The following article originally appeared in the Fall 2014 newsletter of the Kansas Bar Association Real Estate, Probate and Trust Law Section. It is reprinted here by permission.
By Mike Cannady
SPENDTHRIFT PROVISIONS IN KANSAS UNIFORM TRUST CODE AMENDED
RECENT STATUTORY DEVELOPMENTS
K.S.A. 58a-502 was amended effective July 1, 2014, to more closely mirror uniform law provisions. Previously, the law stated that, regardless of whether a trust contains a spendthrift provision, a creditor of a beneficiary cannot compel a distribution that is subject to the trustee’s discretion, even if the discretion is expressed in the form of a standard for distribution or
the trustee has abused discretion. Under the amended statute, regardless of whether a trust contains a spendthrift provision, a creditor may not compel a distribution even if both the standard of distribution is expressed in the form of a standard and
the trustee has abused the trustee’s discretion.
Additionally, under the amended statute, there is a special rule for instances in which a beneficiary is serving as sole trustee. If a beneficiary is or was serving as sole trustee and the standard of distribution with respect to such beneficiary is not in the form of an ascertainable standard relating to such beneficiary’s health, education, support, or maintenance, the statute now allows a creditor to:
POSSIBLE VOTE ON ESTATE TAX REPEAL
- Compel any distribution the beneficiary, while serving as sole trustee, either is presently authorized to make to such beneficiary or was authorized to make to such beneficiary and did not make; and
- Attach such beneficiary’s beneficial interest in the trust with respect to any present or future discretionary distributions to such beneficiary, in the absence of a spendthrift provision precluding such attachment.
In an interview with reporters on July 30, 2014, House Ways and Means Committee Chair Dave Camp (R-Mich.) stated that there could quite possibly be another vote on outright repeal of the estate tax before the end of this year. It is not clear which bill would be voted on, but H.R. 2429 already has more than half of the House members as co-sponsors. Passage of any such bill is likely in the House of Representatives, but at this point, support in the Senate does not appear to be great enough to defeat a filibuster.
ESTATE OF FRANKLIN Z. ADELL, TC MEMO 2014-89 (May 14, 2014) AND TC MEMO 2014-155 (August 24, 2014)—TWO TAX COURT DECISIONS REGARDING A LEVY ACTION FOR UNPAID GIFT TAX AND THE VALUATION OF CLOSELY HELD STOCK
Franklin Z. Adell died on Aug. 13, 2006, and two Tax Court cases have been reported in relation to that estate. Estate of Franklin Z. Adell
, TC Memo 2014-89, involves the filing of an estate tax return, which reported the amount of a judgment paid by the decedent on behalf of his son as a loan receivable by the estate and thus an asset of the gross estate. The return reported $15,288,517 of total estate tax due, and the estate paid the $8,094,558 portion of the estate tax that could not be deferred under Code Sec. 6166 at the time it submitted the estate tax return. Payment of the remaining $7,193,960 of estate tax was deferred.
Later the estate filed amended estate tax returns, which reclassified the payment of the judgment as a taxable gift to the decedent’s son, and a gift tax return, which reported the judgment as a taxable gift. The gift tax return showed $2,889,108 of gift tax due. In response, the IRS assessed $2,889,108 of gift tax on the basis of the gift tax return, and assessed a $650,049 penalty for late filing of the gift tax return, a $606,713 penalty for late payment of the gift tax, and $742,847 of interest.
The estate filed a protest letter with the IRS concerning the 2006 gift tax liability, requesting that the IRS (1) stay all collection actions; (2) consolidate consideration of the gift tax liability with consideration of the estate tax liability; and (3) abate the penalties. The estate requested penalty abatement on the grounds that the judgment had already been reported as an asset on the initial estate tax return and that the gift tax liability could be satisfied by applying the $8,094,558 estate tax payment against the gift tax liability. The Appeals officer disallowed the claim for abatement.
Before the Tax Court, the estate contended that the IRS should have credited the initial payment it made with initial estate tax return against its gift tax liability.
The Court noted that the IRS allows a taxpayer to designate the application of a voluntary tax payment if the IRS has assessed one or more tax liabilities against the taxpayer when he or she submits the payment and the taxpayer provides specific, contemporaneous written directions for application of the payment. If the taxpayer does not properly designate how a payment should be applied, the IRS generally applies the payment in a manner that best serves its interest.
The Tax Court pointed out that the estate remitted the initial payment to the IRS with the initial estate tax return, and at that time, the IRS had assessed only the estate tax against the estate. The estate did not file a gift tax return and the IRS did not assess the gift tax liability until later, and therefore the estate could not have designated that the initial payment be applied against the gift tax liability.
