Welcome to TaxView with Chris Moss CPA Tax Attorney
 
If you have been following TaxView with Chris Moss CPA Tax Attorney regarding Irrevocable Spousal Lifetime Access Trusts and Domestic Asset Protection Trusts (SLATs and DAPTs) we have recommended best practice in 2019 is to have your Irrevocable SLAT/DAPT own your Family or Holding LLC partnership with your spouse, children and grandchildren as beneficiaries, and to transfer as much of your assets to your family Holding LLC as you can prior to the 2020 elections.  However, there are IRS traps waiting to be sprung, as the Government waits, patiently I might add, until you die, disallowing your 2019 gift tax returns and bringing back all those assets ($22.8M married in 2019) back into your estate to be taxed at whatever rate Congress has enacted at the time of your death.  The trap?  The Business Purpose Doctrine of Court made case law and the IRS Code Section 2036(a): requires a valid business purpose. How to avoid this trap?  Stay with us here on TaxView, with Chris Moss CPA Tax attorney to find out how to easily maneuver past this trap so your SLAT/DAPT and family Holding LLC will be created on a solid structural foundation to withstand the IRS storms ahead when your estate gets audited years after your passing.

We are going to start with what seems to be a very simple concept the “Business Purpose Doctrine”. Courts have held that any structure set up to primarily avoid paying tax will not withstand an IRS audit unless the structure has a legitimate “Business Purpose”.  However, as simple as it seems the Business Purpose Doctrine has been the downfall of many estate plans.  This is especially true for the Family Holding LLC set by Edward Beyer as his estate discovered after his death in US Tax Court Case Beyer v IRS T.C. Memo 2016-183.  The facts are very complex, but in essence Trusts were set up and eventually owned Holding Company EGBLP.  The IRS auditors claimed that the value of the assets Beyer transferred to EGBLP through the Trusts should be includible in the value of his gross estate under Section 2036(a).

Judge Chiechi of the US Tax Court asks on page 114 of this long Opinion “Was there a transfer of property by Beyer, for full consideration, and if not did Beyer retain possession or enjoyment of the right to income within the meaning of Section 2036(a)(1) or did he retain the power of appointment, the right to designate the person would would enjoy the property transferred.  The Court finds that a transfer was made but in order to avoid Section 2036(a) that had to be a bona fide sale.  In connection with a family Holding company the Court points out that “where the record establishes the existence of a “legitimate” and significant non tax reason for creating the Family LLC and the transferors received partnership interests proportionate to the value of the property transferred then the “bona fine sale” exception under 2036(a) is satisfied.  Citing Estate of Bongard V IRS 124 T.C. 95 at page 118 (2005).

Unfortunately for Beyer his only non-tax reasons for setting up the EGBLP was to keep some stock holdings in a block, to give his brother experience in managing Beyer’s assets, and to ensure continuity of management of his assets.  The Court found that none of these were legitimate non-tax reasons based on the facts that Beyer presented.  The Court eventually found for the IRS claiming that there was no legitimate business purpose in Beyer created his Family Holding LLC and that therefore Section 2036(a) would claw back the transfers back into the Beyer’s estate.  IRS wins Beyer loses.

Lea Hillgren’s estate found out they made the same mistake as Beyer when Hillgren in early 1997 shortly before her death, but after various suicide attempts,  her CPA Tax Attorney set up in California her family Holding company, LKHP.  But after her final successful suicide death in June of 1997 the IRS audited and clawed back the transfers back into the Hillgren estate claiming LKHP had no legitimate business purpose.  Hillgren’s estate appealed to the US Tax Court. The facts in Estate of Hillgren vs IRS T.C. Memo 2004-46. are rather complex.  Lea Hillgren set up LKHP her family LLC as a California limited partnership to own various income-producing properties.  She did not marry and had no children but had an on again off again relationship with O’Brien.  Unfortunately, Hillgren at age of 41 committed suicide and was survived by her parents and brother.


Hillgren’s estate contends that the creation of LKHP was indeed motivated by legitimate business interests. The first business purpose the estate put forth for LKHP was a “premarital asset protection” device, but IRS points out that Hillgren permanently broke up with O’Brien before her initial unsuccessful suicide attempt.  The Court notes that it is unclear from the record whether Obrien and Hillgren were intending to get married.  The IRS argues further that under California law as a community property state Hillgren still had the right to transfer her interest to a spouse and had the power to approve that transfer in spite of the LKHP operating agreement prohibition over such transfer.  Judge Cohen concludes “There is nothing in the language of the LKHP agreement stating the reasoning behind the formation of the partnership….The estate’s claim that the partnership served to protect decedents assets from an impending marriage to O’Brien is unsupported by the record, therefore, the Court concludes that “the value of the properties that were transferred to Family Holding Company LKHP are includable in Hillgren’s estate under Section 2036(a).  IRS Wins, Hillgren loses.

Finally, once again a lack of business purpose proved fatal for Theodore R Thompson when IRS clawed back all his assets from his Family Holding LLC.  After losing in US Tax Court Estate of Thompson, Betsy Turner Executrix vs IRS T C Memo 2002-246 the estate appealed to the 3rd Circuit in Turner v IRS over at the 3rd Circuit 382 F.3d 367 (3d Cir. 2004) claiming that the Family Holding company,  Thompson Corporation had a legitimate business purpose.  Chief Judge Scirica of the 3rd Circuit points out that even if the Thompson’s transfer had a retained lifetime interest it could still avoid the claw back of Section 2036 (a) if the transfer was a “bona fide sale for adequate and full consideration, citing IRS Code 2036(a). Scirica noted that the Tax Court concluded there were no legitimate business concerns citing the US Tax Court case  Estate of Thompson, Betsy Turner Executrix vs IRS TC Memo 2002-246.  Further citing Strangi v IRS 85 TCM at 1331 (2003) where the Strangi family LLC engaged in no business operations or commercial transactions until Strangi’s death.  The Court concluded that the Family LLC fails to qualify as the sort of functioning business enterprise that could potentially inject intangibles that would lift the situation beyond mere recycling. Strangi 85 TCM at 1344.  Judge Scirica argues that “for essential the same reasons, we conclude there was no transfer for consideration within the meaning of Section 2036(a). The record demonstrates that the Family LLC was not a valid functioning business enterprise and did not rise to the level of legitimate business operations.

As the 3rd Circuit concludes by citing the US Supreme Court a “good faith" transfer to a family limited partnership must provide the transferor some potential for benefit other than the potential estate tax advantages that might result from holding assets in the partnership form. Even when all the "i's are dotted and t's are crossed," a transaction motivated solely by tax planning and with "no business or corporate purpose . . is nothing more than a contrivance." Gregory v. Helvering, 293 U.S. 465, 469, 55 S.Ct. 266, 79 L.Ed. 596 (1935). As discussed in the context of "adequate and full consideration," objective indicia that the partnership operates a legitimate business may provide a sufficient factual basis for finding a good faith transfer. But if there is no discernable purpose or benefit for the transfer other than estate tax savings, the sale is not "bona fide" within the meaning of § 2036.  

Chief Judge Scirica concludes for the 3rd Circuit  that after a thorough review of the record, we agree with the Tax Court that decedent's inter vivos transfers do not qualify for the § 2036(a) exception because Turner’s Family LLC did not conduct any legitimate business operations, nor provided decedent with any potential non-tax benefit from the transfers. IRS Wins Thompson Estate Loses.
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Now that we all understand the Business Purpose Doctrine Trap, how does the Business Purpose Doctrine apply to you and how you can avoid it? While the Business Purpose Doctrine Trap seems easy enough to navigate around, quite a few estate plans put forth by very highly paid Attorneys and CPAs have been tripped up by this trap.  Don’t let this happen to you.  Make sure your CPA Tax Attorney creates your SLAT/DAPT estate plan with a Family Holding LLC that has numerous legitimate non-tax business purposes specifically as they relate to your spouse, children and grandchildren, and make sure you get a  written guarantee from your tax professionals, hopefully at no extra charge, that they will defend any IRS Section 2036 (a) Business Purpose Doctrine audit years after the gift tax returns are filed, after your SLATs and DAPTs have been created after your Family Holding LLC has been set up, after all the partnerships and personal tax returns have been filed, and perhaps most likely a few short years after you have passed.  Bullet proof your SLAT and DAPT from the IRS Business Purpose Doctrine SLAT/DAPT Family LLC Audit.   Your spouse, children and grandchildren will be most thankful that you did. Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney.
 
