​​by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA. Tax Attorney

Has your tax attorney mentioned that Congress and our next President could someday sooner than you might think in 2017 dramatically reduce the 2016 $5.45 Million gift exemption ($10..9 Million married) to which President Obama gave his blessing in December of 2012. If you are a baby boomer thinking of retiring with substantial assets, and want to take advantage of these historic large gift tax exemptions, you most likely will soon be aggressively gifting your assets to the kids and grandchildren with substantial discounts -before the next election in November 2016-through a strictly controlled Family Limited Liability Company. But in case you have not yet started the gifting process but are thinking of doing so, or if you are in the process of gifting now, did you know the two basic steps that you need to take to protect your assets from adverse government action if you get audited by the IRS ina a Family LLC Discount Audit. Moreover, without including such steps in your estate and gifting plan, an IRS audit may dramatically increase you gift and estate tax liability to the Government many years from now, perhaps even many years after you are long gone. So I would recommend that you all continue with Chris Moss CPA Tax Attorneyj on TaxView to review the basic two steps in bulletproofing your gift tax returns from harm in the likely event of an IRS audit.

Step one is to gift your children the LLC memberships, not the assets themselves. Let’s take a look why this matters as we review US Tax Court SUZANNE J. PIERRE VS IRS to learn the difference between valuations of underlying assets vs the valuation of LLC member interests and why this is so important. Pierre transferred over $4 Million in publically traded stock to a single member LLC and then days later transferred substantial memberships to trusts for her son and granddaughter. Gift tax returns were filed reflecting over 30% discounted gifts due to lack of marketability and control. The IRS audited the Gift Tax returns and issued a notice of deficiency of over $1 Million. The government argued that the underlying assets, the stocks and securities were the gift, not the LLC and that no discounts could be applied directly to those assets. Pierre argued the opposite view, that IRS rules do not control, that state law controls and more specifically under state law, a membership interest in an LLC is personal property, and a member has no interest in specific property of the LLC. You may want to also review “Cost Basis For Beginners” on the difference between inside and outside basis. Judge Wells sided with Pierre because pursuant to state law Pierre did not have a property interest in the underlying assets of Pierre LLC. Accordingly, the IRS could not create a property right in those assets.

The second and final step in gifting to the kids is a little more complicated. Your discount must be supported by an expert appraiser sometimes many years later in US Tax Court after you are long gone. While Pierre allowed for a 30% discount, other cases have not always been so generous to the taxpayers. For example, in Lappo vs IRS 2003 Lappogifted to children though a family partnership in 1996. In 2001 the IRS audited the 2006 gift tax return increasing the gift from $1,040,000 to $3,137,287, Larro appealed to US Tax Court. Larro’s expert concluded a 35% discount was appropriate. The Government’s expert concluded an 8% discount was appropriate. Judge Thornton’s rather short but very well thought out 27 page Opinion compacted with facts and details only appraisers could appreciate, concludes after an exhaustive examination of expert witnesses for both sides that a 24% discount was appropriate. Just in case you didn’t notice the average between 35% and 8% is 25.5%, and not too bad for Lappo. Unfortunately Tax Court judges do not usually average the discount valuations from the IRS and the Taxpayer and split the difference as clearly evidenced in our next case of True vs IRS.

The True family of Casper, Wyoming didn’t fare so well in US Tax Court case of True vs IRS in 2001. The True clan made their money in Oil and Gas Exploration and Drilling. True believed in the family partnerships and the strength of a unified family in business and America. Dave True gave each of his children general partnership interests in various family business interests. True created numerous operating agreements severely restricted the marketability and control of the family members through the use of buy sell agreements requiring family members to participate in the business or be bought out at predetermined appraised market values forming the basis of the gift tax returns filed in 1993 and 1994 using 30% discounts.

