US Tax Court Protects Transfers of Family Business

The recent US Tax Court ruling in Wandry v Commissioner of Internal Revenue Service (IRS) has been welcomed by tax advisers to family businesses.

The case was brought by a Colorado couple, Dean and Joanne Wandry. They owned a limited liability company called Norseman, worth about US$11 million in 2004. At that point they consulted a tax planning adviser on how to transfer shares in the business to their children and grandchildren without incurring gift tax. At the time, the federal lifetime gift tax exemption was US$1 million, plus US$11,000 per gift.

The difficulty with such transfers is that a closely held family business is often hard to value accurately. Even if the owner obtains a professional valuation at the time of the gift, the IRS will often challenge it later. So, if the owner gives away a fixed percentage of the company, which he calculates will fall within the gift tax exemption, the IRS may later decide that it exceeded the exemption. Then a tax charge of up to 35 per cent of the excess becomes payable.

The Wandrys avoided this by specifying the value of their gifts in cash terms. They made nine gifts adding up to a total value of US$1.099 million, which was within the exemption. The actual fraction of the company equity to be given away was left open in the transfer deed. It was to be calculated later, depending on whether the IRS accepted the Wandrys' own valuation of the business.

The IRS did indeed challenge the Wandrys' valuation, claiming that it was a 20 per cent underestimate. Moreover, it did not accept that the Wandrys could adjust the number of company shares transferred to their children so as to make the transfer again fall within the gift tax exemption. Accordingly it imposed a tax charge on the gifts.

The Wandrys appealed, and now the Federal Tax Court has upheld their appeal. The judge ruled that the couple intended to make a gift equal to their exemptions, so that they never actually transferred any more than that amount. Thus no tax was due on the gifts.

The decision allows tax-free transfers from one generation to another "with certainty and in an orderly manner", according to tax expert David Kautter. Previously the only certain way of avoiding an unexpected gift tax charge due to an IRS revaluation was to allocate the excess gift to a charity - a method that had its own drawbacks.

However, the IRS is not likely to be happy about the decision and may yet appeal it. Thus business owners who rely on Wandry to take advantage of the current US$5.12 million gift-tax exemption may be taking a risk.

Even if the IRS does not appeal, it may seek a change in the law to reverse the Wandry ruling - though not with retrospective effect.

Sources

Wall Street Journal

US Tax Court (PDF file)

The US Experiences a Dramatic increase in Citizenship Renunciation during 2011.

According to Internal Revenue Service (IRS) figures, at least 1,800 Americans renounced their USA citizenship in 2011, an all-time record at eight times the 2008 number.

The USA's worldwide taxation system, including the Foreign Bank and Financial Accounts (FBAR) and now the Foreign Accounts Tax Compliance Act (FATCA) regimes, is to blame, according to lobby group American Citizens Abroad.

The State Department said records it keeps differ from those published by the IRS. They indicate that renunciations have remained steady, at about 1,100 each year, said an official.

The decision by the IRS to publish the names is referred to by lawyers as 'name and shame.' That's because those who renounce are seen as willing to give up their citizenship primarily for financial reasons.

There's also an 'exit tax' for the very rich who choose to leave. During the last 25 years, a number of millionaires and billionaires have renounced their citizenship. Among them: Ted Arison, the late founder of Carnival Cruises, and Michael Dingman, a former Ford Motor Co. director.

Read more: http://www.dailymail.co.uk/news/article-2131225/Record-number-American-citizens-renouncing-citizenship-avoid-paying-taxes.html#ixzz1ssrtBbyT

Less Than 9 Months Left To Make $10 Million Of Tax-Free Gifts

This may be the best time to transfer a large amount of wealth without transfer taxes. Unfortunately time is running out on this short term opportunity because the current generous gift-tax exemptions are scheduled to expire at the end of 2012.

The lifetime exemption from Federal gift tax has been at its highest level the last two years. During 2011 and 2012 individuals have been able to transfer up to $5 million, or $10 million per married couple, without Federal gift tax ($5.12 million/$10.24 million in 2012). Now may be the best time to take advantage of this increased exemption for the following reasons:

1. Unless Congress and the President come to a compromise, the 2010 Tax Act will automatically expire at the end of 2012. The current lifetime estate and gift tax exemptions of $5 million plus for individuals will drop to only $1 million. The Federal estate tax rate will also increase to 55%.

