Thursday, December 31, 2009

Last Minute Goal by Taxpayers Makes FLP Hockey a Draw for 2009

The Estate of Samuel Black is another win for taxpayers on the issue of whether interests in family limited partnerships should be valued based on the fair market value of the underlying assets or the partnership interest, which will have a discounted value. Like most of these cases the discussion of the facts reads something like a novel. Mr. Black was born in 1902 and was selling bread on a street corner at the age of 11. He goes to work for an insurance company and quickly rises in the ranks as the company grows. When he dies at the age of 99 having not missed a single board meeting in 67 years, his estate is well north of $100,000,000.

All is not well though a son with a troubled marriage and two grandsons, who at the age of 20 have never had jobs concern him. So he starts a family limited partnership to protect his fortune from there future improvidence. Incidentally the technique saves many millions of estate tax dollars. The IRS and the executor agreed on what the discount should be, if there was one. Sadly it is not stated what the discount was. There might be a way to infer it from the numbers, but I couldn’t come up with it.

The other taxpayer win was Keller, which was really an amazing one. It was a refund case. The taxpayer had died before the partnership was funded, but the transaction was far enough along that the court allowed the valuation discount since they saw that the funding was committed. The thing I really like about this case was that the accountant really comes off as a hero.

The two IRS wins, Jorgensen and Linton, were, as usual, failures of execution. The entities weren’t respected. Personal bills were paid with partnership funds and partnership expenses were paid with personal fund. In Linton, the documents made it ambiguous as to which came first the funding or the gift. Jorgensen’s son commented that he just couldn’t “get his head around” the idea that the partnership wasn’t just like a bank account.
Ironically some of the facts that weighed against Jorgensen, a passive buy and hold strategy and continued control by the donor, were seen as positives for Black. As I wrote in one of my previous blogs, the devil is in the details

Oh by the way :

Any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Wednesday, December 30, 2009

Read This Before You Bundle Grandma Onto the Plane

I just read in the Wall Street Journal that many people are being kept on life support in the expectation of living till the effective date of estate tax repeal.  I doubt its enough to create a power surge in the grid when all those plugs are pulled on January 1, but it is a real phenomenon.  Being one willing to go from the ridiculous to the ridiculously absurd, it occured to me that in order to be as safe as possible, you might want to equip a hospital plane to get to a more favorable time zone.  Which way should you fly ?

A lot of people would think to go East.  After all we are GMT - 5 making it later as we fly East.  That's what a lot of people think.  Don't be one of them.  Head west.  Only don't stop in LA or Hawaii or even Samoa.  Get to Fiji.  Actually Tonga is good enough.  That puts you in GMT + 12, which is as good as it gets.  Kiribati is even closer, but I never even heard of that till just now.  But wait.

It doesn't do you any good.  According to Revenue Ruling 66-85 your time of death for estate tax purposes is based on the time zone where the estate tax return is to be filed.  That's the rule for US citizens residing in the US.  Revenue Ruling 74-24 gives a different rule for US citizens living overseas.  There is is based on their domicile at time of death.  Now your domicile is not where you are at any point in time.  It is not necessarily even where you spend most of of your time.  "Home is where the heart is".  In the United States states with high income tax rates think that nobody, in their heart, ever leaves them.  Don't get me started on this one.

According to the latest 706 instructions all estate tax returns are filed in Cincinatti, Ohio.  That would mean that all you have to be able to do is hang on till the ball finishes dropping in Times Square.  Unless you are domiciled in the Yukon.  The commentator from whom I got these cites says that sombody from LA who dies in New York goes by West Coast time, so there is a little bit of doubt in my mind.  Maybe you should hang on till the calendar turns in Samoa to be totally free from doubt.

At any rate forget about chartering the plane.  I doubt it is practical but if you could establish domicile in Fiji between now and then you would be in the best shape possible.  Maybe send a couple of cases of Fiji water to everybody in the family.  That wouldn't be enough, but every little bit helps.

