Teaching Team Roger A. McEowen CALT Director mceowen@iastate.edu - - PDF document

8/3/2015 1 CALT SUMMER SEMINAR OLYMPIC VALLEY, CA JULY 30-31, 2015

Center for Agricultural Law and Taxation

Teaching Team

• Roger A. McEowen

– CALT Director – mceowen@iastate.edu – www.it.iastate.edu – @CALT_IowaState

• Paul Neiffer

– CliftonLarsonAllen, Principal in Agribusiness Group – www.farmcpatoday.com

• Kristy S. Maitre

– CALT Tax Specialist and former IRS

• Andy Morehead

– Accountant, Eaton, Colorado – andy@amorehead.com

8/3/2015 2

New Legislation

• H.R. 3236 ‐ Surface Transportation and

Veterans Health Care Choice Improvement Act of 2015

– Partnership returns

• Due date is March 15 (for calendar‐year partnerships)

and the 15th day of the third month following the close

• f the fiscal year (for fiscal‐year partnerships).

– IRS directed to allow a maximum extension of six months for Forms 1065 – Applicable for returns due after 2015

New Legislation

• H.R. 3236 ‐ Surface Transportation and Veterans

Health Care Choice Improvement Act of 2015

– C corporation returns

• Due date is the 15th day of the fourth month following the

close of the corporation’s year.

• Corporations will be allowed a six‐month (instead of the

current three‐month) extension, except that calendar‐year corporations would get a five‐month extension until 2026 and corporations with a June 30 year end would get a seven‐ month extension until 2026.

• Applicable for returns due after 2015 except that if C corp.

has fiscal year ending June 30, new rules won’t apply until tax years beginning after 2025

New Legislation

• H.R. 3236 ‐ Surface Transportation and

Veterans Health Care Choice Improvement Act of 2015

– Due date for FinCEN Form 114 is changed from June 30 to April 15

• Six‐month extension possible

– Due date for Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, will be April 15 for calendar‐ year filers, with a maximum six‐month extension

8/3/2015 3

New Legislation

• H.R. 3236 ‐ Surface Transportation and Veterans

Health Care Choice Improvement Act of 2015

– I.R.C. §6050H is amended to require new information

• n the mortgage information statements that are

required to be sent to individuals who pay more than $600 in mortgage interest in a year.

• Statements must report the outstanding principal on the

mortgage at the beginning of the calendar year, the address

• f the property securing the mortgage, and the mortgage
• rigination date.

– Applicable to returns and statements due after Dec. 31, 2016.

New Legislation

• H.R. 3236 ‐ Surface Transportation and Veterans

Health Care Choice Improvement Act of 2015

– I.R.C. §1014 is amended to mandate that anyone inheriting property from a decedent cannot treat the property as having a higher basis than the basis reported by the estate for estate tax purposes. – Act creates I.R.C. §6035, which requires executors of estates that are required to file an estate tax return to furnish information returns to the IRS and payee statements to any person acquiring an interest in property from the estate.

• Statements must identify the value of each interest in property

acquired from the estate as reported on the estate tax return.

– The new basis reporting provisions apply to property with respect to which an estate tax return is filed after the date of enactment.

New Legislation

• H.R. 3236 ‐ Surface Transportation and Veterans

Health Care Choice Improvement Act of 2015

– Home Concrete & Supply, LLC, 132 S. Ct. 1836 (2012) vacated.

• The Supreme Court held that the extended six‐year statute of

limitation under Sec. 6501(e)(1)(A), which applies when a taxpayer “omits from gross income an amount properly includible” in excess

• f 25% of gross income, does not apply when a taxpayer
• verstates its basis in property it has sold.
• The act amends I.R.C. §6501(e)(1)(B) as follows:

– “An understatement of gross income by reason of an overstatement of unrecovered cost or other basis is an omission from gross income.”

• The change applies to returns filed after the date of enactment as

well as previously filed returns that are still open under Sec. 6501 (determined without regard to the amendments made by the act).

8/3/2015 4

Key Transfer Tax Changes Under “The American Taxpayer Relief Act of 2012” (ATRA)

[Enacted on January 2, 2013]

• Permanence
• Indexing
• Unification
• Portability

HR 8: the Fiscal Cliff Bill

Permanency of Transfer Tax Provisions

• Rate raised to 40% (from 35%)
• Lifetime exemption remains at $5 million,

with inflation indexing

• $5,250,000 for 2013 deaths
• $5,340,000 for 2014 deaths
• $5,430,000 for 2015 deaths
• The exclusion remains coupled
• Matching Gifting and GST exemption
• “Portability” retained (surviving spouse

can inherit decedent’s unused exemption)

Transfer Tax Changes

• The rate change is easy to deal with

– No carryover effect from year‐to‐year or from gifts to estates – No need to revise familiar estate planning techniques – New law doesn’t give any reason to alter existing plans

• But revisit plans where there have been changes in

finances or personal life

8/3/2015 5

Transfer Tax Changes

• How the new rate structure works:

– 40% rate reached at a taxable estate or cumulative gifts of $1 million

• The “run up the brackets” for the first $1 million is

$54,200 (i.e., any tax payable would be $54,200 less than if the tax were a flat 40% from the first dollar)

– Unified credit is $2,117,800 (2015) and offsets a taxable estate (or taxable gift) of $5.43 million

HR 8: the Fiscal Cliff Bill

Permanency of Transfer Tax Provisions

• Rate raised to 40% (from 35%)
• Lifetime exemption remains at $5 million, with inflation

indexing ($5,430,000 for 2015 deaths)

• The exclusion remains coupled
• Matching Gifting and GST exemption
• “Portability” retained (surviving spouse can inherit

decedent’s unused exemption)

Portability

• Made permanent
• Technical correction made

– “Basic exclusion amount” changed to “applicable exclusion amount” in I.R.C. §2010(c)(4)(B)(i)

• June 15, 2012 portability regulations have expired

and are replaced with final regulations

• Still have to file Form 706 in first spouse’s estate

to make election

– 9 months after death with 6 month extension possible

8/3/2015 6 Obama Administration Green Book For FY 2016 Revenue Proposals

• Estate, gift and GSTT rates and exemptions

– For deaths and transfers after 2017

• Top rate of 45%
• Exclusion of $3.5 million for estate and GSTT purposes

– No adjustment for inflation – No portability

• Exclusion of $1 million for gift tax purposes

– No adjustment for inflation – No portability

Obama Administration Green Book For FY 2016 Revenue Proposals

• Capital gain rate

– Top rate from 20% to 24.2%

• Gets to 28% for passive gains

– Transfer by gift or transfer of property upon death would be considered a sale of the transferred property

• Triggers tax on appreciation in value of the property

– Tax would be payable by donor in the case of a gift and by the decedent’s estate in the case of a bequest.

• Gifts or bequests to a spouse or charity would not be taxable

events

– But, spouse or charity gets a carryover basis

• Gifts or bequests of tangible personal property (except

collectibles) would not be subject to taxation

Obama Administration Green Book For FY 2016 Revenue Proposals

• Capital gains

– $100,000 exclusion for capital gains arising due to death

• Any unused amount portable to decedent’s surviving spouse

– Current §121 exclusion would apply to capital gains on bequests and would be portable to surviving spouse – Certain exclusions for small business stock and family‐

• wned and operated businesses

– For capital gains arising upon death, they would be payable over 15 years – Tax imposed on gains realized at death would be deductible on Form 706

8/3/2015 7 Obama Administration Green Book For FY 2016 Revenue Proposals

• Reporting requirement imposed on executor and donor or

lifetime gift

– Basis information to recipient and IRS

• Inclusion of trust assets in an estate that are presently not

included in gross estate

• GRATs

– Minimum 10‐year term – Maximum term of the life expectancy of the annuitant plus 10 years – Remainder interest with a value equal to the greater of 25% or the value of the assets contributed to the GRAT or $500,000 – Prohibit any decrease in annuity during GRAT term – Prohibition on any I.R.C. §1031 exchange of any asset held in the trust

Obama Administration Green Book For FY 2016 Revenue Proposals

• Limitation on Duration of GSTT exemption

– 90 years from creation of the trust

• Annual exclusion gift changes

– Crummey gifts limited to $50,000 for any year

• Numerous proposed changes with respect to

IRAs

LLC/FLP

• S.E. tax on distributive share

– CCM 201436049

• Recapitalization and gifts

– CCM 201442053

• State‐level cases on pages 2‐6

1

8/3/2015 8 IRS Guidance on Guaranteeing LLC Debt

• AM2014‐003 (Aug. 27, 2013)

– Losses are deductible to extent taxpayer is “at risk”

• Generally measured by amount of money and adjusted

basis of other property that taxpayer contributes to activity and amount borrowed with respect to the activity

• Guarantees of LLC debt are “at risk” if the member

can’t be reimbursed from persons other than the LLC and the debt is bona fide and LLC’s creditors can enforce it

• Guidance with respect to LLCs that hold real estate

1‐2

Checklist of Ideas for FLP Maintenance

• File required annual filings
• Memorialize all significant partnership decisions
• Comply with the terms of the partnership agreement
• Comply with the loan terms, if loans are made
• Make any distributions pro rata (and pursuant to terms of the

partnership agreement)

• Refrain from the personal use of partnership assets (at least unless

fair rental is paid) or using assets for the partners’ personal

• bligations
• Refrain from having partners individually pay partnership
• bligations
• Maintain current and accurate books and records
• Review the non‐tax reasons for forming the partnership and follow

them

Other Ways to Minimize Estate Tax?

• “Charitable Lid” Planning

– An estate plan is created where the testator leaves a set dollar amount of the estate to the children with the residuary estate passing to a charitable

• rganization.
• The portion passing to the charity qualifies for the

estate tax charitable deduction and, thus, puts a lid on the amount of estate tax owed

Pages 18‐20 of Use of Charitable Trusts

8/3/2015 9

Formula Allocation Clauses With Excess Passing To Charity

• McCord (5th Cir. 2006)
• Christiansen (8th Cir. 2009)
• Petter (9th Cir. 2011)
• Hendrix (Tax Court 2011)

Pages 6‐9 of Practical Estate Planning

“Charitable Lid” Planning

• Attractive technique when combined with

hard to value assets such as business interests

• r family partnership interests
• Good way to defeat an IRS audit

– If IRS challenges the valuation of assets on audit, any increase in value on audit does not increase the estate tax due – it simply passes to the charity

Page 20 of ATRA session

“Charitable Lid” Planning

• Key case – Christiansen v. Comr., 130 T.C. No. 1

(2008)

– Decedent owned cattle ranches in South Dakota with her husband. He died in 1986 and she continued to

• perate the ranches until her death in 2001. Her

entire estate passed to her daughter, but the will said she could disclaim all or any portion of her inheritance, with the disclaimed property passing 75 percent to a CLAT and 25 percent to a private foundation

Pages 6‐8 of Practical Estate Planning

8/3/2015 10

Christiansen Case

• Daughter filed a disclaimer. Largest asset in

estate were FLP interests that carried out valuation discounts.

– With discounts, decedent’s estate was just over $6.5 million – Daughter’s disclaimer resulted in the foundation and the CLAT receiving about $140,000 – IRS audited and increased FLP interests by about 35% ‐ but that resulted in more property passing to charity and no increase in estate tax

• Daughter did not retain a continuing interest in the CLAT

after the disclaimer, so no charitable deduction

Christiansen Case

• IRS appealed the portion of the decision

allowing the enhanced deduction for the amount passing to the foundation

– Attacks the disclaimer:

• Any amount passing to the charity was contingent on a

condition subsequent (i.e., the Service’s ultimate determination of value of the decedent’s estate)

• Adjustment clause in disclaimer should be declared

void on public policy grounds – discourage them from examining estate tax returns

– Court disagreed with IRS (586 F.3d 1061)

Petter v. Comr., T.C. Memo. 2009‐290

• Court upheld a defined‐value gift tax clause

and rejected IRS’ policy‐based argument

– UPS stock in LLC transferred to IDGTs and charities, with split determined by formula – IRS tried to negate defined‐value clause based on policy reasons, but court determined that gift was

• f ascertainable value of stock rather than a

specific number of shares or percentage interests in LLC

• 9th Circuit affirmed on appeal (Aug. 4, 2011)

Page 8 of Practical Estate Planning

8/3/2015 11 Hendrix v. Comr., T.C. Memo. 2011‐133

• Court approved transfers with “defined value”

formula provisions to limit gift tax exposure from the transfers

– Transfer of closely held stock in a gift/sale transaction to family trusts and gift to Foundation under coordinated formula provisions was at arm’s length and not contrary to public policy – Clause at issue allocated stock between family trusts and Foundation based on values as determined by IRS willing buyer/willing seller test

Pages 8‐9 of Practical Estate Planning

Wandry v. Comr., T.C. Memo. 2012‐88

• Facts:

– Married couple gifted membership units in LLC to children and grandchildren; transfers made in accordance with dollar value of gifts and were determined by a fraction (numerator was state dollar amount and denominator was value of entire company as determined by IRS or court) – IRS claimed gifts were of fixed fractional interests in LLC and, as a result, LLC unit value understated; court determined that defined value clause reallocated LLC membership units among parties in conformance with formula in which unit value as of transfer date was "unknown constant“ – IRS lost

Pages 9‐10 of Practical Estate Planning

Wandry

• IRS filed notice of appeal on 8/28/12, but then

filed dismissal and dropped appeal

– Appeal would have been to 10th Cir.

• IRS then filed non‐acquiescence in A.O.D.

2012‐4, I.R.B. 2012‐46

8/3/2015 12

Corporations

• Politte

– Majority shareholders liable for unpaid employment tax

• Adell

– Personal goodwill can reduce estate tax value of stock

• Here, son’s goodwill was key to the success of the

decedent’s business and had not been transferred to the decedent’s corporation

Pages 6‐8 of Estate & Business Planning Cases

Estate Tax Valuation

• Estate of Giustina (9th Cir. Dec. 5, 2014)

– At issue was a 41.1% partnership interest in a partnership involved in forestry operations

• No evidence that any sale or liquidation anticipated
• Decedent couldn’t liquidate
• Tax Court said there was a 25% chance that a

hypothetical buyer could find another partner to agree

• 9th Circuit said it was error to assign a 25% probability
• f everything happening that needed to happen to

liquidate.

• Partnership must be valued as a going concern

6

Valuation

• Estate of Kessel v. Comr., T.C. Memo. 2014‐97

– Investment account valued at $4.8 million at time of death

• Estate paid FET of $1.9 million
• Refund sought on basis that account was part of Madoff ponzi

scheme and really had no value

• Court denied s.j. for IRS because taxable asset was account itself

and not the assets in the account

• No s.j. for IRS on willing/buyer, willing/seller test – hypothetical

buyer might have discovered the ponzi scheme

• Case goes to trial

– Note: Decedent made a killing on the account during life – bankruptcy trustee may be able to get hands on account funds.

6

8/3/2015 13

Special Use Valuation ‐ Basis

• Van Alen v. Comr., T.C. Memo. 2013‐255

– Special use value establishes income tax basis in the heirs’ hands – Heirs signed consent agreement agreeing to liability for any additional taxes imposed due to violation of recapture rules – Heirs even stuck with negotiated basis even though they had no part of the negotiations

7

Special Use Valuation

• FCB Interest Rates for Deaths in 2014

– Ag First: 5.29% – Agribank: 4.71% – Co‐Bank: 4.31% – Texas: 4.82%

43

Special Use Valuation

• Finfrock

– Real estate eligible for election must make up at least 25% of gross estate, but 25% test need not be satisfied only with the property that is subject to the election – Reg. had previously been held invalid – Still invalid under greater deferential standard

• Swallows (3d Cir. 2008) applies Chevron deference to

Treasury Regulations

Discussed in Practical Estate Planning

8/3/2015 14

Installment Payment of FET

• Estate of McNeely (D. Minn. Jun. 12, 2014)

– Estate paid estimated estate tax with request for extension of time to file Form 706

• Estate also advised IRS of intent to make Sec. 6166

election

– Upon filing Form 706, estate had overpaid non‐ deferred portion by over $500,000 and sought refund

• Denied, but court allowed excess to be applied to the

taxes eligible for deferral as installments become due

36

Crummey Trusts

• Mikel v. Comr., T.C. Memo. 2015‐64

– Married couple set‐up an irrevocable family trust and put property in it worth $3.26 million

• 60 beneficiaries named
• Trust required notice of right to demand withdrawals within

30 days of receiving notice

– Trustee to make distributions in accordance for health, education and welfare

• Beneficiary would forfeit trust rights upon opposing

distribution decisions of trustees

• Gift tax returns showed $720,000 of gifts per spouse
• IRS said not present interest gifts
• Court said it’s ok – merely seeking arbitration when trustee

breached fiduciary duties by refusing demand notice did not make gifts future interests and forfeiture language did not apply to mandatory withdrawal distributions

Why It’s Important To File A Gift Tax Return

• Redstone v. Comr. (filed with Tax Court on
• Apr. 10, 2013)

– IRS claims that, in 1972, Sumner Redstone (the chairman of Viacom/CBS) made taxable gift (stock in family company) to his children and didn’t file a gift tax return. – Gift tax being asserted 41 years after the gift

• $1.1 million in taxes and penalties plus interest of

about $1.4 million

11

8/3/2015 15

The Passive Loss Rules

• When does a trust materially participate in a

business?

– A concern under the passive loss rules of I.R.C. §469 – Now, also a concern for purposes of the 3.8% NIIT

• f I.R.C. §1411
• The passive loss rules are used to determine if certain

activities are investment income/loss for NIIT purposes

51

The Passive Loss Rules and Trusts

• IRS position

– Only a trustee’s actions as trustee count in determining the trust’s material participation

• But, this is only a litigating position.
• The PAL regulations have reserved the section dealing

with material participation by a trust

• A federal district court rejected the IRS position, stating

that it “defies common sense.”

• The Tax Court, in 2014 also rejected the IRS position

Frank Aragona Trust v. Comr., 142 T.C.

