Posts Categorized: Tax Update

Steinberg v. Commissioner

Net, Net Gifts: Donee Assumption of Section 2035(b) Tax Liability
Steinberg v. Commissioner, 141 T.C. No. 8, Code Sec. 2035(b), 2512(b)
Issued September 30, 2013

Author: Kerry Reilly, Esq.

Facts:

In April 2007, Jean Steinberg (“Taxpayer”) entered into a “net gift agreement” with her four adult daughters.  Under the net gift agreement, Taxpayer made gifts of cash and securities to each of her four daughters (“Donees”).  In exchange, the Donees agreed to assume responsibility for any federal gift tax imposed as a result of the gift and any federal or state estate tax imposed on the gift under Section 2035(b) in the event the Taxpayer passed away within three years of the gift.

Taxpayer filed a timely Form 709 for tax year 2007 reflecting a net gift amount of approximately $71.6 million and total gift tax of approximately $32 million.  An appraiser, hired by the Taxpayer, calculated the amount of the net gift by reducing the fair market value of the gift by (1) the gift taxes paid by the Donees and (2) the actuarial value of the potential Section 2035(b) estate tax (approximately $5.84 million).

The Internal Revenue Service (IRS) mailed a notice of deficiency disallowing Taxpayer’s entire discount for the Donees’ assumption of the potential 2035(b) tax liability ($5.84 million) and increasing the gift taxes due by approximately $1.8 million.

The IRS requested a summary judgment on one issue only – whether a Donees’ promise to pay any federal or state estate tax liability that may arise under Section 2035(b) may constitute consideration in money or money’s worth within the meaning of Section 2512(b). (emphasis added)

Discussion and Analysis:

Under Internal Revenue Code Sec. 2035(b), the decedent’s gross estate is increased by the amount of any gift tax paid by the decedent or the decedent’s estate on any gift made by the decedent during the three years prior to the decedent’s death.  Under Internal Revenue Code Sec. 2512(b) the amount of the gift is the amount by which the value of the transferred property exceeds the value of the consideration received in money or money’s worth.

The IRS claimed that the Donees’ assumption of the potential Section 2035(b) estate tax failed to build-up or contribute to (“replenish”) Taxpayer’s estate, (monetarily or otherwise) providing only “peace of mind” and therefore failed as consideration under the “estate depletion” theory of gift tax.  The “estate depletion” theory determines what constitutes consideration in money or money’s worth.  If a donor’s estate has not been replenished, then that donor has not received consideration. The IRS rested its claims in part on the Tax Court’s holding in McCord v. Commissioner, 120 T.C. 358 (2003), rev’d and remanded sub nom.  Succession of McCord v. Commissioner, 461 F.3d 617 (5th Cir. 2006) ((a) donees’ assumption of the taxpayer’s 2035(b) estate tax liability was too speculative to be reduced to monetary value and (b) any benefit from the donees’ assumption of the Section 2035(b) tax liability would accrue to the donor’s estate rather than the donor).

The Court agreed with the Court of Appeals and reversed its position in McCord with respect to the “too speculative” claim.  It held that assumption of the potential Section 2035(b) tax liability was not too speculative because a “willing buyer and seller in appropriate circumstances may take into account a donee’s assumption of [this] liability in arriving at a sale price.”  The Court noted that “many courts have held that the value of stock received by gift or bequest must be reduced by capital gains tax regardless of the lack of indication that the capital gains will be triggered by the donee or beneficiary in the near future.” E.g. Estate of Jelke v. Commissioner, 507 F.3d 1317, 1319, 1333 (11th Cir. 2007).  The Court also noted that these cases show it is possible to determine the value of built-in capital gains on the valuation date despite the uncertainty of surrounding factors (i.e. rates, potential repeal of tax, future sale/trigger date, amount of tax due from beneficiary/donee, etc.) and that there is a “possibility that an appropriate method may likewise exist to fix the value of the potential Section 2035(b) estate tax liability…”

