum contacts (as required by the Due Process Clause) with North Carolina to subject the trust to North Carolina income tax. The court cited both International Shoe Co. v. Washington, 326 U.S. 310 (1945) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992) to support its position on this point. The trust did not have any physical presence in the state during the tax years at issue, contained no North Carolina property or investments, had no trust records that were created or kept in North Carolina, and the place of trust administration was not in North Carolina. Basing the imposition of state tax on a beneficiary’s domicile, by itself, did not establish sufficient minimum contacts with the state to satisfy the Due Process Clause and allow North Carolina to tax a non-North Carolina trust. The appellate court held that Brooke v. Norfolk, 277 U.S. 27 (1928) was controlling. In that case, a Maryland resident created a testamentary trust with a Maryland situs for a Virginia beneficiary. Virginia assessed tax on the trust corpus, but the Court held the assessment to be unconstitutional.
On further review, the state Supreme Court affirmed, also noting that a key to the case was that the trust beneficiary did not receive trust distributions during the years at issue. As such, the North Carolina statute violated the Due Process Clause of the U.S. Constitution.
The North Carolina Supreme Court’s decision was delivered 13 days before the U.S. Supreme Wayfair decision, and was based on the controlling U.S. Supreme Court decision at that time – Quill. Consequently, the North Carolina Department of Revenue, based on Wayfair, sought U.S. Supreme Court review. On January 11, 2019, the U.S. Supreme Court agreed to hear the case.
State taxation of trusts varies greatly from state to state in those states that have a state income tax. A trust’s situs in a state certainly permits that state to subject the trust to the state’s income tax as a resident. But, a trust may be tied to a state in other ways via a grantor, trustee, assets, or a beneficiary. In addition, whether a trust is a revocable or irrevocable trust can make a difference. For instance, the Illinois definition of “resident” includes “an irrevocable trust the grantor of which was domiciled in this State at the time such trust became irrevocable.” 35 ILCS/1501(A)(20)(D); see also, Linn v. Department of Revenue, 2 N.E.3d 1203 (Ill. Ct. App. 2013). Indeed, a trust may have multiples states asserting tax on the trust’s income.
However, due process requires that before a state can tax a trust’s income, the trust must have a substantial enough connection (e.g., nexus) with the state. How the U.S. Supreme Court decides the North Carolina case in light of its Wayfair decision will be interesting. It’s a similar issue but, income tax is involved rather than sales or use tax. In my post last summer (noted above) I discussed why that difference could be a key distinction. In addition, while a trust could be subject to state income tax based on its residency, the trust has grantors and trustees and beneficiaries and assets that can all be located in different states – and can move from state-to-state (at least to a degree).
The U.S. Supreme Court decision will have implications for trust planning as well as estate and business planning. Siting a trust in a state without an income tax (and no rule against perpetuities) is looking better each day.
Friday, February 1, 2019
The laws surrounding estate planning have changed significantly in recent years and have done so multiple times. That means that it might be a good idea to review wills, trusts and associated estate planning documents to make sure they still will function as intended at the time of death.
But, just exactly what should be looked for that might need to be modified? One item is clause language in a will or trust that is now outdated because of the current federal estate tax exemption that is presently much higher than it has been in prior years.
That’s the topic of today’s post – the need to review and modifying (when necessary) clause language in a will or trust that no longer will work as anticipated because of the increase in the federal estate tax exemption.
Common Will and Trust Language
Wills and trusts that haven’t been examined in the last five to seven years should be reviewed to determine if pecuniary bequests, percentage allocations and formula clauses will operate as desired upon death. For example, if will or trust language refers to the “Code” and/or uses Code definitions for transfer tax purposes, or otherwise refers to the Code to carry out bequests, that language may now produce a result that no longer is consistent with the testator’s intent.
Common language used in wills and trust to split out shares to a surviving spouse in “marital deduction” and “credit shelter” amounts often refers to the “Code.” In other words, the split of the shares is tied to the amount of the federal estate tax exemption at the time of the testator’s death. This results in an automatic adjustment of the marital deduction portion of the first spouse’s estate (as well as the credit shelter amount) in accordance with the value of the federal estate tax exemption at the time of the decedent’s death.
Why is such language an issue? For starters, it could result in nothing being left outright to a surviving spouse. For example, a clause that leaves a surviving spouse “the minimum amount needed to reduce the federal estate tax to zero” with the balance passing to the spouse in life estate form could result in nothing passing outright to the surviving spouse in marital deduction form. That would be the case, for example, with respect to an estate that is not large enough to incur federal estate tax. Presently, the threshold for estate taxability at the federal level is a taxable estate of $11.4 million which means that very few estates will be large enough to incur federal estate tax. For nontaxable estates, the formula language that was designed to minimize estate tax by splitting the bequests to the surviving spouse between marital property and life estate property no longer works - surviving spouse would receive nothing outright.
On the other hand, a beneficiary of an estate that is not subject to federal estate tax would receive everything under a provision that provides that the beneficiary receives “the maximum amount that can pass free of federal estate tax.”