See you next time on TaxView with Chris Moss CPA Tax Attorney.

Welcome to TaxView with Chris Moss CPA Attorney

For those of you married couples who earn substantial income in the entertainment industry, the 2019 best estate plan in my view is to have your Loan-Out LLC owned by a Family LLC or what I refer to as a Holding LLC.  Why?  If your retired parents, the “grandparents” of your children,  have already gifted to you up to the their lifetime exemption---which in 2019 is a record $22.8M married and $11.4M single, the Loan Out estate plan might allow them to “invest” rather than “gift” additional assets to Holding LLC as part of a comprehensive estate plan.  Such an investment would transfer assets prior to the 2020 elections, thus avoiding the possible decrease in 2021 of their lifetime exemptions.  Ask your CPA Tax attorney to create SLAT/DAPT his and her trusts in one of 17 DAPT friendly states to own the Holding LLC to keep the structure safe and protected when the IRS audits your parents estate years later claiming that the additional investments your parents made were in fact disguised gifts or worse never left their estate at all. How?  Stay tuned in to TaxView with Chris Moss CPA Attorney and find out how to bullet proof your entertainment industry Loan-Out estate plan from IRS attack.

As part of a comprehensive estate plan, your CPA tax attorney should create two Lifetime Access Trusts, one for you and one for your spouse integrated within a Domestic Asset Protection Trust state. There are now 17 DAPT states by law:  Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia and Wyoming.   Both spouses would be trustee for each other, and a third Independent Trustee would be appointed with your children as the beneficiaries. The SLATs would then acquire Holding LLC.  Holding LLC would own Loan Out LLC and also own any Rental LLCs operating either commercial or residential real estate.  Holding LLC also can convert your primary residence, but not your parents, into a residential rental property where you would end up tenants with Holding LLC as Landlord.  You then have your parents without filing gift tax returns make a legal arms length “investment” in Holding LLC as Purdue did in Estate of Barbara Purdue v IRS 2015.   

Grandparents, Mr. and Mrs. Purdue, and their tax attorney created the Purdue Holding company PFLLC for various non-tax reasons including asset protection , which acquired all their assets. Various Purdue trusts were created funded with children and grandchildren beneficiaries. Over the years the trusts acquired more and more ownership of PFLLC.  After the death of Mr. and Mrs. Purdue, the IRS audited the Estate Tax return and issued a notice of deficiency for estate and gift tax. The Purdue estate appealed to US Tax Court in Estate of Barbara Purdue vs IRS 2015.  

Judge Goeke of the US Tax Court asks whether the value of the assets from the Trusts transferred to PFLLC is included in the value of their estate under various IRS clawback provisions in IRS Code 2036(a). The court notes that the purpose of IRS Code Section 2036 is to include the value of testamentary inter vivos transfers in the value of the deceased taxpayer’s gross estate that were not made for a bona fide sales price with adequate and full consideration.  The Court further points out that in the context of a Family LLC the bona fide sale for adequate and full consideration exception is met where the record establishes the existence of a legitimate and significant nontax reason for creating the Family LLC and the beneficiaries received partnership interests proportional to the value of the property transferred.

Judge Goeke argues that this estate plan was more than “circuitous recycling of value” citing Estate of Harper vs IRS 2002.  “With regard to recycling of value, we have stated that when a decedent employs his capital to achieve a legitimate non-tax purpose, the Court cannot conclude that the taxpayer merely recycled his shareholdings” citing Estate of Schutt vs IRS 2005.  The Court concludes that having found a legitimate nontax purpose for PFLLC we find the transfer as not merely an attempt to change the form in which Purdue held their assets and that full and adequate consideration is satisfied, citing Estate of Stone vs IRS 2012.  Purdue wins, IRS loses.

How does this apply to you?  Create the SLAT/DAPT to own the Holding LLC in 2019 or 2020. By all means allow your parents to invest in Holding LLC without them retaining any power of appointment type powers for their ownership interest.  Do not make the mistake of setting up a Holding LLC and  giving a power of appointment to your parents, as did Strangi in Strangi v IRS US Tax Court 2003. Appealed to the 5th Circuit Affirmed 2005.  In that US Tax Court case Judge Cohen at the US Tax Court grappled with whether the value of the property transferred by Albert Strangi to the Holding LLC and related LLCs and Corporations was includable in his gross estate pursuant to IRS Code Section 2036(a). The Court concludes that the arrangement placed Strangi in a position to act, alone or in conjunction with others, through his attorney in fact, to cause distributions of property previously transferred to the entities or of income therefrom.  Decedent’s powers, absent sufficient limitation, therefore, fell within the purview of IRS section 2036(a).  What kind of limitations would be sufficient?  The Court cites Supreme Court case US v Byrum.  The US Supreme Court argues that the existence of an independent trustee with the sole authority ultimately to pay or withhold income from the trust would be a sufficient limitation.  Judge Cohen points out that Strangi owned 47 percent of his family LLC and was the largest shareholder.  All decisions ultimately where made by Strangi’s attorney in fact.  Strangi of course didn’t have a SLAT/DAPT own the family LLC with an independent trustee, and therefore, IRS wins Strangi Loses.

What does all this mean for the high end Entertainment Loan-Out Industry, asset protection and estate planning?  First you can not have a multiple Loan-Outs earning substantial income and expect- if audited by the Government- to win an IRS audit without a comprehensive estate plan set up for non-tax reasons like asset protection and family unity.  This requires in my view Holding LLC to own your Loan Out LLC. Second, create a SLAT/DAPT in one of the 17 asset protected states, with an independent trustee to acquire Holding LLC, its 100% owned Loan Out LLC and Rental LLC.  Invite your parents to invest in Holding LLC avoiding the IRS Code Section 2036(a) traps discussed in Strangi and Purdue. Make sure the SLAT is created in one of 17 DAPT friendly states.  You, but not your parents, can become tenants in your primary home if acquired by Holdings LLC.  If you work with a good CPA Tax Attorney who will file all your tax returns including the Holding LLC partnership and your personal returns--- and---who will be around to defend against any IRS audit when your parents pass, you can rest assured that your estate assets will be safe and well protected for many generations to come.
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Thank you for joining us on TaxView, with Chris Moss CPA Tax Attorney.  

Welcome to TaxView with Chris Moss CPA Tax Attorney. 

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Parents and Grandparents who are thinking about the next few generations for estate planning may want to consider a Spousal Lifetime Access Trust or SLAT for 2019.  Create the SLAT in a state that allows for Domestic Asset Protected Trusts (DAPT) and you have the perfect trust for estate planning.  The married gift tax exemption for 2019 is $22.8 Million, the largest in history.  Depending on the outcome of the 2020 Presidential and Congressional election, best practice in estate planning for 2019 is to gift now rather than later to the next generation.  The SLAT/DAPT combination in my view is the best way to go to keep your assets protected and safe for generations to come,  allow for dramatic reduction of estate taxes, and as secondary benefit, annual income tax deductions as well.  But beware---as gift tax returns are filed with the IRS, the Government waits, patiently I might add, for your passing to audit your estate, claiming that the SLAT assets never really left your estate and those assets now are taxable upon your death.  So if you want to know the best way to set up a bullet proof SLAT so you can win any IRS estate audit after your passing, please stay with us here on TaxView with Chris Moss CPA Tax Attorney.

In order to best understand the concept of the SLAT I suggest you all read my 2015 article on Spousal Lifetime Access Trusts and Domestic Asset Protection Trusts (SLATs and DAPTs).  I always couple my SLATs  with DAPT’s in asset protection states.  There are now 17 DAPT states by law:  Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia and Wyoming.

So what is a SLAT? First and most important SLATs are for married couples only.  Husband Trust 1 gifts to his children all his assets and appoints his wife as Trustee.  Wife Trust 2 gifts to her children all her assets and appoints her husband as Trustee.  If this trust was created in a friendly asset protection state like Virginia, an independent Virginia Trustee would be appointed for both trusts.  The reason why a SLAT is considered the perfect married couple trust is that you are not only able to remove all your assets from your estate with no estate tax upon your death, but you are also while alive able to care for you spouse and still live very comfortably even though you have given all your assets to your children and grandchildren.  This is possible only with the “ascertainable standard” defined as your spouse’s health, education, maintenance or support.  The Independent Trustee as well as the Spouse Trustee must have “absolute discretion” on whether or not to make these payments because herein lies the first IRS trap as the “ascertainable standard” trap.