• No. 9 (2014)
• Trusts and the passive loss rules

– Trusts can qualify for the real estate professional exception to the rule that rental activities are per se passive – Activities of trustees that were employees of wholly‐owned subsidiary of trust, acting in capacity of employees count toward material participation test – Activities of non‐trust employees probably also count (issue not before court) – Implications for imposition of the 3.8 percent NIIT

13

8/3/2015 16

Implications of Aragona

• IRS position really makes no sense
• A trustee’s actions as employee should count

as material participation for the trust

– The trustee can’t remove the fiduciary “hat” in anything that the trustee does

• Until regulations are developed that set forth

the IRS position, Aragona can be relied upon

– It will likely be several years before any guidance is issued

Stable Investment Partnership v. Vilsack, (N.D. Ill. Mar. 17, 2014)

• Title to land held in trust
• Partnership only owned personal property

interest

• Partnership not eligible for farm program

payment limits

13

Excluding Gain on Sale of Residence

• CCM 201429022 (May 27, 2014)

– In 2010, estates could elect out of FET – If election made, modified carry‐over basis rule applied – Under Sec. 121(d)(11), a taxpayer acquiring a residence from an estate can use the decedent’s

• wnership and use to determine eligibility for Sec.

121 exclusion – IRS said the provision is not repealed for 2010 deaths, but is for deaths before or after 2010.

17

8/3/2015 17

Option to Buy Farmland

• Kasben v. Kasben, et al. (Mich. Ct. App. May

19, 2015)

– Son deeded farmland to Dad and reserved an

• ption to buy the land “when the grantee no

longer farms the land or decides to sell it or upon his death.”

• While still farming, Dad gifted the tracts to his four

children equally

• Court said option “ran with the land” and is valid

21

13% is 50% in Divorce

• Kunnemann (Neb. Ct. App. Jun. 10, 2014)

– Farm partnership formed with brother 8 years before divorce

• Husband contributed $80,000 and brother put in

$472,000

– Turns into 50% in divorce proceedings

• Represented to USDA on financial documents, tax

returns and USDA disclosures that it was a 50/50 partnership and they equally shared in profits, losses, income, expenses and depreciation

Trust Protector Can’t Challenge Trust Liquidation and Termination

• Schwartz v. Wellin (D. S.C. Apr. 17, 2014)

– Irrevocable trust with SD situs – Trust protector had “the power to represent the Trust with respect to any litigation brought by or against the Trust if a Trustee is a party to such litigation” and “to prosecute or defend such litigation for the protection of Trust assets” – Power not triggered when beneficiaries and trustees liquidated the trust and distributed the proceeds to themselves

27

8/3/2015 18

No Equitable Adoption in Wyoming

• In re Estate of Scherer (2014)

– Decedent believed to be biological father, but learned post‐death that he wasn’t – Claimed she was an heir based on theory of “equitable adoption”

• Note – WY law does not allow stepchildren and foster

kids (and their descendants) to inherit

– Court refused to recognize the concept of equitable adoption

32

Assignment of Farm Rental Income as a Medicaid Strategy

• Bleick v. ND DOHS (N.D. 2015)

– Farmland transferred to son in 1998 with reserved life estate

• Rental income was $5,332 annually for life

– In 1992, son leased portion of farm to another farmer for $8,200 annually – Mom moved off farm and then later applied for Medicaid

• Denied – she should be receiving a portion of the $8,200 and

asset level too high

• Court agreed

– Not an annual gift to son because no release of life estate coupled with title transfer to son 39

Interim Changes and Adjustments

• Annual exclusion

– $14,000

• I.R.C. §6166(j)

– 2% portion ‐ $1,470,000

• Non‐citizen spouse annual exclusion

– $147,000

• Basic exclusion amounts

– $5,430,000

42

8/3/2015 19 State Legislative Developments On Estate/Inheritance Tax

• Hawaii

– For estates of decedents dying on or after Jan. 25, 2012, state law exemption mirrors federal exemption

• Indiana

– State inheritance tax repealed effective January 1, 2013

State Legislative Developments on Estate/Inheritance Tax

• Illinois

– Sets state law exemption at $4 million, but does not allow for portability of unused exemption at death of first spouse, and eliminates gift tax

• Can make separate state QTIP election
• Maine

– Exemption is $2 million for decedents dying on or after Jan. 1, 2013

State Law Developments on Estate/Inheritance Tax

• Ohio

– State estate tax repealed effective for decedents dying

• n or after Jan. 1, 2013.
• Oregon

– State inheritance tax changed to a “stand‐alone” estate tax with an exemption of $1 million effective for deaths on or after Jan. 1, 2012

• Tennessee

– Legislation phases out the inheritance tax over four years (gone as of Jan. 1, 2016). The exemption is $2 million for 2014

• Gift tax is repealed retroactive for gifts made on or after
• Jan. 1, 2012.

8/3/2015 20

Minnesota Estate and Gift Tax

• Legislation signed into law (effective 6/30/13)

– Gift tax rate of 10% on residents and non‐ residents owning property in MN

• Transfer of title to real estate w/o full consideration
• Transfer of tangible personal property “customarily kept

in MN at time of gift

• Gifts of intangible assets

Minnesota Estate and Gift Tax

• $1 million exemption for lifetime gifts

– Applicable after $14,000 present interest annual exclusion

• No gift tax on the following:

– Transfers to spouses – Charitable gifts – Transfers for educational or medical purposes

Minnesota Estate and Gift Tax

• Generally inapplicable to non‐residents unless

gifts made within 3 years of death

• Effective June 30,2013

8/3/2015 21

Minnesota Estate Tax

• Applicable to estates over $1 million
• Starting in 2013, both residents and non‐

residents with property in MN must include MN taxable gifts made w/i 3 years of death in MN taxable estate

• Entities disregarded for estate tax purposes

– Eliminates discounting

Minnesota Estate Tax

• HF 1777 signed into law on Mar. 21, 2014

– Retroactively repeals the gift tax enacted in 2013 – Estate tax exemption increased to $1.2 million for 2014

• Increases in $200,000 increments and will be $2,000,000 in 2018

– Modifies computation of estate tax

• First dollars taxed at 9%, and increases to 16%

– Separate state QTIP election can be made – Estate tax on non‐residents owning an interest in pass‐ through entity owning personal property in MN does not apply to publicly traded entities. Still applies to entities taxed as partnership or S corporation owning closely held businesses, farms and cabins

8/3/2015 22

IRS Issues Associated with Estate and Business Planning

Kristy S. Maitre, Tax Specialist Center for Agricultural Law and Taxation

Estate Tax Closing Letters

• IRS has announced that, for estate tax returns filed on
• r after June 1, 2015, estate tax closing letters will be

issued only upon request by the taxpayer

– It has also clarified whether it will, under various circumstances, issue a closing letter with respect to estate tax returns filed before June 1, 2015 – In Rev. Proc. 2014‐18, 2014‐7 IRB 513, IRS provided procedures under which estates of decedents that died before Jan. 1, 2014, that fall below the dollar threshold for having to file an estate tax return, that failed to file Form 706, and that wanted to elect to take the estate tax portability exclusion, could get an automatic extension of time, to Dec. 31, 2014, to file Form 706 to make that election

Estate Tax Closing Letter

• In the past, IRS issued closing letters to estates for federal estate tax

purposes, acknowledging that it has accepted the estate tax return as filed, or as adjusted pursuant to audit. This used to be an automatic process.

• The IRS has now announced on its website that a closing letter will be

issued only if the taxpayer requests it.

– To make matters worse, the IRS asks that the request not be submitted until 4 months after the return is filed – thus ruling out making the request as part of the return filing.

• This makes you wonder whether the IRS no longer has the resources to do

a preliminary review of every filed Form 706, as in the past.

– If that is the reason for this new policy, then perhaps it may be advantageous to NOT request a closing letter since that may generate a review of a filed return that might not otherwise have occurred. – However, in those localities where a probate court will require a closing agreement to close an estate administration, this may not be practical or possible.

8/3/2015 23

Estate Tax Closing Letters

• For estate tax returns filed before June 1,

2015, IRS has continued its former instructions that:

– a) personal representatives can expect a closing letter to be issued within four to six months from the date that Form 706 is filed if the return is without errors or special circumstances; and – b) letters for returns that are selected for examination or reviewed for statistical purposes will take longer.

Estate Tax Closing Letters

• In addition, IRS has indicated that, for estate tax returns filed after
• Jan. 1, 2015 and before June 1, 2015, its previous policy of issuing

closing letters has been changed to reflect the portability rules

• For example, no closing letter will be issued for such a return if:

– a) the estate didn't meet the filing threshold and the portability election was denied due to a late filing; or – b) the return was filed pursuant to Rev Proc 2014‐18 and the portability election was denied due to failure to meet Rev Proc 2014‐ 18's requirements On the other hand, where such a return was filed, the estate met the filing threshold, and the portability election was denied due to a late filing, a closing letter will be issued.

• It appears that the rules described in the immediately preceding

paragraph are actually intended to apply to estate tax returns filed at any time before June 1, 2015.

Termination of a Fiduciary Relationship

• Form 56 is used to notify IRS of the creation or

termination of a fiduciary relationship

• Form 56 revised in December 2011
• Revocation section removed from new

revision

• Write “TERMINATION” on the top of Form 56

1

8/3/2015 24

Form 56 Address Changes

• Form 56 cannot be used to update the last

known address of the person for whom you are acting

• Must file Form 8822 or 8822‐B
• Change of address on Form 56 will not be

processed

• Form 56 needs to be filed at the campus

where the person for whom you are acting is required to file.

Form 56 Special Rules

• Proceedings (other than bankruptcy) and

assignments for the benefit of creditors.

– A receiver in a receivership proceeding or similar fiduciary or – An assignee for the benefit of creditors must file with Form 56 on or within 10 days of the date of appointment with:

• Advisory Group Manager – Publication 4235
• The receiver or assignee may also file a separate Form 56

with the service center where the person for whom the fiduciary is acting is required to file tax returns to provide the notice required by section 6903.

Estate and Gift Tax Contact – Discharge of Federal Tax Lien

• Form 4422 should be sent when the following applies

– Form 706 has an assessed unpaid balance – Been granted a payment deferral or – Has received Letter 627, Estate Tax Closing Letter Address: Internal Revenue Service Advisory Estate Tax Group 55 South Market Street Mail Stop 5350 San Jose, CA 95113‐2324 Attention: Group Manager Applies to §2032A or §6166 and other elections

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8/3/2015 25 Estate and Gift Tax Contact – Discharge

• f Federal Tax Lien
• If the Form 706:

– has not been filed or, – is non‐taxable or, – the tax assessment has been paid in full, or – has been filed and the tax assessment has been paid in full and – Letter 627, Estate Tax Closing Letter, has not been issued, Submit Form 4422 and all supporting documents to: Internal Revenue Service Attn: Estate and Gift Tax Exam Group Manager Call 866‐699‐4083

1041 Payment Voucher

• In response to practitioner concerns that payments for

Form 1041, US Income Tax Return for Estates and Trusts, are posting incorrectly, especially SHORT YEAR returns

• IRS is considering revising Form 1041‐V payment

voucher to allow entry for the tax period ending date for fiscal year and short year filers

• In the meantime, taxpayers who file Form 1041 using a

tax period ending in a month other than December should mark out the tax year on the upper right hand corner of the Form 1041 V and write in the tax period ending date (MM/DD/YYYY)

2‐3

Gift Tax Issues

• Interfamily gifts ‐ audits
• Gift Tax Return Copies – NO Form 4506

– Letter required

4

8/3/2015 26 Identity Theft Deceased individuals

• IRS can lock accounts
• Proactive

– Notify IRS of death – Send in death certificate – IRS will note account – Limit obit information

5

Abatement of Dishonored Check

• Evidence the account had sufficient funds
• Bank error – document
• Provide letter with explanation
• Note IRM 20.1.1.3

Form 1041‐T

• Election
• Method to Allocate estimated tax payment
• For the election to be valid, a trust or decedent’s

estate must file Form 1041‐T by the 65th day after the close of the tax year as shown at the top

• f the form
• If the due date falls on a Saturday, Sunday, or

legal holiday, file on the next business day

• For a 2014 calendar year decedent’s estate or

trust, that date is March 6, 2015

5‐6

8/3/2015 27

Unable to Process Conditions

• Delays the processing
• Generally handled through correspondence
• Statute begins when reply is received and

addresses the issue

6‐7

Administrative Files

• IRM 4.2.5.7 and 5.1.22.6 states that the

Service will provide copies of the case file without going through the formal process of the FOIA request, unless the release would seriously impair tax administration.

• Lengthy process
• Files stored off site – 6‐8 weeks minimum

7

Filing Final Returns

• DO NOT cross through years and write in new

year

• IRS cannot process a 1040 final 2015 return

until 2016

• IRS cannot process any estate tax return until

the forms are final

• Often a duplicate file issue will occur

– Months to fix – With ID Theft IRS could assume it is ID Theft

8

8/3/2015 28

Form 1310

• Form 1310 is used to claim a refund on behalf of a deceased

individual

• IRS states that a Form 1310 is not required for a surviving spouse

filing an original or amended joint return with the decedent or the person is a personal representative (executor or administrator of the decedent’s estate) filing an original return

• Form 1040 series and a court certificate showing the appointment

is attached to the return

– Note, the court certificate is not always attached in the case of a personal representative. – IRS looks for a Form 1310 even though one may not be required. It is a good practice to always include a Form 1310, do not depend on IRS training of assistors who are involved in the processing of the final return.

8‐9

Late Established Estate

• A practitioner requested information on how to

prepare Form 2848, so an estate filing Form 1041 with an Employer Identification Number can get information returns filed with a Social Security number

• In the practitioner’s scenario, the taxpayer died in

2011, the estate opened in 2013 and the practitioner needed information returns for 2012

• Form 2848 instructions don’t address this

situation.

9‐10

Late Established Estate Process

• The IRS will accept Form 2848 with two Taxpayer Identification

Numbers, if the taxpayer is an estate and the Form 2848 includes Form 1040 issues

• The Form 2848 should include both the decedent’s SSN and EIN (if

estate has an EIN)

• You will list both Forms 1040 and 1041, as well as the tax periods, in

the tax matters field of Form 2848

• Generally, in the case of a deceased individual, enter the name and

SSN (or Individual Taxpayer Identification Number) of the decedent as well as the name, title, and address of the decedent’s executor

• r personal representative on Form 2848
• However, in the case of an estate, enter the name of the decedent

and the EIN for the estate (if assigned) as well as the name, title, and address of the decedent’s executor or personal representative

• n Form 2848.

8/3/2015 29 Obtaining transcripts for a deceased taxpayer

• Estate attorney was denied transcripts through e‐

services because the decedent's account was assigned to the identity theft unit

• The IRS response showed the taxpayer as

deceased but told the authorized representative for the estate to have the taxpayer call the identity theft unit

– The executor of the estate should file Form 56, Notice Concerning Fiduciary Relationship, and then call the Identity Protection Specialized Unit to get a copy of the transcript.

10

Estate/Gift Tax Pre‐Appeals Conferences Effective January 30, 2015

• Eligibility for an IRS Appeals conference in jeopardy
• The information (SBSE‐04‐0115‐0015) outlines the options available

if the taxpayer does not agree with the auditor’s proposed adjustments

• IRS will issue the “30 day” letter with the report of proposed

adjustments to the tax return along with the newly created Letter 5262‐D, Additional Information Due Estate and Gift Tax

• The move to the new letter hopes to increase consistency when

notifying the taxpayer of the audit results

• The taxpayer has 15 days to respond and provide or verify they do
• r do not have the information requested.
• IRM sections 4.25.10 and 4.25.11 were changed due to the interim
• guidance. This procedure will apply through December 31, 2015.

10‐11

What Does This Mean?

• IRS in the last few years has seen an increase in Appeals

cases

• The procedural change, places more responsibility on the

auditor to get the information needed from the taxpayer

• If new information is presented in an Appeals case, the case

will generally be returned to the auditor

• When the audit begins, along with the audit notice is Form

4564, an Information Document Request

• This form lists the information IRS would like to view to

verify the information on the tax return

• Letter 5262‐D will only be issued if the information is not

provided or the taxpayer has not advised the auditor that no further information is available

8/3/2015 30 PRESERVE THE APPEALS CONFERENCE.

• IRS requires a response from the taxpayer or

representative, without a response Letter 5262‐D will be issued with the final report

• This will, have a direct impact on whether or not the

taxpayer is eligible for an Appeals conference

• IRM 1.4.40.4.11.5 Un‐agreed Case Procedures states

the case file should not be sent to Appeals unless the information requested has been provided or there is information provided that the taxpayer does not have the information. YOU MUST RESPOND EITHER WAY TO PRESERVE THE APPEALS CONFERENCE

New Statute of Limitation

• On September 2, 2014, the IRS Office of

Appeals issued new procedures concerning the number of days that remain on the statute

• f limitations for assessment (270 days for

non‐docketed estates cases and 365 days for gift tax cases) before the Office of Appeals will accept case from the examination division.

14

New Statute of Limitation

• Exception applies in estate cases where the Office
• f Appeals returns a case to the examination

division for consideration of new information or a new issue

• In these estate cases, there must be at least 180

days remaining on the statute of limitations for appeals to accept the returning case

• This exception does not apply to gift tax cases
• The statute of limitations cannot be extended in

estate and gift tax cases.

8/3/2015 31

§6404(a) and CCA 201520010

• Taxpayer Assistance Order request
• Scenario

– Taxpayer filed a late return with a balance due and tax was paid including the penalties and interest – An error was found and an amended return was filed reflecting a refund – IRS agreed the amended return was correct – IRS calculated penalties and interest based on balance due of the original return

• Penalties excessive due to the amended return reflected a

refund and the true liability was lower which would have resulted in lower penalties and interest

§6404(a)

• IRC section 6404(a)(1) authorizes the IRS to

abate the unpaid portion of an assessment that is excessive in amount

• While the statute specifies “unpaid”

assessments, Counsel’s view is that IRC section 6404(a)(1) is permissive and that the IRS is not prohibited from abating the paid portion of assessments

§6404(a) and CCA 201520010 Refund Barred has no Effect

• The timing of a claim for credit or refund has no effect on the IRS’s

authority to abate an assessment

• Thus, although the refund of tax reported on the amended return is

time‐ barred under IRC section 6511 (the amended return was not filed within 3 years from the filing of the original return and the taxpayer full‐paid the liability when he filed the original return), the IRS may still abate the penalties and interest that exceed the true amount of penalties and interest the taxpayer owes

• As a result of the payments of penalties and interest that the

taxpayer has been making each month, the taxpayer has overpaid the penalties and interest

• The amended return should be treated as a claim for refund for the

penalties and interest paid in the two years prior to the date the amended return was filed, to the extent those amounts exceed what the taxpayer actually owed

8/3/2015 32 Power of Attorney Subject to FBAR Reporting

• IRS has taken the position in their “FBAR

Reference Guide” that “signature authority” includes “the authority of an individual (alone

• r in conjunction with another individual) to

control the disposition of assets held in a foreign financial account by direct communication (whether in writing or

• therwise) to the bank or other financial

institution that maintains the financial account.”