The estate also contended that it made an overpayment of estate tax, and that Code Sec. 6402(a) authorizes the IRS to credit a taxpayer’s overpayment against any internal revenue tax liability of the taxpayer. For a tax payable in installments, Code Sec. 6403 provides that any overpayment of an installment must be applied first to any unpaid installments. If the amount of the overpayment exceeds the full amount of the tax due, then it may be credited or refunded as provided in Code Sec. 6402.
The Tax Court said it had previously held in Estate of Bell
, 92 TC 714 (1989), that where the taxpayer makes an election under Code Sec. 6166 and overpays the nondeferrable portion of the estate tax, the IRS must apply any overpayment of the nondeferrable portion to the deferred portion before it can credit or refund the overpayment to the taxpayer. Therefore, even if the estate overpaid the nondeferrable portion, it did not pay more than the full amount of estate tax due. Thus, the Tax Court held that the IRS did not have an available overpayment of estate tax to credit against the estate’s gift tax liability. Consequently, the Court concluded that the IRS could proceed with collection against the estate.
Estate of Franklin Z. Adel
l, TC Memo 2014-155, involves a separate issue relating to the valuation of STN.Com stock that was owned by the decedent. STN.Com’s board of directors included the decedent, his son, Kevin, and their accountant. Kevin served as STN.Com’s president, but he never had an employment agreement or a non-compete agreement with STN.Com.
In the initial estate tax return, the STN.Com shares were reported with a date-of-death value of $9.3 million, but that value was changed in the second amended return to a date-of-death value of zero. The IRS determined the value of the STN.Com stock to be $92.2 million, and issued a notice of deficiency of nearly $40 million.
Before the court, the parties substantially changed their positions, with the estate arguing that the fair market value of the STN.Com stock on the valuation date was $4.3 million and the IRS arguing that it was over $26 million.
The court found that the estate failed to introduce any evidence or present any arguments to persuade the court that the value reported on its original estate tax return was incorrect, and that the IRS’s valuation was not persuasive because it did not reasonably account for Kevin’s personal goodwill. Thus, the court concluded that the valuation report on the STN.Com stock included with the original estate tax return was the most credible because it properly accounted for Kevin’s personal goodwill and appropriately used the discounted cash flow analysis of the income approach to value the STN.Com stock.
Because the court found that the value of the STN.Com stock held by the estate was the value reported on its original estate tax return, it did not need to address whether the estate was liable for the substantial estate tax valuation understatement penalty.
CLARK V. RAMEKER, 113 AFTR 2D ¶ 2014-889 (U.S. SUPREME COURT June 12, 2014)— INHERITED IRAS NOT EXEMPT UNDER THE BANKRUPTCY CODE
In 2010, the Clarks filed a bankruptcy petition under Chapter 7 of the Bankruptcy Code, and in their petition, sought to exempt an IRA inherited from Mrs. Clark’s mother, which was then worth about $300,000, from their bankruptcy estate, under Bankruptcy Code §522(b)(3)(C). The bankruptcy court found that inherited IRAs don’t hold “anyone’s” retirement funds, because the funds are not set aside for retirement needs, and are therefore not exempt. The bankruptcy court’s decision was appealed to a federal district court, which reversed the decision and held that the inherited IRA did qualify for the exemption. This decision was again appealed, this time to the Seventh Circuit, which found that the bankruptcy court had gotten it right, and that the Clarks’ inherited IRA did not qualify for the exemption.
The Seventh Circuit’s decision was at odds with an earlier holding by the Fifth Circuit (In re Chilton
, 109 AFTR 2d 2012-1375 (5th Cir. 2012), so the Supreme Court agreed to hear the case to resolve the split among the circuit courts.
Justice Sotomayor delivered the opinion for a unanimous court, stating that “text and purpose” of the Bankruptcy Code provided that funds held in inherited IRAs are not “retirement funds” for purposes of the Bankruptcy Code §522(b)(3)(C) exemption.
The Court stated that “retirement funds” refers to money that is set aside for the time that a person is no longer working, and the determination of whether funds held in an account are “retirement funds” should be based on the legal characteristics of the account holding the funds and on whether the account is one that was set aside for when an individual is no longer working.
The Court stated that inherited IRAs can be used for current consumption, while those in traditional and Roth IRAs cannot, and therefore funds held in these accounts are “not objectively set aside for the purpose of retirement.”
According to the Court, the exemptions provided by the Bankruptcy Code create a balance between the rights of creditors and the needs of debtors. Allowing debtors to protect funds held in traditional and Roth IRAs aligns with this balance by helping to ensure that debtors will be able to meet their basic needs during retirement. By contrast, nothing about an inherited IRA’s legal characteristics prevent or discourage an individual from using the entire balance immediately after bankruptcy for purposes of current consumption.