Under IRS Reg 26 CFR 20.2041-1 (c)(2) a power of the trustee to make distributions for the health, education, or support”, an “ascertainable standard” is not a power of appointment so even a spouse trustee can have this power.  However, if the Trust requires such distributions and does not give the Trustee absolute discretion to make such distributions, there is a good chance the Trust will not be asset protected against creditors as was the case in Ducket v Enomoto decided in 2016 in the US District Court of Arizona. In that case the IRS tried to impose a tax lien on the trust.  Under Arizona law, the state where the trust was created, a beneficiary may sue a trustee for money owed.  Under the terms of the trust the Trustee was required to support the beneficiary as follows:  The trustee shall pay to Enomoto so much or all of the net income and principal of the trust as in the sole discretion of the Trustee may be required for support in the beneficiary’s accustomed manner of living, for medical, dental, hospital, and nursing expense or for reasonable expense of education including study at college and graduate levels.  The Court concludes that because the “Trustee shall pay” was used and not “may pay” the beneficiary had sufficient rights over the Trustee to allow the IRS lien to pierce the trust.  IRS wins, Enomoto loses.

Also watch out here for the Reciprocal Trust Doctrine IRS trap.  The Reciprocal Trust Doctrine is an old doctrine fully developed in United States v Estate of Grace, 395 U.S. 316 (1969).  In that case the decedent Joseph Grace executed a trust instrument providing for payment of income to his wife Janet for her life.  Shortly thereafter, Mrs. Grace executed a virtually identical trust instrument naming her husband as a life beneficiary. After Mr. and Mrs. Grace had both died, the IRS audited and determined that the trusts were reciprocal and included the amount of Mrs. Grace’s trust back into the estate of Mr. Grace.  The case was eventually argued before the US Supreme Court in 1969 on Certiorari from the United States Court of Claims.

Justice Marshall writing for the majority opinion says “we hold that application of the reciprocal trust doctrine requires only that the trustee be interrelated, and that the arrangement, to the extent of mutual value, leaves the settlors in approximately the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries”.  As a result, the Court required that the trust be included in taxpayer’s estate.  IRS wins, Grace Loses.

Once you navigate past the ascertainable standard and reciprocal trust traps,  make sure you create your SLAT as a fully asset protected trust, a Domestic Asset Protected Trust (DAPT) within the  17 asset protected states as Sessions should have done in Rush Univ Med Center v. Sessions, N.E. 2d , 2012 IL 112906, 2012 WL 4127261 (Ill, Sept. 20, 2012) (Rush U).  The facts in Rush are rather simple.  Sessions established a DAPT which irrevocably pledged $1.5M to Rush.  Rush commenced construction in reliance on the pledge.  Sessions however was diagnosed with cancer that he blamed on Rush for failure to diagnose.  He wrote Rush out of his Will before he died in effect voiding the $1.5M gift.  Rush sued the Sessions estate in Rush v Sessions claiming the estate was liable for the $1.5.  Lower Courts grappled with conflicts between the Common law in Equity and the Illinois Fraudulent Transfer Act with the Appeals Court eventually ruling for Sessions.  However, the Illinois Supreme Court reversed noting that Sessions created a DAPT for his own benefit and used the “spendthrift clause” to protect the assets from Rush, a legal creditor.  Justice Thomas further opined that regardless of state statute supporting Sessions, justice and fairness require that Illinois common  law in equity void the “spendthrift clause” of Sessions DAPT and allow Rush to pierce the DAPT and collect their debt.  Rush wins, Estate of Sessions loses.

After you set up your SLATs then you need to restructure your assets by creating a family LLC Holding Company to acquire your other LLCs including your business, rental properties and other real estate as well as your primary residences.  Stay tuned for the next TaxView with Chris Moss CPA Tax Attorney to hear more on the benefit of having your SLAT own the LLC Holding company and not the assets directly creating the sturdy foundation you need to bulletproof your structure from IRS audit and keeping your assets protected and safe for generations to come.  Thank you for joining us on TaxView from Chris Moss CPA Tax Attorney

Welcome to TaxView with Chris Moss CPA Tax Attorney

If you are still an S Corporation and for whatever reason have not converted to an Limited Liability Company, and are getting ready to hand your business over to the next generation still operating as an S Corporation, why not consider transferring S Corporation ownership of your various family members to an Intentionally Defective Irrevocable Grantor Trust.  Having an Intentionally Defective Irrevocable Grantor Trust own S Corporation shares will not only allow an easy direct succession to your heirs but will also protect your children and grandchildren from unexpected divorce, bankruptcy and creditor law suits and at the same time allow for the Trust to pay the taxes each year on behalf of the beneficiaries without incurring Gift tax.  Too good to be true?   While this strategy is indeed tried and true, the danger remains as the IRS waits until you die, very patiently I might add, to audit not only your estate, but to try as hard as they can to disallow your S Corporation election based on an expected Government claim that the required grantor trust status to hold the S Corporation stock was not adequately achieved.  As a result if you lose in US Tax Court you could owe huge back taxes and may have to sell the business to pay the tax. So if you are interested in handing down your family business to the next generation in a safe protected structure that will last for generations while at the same time saving annual gift and income tax each year, stay with us here on TaxView with Chris Moss CPA Tax Attorney to learn how best to protect your family business S Corporation from the IRS S Corporation Intentionally Defective Grantor Trust Audit.

IRS Code Section 671-679 says if you transfer assets to a trust you control, by definition, a revocable trust, you are in fact the Grantor, and income and expense of the trust are taxed to you personally.  But unfortunately if you were to fund your revocable grantor trust with S Corporation shares and related corporate dividend distributions from a family business, your ownership of these S Corporation shares would still remain inside and part of your estate.  Thus upon your passing your S Corporation would be taxed in 2017 on any value over your $5.49M ($10.98 Married) lifetime exclusion.

Alternatively, if you give away your S Corporation shares through an irrevocable trust, you successfully have transferred your assets out of your estate for estate tax purposes, but unfortunately Section 1361 says you lose the S Corporation election because you don’t own the stock anymore.  While you can gift your S Shares through a qualified subchapter S trust (QSST) or elect a small business trust (ESBT) each of those trusts are subject to a complex set of IRS rules and regulations that require in my view too much attention to make them worthwhile for most small business S Corporation taxpayers. 
But no worry because there is a simple way to both transfer your s corporation shares out of your estate, and at the same time keep the S Election through an intentionally defective irrevocable grantor trust, allowing the triple benefit of the irrevocable trust “effective” for keeping the assets out of your estate but “defective” for income tax purposes thereby defaulting back to a revocable trust allowing for the S Election to be protected and finally being able to pay the taxes each year on the S Corporation profits attributable to the beneficiaries without incurring gift tax.
 
How is this possible?  It starts with IRS Section 2036, which requires any gifts be brought back to you estate after your death to the extent which you retained a right of possession or enjoyment of, or the right to the income from the property gifted or the right to determine who that person should be to enjoy the property you gifted and the related income thereon.

There is, however, a few IRS sanctioned powers that the IRS says gives you the settlor or grantor irrevocable out of your estate upon death protection, yet at the same time allows S Corporation stock to be owned in the IRS approved Grantor Trust, and the same time the power to of the Grantor to pay taxes each year on the income generated by assets owned by the beneficiaries.  A simple power for the Grantor to be able to substitute assets has been approved by the IRS under Revenue Ruling 2008-22.
  
The facts in Ruling 2008-22 are simple.  Taxpayer funded an irrevocable trust for benefit of children. The Trustee has the power to acquire any property held by the trust and substitute other property of equivalent value.  Citing Estate of Jordahl v Commissioner 65 T.C. 92 (1975) the IRS holds that substitution power was not a power to alter, amend or revoke the trust within the meaning of Section 2038 (a)(1) and 26 CRF 20.2038-1.
 
The facts in Jordahl were as follows:  Jordahl, the decedent donor, created a trust for his wife with a provision that allowed for the substituting of insurance policies and securities or other property.  The IRS said that this power of substitution required all the assets held by the trust to be taxed as part of the taxpayer’s estate under Section 2038 (a)(2).  Judge Tietjens of the US Tax Court disagreed saying “we think although the decedent, under his broad discretionary powers with respect to investments, might invest in properties producing either a high or low return, such powers would have to be exercised in good faith in accordance with his fiduciary responsibility and could not be used for the purpose of attempting to favor any beneficiary to the detriment of other beneficiaries. . In other words, a power to replace trust assets with assets of equivalent value simply requires the Trustee to make sure that such a replacement of assets is in the best interest of all the beneficiaries.

