Warning

ANY TAX ADVICE CONTAINED IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED FOR THE PURPOSE OF AVOIDING PENALTIES UNDER THE INTERNAL REVENUE CODE OR PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY TRANSACTON OR MATTER ADDRESSED HEREIN.





Sunday, September 25, 2011

Windfall For "Unmarried' Couples

This was originally published on PAOO on July 3, 2010.

CCA 201021050


CCA 201021050 may provide a significant windfall for some unmarried couples.  It is directed toward registered domestic partners in California and some commentators indicate that it is logically applicable to California same sex married couples.  The ruling emphasizes the point that state law determines ownership of property and that the taxation of income follows the ownership of that income.  California is a community property state and effective in 2007 the community property laws were amended so that registered domestic partners were required to file joint California returns even though they would not be considered married for federal income tax purposes.

I've thought a bit about the tax advantages that an unmarried couple might have even prior to this ruling.  I find it easier to refer to a hypothetical couple I call Robin and Terry.  How exciting is this ruling ?  It really depends on how high Robin and Terry's income is and also how unequal.  For the sake of simplicity I'm going to assume that neither Robin nor Terry itemize (probably unrealistic since the California income tax alone might put one of them over the threshold) and have a total gross income of $250,000.  Computations are for 2009  If all the income is earned by Robin the total federal tax would be $64,830.  This compares to $54,150 if they were allowed to file a join return.  Under the new interpretation they are each deemed to have income of $125,000 resulting in a tax of $26,102 each for a total of $52,204.  If one of them can qualify as head of household the total becomes $49,205. 

Unlike the filing of a joint return by a married couple, the ruling indicates that this income splitting is not elective.  It also indicates that people who have already filed do not need to amend their returns, but that they are permitted to.  The ruling is applicable to years after 2006.  The amended return option is the part that I find very interesting. Suppose Robin had grossed $200,000 and Terry $50,000.  Their total tax would be $54,150, slightly less than a married couple with the same income, but still a bit more than they would pay income splitting with one another.  What if Robin amends to claim a refund of $22,068 ?  Is there a mechanism to force Terry to amend.  I don't think the IRS even has the right to tell Terry what Robin did.  This gets somewhat less exciting if Robin is an employee, since withholdings track to community property income so Robin's amended return would show reduced withholding.

It will be interesting to see if the IRS issues more formal guidance on this issue.  In the mean time all those Robins and Terries out there might want to dust off their returns and crunch some numbers.  They have until April of 2011 to amend their 2007 returns, but have a heart for your tax professionals and don't go asking them to amend old returns during crunch time.

I'm planning on my next post to be about the tax opportunities that "unmarried" couples have generally. It will be titled "Just Because They Won't Let You Do It Doesn't Make It a Good Idea".(It's now available.)

Breaking Up is Hard to Do

This was originally published on PAOO June 27, 2010.

There are quite a few developments in the last few months I am hoping to spout about, but I am going to skip straight to PLR 201024005. The situation is not a common one , but it is a good starting point for a discussion of the tax aspects of divorce. The taxpayer held securities that were qualified replacement property from the sale of stock to an ESOP. The requested ruling , which is favorable, holds that the transfer of the securities to the taxpayer’s spouse will not be a gain recognition event.



All well and good. The question that intrigues me is whether taxpayer’s spouse knows the implications of the settlement. In my fantasy spouse will turn the securities over to a money manager who will sell them all and end up being shocked with the resulting tax bill. There used to be a joke that there are three ways to get out of a burned out tax shelter. The first was to put the interest into a defective grantor trust and then cure the defect . It was a really neat idea. It doesn’t actually work, but it was clever. Then there was dying. Pretty drastic, but it worked (until this year anyway). Finally there is giving it to your spouse and getting a divorce. Still works.




The important thing to remember is that property received in a divorce has the same basis that it had to the couple. So if one spouse gets a pile of money and the other spouse gets a pile of low basis assets of equal gross value, there really hasn’t been an even split. If the couple has significant assets, this could be a much more important issue than who gets the dependency deduction. The dependency deduction seems to garner much more attention than it is worth. Ironically, despite all the attention it is not unusual to neglect to follow through on the requirement that non-custodial parents obtain a release form.






Filing joint returns, in my experience, seems to usually be taken as a given. In situations where you have reason to believe that your spouse has unreported income or even when they have a high exposure return, the smart thing could be to forgo some savings in the interest of peace of mind.