FINAL CIRCULAR 230 REGS PROVIDE NEW RULES ON WRITTEN TAX ADVICE
The IRS issued final regulations, effective June 12, 2014, updating the Circular 230 practice standards, deleting the rules relating to covered opinions, and eliminating the need for the Circular 230 Disclaimer. The final regulations, like the proposed regulations issued in 2012, delete section 10.35 and amend section 10.37 of Circular 230, to eliminate entirely the concept of a covered opinion, and the distinctions among marketed opinions, limited scope opinions, and opinions that fail to conclude at a confidence level of at least more likely than not that the issue will be favorably resolved. The new regulations instead create a single set of rules for written tax advice, contained in revised section 10.37.
New section 10.37 of Circular 230 requires that all written tax advice must:
- Be based on reasonable factual and legal assumptions (including assumptions on future events).
- Reasonably consider all relevant facts and circumstances that the practitioner knows or reasonably should know, which includes a requirement that the practitioner consider all relevant legal authorities and relate that law to the relevant facts.
- Not rely on representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) of the taxpayer or any other person if reliance on them would be unreasonable.
- Relate applicable law and authorities to the adduced facts.
- Not consider the possibility that a tax return will not be audited or that a matter will not be raised on audit, although they allow the advice to take into account the possibility that an issue will be resolved through settlement.
The regulations eliminate the requirement that the written advice include a description of the relevant facts, the application of the law to those facts, and the conclusions. They also permit advice to take into account the scope of the engagement and the type and specificity of the advice sought by the client as factors in determining the extent to which the relevant facts, application of the law to those facts, and the conclusions must be contained in the written advice.
The new rules apply to all written advice respecting a “federal tax matter,” which they define as any matter concerning the application or interpretation of:
A revenue provision, as defined in Section 6110(i)(1)(B).
- Any provision of law affecting a person’s obligations under the internal revenue laws and regulations, including the person’s liability to pay tax or obligation to file returns.
- Any other law or regulation administered by the IRS.
The Preamble to the regulations makes it clear that written tax advice does not include continuing legal education or similar presentations, or submissions to government agencies on behalf of clients.
The new regulations state that a practitioner may rely on the advice of others in preparing written tax advice, if that advice was reasonable and the reliance is in good faith. Reliance is not reasonable if the practitioner knows (or should know) that the other person’s opinion should not be relied upon, that the other person is not competent or lacks the necessary qualifications to provide the specific advice, or that the other person has a conflict of interest.
A practitioner relying on the advice or expertise of another person will be required to inquire into the other person’s background, skills, and expertise, in determining whether such reliance is reasonable. A practitioner may rely on another person who has a conflict of interest, if that conflict has been waived by all affected clients through informed consent.
With regard to the Circular 230 disclaimer, Treasury Decision 9668 states that “Because amended §10.37 does not include the disclosure provisions in the current covered opinion rules, Treasury and the IRS expect that these amendments will eliminate the use of a Circular 230 disclaimer in e-mail and other writings.”
The new regulations also amend section 10.36 of Circular 230 to impose on law or accounting firm management the primary authority and responsibility for overseeing a firm’s practice under Circular 230, and to require that they establish procedures to ensure compliance with the provisions of Circular 230. The final regulations clarify that firm managers must ensure that the firm has adequate procedures in place and that those procedures are properly followed.
FINAL REGS REGARDING TRUST/ESTATE EXPENSES AND THE 2% AGI FLOOR
The IRS issued final regulations, effective for tax years that begin on or after May 9, 2014, regarding which costs incurred by estates and non-grantor trusts are subject to Code Sec. 67(a)’s 2% floor for miscellaneous itemized deductions. While largely following the proposed regs, the final regs contain several changes and additions to the proposed regs.
