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.

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

​by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Many large public businesses have their corporate operations legally headquartered offshore. For example Apple, General Electric, Pfizer, IBM, and Merck have offshore operations legally sheltering billions of dollars from US income taxation.   However, if any of you individuals or small business owners out there are ever approached with a too good to be true personal tax savings arrangement that involves offshore investing or business operations that result in you personally saving taxes on your From 1040 get a second opinion before you invest in and activate such a scheme.  Once the scheme is discovered by the Government action is immediate and devastating to the promoter of the shelter.  Unfortunately in many cases you the taxpayer/victim are accused of tax fraud as well resulting in severe civil fraud penalties in addition to all the additional income tax you owe.  So if you have money offshore right now or are thinking about a plan that purportedly legally allows you to send money offshore, please stay with us here on TaxView with Chris Moss CPA Tax Attorney to give you a fair warning that such schemes lead nowhere but to large civil fraud penalties and in some cases criminal Government tax investigations.

Big and small business have always been able to operate abroad and save taxes.  But owners of closely held businesses are not legally able to take advantage of these provisions.  In fact Americans are taxed on worldwide income regardless of whether or not the funds are deposited to a foreign bank in a tax free haven. Unfortunately there are many taxpayers out there who don’t know that these schemes are illegal, like Stanley and Ruth Alexander who were in US Tax Court over this very issue in Alexander vs IRS T.C. Memo 2013-203.

The facts are very complex in this 71 page Opinion.  Dr Alexander, a plastic surgeon, used offshore tax strategy to lease back his medical services to his professional Ohio practice.  Alexander met attorney Reiserer from Seattle who reviewed offshore employment leasing with Alexander.  There were numerous doctors who were well versed through seminars in the Bahamas about this strategy. Reiserer and a CPA Kritt “structured, implemented and managed” the offshore strategy for tax year 1996-2003 for Alexander.  In 2003 the IRS initiated a criminal investigation of Kritt.  Kritt was charged with criminal tax evasion, but Kritt was found not guilty by jury of any criminal misconduct.

As a result of the Kritt criminal investigation, Alexander and hundreds of other doctors were audited by the IRS for years 2000-2002 and were accused of substantial understatement of income and tax fraud.  Alexander appealed to US Tax Court in Alexander vs IRS US Tax Court (2013).  Alexander claimed the offshore strategy was to create retirement for his family.  The Government argued that the motivation was avoidance of tax as there was no meaningful economic substance to the strategy.  Judge Goeke on Page 45 of the Opinion opines Alexander relied on Krit and Riserer and Alexander had limited ability to understand the tax law.  As the case unfolds the Court seems to have sympathy for Alexander who “placed a great deal of reliance on Kritt”.  The Court concludes that Alexander did not possess the education that would allow him to know he should have reported additional income”. Page 50.  IRS loses on tax fraud, but IRS wins on understatement.

Our next case involves Dr Child in Child vs IRS T.C. Memo 2010-58.   The facts are relatively simple.  Dennis Evanson designed organized and promoted schemes to shelter income from taxation.  He was ultimately convicted of Federal income tax evasion by a jury in 2008.  All of Evanson’s tax evasion schemes used sham transactions to transfer clients’ untaxed income to offshore entities that Evanson created and controlled.  The funds were typically returned to his clients disguised as disbursements from fictitious loans to avoid taxation.

Dr Child was a highly compensated radiologist who met Evanson at a party.  Evanson helped Child and hundreds of over doctors create a tax evasion scheme which allowed a fictitious offshore insurance company to providing insurance coverage for Child. Premiums were paid and deducted on Child’s tax returns from 1997-2003.  The IRS audited not only disallowing over $280K of deductions but  claimed Child was guilty of tax fraud as the whole scheme was nothing but a tax avoidance sham transaction lacking any economic substance. Child appealed to US Tax Court in Child vs IRS US Tax Court (2010). Judge Kroupa concluded that indeed Child fraudulently intended to evade taxes and this was liable for additional fraud penalties under Section 6663 of the IRS Code which increases the penalty by 75% of the tax owed. IRS wins and Child loses on fraud under IRS Code Section 6663.

If you lose on Fraud you owe additional 75% of the tax owed, a lot of money for most of us.  So why did Child lose on Fraud but not Alexander?   The law says you commit tax fraud if “badges of fraud” are present:  you have inadequate records, you participate in the promoter’s scheme to mislead the Government, you give implausible explanations of behavior to conceal the fraud, you file false documents, and you fail to respond to subpoenas.  Finally you don’t cooperate with the Government. Judge Kroupa in Child argued that “most of the badges of fraud upon which this Court relies were present in Child”. Page 23.   Judge Goeke didn’t feel that way with Alexander and so Alexander did not have to pay the 75% fraud penalty.

In conclusion, if you are a small business owner who attends a seminar on offshore investing schemes, simply say no.  There is no legal tax strategy for individuals and small business owners to keep their offshore earnings from being reported on their personal tax return Form 1040.  Unless you are willing to give up your US Citizenship and leave the country there is simply no legal way to avoid paying personal income taxes by keeping your earnings offshore.  Work within the system to change the tax to perhaps a flat tax or national sales tax, but say no to offshore tax schemes.  You will be happy you did when the IRS comes knocking on your door for an offshore tax audit.

