• Private letter ruling regarding incomplete non-grantor trust holding community property—In PLR 201838007 (Sept. 21, 2018), the Internal Revenue Service ruled on the income, gift and estate tax consequences of an incomplete non-grantor trust funded with community property. The taxpayers lived in a community property state and established an irrevocable trust in a second state for the benefit of themselves, their issue and their mothers. The taxpayers appointed a corporate trustee in the second state (presumably one with no state income tax). The trustee was directed to make certain distributions to the grantors and other beneficiaries as directed by a committee comprised of the grantors and the beneficiaries. The trust provided that the property transferred to the trust would remain community property.
The PLR confirmed that the trust was properly structured to result in the following:
• The trust would be treated as a non-grantor trust as long as the committee is in existence, so that no items of income, deductions or credits of tax relating to the trust would be attributed to the grantors (or members of the committee).
• The grantors’ transfers to the trust wouldn’t be completed gifts (and each of the grantor’s interest in the trust property would be includible in that grantor’s estate).
• Distributions from the trust to the grantors or any other beneficiary wouldn’t be completed gifts by committee members because no member of the committee was deemed to have a general power of appointment.
• The trust property wouldn’t be included in the estate of any committee member because of his powers on the committee.
In addition, the PLR held that the basis of all of the community property held in the trust on the date of the death of the first grantor to die would receive a full basis step-up to the value of the property on such date. This was based on the taxpayers’ representation that all trust property transferred to the trust prior to the death of the first spouse to die was and would remain community property.
This is an interesting ruling because it provides an example in which an incomplete non-grantor trust holds community property and keeps the advantage of the full basis step-up on the death of the first spouse to die, even though the situs of the trust wasn’t in a community property state. This illustrates another dimension to the income tax advantages of these types of trusts.
• Tax Court holds taxpayer didn’t comply with reporting requirements for charitable contribution—In Belair Woods LLC v. Commissioner (T.C. Memo. 2018-159 (Sept. 20, 2018)), the taxpayer filed an income tax return claiming a charitable deduction for a conservation easement on more than 141 acres in Effingham County, Ga. The IRS disallowed the deduction based on a failure to include the tax basis on the Form 8283, as required.
Belair received the tract of land in 2008 in a distribution from a related entity owned by real estate developers (HRH Investments LLC (HRH)). The transfer occurred in the midst of the financial crisis that significantly affected the housing market in the Southeast. A year later, in 2009, Belair contributed the conservation easement to George Land Trust, a qualified organization.
Belair timely filed its 2009 partnership return and claimed a charitable contribution deduction of over $4.7 million, or almost $34,000 per acre. When HRH acquired the tract in 2007, it paid about $2,600 per acre. Belair attached the Form 8283 and an appraisal to its return, but the appraisal didn’t report Belair’s cost basis in the land.
The regulations under Internal Revenue Code Section 170 require, and the Form 8283 directs, that the taxpayer provide certain information regarding noncash charitable contributions, including the taxpayer’s cost or adjusted basis. The instructions to the form provide that if the taxpayer has reasonable cause for not providing the requested information, it should attach an explanation to avoid automatic disallowance.
Belair had retained a consulting firm to advise it in structuring and reporting the easement. The consulting firm relayed advice it received from a law firm stating that: (1) it shouldn’t be necessary to include the basis information on the form because there was reasonable cause, and (2) the reasonable cause was that the basis of the property isn’t relevant to the calculation of the deduction. Relying on that advice, Belair attached an explanation to its Form 8283 stating that it didn’t declare its basis in the property on the Form 8283 because the basis isn’t taken into consideration when calculating the amount of the deduction.
The IRS audited the return and, in 2012, sent an information document request, along with a notice stating that the deduction would be denied because Belair had omitted the basis information from the Form 8283. Belair’s accountant responded about a month later and provided the cost basis. In 2017, the IRS issued a notice of adjustment disallowing the deduction because the requirements weren’t met initially and assessed penalties.
