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On the 58th Annual Heckerling Institute on Property Planning in Orlando this week, John W. Porter of Baker Botts L.L.P offered present points in property and reward tax audits and litigation and emphasised two key themes all through: (1) preparation for a switch tax audit or dispute ought to start on the property planning stage and (2) an excellent appraisal might be key to a taxpayer’s success towards the IRS. On the property planning stage, advisors ought to take into consideration how every doc will look to an IRS agent, an appeals officer, decide or related in tax litigation. For instance, when writing letters or inside memoranda, all related causes for the transaction, and never simply the potential property and reward tax financial savings, needs to be famous. A “good” appraisal is usually one by a professional appraiser.
Given the numerous leads to case legislation associated to hard-to-value property like carefully held entities, worth adjustment method clauses can be utilized to take away valuation uncertainty from transactions. Porter detailed the varied kinds of method clauses, specifically (1) outlined worth clauses primarily based on values “as lastly decided for property/reward tax functions,” as seen in Property of Christiansen v. Commissioner, Property of Petter v. Commissioner, and Property of Wandry v. Commissioner, (2) outlined worth clauses, as seen in Succession of McCord v. Commissioner and Hendrix v. Commissioner; and worth adjustment clauses, as seen in King v. United States. Importantly, reversion clauses is not going to achieve success pursuant to the holding in Commissioner v. Procter, 142 F.2nd 824 (4th Cir. 1944). Porter famous that the place a method clause is used, the instrument ought to embrace an outline of the right way to reallocate shares whether it is decided that the shares are of a higher or lesser worth than the appraised worth.
For a method clause to achieve success, the quantity in extra of the outlined worth should move to an individual or entity that won’t outcome within the imposition of switch taxes. McCord, Hendrix, Petter and Christiansen all concerned transfers of the surplus quantity to charity. Purchasers who aren’t charitably inclined can look to Wandry, which concerned the switch of a specified greenback quantity of property, with any “overage” being retained by the transferor, or can contemplate QTIP trusts and GRATs as recipients of the nontaxable portion of the switch.
Porter then turned to areas by which the IRS is targeted on, together with QTIP terminations that contain a surviving partner and installment gross sales. Porter centered on the next areas:
- Ample Disclosure for Statute of Limitations. I.R.C. § 6501(a) offers {that a} three-year statute of limitations typically applies from the date a present tax return is filed for the IRS to evaluate reward tax, however the statute doesn’t begin working with out “sufficient disclosure.” Circumstances can due to this fact come up at a taxpayer’s demise on reward taxes filed years in the past however which the IRS says sufficient disclosure was not glad. Thankfully, the Tax Court docket’s latest choice in Schlapfer v. Commissioner supplied steerage that sufficient disclosure requires substantial compliance moderately than strict compliance with the sufficient disclosure guidelines.
- Promissory Notes. The IRS generally takes the place that loans on the AFR price might be valued at lower than face worth for reward tax functions. I.R.C. § 7872 applies to loans that cost below-market rates of interest, the consequence of which is the recharacterization of the transaction as one by which the quantity of curiosity wanted for the mortgage to cost market curiosity is presented from the lender to the borrower after which retransferred by the borrower to the lender as curiosity. Porter defined that if the IRS takes such a place, responses can embrace quotation of PLR 9535026, by which the Commissioner acknowledged {that a} be aware bearing curiosity on the relevant Federal price doesn’t lead to a present topic to reward tax, and of the proposed laws for § 7872, which give a protected harbor for notes bearing curiosity on the relevant Federal price. Exterior of the rate of interest context, courts will respect an intra-family mortgage as debt if the events supposed the mortgage to be a debt, and the events had an inexpensive expectation of reimbursement. The IRS will evaluate the administration of the mortgage in such a dispute, together with whether or not information mirror the debt proof by the mortgage, or if precise repayments had been made. It will be significant that curiosity be paid, and well timed.
- GRATs. The IRS has more and more audited GRAT transactions with three precept focuses: (1) whether or not the phrases of the GRAT adjust to the § 2702 laws; (2) whether or not the GRAT has been operated in accordance with its phrases; and (3) valuation points. Porter once more famous the significance of an excellent valuation, notably the place arduous to worth property are used to pay the annuity, and of correct administration of the GRAT. The IRS will search to substantiate annuity all funds and, if not well timed made, may argue that the retained annuity is non-qualified curiosity underneath an evaluation primarily based on Property of Atkinson v. Commissioner.
- I.R.C. § 2036(a). Ported famous that I.R.C. § 2036(a) is probably the most litigated space, and the IRS has use it to problem household restricted partnerships the place the taxpayers didn’t respect the integrity of the entity. The place the IRS is profitable, the property of the partnership are introduced again into the decedent’s property as a retained life curiosity, even the place the asset was transferred throughout life, and generally leading to a marital or charitable deduction being inapplicable. Porter mentioned a number of methods to keep away from this outcome, together with satisfying the bona fide sale check, or creating two lessons of pursuits (with and with out vote on dissolution/modification). He additionally famous that contemplating the IRS’s explicit curiosity in I.R.C. § 2036(a)(2), warning needs to be used the place a member of the family is performing as normal companion, and that particular person mustn’t have unfettered discretion with regard to distributions from an entity. He recommended use of a “greatest enterprise judgment” or related customary the place a member of the family should be in that function.
Porter concluded his remarks by noting that the IRS has more and more tried to impose valuation penalties in switch tax audits for valuation understatements pursuant to I.R.C. § 6662(g) and (h) which impose penalties of 20 to 40 p.c. §6664(c) offers an inexpensive trigger exception the place the taxpayer acted in good religion and with affordable trigger in reporting the worth of transferred property.
Given the rise in audits by the IRS and its curiosity in making use of penalties, Porter’s recommendation to plan for an audit on the property planning stage and to safe an excellent appraisal needs to be heeded.
Sarah M. Roscioli is an affiliate at ArentFox Schiff, LLP, in Chicago.
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