Finally, if alimony is involved you need to be aware that there are fairly complex rules to prevent alimony treatment for payments that are more in the nature of property settlement or child support.

The Magic of S Corporations - Tax Alchemy in Reverse

This was orignially published on PAOO on June 21, 2010.

I remember a time when we had an Internal Revenue Code that was almost as old as I was. The Internal Revenue Code of 1954. Thankfully they kept the numbering scheme intact. Back then we had real tax shelters. Pure tax shelters worked on two principles. Defferal and conversion. You sheltered ordinary income with de

ductions in excess of your cash outlay. That turned around on you eventually but you recognized the turn around as a capital gain. That’s the conversion. Ordinary income taxed at 70% converted into capital gains taxed at 20%. Lead into gold.

I think it takes someone of my age to fully feel the pain of the Nathel brothers who managed to turn gold into lead with their S corporations. The arguments to salvage the situation were clever, but the tax court would have none of them and the second circuit recently confirmed the tax court. The Nathel brotheres each owned 25% of three S corporation. The same unrelated person owned the remaining 50% in each of the corporations. They entered into an agreement whereby one of the corporations was liquidated, they redeemed the third party from another and they were redeemed from the third. The third one called G&D was the source of their tax troubles.




G&D had been experiencing losses so the basis in their stock was exhausted. Additional losses had reduced their basis in loans of $649,775 that they had each made to around 112,547 each. In addition they had guaranteed about 2.5 million of G&D debt. In 2001 G&D fully repaid their debt. Then they each made a capital contribution of $537,228 to G&D which allowed them to be released from their guarantees. Then they surrendered their stock in G&;D in accordance with the restructuring.
The bottom line of their check swapping with G&D was ordinary income of $537,228 from the debt repayment and $537,228 of capital loss from the stock redemption. They tried two arguments. The first was that the capital contribution was a form of exempt income to the corporation. If the corporation had income it would go first to restore debt basis rather than stock basis. The second argument was that the capital contribution was motivated by getting out of the debt guarantee and therefore should be an treated as an ordinary loss. Neither argument went anywhere.

There are two observations to be made here. The first is that it is possible that LLC’s would have better served their purposes. The unified basis of partnership interests would likely have prevented this odd result. The other is that just a little bit of paperwork might have also saved the day. If the S corporation loans had had written evidence of indebtedness then the repayment would have been a capital gain.






All in all, it is a sad tale.

Wednesday, September 14, 2011

Sometimes You Should Just Pay The Taxes

This was originally published on PAOO on 6/17/10.

PMTA 2010-05

PMTA 2010-05 is a reasonably taxpayer friendly statement. It is, however, reasonable to infer that the affected taxpayers are not exactly jubilant. PMTA stands for Program Manager Technical Assistance. True tax junkies are not satisfied with the various rulings issued by the IRS for public consumption - Revenue Rulings, Revenue Procedures, Notices, etc. We have to use the Freedom of Information Act to eavesdrop when the IRS is talking to itself. Of course Research Institute of America does the heavy lifting. The question that the PMTA addressed was :


Whether the temporary pooling of funds on a non-pro rata basis and the appointment of a tenant-in-common owner (“TIC Owner”) as a payment and/or communications agent because of the bankruptcy of the master tenant will cause the tenants-in-common to become partners in a partnership for federal income tax purposes?

The answer was no. With typical IRS hedging the no was qualified with the assumption that the arrangements weren’t actually partnerships to begin with.

I suspect that there are many sad stories hidden behind this ruling. The TIC structure is a creature of tax law. The most general rule of tax law is that when you exchange one thing for something else, you recognize gain, if any. There are of course exceptions. Several of them are collected in Part III of Subchapter O under the heading “Common Non-Taxable Exchanges” including Section 1031 which calls for non recognition of gain or loss when the properties exchanged are of “like kind”. Of course exceptions wouldn’t be real exceptions if they didn’t have their own exceptions. Among the items that cannot be on either side of a qualified like kind exchange along with stocks, bonds, animals of different sexes and “choses in action”(whatever they are) are interests in a partnership.

The 1031 exception is particularly significant in real estate because, for the most part, all real estate in the United States is like-kind to all other real estate in the United States. So if you trade your stallion for a brood mare that is not like-kind, but if you trade your horse farm for an office building it is. You can even exchange your whole horse farm for part of an office building. Which is where the partnership thing comes in. What is the difference between a piece of real estate owned by diverse persons and a partnership of diverse persons that owns a piece of real estate? Such questions keep tax attorneys awake at night and also well fed. Revenue Procedure 2002-22 tells your the conditions your arrangement must meet to be worthy of asking the IRS to rule that it is not a partnership.