Formula clause language. As can be surmised from above, a common estate planning approach for a married couple facing the possibility of at least some estate tax upon either the death of the first spouse or the surviving spouse has been for the estate of the first spouse to be split into a marital trust and a credit shelter (bypass) trust. To implement this estate planning technique, the couple’s property is typically re-titled, if necessary, to roughly balance the estates (in terms of value) so that the order of death of the spouses becomes immaterial from a federal estate tax standpoint. This necessarily requires the severance of joint tenancy property. Estate “balancing” between the spouses is critical where combined spousal wealth is between one and two times the amount of the federal estate tax exemption. For many years that range was between $600,000 and $1.2 million. Then the ranged ratcheted upward to between $3 million and $6 million. It then moved upward again to a range of $5 million to $10 million. Now it is a range of $11.4 million to $22.8 million.
What formula clause language does is cause the trusts to be split in accordance with a formula that funds the credit shelter trust with the deceased spouse’s unused exemption, and funds the marital trust with the balance of the estate. As indicated above, the increase in the exemption can cause, a complete “defunding” of the surviving spouse’s marital trust and an “over stuffing” of the credit shelter trust. That may not be what the decedent had planned to occur. For instance, here’s a sample of language to be on the lookout for:
“To my Trustee…that fraction of my residuary estate of which the numerator shall be a sum equal to the largest amount, after taking into account all allowable credits and all property passing in a manner resulting in a reduction of the Federal Estate Tax Unified Credit available to my estate, that can pass free of Federal Estate Tax and the denominator of which shall be the total value of my residuary estate
For the purpose of establishing such fraction the values finally fixed in the Federal Estate Tax proceeding in my estate shall control.
The residue of my estate after the satisfaction of the above devise, I devise to my spouse; provided that, any property otherwise passing under this subparagraph which shall be effectively disclaimed or renounced by my spouse under the provisions of the governing state law or the Internal Revenue Code shall pass under the provisions of paragraph…”.
To reiterate, while the above language typically worked well with federal estate tax exemption levels much lower than the current $11.4 million amount, the language can now result in an “over-stuffed” credit shelter trust (and related de-funding of the marital trust).
Consider the following example:
John and Mary, a married couple, had a combined spousal wealth of $3 million in 2001 at a time when the exclusion from the estate tax was $1 million. As part of the estate planning process, they re-titled their assets and balanced the value of the assets between them to eliminate problems associated with the order of their deaths. Assuming John dies first with a taxable estate of $1.5 million, the clause would result in $1 million passing to the bypass trust and $500,000 passing outright to Mary in the marital trust created by the residuary language. Upon Mary’s subsequent death, her estate would consist of her separate $1.5 million (assuming asset values have not changed) and the $500,000 passing outright to her under the terms of John’s will. With a $1 million exclusion, only $1 million would be subject to the federal estate tax.
With the present $11.4 million exclusion, the clause would result in John’s entire estate passing to the bypass trust, and nothing passing outright to Mary as part of the marital trust. While the couple’s estate value is not large enough to trigger an estate tax problem, it would be better to have some of the property that the clause caused to be included in the bypass trust be included in Mary’s estate so that it could receive an income tax basis equal to the date of death value. With the present $11.4 million exclusion, all of John’s property could be left outright to Mary and added to her separate property with the result that Mary’s estate would still not be subject to federal estate tax. But, all of the property would be included in her estate at death and the heirs would receive an income tax basis equal to the fair market value at the time of Mary’s death.
Charitable bequests. The same problem with formula clause language applies to many charitable bequests that are phrased in terms of a percentage of the “adjusted gross estate” or establish a floor or ceiling based on the extent of the “adjusted gross estate.”
The standard advice has been to routinely revisit existing estate planning documents every couple of years. Not only does the law change, but family circumstances can change and goals and objectives can change. But, the rules surrounding estate planning have been modified several times in recent years which means that plan should be revisited even more frequently.
One final thought. The current rules sunset at the end of 2025 and then revert back to the rules in play in 2018. That means that the estate tax exemption would go back to $5 million plus inflation adjustments. So, just because federal estate tax might not be a problem for a particular estate, that doesn’t mean that estate planning can be ignored. Reviewing wills and trusts for outdated language is important, but overall objectives should be reviewed and related documents such as financial and health care powers of attorney should be executed or modified as necessary.
The bottom line - there remain numerous reasons for seeing an estate planning attorney for a review of estate planning documents. Examining drafting language in older wills and trusts is just one of them.
Monday, January 14, 2019
I will be doing an early tax season 2-hour continuing education event in February, and the date is set for Washburn Law School’s summer ag tax and estate/business planning conference. These events are the topic of today’s post – tax season CLE/CPE and summer seminar.