14‐15

Example

• In an example, IRS explains that this definition

includes agents acting under a power of attorney (POA)

• It is immaterial if the power has ever been

exercised

• The agent (along with the principal) is subject to

the FBAR filing requirements if the POA gives the agent signature authority over a foreign account that exceeds the dollar threshold

8/3/2015 33

Estate Planners

• Estate planners should immediately advise all clients

where POA’s are in place of this requirement

• It is standard practice to give agents authority over

bank accounts of their principal

• Remember, it is the agent that has liability for non‐

filing, along with the principal.

• Estate planners must take care to ensure that all agents

named in POAs know that they have been named (this can be an issue with respect to durable POAs) that are not delivered to the agent until necessary

• Clearly, the best practice is to have the agent sign the

POA along with the principal

Employer Identification Number (EIN) Estates

• You will be required to obtain a new EIN if any
• f the following statements are true:

– A trust is created with funds from the estate (not simply a continuation of the estate) – You represent an estate that operates a business after the owner's death

15

Employer Identification Number (EIN) Estates

• You will not be required to obtain a new EIN if

any of the following statement is true:

– The administrator, personal representative, or executor changes his/her name or address

8/3/2015 34

Trusts and EIN

• You will be required to obtain a new EIN if any
• f the following statements are true

– One person is the grantor/maker of many trusts – A trust changes to an estate – A living or intervivos trust changes to a testamentary trust – A living trust terminates by distributing its property to a residual trust.

15

Trusts and EIN

• You will not be required to obtain a new EIN if

any of the following statements are true

– The trustee changes – The grantor or beneficiary changes his/her name

• r address.

Requesting an Employer Identification Number for a Trust

• Practitioner's client was trustee of her living trust since its creation

in 1989

• She became incapacitated in 2013, requiring a change in the trustee
• Although an EIN was not required for the new trustee in this case,

the practitioner applied for one using the Online EIN Assistant on IRS.gov

• When prompted for the funding date of the trust, he entered 1989,

the year the trust was created

• This generated an IRS request for 23 years of trust returns
• To eliminate confusion and minimize taxpayer burden, the

practitioner suggests the Online EIN Assistant include information clarifying which date to enter when an EIN is required.

16

8/3/2015 35

Answer

• Changes to the Online EIN Assistant are

prioritized

• During the next update to the Online EIN

Assistant, IRS will add a help topic providing clarification on the date that should be used for the "date trust funded" question and when an EIN is required due to a change in circumstances.

Perfection of Returns Why is it Important?

• All returns are perfected
• If information, schedules documents are

missing the return can be deemed invalid and not processable

• This could and does extend the statute time

frame depending on the importance of the document

• Text provides a checklist for Estate and Gift Tax

Returns

16

Estate Closing Letter

• There can be some variation, but for returns

that are accepted as filed and contain no

• ther errors or special circumstances, you

should expect to wait about 4 to 6 months after the return is filed to receive your closing letter

• Returns that are selected for examination or

reviewed for statistical purposes will take longer

17

8/3/2015 36

You Snooze You Lose Hot Issues

• Karen Hawkins retirement
• 2015 Allowed Living Expense Standards have

been released – OIC

• Cal Pure Pistachios, Inc v. United States
• Education Credits – audits

– 3.6 million received more than 5.6 million in erroneous education credits for tax year 2012

• No form 1098‐T was issued
• Attending ineligible institutions
• Claimed credit for more than four years
• Attended school less than half‐time

More Hot Issues

• Omitting information from the form 1040 can

extend the statue of limitations

• Electronic Confirmation Notices to Employer
• Employer Notices of Address Changes
• Filing deadline for 2016 = April 18, 2016
• Medicare Premium Hikes could effect your

clients in 2018

– Premiums are based on 2016 data, so deferring income could have an impact on 2018 premiums

8/3/2015 37

• Tax Information with Indy 500 Speed
• Kristy Maitre

– CALT Tax Specialist

CALT RESOURCES

8/3/2015 38

Scoop Dates for Post‐Filing Season

• August 5, 2015
• September 23, 2015
• October 21, 2015
• October 28, 2015

CALT Website

http://www.calt.iastate.edu/

Tour of the CALT Website

8/3/2015 39

CALT Staff

Roger A. McEowen CALT Director and is a Leonard Dolezal Professor in Agricultural Law Email: mceowen@iastate.edu Phone: (515) 294‐4076 Fax: (515) 294‐0700

Kristine A. Tidgren Staff Attorney E‐mail: ktidgren@iastate.edu Phone: (515) 294‐6365 Fax: (515) 294‐0700

CALT Staff

Kristy S. Maitre Tax Specialist E‐mail: ksmaitre@iastate.edu Phone: (515) 296‐3810 Fax: (515) 294‐0700 Tiffany Kayser Program Administrator Email: tlkayser@iastate.edu Phone: (515) 294‐5217 Fax: (515) 294‐0700

Time For A Break!

• Morning Break:

– 9:45 – 10:05 a.m.

8/3/2015 40

The Impact of State‐Level Estate/Inheritance Tax on Farm Succession Planning

Chris Hesse

16 States with Estate Tax

• Connecticut
• Delaware
• DC
• Hawaii
• Illinois
• Maine
• Maryland
• Massachusetts
• Minnesota
• New Jersey
• New York
• Oregon
• Rhode Island
• Tennessee
• Vermont
• Washington

1

States with Inheritance Tax

• Iowa
• Kentucky
• Maryland
• Nebraska (County level)
• New Jersey
• Pennsylvania
• Tennessee calls it an

inheritance tax, but it is really an estate tax

8/3/2015 41

Maximum State Estate Tax Rate

• 20%

– Washington

• 16%

– Delaware – DC – Hawaii – Illinois – Maryland – Massachusetts – Minnesota – New Jersey

• 16% (continued)

– New York – Oregon – Rhode Island – Vermont

• 12%

– Connecticut – Maine

• 9.5%

– Tennesee

2015 State Estate Tax Threshold

• $675 thousand

– New Jersey

• $ 1 million

– DC – Massachusetts – Oregon

• $1.4 million

– Minnesota

• $1.5 million

– Maryland – Rhode Island (indexed)

• $2 million

– Connecticut – Maine – Washington (Indexed)

• $2.0625 or 3.125

– New York

• $2.75 million

– Vermont

• $4 million

– Illinois

• $5.43 million

– Delaware – Hawaii

How Does State Threshold Work

• The threshold is usually applied to the federal

gross taxable estate

• Then state tax is calculated based on the

federal estate

• The percentage of state level assets to federal

estate level is then multiplied by the federal tax

• Most of the states have a pick‐up level tax

8/3/2015 42

Portability

• Allowed at federal level

– DSUE ported over to surviving spouse – Not allowed for GST – Not indexed to inflation

• Not allowed at state level (other than Hawaii)

– Wrong title of assets exposes second spouse to additional tax

1

Example of Additional State Estate Tax

• Ben & Maria married for over 50 years;

Oregon residents; All assets titled in Ben’s name; Net worth of $10.5 million

– Federal portability results in no federal estate tax – Additional Oregon tax of about $150,000 owed to no portability at Oregon level

1‐2

AB Trust Planning

• “A” trust commonly known as

– “Marital Trust”, – “QTIP Trust” or – “Marital Deduction Trust”

• “B” trust commonly referred to as

– “Bypass Trust”, – “Credit Shelter Trust”, or – “Family Trust”

2

8/3/2015 43

AB Trust Reasons

• Portability is not indexed to inflation
• Spouses have different sets of final

beneficiaries

– Blended families

• Federal GST is not portable

AB Trust Structure

• Appropriate AB Trust language in wills or RLT
• Couple divide assets to equalize
• First deceased spouse up to $5.43 million into “B”

Trust

• Excess goes into “A” Trust
• Surviving spouse reports their assets plus value of “A”

trust

• Assets in “B” trust not subject to second estate tax
• If “A” Trust not needed, then unused portion is ported

to surviving spouse

2‐3

State Marital Trust Requires “C” Trust

• If the state death tax threshold is less than

the federal exemption amount, then a “C” trust is required to hold the difference

– Normally requires state level QTIP election – DC and Vermont do not allow separate state level QTIP election

8/3/2015 44

ABC Trust Structure

• “B” Trust holds assets up to state estate tax

threshold

• “C” Trust holds assets from that level to

federal exemption level

• “A” Trust holds assets above federal

exemption level

Ben & Maria Example

• Ben worth $7 million

– “B” Trust is funded with $1 million – “C” Trust is funded with $4.43 million – “A” Trust is funded with $1.57 million

• “A” Trust is included in Maria’s estate for both

federal and state estate tax purposes

• “C” Trust is only included in Maria’s Oregon

estate tax filing

4

Lifetime Gifts

• Most states with estate tax have no gift tax

– Therefore gifts made during life will not be subject to any state level transfer tax – Care must be taken with assets to be gifted

• Basis equals FMV – Best to gift
• FMV much greater than basis – May want to run

through estate to get step‐up

– However, immediate state estate tax may be more costly than possible future capital gains tax

4

8/3/2015 45

Non‐Residents and Real Property

• All states tax real property located in state for

non‐residents

• Possible planning steps

– Move to another state (for personal property) – Place real property in LLE

• Does not work for all states (must look to state law)
• Even if allowed by statute, state may fight it if only

reason is for estate tax planning purposes

5

U.S. Income Tax Considerations When Using Foreign Guest Workers

Michelle VanDellen, CPA, MS

What We’ll Cover Today

• U.S. Immigration and Tax

Residency Status

• Income Tax Return Filing
• Employer Withholding and

Reporting

8/3/2015 46

U.S. Immigration and Tax Status

• Immigration Categories – In General

– U.S. Citizenship

• Birth
• Naturalization

– Immigration Visa

• Those intending to immigrate permanently to the

U.S.

– Non‐Immigration Visa

• Student visas
• Temporary worker visas

2

U.S. Immigration and Tax Status

• Tax Categories – In General

– U.S. Citizen

• Taxed by U.S. on worldwide income
• Subject to U.S. tax regardless of residence

– U.S. Resident

• Taxed by U.S. on worldwide income
• Eligible for foreign tax credits to reduce double taxation

– Neither U.S. Citizen nor U.S. Resident

• Taxed by U.S. on U.S.‐sourced income only

3

Tax Classification of Common Visas

Tax Category Corresponding Visa Classification

U.S. Citizen N/A Resident Alien Permanent Resident Card (green card; LPR) E, H‐2A, L Nonresident Alien E, H‐2A, L

8/3/2015 47

Substantial Presence Test

• Sec. 7701(b)(3)(A)
• An individual was physically present in the

U.S. for at least 31 days during the current (calendar) year, and

• The sum of the number of days (when

multiplied by a formula) on which such individual was present in the U.S. for the current and the two preceding calendar years equals or exceeds 183 days.

4

Substantial presence test formula

• 100% of current year days, plus
• 1/3rd of prior year days, plus
• 1/6th of second prior year days
• equals or exceeds 183 days

An individual who is present in the U.S. for 122 days during each of the three years will be considered to have met the substantial presence test.

Substantial presence test

• Less than 183 by formula: U.S. tax non‐

resident

• 183 or more by formula (but less than 183 in

current year): U.S. tax resident under the Substantial Presence Test

– an exception exists for “closer connection” to another country

• 183 or more in current year: U.S. tax resident

– may gain non‐resident status under treaty

5

8/3/2015 48

Closer connection exception

• Sec. 7701(b)(3)(B)
• Individual is present in the U.S. less than 183

days in current year, and

– maintains a tax home in a foreign country, and – has a closer connection to such foreign country.

• Individual must File IRS Form 8840 with

individual income tax return to make a claim for a closer connection to a foreign country.

How this impacts foreign guest workers with h‐2a visas

• Treated as a tax nonresident, unless s/he

meets the substantial presence test.

• If the substantial presence test is met, the

worker may still be treated as a tax nonresident if s/he has a closer connection to another country.

• If the worker is in the U.S. for 183+ days in the

current year, s/he is a U.S. tax resident unless a treaty exception applies.

6

Special rules applicable to foreign agricultural workers with h‐2a visas

• Exempt from U.S. Social Security and Medicare

taxes on wages paid in connection with the H‐2A visa,

– Regardless of whether the worker is a resident or nonresident alien.

• Wages paid in connection with the H‐2A visa are

not subject to FIT withholding (unless backup withholding applies).

– Worker and employer should consider voluntary FIT withholding if worker may owe U.S. income tax. – State withholding rules may differ.

8/3/2015 49 Requirement to File a U.S. Income Tax Return ‐ nonresidents

• Nonresident must file a U.S. income tax return

(Form 1040NR) if s/he has U.S. source income.

• Reg. 1.6012‐1(b)(1)
• Exception for nonresident who earns U.S.

sourced wages, who would be required to file a U.S. income tax return solely because of those wages, if those wages are less than the personal exemption amount ($4,000 for 2015).

Notice 2005‐77

7

Form 1040NR

• May also need to file:

– Form 8840 – Closer Connection Exception Statement, or – Form 8833 – Treaty‐Based Return Position Disclosure

• Due date for filing (Reg. 1.6072‐1)

– Nonresident alien individual – June 15 (generally) – Nonresident alien who has wages subject to withholding – April 15.

• IRS: “compensation paid to H‐2A agricultural

workers for services performed in connection with the H‐2A visa is not considered to be “wages” for purposes of federal income tax withholding . . .”

Dependency exemptions

• Entitled to one personal exemption.
• Residents of Canada and Mexico may claim

additional exemptions:

– for his/her spouse (if s/he has no gross income and is not the dependent of another taxpayer), – for other dependents using the same rules as for U.S. citizens.

• Sec. 873(b)(3) and 151(b)

8

8/3/2015 50

Qualifying child

• Child (including step and foster), sibling (including

half and step), or a descendant of any of them.

• Under age 19 (age 24 if a student) and younger

than the taxpayer, or any age if permanently and totally disabled.

• Lived with the taxpayer for more than half the

year

• Must not have provided more than half of his/her
• wn support.
• Not filing a joint return for the year.

Qualifying relative

• Not Qualifying Child
• Either live with the taxpayer all year as a member of the

taxpayer’s household or be related to the taxpayer: descendants, siblings, ancestors, nieces and nephews, most in‐laws.

• Gross income must be less than the personal exemption

amount ($4,000 for 2015).

• Taxpayer must provide more than half of the person’s

total support during the calendar year.

9

Individual taxpayer identification numbers (itins)

• In order to be claimed as a dependent,

qualifying individuals must have an ITIN or SSN.

• Complete Form W‐7 or W‐7(SP) to obtain ITIN.

– File with tax return for the first year the ITIN is needed. – Original (or certified copies) of documents that support the information provided on Form W‐7. – Original documents are returned to the mailing address shown on the W‐7.

8/3/2015 51 Requirement to file a U.S. income tax return – residents

For individuals who trigger the substantial presence test:

• File Form 1040 reporting worldwide income.
• Credits:

– Earned income credit: qualifying child must live with the parent in the U.S. Both the parent and the child must have SSNs to claim the credit. – Child tax credit: qualifying child must be a U.S. citizen, U.S. national, or a resident alien.

10

Form W‐2 REPORTING

• Wages paid in connection with H‐2A visas must

be reported on Form W‐2 if $600 or more.

• Complete:

– Box 1: Wages, tips, and other compensation – Box 2: Federal income tax withheld if the employee elected voluntary FIT withholding

• Do not complete:

– Box 3: Social Security wages – Box 5: Medicare wages

Form W‐2 REPORTING

11

8/3/2015 52

FORM 943 REPORTING

• Complete:

– Line 1 – Number of agricultural employees – Line 8 – Federal income tax withheld if the worker elected voluntary FIT withholding

• Do not complete:

– Lines 2, 4, and 6: total wages subject to social security and Medicare taxes

Form 943 reporting

12

FUTA tax

• Wages paid to workers on H‐2A visas are not

subject to the FUTA tax.

• However, their wages must be counted in

determining the FUTA threshold of:

– $20,000 wages per quarter, – 10 or more workers per day for 20 weeks.

8/3/2015 53

Form 940 reporting

• Include workers’ wages on Line 3: Total

payments to all employees

• Subtract these wages on Line 4: Payments

exempt from FUTA tax

• Check Box 4e: Other

13

Form 940 Questions?

Michelle VanDellen, CPA, MS Michelle.vandellen@mossadams.com 360‐685‐2205

8/3/2015 54

Long Term Care Planning Strategies

Roger McEowen

161

Planning for Long-Term Health Care

• Deficit Reduction Act of 2005

– Signed by President on Feb. 8, 2006

• Among other things, makes Medicaid asset-

preservation planning more difficult

Page 16 of Planning Techniques

162

Deficit Reduction Act

• Look-back period extended to five years for

all transfers

– Can no longer transfer assets and wait three years for Medicaid eligibility – Planning options:

• Set aside enough funds to pay for 5 years of care and

transfer the balance to the kids; or

• Transfer all assets to the kids and let the children pay

for parent’s nursing home care for 5 years

– A child can then claim parent as a medical dependent on tax return Page 16‐17 of Planning Techniques

8/3/2015 55

163

Extended Look-back Period

• Planning options:

– Use grantor trusts instead of transferring assets to the children

• Less risky
• Retain I.R.C. §121 exclusion
• Step-up basis available for appreciated assets
• Income taxed to grantor

164

Extended Look-back Period

• Planning options:

– Buy long-term care insurance for a period

• f five years
• If care needed in the future, transfer assets

and wait-out the 5-year look-back period via use of the long-term care insurance

165

Deficit Reduction Act

• Change in beginning date for

computation of ineligibility period for transferred assets

– Later of:

• Date transfer made or date individual would

– be eligible for medical assistance; – otherwise be receiving institutional care based on an approved application for such care, but for the application of the penalty period (whichever is later); and – which does not occur during any other period of ineligibility

8/3/2015 56

166

Change in Ineligibility Period

• Planning options (step by step):

– Parent transfers assets and applies for Medicaid – Application denied – Child then re-transfers roughly half of the assets to the parent – Parent reapplies and is rejected – Parent pays for care during period of ineligibility

167

Deficit Reduction Act

• Home equity

– Medicaid ineligibility if applicant has home equity in excess of $500,000 (or $750,000 at state’s option)

• Exceptions apply is home occupied by:

– Spouse – Child under age 21 – Child who is blind or permanently and totally disabled

168

Home Equity Rule

• No impact on planning if applicant is

single

• For married applicants, have the

community spouse buy a more expensive home as a means of sheltering assets

8/3/2015 57

169

Deficit Reduction Act

• Mandates partial month penalties for asset

transfers – Can no longer transfer small sums (lower than the state’s divisor) and not be penalized – No longer possible to transfer assets and then make additional transfers within the look-back period that are structured in a manner that the penalty for the subsequent transfers did not extend beyond the original look-back period

170

Deficit Reduction Act

• Accumulation of multiple transfers

– Fractional transfers of assets in more than

• ne month are accumulated

– Transfers during all months within the 5-yr look-back period are treated as one transfer

• All transfers within the 5-yr look-back period

are penalized

171

Title XIX and Saving the Family Business

• General comments:

– Obtain nursing home insurance at age 60‐65 (not beyond age 70)

• Get what you need and no more (can get a rider

to increase policy benefits as time passes)

• Determine what income is from Soc. Sec., rents,

dividends, etc.