The Court also reversed its position on McCord with respect to the “estate depletion” theory.  It held that its prior distinction between a donor and his/her estate was incorrect and that “they are inextricably bound.”  The Court also reasoned that when the Donees assumed the gift tax liability the Taxpayer’s assets were “replenished” by the amount of the gift tax liability assumed by the Donees because the “consideration may discharge [the donor] from liability…the benefit to the donor in money or money’s worth, rather than the detriment to the donee determines the existence…of consideration.” Commissioner v. Wemyss, 324 U.S. 303, 306-308 (1945). The Court reasoned that likewise the assumption of the liability for the potential 2035(b) tax by the Donees may also replenish the Taxpayer’s assets because the Taxpayer’s estate would be relieved of that liability.

Significant Holdings:

The IRS’ motion for summary judgment was denied.  The majority opinion stated that IRS failed to show, as a matter of law, that the Donees’ assumption of the Taxpayer’s potential Section 2035(b) estate tax liability cannot be considered money or money’s worth within the meaning of Section 2512(b).  The majority also held that there were disputes of material fact with respect to whether the Donees’ assumption of potential Section 2035(b) estate tax liabilities constituted consideration in money or money’s worth.  The majority did not enumerate any of these issues however.

A concurring opinion stated that this holding creates a potential valuation issue for the future – that the legal obligation of the Donees to pay the Section 2035(b) estate taxes could be considered an “asset” of the Taxpayer’s estate.  This new asset may result in a windfall to the Donees if the Taxpayer does not die within the three-year period, or could result in the Donees potentially paying an amount in estate taxes that is greater than the discount received.

A second concurring opinion stated that with respect to the “too speculative” theory, neither party had asked the Court to consider that issue, thus the Court’s discussion of that point was premature.  This concurring opinion reflected that with respect to the “estate depletion” theory, the IRS may be able to show that the Donees agreement to pay the Section 2035(b) taxes did not in fact increase the Taxpayer’s estate and was in fact merely (1) a way to apportion the tax within the estate and among the beneficiaries as the Donees will “pay” the taxes either as part of the net gift agreement or in the receipt of a smaller inheritance (if the taxes were paid by the Taxpayer’s estate), and further that (2) the net gift agreement simply memorializes an obligation that the Donees have under New York State law, thus the value of the net gift agreement as it relates to the Section 2035(b) obligation is merely as a “enforcement mechanism.”

The dissenting opinion provides numerous calculations detailing the difference in gift and estate tax amounts due for the gift and net, net gift scenarios if the taxpayer dies within three years of making the gift.  These calculations are provided as illustrative examples that the allowance of the Section 2035(b) payment by the Donees is contrary to Congress’ purpose in enacting Section 2035(b), i.e. to mitigate in part a disparity between the tax bases subject to the gift and estate tax, respectively.  The opinion provides that the allowance of the deduction for the potential Section 2035(b) taxes “allows the transferor to render more lenient the gift taxation (if no Section 2035(b) liability arises) and the estate taxation [(if that liability does arise)].”

2014 Inflation-Adjusted Figures

Authors:
Nikki Marie Oliveira, Esq., LL.M., Bass, Doherty & Finks, P.C.
Michelle B. Kalas, Esq., Riemer & Braunstein LLP

The IRS recently announced the following inflation-adjusted items for 2014:

Gift Tax 

  • Annual Exclusion for Gifts.  The annual exclusion for gifts remains at $14,000 for 2014.
  • Annual Exclusion for Gifts to Non-U.S. Citizen Spouse.  The annual exclusion for gifts to a non-U.S. citizen spouse under §§ 2503 and 2523(i)(2) increases to $145,000 for 2014 (up from $143,000 in 2013).
  • Notice of Large Gifts Received from Foreign Persons.  For 2014, gifts from foreign persons in excess of $15,358 in a taxable year are required to be reported (the threshold in 2013 was $15,102).