Tax Season Seminar/Webinar
The Tax Cuts and Jobs Act (TCJA) enacted in late 2017, has dramatically changed the computation of taxable income and tax liability. One result of this tax reform is that practically all farmers and ranchers will see a lower tax liability. One of the primary reasons for this, at least for sole proprietorships and pass-through entities is the 20 percent qualified business income deduction (QBID). Depreciation rules also have changed significantly as have the rules surrounding like-kind exchanges. Indeed, the disallowance of like-kind exchange treatment for post-2017 trades of personal property also has self-employment tax implications that must be accounted for. There are also numerous other provisions that can impact the tax return including changes in various credits, the doubling of the standard deduction, the elimination of many itemized deductions, changes to loss limitation rules and changes to methods of accounting.
On February 8, 2019, I will be conducting a 2-hour CLE/CPE from noon to 2 p.m. (cst). The seminar will be held live at the law school and will also be simulcast over the web. I will cover the latest changes to IRS forms, Treasury Regulations, and any other last-minute developments impacting the filing of returns during the 2019 filing season. Hopefully, the QBID final regulations will be released before the seminar in time to allow analysis and comment. They are due to be released by January 28 but could be released before then unless the partial government shut-down causes a delay. In any event, attendees will get the latest update of what is necessary to know for filing 2018 returns.
For more information about the February 8 event, click here: http://washburnlaw.edu/employers/cle/taxseasonupdate.html
To register click here: http://washburnlaw.edu/employers/cle/taxseasonupdateregister.html
2019 Summer Seminar
Washburn Law School’s rural law program in conjunction with the Department of Agricultural Economics at Kansas State University will be hold it’s 2019 summer farm income tax and estate/business planning seminar in Steamboat Springs, Colorado on August 13 and 14 at the Grand Hotel. On August 13 myself and Paul Neiffer will be addressing key farm income tax planning concepts, particularly how the final regulations under I.R.C. §199A apply in the farm/ranch context. On August 14, myself and others will be addressing important estate and business planning principles that can be applied to farm and ranch estates.
The summer seminar is also being co-sponsored by WealthCounsel, a network of estate and business planning attorneys that provide educational seminars and an automated drafting system, among other things.
Hold the date for the summer seminar and be watching for further details. If you aren’t able to attend in person, the seminar will be live simulcast over the web.
2019 will be another very busy year on the ag tax and estate/business planning front. I hope to see you at any event somewhere along the road.
Monday, December 31, 2018
2018 was a big year for developments in law and tax that impact farmers, ranchers, agribusinesses and the professionals that provide professional services to them. It was also a big year in other key areas which are important to agricultural production and the provision of food and energy to the public. For example, carbon emissions in the U.S. fell to the lowest point since WWII while they rose in the European Union. Poverty in the U.S. dropped to the lowest point in the past decade, and the unemployment rate became the lowest since 1969 with some sectors reporting the lowest unemployment rate ever. The Tax Cuts and Jobs Act (TCJA) doubles the standard deduction in 2018 compared to 2017, which will result additional persons having no federal income tax liability and other taxpayers (those without a Schedule C or F business, in particular) having a simplified return. Wages continued to rise through 2018, increasing over three percent during the third quarter of 2018. This all bodes well for the ability of more people to buy food products and, in turn, increase demand for agricultural crop and livestock products. That’s good news to U.S. agriculture after another difficult year for many commodity prices.
On the worldwide front, China made trade concessions and pledged to eliminate its “Made in China 2025” program that was intended to put China in a position of dominating world economic production. The North-Korea/South Korea relationship also appears to be improving, and during 2018 the U.S. became a net exporter of oil for the first time since WWII. While trade issues with China remain, they did appear to improve as 2018 progressed, and the USDA issued market facilitation payments (yes, they are taxed in the year of receipt and, no, they are not deferable as is crop insurance) to producers to provide relief from commodity price drops as a result of the tariff battle.
So, on an economic and policy front, 2019 appears to bode well for agriculture. But, looking back on 2018, of the many ag law and tax developments of 2018, which ones were important to the ag sector but just not quite of big enough significance nationally to make the “Top Ten”? The almost Top Ten – that’s the topic of today’s post.
The “Almost Top Ten” - No Particular Order
Syngenta litigation settles. Of importance to many corn farmers, during 2018 the class action litigation that had been filed a few years ago against Syngenta settled. The litigation generally related to Syngenta's commercialization of genetically-modified corn seed products known as Viptera and Duracade (containing the trait MIR 162) without approval of such corn by China, an export market. The farmer plaintiffs (corn producers), who did not use Syngenta's products, claimed that Syngenta's commercialization of its products caused the genetically-modified corn to be commingled throughout the corn supply in the United States; that China rejected imports of all corn from the United States because of the presence of MIR 162; that the rejection caused corn prices to drop in the United States; and that corn farmers were harmed by that market effect. In April of 2018, the Kansas federal judge handling the multi-district litigation preliminarily approved a nationwide settlement of claims for farmers, grain elevators and ethanol plants. The proposed settlement involved Syngenta paying $1.5 billion to the class. The class included, in addition to corn farmers selling corn between September of 2013 and April of 2018, grain elevators and ethanol plants that met certain definition requirements. Those not opting out of the class at that point are barred from filing any future claims against Syngenta arising from the presence of the MIR 162 trait in the corn supply. Parties opting out of the class can't receive any settlement proceeds, but can still file private actions against Syngenta. Parties remaining in the class had to file claim forms by October of 2018. The court approved the settlement in December of 2018, and payments to the class members could begin as early as April of 2019.