• Set up such that no benefits paid during first 6

months

• Get lifetime coverage

8/3/2015 58

172

Title XIX and Saving the Family Business

• What if person is too old to get insurance?

– Sell 20 acres at a time to family members on installment basis

• Make sure contract provides that upon death the

contract is cancelled and conveyance to buyer of

• nly the fractional part of the contract that has

been paid for

– Have family members make a loan to the person in the nursing home

• Document carefully and obtain a mortgage and

make copies of checks

173

Title XIX and Saving the Family Business

• What if one spouse is in the nursing home and

the other isn’t

– Exempt assets should be turned over to spouse not in nursing home – Division of non‐exempt assets

• First $24,000 goes to spouse at home
• Next $24,000 goes to spouse in nursing home
• 50/50 split thereafter up to $90,660 (each)
• Balance goes to spouse in nursing home

174

Long Term Care Planning

• Estate Recovery

– Any money spent by Medicaid for a person’s care can be recovered from assets owned by the person at the time of death

8/3/2015 59

175

Long Term Care Planning

• Strategies

– Plan to pay for your own care out of your income and assets – Purchase long term care insurance – Purchase long term care insurance to cover the 5 year period – Transfer assets before the 5 year period

176

Long Term Care Expenses

• Average annual cost of nursing home around

$65,000 (not including incidentals)

• What if income is also needed for the

community spouse?

177

Long Term Care Risk

• Business Assets

$800,000

• Non Business Assets

$100,000

• Total Assets

$900,000

• Income

Social Security $15,000

• Rent

$30,000

• 3 children
• One child in the business

Question: Are the Business Assets and the son’s vocation at RISK?

8/3/2015 60

More Thoughts on Long Term Care Planning

8‐13

LTC Demand

• Need may be rising
• Demand for policies dropping
• Anybody who can afford it doesn’t need it;
• Anybody who needs it can’t afford it!

LTC and the Insurance Companies

• Losing on LTC policies for years
• New policies with much more conservative

assumptions

• Options include return of unused premium ‐

costly

8/3/2015 61 LTC Options

• Self‐Insure
• Annuity Hybrids

– Include LTC benefits riders – Single payment

• Traditional income annuity
• Life Insurance – current or exchange

– Include LTC benefits riders – Withdrawals/policy loans

LTC Options

• Reverse Mortgages
• Potential changes:

– LT Disability plan reverting to LTC – Term life version of LTC policy

• Higher premium during earning years
• Eliminates concern for increases

– ?????

Time for Lunch!

• Session Resumes at 1:00 p.m.

8/3/2015 62 Planning Techniques Designed to Aid Farm Operational and Succession Planning

Roger McEowen and Chris Hesse

Reasons Why Businesses Don’t Have Succession Plans

• Successor doesn’t believe that the predecessor

will ever retire

– Arthur Andersen survey

• Between 25% and 33% of leaders of family businesses don’t

intend to retire or plan to remain involved throughout their lives

• 30‐40% of family businesses have no plan in place
• Taboo subject

– Relationships and emotions involved – Business may be founder’s self‐identification – Animosity toward younger generation

• Primogeniture

186

OBJECTIVES OF SUCCESSION PLANNING

• Objectives must drive the process

and must be clearly articulated

1

8/3/2015 63

187

Objectives of Succession Planning

• Successfully bringing the next generation into

the business

• Providing vocation for next generation
• Establishing a base for a financially successful

business into future

• Providing a plan for the older generation
• Providing an estate plan that is fair to business

and non‐business heirs

• Tax minimization

1

188

Thread Through Other Efforts

Estate Planning Business Planning Succession Planning

Steps to Successful Succession Planning

• Determine business owner’s long‐term goals and
• bjectives
• Determine financial needs of business owner and

spouse and develop plan assuring financial security

• Determine who will manage the business and

develop the management plan

• Determine who will own the business and how to

transfer owner’s interest

• Minimize transfer taxes and establish estate plan

8/3/2015 64

Step One

• Family business assessment
• One‐on‐one interviews with all family members
• “To do” list for family and business

– Must have family chemistry

• Advisory board meetings
• Life insurance requirements

– Buy out? – Trust as beneficiary set up in business’ name? – Payout stays in the business?

Step Two

• Financial needs

– Can business support owner and spouse after succession? – Can business support children? – Should business be sold to third party?

Step Three

• Who will manage the business?

– Management and ownership may not be the same thing

• Multiple entities?
• Ownership could stay in the family, but management

could be outside the family

• Plan on 3‐5 years to select, mentor and train new

management team

8/3/2015 65

Retaining Key Employees

• Employee agreement
• Non‐qualified deferred compensation plan

– Business promises to pay key employee upon loss

• f founder in return for continued employment

through specified term provided in contract

• No reporting of any payment until made

Ensuring Viability

• Sell business to active children

– Valuation by outside appraisers – Use of voting and non‐voting shares – Gifts of non‐business assets to inactive children – Equality does not equal fairness – Retaining voting shares – Buy‐sell agreement

195

INVOLVING CHILDREN IN THE BUSINESS

1

8/3/2015 66

196

Child Coming into the Business

• Long‐term acquisition with supplemental

income

– Child establishes own vocation and gradually acquires interest in family business, but is never involved full time while parents are alive

1

197

Sharing of Labor and Capital

• Parents loan funds to child so child can

acquire an interest in the business. Over time, there may be a sharing of capital and labor

• Consideration should be made as to whether

sharing arrangement constitutes a partnership

– Liability issues – Entitlement to deceased “partner’s” share

1‐2

198

Parent and Child Conducting Separate Businesses

• Child establishes comparable or

complimentary business and gradually merges with the parents’ business

– Tends to work well if parents are retirement age – Parent could become employee

2

8/3/2015 67

199

Joint Operators

• Parent and Child may jointly start partnership,

LLC, or corporate form of business

– May be preferred structure if parents not retirement age – May involve multiple entities – May provide mechanism for equitable treatment

• f non‐business heirs

2

200

Case Example #1

Small business with business heirs

Critical to recognize when it is timely to bring the next generation into the operation Flexibility is crucial to maintain

2‐3

201

Case Example #2

Sell‐out of small operation

Business ends upon parents’ retirement and child moves into different career

3

8/3/2015 68

202

Case Example #3

Small operation transitioned via family agreement

One business heir Successful family meeting Non‐business heirs agreed to reduced inheritance and be named beneficiaries of life insurance policies Plan in place that any appreciation in asset value would be shared if business heir sold out

203

Case Example #4

The larger business with both business and non‐ business heirs

Issues

Transfer of management to business heirs Equitable treatment of non‐business heirs What if there is an untimely death Role of insurance

3‐4

204

Case Example #5

Complications of divorce An operating partnership had been created by Father and son‐in‐law Complications to parents’ estate plan Probably requires use of long‐term leases and contracts

5

8/3/2015 69

205

Case Example #6

Joint arrangements (keys to success) ‐Expanding land base ‐Operating partnership ‐Maximization of payment limits

4

206

Case Example #7

Complex entity arrangements

4‐5

207

Case Example #8

Gifting strategy for multiple heirs

5

8/3/2015 70

208

Basic Entity Choices (See Pages 6‐7 for Summary Table)

• Sole Proprietorship
• General Partnership
• Limited Partnership
• Limited Liability Company
• Limited Liability Partnership
• S Corporation
• C Corporation
• Cooperatives

209

Major Considerations in Entity Choice

• Income Taxation
• FICA Taxes

– Recent case – 7th Cir. was amazed at stupidity of accounting firm in Rockford

8

Fringe Benefits

• Health Insurance and retirement plans

– Tax distinctions between various entities

• Qualified retirement plan options

9

8/3/2015 71

Liquidation Costs

• C Corp

– Highest liquidation cost – Distributions in excess of stock basis result in capital gain

• S Corp

– Others

• LLC

– Distribution of assets on tax‐free basis

• Discounting of Business Interests

10

212

Major Considerations in Entity Choice

• Continuity and Transferability of the Business
• Management Structure

– One Manager – Multiple Managers

• Liability of Owners

– Unlimited – Sole Proprietor, General Partnership, Gen. Partner of Limited Partnership – Limited – LLC, S Corp, C Corp, Limited Partner

8‐9

213

Other Points Concerning Leases

• Estate planning implications

– Material participation and social security benefits – Material participation and post‐mortem estate planning techniques

• Post‐death cash leasing (Secs. 6166 and 2032A)

8/3/2015 72

214

BUSINESS ORGANIZATION STRATEGIES

11

215

Single Entity

Most U.S. Businesses

70 to 75% of farms and 50‐60 percent

• f non‐farm

businesses

216

Multiple Entities

 OPERATIONAL ENTITY  REAL ESTATE ENTITIES Sole Proprietorship Partnership LLC C Corporation S Corporation

__lease____

Parents’ capital Child’s capital

Equipment

LLC

11

8/3/2015 73

217

Operational Entity

• Typical choices include:

– Sole proprietorship – General partnership – LLC – C Corp – S Corp

11

218

Operational Entity

• Assets Possible to Be Placed into Business

– Checkbook – Inventory – Equipment – Very Limited Real Estate

11

219

Landholding Entities

• Selected entity is usually sole proprietorship
• r LLC
• Typically not wise to put real estate in

corporation

11

8/3/2015 74

220

HEIRS NOT IN THE BUSINESS

How to achieve equitable treatment

11

221

Heirs not in the Business

• Usually not wise to involve non‐business heirs in

day‐to‐day operations

– Often do not distribute any income – Operational business may have day to day decisions that do not match objectives of business heirs – Ownership usually small compared to on business heirs – Little incentive for business heirs to buy out interest of non‐business heir

• Value of non‐business heir’s minority interest has severe

value discount

11

222

How to Treat Non‐Business Heirs

• Inheritance or gift
• Beneficiaries or life insurance
• Beneficiaries of retirement plans
• Acquire interest in business real estate

– Possibly in conjunction with gifting

11

8/3/2015 75

223

How to Treat Non‐Business Heirs

• The non‐business heir may not be distributed

an equal share in the value of assets

• If non‐business heir were to receive real estate

– Subject to long term rental contract in favor of business heir’s business – Subject to purchase options favoring business heir – Placed into an entity in which either all heirs are co‐owners

11‐12

224

How to Treat Non‐Business Heirs

• Seldom is it recommended that real estate be

inherited by children as tenants in common

– Joint decision making difficult – Each co‐owner has power of partition – Usually no structured buy‐out provision – Often questions of rights of possession

11‐12

225

TRANSFERRING ASSETS

12

8/3/2015 76

226

Transferring Assets

• Gifting Strategies

– FLP? – Petter, Hendrix, Wandry (defined value clauses)

• Rental Strategies
• Sales Strategies

– Real estate – Equipment – Residence

• Inheritance Strategies

12

227

Social Security Planning

• Retire at or before full retirement age?
• Complication with pre‐paying expenses

12‐13

228

USING TRUSTS TO PROVIDE FOR SPOUSE AND NEXT GENERATION

13

8/3/2015 77

229

Credit Shelter / Marital Deduction Trusts  Funding during life or by will Credit shelter $5,000,000 Surviving Spouse First death Second death Marital excess earnings from both trusts principal for living needs Beneficiaries

230

Single Person

Parent’s death Title to assets

Child One Child Two Child Three

231

Generation Skipping

Parent’s death Child’s death Child earnings principal for needs Title to assets

8/3/2015 78

232

CUSTOM DISTRIBUTION PLANS WITHIN TRUSTS

13‐15

233

Distribution Plans within Trusts

• Business assets being distributed to business

heir

• Buy out and rental options of assets
• Rights of refusal and purchase option to

business heir

• Non‐business assets to non‐business children
• Shared appreciation among all heirs
• Sharing estate settlement costs in proportion

to assets received

234

Succession Planning & Divorce

• Major concern for many

– What if divorce occurs after gifting has begun? – What if divorce occurs after an inheritance has been received? – Role of trusts – Role of buy‐sell agreement – Consider how the possibility of divorce might affect business entity selection – Who should be co‐owners – spouses? – What might happen if the son‐in‐law is in the business – How would the business be impacted?

16

8/3/2015 79

235

TRANSFERRING LEADERSHIP AND MANAGEMENT

18

236

Leader

• Vision
• Financial
• Provide Leadership
• Personnel
• Facilities, equipment…
• Business structure
• Day to day decisions
• Conflict Management
• Public relations

18

237

Leader

• Identifying the next leader
• Training the next leader

– Mentoring – Gradual – Educate – Challenge

• Developing exit plan

– Income needed – Sources of income

8/3/2015 80

238

OUTSIDE ADVISORS

18

239

Gleaning from Outside Advisor

• Possible advisors

– Accountant – Attorney – Business Consultants – Counselors – Financial planner – Insurance agent – Lender – Mediators – Other respected business persons

18

240

Gleaning from Outside Advisor

• Form an advisory committee

– Bare your soul – Could be mutual sharing – Could be persons some distance away

• Form a board
• An investment, not just a cost

18

8/3/2015 81

241

EXECUTING THE PLAN

The Use of Life Insurance as a Succession Planning Tool

• General Comments

– Tax favored status – What if estate tax (and stepped‐up basis) is repealed – If in ILIT, death benefits not subject to FET or GSTT

Life Insurance

• Benefits of life insurance in business

succession process

– Estate liquidity and asset preservation

• Ownership in ILIT
• Proceeds payable to business owner’s estate via loans
• r buying assets from estate at FMV
• ILIT could buy decedent’ s business interest at discount

– Freeze accomplished – Cash received by surviving spouse could be gifted to non‐ business heirs and/or fund ILIT for benefit of non‐business heirs

8/3/2015 82

Benefits of Life Insurance

• Wealth replacement
• Estate equalization
• Fund a buy‐sell
• Tax hedge
• Retirement income
• Fund stock redemption
• Liquidity
• NQDC

Benefits of Life Insurance

• Key‐person insurance
• GRATs
• Asset protection planning
• Private annuities and SCINS
• Family bank

ILITS

• Basic planning points

– Death benefits held at death

• Allows use of grantor’s gift tax exemption and GSTT

exemption amount

• Multiple beneficiaries can have interest in death

benefits

• Draft with flexibility in mind

8/3/2015 83

ILITS – Accomplishing Flexibility

• Donor powers

– Change beneficiaries that will receive Crummey powers – Use tiered Crummey powers – Beneficiaries holding contingent remainders can have a vested interest in ILIT

Page 1 of Practical Estate Planning

ILIT Drafting Provisions

• 5 and 5 power applied to entire ILIT
• Ordering rule for donee holding mutiple

withdrawal rights

• Special powerholder with limited power to

appoint trust property during grantor’s lifetime

Beneficiary Powers

• Testamentary limited powers of appointment

in beneficiaries

• Power of grantor, grantor’s spouse and

beneficiaries to change trustee

8/3/2015 84

Trustee Powers

• Discretion to satisfy Crummey notice

requirements

• Crummey powers satisfied against all trust

property

• Allow trustee to appoint guardian for minors

likely to receive Crummey withdrawal right

Corporate Buy‐Sell Agreements

• Entity purchase agreement

– Contract between stockholders and corporation

• Cross purchase agreement

– Contract between stockholders

• Hybrid agreements

– Contract between corporation and stockholders whereby stockholders agree to offer their shares first to the corporation and then to other stockholders

15

Advantages of Buy‐Sell Agreements

• Prevention of the sale of stock outside the

family unit

• Relatively simple
• Creates a ready market for the stock

– Remedies a liquidity problem – Can help set a value for stock

8/3/2015 85 Disadvantages of Buy‐Sell Agreements

• Hybrid type agreement may pose difficult tax

issue

– Must meet technical requirements of Sec. 302(b)

• r Sec. 303
• Less tax problems with cross‐purchase

agreements

Buy‐Sell Agreement and Life Insurance

• Provides funds to cover purchase price or

down payment

– Premiums not deductible and can cause ongoing expense

15

Other Post‐Mortem Issues

• Buy‐out of deceased shareholder’s stock could

jeopardize estate’s making Sec. 6166 election

– Watch acceleration of deferred taxes

• Planning around this?
• Buy‐sell could trigger gift of stock to trust for

surviving spouse not to qualify for marital deduction

– Rinaldi case

4

8/3/2015 86

Funding a Buy‐Sell

• Life insurance often funds if death is triggering

event

– Proceeds received by beneficiary without income tax liability

16

Funding a Buy‐Sell

• Problems with life insurance

– If proceeds received by C corporation can increase C corporation’s AMT liability by increasing C corporation’s current earnings – May not be sufficient to fund lifetime redemption caused by stockholder’s disability or retirement

16

Funding a Buy‐Sell

• Accumulated earnings

– May not be a “reasonable need of the business” and, thus, could subject corporation to accumulated earnings tax

8/3/2015 87

Funding a Buy‐Sell

• Buy enough permanent life insurance to fund

post‐mortem buyouts, obtain debt financing to pay for stock bought other than at death , with use of excess of postmortem purchase price over insurance death benefit to pay off loan

Income Tax Treatment

• Cross‐purchase agreement

– Gain is capital gain regardless of character of corporation’s underlying assets (unless shareholder is dealer in stock) – If estate sells stock shortly after shareholder’s death, no gain recognized if agreement sets sales price at date of death value – Purchasing shareholders increase basis in total holdings of corporate stock by price paid for shares purchased via agreement

Income Tax Treatment

• Redemption agreement

– Must satisfy Secs. 302 or 303 to avoid dividend treatment

• Big potential problem for post‐mortem redemptions

8/3/2015 88

Income Tax Treatment

• Hybrid agreement

– Corporation must redeem only as much stock as qualifies for sale or exchange treatment under

• Sec. 303, and other shareholders must buy

balance of available stock.