By the way :

Any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Tuesday, December 29, 2009

Happy Saint Patrick's Day

On March 17, 2009 Revenue Ruling 2009-9 was issued.  It indicated that investors who had all their money stolen by somebody who was supposed to have invested it had a theft loss rather than a capital loss.  So now you know what to do if somebody made off with your money.

This wasn't necessarily a great result for taxpayers in Massachusetts where theft losses are not deductible in computing state income tax.

Another Year

Every year I try to go through all the primary source tax material looking for odd items of interest that might not make the news. My next few posts will be about these items.  I'd love to hear that you read it here first and that it might actually be of some use.

Those Pesky 1099's

The health care reform bill in the Senate has some provisions that have nothing to do with health, care or reform. They are in there to get some more money coming in. One of them is to eliminate the exception to information reporting where the recipient is a corporation. Businesses that are serious about 1099 compliance probably won’t be affected all that much. They probably already send 1099’s to corporate vendors, since you really don’t know whether an entity is a trade name, a corporation or possibly an LLC. There may be a sever wake-up call for other businesses.

I sometimes get the impression that most 1099’s are sent to people who are actually employees. They will be referred to as “independent contractors” or “contract labor”. There are around 20 factors that distinguish an independent contractor from an employee. I’ve come up with a much simpler analysis. If you ask the question, they are probably employees.

Then there are all these actual independent contractors who show up when you call them – or not, with their own stuff and maybe people who work for them and do something or other that is an ordinary and necessary expense of your trade or business. You get a bill from them and make out a check to Fred’s Plumbing and don’t think about sending a 1099. Those are for the so-called “independent contractors”. You figure they must be corporations anyway. Even though you are an LLC. If you provide services to businesses and are not incorporated how many of your clients/customers send you 1099’s ? They all should.

I didn’t used to worry about this quite as much until I read the IRS audit manual for auto body repair shops. The writer makes the interesting observation that there might be more money in penalties for failure to withhold from the people you should have sent 1099’s than in disallowing deductions.

So for now you can say I could have sworn they were incorporated and hope for the best. You won’t have that out in 2011, but you won’t have to worry about your health anymore. Right ?


Oh by the way :
Any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Devil is in The Details

In June of 2007, the Estate of Sylvia Gore joined the ranks of failed Family Limited Partnership. The case is worthy of consideration, because it illustrates clearly why the partnerships fail. If you are going to set up a family limited partnership it is critical that you consult with a well qualified attorney. The attorney will create a package, more or less thick, of documents, more or less mysterious and will see that you sign them with witnesses, notarized, with an extra copy in her safe in case you lose yours. That’s service. That’s follow through. Valuation discounts are what tends to be at stake when the IRS attacks Family Limited Partnerships. Having had great service from your attorney, you probably think that when people lose it is because they didn’t hire a good attorney. Perhaps the documents weren’t witnessed. Maybe one of the incantations in the mysterious documents was missing. Maybe there wasn’t an extra copy in the safe, after they lost theirs.

The follow through needed is not the extra hour in the attorney’s office. The follow through will be many hours year in and year out in your accountant’s office. The clue to this is in the importance attributed to the extra copy in the attorney’s safe. Why doesn’t the accountant who has to prepare the income tax return for the partnership have a copy? Why don’t you need to look at your copy from time to time too? Here’s why:

each partner's capital account is increased by (1) the amount of money contributed by him to the partnership, (2) the fair market value of property contributed by him to the partnership (net of liabilities that the partnership is considered to assume or take subject to), and (3) allocations to him of partnership income and gain (or items thereof), including income and gain exempt from tax and income and gain described in paragraph (b)(2)(iv)(g) of this section, but excluding income and gain described in paragraph (b)(4)(i) of this section; and is decreased by (4) the amount of money distributed to him by the partnership, (5) the fair market value of property distributed to him by the partnership (net of liabilities that such partner is considered to assume or take subject to), (6) allocations to him of expenditures of the partnership described in section 705(a)(2)(B), and (7) allocations of partnership loss and deduction (or item thereof), including loss and deduction described in paragraph (b)(2)(iv)(g) of this section, but excluding items described in (6) above and loss or deduction described in paragraphs