Estate Tax

  • Federal Estate Tax Applicable Exclusion Amount.  For estates of decedents dying in 2014, the federal estate tax applicable exclusion amount under § 2010 is $5,340,000 (an increase of $90,000 from 2013).
  • Valuation of Qualified Real Property in Decedent’s Gross Estate.  For estates of decedents dying in 2014, if the personal representative elects to use the special use valuation method under § 2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from the election for purposes of the estate tax cannot exceed $1,090,000 (formerly $1,070,000 in 2013).
  • Interest on a Certain Portion of the Estate Tax Payable in Installments.  The dollar amount used to determine the “2-percent portion” for calculating interest under § 6601(j) of the estate tax extended as provided in § 6166 is $1,450,000 for 2014 (up from $1,430,000 in 2013).


Income Tax

  • Foreign Earned Income Exclusion.  Under § 911(b)(2)(D)(i), this figure is now $99,200 (previously $97,600 in 2013).
  • Tax Responsibilities of Expatriation. The exemption for appreciation in assets recognized by a covered expatriate is increased to $680,000 for expatriations that occur in 2014.
  • Expatriation to Avoid Tax. The standard for determining whether an expatriate is a “covered expatriate” under section 877A(g)(1) is based on whether his or her average annual net income tax exceeded $157,000 for the five taxable years ending before the date of expatriation for tax years beginning in 2014.


Long-Term Care Insurance Premiums

  • For 2014, the limitations under § 213(d)(10) regarding a portion of eligible long-term care insurance policy premiums to be treated as a medical expense for itemizing deductions is based on the taxpayer’s age, as follows:

Age                             Per Individual
40 and under               $370
41-50                           $700
51-60                           $1,400
61-70                           $3,720
71+                              $4,660

Please see Rev. Proc. 2013-35 for additional inflation updates.

Revenue Ruling 2013-17 Clarifies Application of Windsor

Author: Alison Lothes, Esq., Sullivan & Worcester LLP

In Revenue Ruling 2013-17 (8/29/2013), the U.S. Department of Treasury and the Internal Revenue Service issued guidance regarding the application of U.S. v. Windsor, 570 U.S. ___ (2013), which held that the exclusion of same sex couples from the definition of marriage under the Defense of Marriage Act was unconstitutional.  The ruling contained three important determinations.

First, same-sex couples will be considered married for federal tax purposes if they are lawfully married under state law based on the state of the “celebration” (i.e., legal ceremony) of their marriage.  This means that if a couple has been legally married in one state, but later moves to another state which does not recognize same-sex marriage, the couple will still be considered married for federal tax purposes, regardless of their domicile.  The ruling reasoned that this was a natural development of Revenue Ruling 58-66, which held that a couple married through common-law continues to be treated as married for federal purposes even if they move to a state which does not recognize common-law marriages.

Second, the terms “husband”, “wife”, “spouse” and “marriage” will be interpreted in a gender neutral way to refer to persons married in a same-sex marriage.  The Ruling noted that these terms appear in more than 200 Code provisions and Treasury regulations, and that a gender-neutral construction is necessary to avoid constitutional problems under Windsor and consistent with legislative history.

Third, the terms “spouse” and “husband” and “wife” do not include persons who have entered into a domestic partnership, civil union or other formal relationship other than marriage that may be recognized by a state. This applies to both same-sex or opposite-sex couples.

The ruling noted that while the ruling will be applied prospectively as of September 16, 2013, taxpayers may file original, amended, or adjusted returns declaring their marital status as long as the statute of limitations has not expired.  Therefore, amended returns may generally be filed for 2010, 2011 and 2012.  In addition, further guidance will be issued regarding how Windsor will apply to employee benefits and plans.

The New 3.8% Surtax on Investment Income

 

Author: 

 

The Health Care and Education Reconciliation Act of 2010, signed into law by President Obama on March 30, 2010, created a 3.8 percent surtax on certain net investment income.  The application of the surtax began on January 1, 2013. 