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

See you next time on TaxView.
​
Kindest regardS

Chris Moss CPA Tax Attorney

by Chris Moss CPA Tax Attorney

Submitted by Chris Moss CPA Tax Attorney

It is a fact that in your lifetime you likely will be audited by the IRS examination division as long as you are legally required to file tax returns each year. However, trending in 2016 there is a 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). This may happen because of something you innocently said to the IRS agent. Or perhaps a disgruntled ex-employee or not so happy ex-wife communicated with the agent? Perhaps you talked too much to the agent and innocently said something misleading that was not quite true? Moreover, for whatever reason, if CID is called in to investigate you and finds insufficient evidence to continue their investigation, CID will refer the case back to IRS agent to conclude the examination. However, as I see it, any IRS audit of your tax return throws your constitutional 5th amendment rights to remain silent in a boxing ring with a powerful legitimate government interest to enforce tax collection for the US Treasury. These clashing interests emerge at the precise moment that the IRS examining agent begins the audit of your income tax return, up to the point that the agent refers your audit to CID. If this referral to CID should happen to you how would you protect yourself and your family from the adverse consequences and publicity that would soon come crashing through your door? So stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out how to protect your family from this unlikely but possible Government intrusion of an IRS criminal investigation into your life.

Before we can answer this question we need to review a few interesting facts about the CID. According to the IRS website: “IRS Criminal Investigation Division (CID) is comprised of approximately 3,700 employees worldwide, approximately 2,600 of whom are special agents whose investigative jurisdiction includes tax, money laundering and Bank Secrecy Act laws” The site goes on to say: 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. While no doubt there are only about a thousand or so taxpayers that 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.

In order to better understand the significance of the words we say to the IRS we turn as we often do to case law. The Greve case decided in 2007, US v Greve US Court of Appeals for the 7th Circuit. involved James Greve who was head of Greve Construction his family business. Greve’s 1997 tax return was audited by IRS examination division agent Luke. As the audit progressed Greve seemed disorganized and overwhelmed and in my view should have brought in an attorney sooner than he did. 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 appealed to Federal District Court and lost. Greve then appealed to the 7th Circuit and filed 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.

Let’s take a look at Kontny. The facts in Kontny 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. Frazier v. Cupp, 394 U.S. 731.

Frazier was convicted in an Oregon state court of second-degree murder in connection with the September 22, 1964, slaying of one Russell Anton Marleau. After the Supreme Court of Oregon had affirmed his conviction, 245 Or. 4, 418 P.2d 841 (1966), Frazier filed a petition for a writ of habeas corpus in the United States District Court for the District of Oregon. The District Court granted the writ, but the Court of Appeals for the Ninth Circuit reversed, 388 F.2d 777 (1968). The US Supreme Court granted certiorari to consider three contentions of error raised by Frazier. Justice Thurgood Marshall’s Opinion finds none of these allegations sufficient to warrant reversal. Here are the facts: When Frazier was brought in by police for questioning he was still was reluctant to talk, but after the officer sympathetically suggested that the victim had started a fight by making homosexual advances, petitioner began to spill out his story. Shortly after he began he again showed signs of reluctance and said, “I think I had better get a lawyer before I talk any more. I am going to get into trouble more than I am in now.” The officer replied, “You can’t be in any more trouble than you are in now,” and the questioning session proceeded. A full confession was obtained and, after further warnings, a written version was signed. Since Frazier was tried after this Court’s decision in Escobedo v. Illinois, 378 U.S. 478 (1964), but before the decision in Miranda v. Arizona, 384 U.S. 436 (1966), only the rule of the former case is directly applicable. Johnson v. New Jersey, 384 U.S. 719 (1966). Petitioner argues that his statement about getting a lawyer was sufficient to bring Escobedo into play and that the police should immediately have stopped the questioning and obtained counsel for him. The Court concludes it was not. The Confession was valid because Frazier predated Miranda.

Miranda notwithstanding, as far as I can tell, if you say something in your polite conversation to an IRS agent during a routine audit that possible incriminates you later during a criminal investigation, you cannot then suppress what you said even if the government knew that a criminal investigation was underway, and sadly even if the IRS questioning of you violates its own internal rules during the civil examination. What does this mean for all of you who file tax returns each year? As Frazier makes clear, if you get audited by the IRS, and if you voluntarily talk to the IRS agent during your audit, you have no constitutional 5th amendment rights to suppress those statements in later criminal proceedings. In conclusion, it appears to me that If you get audited best practice would be to have your tax attorney do the talking. We should never forget that Americans have a 5th amendment right to remain silent and to have an attorney represent us to keep us safe and protected.