Coupling the power to substitute property with a power to pay taxes almost appears “too good to be true” but is in fact true because IRS Revenue Ruling 2004-64 (July 6, 2004) allows the Grantor to pay income tax each year without having to report gift taxes to the beneficiaries on the tax paid.  The facts in the case are simple:  Taxpayer created an irrevocable trust for benefit of the children and retains no beneficial interest or power over the Trust income or principal that would cause the assets to be included in the Taxpayer’s estate.  The Trust further allowed but did not require the independent trustee to reimburse the beneficiaries for any income tax liability they incurred on trust income attributable to the beneficiaries’.  The Question presented to the IRS was whether a trustee discretionary decision to pay the taxes constituted a taxable gift to the beneficiaries.

The IRS concludes that the Taxpayer’s discretionary payment of taxes on the Trust income attributable to the beneficiaries is not a gift because the taxpayer not the Trust is liable for the taxes citing a 1944 case Commissioner v Estate of Douglas 143 F.2d 961 (3rd Cir 1944).  As the Douglas case makes clear the trustee must he independent and have discretionary not mandatory power to pay the taxes.  Taxpayer wins, IRS loses.

What does all this mean for Estate Planning with S Corporation stock?  By all means after consulting with your tax attorney transfer the S Corporation shares to an Intentionally Defective Grantor Trust for all owners with key discretionary substitution provisions to allow for Grantor Status and discretionary power to pay annual income taxes.  You will be not only creating a solid Estate Plan, but saving annual gift tax on the taxes the Trust pays while saving annual income tax to the beneficiaries.   Rest assured with good advice from your tax attorney your tax strategy will win big when the IRS intentionally defective Grantor Trust audit comes knocking on your door years after you have long passed.  Thank you for joining Chris Moss CPA Tax Attorney on TaxView.
 
See you next time on TaxView
 
Kindest regards
Chris Moss CPA Tax Attorney

​IRS Criminal Tax Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

If your income tax returns have ever been audited by the IRS you might remember discussing with your husband whether you should represent yourself in the audit or retain the person who prepared your tax return to represent you? Or if your tax structure was a bit more complex you may have considered hiring a tax attorney.  Whoever you chose to represent you becomes important due to the remote possibility that an IRS agent during a routine examination of your tax return might refer your case or at least consider referring your case to the IRS Criminal Investigation Division (CID) all because of something you said to the agent.  Furthermore, did you know your constitutional 5th amendment right to remain silent also applies to an IRS audit?  Indeed,  unbeknownst to most Americans without the benefit of Miranda type warnings, these clashing interests between your right to remain silent and the Government’s right to collect taxes, emerge at the precise moment that the IRS examining agent begins your audit.  While only a few thousand taxpayers actually are indicted and convicted of tax evasion each year, just the threat of a criminal investigation may be enough to turn your life inside out.  So if you are interested in learning the best way in 2017 to fully cooperate with the Government’s legitimate interest to collect taxes, but also at the same time fully protect you and your family from harm, stay with us on Taxview with Chris Moss CPA Tax Attorney to learn how to defend yourself from an IRS Criminal Tax Audit that may find its way to your front door.

So how could something you say in 2017 during a routine IRS audit examination trigger the involvement by the CID? First some background on the CID: The IRS Criminal Investigation Division (CID)  is comprised of approximately 3,500 employees worldwide, approximately 2,500 of whom are special agents whose investigative jurisdiction includes, but is not limited to, tax, money laundering and Bank Secrecy Act laws. The IRS site goes on to say that IRS special agents must follow strict procedures to initiate an investigation and recommend prosecution to the Department of Justice. These procedures include approval by several IRS officials to ensure investigations are based on factual evidence that tax fraud or another financial crime has occurred. CID publishes an annual business plan and is the only Federal agency that can investigate potential criminal violations of the Internal Revenue Code.

In order to better understand the significance of the words we say to the IRS examination agent, let’s review the Greve case decided in 2007, US v Greve US Court of Appeals for the 7th Circuit.  James Greve head of his family business was audited by IRS examination division in 1997 by agent Luke. As the audit progressed Greve seemed disorganized and overwhelmed.  By 2001 examination agent Luke and other revenue agents were considering a referral to CID. As a result, Greve was indicted by a Grand Jury in 2005. Greve was subsequently convicted and found guilty of criminal tax evasion.

Greve lost his appeal to Federal District Court and then appealed to the 7th Circuit filing a motion to suppress and dismiss his statements to the IRS agents based on 5th Amendment violations of his right to remain silent. Greve contends in his motion that Luke affirmatively mislead him by continuing to conduct a civil audit after she had firm indications of fraud. Specifically, Greve maintains that Luke made false promises to him by repeatedly advising him that his cooperation would result solely in a civil tax assessment. This allegedly caused Greve to talk too much in violation of his 5th amendment right to remain silent in a possible criminal proceedings. The Court did not agree.

Although the IRS regulations require a civil investigator to cease her investigation when she has developed firm indications of fraud, see Internal Revenue Manual §§ 4565.21(1), 9311.83(1), we have held that “[a] failure to terminate a civil investigation when the revenue agent has obtained firm indications of fraud does not, without more, establish the inadmissibility of evidence obtained by [the agent] in continuing to pursue the investigation."United States v. Kontny, 238 F.3d 815, 820 (7th Cir. 2001). Based on this interpretation of Kontny, the Court found for the US Government.  United States wins, Greve loses.

Moving to Kontny, the facts are simple: The Kontnys owned an equipment supply business. For over 10 years they defrauded the government of payroll and income taxes by not reporting overtime of their employees to the IRS. The employees knew about this scheme and benefited as well. However, as a result of a labor dispute, one of the disgruntled employees informed CID of the IRS about the scheme. CID assigned civil agent Furnas, who know all about the CID involvement, to investigate Kontny’s tax return. Kontny talked with Furnas before hiring legal counsel. Partly due to his excessive chatter with Furnas, Kontny was convicted of tax fraud and sentenced to jail. Kontnys motion to suppress his statements to Furnas based on the 5th amendment right to remain silent was denied by the District Court and Kontny appealed to the 7th Circuit where his motion was denied.

Judge Posner’s Opinion was that Kontnys talking to Furnas was voluntary and therefore not protected by his 5th amendment right to remain silent. The Court notes that virtually all cases involving coerced confessions involve the questioning of a suspect who is in police custody, an inherently intimidating situation in which people find it difficult to stand up for their rights or even to think straight. The situation is different when a person who does not even know that he is a criminal suspect (that is a premise of the Kontnys’ appeal) is being interviewed in his home, and by a civil rather than a criminal investigator to boot. Furnas was unarmed, un-uniformed, unaccompanied. The Kontnys were at no disadvantage in dealing with him. They were under no pressure to answer his questions. Any answers they gave were voluntary. Trickery, deceit, even impersonation do not render a confession inadmissible, certainly in noncustodial situations and usually in custodial ones as well, unless government agents make threats or promises citing a pre Miranda case, Frazier v. Cupp, 394 U.S. 731.  United States wins, Kontny losses.

But what if you never see or talk to the IRS during the audit because you retain the non-attorney tax preparer who prepared your tax returns to represent you in the audit, just like former Judge Diane L Kroupa did in US VS Kroupa USDC (2016) District of Minnesota Case No 0:16-cr-00084.   Kroupa , a former tax court judge no less, was accused of various tax crimes involving false information she was sending to her tax preparer.  She was indicted and pled guilty to one count of impeding, impairing, obstructing and defeating the lawful functions of the US Department of Treasury in violation of US Code Section 371.  More specifically Kroupa gave false information to her non attorney tax preparer, who then in turn gave the false documents to the IRS. During the routine audit, the tax preparer claimed to be unaware that these documents were false and clearly testified against Kroupa.  While the outcome might have been very different if a tax attorney represented Kroupa at the very beginning of the audit, the facts show unfortunately for Kroupa that no tax attorney had ever been retained.  United States wins, Kroupa loses.

In conclusion, it appears to me that if you get audited by the IRS in 2017 and you have sufficient assets to protect and rather complex structures and tax strategies to explain, best practice would be to have your tax attorney do the talking. Better yet, have your tax attorney prepare your personal and business tax returns and have that same tax attorney guarantee that she will be there years later during an audit to do the talking. A good tax attorney during the routine audit examination will represent you, effectively communicate with the Government agents, keep you safe, your assets preserved and your family protected to keep that  IRS Criminal Tax Audit  far away from your door.

Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney.

See you next time on TaxView.

