• Closing letters don’t provide full closure—In a partially published correspondence letter to a certain taxpayer (ID CCA_2021040115194343, April 21, 2021), the Internal Revenue Service reminds us that a closing letter doesn’t preclude a later audit. In this letter, the IRS explains that a closing letter (Letter 627) constitutes only acceptance of the filed return. That letter of acceptance is, under Revenue Procedure 2005-32, only a “narrow, limited” communication between the IRS and the taxpayer. In Rev. Proc. 2005-32, the IRS summarizes the procedures relating to re-opening of examinations. It lists categories of certain contacts and actions that don’t constitute examinations and therefore allow a later audit without following other procedures that are necessary for “reopening” a closed case. In this letter, the IRS explains that a closing letter isn’t an examination, so the IRS may initiate an audit later without triggering the procedures for reopening closed cases.
• U.S. Court of Appeals for the Fifth Circuit rules on formula clause gift—The Fifth Circuit upheld the Tax Court in Nelson v. Commissioner (5th Cir. No. 20-61068, Nov. 3, 2021) in favor of the IRS on a formula gift. The taxpayer, Mary Pat Nelson, made a gift of limited partnership interests. The transfer agreement provided that she was transferring limited partnership interests having a fair market value (FMV) of $2.096 million, as determined by a qualified appraiser within 90 days of the assignment. The IRS audited and re-determined the value of the limited partnership interests and assessed additional tax. The taxpayer appealed, arguing that her original appraisal was correct, and even if the valuation was adjusted, the percentage interests transferred would be reduced, regardless, so that only the stated value was transferred.
The Tax Court and the Fifth Circuit disagreed. They noted that the assignment stated the appraisal determined the percentage interests transferred. Once the appraisal was complete, that locked the percentage partnership interests transferred. The transfer agreement didn’t include any provision causing the percentage interests transferred to be dependent on the FMV as determined for federal gift or estate tax purposes or subject to adjustment for revaluation on audit. Nor was there any provision for reallocation of excess units if the valuation changed. Further, because the transfer agreement wasn’t ambiguous, the court didn’t consider any extrinsic evidence.
• Private foundation (PF) seeks approval of transaction relating to excess business holdings—In Private Letter Ruling 2021143001 (Oct. 29, 2021) a PF sought approval of a certain transaction to make sure it wouldn’t run afoul of the excess business holdings restrictions under Internal Revenue Code Section 4943. The PF was a remainder beneficiary of a testamentary trust. Under the terms of that trust, when the last of the income beneficiaries died, the PF would receive shares of Company X, a holding company that owns 100% of a business enterprise, along with some other assets. The PF was interested in assigning most of its remainder interest in the trust to a public charity (retaining a certain number of shares of Company X and one or two other assets), and it obtained a declaratory judgment that approved the transaction, pending a positive ruling from the IRS on the excess business holdings.
IRC Section 4943 imposes an excise tax on excess business holdings of a PF. When determining the PF’s business holdings, the IRS looks through to holdings of other entities owned by the PF. This generally includes income and remainder interests in trusts, unless the business interests were transferred to the trust before May 26, 1969 and the PF holds only one of such interests, not both. Under the Treasury regulations, a PF’s business holdings for Section 4943 purposes will also include business interests disposed of by the PF if it retains some control over the interests by imposing material restrictions or conditions that restrict the recipient from freely using or disposing of the business interests itself.
First, the PF requested a ruling that the stock in the company transferred to the public charity via the assignment wouldn’t be attributed to the PF and that the public charity wouldn’t be treated as a disqualified person. The PF imposed no restrictions on its assignment to the public charity so the business interests wouldn’t continue to be treated as owned by it under the regulations. In addition, because the PF didn’t hold a beneficial or ownership interest in the public charity, it wasn’t owned by the PF nor was it a disqualified person with respect to the PF. Lastly, because the trust was funded prior to May 26, 1969, the business interests held by the trust weren’t attributable to the PF through its remainder interest.