Thank you for joining Chris Moss CPA Tax Attorney on TaxView

See you next time on TaxView

Kindest regards 

Chris Moss CPA Tax Attorney

​​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

​by Chris Moss CPA  Tax Attorney

Welcome to TaxView with Chris Moss CPA Tax Attorney

​Are you planning on giving a large gift to charity after you die?  The Charitable Remainder Unitrust (CRUT) and the Charitable Remainder Annuity Trust (CRAT) as per IRS Code 664 are great tax strategies for charitable giving.  The CRUT for example allows you to take an immediate charitable deduction on your income tax return, deferring the actual donation of the remainder of the trust until after your death, but at the same time allowing for you to live off the income of the trust while you are alive.  Sounds too good to be true?   It’s true, but unfortunately  the IRS  seems to be thinking otherwise,  waiting perhaps patiently I might add, until you die only to commence a CRUT Audit with disastrous results for for your children and other heirs at the conclusion of the CRUT Audit.  So if you have already established a CRUT or are thinking about setting up a CRUT IN 2016 stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out how to bullet proof your CRUT and related tax returns from adverse Government  audit action when the IRS CRUT audit team
arrives shortly after you have passed.

While the Joint Committee on Taxation has always favored charitable giving deductions, Congress strictly limits the deductibility of the Charitable Remainder of your CRUT on your personal tax return to the present value of the CRUT remainder using a current qualified appraisal, as defined in § 1.170A-13(c)(3), from a qualified appraiser, as defined in § 1.170A-13(c)(5). Section 664(d)(2)(D) requires that the valued remainder be at least 10% of the property’s net fair value on the date of contribution.  After the initial appraisal year IRS Regulations 1.664.1, and 1.664.3 generally with some exceptions allows you to pay to yourself annually not less than 5% of the net fair value of the trust corpus.  Sounds pretty easy, but as Arthur Schaefer’s Estate found out in Schaefer v IRS US Tax Court (2015) there are IRS traps surrounding CRUTS after you die which could make you turn over in the grave.

On February 21, 2006 Schaefer created a CRUT with a slight variation, an exception to the general rule as per Section 664(d)(3)(A).  The exception allowed Schaefer to distribute only the trust income for the year but limited by a fixed percentage. Trusts created under this exception are called Net Income Charitable Remainder Unitrusts (NICRUTs). Additionally, 664(d)(3)(B) allowed Schaefer to distribute to himself the current trust income in excess of the fixed percentage to the extent that the aggregate amounts distributed in prior years were less than the aggregate of the fixed percentage amounts for those prior years. Trusts using this provision are Net Income with Makeup Charitable Remainder Unitrusts (NIMCRUTs) and this is the trust Mr. Schaefer created.

Sure enough after Schaefer died, and after the Estate tax return Form 706 was filed, the IRS came knocking on Schaefer’s Estate door and indeed audited and disallowed the NIMCRUT charitable deduction in its entirety because the trusts did not meet the requirements of Section 664(d)(2)(D) in that the value of each remainder interest be at least 10% of the net fair value of the property on the date of contribution claiming Schaefer used an incorrect valuation method.  Schaefer’s appealed to Tax Court in Schaefer v IRS US Tax Court (7/28/2015).

Judge Buch opined that while the legislative history is rather unclear on this matter, nevertheless Congress gave the IRS the power to issue administrative guidance on the subject of valuing a remainder interest in a NIMCRUT citing Rev. Rul. 72-395, sec. 7.01 superseded by Internal Revenue Bulletin:  2005-34, which includes all the relevant Revenue Procedures including   Rev Proc 2005-52, 2005-53 and 2005-54 requiring the remainder interest of a NIMCRUT to be valued using the fixed percentage stated in the trust instrument, regardless of the fact that distributions are limited to trust income.   The Court observes that Schaefer was using a rate that was less than stated in the trust instrument.  When the Court converted the Schaefer rate to the fixed rate required by IRS regulations the Schaefer NIMCRUT remainder fell below the 10% threshold thereby terminating the entire NIMCRUT.  IRS wins Schaefer loses.

A second IRS trap, as Joseph Mohamed found out, is the requirements for a “qualified appraisal” in Mohamed v IRS US Tax Court (2012). Mohamed set up a CRUT in 2003 worth millions with the remainder to go to the Shriners Hospitals for Children.  Mohamed filed his tax returns along with Form 8283 claiming millions of dollars of charity deductions.  The IRS noticed this almost immediately and commenced a CRUT audit.  It turns out that Mohamed self-appraised his donations, albeit on the low side, but nevertheless, in violation of IRS regulations requiring a qualified appraisal by a qualified appraiser.   Mohammed retained a qualified appraiser, while the audit was ongoing, to perform a qualified appraisal and even though the remainder asset value appraised higher than Mohamed’s charitable tax deduction, the appraisal was performed simply too late to do any good.  The IRS invalidated the entire CRUT and disallowed the millions of deductions that Mohamed had claimed as a charity deduction.  Mohamed appealed to US Tax Court in Mohamed v IRS US Tax Court (2012).

The Court reluctantly ruled for the Government in that Mohamed did not comply with IRS regulations.  Judge Holmes sadly opines that this result is harsh–a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions–all reported on forms that even to the Court’s eyes seemed likely to mislead someone who didn’t read the instructions. But the problems of bad appraisals of property was so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules.  IRS wins Mohamed loses.