Checkoff programs. In 2018, legal challenges to ag “checkoff” programs continued. In 2017, a federal court in Montana enjoined the Montana Beef Checkoff. In that case, Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, No. CV-16-41-GF-BMM, 2017 U.S. Dist. LEXIS 95861 (D. Mont. Jun. 21, 2017), the plaintiff claimed that the federal law requiring funding of the Montana Beef Council (MBC) via funds from the federal beef checkoff was unconstitutional. The Beef Checkoff imposes a $1.00/head fee at the time cattle are sold. The money generated funds promotional campaigns and research, and state beef councils can collect the funds and retain half of the collected amount with the balance going to the Cattleman’s Beef Production and Research Board (Beef Board). But, a producer can direct that all of the producer’s assessment go to the Beef Board. The plaintiff claimed that the use of the collected funds violated their First Amendment rights by forcing them to pay for “speech” with which they did not agree. The defendant (USDA) motioned to dismiss, but the Magistrate Judge denied the motion. The court determined that the plaintiffs had standing, and that the U.S. Supreme Court had held in prior cases that forcing an individual to fund a private message that they did not agree with violated the First Amendment. Any legal effect of an existing “opt-out” provision was not evaluated. The court also rejected the defendant’s claim that the case should be delayed until federal regulations with respect to the opt-out provision was finalized because the defendant was needlessly dragging its heels on developing those rules and had no timeline for finalization. The court entered a preliminary injunction barring the MBC from spending funds received from the checkoff. On further review by the federal trial court, the court adopted the magistrate judge’s decision in full. The trial court determined that the plaintiff had standing on the basis that the plaintiff would have a viable First Amendment claim if the Montana Beef Council’s advertising involves private speech, and the plaintiff did not have the ability to influence the advertising of the Montana Beef Council. The trial court rejected the defendant’s motion to dismiss for failure to state a claim on the basis that the court could not conclude, as a matter of law, that the Montana Beef Council’s advertisements qualify as government speech. The trial court also determined that the plaintiff satisfied its burden to show that a preliminary injunction would be appropriate.
The USDA appealed the trial court’s decision, but the U.S. Court of Appeals for the Ninth Circuit affirmed the trial court in 2018. Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, 718 Fed. Appx. 541 (9th Cir. 2018). Later in 2018, as part of the 2018 Farm Bill debate, a provision was proposed that would have changed the structure of federal ag checkoff programs. It did not pass, but did receive forty percent favorable votes.
GIPSA rules withdrawn. In the fall of 2016, the USDA sent to the Office of Management and Budget (OMB) an interim final rule and two proposed regulations setting forth the agency’s interpretation of certain aspects of the Packers and Stockyards Act (PSA) involving the buying and selling of livestock and poultry. The proposals generated thousands of comments, with ag groups and producers split in their support. The proposals concern Section 202 of the PSA (7 U.S.C. §§ 192 (a) and (e)) which makes it unlawful for any packer who inspects livestock, meat products or livestock products to engage in or use any unfair, unjustly discriminatory or deceptive practice or device, or engage in any course of business or do any act for the purpose or with the effect of manipulating or controlling prices or creating a monopoly in the buying, selling or dealing any article in restraint of commerce. The “effect” language of the statute would seem to eliminate any requirement that the producer show that the packer acted with the intent to control or manipulate prices. However, the federal courts have largely interpreted the provision to require a plaintiff to show an anti-competitive effect in order to have an actionable claim.
The interim final rule and the two proposed regulations stemmed from 2010. In that year, the Obama administration’s USDA issued proposed regulations providing guidance on the handling of antitrust-related issues under the PSA. 75 Fed. Reg. No. 119, 75 FR 35338 (Jun. 22, 2010). Under the proposed regulations, "likelihood of competitive injury" was defined as "a reasonable basis to believe that a competitive injury is likely to occur in the market channel or marketplace.” It included, but was not limited to, situations in which a packer, swine contractor, or live poultry dealer raises rivals' costs, improperly forecloses competition in a large share of the market through exclusive dealing, restrains competition, or represents a misuse of market power to distort competition among other packers, swine contractors, or live poultry dealers. It also includes situations “in which a packer, swine contractor, or live poultry dealer wrongfully depresses prices paid to a producer or grower below market value, or impairs a producer's or grower's ability to compete with other producers or growers or to impair a producer's or grower's ability to receive the reasonably expected full economic value from a transaction in the market channel or marketplace." According to the proposed regulations, a “competitive injury” under the PSA occurs when conduct distorts competition in the market channel or marketplace. The scope of PSA §202(a) and (b) was stated to depend on the nature and circumstances of the challenged conduct. The proposed regulations specifically noted that a finding that a challenged act or practice adversely affects or is likely to affect competition is not necessary in all cases. The proposed regulations also specified that a PSA violation could occur without a finding of harm or likely harm to competition, contrary to numerous court opinions on the issue.