This is one of the magic incantations that will appear in your agreement. If you ask your attorney how that paragraph should be reflected on the partnership’s tax return, he is likely to tell you that he doesn’t prepare partnership returns. That’s what accountants do. Now go to your accountant and ask her what that paragraph means. Among the possible answers are “That’s some stuff the attorneys have to put in the agreement. Why don’t you ask him what it means?”

So what did Sylvia Gore and her advisers do or fail to do that cost the estate $1,071,650 in federal estate taxes. Plus ten years of interest. Not to mention the cost of their fruitless efforts in the Tax Court.

In 1995 Sydney Gore met with his accountant in the hospital where he expressed to her “his concerns about preserving the wealth he had accumulated through his life's work, protecting his assets from waste, and conserving them for future generations”. The accountant had an idea, a very good idea. Form a family limited partnership. She’d never advised any of her other clients to take that step, but it seemed to the right thing to do here. She knew that she had limits, though:

Ms. Bowers had little experience with family limited partnerships and had never recommended one to a client before she made the proposal to the Gore children, so she recommended that Ms. Powell, Mr. Gore, and decedent retain an attorney to further advise them about a limited partnership”

Apparently it didn’t occur to anybody that an accountant with more than a little experience with family limited partnerships might be able to bring something to the table.

What happened from here can hardly be blamed on the accountant. The partnership opened a bank account into which substantial sums were deposited. There was an assignment of marketable securities to the partnership. Unfortunately, title to the securities was not transferred to the partnership. The dividends from the securities were not deposited in the partnership’s bank accountant. When Mrs. Gore’s bills need to be paid they were paid sometimes from her personal accounts other times from partnership accounts.

Eventually returns need to be filed, which is when Ms. Bowers came back on the scene. What she did was what most competent accountants would try to do. Observing that what actually happened was not anything near like what was supposed to happen, she attempted to fix it all with journal entries. This process relies on one of the great intellectual breakthroughs that built the modern world – double entry bookkeeping first documented in a mathematical treatise over 500 years ago. It provides a built-in check that shows that you captured everything. It all has to balance. Debits equal credits.

When a check is written we credit cash. Then we have to debit something. Well the check went to Mary, so we debit Mary’s capital account. Unfortunately, by the terms of the partnership agreement we were not supposed to make a distribution to Mary. So we debit “Due from Mary”. Joe, on the other hand was supposed to get a distribution. Well either we won’t worry about that since it’s reflected in Joe’s capital or, if we want the percentages to be where they should be, we will credit “Due to Joe” and debit his capital account. When it’s all done the amounts on our records will agree to the statements (adjusted for the fact that they may not have the right names on them) and “it will all balance.” Mary will owe the partnership and the partnership will owe Joe. We’ll straighten it out next year or we’ll keep making journal entries to keep it straight.

I have learned a hard lesson that many accountants never quite get. When it comes to this “everything’s in balance” routine, almost nobody else cares. Here is some of what the court had to say about Ms. Bower’s efforts:

“The GFLP accounting records prepared by Ms. Bowers purport to show that decedent transferred ….”

“The accounting records also purport to show that after decedent executed the assignment, decedent allegedly sold the Commercial Federal CD, the savings bonds, a Valley National CD, and one of the Treasury notes to GFLP in exchange for a note payable to her from GFLP …”

The word “purport” or one of its forms (e.g. “purporting”) occurs six times. Here is the problem. You can get into law school with a liberal arts degree. They don’t teach double entry accounting in law school. If it’s taught in high school, it’s to kids not on the college track. You certainly don’t need it for a liberal arts degree. Judges are lawyers. It all balances and they don’t care.