What does this mean for all of us who want to set up CRUT’s?  First, make sure you get a qualified appraiser to do a contemporaneously performed qualified appraisal of the remainder interest property that you are currently deducting as a charitable donation on Sch A of your Form 1040. Complete Form 8283 and attach the appraisal to the tax return in a PDF file at the time you file your tax return.  Second, hire the best tax attorney you can find to give you a written opinion that your CRUT, CRAT, NICRUT or NIMCRUT complies with IRS Code 264 and IRS Revenue bulletin 2005-34 including Revenue Procedure 2005-52, 2005-53 and 2005-54.  Give that legal opinion to your children to hold on to as there is a good chance the IRS is out there patiently waiting for your passing.  Finally, introduce your children to your tax attorney so they know what to expect after your pass.  There is a good chance your Estate be subject to an IRS CRUT audit after your passing, and at least you can rest in peace knowing that your tax returns will survive with your Estate protected and safe from harm’s way.

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

Make sure to join us next time on TaxView when we will take closer look at where Domestic Asset Protection Trusts DAPTs and Spousal Lifetime Access Trusts SLATs are trending in 2016.

Kindest regards,
Chris Moss CPA Tax Attorney

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 by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Domestic Asset Protection Trusts (DAPTs) and Spousal Lifetime Access Trust (SLATs) appear to be best practice in 2016 for Asset Protection and Estate Tax Reduction. The SLAT, which is nothing more than a DAPT for a family allows your Husband Grantor Settlor to appoint you his Wife as both Trustee and Beneficiary with your children appointed as successor Beneficiaries.  If your SLAT becomes a member of the Family Business LLC you have an ideal estate tax reduction, asset protection, and additional annual income tax savings all created in an almost “too good to be true” legal tax structure and foundation.  Are in fact DAPTs and SLATs too good to be true? Some feel the IRS is just waiting, patiently I may add, until you die to audit your estate and disallow the entire SLAT arguing before the US Tax Court that the SLAT corpus never legally left the Estate. So if you are interested in setting up a SLAT, stay tuned to TaxView with Chris Moss CPA Tax Attorney to find out how to take advantage of these new Domestic Asset Protection Trusts without losing your advantage during an IRS SLAT Audit soon to be coming your way.

So what is a SLAT?  A SLAT is an irrevocable DAPT established uniquely for a married couple, in many cases with children who ultimately become successor beneficiaries under newly enacted Sweet 16 State Protection Trust laws that allow the SLAT Husband Settlor Grantor to irrevocably gift his assets to his Wife, Trustee and Beneficiary with all lifetime distributions being made according to “ascertainable standard” as per IRS Code Section 2514, and IRS Code Section 2041 and Sweet 16 State laws, relating solely to the health, education, support or maintenance of in the case of a SLAT, your wife, both Beneficiary and Trustee. As Grantor Settlor you must make absolutely certain that you do not retain a life estate of any kind whatsoever in the Trust Corpus or Income Distributions in violation of IRS Code 2036.  If you flawlessly insert a Spendthrift Clause in the Trust documents exactly according to State Law, and then finally appoint a non-family member Trust Protector or Co-Trustee you have what some would consider a “too good to be true” Estate plan.

The “too good to be true” folks out there may very well remember that prior to 1997, State Court Common Law for over 100 years held that these kind of Domestic Asset Protection Trusts were unenforceable and void against public policy.  Yet one State legislature after another have in the last 20 years codified Trust Fund laws making legal what the Courts in Equity have prohibited.  These DAPT and SLAT friendly 16 States (Sweet 16) Alaska, Colorado, Delaware, Hawaii, Missouri, Mississippi, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia and Wyoming are the only States in my view that you can safely create a DAPT or SLAT with some reasonable assurance that creditors could not reach your SLAT assets.

So what steps can you take to prove the “too good to be true” folks wrong.  First keep your DAPT or SLAT within the “Sweet 16” 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.

If you are fortunate enough to live within the Sweet 16 how should you structure the SLAT so that when the IRS audits your SLAT your SLAT will survive intact and protected?  Historically the US Tax Court has looked to States for guidance on whether or not an irrevocable trust is a valid transfer not subject to estate tax of the Settlor Grantor.  For example inOutwin v IRS 76 T.C. 153 (1981), Outwin created various irrevocable trusts under Massachusetts law with Outwin being the sole Beneficiary during his lifetime with family friends as trustees.  The IRS audited and claimed gift taxes were not paid on what the IRS claimed was an irrevocable transfer out of Outwins’s estate. Outwin appealed to US Tax Court inOutwin v IRS 76 T.C. 153 (1981) arguing that he never lost control over the trust because he was the “sole Beneficiary” of the fund assets and therefore no legal gift had been transferred.