On April 11, 2017, the USDA announced that it was delaying the effective date of the interim final rule for 180 days, until October 19, 2017, with the due date for public comment set at June 12, 2017. However, on October 17, 2017, the USDA withdrew the interim rule. The withdrawal of the interim final rule and two proposed regulations was challenged in court. On December 21, 2018, the U.S. Court of Appeals for the Eighth Circuit denied review of the USDA decision. In Organization for Competitive Markets v. United States Department of Agriculture, No. 17-3723, 2018 U.S. App. LEXIS 36093 (8th Cir. Dec. 21, 2018), the court noted that the USDA had declined to withdraw the rule and regulations because the proposal would have generated protracted litigation, adopted vague and ambiguous terms, and potentially bar innovation and stimulate vertical integration in the livestock industry that would disincentivize market entrants. Those concerns, the court determined, were legitimate and substantive. The court also rejected the plaintiff’s argument that the court had to compel agency action. The matter, the court concluded, was not an extraordinary situation. Thus, the USDA did not unlawfully withhold action.
No ”clawback.” In a notice of proposed rulemaking, the U.S Treasury Department eliminated concerns about the imposition of an increase in federal estate tax for decedents dying in the future at a time when the unified credit applicable exclusion amount is lower than its present level and some (or all) of the higher exclusion amount had been previously used. The Treasury addressed four primary questions. On the question of whether pre-2018 gifts on which gift tax was paid will absorb some or all of the 2018-2025 increase in the applicable exclusion amount (and thereby decrease the amount of the credit available for offsetting gift taxes on 2018-2025 gifts), the Treasury indicated that it does not. As such, the Treasury indicated that no regulations were necessary to address the issue. Similarly, the Treasury said that pre-2018 gift taxes will not reduce the applicable exclusion amount for estates of decedents dying in years 2018-2025.
The Treasury also stated that federal gift tax on gifts made after 2025 will not be increased by inclusion in the tax computation a tax on gifts made between 2018 and 2015 that were sheltered from tax by the increased applicable exclusion amount under the TCJA. The Treasury concluded that this is the outcome under current law and needed no regulatory “fix.” As for gifts that are made between 2018-2025 that are sheltered by the applicable exclusion amount, the Treasury said that those amounts will not be subject to federal estate tax in estates of decedents dying in 2026 and later if the applicable exclusion amount is lower than the level it was at when the gifts were made. To accomplish this result, the Treasury will amend Treas. Reg. §20.2010-1 to allow for a basic exclusion amount at death that can be applied against the hypothetical gift tax portion of the estate tax computation that is equal to the higher of the otherwise applicable basic exclusion amount and the basic exclusion amount applied against prior gifts.
The Treasury stated that it had the authority to draft regulations governing these questions based on I.R.C. §2001(g)(2). The Treasury, in the Notice, did not address the generation-skipping tax exemption and its temporary increase under the TCJA through 2025 and whether there would be any adverse consequences from a possible small exemption post-2025. Written and electronic comments must be received by February 21, 2019. A public hearing on the proposed regulations is scheduled for March 13, 2019. IRS Notice of Proposed Rulemaking, REG-106706-18, 83 FR 59343 (Nov. 23, 2018).
These were significant developments in the ag law and tax arena in 2018, but just not quite big enough in terms of their impact sector-wide to make the “Top Ten” list. Wednesday’s post this week will examine the “bottom five” of the “Top Ten” developments for 2018.
December 31, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Thursday, November 15, 2018
Upon death, the typical process is for someone to be appointed to handle the administration of the decedent’s estate. Once the administrator is appointed, a court-governed process is set in motion that includes providing notice to known and unknown creditors of the estate by means of publishing notice and providing actual notice to known creditors or those that could reasonable be determined to be creditors. Once notice is provided, the creditors have only a few months (usually less than six) to present their claims against the estate for payment.
Does that same timeline on presenting claims apply to the IRS? The ability of the IRS to collect on an unpaid tax claim against a decedent’s estate – that’s the topic of today ‘s post.
As an example, Kansas law specifies that “[E]very petitioner who files a petition for administration or probate of a will shall give notice thereof to creditors, pursuant to an order of the court, and within 10 days after such filing. K.S.A. 59-709(a). The notice is to be “to all persons concerned” and shall state the filing date of the petition for administration or probate of a will. The notice must be published three consecutive weeks and is to be actually be given to “known or reasonably ascertainable creditors” (those discovered by searching reasonably available public records) before expiration of the four-month period for filing claims. K.S.A. 59-709(b). Mere conjectural claims are not entitled to actual notice. Impracticable and extended searches for creditors are not required. If proper notice is not given, the personal representative and the heirs may be liable.