Net Investment Income (NII) is defined as: 

(1)   gross income from interest, dividends, annuities, royalties, rents, substitute interest payments and substitute dividend payments unless such income is derived in the ordinary course of a trade or business that is neither a passive activity with regard to the taxpayer nor a financial instrument or commodities business; 

(2)   other gross income derived from a trade or business that is either a passive activity with respect to the taxpayer or a financial instrument or commodities business; and 

(3)   net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property except to the extent the gain is from the sale of property held in an active trade or business other than a financial instrument or commodities business. 

Self-employment income, active trade or business income, gain on the sale of an active interest in a partnership or S-Corp, IRA or qualified plan distributions, trusts for charity (except CLTs) and non-resident alien’s income are all excluded from NII. 

Application of the Tax on Individuals 

The 3.8 percent tax applies to all individuals who have adjusted gross incomes over the threshold amounts and receive net investment income as defined in the Act (see above).  The amount subject to the surtax will be the lesser of (1) the net investment income; or (2) the amount of the taxpayer’s adjusted gross income that exceeds an applicable threshold amount.  The threshold amount for a single taxpayer is $200,000.  The threshold amount for a married taxpayer filing jointly is $250,000 ($125,000 if filing married separate). 

By definition, your adjusted gross income includes wages from work, net investment income, qualified distributions from a retirement plan such as a traditional IRA, 401(k), or 403(b), and any foreign earned income exclusion you may have earned during the tax year. 

How Does the Tax Affect Trusts & Estates? 

The general rule is that the surtax applies to all trusts and estates described in Subtitle A, Chapter J, Part 1 (IRC §§ 641 – 685) that earn income over the threshold amount.  That amount is $11,950 for 2013.  There are however, the following exceptions: 

1.     A trust under which all the unexpired interests are devoted to one or more of the charitable purposes described in IRC § 170(c)(2)(B); 

2.     A grantor trust or § 678 trust; 

a.     Since income in a grantor trust or a § 678 trust is reported on an individual’s income tax returns, the NII will be added to the individual’s 1040 and the surtax will be calculated according to the rules for individuals; 

3.     A trust exempt from tax under IRC § 501(c); 

4.     A charitable remainder trust; 

5.     Most foreign trusts; 

a.     The Treasury Department has indicated that they will take the position that NII accumulated in a foreign trust for the benefit of a domestic beneficiary should be subject to the surtax; 

6.     Business trusts; 

7.     Common trust funds; and 

8.     Pooled income funds. 

The 3.8 percent tax will be imposed on the lesser of: (1) the total undistributed net investment income for the taxable year; or (2) the excess of the entity’s AGI for the taxable year over the highest trust and estate tax bracket ($11,950 for 2013). 

The surtax will not affect everyone but its effect could be steep. Taxpayers, including trusts and estates, in the highest marginal income tax rate, which is currently 39.6 percent, will pay 43.4 percent with the surtax in 2013.

2013 Inflation-Adjusted Figures

Author:
Nikki Marie Oliveira, Esq., LL.M., Margolis & Bloom, LLP

Rev. Proc. 2012-41 was recently released with the inflation-adjusted items for 2013. 

 