Judge Dawson goes further asking whether Outwin’s trusts could be subjected to the claims of the settlor’s creditors under Massachusetts law. Citing Ware v Gulda 331 Mass. 68, 117 N.E.2d 137 (1954) the Court finds that under Massachusetts law Outwin’s trust fails to relinquish dominion and control for gift tax purposes if creditors can reach the trust assets. Concluding there is a strong public policy in Massachusetts common law against persons placing property in trust for their own benefit while at the same time insulating such property from the claims of creditors the Court finds for Outwin.   IRS loses, Outwin, wins
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So in conclusion, to make your 2016 SLAT bullet proof against an IRS SLAT Audit, first, make sure you retain a tax attorney who knows his Sweet 16 SLAT law and knows it well. Have that same tax attorney file all tax returns.  Second,  have your tax attorney structure the SLAT so that you Settlor Grantor Husband appoint your wife as Trustee and as a primary Beneficiary receiving beneficial ascertainable standard distributions for her health education support or maintenance in accordance with IRS Code Section 2041(a)(2), (b1) and (b)(2) making sure you Husband Grantor Settlor are not in violation of IRS Code Section 2036 by not retaining a life estate in the Trust corpus or income. Third make sure your SLAT is absolutely protected from Creditors by inserting exact word for word language of the Spendthrift provisions of your State’s Domestic Asset Protection Trust laws.  Finally, Appoint a non-family member Trust Protector or independent Co-Trustee to give you that extra added protection when the IRS comes on over soon after you are gone.  If you stayed married for the duration, on the day of your passing, you can rest in peace knowing your Wife and children are protected from a very likely IRS SLAT Audit coming your way, with family Business and Estate bulletproofed with a safe and protected SLAT foundation for many years to come.

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

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

IRS Crummey Gift Tax Audit
by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Do you all own a family business and want to start the process of transferring ownership to your children without getting hit with large gift and estate taxes?   Best practice suggests you consider gifting to your minor children, or if you are the older children, have your parents or grandparents gift to you a Crummey Trust membership through your Family Limited Liability Company.  The “Crummey” Trust”, named for Crummey 397 F.2d 82 (9th Cir 1968­) is a great way to get tax deductions, have your children receive annual Family LLC memberships, reduce your estate tax and have the family work together in a unified and protected Estate Plan.  But danger lies ahead during an IRS Estate tax audit after you die or an IRS Gift tax audit before you die claiming if you died the gifts were not irrevocable, or while you are still living that the Trust should be subject to gift tax by disallowing the tax free exclusions.  Either way you lose unless you are structured correctly.  So if you are interested in winning for you your wife, children and grandchildren, stay with us here on TaxViewwith Chris Moss CPA Tax Attorney to learn how to fight back during an IRS Crummey Trust audit so you can win, save taxes, and keep your assets in the family business safe and protected from harm for many generations to come..

Current gift tax law allows exemption for a Husband and Wife to gift tax free $28,000 to a Crummey Trust owning a membership in the Family LLC to each child in 2015. Named after taxpayer Crummey, the Crummey Trust accumulates the $28,000 tax free exemption year after year in a protected irrevocable trust by giving your children the right to demand immediate distribution of exemption.  This is exactly what Crummey did in Crummey vs IRS 397 F.2d 82 (9th Cir 1968).

The facts are simple.  Husband and Wife Crummey each gave in 1962 their 4 minor children $3000, the exemption at that time, or $12,000 total to an irrevocable trust.  The IRS audited and disallowed the Trust claiming that the gifts to minors were nothing more than disguised future interests disallowed under then IRS Section 2503(b).  Crummey appealed first to US Tax Court and next to the US Court of Appeals for the 9th Circuit 397 F.2d 82 (9th Cir 1968).
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District Judge Byrne frames the key issued presented as whether or not a present interest was given by the Crummey’s to their minor children so as to qualify for the exclusion under 2503(b).  The Court looked to California law to determine if the children had the right to demand distributions from the Trustee. The Government said if the children can’t sue under California law they can’t demand the trust assets under California law.  The Crummey’s said if the children can own property under California law they can indeed demand the trust assets under California law..

The Court took particular interest in George W Perkins 27 T.C. 601 (1956) where the Court said that where the parents were capable of asking the Trustee for the assets on behalf of the minor children in order for the children to have the “right to enjoy” the assets and there was no showing that the demand for funds from the children via the parents could be resisted under State law, then the gift was a present interest.  The Court in my view did not clearly have an easy answer, but in the end ruled that under Perkins, the “right to enjoy” test is preferable.  Crummey win IRS loses..

Where is Crummey trending in 2015? Let’s take you all as an example:   In 2015 you and your wife irrevocably gift $28,000 to each of your 3 children ages 5, 7 and 9 and give at this level for 5 more years.  If structured through a Crummey Trust your gifts would be $84,000 per year or $420,000 after 5 years all tax free.  Further suppose your $28,000 irrevocable gift to each child was an LLC membership interest.  With a 35% discount applied to each membership gift for lack of marketability your tax free gifts to 3 children for 5 years would be $630,000.