Timeframe For Filing Claims
As noted above, under Kansas law, the creditors have a four-month period to file their claims. That four-month timeframe runs from the time that notice is first published to creditors. However, with respect to the IRS, it has a 10-year collection period that runs from the date it assesses tax. I.R.C. §6502(a)(1). This provision says that the IRS can collect the unpaid tax by either levy or by a court proceeding begun within 10 years after the tax is assessed.
The ability of the IRS to collect unpaid tax from a decedent’s estate and the application of the 10-year statute was at issue in a recent case. In United States v. Estate of Chicorel, No. 17-2321, 2018 U.S. App. LEXIS 30069 (6th Cir. Oct. 25, 2018), the IRS was seeking to collect on an income tax assessment that it had made more than 10 years earlier. Under the facts of the case, the IRS assessed tax of $140,903.52 on September 12, 2005 for the 2002 tax year. The tax didn’t get paid before the decedent died in the fall of 2006. In early 2007, the decedent’s nephew was appointed the estate's personal representative, and he published a notice to creditors (in accordance with Michigan law) of the four-month deadline for presenting claims. However, he did not mail the notice to the IRS even though he knew of the unpaid tax liability. In early 2009, the IRS filed a proof of claim in the ongoing probate proceeding. The nephew didn’t respond, and the IRS filed a collections proceeding in early 2016 attempting to reduce the 2005 tax assessment to judgment. The estate claimed that the claim was filed too late, but the trial court held that the filing in 2009 of the proof of claim was a “court proceeding” as required by I.R.C. §6502(a)(1). Thus, because it was filed within 10 years from the date the tax was assessed, the IRS could collect the tax outside the 10-year window.
On appeal, the appellate court affirmed. The appellate court noted that whether a proof of claim is a "proceeding in court" is a question of federal law that turns on the nature, function, and effect of the proof of claim under state law. See United States v. Silverman, 621 F.2d 961 (9th Cir. 1980); United States v. Saxe, 261 F.2d 316 (1st Cir. 1958). That meant that the appellate court had to look at how Michigan treated the filing of a proof of claim in a probate proceeding and whether it qualified as a “court proceeding” under I.R.C. §6502(a). The appellate court noted that the nature, function, and effect of a proof of claim in Michigan had significant legal consequences for the creditor, the estate, and for Michigan law generally. Because of this, the appellate court held that the filing of the proof of claim qualified as a proceeding in court under I.R.C. §6502(a). The appellate court noted that the Michigan probate code specifies that "[f]or purposes of a statute of limitations, the proper presentation of a claim . . . is equivalent to commencement of a proceeding on the claim." Mich. Comp. Laws. §700.3802(3). Thus, the filing of the proof of claim not only tolled the statute of limitations, it constituted a “proceeding” that required the decedent’s estate to take action – either providing notice that the claim is disallowed or allowed. The filing of the proof of claim started a process whereby the claim would eventually be dealt with one way or the other. The appellate court also noted that the executor failed to give actual notice to the IRS to present its claim because it was a known creditor of the estate. That failure excused the IRS from filing the claim within the four-month window after notice was first published and extended that deadline to three years from the date of the decedent’s death. Thus, the IRS had timely filed its proof of claim.
The appellate court also determined that the filing of the proof of claim was timely under I.R.C. §6502(a). That statute, the court held, is satisfied once the government started any timely proceeding in court. Because that requirement was satisfied, the IRS has an unlimited amount of time to enforce the assessed tax. The appellate court noted that I.R.C. §6502(a) focuses on the ability of the IRS to collect assessments. While it does not permit the IRS to let an assessed tax lie dormant and then attempt to collect the tax way at some far off future date, once a timely collection action has been filed, the IRS can collect the tax beyond the 10-year timeframe. See United States v. Weintraub, 613 F.2d 612 (6th Cir. 1979). The appellate court noted that the IRS filed its proof of claim in 2009 which was well within the 10-year limitations period for the 2005 assessment. That filing constituted a “proceeding in court” under I.R.C. §6502(a) in satisfaction of that provision’s 10-year requirement. There was no further time bar on the ability of the IRS to collect. The is not requirement that a “judgment” be reached in the proceeding within that 10-year time frame, and the ability of the IRS to collect did not expire until the tax liability is satisfied or becomes unenforceable.
While in just about every situation a creditor must present its claim against a decedent’s estate within a short time-frame post-death, the rules governing the ability of the IRS to collect on an unpaid tax liability from a decedent’s estate are different. Once the IRS timely files its claim in the probate proceeding, it remains a creditor until the tax is paid. It also may not be barred by state law statute of limitations if it doesn’t timely file a claim against an estate. See, Board of Comm'rs of Jackson County v. United States, 308 US 343 (1939); United States v. Summerlin, 310 US 414 (1940) .
Is the executor personally liable for the tax? Perhaps. But, I.R.C. §6905(a) does provide a procedure for the executor to escape personal liability if doing so would not impact the liability of the decedent’s estate.
Just another one of the quirks about tax law and the IRS. It’s helpful to know. As Benjamin Franklin stated in 1789, “In this world nothing can be said to be certain, except death and taxes.”
Thursday, October 18, 2018
For the Spring 2019 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.