Income Tax Treatment

• “Wait and See” agreement

– Definition – Alternative approach – Combination for funding

Dynasty Trusts

• The GSTT

– Tremendous planning opportunity through balance of 2012 to fund GSTT trusts – Watch for Administration’s continued attempts to limit planning opportunities

• Limitation on GRATs
• Elimination of valuation discounts via FLPs

14-15

8/3/2015 89

The GSTT

• Clearly of interest to wealthy clients
• Don’t overlook GSTT trusts for clients with

more modest wealth

• May not be of interest for small estates

14‐15

Dynasty Trusts

• Avoidance of transfer taxes for multiple

generations

• Lasts as long as allowed by maximum term

allowed by local law

Dynasty Trusts

• Mechanics

– Irrevocable trust – Spendthrift provision – Initial funding tied to grantor’s transfer tax exemption

• Take note of the net investment return possible with

enhanced exemption through 2012

8/3/2015 90

Dynasty Trusts

• Tax aspects

– Not subject to GSTT if grantor allocates sufficient GSTT exemption to make inclusion ratio zero

• Must elect to allocate exemption to transfers
• Need to preserve GSTT inclusion ratio for any additional

property transferred to the trust

Dynasty Trusts

• Tax aspects

– Treated as an irrevocable trust

• Initial funding subject to gift tax and will use up

grantor’s unified credit to extent of excess over present interest annual exclusion

Dynasty Trusts

• Can be structured as grantor trust

– Income accumulated tax‐free – During settlor’s lifetime, settlor taxed on trust income and gains – How to achieve grantor trust status:

• Trust terms give discretion over distributions of income

and principal that can be exercised by majority of trustees that are related or subordinate to settlor

8/3/2015 91

Trust Term

• Tied to state’s rule against perpetuities

– Establish situs in state with relaxed or no rule

• Trust term should so state
• Appoint trustee located in jurisdiction with favorable

rule

– Works for personal property – Real property governed by law of state where located

Dynasty Trusts

• Trustee considerations

– Important to select carefully

• Consider limitations on trustee’s exercise of power
• What is the process for replacing a trustee

Dynasty Trusts

• Trustee as a fiduciary?

– Most courts require that trustee must commit serious breach before removal will be allowed – Statutory procedures may apply – UTC provision does not focus on trustee conduct – Trustee retained powers and tax issues

8/3/2015 92

Structure of the Trust

• Commonly drafted as spendthrift trust so as

to provide asset protection

– Beneficiary cannot assign or transfer or encumber an interest in net income or principal of trust

• No creditor attachment until distribution

– Trustee has absolute discretion over distributions

Converting the C Corporate Farming Operation (and other businesses) to Pass-Through Entity Classification Conversion of a C Corp. to an S Corp. (i.e., Extracting Assets from a C Corp.)

• BIG tax as a result of the 1986 Tax Reform Act

– Applies at 35% rate on appreciation of asset value for assets contained in C corporation (I.R.C. §1374)

• In addition to regular corporate tax
• Applies to any asset carried over from C corp. that is

disposed of within 10 years after conversion

– 7 years for gain recognized in 2009‐2010 – 5 years for gains recognized in 2011 ‐ 2014

• BIG for each asset liquidated is limited to its net

unrealized gain as of date of S election

• Consider the fact pattern on page 2

8/3/2015 93

Extracting Assets From a C Corp.

• Step 1:

– Make an S corporation election

• Asset valuation occurs and gain is “locked in” – no

double tax on any additional appreciation in value

• Make election by 15th day of 3rd month after start of tax

year

• If S corporation exists for 10 years from election date, no

double tax on asset appreciation

What To Consider Before Making S Election

• 100 shareholder limit
• NOLs belong to a particular entity – any unused C

corporation NOL is lost

– But NOL is available to reduce BIG

• Cash basis corporations recognize receivables and

payables as built‐in items when received/paid

• Liquidate certain assets before making S election?

– See example at bottom of p. 3

What To Consider Before Making S Election

• Unused NOLs of C corporation cannot be used

by S corporation to offset future S corporation income (except offset built‐in gain)

• S corporation compensation issues

– Payment of “reasonable” wages

• Payroll tax issue

– Watson case – No cases involving issue of reasonable compensation where salary at least at FICA wage base

8/3/2015 94

Extracting Assets From a C Corp.

• Step 2:

– Consider alternatives to selling assets within the 10‐year built‐in gain recognition period

• Sell corporate stock in lieu of asset liquidation

– Probably can be sold at a discount

• Do a like‐kind exchange

– Replacement property still subject to 10‐year BIG period

• Do a long‐term lease with option to purchase after the

expiration of the 10‐yr BIG period

• Liquidate assets when S corporation’s taxable income

can be reduced to zero

– Limited technique due to carryover issue

Step Three – Other Issues

• The “Sting” tax

– For S corporations that were C corporations and have C corporate earnings and profits, S election terminates if three consecutive years of passive receipts more than 25 percent of gross receipts.

• 35 percent rate of tax on excess net passive income

– Watch cash leasing arrangements – May need to prepay farm expenses – Distribute all accumulated C corporate E&P before end of first S corporate year‐end

Other Issues

• Income tax liability incurred on distribution of

C corporate earnings and profits

– Qualified dividends – Favorable rates presently – Impact on taxability of social security benefits

• Corporate stock redemption

8/3/2015 95 Issues Arising Upon Death of Shareholder

• S corporate stock passing to ineligible

shareholder

– Bypass trust must be a QSST or ESBT

7

Liquidation Tax Issues

• No gain recognition results when cash or

property is distributed to the decedent’s estate/heirs (in exchange for stock) to complete the liquidation

– The pass‐through gain is offset by a matching loss from liquidation of the stock – Watch for character mismatch (i.e., recognition of

• rdinary income and capital loss)

Inside and Outside Basis

• At death, decedent’s stock gets FMV basis, but

nothing happens to S corporation’s basis in corporate assets

– Example on page 8

• Significant asset appreciation in S corporation
• Heirs not interested in farming
• Need to liquidate in same year as asset sale – easy to

do if no heirs interested in farming and only one shareholder

8/3/2015 96

The Timing Issue

• Gain from sale of corporate assets recognized

in same year of capital loss triggered by corporate liquidation

– If business not liquidated in year of asset sale, heirs have capital gain to recognize, but no

• ffsetting capital loss
• Capital loss would only offset capital gain for year plus

$3,000 of ordinary income

Liquidations and Multiple Shareholders

• Example on page 9

– Distributions of property treated as sale of property at FMV to the shareholders

• Corporation recognizes gain to extent property’s FMV

exceeds its basis

• Upon distribution to shareholders in exchange for

stock, corporate‐level gain passes through to all shareholders based on percentage ownership

Liquidation and Multiple Shareholders

• Distribution of property to single shareholder

in liquidation of stock interest results in taxable event for all corporate shareholders

– Need for a buy‐sell agreement that facilitates all remaining shareholders buying deceased shareholder’s stock – See example on page 9

• Liquidation alternative – divisive

reorganization (p. 10)

9

8/3/2015 97 Liquidation Reporting Requirements

• Form 966 filed within 30 days after adoption
• f resolution or plan to dissolve a corporation
• r to liquidate part of all of corporation’s stock

Other Exit Strategies

• What if S corporation is to continue, but a

shareholder wants out?

– Basis issues (buy‐out of one shareholder by another)

• Example on p. 11

Converting A C Corporation to an LLC (primarily non‐farm)

• Step one:

– Form LLC and transfer assets to it in exchange for interest in corporation

• Transfer is tax‐free
• Step two:

– Shareholder transfers additional funds to LLC in exchange for interest in entity

• Transfer is tax‐free

8/3/2015 98

C to LLC Conversions

• Corporation and shareholders should receive

interest in LLC equal to the FMV of the assets transferred to the LLC

– If insufficient funds or property transferred to LLC, IRS could assert that excess value was transferred to the corporation’s shareholders who then contributed it to the LLC

• Dividend to shareholders

C to LLC Conversions

• Forming an LLC with unrelated third‐party

investor

– No gain or loss and carryover basis – What about the transfer of intangibles?

• Goodwill might attach to shareholders rather than the

corporation (see “Note” at bottom of page 12)

C to LLC Conversions

• Corporate liquidation and liquidating

distributions

– After transfer to LLC, corporation liquidates – Potential gain or loss

• What is the benefit of conversion?

– Former shareholders no longer taxed on distributions from LLC (unless distributions exceed basis) – Still have to watch passive loss rules

8/3/2015 99

LLCs and Passive Loss Rules

• Per se rule of I.R.C. §469(h)(2)

– Non‐material participation for limited partner interests in a limited partnership (unless Treasury specifies differently in regulations)

• Exception applies if one of three tests (out of the seven
• verall tests) satisfied
• Courts have rejected the IRS position

– Late 2011 proposed regulations

• Entity classified as partnership
• Holder of interest must not have management rights

14

Potential Disadvantage of Conversion to LLC

• LLC members remain liable for full amount of

self‐employment tax on guaranteed payments, plus member’s share of any pass‐ through ordinary income

Tax Differences Between S Corporations and LLCs

• S corporation retained earnings not subject to

self‐employment tax

– Payroll tax advantage

• LLC owners can contribute and withdraw

property generally tax‐free

• In an LLC, debt is included in basis – can more

easily take advantage of losses

• LLC charging orders (under some state statutes)

– Not applicable to single‐member LLCs

• Differences in rules governing distributions

14‐16

8/3/2015 100

Summary and Conclusion

• Clients with assets in C corporations present

difficult issues for practitioners

– Often disappointed upon learning about how difficult it can be to extract the assets – Business succession complications – Always difficult to plan when the rules get changed

Obamacare Final Regulations 3.8% Tax on Passive Sources of Income

• 3.8% additional tax on AGI over $200,000

($250,000 mfj)

• Net Investment Income (NII)

– Interest, dividends, annuities, rents, royalties – Passive income from trade or business – Income from financial trading business – Income from commodity trading business – Income from sale of passive assets – Gains from sale of investment assets

19

Rents – Final Regulations

• Two provisions:

– Property rented to a non‐passive activity (self‐ rental income) is not investment income – Property that is properly grouped in a non‐passive activity is not investment income

19‐20

8/3/2015 101

Rents – Final Regulations

• Example
• Able Farmer operates his farm as a sole proprietorship and

rents land from Landco LLC owned by him and his wife.

• The cash rent income flowing through from the LLC is considered

non‐passive income since it is being rented to his schedule F farm activity and he is a material participant in that farm.

• It is considered non‐passive for both income tax and net investment

income tax purposes

• Any resulting gain is not passive

20

Self‐Rental Rule

• Cally is a self‐employed farmer. Her husband,

Bubba, owns 500‐acres in his own name. Cally pays Bubba $ 300/acre cash rent. Cally and Bubba file a joint return. Is the cash rent that Bubba receives subject to the NIIT?

How to Analyze the Question

• Under Section 1411(c)(2) you go to §469 for purposes of determining the passive

status of the business activity. Under §469, married taxpayers are treated as one for purposes of the passive loss rules (except in meeting the specific tests for real estate professionals). It doesn’t matter that Bubba owns the 500 acres in his name. Since Cally is materially participating in the Schedule F, Bubba is deemed to be materially participating.

• Treas. Reg. 1.469‐5T(f)(3):

Participation of spouse. In the case of any person who is a married individual (within the meaning of section 7703) for the taxable year, any participation by such person's spouse in the activity during the taxable year (without regard to whether the spouse owns an interest in the activity and without regard to whether the spouses file a joint return for the taxable year) shall be treated, for purposes of applying section 469 and the regulations thereunder to such person, as participation by such person in the activity during the taxable year.

8/3/2015 102

Outcome

• Bubba is renting ground to his wife. Under the Cox case,

since he is the sole owner of the rental ground, Cally can pay him 100% of the rental value, and escape SE tax. Bubba gets rental income that is excluded from NII, even though the rental expense reduced Cally’s SE income (this would be different if it were a self‐charged interest question).

• It is recharacterized under Reg. 1.469‐2(f)(6) as nonpassive
• income. The abuses the Section 469 regulations plugged to

prevent the creation of passive income work in the taxpayer’s favor to exclude such income from NII.

Self‐Rental Rule

• Example:
• Now assume that Amber operates her farm in Farmco, a C
• corporation. Farmco cash rents farmland owned by Landco

LLC that Amber also owns

• Again, this is self‐rental income and considered non‐passive for both

income tax and net investment income purposes

• Any resulting gain is not passive

20

Rents – Final Regulations

• Example:

– Now assume that Bob operates Greenway, an S

• corporation. It still cash rents farmland from Landco.
• This is also considered self‐rental income and is non‐passive.
• Additionally, Bob can make an election to properly group Landco

and Farmco as one materially participating activity.

– This makes all income OR loss materially participating and not subject to any passive loss restrictions. – It is also not considered net investment income. – Any resulting gain is not passive

8/3/2015 103

Groupings – Final Regulations

• When can a regrouping election be made?

– In the first year the taxpayer meets the income threshold requirement and has investment income – If a regrouping has been done, and…

• If a taxpayer had properly made a “do‐over” regrouping election

and it was later determined that adjustments required an amended tax return to either reduce gross income below the threshold level or eliminate investment income, then the taxpayer would be required to undo the regrouping election and be bound by this until both tests applied in the future.

Groupings – Final Regulations

• When a regrouping election be made?

– The converse situation:

• If a taxpayer had not made a regrouping election because income

was under the threshold level, but additional income was determined after filing the original return, the taxpayer would be allowed to make a regrouping election at that time

• Note: When an examination of a taxpayer’s records results in

either situation happening, then the taxpayer would be entitled to the same relief or penalty

Regrouping – Final Regulations

• Example:

– Guy Wire has schedule F income of $175,000 and interest income of $20,000 for 2013. His total income

• f $195,000 is under the threshold level; therefore he

is not allowed to make any regrouping elections in 2013. – It is later determined that $10,000 of additional farm income was not reported on the original return. – When the amended tax return is prepared, Guy is allowed to make a regrouping election at that time since his gross income is now in excess of the threshold amount. He is then bound by that election

• n a going‐forward basis

21

8/3/2015 104

Real Estate Professionals

• Proposed regulations;

– All rental income was considered to be investment income unless it rose to the level of a trade or business.

• There is no bright‐line test for trade or business

Real Estate Professional

• Spend more hours on real estate activities

than non‐real estate activities; and

• Perform more than 750 hours of services

during tax year in real property trades or businesses in which the taxpayer materially participates

• A separate election may be necessary to group

rental activities to determine material participation

• Even though a real estate professional, need to

separately materially participate in rental activities

Real Estate Professional Safe Harbor

• If real estate professional participates in rental real

estate activity for more than 500 hours per year, or for more than 500 hours in five of the last ten years, then the rental income associated with that activity will be presumed to be derived in the ordinary course of a trade or business

– Any election made under Treas. Reg. §1.469‐9 to aggregate all of a taxpayer’s rental activities is respected for purposes

• f the 500 hour test.

8/3/2015 105 Real Estate Professional – Final Regulations

• Example:

– Chris owns 12 mini‐storage properties. Chris spends 1,500 hours per year managing the properties. While he does not spend more than 500 hours on any one property, he has elected to aggregate all rental activities, thus he materially participates in the combined activity

• Chris spends more than half of his time during the year on real

estate trade or businesses in which he materially participates.

• In addition, he spends more than 750 hours in real estate activities

in which he materially participated. As a result, Chris qualifies as a real estate professional and the rental activities are no longer passive to him.

Real Estate Professional Safe Harbor

• What if the safe harbor test is not satisfied?

– Taxpayer can still take the position that their rental activity rises to the level of a trade or business

Self‐charged interest

–“…in the case of self‐charged interest received from a nonpassive entity, the amount of interest income excluded from net investment income will be the taxpayer's allocable share of the nonpassive deduction.”

Page 51 of 1st session

8/3/2015 106

Self‐Charged Interest

• Interest generated from funds lent to a pass‐

through entity

• Interest generated by pass‐through entity

from funds lent to owner

• Interest income from identically owned pass‐

through entity

• Not applicable if interest expense reduced

self‐employment income

Net Losses – Final Regulations

• Can offset other investment income

– Treas. Reg. §1.1411‐4(d)(2) ) allows the net capital loss deduction of $3,000 to be allowed to offset

• ther investment income.
• For individuals, net capital losses for any year are

limited to the lesser of:

– Offsetting other capital gains; or – $3,000

• Any amount of net capital losses in excess of $3,000 are

carried forward to future years

Pages 50‐51 of 1st session

Net Losses – Final Regulations

• Example:

– Farmer Bean sells IBM stock for a $15,000 loss which also generated $5,000 of dividend income during the year. He has no other gains or losses or investment income for the year, therefore, he is allowed to deduct $3,000 of the capital losses against other income. – For investment income purposes, his net investment income is $2,000 ($5,000 of dividend income less the $3,000 capital loss allowed).

8/3/2015 107

Net Losses – Another Example

• What about large passive §1231 losses?

– Example:

• Farmer Bean invested in an ethanol plant in the next state. That

typically generates $100,000 of passive income annually. However, for 2013, in addition to the $100,000 of passive ordinary income, the Ethanol plant sold some assets for a net Section 1231 loss of $100,000.