The Mikel family set up this kind of trust in 2007 with one exception:  The Trustee had final and conclusive power to assist the children with “Life Changing Events”, like reasonable wedding costs, the cost to purchase a primary residence, or costs of starting a new trade or business. Finally the Trustee had power over the children’s expenses in connection with their health, education, maintenance and support.  The IRS audited Mikel and disallowed the gifts to his children claiming they never were gifted a “present interest in the property” that is an unrestricted right to immediately use the gifts, citing Regulations 2503-3(a) and 2503-3(b) particularly in light of the special “Life Changing Event” powers granted to the trustee.  Mikel appealed to the US Tax Court Mikel v IRS, US Tax Court (2015).

Mikel argued and surprisingly IRS conceded that each of the children received a timely and effective notice of their right to withdraw the maximum annual exclusion.. Both the Government and Mikel further agreed that the trust declaration stated unequivocally that upon receipt of a timely made withdrawal demand, “the Trustees would have to immediately distribute to the children the property allocable to them.” The IRS finally also conceded that the declaration put forth by Mikel in the Crummey Trust did in fact afford each beneficiary an unconditional right of withdrawal.

However the Government not to be outdone, argued vigorously that the children did not receive a present interest in the trust income and corpus because their rights of withdrawal were not legally enforceable in practical terms.  That is the children’s right of withdrawal was “legally enforceable” only if the children could go before New York State Court to enforce their rights and that such an action by the children was not likely to happen considering the special powers for life changing events granted to the Trustee.

​Judge Lauber’s thoughtful Opinion acknowledges that the Mikel trust, was indeed, a Crummey Trust citing Crummey v Commissioner 397 F.2d 82 (9th Cir 1968) with a substantially similar demand clause providing that whenever an addition was made to the trust, the children or their guardian could demand immediate withdrawal of an amount equivalent to the maximum annual exclusion as required by Section 2503(b). The Court further noted that even though the IRS expressed its general agreement with Crummey citing Estate of Cristofani v IRS 97 Tax Court 74 (1991) it appeared to the Court that the Government was challenging Crummey power only when the withdrawal rights are not in substance what they purport to be in form.  Judge Lauber nevertheless opined that the Government’s claim that the withdrawal right of Mikel children was illusory was flawed.  The Court went on to conclude that the Mikel children under New York law could seek justice to enforce the provisions of the Crummey Trust regardless of the special powers of the Trustee for “Life Changing Events”.  The Court therefore found that under New York law withdrawal demands by the beneficiaries could be in fact legally enforced citing Crummey. Mikel wins, IRS loses..

What does this mean for all families with a small business who want to gift Crummey assets to their young children to take advantage of the $28,000 per year gift tax exclusion?  First, create your Family LLC with your wife as your partner each donating your share of the family business into the Family LLC.  Second, for each subsequent year gift your children Family LLC discounted membership interests to the maximum exclusion $28,000 in 2015 through a Crummey Trust.  Third, make sure your Tax Attorney gives the children the absolute right and power under State Law to withdraw their interests.  Fourth, by the time your children are in their late teens and early 20s you should have successfully used the Annual Exemption and the Lifetime Exclusion to perhaps have your Family LLC owned by a Spousal Lifetime Access Trust (SLAT) with your wife as Trustee and Beneficiary and your children as successor beneficiaries  to further protect your tax free transfer from not only an IRS Estate Tax Audit, but to protect in a spend thrift clause from potential creditors as well.  Finally have your tax attorney prepare for you a written opinion that she will file your tax returns and represent you when and if the IRS should audit disallowing your Crummey Trust.  Include your Crummey Trust in your tax returns as a contemporaneously prepared PDF file before you file your returns.   Rest assured your Estate Plan is safe, secure and protected from IRS audit many years later.

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

Cost Segregation of Structural Components is a tax savings strategy that in my view defies logic, yet nevertheless is a brilliant absolutely legal way to save taxes. What is Cost Segregation of Structural Components you ask? In essence, Cost Segregation separates out costs in a building into structural components which can be depreciated at tax advantageous rates. “Structural components” date back to the investment tax credit (ITC) real estate tax shelters in the late 1970s. Accelerated depreciation rules were enacted by Congress back then allowing “structural components” of a building to qualify for the ITC. The goal was to stimulate the real estate industry. Years later in the 90s, the US Tax Court validated “Cost Segregation” of structural components in Hospital Corporation of America vs IRS (1997). This US Tax Court landmark ruling changed the game for investments in real estate and will be a game changer for you too. How? It could mean big tax savings for you if you own commercial real estate. So stay with us here on TaxView with Chris Moss CPA Tax Attorney to learn how you can use cost segregation of structural components in your commercial or rental real estate for immediate annual income tax savings.
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Do any of you remember the late 1970s ITC shelter partnerships? You would identify the structural components of a building you had just purchased, wrap the deal with a mortgage, add a little of your own money, use the ITC, and presto, you ended up with a large tax loss dramatically reducing your W2 income. By 1981 wealthy taxpayers were starting to discover real estate tax shelters. Just a few years later the hottest topic at any cocktail party throughout the country was who had the best tax shelter with the greatest tax loss.
Now fast forward to 1986. The Tax Reform Act was designed to rid the nation of tax shelters and it did just that. The 1986 Reform Act repealed the ITC, prohibited passive losses from offsetting W2 income and dramatically lengthened depreciation of real estate. All of a sudden commercial property you acquired was now depreciated over 31 year life rather than 19. (Just so you know, it’s 39 years now).