I have no reason to doubt that if I looked at all the statements and agreements, I’d have concluded that Ms. Bower’s journal entries straightened things out. Likely most other accountants would reach a similar conclusion when they see that the cash ties and “it balances”. Much to our professional frustration, almost nobody else, but especially the judge, cares. The meticulous journal entries that “straighten” everything out in our minds, in the mind of the judge “purport”.

Also this year, the Estate of Concetta Rector lost to the tune of $1,633,049 plus about five years of interest. Here is an excerpt:

The estate attempts to downplay the significance of the direct use of RLP funds to pay decedent's personal expenses by attributing that use to “errors”. In the light of John Rector's extensive financial expertise and his testimony that it never occurred to him that RLP should be reimbursed for such “errors” after they were discovered, we find that this argument lacks credibility
This is nothing new. If you study the cases where taxpayers lose FLP cases, you will, almost always, if not inevitably, find that the failure was not one of a flawed plan. The failure was not following the steps transaction by transaction. If somebody is entitled to a distribution and has bills to pay, you distribute to them and let them pay their own bills. All entities have accounts and the payments in and out are the ones that belong to that entity. If a mistake is made it is fixed by a transfer of funds, not a journal entry that creates an indefinite “Due to”.
The moral of the story is that in order for the plan to work you must have coordination between the attorney who prepares the plan and the accountant who will be preparing the relevant returns. If you don’t want to trouble yourself with what entity should pay what bill or accept what deposit, etc, let that piece be handled by your professionals, also, but again in an integrated manner. There has to be somebody who cares what account is used, because that is their job.

Monday, December 28, 2009

All that glitters is not taxed ? Or is it ?

Given any thought to the tax implications of virtual transactions ? I didn't think so. Do you want some thoughts ? If not stop reading.

The IRS has not issued any guidance on the tax issues on virtual transactions. The issues will become more pressing as time goes on. Some of them are

Income Realization - When do you recognize income from virtual transactions? The simple answer seems to be when receiving some real money. This would be based on the theory that all you’re doing is playing a game and that trading with other players is part of the game. Given Blizzard’s terms of service, there is some merit in this argument. You don’t really own anything. There are however public companies more thinly traded than your WOW gold.

The approved market in Linden dollars trades a few hundred thousand real dollars per day. The price, which is market determined, has been hovering around 250 Linden dollars. Linden Labs plays the role of the central bank having the power to increase or decrease the money supply. It is interested in keeping the rate stable. Bottom line -The exchange rate between dollars and euros is much less stable than that between Lindens and dollars.

The only possible guidance on the realization of transactions within a virtual world are cases about whether casino gamblers recognize income before they cash in their chips (literally). Big help. There aren’t many cases and they go both ways.

As long as virtual items are in demand and companies are careful about controlling the money supply, virtual worlds have the potential to become tax havens.

Recognition – Assuming a virtual world transaction is realized could it avoid recognition because all virtual items, including gold or platinum or linden dollars, are of like-kind to all other virtual items? This entertaining thought experiment would be of limited relevance though since it would only apply to investors, not to hobby players or dealers (except in limited circumstances).

Nexus – Where do virtual world transaction take place? – Yuan, a free lance professional WOW player in China raids several tough dungeons and earns 10,000,000 gold. He sells it to a wholesaler for $10,000 who will sell small lots of 500 gold to recreational players in every state in the United States for them to buy better armor or epic mounts within the game. Where did this happen? Can the US tax Yuan? Can Massachusetts tax the wholesaler who is located in Texas? Can Illinois, where the server is located, tax everybody?

Nature of property - Can you invest your IRA funds in Linden dollars? Why not? Because it is a collectible? Collectibles are by definition tangible.

Transfer Taxes – Even WOW’s strict terms of service allow an account to be shared by a parent and a child. A dedicated player could create many avatars worth thousands of dollars (perhaps with dad buying a little gold now and then). Is the value of those avatars includible in dad’s estate since he paid the subscription fees, while junior did most of the monster killing that built the avatars.