• Court interprets guaranty agreement as allowing revocable trust assets to satisfy debt, without limitation, and holds debtor liable for fraudulent transfer—In JP Morgan Chase Bank v. Winget, 129 A.F.T.R.2d 2022-xxx (6th Cir. July 2, 2022), the U.S. Court of Appeals for the Sixth Circuit evaluated another appeal (the ninth!) from the district court decision involving Larry Winget and his debt owed to JPMorgan Chase (the Bank).
Larry’s holding company took out a loan for $450 million from the Bank to purchase another company and eventually defaulted on it. To prevent the acceleration of the debt, Larry and his living trust guaranteed the loan, providing additional collateral. The guaranty agreement limited Larry’s personal liability to $50 million, but there was no limitation of liability applicable to the living trust.
Larry had paid the Bank the $50 million. But after the Bank sued the living trust, Larry revoked the living trust and transferred all the trust assets to himself. A district court found this to be a fraudulent transfer, after which Larry retitled the assets in the living trust. However, before he rescinded his revocation and retitled the assets, he depleted their value. The living trust held valuable limited liability company (LLC) interests prior to the revocation; Larry made hundreds of millions worth of distributions from those LLCs to himself before retitling them in the living trust.
The majority opinion interpreted the living trust as a separate entity and party to the guaranty agreement. The district court had found that the guaranty agreement didn’t explicitly reference the living trust in the provision limiting Larry’s liability. As a result, the living trust wasn’t subject to that protection. As the living trust was liable for the balance of the debt, Larry made a fraudulent transfer when he revoked it. In addition, Larry was unjustly enriched by the cash distributions from the assets prior to the re-funding of the living trust. The court wasn’t convinced by Larry’s arguments that he had a contractual right to revoke the living trust at any time—if the living trust guaranteed the loan, Larry’s revocation after the Bank made its claim was defrauding the Bank under the state’s fraudulent transfer laws. The district court had imposed a constructive trust on the distributions that had been made from the living trust’s assets to Larry, and the Sixth Circuit approved. It noted that the Bank would have sought a charging order that would have entitled it to the distributions made from LLC interests held by the living trust. But before it could do so, Larry revoked the trust and retitled the property and LLC interests in his name.
The dissent, however, argued that a revocable trust isn’t a separate legal entity vis-a-vis creditors. The dissenting judge therefore interpreted the original guaranty agreement to list the living trust as just another source of Larry’s assets for the guaranty, not as a separate party to the agreement. Larry and the living trust were essentially merged with respect to Larrry’s obligations. Therefore, the dissent concluded that the living trust wasn’t separately liable; it was liable on behalf of Larry and, therefore, was protected by Larry’s $50 million limit of liability.
This case shows the cost of drafting errors. More particular language in the guaranty agreement could have saved Larry millions of dollars and years of litigation.
• Taxpayer held to make anticipatory assignment of income with gift of limited partner (LP) interest, and charitable deduction disallowed for incomplete written acknowledgment—In 2015, Kevin Keefer was an LP in Burbank HHG Hotel, LP (HHG), which existed solely to own and operate one hotel property. In April 2015, HHG began discussions with Apple Hospitality REIT (the REIT) regarding a sale of the hotel, and Kevin began talks with the Pi Foundation (the Foundation) regarding a gift of a portion of his LP interest to establish a donor-advised fund (DAF). The timeline of events was as follows:
On April 23, 2015, HHG exchanged a nonbinding letter of intent for a deal including Apple’s purchase of the hotel. It wasn’t signed, as HHG continued to consider other offers.
On June 5, the Foundation provided paperwork to Kevin regarding the gift to the DAF and the applicable provisions that would govern the gift (the DAF packet).
On June 8, Kevin signed the DAF packet.
On June 18, Kevin signed an assignment transferring the 4% LP interest to the Foundation to establish the DAF.
On July 2, HHG and the REIT signed the contract for the REIT to purchase the hotel for $54 million, providing the REIT with a 30-day review period to evaluate the property.
On Aug. 11, the sale closed.
On Sept. 9, the Foundation provided Kevin an acknowledgment letter.
In 2016, Kevin and his wife Patricia timely filed their joint 2015 federal income tax return and claimed a charitable deduction for the 4% LP interest assigned to the Foundation to establish a DAF. Attached to their return was an appraisal of the LP interest, the DAF packet and the acknowledgment letter. However, the Internal Revenue Service disallowed their charitable deduction; Kevin and Patricia paid the asserted deficiency and then sought a refund.
In Keefer et al. v. United States, No. 3:20-CV000836 (U.S. District Ct. for Northern District of Texas, July 6, 2022), the court addressed two main issues: (1) whether Kevin had made an anticipatory assignment of income by the transfer of the LP interest, and (2) whether the paperwork met the requirements of a contemporaneous written acknowledgment (CWA) under the Internal Revenue Code.
Under the assignment of income doctrine, if a taxpayer attempts to assign income to another taxpayer before having recognized it, they’ll be treated as having received the income (and taxed on it) and then paying it to the recipient. Therefore, the taxpayer can’t escape income tax by assigning that income to a charity or another individual. The test applicable to donations of stock holds that there’s no anticipatory assignment of income if: (1) the taxpayer absolutely gives away the entire property, with accrued earnings, (2) before the property gives rise to the sale.