Details of next spring’s online Ag Law course – that’s the topic of today’s post.
The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?
Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.
Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.
Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate. A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?
Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.
Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.
Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.
Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.
Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.
Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.
Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.
Further Information and How to Register
Information about the course is available here:
You can also find information about the text for the course at the following link (including the Table of Contents and the Index):
If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution. Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.
If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.
I hope to see you in January!
Checkout the postcard (401 KB PDF) containing more information about the course and instructor.
October 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, October 10, 2018
The changes made by the Tax Cuts and Jobs Act (TCJA) for tax years beginning after 2017 could have a significant impact on charitable giving. Because of changes made by the TCJA, it is now less likely that any particular taxpayer will itemize deductions. Without itemizing, the tax benefit of making charitable deductions will not be realized. This has raised concerns by many charities.
Are there any tax planning strategies that can be utilized to still get the tax benefit from charitable deductions? There might be. One of those strategies is the donor-advised fund.
Using a donor-advised fund for charitable giving post-TCJA – that’s the topic of today’s post.
A taxpayer gets the tax benefit of charitable deductions by claiming them on Schedule A and itemizing deductions. However, the TCJA eliminates (through 2025) the combined personal exemption and standard deduction and replaces them with a higher standard deduction ($12,000 for a single filer; $24,000 for a couple filing as married filing jointly). The TCJA also either limits (e.g., $10,000 limit on state and local taxes) or eliminates other itemized deductions. As a result, it is now less likely that a taxpayer will have Schedule A deductions that exceed the $12,000 or $24,000 amount. Without itemizing, the tax benefit of charitable deductions is lost. This is likely to be particularly the case for lower and middle-income taxpayers.
One strategy to restore the tax benefit of charitable giving is to bundle two years (or more) of gifts into a single tax year. Doing so can cause the total amount of itemized deductions to exceed the standard deduction threshold. Of course, this strategy results in the donor’s charities receiving a nothing in one year (or multiple years) until the donation year occurs.
A better approach than simple bundling (or bunching) of gifts might be to contribute assets to a donor-advised fund. It’s a concept similar to that of bundling, but by means of a vehicle that provides structure to the bundling concept, with greater tax advantages. A donor-advised fund is viewed as a rather simple charitable giving tool that is versatile and affordable. What it involves is the contribution of property to a separate fund that a public charity maintains. That public charity is called the “sponsoring organization.” The donor retains advisory input with respect to the distribution or investment of the amounts held in the fund. The sponsoring organization, however, owns and controls the property contributed to the fund, and is free to accept or reject the donor’s advice.
While the concept of a donor-advised fund has been around for over 80 years, donor-advised funds really weren’t that visible until the 1980s. Today, they account for approximately 4-5 percent of charitable giving in the United States. Estimates are that over $150 billion has been accumulated in donor advised funds over the years. Because of their flexibility, ease in creating, and the ability of donors to select from pre-approved investments, donor advised funds outnumber other type of charitable giving vehicles, including the combined value included in charitable remainder trusts, charitable remainder annuity trusts, charitable lead trusts, pooled income funds and private foundations.
Mechanics. The structure of the transaction involves the taxpayer making an irrevocable contribution of personal assets to a donor-advised fund account. The contribution is tax deductible. Thus, the donor gets a tax deduction in the year of the contribution to the fund, and the funds can be distributed to charities over multiple years.
The donor also selects the fund advisors (and any successors) as well as the charitable beneficiaries (such as a public charity or community foundation). The amount in the fund account is invested and any fund earnings grow tax-free. The donor also retains the ability to recommend gifts from the account to qualified charities along with the fund advisors. The donor cannot, however, have the power to select distributes or decide the timing or amounts of distributions from the fund. The donor serves in a mere advisory role as to selecting distributees, and the timing and amount of distributions. If the donor retains control over the assets or the income the transaction could end up in the crosshairs of the IRS, with the fund’s tax-exempt status denied. See, I.R. News Release 2006-25, Feb. 7, 2006; New Dynamics Foundation v. United States, 70 Fed. Cl. 782 (2006).
No time limitations apply concerning when the fund assets must be distributed, but the timing of distributions is discretionary with the donor and the fund advisors.
When highly appreciated assets are donated to a donor advised fund, the donor’s overall tax liability can be reduced, capital gain tax eliminated, and a charity can benefit from a relatively larger donation. For taxpayer’s that are retiring, or have a high-income year, a donor advised fund might be a particularly good tax strategy. In addition, a donor advised fund can be of greater benefit because the TCJA increases the income-based percentage limit on charitable donations from 50 percent of adjusted gross income (AGI) to 60 percent of AGI for cash charitable contributions to qualified charities made in any tax year beginning after 2017 and before 2026. The percentage is 30 percent of AGI for gifts of appreciated securities, mutual funds, real estate and other assets. Any excess contributed amount of cash may be carried forward for five years. I.R.C. §170(b)(1)(G)(ii).