That revenue procedure was part of the birth of a veritable industry. Someone selling rental or investment property had always had the opportunity to structure the sale as an exchange by inserting a third party facilitator and is even allowed time after selling the initial property to identify to the facilitator (45 days) the replacement property and for the facilitator to acquire the property (lesser of 180 days or the extended due date of the taxpayer’s return). Someone tired of being a landlord might however view that as exchanging one headache for another. By having a TIC interest as their target there was a broader range of properties available and there would be someone else to deal with all the tenant problems and repairs . Someone else to go bankrupt and leave the TIC members holding the bag.

The saddest part in the PMTA is the reference to the fact that there will be non-prorata cash contributions. Reading between the lines one can infer that some of the owners are bit resentful at having to kick money in to straighten out the mess that they have landed in.

A couple of observations and then a moral. Even if the subsequent events converted the TICs into partnerships, this should not affect the validity of the like kind exchanges that had the TIC’s as their targets. Presumably the investors did not have the master tenant’s bankruptcy as part of their plans, They might want the ruling anyways since preparing a partnership return in these circumstances would be somewhat challenging. Since 1031 defers both losses and gains, some investors might want to argue that the arrangement really was a partnership to begin with and the partnership interest they received was worth less than their basis in their relinquished properties. That would be a real tough argument to make though,

The moral is that tax savings are money. If buying something allows you to save taxes then the thing that you buy doesn’t cost you as much. It doesn’t make it free. And it is possible that , even with the discount that the tax savings creates the thing is not worth what you are paying for it. I might go so far as to speculate that if the thing is designed with tax savings in mind that the designer feels entitled to a goodly share of your tax savings. In some cases, it might be your tax savings and then some. In which case, as the title says, it would be better to have just paid the taxes.



Oh by the way :

Any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Tuesday, September 13, 2011

Steve Martin - Tax Advisor

This was originally published on PAOO on 6/8/10.

Private Letter Ruling 201016097

There is a bit that Steve Martin does where he tells you how to make a million dollars and pay no income tax. It’s a very simple plan. First you make one million dollars. Then you pay no income tax. He then addresses the possibility that the IRS might contact you. Simple. You just say “I forgot”.

Any time I see something of such elegant simplicity I want there to be something to it. Some kernel of truth hidden in the nonsense. When it came to Steve Martin’s routine, though, I despaired Until now.

Private Letter Ruling 201016097 was not directed to Steve Martin. The ruling is directed to a taxpayer who is 82 and according to Wikipedia, Steve was born in 1945. Nonetheless it finally vindicates him as a tax advisor. The taxpayer withdrew all the money from a Roth IRA and failed to put it into a rollover Roth within 60 days. The head note to the ruling indicated that the failure was “due to her mental health conditions which affected her ability to handle her financial affairs”. (That “her” is another clue that it wasn’t Steve Martin, himself, applying for the ruling). More on the gender issue follows.

I thought we might be heading to a punch line involving you have to be crazy to blow a roll over deadline, but I was delighted on deeper reading to find an illustration of the Steve Martin Rule (We need to specify Steve to avoid confusion with Martin Ice Cream, a key decision on personal good will). As we read about Taxpayer A moving funds from IRA Account X to non IRA account Y at financial institution M. We find “Taxpayer A represents that he suffers from a condition which impairs his memory.” There it is. “I forgot.” Whether the memory issues having anything to do with the gender transformation between the head note and the third paragraph is a question left unanswered.


Taxpayer A was granted relief. He or she may have forgotten about the whole thing by now, but the rest of us can remember the next time we are in a jam to say “I forgot.”


Oh by the way :

Any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein

Saint Patrick's Day in May

This was originall published on PAOO on 5/17/10.

This is a true story that happened last week. I've changed the names and locations to keep the people involved annonymous though.

My friend James was in Jacksonvillie FL the other night. He was attending a business reception of some sort. It was one of those events where everybody stands arounds and talks with one another with a brief interlude of some persons of greater or lesser dignitariness patting one another on the back. You need four hands when you are at these events what with limited places to put things down while eating, drinking, shaking hands and exchanging business cards. The last being more or less than the point of attending such events.