– For income tax purposes, Farmer Bean is allowed to offset the $100,000 of I.R.C. §1231 losses against his $100,000 passive income for net taxable income from the investment of zero. – Proposed regs. – loss disallowed and NIIT owed on $100,000 – Final regs. – loss allowed to offset and no NIIT

Net Operating Losses

• Final regs. ‐ can partially offset investment

income

– Essentially, the taxpayer will determine two NOLs for any loss year. The regular NOL computed under I.R.C. §172 is determined. Second, the NOL that arises only from investment sources is then

• determined. This NOL is then divided into the

regular NOL to arrive at a factor for that loss year

Final NIIT Regulations

• Sale of farmland

– Basic principles:

• If gain attributable to sale of capital asset used in trade
• r business in which taxpayer materially participates,

then gain not subject to NIIT

– Use m.p. tests of passive loss rules

• If active farmer sells land from farming operation, gain

not subject to NIIT

Pages 51‐53 of 1st session

8/3/2015 108 NIIT Regulations and Sale of Farmland

• What about farmland sales of retired farmer
• r surviving spouse?

– NIIT applies to income from passive activity – Two schools of thought:

• The I.R.C. §469(h)(3) approach
• Normal material participation tests of I.R.C. §469

Special Rule For “Retired" Farmers

(The I.R.C. §469(h)(3) Approach)

• Material participation in 5 years in the eight year

period before you start drawing social security is evergreen.

53

The “Farmer” Rule

• How the statute works:

– 1411(c)(2): Trades and businesses to which tax applies

• A trade or business is described in this paragraph if

such trade or business is‐

• (A) a passive activity (within the meaning of section

469) with respect to the taxpayer

53

8/3/2015 109

The “Farmer” Rule

• I.R.C. Sec. 469(h)(3):

– Treatment of certain retired individuals and surviving spouses

• A taxpayer shall be treated as materially participating in

any farming activity for a taxable year if paragraph (4)

• r (5) of section 2032A(b) would cause the

requirements of section 2032A(b)(1)(C)(ii) to be met with respect to real property used in such activity if such taxpayer had died during the taxable year.

The “Farmer” Rule

• A taxpayer is treated as materially participating if Sec.

2032A(b)(4) or (5) would cause the requirements of Sec. 2032A(b)(1)(C)(ii) to be met with respect to real property used in the farming activity if the taxpayer had died during the tax year.

– The requirements of I.R.C. §2032A(b)(1)(C)(ii) are met if, during the eight years preceding the decedent’s death, there were periods aggregating five years or more during which the decedent or a member of the decedent’s family materially participated in the farming activity

The “Farmer” Rule

• I.R.C. §2032A(b)(4) says that in applying the 5‐out‐of‐8

years rule, the taxpayer may disregard period in which the decedent was retired (i.e., receiving Social Security)

• r disabled.
• I.R.C. §2032A(b)(5) says that if the 5‐out‐of‐8 years rule is

met with regard to a deceased taxpayer, it is deemed to be met with regard to the taxpayer’s surviving spouse, provided that the surviving spouse actively manages the farming activity when not retired or disabled.

8/3/2015 110

The “Farmer” Rule

• Example:

– Bob materially participated in a farming activity from 2007 through 2011, but did not work in the activity in 2012 or later years. Bob began drawing Social Security in 2015.

• Because Bob had materially participated in the farming activity in

5 of 8 years before his retirement, Bob is treated as materially participating in 2015 and later years (but not in 2012‐2014). – Note: If Bob were to die, Mary (his wife) would be treated as materially participating provided that she is actively managing the

• farm. And, the 5‐out‐8‐year rule applies to benefit Mary if she retires
• r becomes disabled.

Other Approach

(Standard M.P. Rules)

• I.R.C. §469(h)(3) concerns recharacterization
• f farming activity and not recharacterization
• f a rental activity

– Since retired farmer is no longer farming (but is engaged in a rental activity), I.R.C. §469(h)(3) inapplicable and normal m.p. tests apply

• Reg. 1.469‐2(c)(2)(iii)(A): passive gain (subject to NIIT) if

either:

– Held as passive for entire 24‐month period before sale, or – Used in passive activity for 20% of ownership

Farmland Held in Trust

• Remember the Frank Aragona Trust Case

– Count participation of trustees – Count participation of employee/trustees – Probably can count participation of employees

23‐24 of Planning Techniques

8/3/2015 111

Final NIIT Regulations

• Trading in commodities

– NIIT applies if taxpayer is in the business of trading in commodities

• Any commodity that is actively traded as defined in

I.R.C. §1092(d)(1). Included is “a hedge with respect to such commodity.”

– What about pass‐through entities?

• Trade or business determination made at entity level

– Hedging gains not subject to the NIIT – Speculative gains are subject to the NIIT

24‐25

Estate Planning and the NIIT

• Trusts
• Pass‐through entities
• Partnerships
• S corporations
• LLCs
• Manager‐managed LLC

25

Implications for Trusts

• Trusts threshold is the top tax rate bracket (Sec. 1411(a)(2)).

– Surtax applies to lesser of undistributed NII or the excess of an estate/trust’s AGI over $12,150 for 2014

• Regulations allocate investment income between

distributed and undistributed income under usual trust allocation rules.

• Electing small business trusts will have to combine their S

corporation and non‐S corporation portions for computing the tax. Treas. Reg.§1.1411‐3(c)(1)(ii).

8/3/2015 112 Potential Problem of Trapping Income and Gains in Trusts

• Drafting language is key
• Know the DNI rules
• Key will be to distribute income out of the

trust so that it’s not trapped inside the trust where it is subject to tax at the compressed bracket rates

• AICPA podcast of July 2013 by Robert Keebler

– There are techniques that can be used to avoid trapping income and gains in trusts

Implications for Trusts

• Charitable remainder trusts

– Part of distribution is investment income (Reg. §1.1411‐3(c)(2))

• Foreign estates and trusts not normally subject

to NIIT tax.

– The proposed regs say the IRS will subject U.S. beneficiaries on their share of distributed investment income and requests comments on how

• Bankruptcy estates are subject to the tax with a

threshold of $125,000.

– Proposed regulations preamble

Implications for Partners?

Choose your poison!

• If you materially participate in a partnership with

trade or business income, you will have self‐ employment income, potentially subject to the .9% tax – and the old 2.9% Medicare tax.

• If not, you will have passive income subject to the

3.8% tax.

8/3/2015 113

Implication for S Corporations: More Reason to Keep a Lid On Compensation

• S corporation K‐1 income is not subject to FICA or

SE tax.

• Reasonable compensation required.

A186

Implication for Entity Planning

• S corporation is favored over partnerships

because of better ability to avoid both employment tax and investment income tax of active owners.

Using an LLC to Reduce SE Tax and NIIT

8/3/2015 114

Background

• Sole proprietors and partners are subject to SE tax on all
• rdinary income generated.
• Forming a member‐managed LLC will also technically subject

all ordinary income to the same taxation.

• But, if the LLC has a manager‐managed structure, then only

the income allocated to the managers and any guaranteed payments to non‐managers will be subject to self‐ employment income.

– Passive/non‐passive issues tested separately

Background (cont.)

• Proposed Treas. Regs. state that an LLC member is subject to self‐

employment tax under any one of three situations: – The individual has the personal liability for the debts of or claims against the LLC by reason of being a member (personal guarantees do not fail this requirement); – The individual has the authority under state statute to contract on behalf of the limited liability company (the member has management authority); or – The individual participated in the entity’s trade or business for more than 500 hours during the entity’s taxable year

Manager‐Managed Structure

• A manager managed LLC may provide two separate classes of membership for

managers (who have authority to bind LLC under contract) and non‐managers (who have no such authority) – Both classes would default to provide limited liability protection to the members in their capacity as members. – Personal guarantees, making certain debts recourse to the member, do not violate this exemption since such exposure is not due to the status of being a member.

• Non‐managers who do not meet the 500 hour involvement test are not subject to

SE tax, except to the extent of any guaranteed payments.

• Non‐managers who exceed 500 hours are not subject to SE tax if:

– Non‐managers own a “substantial continuing interest” in the class of the interest; and – The individual’s rights and obligations are identical to the rights and

• bligations of members who satisfy the general definition of a “limited

partner” (i.e. non‐manager, less than 500 hours) 27‐28

8/3/2015 115 Manager Managed Structure – (cont.)

• A taxpayer may hold both a manager and non‐

manager interest that may be bifurcated:

– Individuals with non‐manager interests who spend less than 500 hours per year on the activity must hold at least 20% of the LLC interests. – The taxpayer owns a class of non‐manager interests identical to those held by the non‐manager members and a manager’s interest:

• The manager’s interest is subject to SE tax
• The non‐manager’s interest is not subject to SE tax

27‐28

NIIT Application to Manager‐ Managed LLCs

• A non‐manager’s interest in a manager managed LLC is

normally considered passive and thus subject to the net investment income tax (NIIT).

– However, a spouse may take into account the material participation of a spouse who is a manager under I.R.C. §469(d)(5)]. – Thus, if the manager spouse has material participation, than all non‐ manager interest(s) owned by both spouses will not be subject to NIIT.

• Careful structuring of the manager‐managed LLC

– Minimal self‐employment tax – Elimination of the NIIT on the income of the LLC operations.

NIIT – Other Situations

• Hired farm manager

– No imputation

• Multiple entities

– Self‐rental rule

28

8/3/2015 116

Using an Intentionally Defective Grantor Trust (IDGT)

29

Intentionally Defective Grantor Trust (IDGT)

• Income is taxed to the grantor rather than the

trust

• Although “defective” for income tax purposes,

it is “effective” for gift and estate tax purposes

29

Sale to IDGT

• Sale of appreciating assets into a fixed‐yield,

non appreciating asset freezes your estate

– Removal of all Appreciation after the Sale – Gain on sale and interest income on the note is ignored for income tax purposes – Payment of income taxes can create additional benefit (reduce the estate)

29

8/3/2015 117

Implementation

• Usually fund IDGT with seed money equal to

about 20% of the property being sold. This will usually result in a gift

• After the gift, grantor sells appreciating asset

to trust in exchange for promissory note.

• The sale “freezes” the value

29

Implementation (cont.)

• The trust is intentionally structured as a

grantor trust so no income tax is due on sale

• r interest income
• If grantor pays tax on income, then estate is

further reduced (no gift)

29

Implementation (cont.)

• Debt must be documented and collateralized

– Section 1274 interest rate is used (lower than GRAT or GRUT rate) – A single balloon payment of principal – Prepayment of principal – Can be cancelled upon death (SCIN)

29‐30

8/3/2015 118 IDGT Advantages

• vs. GRAT & GRUT
• If seller dies, on the unpaid balance is included in

the estate, whereas all of the trust may be included with a GRAT or GRUT

• The note payment structure can be more flexible

with an IDGT (interest only, balloon payment, etc.)

• The sale to the IDGT requires a lower interest rate
• More assets can be passed tax free to the estate

due to the lower interest rate hurdle

• The GST tax exemption can be allocated to the

gift “seed” money

30

IDGT Disadvantages

• If property sold to the trust does not appreciate

faster than the required interest rate, no value to sale

• Will the seller require more income than that

generated by the note payments

• If the property does not generate enough

income, assets may have to be sold or transferred to grantor

• Disclosure regarding sale to an IDGT is required
• n estate return and a gift tax return should be

filed to start the statute of limitation.

31

Gifts of Profits Interests in the Family Business

• Profits interest

– An interest in the profits of a partnership

• Conveys no interest in the capital of the partnership
• Includes any gains from the investment of the original

partnership capital

– Thus, the capital interest is limited to the original capital contributed to the partnership

32

8/3/2015 119

Profits Interest – Farm Context

• Common scenario:

– One partner contributes land and another contributes services and equipment

• Gift can result if their respective partnership interests

do not reflect the value of the respective contributions

– Profits are split – When partnership ends, partners get back their respective capital contributions

Profits Interest – Farm Context

• Parent/child example

– Parent contributes capital that is 90% of value of partnership capital

• Parent’s share of capital need not be 90% to avoid gift

tax

– Child’s farming services have value – There cannot be a gift of capital because the partners retain the right to receive their respective capital contributions upon termination of the partnership

• From a gift tax standpoint, the question is whether the

annual use of the parent’s land is adequately compensated by the child’s services

Gifting a Profits Interest

• Key Point:

– Granting a child a percentage profits interest for the farm labor utilized in operating the farm partnership that is greater than the child’s percentage of contributed capital does not result in a gift of that portion of the underlying capital

• Ex: Dad contributes 90 percent of the capital to a farm

partnership with son and they split profits 50/50, does not trigger a gift of 40% of the value of the farmland

– In addition, when the partnership terminates and Dad gets the land back, there is no gift back

32

8/3/2015 120

Foreign Ownership/Investment in U.S. Agricultural Businesses

Michelle VanDellen, CPA, MS

Agenda

• Taxation of Nonresidents, Foreign

Corporations, and Trusts

• Ownership Structure Planning and Pitfalls
• Withholding under FIRPTA

2

Foreign Individuals – U.S. Income Tax

Income tax – U.S.‐source income

• Distinction between income connected with a

U.S. trade or business and non‐business income

• Business income (a.k.a. Effectively Connected

Income or “ECI”)

– Eligible for deductions – Taxed at graduated rates

• Non‐business income

– Taxed on a gross basis at 30% – May be eligible for reduced treaty rates

3

8/3/2015 121 Foreign Individuals – U.S. Income Tax

Federal Income Tax (cont.)

• Favorable capital gains rates available
• Single layer of tax

State Income Tax

• General state income tax rules apply

Foreign Individuals – U.S. Estate Tax

• Applies to both tangible and intangible property

situated in the U.S.

• Maximum rate of 40% on taxable estates over

$1MM.

• Credit of $13,000 shelters the first $60,000 of

taxable estate.

– Estate tax credit only – NOT a unified credit

• No marital deduction for transfer to non‐citizen

spouse unless the property is transferred to a QDoT.

4

FOREIGN INDIVIDUALS – U.S.ESTATE TAX

Extent of exposure depends on:

• Location of U.S. property (state)
• Gross value of U.S. property
• Gross value of worldwide property
• Application of U.S. tax concepts (valuation,

fractional interest discounts, “gross estate,” retained rights, etc.)

• Availability of estate tax treaty – provisions vary

8/3/2015 122

Foreign Individuals – U.S. Gift Tax

• Applies to all transfers of real or tangible

property situated within the U.S.

– Does NOT apply to transfers of intangible property

• Annual exclusions are permitted

– $14,000 for 2015

• No unified credit
• No marital deduction (even for gifts to a QDoT)

– Limitation on annual exclusion for gifts to non‐citizen spouse – $147,000 for 2015

5

Foreign Corporations – Income Tax

• A foreign corporation is subject to U.S. tax

when it actively carries on a U.S. trade or business which is “considerable, continuous, and regular.”

• This ECI is subject to U.S. tax at the

graduated corporate tax rates.

• “Fixed or determinable annual or periodical”

(“FDAP”) income (interest, dividends, rents, etc.) is subject to the 30% tax.

– Again, reduced by applicable treaty rates.

Trusts (U.S. and Foreign)

• U.S. Trust (defined):

– U.S. persons must have authority to control all substantial decisions regarding the trust, AND – Trust property must be subject to a U.S. legal jurisdiction.

• Foreign Trust: Any trust that doesn’t meet

both of the above criteria

– Significant income tax and reporting

• bligations.

6

8/3/2015 123 Trusts with Foreign Grantors – Estate Tax

• May shield property from U.S. estate tax

but trust setup and terms must be very restrictive.

• Foreign grantor must not have power over

beneficial enjoyment of trust assets or any ability to redirect trust assets under any circumstance.

Ownership structures: planning and pitfalls

7

Acquisition planning – goals of the proposed investment

• Lease/rental income
• Long‐term appreciation
• Expansion of existing trade or business

activity

• Family legacy ‐ Intent to transfer via gift or

bequest

8/3/2015 124

Acquisition Planning

Factors to consider:

• Estate/gift tax exposure

– Availability of estate or gift tax treaty

• Legal liability exposure
• Tolerance for complexity

– Filing requirements and disclosures – Costs to set‐up and maintain structure

• Size and timeline of investment
• Availability of income tax treaty benefits

– Reduced withholding tax rates – Other

8

Use of Single Member LLCs

• May solve issues of liability exposure, BUT

– Many countries do not recognize a flow‐through corporate entity, – Disregarded entities may not be eligible for treaty benefits, – May create true double tax because of disallowance of foreign tax credit in the owner’s home country for the U.S. tax paid.

Ownership by U.S. Corporation

• U.S. Federal Income Tax

– Graduated corporate rates – No beneficial capital gains rate – Withholding on dividends paid to foreign shareholder – Sale by foreign shareholder of stock in “U.S. Real Property HC” is subject to U.S. income tax and to U.S. withholding tax under FIRPTA

9

8/3/2015 125

Ownership by U.S. Corporation

• U.S. Estate Tax – Value of U.S. corporate

stock is includible in “U.S. gross estate” of a foreign person.

• U.S. Gift tax – Gift of U.S. corporate stock by

foreign person is NOT subject to U.S. gift tax.

Ownership by Foreign Corporation

• U.S. Federal Income Tax

– 30% withholding on gross non‐business income – treaty can reduce withholding %. – Graduated corporate rates and deductions are available for the U.S. trade or business. – For rental activities, must elect to treat as a U.S. trade

• r business to obtain graduated rates and deductions

– No beneficial capital gains rate. – Withholding on distributions of U.S. Earnings & Profits to foreign shareholder (treaty relief available).

10

Ownership by Foreign Corporation

• State Income Tax

– State nexus rules may not apply the same to foreign corporations as they do to domestic corporations.

• U.S. Estate and Gift Tax

– Value of foreign corporate stock is exempt from U.S. estate or gift tax as long as the U.S. property in the corporation was originally acquired from an unrelated party.

8/3/2015 126 Individual or corporate ownership

Foreign Individual Foreign Corp U.S. Corp

Must respect separate corporate identity

Foreign Country U.S.

Consider purchasing life insurance to protect against U.S. estate tax risk Foreign corporation should acquire property from unrelated party U.S. stock subject to U.S. estate tax (but not U.S. gift tax)

Foreign Individual Foreign Individual 11

Trust ownership (cont.)

Foreign Country U.S.

• Foreign grantor contributes

funds to irrevocable trust (not a loan)

• Trust acquires U.S.

property

Foreign Individual Foreign Individual U.S. Trust Foreign Trust

L.P. Ownership

U.S. L.P.