The IRS audited the 1993 1994 gift tax returns and found massive valuation understatements. The True family appealed to US Tax Court. Judge Beghe’s Opinion reviews the work of government expert witnesses, painstakingly detailing the reasoning behind the discounts and then analyzes the use of buy-sell agreements in gift tax valuations. It’s hard to believe but the True family did not retain expert appraisers. Instead, Dave True consulted Mr. Harris, the family’s accountant and longtime financial adviser. Mr. Harris advised True to use a tax book value purchase price formula under the buy-sell agreements for gift tax valuations. However, the Court noted Mr. Harris’s expertise was in accounting not appraisals….and he was the only professional with whom Dave True consulted in selecting the book value formula price” Id at 110. The Court rejected any notion that Mr. Harris was qualified to opine on the reasonableness of using the tax book value formula in the True family buy-sell agreements. The Court further noted that “Mr. Harris was closely associated with the True family; his objectivity was questionable and more importantly, he had no technical training or practical experience in valuing closely held businesses.” Id 111 Without the power of an army of experts to help True, the Government’s experts easily persuaded the Court that only a 10% discount should be allowed, costing the True family millions in dollars of additional taxes, penalties and interest.

How can we learn from True as we close out the 2016 tax year? How can you preserve and keep safe your assets for the next generation in 2016 before the next President and Congress may dramatically reduce the exemption? In my view you need to consider gifting strategies in light of ever changing Congressional intent regarding estate and gift tax exemption amounts and tax rates. I personally prefer to save taxes now, as we may never know what “later” will bring. To save taxes now I recommend many of you baby boomers to consult with your tax attorney and estate planners asking them about the two step process in gifting to your kids and grandchildren through a Family Limited Liability Company.  Make sure you retain the best and the brightest appraiser prior to filing your gift tax return with the US Government. Your gift tax valuations, your Family LLC Member Discounts, and all the taxes you saved now will be bulletproofed from adverse consequences during an IRS Family LLC Discount Audit many years from now.

Happy Gifting to all from Chris Moss CPA Tax Attorney and Thanks for joining us on TaxView.

Kindest regards  Chris Moss CPA Tax Attorney

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Estate Planning is hard to talk about.  Do you really want to talk about death and taxes?  But Estate Planning is also about life-your legacy in this life-and the lives of your children and lives of your grandchildren after you are long gone. Not to mention the tax free estate tax reducing gifts you give to all your children while you are living and enjoying life.  Furthermore, with a custom estate plan, your children and grandchildren can be protected in this life, as you perhaps have been protected if your parents had wisely estate planned in their lifetime. A good Estate Plan will not only secure and protect your family from harm’s way, but also prevent you all from being taxed to death by excessive estate tax so high your kids might just have to sell the farm to pay your death taxes. So if you are interested in protecting your family-and your assets-for generations to come, stay with us here on TaxView with Chris Moss CPA Tax Attorney and find out how you all can create the perfect Estate Plan for your family.

Let’s start your Estate Plan with gifting.  You can actual gift assets to reduce your estate tax to each child and grandchildren up to $14K or $28K married each year tax free. But what if you gift over the $28K annual exclusion?  Current law in 2016 allows you a one-time exclusion a $5.45 Million dollar limit in your lifetime-$10.9 Million married.  But be warned: this lifetime exclusion is subject to Congressional reform just about at any time during any administration. It is very possible that in 2017 the lifetime exclusion could be dramatically adjusted downward by the next President and Congress.  If that should happen and you have not yet made your tax free transfers and you gift over the lifetime exclusion you are taxed at 40% on the overage as the Cavallaro family found out in Cavallaro v IRS US Tax Court (2014).

Cavallaro started out in 1979 and grew the company with his three sons into Camelot Systems and Knight Tools both operating out of the same building.  In 1994 Ernst &Young (E&Y) was retained to consider an Estate Plan for Cavallaro.  They suggested a merger of both Knight and Camelot.  Unbeknownst to E&Y, Cavallaro also retained attorneys Hale & Dore of Boston for Estate Planning.  Mr. Hamel of that firm claimed that much of Camelot was already owned by the three sons based on a one-time transfer made in 1987 to the sons in exchange for $1000 from all three sons.

When E&Y found out about Mr. Hamel’s plan, senior partners in E&Y immediately pointed out that the 1987 transfer was at odds with all the evidence and E&Y would not support this tax strategy. Unfortunately for Cavallaro, the attorneys eventually prevailed and the accountants acquiesced. Gift tax returns were filed after the merger showing no taxable gifts and no gift tax liability.