2. In many instances, valuation discounts are allowed for closely held business interests. There exists some concern, however, that Congress could pass legislation that effectively would eliminate such discounts and other estate planning techniques.

3. We are presently experiencing historically low interest rates. These rates combined with depressed asset values, particularly for real estate, enhance many estate planning techniques.

4. The current law allows the same generous exemptions for "generation-skipping transfers" so gifts can be made to trusts for grandchildren as well as children.

5. Many of the transfer techniques that allow a donor to take advantage of gift, estate, and generation skipping tax savings may also provide an added level of asset protection for the assets.

To use up part or all of his or her gift tax exemption, a donor must make a completed gift of the assets, either outright or through a trust that is irrevocable, and without a retained interest. This may not be an attractive option if there is a concern that the donor may need the gifted funds in the future. Donors should be aware, however, that there are methods that may allow them to both take advantage of their gift tax exemption and retain some access to the transferred assets. One such technique is having one spouse set up an irrevocable trust for the benefit of the other spouse. This planning has its own benefits and drawbacks.

The increased lifetime exemption from gift tax effectively provides a donor and his or her spouse with the ability to remove $10 million plus, and all future appreciation on those assets, from their taxable estates. However, it is important to act now to take advantage of the current exemption levels and other laws that are set to change soon. Given the anticipated level of last minute planning activity anticipated this year, interested donors are best advised to consult with their estate planning counsel sooner rather than later.

 

by Charles (Chuck) Rubin

 

Supreme Court Tells IRS 3 Years To Audit Is PLENTY! (Continued)

Home Concrete & Supply, LLC, (Sup Ct4/25/2012) 109 AFTR 2d 2012-661

The Supreme Court, resolving a split among various Circuit Courts and the Tax Court, has determined that an overstatement of basis isn't an omission of gross income for purposes of Code Sec. 6501(e)(1)(A)'s 6-year limitations period. The Court found that the '58 Colony decision, in which the Court construed the nearly identical language of Code Sec. 6501(e)(1)(A)'s predecessor statute as referring only to items left out, controlled the outcome of this case.

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Background.Code Sec. 6501(a) generally provides that a valid assessment of income tax liability may not be made more than 3 years after the later of the date the tax return was filed or the due date of the tax return. However, under Code Sec. 6501(e)(1)(A), a 6-year period of limitations applies when a taxpayer "omits from gross income" an amount that's greater than 25% of the amount of gross income stated in the return. Code Sec. 6501(e)(1)(B)(i) (which was an amendment in the '54 Code to the predecessor of Code Sec. 6501(e)) provides that "in the case of a trade or business, the term "gross income" means the total of the amounts received or accrued from the sale of goods or services (if such amounts are required to be shown on the return) prior to the diminution by the cost of such sales or services."

The Supreme Court, interpreting the predecessor statute to Code Sec. 6501(e)(1)(A), held that the extended period of limitations applies to situations where specific income receipts have been "left out" in the computation of gross income, and not something put in and overstated. (Colony, Inc. v. Com., (1958, S Ct) 1 AFTR 2d 1894, 357 US 28).

IRS issued final regs in December of 2010 under which an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis is an omission of gross income for purposes of the 6-year period for assessing tax and the minimum period for assessment of tax attributable to partnership items (Reg. § 301.6501(e)-1(e)). The final regs adopt the position IRS had held in temporary regs. IRS disagrees with the courts that hold that the Supreme Court's reading of the predecessor to Code Sec. 6501(e) in Colony applies to Code Sec. 6501(e)(1)(A). IRS takes the position that when Congress enacted the '54 Code, it effectively limited what ultimately became the holding in Colony to cases subject to the '39 Code. Moreover, under Code Sec. 6501(e)(1) of the '54 Code, which remains in effect under the '86 Code, when outside of the trade or business context, the definition of "gross income" in Code Sec. 61 applies. So, the regs provide that any overstatement of basis that results in an understatement of gross income under Code Sec. 61(a) is an omission from gross income under Code Sec. 6501(e)(1)(A).

In a 5-4 decision, with Justice Breyer writing for the majority (which included Chief Justice Roberts and Justices Thomas, Alito, and Scalia), the Supreme Court affirmed the Fourth Circuit and found that Code Sec. 6501(e)(1)(A) doesn't apply to an overstatement of basis. The Court stated that its conclusion "follows directly from this Court's earlier decision in Colony." 