Donor-advised funds are not cost-free. It is common for a fund to charge an administrative fee in the range of 1 percent annually. That’s in addition to any fees that might apply to assets (such as mutual funds) that are contributed to the donor advised fund. Also, the fund might charge a fee for every charitable donation made from the fund. That’s likely to be the case for foreign charities.
In addition, as noted above, the donor can only recommend the charities to be benefited by gifts from the fund. For example, in 2011 the Nevada Supreme Court addressed the issue of what rights a donor to a donor advised fund has in recommending gifts from the fund. In Styles v. Friends of Fiji, No. 51642, 2011 Nev. Unpub. LEXIS 1128 (Nev. Sup. Ct. Feb. 8, 2011), the sponsoring charity of the donor-advised fund used the funds in a manner other than what the donor recommended by completely ignoring the donor’s wishes. The court found that to be a breach of the duty of good faith and fair dealing by the fund advisors. But, the court determined that the donor didn’t have a remedy because he had lost control over his contributed assets and funds based on the agreement he had signed at the time of the contribution to the donor-advised fund. As a result, the directors of the organization that sponsored the donor-advised fund could use the funds in any manner that they wished. That included paying themselves substantial compensation, paying legal fees to battle the donor in court, and sponsoring celebrity golf tournaments.
Also, an excise tax on the sponsoring organization applies if the sponsoring organization makes certain distributions from the fund that don’t satisfy a defined charitable purpose. I.R.C. §4966. Likewise, an excise tax applies on certain distributions from a fund that provide more than an incidental benefit to a donor, a donor-advisor, or related persons. I.R.C. §4967.
The TCJA changes the landscape (at least temporarily) for charitable giving for many taxpayers. To get the maximum tax benefit from charitable gifts, many taxpayers may need to utilize other strategies. One of those might include the use of the donor-advised fund. If structured properly, the donor-advised fund can be a good tool. However, there are potential downsides. In any event, competent tax counsel should be sought to assist in the proper structuring of the transaction.
Monday, October 8, 2018
The Tax Cuts and Jobs Act (TCJA) has made estate 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 $11.18 million per decedent for deaths in 2018, and 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. Indeed, according to the IRS, there were fewer than 6,000 estates that incurred federal estate tax in 2017 (out of 2.7 million decedent’s estates). In 2017, the exemption was only $5.49 million. For 2018, the IRS projects that there will be slightly over 300 taxable estates.
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. I.R.C. §1014.
But, with the slim chance that federal estate tax will apply, should estate planning be ignored? What are the basic estate planning strategies for 2018 and for the life of the TCJA (presently, through 2025)?
Married Couples (and Singles) With Wealth Less Than $11.18 Million.
Most people will be in this “zone.” For these individuals, the possibility and fear of estate tax is largely irrelevant. But, there is a continual need for the guidance of estate planners. The estate planning focus for these individuals should be on basic estate planning matters. Those basic matters include income tax basis planning – utilizing strategies to cause inclusion of property in the taxable estate so as to get a basis “step-up” at death.
Existing plans should also 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 that 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 credit shelter trust property for the surviving spouse that will “bypass” the surviving spouse’s estate upon death. As for the martial trust assets, tax on those assets is postponed (if it is taxed at all) until the surviving spouse dies.
But, here’s the rub. As noted above, the TCJA’s increase in the exemption could cause an existing formula clause to “overfund” the credit shelter trust with up to the full federal exemption amount of $11.18 million. This formula could potentially result in a smaller bequest for the benefit of the surviving spouse to the marital trust than was intended, or even no bequest for the surviving spouse at all. It all depends on the value of assets that the couple holds. The point is that couples should review any existing formula clauses in their current estate plans to ensure they are 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, a 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 qualifying deductions to 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 many clients in this wealth range.
Most persons in this zone will likely fare better by not making gifts, and retaining the ability to achieve a basis step-up at death for the heirs. That means income tax basis planning is far more important for most people. Also, consideration should be made to determine whether insurance is still necessary to fund any potential estate tax liability It also may be possible to recast insurance to fund state death taxes (presently, 12 states retain an estate tax and six states have an inheritance tax (one state (Maryland) has both)) and serve investment and retirement needs, minimize current income taxes, and otherwise provide liquidity at death.
Other estate planning points for moderate wealth individuals include:
- For life insurance, it’s probably not a good idea to cancel the polity 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.” I did a blog post on decanting earlier this summer.
- 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.
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. A “beneficiary-controlled” trust has also become a popular estate planning tool. This allows assets to pass to the beneficiary in trust rather than outright. The beneficiary can have a limited withdrawal right over principal and direct the disposition of the assets at death while simultaneously achieving creditor protection. In some states, such as Nebraska, the beneficiary can be the sole trustee without impairing creditor protection.
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.
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. For deaths in 2026, the federal estate and gift tax exemption is estimated to be somewhere between $6.5 and $7.5 million dollars. While those numbers are still high enough to cover the vast majority of people, they are a far cry from the present $11.18 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 time-frame. A chunk of that will involve farm and ranch real estate, livestock, equipment and other personal property.
Is your plan up-to-date?