As the 1980s came to a close investors began to panic. No ITC and no rapid depreciation and no passive loss offset. Investors looked to their tax professionals for relief. CPAs and tax lawyers in the early 90s partnering with structural engineers were surprised to find the IRS Code still contained the 1970s “structural component” classifications. Was this a simple Congressional oversight back in 1986 or did Congress intend to leave these provisions in the code for some reason? At any rate by the mid-90s tax shelter promoters were claiming that the 1970s classifications supported rapid depreciation of “structural components” as long as they were properly classified by competent structural engineers. It didn’t take long for the IRS to start fighting back..

The battle soon moved to US Tax Court in Hospital Corporation of America vs IRS (1997). The facts are simple: Hospital Corporation (HC) was in the business of building and managing hospitals. HC segregated out various components of their many buildings as Section 1245 personal property allowing them to rapidly depreciate these components over a 5 year period. The IRS disallowed all this Section 1245 depreciation sending a $700 Million tax bill to HC for years 1978 to 1988. The Government argued that all the buildings owned by HC must be depreciated over a much longer period of time as required for Section 1250 property in accordance with provisions of the 1986 Tax Reform Act. The critical key issue for the US Tax Court to decide? Whether the structural components laws that remained in the Code from the 1970s were nevertheless still valid in 1997.

Judge Wells in his 116 page Opinion points out that Congress in the 1986 Act did not specifically address the 1970s provisions of the Code that were created to facilitate the ITC back then. The Court noted that the statutory language manifested a Congressional intent to retain the prior law distinction between components that constitute Section 1250 real estate and items that constitute Section 1245 personal property..

With the US Tax Court giving its blessing in Hospital Corporation of America vs IRS (1997), and the IRS acquiescing, a billion dollar “cost segregation” industry was born to “segregate out” the cost of the tangible Section 1245 portion of a building. With a good engineering analysis the CPAs were able to confidently and legally rapidly depreciate substantial parts of commercial buildings on annual tax returns knowing they could win an IRS audit challenging their depreciation computations.
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What does all this mean to you all? First and most important: Cost Segregation is legal folks but only if your experts are better than the Governments.. So if you are purchasing a building, hire the best structural engineering firm you can afford and segregate out those costs into structural components that will qualify for rapid deprecation and immediate tax savings,. Second, make sure your tax attorney and structural engineers guarantee their work so when the IRS comes knocking on your door, the same people who did your analysis will be there at no extra charge to act as your expert witnesses at a possible US Tax Court trial. Likewise ask that the same tax attorney who prepared your tax return to guarantee that she will be there for the IRS audit and a trip to US Tax Court if needed.. Finally, don’t forget to contemporaneously include your structural engineering cost segregation report summary in the actual tax return you file with the IRS. with full explanation from your tax attorney on how you computed your depreciation.. When you are audited years later you will be glad you did..

We hope you enjoyed this weeks TaxView with Chris Moss CPA. Tax Attorney

See you all next time on TaxView

Kindest regards
Chris Moss CPA Tax Attorney

Welcome to TaxView with Chris Moss CPA Tax Attorney

If you have given a large donation to an IRS designated 501(c)(3) public charity in 2015 you all know that you get to itemize that contribution as a tax deduction on Schedule A of your Form 1040 you will file this April 2016.  But there is also another option: the 501(c)(3) Family Private Foundation or PF. While the super-rich have always had PFs, Bill and Melinda Gates Foundation for example, many more American taxpayers are giving PFs a try.  Your family gets significant control over the types of “grants” they make as well as substantial income and estate tax benefits.  Not to mention a permanent legacy for your family for generations to come.  But watch out: there are many IRS Government placed PF traps that can cause your PF to cost you more than its worth in penalty excise taxes when you get hit with an IRS Private Foundation Audit perhaps years later.  So if you have any interest in forming a Private Foundation, stay with us here on TaxView with Chris Moss CPA Tax Attorney to learn the steps in properly operating a PF so that you stay clear of IRS imposed excise taxes during a routine IRS Private Foundation Audit.

The legislative history of the Private Foundation is to say the least fascinating.  One of the first PFs in the early 20th century was the Rockefeller Foundation formed in 1913.  Did the newly enacted income tax enacted that same year and the estate tax three years later in 1916 have anything to do with this?  What do you think?

Over a 100 years and thousands of private foundations later Congress addressed the wide spread abuse of the tax exempt status of private foundations.  A leading 7th Circuit case, Quarrie Charitable Fund v IRS, 603 F.2d 1274 (7th Cir US Court of Appeals 1979) and the House Ways and Means 2005 Report rewinds us back to the Tax Reform Act of 1969. The Act imposed PF excise taxes on self-dealing between the founding family and the PF and a small 2% tax on investment income.  Even with these excise taxes, PFs continue to be extremely popular with many taxpayers and have evolved into Grant-Making Private Foundations (GPFs), Private Operating Foundations (POFs) and Exempt Private Operating Foundations (EPOFs’) which are relatively easy to set up and operate---that is as long as you know where the IRS traps are during an IRS Private Foundation Audit..