The court analyzed whether the gift was of the entire LP interest. This is often referred to in terms of whether the taxpayer is transplanting a tree (giving away the entire interest) or just giving away the fruit (assigning the income). The donation of the LP interest was subject to an oral agreement that the DAF would share only in proceeds from the hotel sale, but not in the distribution of other assets, including certain cash reserves held in the LP. Because of this condition, the court concluded, Kevin didn’t transfer the 4% LP interest entirely. Instead, he was just transferring a share of the income generated by the sale; it was an assignment of income and not a complete gift of the entire interest. Therefore, it failed the first requirement of the test.
The court did find that the gift of the LP interest (June 18) predated the sale (July 2). The government argued that the sale was so imminent on the date of the gift that the income had essentially vested in the taxpayer, resulting in an assignment of income. Kevin, on the other hand, highlighted all the uncertainty in the transaction at the time of the gift to argue that it didn’t qualify. The court agreed with Kevin that the upcoming sale wasn’t locked in at the time of the gift and that the right to income hadn’t vested at the time of the assignment but held it wasn’t relevant because the donation failed the first factor of the common law test.
Further, Kevin and Patricia lost their charitable income tax deduction due to lack of a sufficient written acknowledgment from the charity. For all charitable donations, IRC Section 170(f)(8) requires that the taxpayer receive a CWA that confirms the amount of cash, a description of any non-cash property contributed and whether the donee organization provided any goods or services in consideration for the donation. In addition, for a donation to a DAF, under Section 170(f)(18), the CWA must state that the DAF’s supervising organization has “exclusive legal control” over the donated property.
The acknowledgment letter didn’t include a statement that the sponsoring organization had “exclusive legal control” over the donated property. Although Kevin’s DAF packet may have established that the organization had exclusive legal control over the donated property, the court wouldn’t consider it as part of the CWA. The DAF packet was given to Kevin before the actual assignment, and it referenced an intended and anticipated donation; it wasn’t contemporaneous with the gift. Additionally, the acknowledgment letter didn’t incorporate the DAF packet by reference or refer to it. As a result, Kevin and Patricia weren’t entitled to the charitable deduction.
• IRS extends time to file late portability election—On July 8, the IRS issued Revenue Procedure 2022-32, allowing certain estates to elect portability of a deceased spouse’s unused federal exclusion amount (known as DSUE) up to five years after the date of death.
Estates of decedents required to file a Form 706, “United States Estate (and Generation-Skipping Transfer) Tax Return” may make a portability election for the DSUE amount on Part 6 of a timely filed return. If a decedent is survived by a spouse but not required to file an estate tax return, the estate may file a Form 706 under IRC Section 2010(c)(5)(a) for the sole purpose of making the portability election. A Form 706 filed solely to elect portability is subject to the same filing deadline: nine months after the decedent’s date of death, unless extended. If the estate misses the filing deadline, the ordinary process for obtaining an extension would be to file a private letter ruling under Treasury Regulations Section 301.9100-3 (known as “9100 relief”).
Under Rev. Proc. 2017-34, an estate could file a return for portability purposes within two years after the decedent’s date of death without having to seek a private letter ruling. Since publication of the 2-year relief period, the IRS has continued to issue numerous PLRs granting extensions of time to those estates that missed the deadline.
Noting that a significant percentage of these PLR requests came from estates of decedents who died within five years, Rev. Proc. 2022-32 was issued to replace Rev. Proc. 2017-34, extending the period to file for portability for five years after the decedent’s date of death. Effective July 8, 2022, the executor must file a complete and properly prepared Form 706 on or before the fifth anniversary of the decedent’s date of death. The executor must state at the top of Form 706 that the return is “filed pursuant to Rev. Proc. 2022-32 to elect portability under Sec. 2010(c)(5)(A).” This method is available so long as the decedent was a U.S. citizen on the date of death, and a Form 706 wasn’t otherwise required and hasn’t been filed.
Rev. Proc. 2022-32 also provides procedural guidance on claims for credit or refund of tax filed under IRC Section 6511(a) by the surviving spouse or the estate of the surviving spouse in anticipation of a portability election.
• Tax Court holds that certain checks deposited on date of death aren’t completed gifts—In Estate of DeMuth v. Commissioner, T.C. Memo. 2022-72 (July 12, 2022), the Tax Court held that checks deposited on a decedent’s date of death, but not paid until three days later, weren’t completed gifts.
Five days prior to the decedent’s death, his son, acting under a power of attorney, wrote 11 checks from the decedent’s investment account. One check was deposited and cleared. Three checks were deposited by the payees on the decedent’s date of death but not paid until three days later. The remaining seven checks were deposited and cleared after the date of death.
The court first considered whether the checks at issue represent completed gifts. In accordance with IRC Section 2033 and corresponding Treasury Regulations Section 20.2031-5, the value of any check written by a decedent that still belongs to them at their death is includible in their gross estate. However, once a decedent makes a completed gift of that check, the value is excludible from the gross estate. State law (Pennsylvania) governed whether a completed gift is made.
In the instant case, although three of the payees deposited their checks prior to the decedent’s death, the decedent’s bank didn’t accept, certify or make final payment on the checks until after the decedent’s death. During this time, a stop order could theoretically have been placed on those checks. Under Pennsylvania law, the court determined that because the decedent retained the power to stop payment on the checks prior to his death, the gifts weren’t completed and should be included in the estate.