Kindest regards
Chris Moss CPA Tax Attorney

Welcome to TaxView with Chris Moss CPA Tax Attorney

Are you moving to the US Virgin Islands in 2017 and looking for that exciting 2016 year-end tax strategy? There are many tax advantages of claiming to the IRS that you are a bona fide resident of the US Virgin Islands including you receiving tax free income.  While you’re there, structure a Virgin Island replacement investment section 1031 tax free exchange.  But be wary of dangerous landmines ahead which will explode into an IRS US Virgin Bona Fide Resident Audit that will take all the joy out of you and your family living in paradise.  Indeed the IRS is just waiting sometimes until after you die as happened to the late Travis L Sanders to audit your estate tax returns arguing that you (now deceased) were never a “Bona Fide Resident” and therefore were not entitled to all that tax free living over the years.  So if you are interested in moving to the US Virgin Islands to take advantage of all that tax free income you can earn over there, stay tuned to TaxView with Chris Moss CPA Tax Attorney, to find out you can obtain that coveted bona fide resident status and at the same time bullet proof your tax returns when the IRS commences its dreaded US Virgin Island Bona Fide Resident Audit.

In order to understand how difficult it is to become a US Virgin Island Bona Fide Resident, let’s jump right into a recent US Tax Court case Travis L Sanders vs IRS, 144 T.C. No. 5 US Tax Court January 2015. The facts are complex.  Sanders became a partner in 2002 of a limited partnership Madison, a designated service business in the US Virgin Islands providing scientific, electronic, investment, economic and management consulting to businesses in the United States.  Section 934(b)(1) of the IRS Code allows for tax free income from sources within the Virgin Islands provided that the owners of the company maintain residency there. 

During 2003 and 2004 Sanders through various trusts, LLCs and other businesses, and claimed residence on a yacht in the Virgin Islands. Tax returns were filed with the Virgin Island Internal Revenue Department (VIBIR) for tax years 2002 2003 and 2004.  On each tax return Sanders reported his home to the Virgin Islands and claimed an Ecomonic Development Commission credit claiming that his interest in Madison allowed him to “reduce his income tax liability by 90% of the income tax attributable to Madison”.  Simultaneous to Sanders personal tax return filings, Madison filed partnership returns with VIBIR for the same years listing Sanders as a partner.

On November 30, 2010 the IRS issued a tax bill to Sanders for almost $1M claiming he was not a bona fide resident of the USVI for the years 2002-2003 and 2004.  Sanders appealed to US Tax Court in Sanders vs IRS  144 T.C. No 5 (2015).   The IRS in Court claimed that all transactions of Madison lacked economic purpose and substance and therefore Sanders was not entitled to tax free recognition during those years.  More importantly the Government claimed Sanders was not entitled to file tax returns with VIBIR but instead Sanders had to file his tax returns with the IRS in Philadelphia.  Sanders claimed the statute of limitations had run citing IRS Code Section 6501.  But the IRS reasoned to the Court that the statute of limitations had not run because no tax returns were ever filed citing that same section 6501.  Judge Kerrigan of the US Tax Court was therefore faced with two key sequential questions presented to the Court: Whether Section 6501 period of limitations expired before the US IRS mailed its tax bill to Sanders and as a logical second follow up question whether Sanders filed a tax return.

The Court acknowledged that under Section 932(c) a bonafide resident is only required to file his tax returns with VIBIR and such a filing starts the statute of limitations running citing Senate Finance Committee report stating that all bona fide Virgin island residents will file their returns with VIBIR quoting from within the S.Report No 99-313 (1986).

Judge Kerrigan then reviews 11 factors that determine whether a taxpayer’s claimed residency in any foreign country is “bona fide citing Sochurek v Commissioner, 300 F.2d 34 (7th Cir 1962).  The 11 factors are 1. Intention of the taxpayer, 2. Establishment of a home in the foreign county, 3. Participation in activities, 4. Physical presence in the foreign country, 5. Nature, extent, and reasons for absences from temporary foreign home, 6. Assumption of economic burdens and payment of taxes to the foreign county, 7. Status of resident contrasted to transient or sojourner, 8. Treatment accorded his income tax status of his employer, 9. Marital status and residence of his family, 10. Nature and duration of employment and 11. Good faith in making the trip abroad.  The 11 factors are then grouped into various broad categories, intent, physical presence, social, family and professional relationships and the taxpayers owns representations, citing Ventro v VIBIR 715 F.3d 455 (3rd Cir. 2013).

The Court then in a surprise ending- in just a few paragraphs no less- and without any substantial analysis of the facts, indicates that the majority of the 11 factors were favorable to Sanders, that Sanders was a bona fide resident of the USVI for tax years 2002-04, that Sanders properly filed his tax returns with the VIBIR and indeed Section 6501 statute of limitations had run its course and therefore the IRS was out of time to audit Sanders.  Sanders wins IRS loses.

But the story does not end here. because the Government appealed.  Sure enough the Tax court decision was overturned and remanded back to the US Tax Court for further consideration by the 11th Circuit in Commissioner v. Estate of Travis Sanders, No. 15-12582 (Aug. 24, 2016) with the 11th Circuit noting that “the facts relied upon the Tax Court were insufficient as a matter of law to establish that Sanders was a bona fide resident….”

The 11th Circuit through an Opinion, written by Circuit Judges Jordan and Anderson and District Judge Dalton, gives examples of how the US Tax Court on remand should inquire about the 11 factors.  For example, the Circuit Court said, it is true as the US Tax Court pointed out that Sanders had a physical presence in the US Virgin Islands. However, “physical presence” is an especially important factor to conside and the Tax Court should have spent more time on it as it specifically had related to Sanders.   The 11th Circuit goes on to say that the US Tax Court did not address the “nature and extent” of Sander’s physical presence and therefore could not have properly weighed the physical presence factor. The Court instructed the US Tax Court on remand to determine how much time Sanders spent in the US Virgin Islands and when, if ever, his contacts with the island became sufficient to make him a bona fide US Virgin Island resident.

The 11th Circuit then went on to give one example after another of how the US Tax Court in fact failed to properly analyze all 11 factors and then vacated the Tax Court’s Opinion entirely.  The Circuit Court directed the Tax Court on remand to make factual findings regarding the amount of time Sanders spent in the US Virgin Islands during each of those years, which would be critical in determining the extent of Sanders physical presence. Also important the 11th Circuit says to the Tax Court, would be factual findings regarding the nature of the time Sanders spent in the US Virgin Islands, including the nature of Sanders’s relationship with Madison (For example, Madison’s economic substance and business purpose, or lack thereof).”

What does this mean for any of you who are planning to move the US Virgin Islands in 2017?  In my view this is great news coming from the 11th Circuit.  Because as a result of this heightened scrutiny on US citizens claiming bona fide residency in the US Virgin Islands we now have specific guidelines strong enough to hold up in any court proceeding.  How?  With the help of your Tax Attorney you can easily use the 11th Circuit Opinion to create the evidence you now need in 2017 to prove years later when the IRS Virgin Island Bona Fide Audit will surely commence possible many years later. 

Finally, include the 11th Circuit Opinion and future cases that support your bona fide residency in the Virgin Islands as the foundation upon which to build all your business structures and tax free income, having your tax attorney in detail apply each of the 11 factors one by one in your income tax return until you have bullet proofed your coveted bona fide residency prior to filing your return.  You all can now relax perhaps at the Old Stone Farmhouse, knowing that your tax returns are bulletproofed from the dreaded IRS US Virgin Island Bona Fide Residence Audit. 

Thanks for joining us for 2016 year-end tax planning on TaxView with Chris Moss CPA Tax Attorney.

Happy New Year!

See you next time in 2017 on TaxView.

Kindest regards
Chris Moss CPA Tax Attorney.