99% LP

Foreign Corp*

1% GP 100%

*This could be

• wned differently

Foreign Country U.S.

• Foreign individual is

settlor

• Trust is irrevocable
• Settlor is not

beneficiary or trustee and has no trust powers

• No U.S. beneficiaries

1. Foreign individual contributes funds to trust (not a loan) and to Foreign corporation 2. Trust and corp. acquire interest in U.S. LP 3. U.S. LP acquires U.S. real property

Foreign Individual

• L.P., Corporation

and Trust will file U.S. (and possibly state) income tax returns annually Foreign Trust 12

8/3/2015 127

U.S. and Foreign Investors

U.S. LP Foreign Corp Foreign Corp U.S. person U.S. person

Foreign Country U.S.

Foreign Corporations can shield Foreign investors from U.S. income and estate tax Foreign Individual Foreign Individual Foreign Individual Foreign Individual

U.S. AND Foreign Investors (cont.)

U.S. LLC Foreign Corp Foreign Corp U.S. person U.S. person

Foreign Country U.S.

U.S. Corp U.S. Corp

U.S. corporations shield foreign investors from direct

• wnership in LLC’s.

Direct LLC ownership may result in double- tax for nonresidents

Foreign Individual Foreign Individual Foreign Individual Foreign Individual 13

Summary

• Including foreign owners or lenders in a U.S.

agricultural business organization will:

– Expose the foreign person(s) to U.S. taxation and – Expose the U.S. structure to additional withholding and reporting requirements

• Consult with experienced U.S. international

tax and legal professionals before:

– Adding a foreign person to an existing U.S. business structure – A foreign person acquires U.S. business or investment property

8/3/2015 128

Summary

Before acquiring assets, select appropriate

• wnership structure. Considerations:
• U.S. federal & state income, estate and gift tax.
• Taxation of structure by owner’s country of

residence.

– Will U.S. taxes be eligible for credit against the residence country’s taxes?

• Taxation during ownership, upon sale, and upon gift
• r bequest.
• Cost of annual tax and legal compliance.
• Potential legal and/or business exposures.
• Consistency of structure with foreign owner’s other

(non‐financial) goals for the property.

14

Withholding under FIRPTA

General rule

FIRPTA taxes the disposition of a U.S. real property interest (“USRPI”) by a foreign person, including an interest in a U.S. real property holding corporation (“USRPHC”), as U.S. source income that is effectively connected with a U.S. trade or business (“ECI”).

15

8/3/2015 129 Withholding on dispositions of USRPI

IRC §1445

• Buyer of U.S. real property interest has a duty

to withhold the “applicable amount”, regardless

• f the amount of cash involved in the

transaction.

– Applicable amount is the lesser of:

• 10% of the total amount realized or
• The transferor’s maximum tax liability (as provided in a

withholding certificate issued by the IRS to the seller)

– Amount withheld is not final tax obligation

• Not subject to FATCA withholding, since gain

from USRPI is considered to be ECI.

Transfers exempt from withholding

• Domestic Seller.

– Seller must provide written assurance of domestic status (“a non‐foreign affidavit”) to buyer (or withholding agent).

• Disposition by a foreign person of stock in a U.S. corporation

that is not a USRPHC. – Corporation must provide affidavit of non‐USRPHC status.

• Purchase of Principal Residence when gross purchase price is

$300K or less.

• Disposition by a foreign person of stock in a foreign

corporation.

16

Questions? Michelle VanDellen, CPA, MS Phone: 360‐685‐2205 E‐mail: michelle.vandellen@mossadams.com

8/3/2015 130

The Use of Charitable Trusts in the Estate and Business Planning Process

Chris Hesse

Charitable Remainder Trusts (CRT)

Donor

Char.

Rmdr. Trust Charity Asset Term Income Rmdr. After Term (No Tax On Asset Sale)

Charitable Remainder Trusts

• ANNUITY TRUST

– Fixed payout – No additional funding

• UNITRUST

– Payout is % of annual value – Additional assets can be contributed

1

8/3/2015 131

Charitable Remainder Trusts

• Charitable Donation

– Allowed for capital gain property based on fair market value – Ordinary income property is limited to lessor of basis or fair market value

2

Charitable Remainder Trusts

• Deduction amount based upon several

factors:

– Annual income to donor – Term in years or life expectancy for income – IRS AFR (select current or prior 2 months #)

2‐3

CRT for Farmers

• Funding a CRT with ordinary farm assets (PLR

9413020)

– No income or SE tax to proprietor for inventory or fully depreciated equipment (other than potential Section 179 recapture) – Expenses allowable for current year crop – CRT sells inventory tax‐free – Distributions from CRT = ord. income but not SE income

3‐4

8/3/2015 132

CRT Anti‐Abuse Rules

• 10% charitable remainder minimum
• 50% maximum payout
• 5% probability of exhaustion

10% Charitable Remainder Minimum

• At time of set up, the amount of residual

expected to pass through to the charity must be calculated to be at least 10% of the current contribution

• The actual amount does not need to be 10%,

but the expected amount based on terms of trust must be at least this %

6

50% Maximum Payout

• The maximum annual payout percentage

cannot be greater than 50% of the initial fair market value of the trust in the case of a CRAT and 50% of the net fair market value of a CRUT on an annual basis.

7‐8

8/3/2015 133

5% Probability of Exhaustion

• In 1977, IRS indicate no deduction if there is more than 5%

chance the trust would be exhausted.

• This is not applicable to a CRUT with a net income limit

(NIMCRUT) since under this formula the trust corpus is never invaded

• As a practical matter, with today’s low interest rates, CRATs

based on a donor life expectancy will fail the 5% rule even though they pass the 10% rule.

• Software is used to determine whether the structure will

meet all three tests.

9

CRT Design Issues

• Select the highest of the 3 AFRs to maximize

the income payout

• Use a fixed term CRAT to reduce income tax

exposure in early years

• Analyze other factors

– Social security – NIIT – MRD, etc.

10

CRT Illustrations

• 1.4% AFR
• 10 yr. term, annual payout at year‐end
• $750,000 funding
• Payout amount ‐ $72,800
• Charitable Remainder – 10%

12

8/3/2015 134

Illustration – Section 1245

• After‐tax accumulation after 10 years:

– Outright sale $460,238 – 10 Yr. CRAT $504,151 – 10 Yr. CRUT $504,190

• Savings using CRT – About $44,000 plus

$75,000 to charity

Illustration – Inventory (SE)

• After‐tax accumulation after 10 years:

– Outright sale $413,869 – 10 Yr. CRAT $504,151 – 10 Yr. CRUT $504,190

• Savings using CRT – About $90,000 plus

$75,000 to charity

Illustration ‐ BIG

• After‐tax accumulation after 10 years:

– Outright sale $254,050 – 10 Yr. CRAT $433,070 – 10 Yr. CRUT $379,000

• Savings using CRT – About $125,000‐$179,000

plus $75,000 to charity

8/3/2015 135

CRT Cautions

• Need appraisal if transfer “unmarketable

securities”

• No active business interests: UBI tax
• No debt into CRT
• No self‐dealing (CRT sells assets in open

market, not to related party of donor. No loans to donor or related party)

13

CRT Compliance

• Form 5227, Split‐Interest Trust Information

Returns

– Schedule K‐1 (Form 1041) to beneficiary – Copy of CRT document in 1st year filing.

14‐15

Pairing of ILIT with CRT

• Many farmers will use tax savings of CRT to

fund an Irrevocable Life Insurance Trust (ILIT):

– Provide liquidity to estate – Vehicle to pass on assets to off‐farm heirs – Increase the amount of assets on an estate tax free basis.

8/3/2015 136

Afternoon Break

• 2:45‐3:00 p.m

407

The Impact of ATRA on Estate Planning

Key Transfer Tax Changes Under ATRA (The Changing Landscape)

• Permanence
• Indexing
• Unification
• Portability

2

8/3/2015 137 Post‐2012 Estate Planning Landscape

• Lower transfer tax costs
• Higher income tax rates
• Greater disparity among states between

transfer taxes and income taxes

• Income tax issues have greater role

Common Pattern – Pre‐2013

• Mid‐to‐high‐wealth clients

– Aggressive use of lifetime asset transfers

• Loss of stepped‐up basis

2

Common Pattern (Pre‐2013)

• High‐wealth clients

– Gifting to utilize estate tax exemption equivalent

• Maybe use to fund an IDGT to establish an estate value

“freeze”

– Dynasty trust

8/3/2015 138

Administration Proposals

• New GRAT requirements:

– 10‐year minimum term – Remainder interest has value greater than zero – Annuity amount cannot decrease in any year during annuity term

• Limited duration of GST term to 90 years after trust created
• $3.5 million estate tax exemption and $1 million gift tax exemption

with a 45% rate

• Inclusion of grantor trusts in grantor estate with any distribution

being a gift as would conversion to non‐grantor status

– Hits ILITS

• Estate tax lien under I.R.C. §6166 would last for full period of

deferral, not just 10 years after date of death

3

Dynasty Trusts

• Leverage the exemption and the GSTT to keep asset

value out of estates for the longest time possible

– Best if established in jurisdiction that has abolished rule against perpetuities.

• AK, ID, NJ, PA, KY, SD
• 90‐year in 29 other states

– Common law rule in balance of states:

• “No interest is good unless it must vest, if at all, not later than

twenty‐one years after the death of some life in being at the creation of the interest.”

– Law of situs controls with respect to real estate – Obama Administration pushing for 90‐year limitation in all states with a $3.5 million estate tax exemption, $1 million gift tax exemption and top rate of 45% for estate and gift tax purposes

3

2012 Estate Tax Numbers

• 9,400 estate tax returns filed

– .4% of all decedent’s estates – Amount of filings doubled from 2011 and amount

• f tax paid increased 70 percent
• Real estate made up smallest portion of estate

in estate’s valued at $20 million and up

• Real estate made up the highest portion of

estate in estates under $5 million

4

8/3/2015 139 The Changed Landscape – 2013 and Forward

• More states repealing death‐related taxes
• Higher exclusion
• Reunified transfer tax system
• Portability permanent
• Transfer tax system permanent
• Higher top ordinary FIT rate
• Higher top fed. cap gain rate
• Higher qualified dividend income rate
• New tax on passive sources of income

– Frank Aragona Trust case

State Estate Taxes

• State estate taxes remain deductible in

calculating the federal taxable estate

• In those states (most of them) that don’t have

an estate tax, or have a state estate tax that is coupled to the (now extinct) state death tax credit, 40% will be the only estate tax rate above the exemption

State Estate Taxes

• Most states that have an estate tax tie it to the

pre‐2002 federal credit for state death taxes

– Top rate of 16% for taxable estates over $10.1 million

• In states that follow the federal law and allow

a deduction for the state tax, the total federal and state top marginal rates will be 48.3%

8/3/2015 140 State‐Level Impacts and Income Tax Ramifications

• Fewer states imposing death taxes tied to the federal

state death tax credit

• Now, the federal state death tax credit is replaced with

a federal estate tax deduction under I.R.C. §2058

• In states that impose tax at death, the size of the

exemption varies and (in inheritance tax states) the amount and type of bequests that are exempt vary

• 7 states have no state income tax

– 2 others only tax dividend and interest income

• Some states have a relatively high income tax burden

6

Focusing Estate Planning Post‐2012

• Life expectancy
• Lifestyle
• Long‐term health care needs
• Size of potential gross estate
• Type of assets decedent owns and potential for appreciation in value
• Preserving eligibility for special use valuation (ag estates)
• Will a basis increase be essential/beneficial?
• State of domicile at death
• Succession planning
• Multiple entities?
• Asset protection
• Economic conditions

7‐10

Post‐2012 Landscape

• Lower transfer tax costs
• Higher income tax rates
• Greater disparity among the states between

transfer taxes and income taxes

• Greater emphasis on income tax issues
• Greater importance of preserving basis step‐

up

8/3/2015 141

Asset Protection

• Ethical Issues for Lawyers

– 1992 Iowa Supreme Court opinion

• Public reprimand for aiding unauthorized practice of

law with respect to a revocable living trust

– 2014 Iowa Supreme Court opinion

• No public reprimand for lawyer who transferred

several million dollars of farmland to an irrevocable trust

– Client subject to murder charge – Trust contained language acknowledging writ of attachment against client in pending lawsuit – Trustee was family member of client – Trust address was P.O. Box in CA

Impact of Coupling (and Portability)

• Use as little of the applicable exclusion during

life to cover taxable gifts

– Exclusion will often cover entire value of gross estate and inclusion in estate gets the property a basis increase for heirs – But, consider business succession planning

10‐12

Portability

• Made permanent
• Technical correction made

– “Basic exclusion amount” changed to “applicable exclusion amount” in I.R.C. §2010(c)(4)(B)(i)

• June 15, 2012 portability regulations remain

applicable

• Still have to file Form 706 in first spouse’s estate

to make election

– 9 months after death with 6 month extension possible

10

8/3/2015 142

Impact of Portability

• Since it is now “permanent,” the use of bypass

trusts for all but the wealthiest of families might be reduced

• But, there are still reasons to use bypass trusts:

– Protect assets from creditors – Surviving spouse might remarry – Assets might go down in value – Plan might already use a bypass trust – Bypass trusts avoid administrative pitfalls

Portability Regulations

• T.D. 9593, effective Jun. 15, 2012

– The election

• 706 must be filed by due date (or extension) regardless of

size of gross estate

• Must be made on complete and properly prepared 706

– No need to report value of property subject to marital or charitable deduction – Must estimate total value of gross estate on line 1, part 2 – Must show computation of DSUEA – DSUEA is lesser of basic exclusion amount of last deceased spouse over amount with respect to which tentative tax determined under Sec. 2001(b)(1)

Portability Regulations

• DSUEA Computation

– Amounts on which gift taxes were paid by a decedent are excluded from adjusted taxable gifts for purposes

• f computing the DSUEA
• This is a big surprise and is contrary to the statute
• You don’t have to reduce the DSUEA by the tax paid on prior

gifts ‐ only prior gifts that used gift tax exclusion are counted (it did not use exclusion and won’t be counted against any remaining exclusion for purposes of portability)

8/3/2015 143

Portability Regulations

• Ordering rule

– When surviving spouse makes taxable gift, that spouse first uses DSUEA amount of the person who was last deceased spouse at time of the gift, before the surviving spouse uses his/her own basic exclusion amount

• In other words “last deceased spouse” is determined at

time of gift or at time of death of surviving spouse

• Again, statute does not read this way

Portability Regulations

• Electing out

– If portability not desired and estate tax return required to be filed, affirmative statement must be made that portability does not apply – Where 706 not required, not filing means portability not elected

Portability Regulations

• Examination of returns

– IRS can examine returns of each deceased spouse

• f surviving spouse to determined allowable

DSUEA even if period of limitations on assessment has expired

• Only for purposes of assessing additional tax on the

return

8/3/2015 144

Portability Regulations

• Nonresident, Non‐Citizen Surviving Spouses

– Not eligible to utilize DSUEA from last surviving spouse

Portability

• Requirements of Form 706

– “Complete and properly‐prepared” Form 706 in

• rder to make the DSUEA election

– Executor can use “best estimate” of value of certain property and report gross amount in the aggregate, rounded up to nearest $250,000 – Simplified reporting for particular assets

• Best‐faith estimates
• Marital and charitable deduction, etc.
• Some things have to be included on 706

12‐13

Portability

• Statute for assessing additional tax

– Later of 3 years from date of filing or 2 years from date tax was paid, but… – IRS can examine DSUEA amount at any time through period of the limitations as it applies to estate of deceased spouse

• The need to retain documentation

– Is this a disadvantage of portability?

8/3/2015 145 DSUEA Portability – Simplified Reporting

• Applies to estates that do not otherwise have a

filing requirement under I.R.C. §6018(a).

– Only applies to marital and charitable deduction property in certain circumstances – List the asset on applicable Schedule without any value listed – Round sum of asset values to next $250,000 increment – Note other information to be included for each asset

• Not in Form 706 instructions, but is in regulations

13

Impact of Portability

• Since it is now “permanent,” the use of bypass

trusts for all but the wealthiest of families might be reduced

• But, there are still reasons to use bypass trusts:

– Protect assets from creditors – Surviving spouse might remarry – Assets might go down in value – Plan might already use a bypass trust – Bypass trusts avoid administrative pitfalls

Portability “Arbitrage”

• Surviving spouse can use multiple DSUEAs by
• utliving multiple spouses where the DSUEA

election is made in each decedent’s estate

– Surviving spouse needs to gift the DSUEA of the last deceased spouse before the next spouse dies

8/3/2015 146

Portability Regulations

• Electing out

– If portability not desired and estate tax return required to be filed, affirmative statement must be made that portability does not apply

• Check box in Section A of Part 6 of Form 706

– Where 706 not required, not filing means portability not elected

Role For Traditional Bypass/Credit Shelter Trusts

• Still have merit, but not necessary for most

clients because of portability

– Not worth modifying estate plan to eliminate it – Can aid with administration – Can provide asset protection

• Alternative plan:

– Use the DSUEA in surviving spouse’s estate to fund contribution to IDGT

• Gets same tax benefit as bypass trust would obtain, but

assets taxed to surviving spouse as a grantor trust. Allows for asset appreciation outside of surviving spouse’s estate

14

Estate Planners Not Irrelevant

• Many non‐tax reasons to see an estate planner:

– Remaining role for traditional bypass/credit‐shelter tusts – Asset protection through entities, trusts, pre‐nups and post‐nups – Planning for long‐term health care – Powers of attorney – Reviewing beneficiary designations and coordinating them with estate plan – Business succession

8/3/2015 147 Compare Transfer Tax Cost With Basis Step‐Up

• In general
• Benefiting from basis step‐up
• Exceptions to basis step‐up rule

– Alternate valuation – Special use valuation – Qualified conservation contribution – IRD – Gift within one year of death and donor receives property back

14‐15

Community Property Considerations

• Advantage over common‐law property estates

– The ownership portion of the couple’s community property that is attributable to the surviving spouse by virtue of I.R.C. §1014(b)(6) gets a new basis when the first spouse dies if at least 50% of the community property is included in the decedent’s estate for FET purposes. – AZ, CA, ID, LA, NV, NM, TX, WA and WI – AK and TN by election – 16 states have UDCPRDA

17

Community Property Planning

• Minimal gifting of assets during life of both

spouses

• Upon first spouse’s death, utilize strategy

based on size of survivor’s estate and goals

8/3/2015 148 Techniques to Achieve Basis Step‐Up In Common‐Law Property States

• GPOA given to each spouse over the other

spouse’s property

– Causes estate inclusion

• JEST

– But, what about I.R.C. §1014(e) – Complex drafting – If it gets too complex, problems can arise

• Estate of Olsen v. Comr., T.C. Memo. 2014‐58

18‐20

Transferee Liability

• Liabilities for deficiencies on decedent’s tax

return(s) do not die

– Estate is liable for any deficiency that existed at time of death – Transferees are liable for taxes due from decedent to extent of assets received – Trusts can be liable too – Recent cases on the matter point out the peril

20‐21

Estate Planning and the NIIT

• Trusts
• Pass‐through entities
• Partnerships
• S corporations
• LLCs
• Manager‐managed LLC

21‐24

8/3/2015 149

NIIT As Applied To Trusts

• NIIT applies to passive sources of income

– Material participation tests route through the passive loss rules of I.R.C. §469 – IRS position is that only the trustee, acting in the capacity of trustee can satisfy the material participation test

• Position rejected in Mattie Carter Trust v. United States (N.D.
• Tex. 2003)
• Position again rejected in Frank Aragona Trust v. Comr., 142

T.C. No. 9 (2014)

– Trustee – Trustee/employee – Employees (implied)

Implications for Trusts

• Trusts threshold is the top tax rate bracket under the proposed

regulations (1411(a)(2)).