Gift Tax.  The figure that is arguably most important to those of us in the T&E field is the annual gift exclusion amount under § 2503.  This amount has been increased from $13,000 to $14,000.  Practitioners will now be advising clients that gift-splitting is permitted at a rate of $28,000.  We’ll get used to it.  For gifts to a noncitizen spouse under §§ 2503 and 2523(i)(2), the exclusion has risen from $139,000 to $143,000.  Recipients of gifts from certain foreign persons are required to report gifts under § 6039F if the aggregate value of gifts received in a taxable year exceeds $15,102 (the threshold in 2012 was $14,723).
Estate Tax.  For estates of decedents dying in 2013, if the personal representative elects to use the special use valuation method under § 2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from the election for purposes of the estate tax cannot exceed $1,070,000 (formerly $1,040,000).  The dollar amount used to determine the “2-percent portion” for calculating interest under § 6601(j) of the estate tax extended as provided in § 6166 is $1,430,000 (up from $1,390,000).
Foreign Earned Income Exclusion.  Under § 911(b)(2)(D)(i), this figure is now $97,600 (previously $95,100).
Please note that Rev. Proc. 2012-41 did not address a number of items, including the following: the tax rate tables under § 1; the adoption credit under § 23; the child tax credit under § 24; the Hope Scholarship and Lifetime Learning Credits under §25A; the earned income credit under § 32; the standard deduction under § 63; the overall limitation on itemized deductions under § 68; the qualified transportation fringe benefit under § 132(f); the adoption assistance exclusion under § 137; the personal exemption under §151; the election to expense certain depreciable assets under § 179; the interest on education loans under § 221; and the unified credit against estate tax for estate of decedents under § 2010(c).  We will keep an eye out for future guidance regarding these items and will update you accordingly.

 

Type of Tax

 

Code Section

 

 

2012

 

 

2013

 

 

 

The “Kiddie Tax”

 

 

 

1(g)

 

 

$950

 

 

$1,000

 

 

 

Rehabilitation Expenditures Treated as Separate New Building

 

 

 

42(e)(3)(A)(ii)(II)

 

 

$6,200

 

 

$6,400

 

 

 

Alternative Minimum Tax Exemption for a Child Subject to the “Kiddie Tax”

 

 

 

59(j)

 

 

The exemption may not exceed the sum of (1) the child’s earned income for the taxable year, plus (2) $6,950.

 

 

The exemption may not exceed the sum of (1) the child’s earned income for the taxable year, plus (2) $7,150.

 

 

Private Activity Bonds Volume Cap

 

 

146(d)(1)

 

 

 

 

The amounts used to calculate the State ceiling for the volume cap for private activity bonds is the greater of (1) $95 multiplied by the State population, or (2) $284,560,000.

 

 

The amounts used to calculate the State ceiling for the volume cap for private activity bonds is the greater of (1) $95 multiplied by the State population, or (2) $291,875,000.

 

 

Eligible Long-Term Care Premiums

 

 

213(d)(10)

 

 

 

 

40 or less … $350
41- 50 … $660
51 – 60 … $1,310
61 – 70 … $3,500
More than 70 … $4,370

 

 

40 or less … $360

 

41- 50 … $680
51 – 60 … $1,360
61 – 70 … $3,640
More than 70 … $4,550

 

Expatriation to Avoid Tax

 

 

877

 

 

 

 

An individual with “average annual net income tax” of more than $151,000 for the five taxable years ending before the date of the loss of United States citizenship is a covered expatriate.

 

 

An individual with “average annual net income tax” of more than $155,000 for the five taxable years ending before the date of the loss of United States citizenship is a covered expatriate.

 

 

Tax Responsibilities of Expatriation

 

 

 

877A

 

 

 

 

The amount that would be includible in the gross income of a covered expatriate is reduced (but not below zero) by $651,000.

 

 

The amount that would be includible in the gross income of a covered expatriate is reduced (but not below zero) by $668,000.

 

 

 

Attorney Fee Awards

 

 

 

7430(c)(1)(B)(iii)

 

 

 $180 per hour.

 

 

$190 per hour.

 

 

Periodic Payments Received under Qualified Long-Term Care Insurance Contracts or under Certain Life Insurance Contracts

 

 

 

7702B(d)(4)

 

 

The stated dollar amount of the per diem limitation regarding periodic payments treated as paid by reason of the death of a chronically ill individual is $310.

 

 

The stated dollar amount of the per diem limitation regarding periodic payments treated as paid by reason of the death of a chronically ill individual is $320.