Welcome to TaxView with Chris Moss CPA Tax Attorney

Have you thought about locking in your record high 2016 stock market capital gains and perhaps offsetting against other current or prior year business investment losses in 2016? Sounds like a good strategy but be careful. If you have investment gains offsetting business losses in 2016, as you may be in store for a direct head on collision with the IRS and the Tax Reform Act of 1986 during an IRS Passive Loss Audit commencing a few years after you file your 2016 tax returns. The journey to disaster starts off innocently enough. You sold some stocks in June 2016 to lock in gains for a $10M long term capital gain and use the proceeds to purchase a small retail shopping center for the same price in July of 2016. You think about structuring the deal so that the losses from the first year of operations in 2016 at the shopping center could offset your 2016 capital gains from the sale of stocks. You never bothered to retain a tax attorney to create a tax plan because as you see it you have a no brainer zero tax due. You believe that a buy and sell for $10 Million equals a full and complete offset come April 15 2017; but perhaps not so fast says TaxView, because the offset is in great danger. There are land mines ahead that seem to explode at the worse possible moment with an IRS Passive Loss Audit usually years later perhaps commencing in 2020.. So if you are interested in how the IRS could dramatically change even your best tax plan for offsetting gains and losses, stay with us on TaxView with Chris Moss CPA Tax Attorney to see how the Tax Reform Act of 1986 makes your no brainer into a brain strainer and a tax disaster for you the unfortunate taxpayer victim of the creation of Section 469 and the dreaded IRS Passive Loss Audit.
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To get a better idea of the catastrophe ahead, first let’s all take a short trip back to the source of confusion to Washington DC. Fasten up your tax plan as we turn back the clock to 1984 landing us right in the middle of the center table at the DC downtown Palm over at 1225 19th Street. Dan Rostenkowski (House Ways Means) and Bob Packwood (Senate Finance) have gotten together to finalize some last minute provisions of the soon to be signed by President Ronald Reagan Tax Reform Act of 1986. Legendary DC Palm manager, who is still there today, Tommy Jacomo spots us immediately with a great table. We hear Rosti roar over the boisterous dinner crowd to Bob: You personally have quite a large portfolio in stocks and bonds. Would you really consider interest and dividends “positive” income? Rosti, says Packwood, you know I don’t like that word “positive” taken in this context. Besides, we can’t really tell the average American taxpayer that the wealthy making dividends and interest are working as hard as they are with “positive income”. Let’s just go with this term “Portfolio”. It bridges the gap between those darn “passive” tax shelters and the American W2 worker. I say we treat these items like positive income similar to a salary except it would not be subject to self-employment tax like salary, but call it “portfolio” not ordinary income. In other words we tell America that their stocks and bonds are…well like working 40 hours a week for them as their “portfolio” not subject to social security withholding. Bob, says in disbelief,  Rosti, you have got to be kidding, that is really dumb, really stupid… but you know, comparing portfolio to W2 earnings except without social security withholding, is so ridiculously outrageous it might just work. See Joint Committee on Taxation, page 209-213 which eventually morphed into IRS Code Section 469 Passive Loss Rules.

Agree or disagree with how this imaginary conversation might have unfolded that night in 1984, the fact is that Section 469 prohibits the offset of “portfolio” gains or losses and regular W2 income against “passive” but not "active"gains all losses.. In order to see the bizarre consequences of how these two opposing types of gains and losses can interact, let’s head over to US Tax Court just a five minute cab ride from the Palm over to Capitol Hill to survey a 2000 case More v IRS 115 T.C. No 9 More was an independent managing underwriter as part of a syndicate for Lloyds of London. In order to be accepted by Lloyds More had to demonstrate his ability to cover potential losses of his syndicate usually by posted a letter of credit. In 1988, More transferred his personal stock portfolio to a brokerage account at Bank Julius Baer (BJB), a London-based bank. During 1992 and 1993, petitioner underwrote £500,000 of Lloyd’s premiums which were secured by a letter of credit from BJB in the amount of £150,000. The policies written by More did in fact incur losses and More cashed in his stocks at a large gain to cover those losses as required by his letter of credit. More reported his losses and gains on his tax returns so that each offset the other. The IRS audited Moore, and disallowed all the losses, arguing “portfolio” income could not be offset against “passive” income. Moore appealed to US Tax Court.

Judge Vasquez in More writes a very short 16 page jam-packed with Section 469 Opinion. The Court then confirmed that Congress enacted passive loss regulations “to curb expansion of tax sheltering”. Judge Vasquez further noted that IRS regulation 469-2T makes an exception to the general rules regarding disposition of More’s stocks at a gain. Specifically, gross income derived in the ordinary course of a trade or business includes “income from investments made in the ordinary course of a trade or business of furnishing insurance or annuity contracts or re-insuring risks underwritten by insurance companies” The Court notices that More’s attorney, Louis B. Jack, did not refute or address this at all and was silent on the reason why More acquired the stock. If More could have shown that he primarily created this portfolio as a way to get into the insurance business and not as an investment More wins IRS loses. Unfortunately for More, no evidence was presented to the Court on when his investments in stocks turned primarily to assist More in keeping his job at Lloyds. I don’t know about you all, but it seemed More’s transfer to a brokerage account back in 1988 was primarily to show sufficient assets so he could work at Lloyds. Nevertheless, since More did not refute the Government’s argument leaving the Court no choice but to hold that More’s stocks were primarily created for investment and not for the convenience of Lloyds. Government wins, More loses.

So to win with any of your offset losses in 2016 make those losses bullet proof from the IRS Passive Loss audit and go with a fact pattern to prove that your losses were active ordinary or portfolio, just like Jose and Maria Lamas did in US Tax Court Lamas vs IRS March 25, 2015. The facts are simple: Mr and Mrs Lamas incurred substantial losses from Shoma Development Corp and Greens at Doral LLC in 2008.  Lamas carried back their losses to 2006 resulting in a refund to Lamas of over $5 Million. Unfortunately, years later IRS audited and disallowed the losses claiming the losses were passive and could not offset 2006 income. with the Government sending Lamas a $5 Million tax bill.  Lamas fought back and filed a US Tax Court petition in US Tax Court Lamas vs IRS March 25, 2016 arguing that the losses were not passive and indeed could offset ordinary and portfolio income..

During the US Tax court trial, Lamas called 10 witnesses arguing credibly that Lamas was very much involved in Shoma and Greens..  Judge Buch in a well thought out opinion opines that to establish the hours spent on the business you don't necessarily have to have contemporaneously daily records, but you can use other reasonable means to establish the facts that support that you are actively involved in the business. The Court goes on to say that "reasonable means includes the identification of the services performed over a period of time and the approximate number of hours spent performing such services during the period based on books, calendars or narrative summaries." While Lamas had none of these records the Court goes on to show that witnesses presented credible testimony and phone records to show that Lamas worked the required hours on Shoma and Green to materially participate to make the activity active not passive.. Lamas wins IRS Loses.

So in conclusion anyone out there in 2016 who wants to offset losses from one activity against gains of another be warned, the IRS in 2016 is actively and aggressively auditing these kinds of offsets, particularly any losses that offset W2 income or Investment Portfolio Income, or any gains that offset passive losses.  The fix is easy:. Prior to filing your tax return with any offsets from different sources of gains and losses, ask your tax attorney the ramifications of Section 469, with particularly emphasis on what kind of offsets you have. If you have “portfolio” and “passive” losses or gains pay particular attention to whether or not the Section 469 allows those offsets. Finally have your tax attorney insert into your tax return detailed preferably contemporaneously  prepared evidence of your tax strategy in 2016, or perhaps notarized witness affidavits if you don't have the required records,. explaining how these offsets were created, what provision of Section 469 controls, and how your tax strategy is being implemented for 2016 and beyond. For example if your tax strategy involves long range estate planning, make sure you tax attorney discloses this in the tax return before she files on April 15, 2017. Better you should support and bullet proof your tax strategy now before you file the tax return than to have to wait four years for the Government to do it for you during a surprise IRS Passive Loss audit.
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May your 2016 losses and gains offset wisely as 2016 comes to a close.. See you all next year on TaxView in 2017.

Thanks for joining Chris Moss CPA Tax Attorney on TaxView

Kindest regards,

Chris Moss CPA Tax Attorney

by Chris Moss CPA Tax Attorney

Welcome to TaxView with Chris Moss CPA Tax Attorney

Do you all want your kids and grandchildren to share in some way that legacy you or your wife, your grandmother or grandfather, or other family members are leaving you. But many of you as family members are not always in concurrence as to how each generation's estate plan shall be implemented for the good of the entire family and surely not all generations are in 100% agreement as what will work best for the entire family estate plan as we end the year of 2016.  For those of you in this situation, may I suggest you think carefully before you set in motion an estate plan that might change a few years later. due to family disagreements or discord.  Any major changes in the estate plan between generations could be construed by the IRS as various steps in the deadly estate tax trap known as the  Step Transaction Doctrine. Unfortunately the IRS sees "steps" even when there are none, resulting in dramatic increase in taxes for all the family.. So whether you have created a private foundation for the arts, or whether you own a family farm or perhaps are now ready to pass your real estate portfolio on to the next generation, stay tuned to TaxView with Chris Moss CPA Tax Attorney to learn how to stay clear of IRS Step Transaction Traps so you can preserve and transfer these assets to your children and grandchildren safe from IRS adverse action in an IRS Step Transaction Estate Tax Audit

You will not find Step Transactions in the IRS code. The concept of Step Transactions is carved from hundreds of Federal tax court cases and is a spin-off from the Substance over Form Doctrine codified by Congress into IRS Code 7701(o) as part of the Health Care and Education Reconciliation Act of 2010. Step Transactions then remains a totally Court made law or Doctrine somewhat guided by Section 7701(o). The IRS generally argues that Step Transactions are a series of transactions or “steps” over many months or years, that when taken as a whole, convert what you all thought was the perfect estate plan to a sinister Step Transaction scheme to avoid estate taxation.