The majority found that the language of the provision at issue in Colony was substantially identical to Code Sec. 6501(e)(1)(A). In Colony, the Court found that the plain language of the term "omits" refers only to something which is left out. Although a basis overstatement can have the same ultimate effect of understating a taxpayer's income, it doesn't constitute an omission. The Colony Court also observed that the legislative history of the provision at issue in that case only demonstrated an intent to create an exception to the usual 3-year period in cases involving failures to report income receipts and accruals, where IRS is at a disadvantage because the return doesn't indicate the existence of the omitted item(s), and not to extend the period in every instance where income is understated.

According to the majority, to hold otherwise would effectively overrule Colony. The Court noted that principles of stare decisis are especially compelling in cases involving statutory interpretation because Congress is free to legislate a different result.

With regard to Reg. § 301.6501(e)-1, IRS argued that a prior judicial construction "trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute" (Nat'l Cable & Telecomms. Ass'n v. Brand X Internet Servs., (2005) 545 U.S. 967), and that the Colony court itself said of the provision at issue that "it cannot be said that the language is unambiguous." Therefore, argued IRS, Colony couldn't control, and the operative issue is whether the reg is a "permissible construction of the statute" under Chevron.

However, the Court stated that Colony's prior interpretation of the statute effectively foreclosed IRS's contrary construction in Reg. § 301.6501(e)-1 , noting that the "linguistic ambiguity" observed by the Colony court 30 years before Chevron didn't necessarily warrant a post-Chevron conclusion that Congress has delegated "gap-filling power" to IRS. On the contrary, the Colony decision indicated overall that the Court didn't believe that the statute left such a gap.

In the end, because the reg was a reasonable interpretation of Code Sec. 6501(e)(1)(A), and because the Court's Colony decision construed a predecessor version of the provision, the dissent determined that the reg should control in this case.

The Court's decision will likely have an adverse impact on IRS's efforts to collect taxes in other Son-of-BOSS and similar tax shelter cases.

However, the IRS may now seek a law change in response to this loss.

IRS Contemplates Guidance Clarifying Rescission Doctrine, Alexander Says

The Internal Revenue Service continues to contemplate the contents of a possible guidance project to assist taxpayers when applying the rescission doctrine after the Service ruled in January that it will no longer offer additional interpretations of the doctrine, IRS Associate Chief Counsel (Corporate) William D. Alexander said.

Currently taxpayers have only a 32- year-old revenue ruling and a 1940 federal case, Penn v. Robertson, to rely on for guidance when interpreting the doctrine, which aims to allow counterparties essentially to undo contractual stipulations under certain circumstances.
In January, IRS issued Rev. Proc. 2012-3, which stated the agency would no longer issue private letter rulings or determination rulings regarding the issue.

“For the moment, you're on your own but you do have the revenue ruling,” Alexander said April 19 at a mergers and acquisitions tax conference sponsored by the New York City Bar and the Penn State Dickinson School of Law.

“What I can tell you for the moment is that revenue ruling is our published position.”
When asked how long taxpayers will have to wait until guidance on the doctrine is issued, Alexander said, “I don't think it will be too long.”

Refund claim, filed by a Ponzi scheme victim, was modification of earlier one and therefore not untimely

In Chief Counsel Advice (CCA) 201216033, IRS has concluded that a Form 843 (Claim for Refund and Request for Abatement) filed by a Ponzi scheme victim was a permissible amendment to her timely filed Form 1040X rather than a new, untimely claim for refund for tax year 2003.

Background.Code Sec. 6402 authorizes IRS to make credits or refunds. Refunds may not be allowed or made after the expiration of the properly applicable statutory period of limitation unless, before the expiration of such period, a claim for the refund has been filed by the taxpayer. (Reg. § 301.6402-2(a)(1))

Under Code Sec. 6511(a), a claim for credit or refund of an overpayment must be filed within three years from the time the return was filed or two years from the time the tax was paid, whichever period expires later. No credit or refund is allowed if a claim is not filed within these time limits. (Code Sec. 6511(b))

Facts. Beginning in 2003 and continuing until sometime in early 2006, a taxpayer, invested a sum of money with a businessman. For tax year 2003, she received a Form 1099-INT, reporting interest income, and reported it on her 2003 Form 1040 filed on Apr. 15, 2004.

