Wills, Trusts & Estates Prof Blog

Tax Tactic Of The Ultra-Wealthy: Split The Masterpiece In Two

Beautiful, timeless art pieces are not only a source of pride and joy for billionaires art lovers—they are also a great way to get a tax break. 

Lawyers for the ultra-wealthy say that "they're increasingly getting requests from art collectors to find strategies to shield their wealth from the Internal Revenue Service. The solution: giving away just a fraction of their ownership." 

With the use of fractional donations, the ultra-wealthy can get a tax benefit "tied to surging art values without donating a painting outright." Under this strategy, the art piece will go back and forth between the donor and the museum and the owner will receive an income-tax deduction "based on the fair market value. . ." 

According to John Mezzanotte, managing partner in the Greenwich, Connecticut, office of accounting and tax-advisory firm Marcum, "If you're dividing time between two places, you won't even miss the art."

Fractional donations of art pieces is another example of another creative strategy that the ultra-rich are using to obtain tax benefits and avoid the proposed tax levies on high earners. 

See Heather Perlberg, Tax Tactic Of The Ultra-Wealthy: Split The Masterpiece In Two, Financial Advisor Magazine, November 2, 2021. 

Special thanks to Joel C. Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.

TAX PROPOSALS IN THE NEW “BUILD BACK BETTER” FRAMEWORK

"The White House released a new framework for the build back better plan, followed by a preliminary draft of the Bill from the house rules committee." 

Included in the proposal is a spending and tax plan. The specifics of the plan are complicated and involve "rapidly evolving, Congressional dynamics." 

The House Rules Committee text did not include provisions for tax changes like lowering of gift and estate tax exemption amounts; limitations on grantor trusts; increased corporate, income and capital gain tax rates; and provisions related to IRAs and Roth IRAs. Also notably left out was the "Billionaire Income Tax." 

Draft provisions that were included were: 

• A 15% minimum tax on corporations with more than $1 billion in profits, 1% surcharge on corporate stock buybacks for public companies, and 15% global minimum tax
• An income surtax applying a 5% percent rate on modified adjusted gross income (AGI) over $10 million, and an additional 3% on modified AGI above $25 million. The income surtax thresholds are lower for trusts, applying a 5% surtax on modified AGI over $200,000, and an additional 3% surtax on modified AGI over $500,000
• An expansion of the 3.8% net investment income (NII) tax to business profits for material participants making over $400,000, joint filers over $500,000 and all trust and estates (regardless of income levels)
• Limitation of the qualified small business stock exclusion to 50% for most sales of QSBS after September 13, 2021
• Limitations on excess business losses of noncorporate taxpayers, including a no-carryover of disallowed losses

See TAX PROPOSALS IN THE NEW “BUILD BACK BETTER” FRAMEWORK, Wealth: Northern Trust, October 28, 2021. 

Special thanks to Joel C. Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.

As Second Homes Get Far More Use, the Question Is: Where Do You Live?

Of course, owning one home comes with its challenges. But the challenges may mount even higher when owners split their time equally between two or more properties. In these cases, owners face tax, legal, financial, and personal challenges. 

The Rounds family have recently faced these challenges since they have began to spend an extensive amount of time at their second home in the Teton Vally region on the Wyoming/Idaho border. 

Mr. Rounds and his wife closed on a $2.5 million house in Idaho, and although the family planned on splitting their time equally between their home on the East Coast and the new home, they have already spent six months in the new home. 

The family has had to figure out how to "ship cars halfway across the country, find a second pediatrician for their 11-mont-old-daughter, and get their three Maltese dogs back and forth between the two homes." These challenges are not typically encountered by people who only spend weekends and the occasional vacation week at a second home. 

This "co-primary home" lifestyle has been the norm for the ultra-rich. But due to the pandemic, working remotely has become more of the norm and has made the co-primary home lifestyle a more realistic lifestyle choice for second-home owners who are less wealthy.

For those thinking about the lifestyle, it is important to consider the tax, financial, legal, and personal challenges that may come along with it.

See E.B. Solomont, As Second Homes Get Far More Use, the Question Is: Where Do You Live? , The Wall Street Journal, October 14, 2021.

Special thanks to Joel C. Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.

Article: Incentivizing Wills Through Tax

Margaret Ryznar recently published an article entitled, Incentivizing Wills Through Tax, Wills, Trusts, & Estates Law ejournal (2021). Provided below is the abstract to the Article.

There have been recent calls to loosen will formalities in order to allow more people to execute wills, the importance of which has been highlighted by the COVID-19 pandemic. The reduction of necessary will formalities can be successful in expanding the use of wills, as can potential tax incentives for creation of wills, such as a tax credit. However, there are numerous advantages to using tax to initiate change, as considered in this Article.

Article: The U.S. Supreme Court In Kaestner: Deciphering the Constitutionally Required Minimum Contacts Necessary for State Taxation of Trust Income

Beckett Cantley and Geoffrey Dietrich recently published an article entitled, The U.S. Supreme Court In Kaestner: Deciphering the Constitutionally Required Minimum Contacts Necessary for State Taxation of Trust Income, Wills, Trusts, & Estates Law ejournal (2021). Provided below is the abstract to the Article.