Anyway James is less than gifted as a mingler but his job requires him to attend such events from time to time. Not unusually for him he got confused on the way there and ended up parking a goodly distance from the event. After walking a couple of blocks he decided to leave his car where it was since he finds walking less stressful than driving. Whether some greater force was involved in his decision is left for the reader to decide. If there is one.

The event was noiser than most and due to fatigue (from a very early flight not from the walk which was actually invigorating) his mingling was below par even for him. On the other hand they had shrimp and really tender roast beef on small pieces of bread. After the remarks, he circled the crowd a few more times. Deciding he could call it a night he headed back to his rental car.

Halfway back to his car he met Sammy. Sammy was a scrawny looking white guy in his mid 40's with a really impressive set of tatoos who asked James for some money. James has a policy of not giving money to pan handlers but there is nothing hostile about it. Not having any futher agenda for the night he perked up and asked Sammy if he was hungry. This is James method for distinguishing professional pan handlers from people that he might be able to help out a little. Sammy indicated that he was quite hungry. He was banned from the nearby convenince store so James took his order and went in and bought him a sub and a Coke.

Before chowing down Sammy asked if he could borrow Jim's phone to call his aunt in Chicago. He had to leave her a message. James would have preferred to take Sammy to a restaurant, but there was none nearby so they just stood on the sidewalk and chatted.

Sammy had been having a hard time. He was having a hard time finding any work. He was living by the railroad track and had been recently beaten up pretty badly. As the story developed it became quite clear that Sammy would be a lot better off if he could be with his aunt.

Sometimes its just real clear what needs to be done. So James drove Sammy to the Greyhound station and bought him a non-refundalbe ticket to Chicago. He watched him get on the bus and then phoned the aunt to let her know he was on the way.

He was worried about Sammy spending 20 plus hours in transit with no money so he gave a few bucks to go with the tooth brush, mouth wash and snacks that he bought him for the ride. The next day he was worried that the money might have been a bad idea because Sammy confessed while waiting for the bus that he would have drank the price of a bus ticket if James had given it to him rather than buying a ticket for him. The ride to Chicago involved a couple of bus changes. So James called the aunt one more time and ended up talking to Sammy who is very grateful to be off the street.

James is still processing the experience. He wants to cultivate a spirit of detached generosity. On the other hand he wants to share his joy in the whole experience. It is just possible that he saved Sammy's life. He is hoping Sammy doesn't screw up agian, but - I don't know.

So what does this have to do with St Patrick's Day. This year I started San Patricios Against Hunger, because I think that Americans of Irish descent should remember that they are quite likely descended from famine refugees and should celebrate by making donations tohunger fighting charities. The approach James takes towards panhnandlers is an extension of the principal. The point is not to just stop enabling alcohol abuse, but to substitute a positive life affirming act.


We'll see what happens in June.

Lets Be Counted Early and Often

This was originally published on PAOO on 3/24/10.

So two weeks ago I got a note letting me know the census form is on the way. Nice little bit of excitement. Last week it arrived. More anticipation. They want to know who is living in my place on April 1. They also want to know if somebody who doesn’t have anyplace else to stay is there. And in a different context if there is anybody who happens to be staying over, even though they might be listed some place else.
I immediately was thinking about finding a bunch of homeless guys to stay over so that what the genealogy bug bights some future descendant, they can be utterly confused by the 2010 census that includes me. My brother had this experience with the 1920 census report on 48 Anderson Avenue Fairview NJ which included a mysterious Italian teenager of the female persuasion along with the Lyons brothers , their wives and children one of whom is my mother. Fortunately my Aunt Dorothy, cousin really, was around to explain the collection.

Since I really don’t have time to arrange the homeless party and it isn’t really the legitimate business of the census to be checking on whether someone counted elsewhere is visiting me on that night, I probably could have filled the form out.

But you never know. “What is the greatest wonder of all ?” “The greatest wonder of all is that each day death takes lives beyond counting and each day each of us says ‘Not me – not today’”. A lot can happen between now and April 1.

Which is why I was disturbed to get a card in the mail yesterday to confirm that I had gotten the census form and thanking me if I had already sent it in.

Back in the good old days when we did tax returns by hand my favorite review note was RTFI. Which stood for READ THE INSTRUCTIONS. I think I might write that on the card and mail it back.