In 2006, Terry learned the businessman had been embezzling funds and the investment was a Ponzi scheme. She filed Form 1040X for 2003, eliminating the interest income, as she had never actually received any interest income. As a result, she timely claimed a refund for 2003.

After Terry recovered a portion of the amount she invested, she claimed the remaining amount as a theft loss on Form 1040 for tax year 2006.

IRS disallowed the refund for 2003, explaining in Letter 906 that any loss arising from theft is treated as sustained in the year in which the taxpayer discovers the loss.

Subsequently, more than three years after she filed her 2003 return, Terry filed Form 843 for tax year 2003, again requesting a refund for that year on the theory that the interest income originally reported was fictitious and the money she actually received was a return of capital. Time passed and she contacted IRS to ascertain the status of the Form 843. IRS responded that it was still doing research. She never heard anything further from IRS.

Claim was an amendment. The CCA observed that Terry's Form 843 for tax year 2003 did not require investigation of new matters. The Form 843 and the Form 1040X claimed the same basis for a refund-that she had zero interest income rather than the interest income initially reported on her Form 1040. The facts upon which the Form 843 was based would have been ascertained by IRS in determining the merits of the Form 1040X if IRS had evaluated the precise grounds in the Form 1040X rather than concluding that Terry was trying to recoup her entire loss from the investment scheme.

In addition, although IRS acted on the Form 1040X by issuing a notice of claim disallowance for 2003, that was not "final action" because IRS overlooked the grounds stated in the Form 1040X. Terry was not seeking to claim the amount of her loss from the investment scheme when she filed Form 1040X. Rather, she was seeking a refund as a result of improperly including a fictitious amount of interest income on her original return for tax year 2003. Consequently, Terry's Form 843 should be viewed as a permissible amendment to the timely filed Form 1040X, and therefore her refund for tax year 2003 is not time-barred.

Supreme Court Tells IRS 3 Years To Audit Is PLENTY!

Forbes - Even the IRS has limits. If you’ve ever been audited by the IRS, you may think going back three years is bad enough. The tax code generally allows the IRS to audit three years back, and six in some cases. The U.S. Supreme Court in U.S. v. Home Concrete & Supply, LLC has dramatically cut back on IRS reaches into six year territory. It’s a positively stunning result.

The main rule is that the IRS time to audit runs three years after filing or due date. However, the IRS gets double time for a “substantial understatement of income”—where you omit 25% or more. The debate is over what it means to omit 25% or more of your gross income. 

Example: You sell a piece of property for $3M, claiming that your basis (what you have invested in the property) was $1.5M. In fact, your basis was only $500,000. The effect of your basis overstatement was that you paid tax on $1.5M of gain when you should have paid tax on $2.5M. Your basis over-statement probably means a six-year statute applies.

The Supreme Court agreed to decide if the IRS can go back six years or only three. See Home Concrete & Supply v. U.S. Our highest court hears few tax cases, and this decision is huge. The Supreme Court had good reason to resolve the scuffle given this messy split.

IRS won so six-year statute of limitations applied:

·   Seventh Circuit: Beard v. Comm’r

·   Federal Circuit: Grapevine Imports v. U.S.

·   Tenth Circuit: Salman Ranch v. Comm’r

·   D.C. Circuit: Intermountain Ins. Serv. of Vail LLC v. Comm’r

IRS lost so was limited to three years:

·   Fourth Circuit: Home Concrete & Supply v. U.S.

·   Fifth Circuit: Burks v. U.S. and Equipment Holding Co. LLC v. Comm’r

·   Ninth Circuit: Bakersfield Energy Partners v. Comm’r

The Home Concrete & Supply case was a tax shelter case—where sometimes the usual rules are somehow bent to try to undo something that seems beyond the pale. For that reason, some observers thought the Supreme Court might try to find a way to allow the IRS to go for six years in a tax shelter case, even though the home sale basis example above might be limited to three years. Nope, the High Court stuck to three years.

The taxpayer win in Home Concrete & Supply will have a huge trickle down effect too, not just impacting these cases.

The IRS was hoping to collect this huge amount in about 30 related cases involving “Son of Boss” tax shelters. For taxpayers everwhere, this case just may mean a little more security.