The proposed regs provided that “ownership costs” are costs that are chargeable to or incurred by an owner of property simply by reason of being the owner of the property. They also set out that such costs are customarily or commonly incurred by all property owners, including individual owners. The final regs don’t change the proposed regs, but they note that other expenses incurred merely by reason of the ownership of property may be fully deductible under other provisions of the Code, and thus would not be miscellaneous itemized deductions subject to Code Sec. 67(e). (Reg. § 1.67-4(b)(2))
The proposed regs set out a list of tax returns the costs relating to which are not subject to the 2% floor. Those returns are estate and generation-skipping transfer tax returns, fiduciary income tax returns, and the decedent’s final individual income tax returns. The final regs clarify that the above list is an exclusive list; the costs of preparing all other tax returns are subject to the 2% floor. (Reg. § 1.67-4(b)(3))
The proposed regs provided that fees for investment advice (including any related services that would be provided to any individual investor as part of an investment advisory fee) are subject to the 2% floor. They also provide that, to the extent that a portion (if any) of an investment advisory fee exceeds the fee generally charged to an individual investor, and that excess is attributable to an unusual investment objective of the trust or estate or to a specialized balancing of the interests of various parties such that a reasonable comparison with individual investors would be improper, that excess is not subject to the 2% floor. The final regs make no change to these provisions. (Reg. § 1.67-4(b)(4))
The final regs provide that appraisal fees incurred by an estate or a trust to determine the fair market value of assets as of the decedent’s date of death (or the alternate valuation date), to determine value for purposes of making distributions, or as otherwise required to properly prepare the estate’s or trust’s tax returns, or a generation-skipping transfer tax return, are not subject to the 2% floor. The cost of appraisals for other purposes (for example, appraisals to determine the proper amount of insurance needed on property) is subject to the 2% floor. (Reg. § 1.67-4(b)(5))
The final regs provide that certain other fiduciary expenses are not subject to the 2% floor. Such expenses include, without limitation: probate court fees and costs; fiduciary bond premiums; legal publication costs of notices to creditors or heirs; the cost of certified copies of the decedent’s death certificate; and costs related to fiduciary accounts. (Reg. § 1.67-4(b)(6))
Under the proposed regs, if an estate or trust pays a bundled fee, that fee must be allocated, for purposes of computing the adjusted gross income of the estate or trust in compliance with Code Sec. 67(e), between the costs that are subject to the 2% floor and those that are not. The proposed regs provided an exception to this rule for certain bundled fees. They also provided that any reasonable method may be used to allocate the bundled fee between the two types of costs. The final regs make no changes to the proposed regs, but they add the following:
- IRS creates the possibility of additional exceptions to the bundling rule by adding “except to the extent provided otherwise by guidance published in the Internal Revenue Bulletin” to the bundling rule. (Reg. § 1.67-4(c)(1))
- Facts that may be considered in determining whether an allocation is reasonable include, but are not limited to, the percentage of the value of the corpus subject to investment advice, whether a third party advisor would have charged a comparable fee for similar advisory services, and the amount of the fiduciary’s attention to the trust or estate that is devoted to investment advice as compared to dealings with beneficiaries and distribution decisions and other fiduciary functions. (Reg. § 1.67-4(c)(4))
PLR 201429009 (June 18, 2014)—FAILURE OF SURVIVING SPOUSE TO SEGREGATE ASSETS IN DECEASED SPOUSE’S TRUST
In PLR 201429009 (July 18, 2014), the decedent and his spouse created a joint revocable trust which, upon the death of the first spouse to die, was to be divided into two separate trusts, one containing the surviving spouse’s share and one containing the deceased spouse’s share. Based upon incorrect advice from an attorney, the surviving spouse, who served as trustee of the joint revocable trust, did not segregate the trust assets into two shares. During the surviving spouse’s lifetime, the surviving spouse, acting as trustee, adhered to a “buy and hold” investment strategy for the assets of the trust, purchasing securities, reinvesting all dividends, and retaining holdings indefinitely. Prior to the surviving spouse’s death, new estate planning counsel advised the surviving spouse that he had been improperly advised regarding the segregation of the trust assets, and corrective measures were immediately taken during the surviving spouse’s lifetime. Through a forensic review of the historical financial records, the surviving spouse was able to ascertain and track the assets which should have been allocated to the Family Trust at the first spouse’s death.
The IRS concluded that, through a forensic review of the historical financial records, the decedent was able to ascertain and track the assets which should have been allocated to the Family Trust at the first spouse’s death, and accordingly, the value of the assets of Family Trust were not includable in the gross estate of the decedent under Code Sec. 2036 (retained life estate), Code Sec. 2038 (power to alter, amend, revoke, or terminate), or Code Sec. 2041 (power of appointment).
PLR 201423009 (JUNE 6, 2014) AND PLR 201426005 (JUNE 27, 2014)—TRUST TO TRUST SALE OF SURVIVORSHIP POLICIES
PLR 201423009 and PLR 201426005 both address the same issue. A husband and wife, who are both Grantors of Grantor Trust#1, which owns survivorship life policies on them, propose that Grantor Trust#1 sell the survivorship life policies to Grantor Trust#2, the Grantor of which is only the husband. The IRS said that the movement of the life insurance policy has two aspects. The first aspect is in relation to the husband, who is the Grantor of both Grantor Trust#1 and Grantor Trust#2. As the husband is considered to be the owner of both trusts, the transaction with respect to the husband cannot be recognized as a sale or exchange for income tax purposes. The second aspect is in relation to the wife, who is the Grantor of Grantor Trust#1, but not of Grantor Trust#2. Because the policies are being moved to Grantor Trust#2, the Grantor of which is the wife’s spouse, under § 1041(a), the transaction is treated as a gift to her spouse, who pursuant § 1041(b) receives a carryover basis in the policies. Therefore, the IRS ruled that the proposed purchase of the life insurance policies by Grantor Trust#2 from Grantor Trust#1 is not a transfer for valuable consideration within the meaning of §101(a)(2).