The first trap is easy to avoid, but apparently not to Todd v IRS US Tax Court (2002).  In 1994 Todd formed the Todd Family Foundation and transferred 6,350 shares of Union Colony Bancorp to the PF. Todd took a $500,000 charity deduction on Schedule A of his 1994 Form 1040 using form 8283 Noncash Charitable Contributions as substantiation for the deduction.  The IRS audited and disallowed all deductions including carryforwards to 1995-1997 arguing that there had been no qualified appraisal of the stock.  Todd appealed to US Tax Court in Todd V IRS US Tax Court (2002).  Judge Halpern easily finds for the Government citing IRS regulation 1.170A-13 that a qualified appraisal must be made no earlier than 60 days prior to the date of contribution, be prepared and signed by a qualified appraiser and must have been included in the tax return along with Form 8283.  IRS Wins Todd Loses.

The next two traps of control and self-dealing are more complex as discussed by the IRS themselves in their article Developments in the Private Foundation Area (1990). Unlike public charities, PFs are most likely controlled by the founding family, as in Bell v IRS US Tax Court (2009). Bell owned the Bell Family Foundation and numerous other profitable business entities.  Bell contributed stock in Northeast Investors Trust to the Bell Foundation and properly deducted a charitable deduction with a signed appraisal on his 1996 tax return.  There were in addition subsequent charitable carryforwards to years 1997-2000.  The IRS audited and disallowed all Bell’s donations to the Bell Foundation for all years claiming that Bell still controlled the stock because Bell controlled the Foundation. Since Bell still controlled the stock there was never a charitable donation to deduct because no charitable gift had ever been transferred.  The Bells appealed to US Tax Court in Bell v IRS US Tax Court (2009).  The Court noted that although the PF is controlled by the Bells, control alone is not sufficient to defeat the charity deduction by the Bells.  Judge Wells further argues that the IRS had not cited any authority in support of their contention that merely having control over the foundation disqualifies the Bells from claiming the charitable contribution deductions for the contribution of the shares of Northeast Investors Trust to the Foundation. Indeed the Court opines, the “Self-dealing” trap is more likely to trip up PFs as per IRS Code Section 4940 through Section 4945.  IRS loses, Bell Wins. 

Which brings us to the trap of self-dealing.  “Self-dealing’ includes the furnishing of goods, services or facilities between a PF and a disqualified person as per Section 4941(d)(1)(C).  There is one exception: Section 4941(d)(2)(E) allows “self-dealing” to family members if their service was of a professional nature and their compensation was not excessive.  But what about for example a janitorial service? 

In Madden v IRS US Tax Court (1997), Madden’s PF, the Museum of Outdoor Arts contracted with Madden’s Maintenance Company to perform maintenance, janitorial and custodial work.  The IRS audited six years’ worth of Madden’s tax returns from 1983-1989 and charged him self-dealing excise tax on all years. Madden appealed to US Tax Court in Madden v IRS US Tax Court (1997).  Judge Fay reviews the legislative history involving the “personal service” exception of Section 4941(d)(2)(E) noting that in order to prevent PFs from being used by their Founders for personal gain, Congress established a set of arm’s length standards for dealings between the foundation and the Founder members or “disqualified individuals”. H. Rept. 91-413 (Part 1), at 21(1969).  The Court notes that while the IRS regulations do not define the term “personal service” they offer several examples such as legal services, investment management services and general banking services.  The Court therefore concluded that janitorial service was not “personal service” and that Madden was subject to the “self-dealing” excise tax under Section 4941(a)(1).  IRS Wins Madden Loses.

So what can you do to set up your Private Foundation right now in 2016 and be protected during an IRS Private Foundation Audit?  First, choose what area you want to make a difference in the world. One family can change the world with the properly structured PF.  Look at Water Missions and see how this one family is changing the world working through the power of the Holy Spirit to provide fresh water to nations in need.  Next make sure to consult with your tax attorney.  She can set up your PF, including State entity formation, IRS EIN number, application to the IRS for tax exemption Form 1023 and can act as your PF in house legal counsel as well.  Third transfer assets to the Foundation either in cash, stock and/or real estate and begin the journey to create your legacy.  As a secondary yet important benefit your transferred assets are removed from your taxable estate saving you and your family estate tax upon your passing.  Last but not least is the annual income tax savings you receive as you deduct one very large charitable donation on Schedule A of your personal tax return and make sure your Tax Attorney includes her contemporaneously prepared opinion in your tax return prior to filing that your Foundation is legal and in accordance with IRS regulations and Federal law.  When the IRS comes knocking on your door years later you can rest assured you will win the IRS Private Foundation Audit.  All said and done, not a bad way to change the world.  Hope your Private Foundation goes well in 2016.  Thanks for joining us on TaxView, with Chris Moss CPA Tax Attorney. 

See you next time on TaxView,

Kindest regards and Happy New Year 2016

Chris Moss CPA Tax Attorney.