The Tax Court ruled on summary judgment motions for the IRS that Belair wasn’t in strict or substantial compliance with the regulations because it had specifically decided not to include the information on the return. The provision of the information by the accountant as part of the audit process almost three years later didn’t change the outcome. Nor did the fact that there was information attached to the return from which the cost basis could be derived.
While the Tax Court held that Belair wasn’t in compliance, Belair claimed reasonable cause as an excuse. Under IRC Section 170(f)(11), there’s a reasonable cause defense for the failure to comply with regulatory reporting requirements if the failure is due to reasonable cause and not willful neglect. Reasonable cause can be shown if the taxpayer reasonably relied on the advice of a tax professional in good faith. The Tax Court wasn’t able to decide whether Belair reasonably relied on advice from the consultant without further resolution of certain facts (whether the consultant was a tax professional, among others) and so didn’t grant summary judgment on this issue.
This case illustrates the dire consequences of failing to adhere to the disclosure requirements for charitable contributions.
• Tax Court finds taxpayers didn’t properly report benefits of insurance arrangement as income—In De Los Santos v. Comm’r (T.C. Memo. 2018-155 (Sept. 18, 2018)), a married couple disputed the IRS’ characterization of a certain benefit plan. The husband was the sole owner of an S corporation (S corp) that employed him, as a physician, his wife, as an office manager, and four other individuals. In 2006, the S corp elected to participate in a benefit plan run by Legacy Benefit Plans, LLC. Under the benefit plan, the S corp made contributions to a certain trust administered by the plan. The trust purchased an insurance policy on the lives of the taxpayers of which the trust was the owner and beneficiary. Under the benefit plan, the taxpayers were entitled to a $12.5 million death benefit, funded by the insurance policy owned by the trust.
From 2006 to 2010, the S corp contributed just over $372,000 each year to the trust as part of the plan. The trust then paid the premiums on the policy. No additional payments were required after 2010; the S corp had made all the contributions required to fund the insurance policy. The contributions to the trust exceeded the cost of the premiums, so there was accumulated value in the policy by 2011.
The taxpayers filed their income tax returns for 2011 and 2012 but didn’t report any income related to their participation in the plan. The IRS determined deficiencies of over $1 million in income for the taxpayers’ 2011 and 2012 income tax returns and assessed penalties, asserting that the taxpayers had received taxable economic benefits from their participation in the plan.
The Tax Court agreed with the IRS and held that the participation in the plan met the requirements in the income tax regulations as a compensatory split-dollar arrangement. As a result, the taxpayers had to report the full value of all economic benefits they received, reduced by any consideration paid to the
S corp (of which there was none). Those economic benefits include the amount of policy cash value to which the taxpayers had “access.” Under the regulations, “access” includes the taxpayers’ current or future rights to that cash value.
The Tax Court held that, under prior case law, the taxpayers had a future right to the policy cash value because they had a right to designate who would receive the death benefits under the plan. And, once the S corp had made contributions to the trust under the plan, those contributions were irrevocable and inaccessible to the S corp. So, even though the taxpayers couldn’t withdraw funds from the policy directly or indirectly through the trust, the policy cash value was beyond the control of the S corp. That was enough to cause the cash value of the plan to be taxable to the taxpayers each year (to the extent it wasn’t taken into account for a prior year) as an economic benefit under the split-dollar rules.
• Projected 2019 inflation adjustments—The IRS hasn’t yet released the official inflation adjustments for 2019, but the following are projected:
For an estate of any decedent dying in calendar year 2019, the basic exclusion amount will be $11.4 million for determining the amount of the unified credit against estate tax under IRC Section 2010. The exemption for generation-skipping transfer tax, which is determined by reference to the unified credit, will also be $11.4 million.
The annual exclusion will remain the same as in 2018: the first $15,000 of qualifying gifts to any person is excluded from the calculation of taxable gifts under IRC Section 2503 made during that year.
For calendar year 2019, the first $155,000 (up from $152,000) of qualifying gifts to a spouse who isn’t a U.S. citizen (other than gifts of future interests in property) will be excluded from the total amount of taxable gifts under IRC Sections 2503 and 2523(i)(2) made during that year.