– Surtax applies to lesser of undistributed NII or the excess of an estate/trust’s AGI over $12,150 for 2014

• Regulations allocate investment income between distributed and

undistributed income under usual trust allocation rules.

• Electing small business trusts will have to combine their S

corporation and non‐S corporation portions for computing the tax. Proposed Treas. Reg.§1.1411‐3(c)(1)(ii).

Potential Problem of Trapping Income and Gains in Trusts

• Drafting language is key
• Know the DNI rules
• Key will be to distribute income out of the

trust so that it’s not trapped inside the trust where it is subject to tax at the compressed bracket rates

• AICPA podcast of July 2013 by Robert Keebler

– There are techniques that can be used to avoid trapping income and gains in trusts

8/3/2015 150

Implications for Trusts

• Charitable remainder trusts

– Proposed regs treat part of distribution as investment income (Proposed §1.1411‐3(c)(2))

• Foreign estates and trusts not normally subject

to NIIT tax.

– The proposed regs say the IRS will subject U.S. beneficiaries on their share of distributed investment income and requests comments on how

• Bankruptcy estates are subject to the tax with a

threshold of $125,000.

– Proposed regulations preamble

Implications for partners?

Choose your poison!

• If you materially participate in a partnership with

trade or business income, you will have self‐ employment income, potentially subject to the .9% tax – and the old 2.9% Medicare tax.

• If not, you will have passive income subject to the

3.8% tax.

Implication for S corporations:

more reason to keep a lid on "compensation."

• S corporation K‐1 income is not subject to FICA or

SE tax.

• Reasonable compensation required.

16

8/3/2015 151 Implication for Entity Planning

• S corporation is favored over partnerships

because of better ability to avoid both employment tax and investment income tax of active owners.

Using an LLC to Reduce SE Tax and NIIT Background

• Sole proprietors and partners are subject to SE tax on all
• rdinary income generated.
• Forming a member‐managed LLC will also technically subject

all ordinary income to the same taxation.

• But, if the LLC has a manager‐managed structure, then only

the income allocated to the managers and any guaranteed payments to non‐managers will be subject to self‐

employment income.

– It’s non‐passive

8/3/2015 152

Background (cont.)

• Proposed Treas. Regs. state that an LLC member is subject to self‐

employment tax under any one of three situations: – The individual has the personal liability for the debts of or claims against the LLC by reason of being a member (personal guarantees do not fail this requirement); – The individual has the authority under state statute to contract on behalf of the limited liability company (the member has management authority); or – The individual participated in the entity’s trade or business for more than 500 hours during the entity’s taxable year

Manager‐Managed Structure

• A manager managed LLC may provide two separate classes of

membership for managers (who have authority to bind LLC under contract) and non‐managers (who have no such authority)

– Both classes would default to provide limited liability protection to the members in their capacity as members. – Personal guarantees, making certain debts recourse to the member, do not violate this exemption since such exposure is not due to the status

• f being a member.
• Non‐managers who do not meet the 500 hour involvement test

are not subject to SE tax, except to the extent of any guaranteed payments.

• Non‐managers who exceed 500 hours are not subject to SE tax if:

– Non‐managers own a “substantial continuing interest” in the class of the interest; and – The individual’s rights and obligations are identical to the rights and

• bligations of members who satisfy the general definition of a “limited

partner” (i.e. non‐manager, less than 500 hours) 23‐24

Manager Managed Structure – (cont.)

• A taxpayer may hold both a manager and non‐

manager interest that may be bifurcated:

– Individuals with non‐manager interests who spend less than 500 hours per year on the activity must hold at least 20% of the LLC interests. – The taxpayer owns a class of non‐manager interests identical to those held by the non‐manager members and a manager’s interest:

• The manager’s interest is subject to SE tax
• The non‐manager’s interest is not subject to SE tax

8/3/2015 153

NIIT Application to Manager‐ Managed LLCs

• A non‐manager’s interest in a manager managed LLC is

normally considered passive and thus subject to the net investment income tax (NIIT).

– However, a spouse may take into account the material participation of a spouse who is a manager under I.R.C. §469(d)(5)]. – Thus, if the manager spouse has material participation, than all non‐ manager interest(s) owned by both spouses will not be subject to NIIT.

• Careful structuring of the manager‐managed LLC

– Minimal self‐employment tax – Elimination of the NIIT on the income of the LLC operations.

NIIT – Other Situations

• Hired Farm Manager

– Share that owner receives is potentially subject to NIIT – No imputation of agent’s activity

• Multiple entities

– Rent paid by farming spouse to non‐farming spouse (where land is owned jointly)

• No NIIT – it’s a self‐rental situation

25

Final NIIT Regulations

• Sale of farmland

– Basic principles:

• If gain attributable to sale of capital asset used in trade
• r business in which taxpayer materially, then gain not

subject to NIIT

– Use m.p. tests of passive loss rules

• If active farmer sells land from farming operation, gain

not subject to NIIT

8/3/2015 154 NIIT Regulations and Sale of Farmland

• What about farmland sales of retired farmer
• r surviving spouse?

– NIIT applies to income from passive activity – Two schools of thought:

• The I.R.C. §469(h)(3) approach
• Normal material participation tests of I.R.C. §469

Special Rule For “Retired" Farmers

(The I.R.C. §469(h)(3) Approach)

• Material participation in 5 years in the eight year

period before you start drawing social security is evergreen.

The “Farmer” Rule

• How the statute works:

– 1411(c)(2): Trades and businesses to which tax applies

• A trade or business is described in this paragraph if

such trade or business is‐

• (A) a passive activity (within the meaning of section

469) with respect to the taxpayer

8/3/2015 155

The “Farmer” Rule

• I.R.C. Sec. 469(h)(3):

– Treatment of certain retired individuals and surviving spouses

• A taxpayer shall be treated as materially participating in

any farming activity for a taxable year if paragraph (4)

• r (5) of section 2032A(b) would cause the

requirements of section 2032A(b)(1)(C)(ii) to be met with respect to real property used in such activity if such taxpayer had died during the taxable year.

The “Farmer” Rule

• A taxpayer is treated as materially participating if Sec.

2032A(b)(4) or (5) would cause the requirements of Sec. 2032A(b)(1)(C)(ii) to be met with respect to real property used in the farming activity if the taxpayer had died during the tax year.

– The requirements of I.R.C. §2032A(b)(1)(C)(ii) are met if, during the eight years preceding the decedent’s death, there were periods aggregating five years or more during which the decedent or a member of the decedent’s family materially participated in the farming activity

The “Farmer” Rule

• I.R.C. §2032A(b)(4) says that in applying the 5‐out‐of‐8

years rule, the taxpayer may disregard period in which the decedent was retired (i.e., receiving Social Security)

• r disabled.
• I.R.C. §2032A(b)(5) says that if the 5‐out‐of‐8 years rule is

met with regard to a deceased taxpayer, it is deemed to be met with regard to the taxpayer’s surviving spouse, provided that the surviving spouse actively manages the farming activity when not retired or disabled.

8/3/2015 156

The “Farmer” Rule

• Example:

– Bob materially participated in a farming activity from 2007 through 2011, but did not work in the activity in 2012 or later years. Bob began drawing Social Security in 2015.

• Because Bob had materially participated in the farming activity in

5 of 8 years before his retirement, Bob is treated as materially participating in 2015 and later years (but not in 2012‐2014). – Note: If Bob were to die, Mary (his wife) would be treated as materially participating provided that she is actively managing the

• farm. And, the 5‐out‐8‐year rule applies to benefit Mary if she retires
• r becomes disabled.

Other Approach

(Standard M.P. Rules)

• I.R.C. §469(h)(3) concerns recharacterization
• f farming activity and not recharacterization
• f a rental activity

– Since retired farmer is no longer farming (but is engaged in a rental activity), I.R.C. §469(h)(3) inapplicable and normal I.R.C. §469(h)(3) m.p. tests do apply

• 5 of the previous 10 years immediately preceding the

sale

General Approaches to Estate Planning Post ATRA

• The “new normal”

– Certainty – Indexed exemptions – Portability – Very little impact on most clients

• Less than 0.2% of decedent’s estates subject to federal

estate tax

8/3/2015 157 Planning for Married Couples Under $5.34 Million

• Transfer taxes generally irrelevant

– Portability election in first estate

• Core dispositive planning

– Beneficiary designations, etc.

• Income tax planning

– Preservation of stepped‐up basis at death of each spouse – If trust utilized, give spouse testamentary POA to allow basis adjustment on surviving spouse’s death

• Maintain standard of living
• Qualified retirement plans
• Elder law/Medicaid planning
• Asset protection planning

– Inter vivos QTIP trusts – Lifetime credit shelter trusts

1

Planning for Couples in the $5.34‐ $10.68 Million Range

• Portability decision

– Leave up to surviving spouse?

• Let surviving spouse disclaim outright bequest with

provision that disclaimed assets pass to bypass trust, or leave assets to QTIP trust

Planning for Couples Above $10.86 Million

• Large gifts with sales or other leveraged

transactions

– Can remove huge amounts from transfer tax base for estate and GST tax purposes – Gift splitting? – What about loss of stepped‐up basis? – Funding grantor trusts sooner rather than later? – Defined value formula clauses

8/3/2015 158

Practical Estate Tax Planning Features of the Farm Family

• Family togetherness
• Generations working together
• Spousal business participation
• Intergenerational vision
• Typical illiquidity of family assets
• Typical low income return vs. asset values

Planning Issues

• Focus of planning after ATRA
• Retirement and succession of management

during parents’ lifetimes

• Ownership between spouses ‐‐ equality
• The role of the surviving spouse in management
• Succession of management at the death of the

parents

• Debt and estate tax cost as affecting succession
• Separation of on‐farm and off‐farm heirs

8/3/2015 159

Succession of Management

• Selection of successor manager(s)
• Bringing the successor(s) into ownership –

lifetime, inheritance

• Separation of control between successor(s)

and non‐successors

• Separation of ownership between sucessor(s)

and non‐successors

Separation of Control/Ownership Among Heirs

• Production assets vs. land
• Non‐farm assets to off‐farm heirs if feasible – use
• f life insurance – relative income of inheritances
• Lifetime sales to successor managers
• Off‐farm heirs as landlord to on‐farm heirs
• Use of business entities – allocation of control

and ownership through ownership classes – buy‐ sell provisions

• Post‐estate buy‐outs and options

Lifetime Gifts/Sales to Successors I

• Low basis assets and capital gain cost –

depreciation recovery

• Transfer basis on gifted assets
• Funding of purchase price
• Sales of discounted stock/partnership

interests

• Leasing of land to successor(s) – parent

retirement – option to purchase

8/3/2015 160

Lifetime Gifts/Sales to Successors II

• Successor(s) may want a separate operation as

a base for the future

• Acquiring production assets
• Contract sale of land – part gift maybe –

economics of funding purchase price

• Sellers’ interest in the contract of sale could

be left to off‐farm heirs

Estate Tax Planning I

• Estate tax ‐‐ Just another type of debt
• Planning for basis step‐up
• Allocation of tax – can be used as part of buy‐out
• f non‐farm heirs ‐‐ §6166 installments
• Tax minimization should be consistent with

succession plans (e.g. use of business entities)

• Handling Special Use Value election between on‐

farm and off‐farm heirs

• Other taxes – NIIT, Self‐employment

Planning For Estate Tax

• Applicable Exclusion of $5M + may eliminate

estate tax in many farms – but values are increasing

• Planning with the credit trust vs portability of

exemption

• Planning for state estate/inheritance tax may still

be required

• Planning for inflation – traditional value reduction

& freeze techniques such as business entity stock/interest discounting may be appropriate

• Portability vs. traditional credit shelter trust

8/3/2015 161

Valuation Control for Tax Purposes

• Real Property Valuation
• Use of business entity interest holdings –

discounts, preferred stock, fixed value pship interests

• Special Use Value
• Value freezing through gifts (2011, 2012 $5M)
• Value freezing through installment sales
• Deferred payment of estate taxes under §6166

Selection of Business Entities

• Income distribution
• Income tax issues
• Flexibility for future division among owners
• Management
• Estate tax planning with discounted interests

in the entity

• Client tolerance for complexity

Estate Planning with Business Entities

• Effect of the entity on gift and estate tax of
• wners
• Valuation of interests in the entity – discounting
• Effect of death, retirement or withdrawal of an
• wner
• Retirement planning of owners
• Restrictions on transfer of entity interests –

control agreements

• Multiple entities – production assets vs. land

8/3/2015 162

Checklist for Entity Formation

• Clients’ goals – tax saving, education of

members, facilitation of management, etc.

• Estate tax effect of entity
• Optimum valuation adjustment of entity

interests

• Economic effect of entity (income distribution,

division of ownership

• Problems, concerns and dangers of gifting

through family business entities

Separation of On‐Farm & Off‐Farm Heirs

• Effect of inclusion of both in business entity
• Multiple entities
• Farm asset legacies vs. non‐farm asset legacies
• Splitting farm assets, if buy‐out can’t be funded
• Funding buy‐outs with farm income or

installment sales

• Use of life insurance to fund buy‐out or off‐farm

inheritance

Retirement Planning

• Effect of cash basis accounting
• Debentures for retirement cash flow
• Cash flow from limited pship interests
• Lease rentals
• Installment sales
• Consulting fees
• Funded and unfunded deferred comp plans
• Tax deferred retirement plans ‐‐ IRA, 401k

8/3/2015 163

Optimize Entity Selection

• Separate operating assets from land
• wnership

– Saves on SE tax – Provides easier transfer for heirs (on‐farm and off) – Provides additional legal protection

• LLC or LLP or LP for real estate
• About any entity for operating

Take Advantage of Annual Giving

• $14,000 per year per donee
• Discounts get equivalent of close to $25‐

30,000

• Over 15 years, can easily add up to $5 million
• r more and still retain lifetime estate

exemption

• Use care of deciding which assets to gift

Loan Funds to Children

• Interest rates are low

– Return to Child earned in excess of interest escapes gift/estate tax – Allows for pride of ownership and skin in the game – Proper documentation required

8/3/2015 164

Child Purchase Assets

• Similar to loaning to child
• Permanent removal of value from estate
• Provides pride of ownership

– How often do we have dad at age 85 and “child” at age 60 owns nothing

Consider Inter‐Family Sales

• Freezes value for estate tax purposes
• Can be part sale/part gift (IDGT, etc.)
• Provides for retirement income to parents
• If high basis assets, may not have much tax

affect

• Not subject to SE tax
• Capital gains to parents
• Interest deductible by child

Proper Use of Trusts

• The use of a credit shelter trust still makes

sense versus portability

• Portable amount is not indexed to inflation
• Privacy concerns can be met
• Avoid probate
• Easier transfer of asset

8/3/2015 165

How it Might Work

• At second spouse’s death, property to children
• For small estates (under $2 million) works just fine

Unlimited Marital Transfer Applies

• Law provides for portability of unused marital deduction
• Must file return

Portability

• Objective to maximize use of each spouse’s federal and state (if any)

estate tax exclusion

• Will should provide for bypass or credit shelter
• Purpose to use some or all of each spouse’s lifetime estate exemption

Strategy

Dad has $10 Million Estate Exempt Trust a/k/a Credit Bypass Trust $5 million Income to surviving spouse Principal if needed Spouse share in trust or outright $5 million Remaining amount is included in spouse’s estate Estate Plan – Use of Exemptions

8/3/2015 166 Review Special Use Valuation Metrics

• Special Use can save up to $1.090 million

(indexed to inflation) of farmland value in estate

• Many stringent rules

– Review frequently to see if taxpayers still qualify

State Estate & Gift Tax Issues

• Many states have gift, estate or inheritance

taxes.

• This tax may be substantially higher than the

federal tax

– Rates are lower – Exemption is much lower

State Estate Tax Example

• John passes away with a taxable estate of $5
• million. There is no federal tax owed,

however, he lives in a state with a 15% estate tax rate on assets over $1 million.

• Therefore, the estate owes $600,000 of state

estate taxes ($5 million less $1 million times 15%).

8/3/2015 167

State Issues (continued)

• In many cases, the estate tax could have been

avoided with a lifetime gift

– Many states have estate taxes, but no gift taxes – Miss step up in basis, but estate tax rate is higher than income tax rate – Must incorporate both state and federal rules in the planning process

Consider Section 6166 Election

• If a large farm estate, Section 6166 allows for

that part of the estate to be paid over 15 years

– First five years interest only – Next ten years interest and principal

• First $1.45 million (indexed to inflation)

qualifies for 2% rate

• Remainder has an interest rate equal to 45%
• f the Section 6601(a) rate

THANK YOU FOR ATTENDING!

• mceowen@iastate.edu

– www.calt.iastate.edu – @CALT_IowaState

• ksmaitre@iastate.edu
• Chris Hesse
• Michelle Van Dellen
• Stephanie Hathaway