Listen Pete Reilly Has Come Unstuck in Time

This was originally published on PAOO on 3/8/10

It started when I was trying to figure why I found Avatar so upsetting. It happens that I have no central vision in my left eye. Besides making it difficult to parallel park and hammer nails the lack of natural depth perception made the visual effects somewhat less stunning. Also the colors and odd creatures are not quite as amazing to those of us who have labored long in Azeroth leveling our own avatars. So I paid a little more attention to the plot.

Talk about heavy handed. Bad military. Bad businessman. Mercenary very very double plus ungood - bad bad. Nice scientists. Wonderful wonderful indigenous peoples - especially female ones. Dances With Wolves meets Apocalypse Now.

I realized that what was bothering me was the Mexican War. My friend Jonathan and I are working on a film that will focus on Margaret Fuller. All my reading is focusing on the project now. It happens that I'm in New York with her reading her articles in Greeley's paper, the New York Tribune. (I keep wanting to call it the Herald, because I fondly remember the Herald Tribune. My father would bring it home from work and we would read Art Buchwald.). (I’m not literally in New York now you understand. That’s where Margaret is. Or rather was in 1844 – 1846.)

The Mexican War was her generation’s Vietnam. Only it didn’t last as long. And there wasn’t a draft. And what was probably the worst part for her generation was that the United States won that war. It wasn’t just proto-hippy Henry David Thoreau and his ilk that were against the war -

"Generally the officers of the army were indifferent whether the annexation [of Texas] was consummated or not; but not so all of them. For myself, I was bitterly opposed to the measure, and to this day regard the war, which resulted, as one of the most unjust ever waged by a stronger against a weaker nation. It was an instance of a republic following the bad example of European monarchies, in not considering justice in their desire to acquire additional territory."

Although he quit the Army in 1854, possibly under questionable circumstances, the above officer, known to have a serious drinking problem, had no cause to complain about his career. He was the first US Army officer to be awarded a fourth star and he went on from there to be president.

To compound my problem with all this, when I was watching Avalon I happened to be in Arizona. And I didn’t have my passport with me. So an alternate ending to the Mexican War might have put in tough circumstances.


By some quirky coincidence I finally stumbled on a movie that I had long wanted to see. One Man’s Hero. One Man’s Hero is about the San Patricios. The San Patricios were a battalion in the Mexican Army that contained numerous deserters from the US Army, most of whom were Irish. There were a mixture of motives including shabby treatment of Catholics by the US Army. I was extremely distressed to find that One Man’s Hero had exactly the same plot as Avatar – except for the wonderful indigenous people losing the war. There was the same romantic triangle and – spoiler alert – after surviving his fifty lashes and being branded with a D the hero manages to hook up with the woman who saved his life and embodied Mexico for him.


Nonetheless it is comforting that if I really do slip into that alternate reality where Arizona is still part of Mexico it will be peopled by an alliance of Irish Catholics and Unitarian abolitionists and I'll feel right at home.

Monday, September 12, 2011

IRS Lactation Intolerant

This was published on PAOO on January 11, 2010

PLR 200941003


Somebody once told me about a tax attorney who was presented with a question that he found extremely interesting. His comment was “That is an extremely interesting question. I hope we will have a client situation that it bears on it so I will be able to research it.” For better or worse I lack that discipline and will go poking around at things that will be of little or no practical benefit. It happens that about the most, to me, intriguing ruling of 2009 falls into that category.

PLR 200941003 was about the deductibility of infant formula as a medical expense. Citing Revenue Ruling 55-261, the service held that the formula was not deductible; the reasoning was that the formula just provided for normal nutrition. I think the ruling is wrong and the basis that they used indicates that they missed the point of the ruling request. The ruling request was on the behalf of not, the presumably well-fed, infant, but rather on behalf of the mother, who as it happens, had had a double mastectomy.

The definition of a deductible medical expense is fairly broad. It includes not only diagnosis, treatment and prevention, but also mitigation. Included in the last, for example, would be the cost of a special school. PLR 200318017 allowed a deduction for the various expenses involved in arranging for an egg donation for a woman unable to conceive using her own eggs.

What I find really curious, though, is why the ruling was requested in the first place. I did some, admittedly cursory, research which leads me to believe that the dollars involved cannot possibly be substantial. The furthest out estimate for annual cost of infant formula that I found was around $3,000. $1,200 would be a more representative estimate. Regardless you are not talking much north of $1,000 in tax probably somewhat less. Furthermore, it is not as if the deal will rise or fall based on the tax answer. Conceivably you might scuttle a merger if you can’t get a favorable ruling, but it is pretty clear that deductible or not the formula will be purchased.
It would seem to be a little silly to pay for a ruling request that you might think was frivolous, so why not just take the deduction and disclose?