As far back as 1929, several states have sought to broaden their tax base by expanding taxation to out-of-state trusts that have in-state beneficiaries, even when the beneficiaries possess only a contingent interest in the trust’s assets. On June 21, 2019, the U.S. Supreme Court confronted the constitutionality of this trust tax practice in North Carolina Dep’t of Revenue v. Kimberley Rice Kaestner 1992 Family Trust (“Kaestner Trust”). In Kaestner Trust, the Supreme Court issued a narrow decision in favor of the Trust, basing its opinion on a compilation of landmark constitutional law and civil procedure cases. Specifically, the Court ruled that the domicile of a contingent beneficiary on its own does not constitute sufficient “minimum contacts” between a trust and a jurisdiction for tax purposes, and thus the North Carolina statute violated the Due Process Clause of the U.S. Constitution.

Every jurisdiction has its own method of defining the minimum contacts necessary to bring a trust into its taxation orbit. In light of the Court’s decision, other state statutes that impose a fiduciary income tax based on weak connections may face constitutional scrutiny in the near future, including tax regimes containing “throwback” rules, “one-dollar” rules, and testamentary trust residency standards that rely indefinitely on the domicile of a testator. The main purpose of this article is to understand the Kaestner Trust decision, discuss how the impacted states have adjusted, and identify any statutes peripheral to the case that may face constitutional inquiry in the future.

The introduction to this article provides the foundation for understanding state trust taxation regimes and frames the controversy of multi-state taxation. Part II explains the facts within Kaestner Trust and analysis used by the Supreme Court in rendering the North Carolina statute unconstitutional. It also discusses how the North Carolina trust statute has been impacted. Part III identifies the other states, besides North Carolina, directly impacted by the Kaestner Trust decision and how these states have responded to the case. Part IV analyzes how the decision might promote further inquiry into the constitutionality of statutes that lie on the margins of Kaestner Trust. Finally, the article considers estate planning and trust drafting opportunities created by the case and concludes by briefly summarizing the significance of Kaestner Trust.

To get the wealthy to pay more tax, first we need to work out why they avoid it

You do not often hear rich people advocating for paying taxes. John McAfee, who in June was found dead in a Spanish prison from an apparent suicide, was "inarguably the most [colorful] character in the world of antivirus software." 

Mere hours before McAfee's death, the Spanish authorities agreed to extradite him to the US to face tax evasion charges. McAfee was openly against taxation. In 2018 McAfee tweeted, that he had not filed a US tax return in eight years because "taxation is theft" claiming he had already paid "tens of millions already and received jack [expletive] in services."

Abigail Disney, wrote in an article that she was "taught from a young age to protect [her] dynastic wealth." 

The ultra rich often use legal tax-avoidance strategies to limit their federal income tax bills. A report by non-profit ProPublica concluded that legal tax-avoidance strategies allowed the 25 richest Americans to limit their federal income tax bills to $13.6 billion in the five years to 2018 even though their wealth had been boosted by an estimated $401 billion. 

According to Abigail Disney, a big part of the problem is that wealth is not income and tax avoidance is not tax evasion. Legal tax avoidance strategies are just that—legal. Disney also acknowledged that, like Jeff Bezos, the system allows the rich legally to avoid paying tax on huge fortunes that grow every year. 

Some argue that we live in a world in which the rich do not need to practice illegal tax evasion because legal tax avoidance is "so easy and effective." Disney then posed the question: "What motivates people with so much money to try to withhold every last bit of it from the public's reach." 

Alex Rees-Jones, a behavioral economist at Wharton Business School, wrote that "analysis of tax data confirms that tax decision [the desire to pay or avoid] are influenced by loss aversion." In other words, taxpayers engage in strategies that make losses smaller and gains larger. 

From here, Rees-Jones suggested "reframing taxpayer perceptions of what constitutes a gain or a loss." 

The "fix" may be to convince taxpayers that the losses they take as a consequence of tax avoidance are worse than whatever loss they may take if they were to avoid the loopholes. 

See Rhymer Rigby, To get the wealthy to pay more tax, first we need to work out why they avoid it, Financial Times, August 29, 2021. 

Special thanks to Joel C. Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.

Impact of President Biden's Tax Plan on Estate Planning

There has been speculation on what President Biden's tax proposal will look like and what effects it will have on estate planning. There is also a question about the likelihood that President Biden's tax plan will be enacted into law. 

The Biden Administration announced the American Families Plan in April 2021, which proposed "significant tax law changes to increase taxes on both corporations and high-net worth individuals and to provide more resources to enhance IRS tax enforcement efforts. 

In May 2021, the United States Department of Treasury issued a report entitled, "General Explanation of the Administration's Fiscal 2022 Revenue Proposals (generally referred to as the Green Book) which included more details on the tax law changes previously proposed in the American Families Plan." The memo provided an overview of the proposed changes of the American Families Plan and the impact those changes may have on estate planning. 