In 1998 the IRS audited the business returns for 1994 and 1995 eventually claiming that gifts from parents to children as a result of the merger were grossly undervalued in the gift tax returns Form 709 filed in those years of the merger.  The IRS issued third party summonses to E&Y.  The tax attorneys filed petitions to quash the summonses fighting all the way to the Court of Appeals for the First Circuit, but eventually lost on all counts.

The Court denied Cavallaro’s motion to quash and ordered the summons enforced as perCavallaro v United States 284 F.3d 236 (1st Cir 2002) affirmed 153 F. Supp. 2d 52 (D. Mass 2001).    As the Court noted there was no attorney client privilege with a CPAs.  Therefore all documents had to be handed over to the Government and the E&Y accountants had to testify in many cases against their client’s best interest in compliance with the Court Order.  Cavallaro appealed in Cavallaro v IRS US Tax Court (2014)  and claimed the gift was at arm’s length. After hearing all the witnesses and reviewing the documents, Judge Gustafson opined that the 1995 merger transaction was notably lacking in arm’s length character, and concluded that the gift was undervalued by Cavallaro.  The Court then ruled that Cavallaro made gifts totally $29.6M in 1995 when the two businesses merged handing Cavallaro a tax bill of $12,889.550.   IRS wins Cavallaro loses.

Another case Estate of Rosen v IRS (2006) brings us to the next key component of gifting: control.  Unless you lose control of the assets you gift, the assets unfortunately still remain in your taxable estate upon your passing.  The facts in the Rosen case are simple.  Her assets were mostly stocks, bonds, and cash.  Her son-in-law formed a family limited partnership in 1996 and the children signed a partnership agreement and a certificate of limited partnership was filed with the State of Florida.  Each of the children were given a .5% interest and the Lillie Investment Trust was formed to own a 99% interest. $2.5 million was transferred from Rosen to the Lillie Investment Trust as consideration for its 99% interest.

What is interesting is the partnership conducted no business and had no business purpose for its existence other than to save taxes.  When Rosen died the IRS audited sending the Estate over a $1 Million tax bill, claiming all the money in the partnership was includable in Rosen’s estate because Rosen controlled until her death the possession or enjoyment of, or the right to the income from the assets. The Estate of Rosen appealed to US Tax Court  inEstate of Rosen v IRS (2006) claiming that Section 2036(a)(1) does not apply because the assets were transferred in a bona fide sale for full and adequate consideration. Alternatively the Estate argued that Rosen did not in fact retain enjoyment or “control” of the assets while she was alive.

Judge Laro observes that the US Tax Court has recently stated, a transfer of assets to a family limited partnership or family limited liability company may be considered a bona fide sale if the record establishes that: (1) The family limited partnership was formed for a legitimate and significant nontax reason and (2) each transferor received a partnership interest proportionate to the fair market value of the property transferred citing the Estate of Bongard v. Commissioner, Estate of Strangi v. Commissioner, Estate of Thompson v. Commissioner, US Tax Court on remand, and Thompson v. Commissioner on Appeal 382 F.3d 367 (3d Cir. 2004)

The Court concluded that the overwhelming reason for forming the partnership was to avoid Federal estate and gift taxes and that neither Rosen nor her children had any legitimate and significant nontax reason for that formation.  In addition Rosen herself used the partnership to pay for her personal expenses all the way up to her death and therefore never truly “gifted” the assets out of her estate.  IRS wins, Rosen Loses.

So how do you safely start gifting in 2016 so that your assets are permanently out of your taxable estate in a protected Estate Plan?  First create an Estate Plan that has a legitimate business purpose in mind.  Second, make sure you have sufficient assets to live without the Family LLC having to support you.  Third make sure you have transferred control of these assets to your children with properly filed gift tax returns.  Finally, with the help of your tax attorney make sure all transactions are contemporaneously documented with appraisals inserted into the gift and personal tax returns before you file.  When the IRS comes to examine your Estate Plan your children will be happy you did.

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