How does this happen?  A series of family disagreements or even litigation between brothers or cousins could result in innocent steps not adequately documented. years earlier when these steps occurred. The IRS audits, patiently waiting until after you die I might add, and claims to your Executor that these series of steps were part of a sinister scheme planned years earlier by you (now deceased) to avoid estate tax.  A super large tax bill is sent to your Executor which sometimes unfortunately forces your Executor to sell quickly at a great discount substantial assets to pay the tax.  

However, there is good news: If the appropriate evidence had been contemporaneously preserved years earlier in the various income, gift tax and estate tax returns before filing you are absolutely safe from the Step Transaction Trap. That is why it is critical for the tax attorney for the grandparents work with the tax attorney of the children and grandchildren to make sure any future family disagreements would not be construed by the Government as disguised "steps".

Unfortunately, there are some taxpayers out there who fall into the step transaction trap through perhaps bad advice from tax advisors. Directly in response to these poorly structured estate plans, IRS audits have been dismantling even legitimate estate plans finding step transactions even if there were none, and have been winning big in US Tax Court. See US Tax Court Bianca Gross v IRS (2008), US Tax Court Holman v IRS (2008), US Tax Court Pierre v IRS (2010), CGF Industries v IRS (1999), US Tax Court CNT Investors LLC
v IRS (2015).
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One case the IRS did lose was Klauer v IRS (2010). where the Klauer was smart enough to plan his steps with enough evidence to prove he had no illegal tax scheme, but a legitimate estate plan.  The facts are relatively simple, Peter Klauer founded Klauer Manufacturing in Iowa in 1870 and branched out in New Mexico in 1919. More recently Klauer descendants were in discussions with the US Bureau of Land Management, the US Trust for Preservation of Land and various Indian tribes regarding purchase of the Taos Overlook or at least an option to purchase. Over three years from 2001 2002 and 2003 various agreements were executed all independent of the other. Taken separately each land sale was substantially below market value. Klauer’s S Corporation tax return for 2001 2002 and 2003 claimed millions of dollars as land donated on Form 8283 Noncash Charitable Contributions and various K1s were distributed to the stockholders with their proportionate share of the contribution. All the shareholders filed their Form 1040s for 2001 2002 and 2003 with very large charitable deductions. The IRS audited as a whipsaw and disallowed all charity deductions for all three years causing large amounts of taxes owed by the individual shareholders. The Government claimed all three years were one big series of step transactions voiding the below market sales and subsequent large charity deductions. Klauer appealed to US Tax Court in Klauer v IRS 2010 claiming each year stood by itself as separate transactions.

The Court agreed with Klauer because it was clear that each year was separately negotiated with distinct separate agreements. Specifically, Judge Chiechi points out that the supposed first step created no binding commitment to take the second step siting Security Industrial Insurance v US 702 F.2d 1234 (5th Circuit 1983). The Court then focuses on whether the Klauer family intended to save taxes by structuring the three years from 2001-2003 a certain way citing King v US 418 F.2d 511 (Fed Cir 1969). Judge Chiechi argues that Klauer’s subjective intent was especially relevant in allowing the Court to see if Klauer directed a series of transactions to an intended purpose solely to save taxes. The Court found facts created in the record as evidence that Klauer’s primary intent from 2001-2003 was not to create a tax savings scheme but to work the Bureau of Land Management, the Land Trust, and various Indian tribes to allow for the preservation of the Taos Overlook, This had been the intent of the Klauer family for many years. While there were huge tax savings for the shareholders the way the sales were structured that result was secondary to the primary purpose of land preservation. Klauer wins IRS loses.

So where do we all go from here? First, now that you know Step Transactions are thinly disguised tax schemes, your goal is to protect your estate plan with plenty of written evidence and facts proving to an IRS agent years later, after you have died, that your primary goal is, was and has always been legacy preservation and protection with tax savings merely as a secondary goal. Second, discuss with your tax attorney  your options in operating a Family Limited Liability Company (FLLC) owned by SLAT, Crummey, or DAPT trusts to maximize asset protection and keep the family assets safe protected and secure for generations to come, Finally, as 2016 comes to a close ask your tax attorney to bullet proof your family estate plan factually documented with contemporaneous created facts inserted into tax returns prior to being filed with the IRS, with no one step leading to a predetermined second step. While the estate path may change direction due to family disputes, disagreements, or even litigation, if you have the facts on your side, you can relax knowing that your estate plan if protected against Step Transaction traps that lie ahead. even years after you are long gone.

Thank you joining us on TaxView with Chris Moss CPA Tax Attorney

Stay tuned for our 2016 year end TaxView.

Kindest regards

Chris Moss CPA Tax Attorney

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Remember the cash for clunkers program Congress created in 2009 for your old beat up car. You brought in your clunker car to the dealer and got cash to buy a new car to stimulate the economy? Well in 2016 the 100 year old income tax has become the new clunkers program, an obsolete and inelastic “clunker tax” that is not working. The income tax needs to be replaced with a new tax better suited for the 21srt century, a National Sales Tax.  So if you want to see how a National Sales Tax could help you save taxes stay tuned to TaxView with Chris Moss CPA Tax Attorney to find out why a National Sales Tax is good for you and good for America.

Historically income tax has always been somewhat of a voluntary tax. History shows most Americans when given the choice, choose not to pay the income tax. That is why in 1943 with the introduction of the W2 form in just two years revenue collection increased from $7 billion to $43 billion with 60 million Americans added to the tax rolls almost overnight.

Congress realized the power of the W2 with revenue collections as a percent of Gross Domestic Product surging from less than 6% to almost 20%. Unfortunately Americans would fight back against the W2 form. Slowly an underground economy thwarted forced W2 withholding now estimated to total almost $2 Trillion a year in unreported income. Congress fought back as well

Over the last 30 years there has been an attempt by the Government to “capture” all that underground income by creating the 1099 network of reporting hoping for another W2-like increase in collections as percentage of GDP. The ultimate 1099 program was enacted in 2010 when Congress tried to capture all income from everyone, but Congress soon realized this was impossible to enforce let alone comply with. That law was repealed a year later in 2011.

The fact is that it is impossible in the 21st century to capture all income from 1099s unless the IRS audits everyone. The solution? An involuntary national sales tax, taxed at the source of each purchase at the same time state sales tax is collected. Easy, simple and very effective., and most importantly involuntary. But just in case you’re not convinced yet that a voluntary income tax does not work in the 21st century, there’s more: Identify theft, a 21st century crime is further eroding income tax collections.

The Government is losing at least $6 billion a year to identity theft as organized crime has moved its operations from drug dealing to identity theft. John Koskinen, the former Commissioner of the IRS had recently commented that he had heard from Florida police that “street crime is down, and drug deals have been replaced, because these former drug dealers are now filing false IRS returns”.

​Add identity theft to the underground economy and the IRS is losing so much money the Government is simply unable to collect enough money each year to allow America to pay its bills. Further add additional tax revenue being lost to off shore illegal tax shelters and you have the triple crown of tax evasion: Underground economy, identify theft, and offshore tax shelters. No wonder our National Debt is $19.8 Trillion dramatically approaching the unthinkable $20 Trillion level.

Furthermore, the IRS in the 21st century does not have the manpower to find, the perpetrators, prosecute the criminals and throw in jail the felons living underground, filing false returns and moving funds illegally offshore.. A national sales tax would no need an entire army of enforcement auditors and investigators to administer as such a tax would piggy back off state and local sales tax already in place and already under control.

As an added benefit of enacting a National Sales Tax, all off shore money would soon return home and many if not all tax shelters would disappear back to the 20th century where they belong. With our new President leading the way, if Congress were bold enough to embark on a 21st century solution to increase revenue collection, perhaps annual deficits would be wiped out as well. Could the dramatic rise in collections as a percent of GDP from 1943 be recreated in 2015 with a National Sales Tax?