Under the current proposal, "there will be a realization of capital gains to the extent such gains are in excess of a $1 million exclusion per person, upon the transfer of appreciated assets at death or by a gift. . .the proposal would provide various exclusions and exceptions for certain family-owned and operated businesses. 

One thing that was not addressed in the Green Book are changes to the federal estate, gift and generation skipping transfer (GST) tax system, although Biden did propose these changes during his campaign. 

There is a lot of uncertainty surrounding new tax laws, so high-net-worth individuals with estate tax concerns should consider taking advantage heightened exemptions by implementing wealth transfer strategies like the following: 

• Intentionally Defective Grantor Trust (IDGT)
• Spousal Lifetime Access Trust (SLAT)
• Grantor Retained Annuity Trust (GRAT)
• Charitable Lead Annuity Trust (CLAT)
• Annual Gifts 
• And more. 

See Jeffrey M. Glogower, Stephen J. Bahr, & Adam W. Randle, Impact of President Biden's Tax Plan on Estate Planning, The National Law Review, July 26, 2021. 

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.

Plan to Revive I.R.S. ‘Wealth Squad’ Puts the Richest on Notice

President Biden has proposed "adding $80 billion to the Internal Revenue Service budget as well as giving the agency more authority to crack down on tax evasion by high-earners and large corporations." 

The propose additions came before reports were released that indicated how little in taxes the richest Americans paid from 2014 to 2018. In addition to President Biden's proposals, those reports have "intensified interest in the tax code." 

The reports do not necessarily indicate those in the high net worth categories have been engaging in illegal activity in order to pay less in taxes. It is just as likely that high-earners have simply been using the tax code to their advantage.

There are many legal tax strategies that high-earners have used to "minimize their taxes." The tax strategies appear to be exactly what President Biden looks to eliminate. 

In order to deal with this new attention to tax strategies, tax experts have agreed that the wealthy and slightly-less-wealthy should keep better records. 

If President Biden's plan is adopted, "[s]ome of the additional money in his budget would toward reviving an underfunded organization within the I.R.S. called the global high-wealth industry group, which focuses on the complicated tax returns filed by the affluent." 

See Paul Sullivan, Plan to Revive I.R.S. ‘Wealth Squad’ Puts the Richest on Notice, N.Y. Times, June 11, 2021. 

Special thanks to Matthew Bogin, (Esq., Bogin Law) for bringing this article to my attention. 

IRS Practice Units

"As part of LB&I's knowledge management efforts, Practice Units are developed through internal collaboration and serve as both job aids and training materials on tax issues. For example, Practice Units provide IRS staff with explanations of general tax concepts as well as information about a specific type of transaction. Practice Units will continue to evolve as the compliance environment changes and new insights and experiences are contributed."

Visit the link below to view the practice units: 

https://www.irs.gov/businesses/corporations/practice-units

Special thanks to Mark J. Bade (CPA, GCMA, St. Louis, Missouri) for bringing this article to my attention. 

 

Dividends Received by an Employee of a Corporation are Still Part of Net Investment Income

In Chief Counsel Advice 202118009 the IRS addresses an interesting question: "Whether tax dividends received by a shareholder who is also employed by the C corporation is subject to the net investment income tax, as well as if the answer changes if the corporation is closely held." 

Net Investment Income Under IRC §1411

IRC §1411, which was added to The Affordable Care Act, "imposes a tax on the lesser of the net investment income of a taxpayer or the taxpayer's adjusted gross income in excess of threshold amounts that vary by filing status." 

This "net investment income" includes gross income from dividends apart from those that are the result of the ordinary course of a trade or business. (IRC §1411(c)(1)). 

The situation that is addressed by the IRS is quoted below: 

The Taxpayer is a shareholder in a C corporation. It was determined under examination that the corporation paid Taxpayer’s personal expenses from corporate accounts, and the payments were reclassified as dividend income paid to the Taxpayer by the corporation. The Taxpayer is also an employee of the corporation and is involved in the day-to-day operations of the corporation’s manufacturing trade or business. The facts further indicate that the corporation may be a closely-held corporation within the meaning of § 469(h)(1) as described in § 465(a)(1)(B) (the Taxpayer appears to own a majority of the shares of the corporation). The Taxpayer contends that because the Taxpayer materially participates in the manufacturing trade or business of the corporation as an employee, the dividend income that the Taxpayer received from the corporation is not subject to tax under § 1411, because the dividend income is derived in the ordinary course of a trade or business that is not a passive activity of the Taxpayer within the meaning of § 469

The deeper question is, under IRC §1411(c)(1), if a taxpayer is involved in day to day operations of the corporation whether the dividend income is removed from the investment income category found in (c)(1), or whether the dividends retain their status as investment income, and are outside the scope of the ordinary course of a trade or business. 

According to the IRS, employment does not change the nature of the dividends, meaning they retain their status as part of investment income.

For more information see, Ed Zollars, CPA, Dividends Received by an Employee of a Corporation are Still Part of Net Investment Income, Kaplan Financial Education: Current Federal Tax Developments, May 7, 2021. 

Special thanks to Mark J. Bade (CPA, GCMA, St. Louis, Missouri) for bringing this article to my attention.