I don’t know about you all, but I don’t want to see our Government IN 2017 cut services to Americans, including our military, just because Congress does not have the courage to see that the income tax has become a “clunker tax” income tax has become inelastic and outdated and simple Economics of Tax theory requires and demands an elastic tax for the 21st century.. If you all believe that the income tax is now an obsolete clunker, let your elected representatives know how you feel. Perhaps House Ways and Means and Senate Finance can best serve America by creating a national sales tax, a new tax, better suited for the 21st century rather than trying to reform a 100 year old clunker.

Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney.

See you next time on TaxView with Chris Moss Tax Attorney CPA

Kindest regards
Chris Moss CPA

Chris Moss CPA Tax Attorney

Welcome to TaxView with Chris Moss CPA Tax Attorney

Most of you know the IRS has a 3 years from the date you file your tax return to commence and complete an audit of your tax return and assess you additional tax owed to the Government.   What you might not be aware of is that the Government due to budget cuts in 2016 now routinely asks you to extend the three year “statute of limitations” to give the IRS more time to complete the audit.  If the IRS asks you to sign Form 872, Consent to Extend the Statute, what should you do?   If you do sign Form 872 you keep the period to assess the tax longer than required by the 3 year statute of limitations.  But if you don’t sign Form 872 the IRS in most cases immediately assesses you a tax and issues you  a 90 day Notice of Deficiency propelling the case into US Tax Court and into the hands of a high priced tax attorney. So if you are not sure what you would do, stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out just how to handle a Government request to extend the statue of limitations in a way that best protects your family and saves you taxes.

IRS Code 6501 prohibits the IRS from “assessing a tax” on your income after your tax return has been filed for 3 years.  This three year statute of limitations enacted in 1918 has worked well for almost 100 years.  But recently agents have told me that due to Federal budget cuts reducing staff the IRS has insufficient time to complete your audit in an expeditious manner within the 3 year period.  So taxpayers are now routinely asked to consent to extend the 3 year statute on Form 872.   Further complications arise as a result of agents trying to comply with a very complex set of internal rules as per this IRS audit manual yet at the same time trying as best they can to finish up a taxpayer audit prior to the expiration of the 3 year window.

In order to best ascertain whether or not to extend the 3 year statute of limitations best practice is to review with your tax attorney how your audit is going.   If you have deductions that cannot be easily and timely documented, but nevertheless know you can at some point provide the necessary documentation the Government has asked for, and you believe the IRS agent is going to need more time to complete your audit examination, you would perhaps want to extend the statute to give the agent time to finish up and give you a no change audit.  On the other hand, if you have given the agent sufficient documentation to support your deductions and the audit is taking a long time to complete through no fault of your own, then you would not extend the statute as long as your tax attorney who prepared and filed your tax return could cost effectively litigate the case in US Tax Court.

Furthermore, for those of you being audited who might have underreported income, there should begin a series of confidential attorney-client privileged discussions with your tax attorney on whether or not you should agree to sign a statute extender on Form 872.  That is because as Williamson’s Estate found out in Williams v IRS US Tax Court (1996) there are exceptions to the 3 year statute, and of particular relevance to Judge Korner is Code Section 6501 (e) which extends the statute 3 more years to 6 years if there is an undisclosed 25% understatement of gross income on your tax return.  Citing Colony v Commissioner 357 US 28 (1958)  the Supreme Court said “Congress manifested no broader purpose than to give the Commissioner an additional 2 (now 3) years in cases where because of a taxpayer’s omission to report some taxable income, the IRS is at a special disadvantage.”  In Williams, the tax return did in fact disclose the understatement so Williams wins IRS loses.

But for other taxpayers who by accident or intention, there is a 25% understatement of gross income that has not yet been discovered by the IRS audit or IRS criminal investigation unit, best practice with these facts might suggest for you not to sign Form 872 and allow the case go to US Tax Court.  Unfortunately this was not the case in Connell v IRS US Tax Court (2004).  Thomas and Sara Anne Connell had four small trusts which they used to under-report income on their personal return. This scheme was discovered by the IRS Criminal investigation division.  While a recommendation to prosecute was made by Criminal division, for reasons not known to the US Tax Court no criminal action was ever undertaken.  The IRS then issued Notices of Deficiency which were issued more than 3 but less than 6 years after the returns were filed.  Connell appealed to US Tax Court in Connell v IRS US Tax Court (2004) claiming they failed to report additional income, but they adequately disclosed this by filing the bogus trusts.

Judge Gale easily brushes aside the Connell argument and rules for the Government citing Reuter v IRS US Tax Court (1985)  requiring that the actual tax returns themselves have to disclose the understatement not some other return or document.  In Reuter there was undisclosed S Corporation distributions.  In Connell it was the trusts.  In both cases the actual 1040 personal tax returns did not disclose the omitted income.  As Reuter points out “the legislative history of the 1954 changes made to section 6501(e)(1)(A) does not suggest looking beyond the face of the return to determine disclosure of an omitted item of income.  So in Connell as in Reuter, IRS wins, Connell loses.

Further complicating understatement of income issues are the growing popularity of larger partnerships as underscored in a recent 2014 report from the US Government Accountability Office to the Senate Committee on Homeland Security.  The report claims the IRS finds it very difficult to audit all these entities within the 3 year statute even if fully staffed with no budget cuts.  What happens if you should file your personal tax return with a K1 that as a result of an audit at the partnership level puts you at risk of a substantial understatement?  If you get audited personally should you agree to sign Form 872 even though you know you might have substantially overstated your basis on various sales from complex partnerships you have an ownership interest in causing you to have a substantial 25% understatement of income?

In fact, this very question was addressed by a divided US Supreme Court in,  US v Home Concrete and Supply LLC, US Supreme Court  566 US_____(2012) affirming 634 F 3d 249.   The facts in Concrete were simple, but existing Federal law as applied to these facts was anything but simple. Here are the facts:  Partnership tax shelters generated losses to Home Concrete.  The losses were a result of an overstated basis which in turn caused a substantial understatement of income.  The question presented to the Supreme Court was whether a basis overstatement on sold property can trigger the 6 year statute under 6501(e) and US Treasury regulation 301.6501(e )(1)(A).  The majority opinion given by Justice Breyer ruled that based on the facts in this case, Congress did not intend to make basis overstatement the same as substantial understatement of “gross”  income subject to the 6 year statute of limitations, thereby in effect overruling the US Treasury regulation.  The reason given by Justice Breyer: “taken literally, “omit” limits the statute’s scope to situations in which specific receipts or accruals of income are left out of the computation of gross income; to inflate the basis, however, is not to “omit” a specific item, not even of profit.”

But Justice Kennedy, Ginsburg, Sotomayor and Kagan strongly dissented arguing that “there is a serious difficulty to insisting, as the Court does today, that an ambiguous provision must continue to be read the same way even after it has been reenacted with additional language suggesting Congress would permit a different interpretation. Agencies with the responsibility and expertise necessary to administer ongoing regulatory schemes should have the latitude and discretion to implement their interpretation of provisions reenacted in a new statutory framework.”

So what can you do if the IRS asks you in 2016 to sign Form 872?  Perhaps  you could do the same thing Home Concrete and their tax attorney did when they saw a gray area of the law:  You just might decide not to sign Form 872 and have your tax attorney take the case to US Tax Court and perhaps as did Home Concrete achieve ultimate victory in the US Supreme Court.  So first and foremost if you are asked by the Government to sign Form 872 retain the services of a tax attorney, hopefully the same tax attorney who prepared, filed and handled the audit of  your tax return in the first place, before you make a decision whether to sign Form 872 or not.  Second, make sure you always contemporaneously prepare the documents and records needed to support your tax return in the unlikely event of an IRS audit, and include summary documents in the tax return you file to create the facts and records you need to win an audit.  With a good set of records supporting your tax positions you will hopefully finish up the audit with no adjustments.  Finally, if your audit is taking too much time due to staff reductions over at the IRS and US Treasury, whether due to Government budget cuts, or for lack of records, make sure you have your tax attorney standing by to help you answer the soon to be asked question by your IRS agent:  Would you please sign Form 872 to extend the statute of limitations on your audit?  If the IRS asks you to sign Form 872, Consent to Extend the Statute, what would you do?  Whether you sign or not may ultimately decide whether you win or lose.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney.

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Kindest regards

Chris Moss CPA Tax Attorney