The only thing I could think of was to create some stir on the issue. I couldn’t find that the ruling generated much other interest though.

Cohan Rules


Originally published in PAOO December 30, 2009.

Every tax geek who visits New York should be sure to stop at Times Square to pay respects to the founder of one of our great principles - The Cohan Rule.  As a Broadway producer Cohan had to spend lots of money entertaining and the like.  The court thought that even though he didn't have any receipts, he must have spent something and the IRS should recognize that.

Sadly the scope of the Cohan rule is constantly narrowed by legislation.  Cohan, himself, would have been nailed by Code Section 274 and you can no longer deduct all the cash you put in the collection plate every Sunday.

The rule still has validity in other areas.  So when you are audited and you don't have receipts, try to have a good story.  If it works, you should be sure to give your regards to Broadway.

Read This Before You Bundle Grandma Onto the Plane

Originally published on PAOO December 30, 2009 just two days before the year without an estate tax.  The end of that year promises to be a trope in many murder mysteries for years to come.

I just read in the Wall Street Journal that many people are being kept on life support in the expectation of living till the effective date of estate tax repeal.  I doubt its enough to create a power surge in the grid when all those plugs are pulled on January 1, but it is a real phenomenon.  Being one willing to go from the ridiculous to the ridiculously absurd, it occured to me that in order to be as safe as possible, you might want to equip a hospital plane to get to a more favorable time zone.  Which way should you fly ?

A lot of people would think to go East.  After all we are GMT - 5 making it later as we fly East.  That's what a lot of people think.  Don't be one of them.  Head west.  Only don't stop in LA or Hawaii or even Samoa.  Get to Fiji.  Actually Tonga is good enough.  That puts you in GMT + 12, which is as good as it gets.  Kiribati is even closer, but I never even heard of that till just now.  But wait.

It doesn't do you any good.  According to Revenue Ruling 66-85 your time of death for estate tax purposes is based on the time zone where the estate tax return is to be filed.  That's the rule for US citizens residing in the US.  Revenue Ruling 74-24 gives a different rule for US citizens living overseas.  There is is based on their domicile at time of death.  Now your domicile is not where you are at any point in time.  It is not necessarily even where you spend most of of your time.  "Home is where the heart is".  In the United States states with high income tax rates think that nobody, in their heart, ever leaves them.  Don't get me started on this one.

According to the latest 706 instructions all estate tax returns are filed in Cincinatti, Ohio.  That would mean that all you have to be able to do is hang on till the ball finishes dropping in Times Square.  Unless you are domiciled in the Yukon.  The commentator from whom I got these cites says that sombody from LA who dies in New York goes by West Coast time, so there is a little bit of doubt in my mind.  Maybe you should hang on till the calendar turns in Samoa to be totally free from doubt.

At any rate forget about chartering the plane.  I doubt it is practical but if you could establish domicile in Fiji between now and then you would be in the best shape possible.  Maybe send a couple of cases of Fiji water to everybody in the family.  That wouldn't be enough, but every little bit helps.

Sunday, September 11, 2011

Devil is in The Details

Originially published on PAOO December 29, 2009.

In June of 2007, the Estate of Sylvia Gore joined the ranks of failed Family Limited Partnership. The case is worthy of consideration, because it illustrates clearly why the partnerships fail. If you are going to set up a family limited partnership it is critical that you consult with a well qualified attorney. The attorney will create a package, more or less thick, of documents, more or less mysterious and will see that you sign them with witnesses, notarized, with an extra copy in her safe in case you lose yours. That’s service. That’s follow through. Valuation discounts are what tends to be at stake when the IRS attacks Family Limited Partnerships. Having had great service from your attorney, you probably think that when people lose it is because they didn’t hire a good attorney. Perhaps the documents weren’t witnessed. Maybe one of the incantations in the mysterious documents was missing. Maybe there wasn’t an extra copy in the safe, after they lost theirs.

The follow through needed is not the extra hour in the attorney’s office. The follow through will be many hours year in and year out in your accountant’s office. The clue to this is in the importance attributed to the extra copy in the attorney’s safe. Why doesn’t the accountant who has to prepare the income tax return for the partnership have a copy? Why don’t you need to look at your copy from time to time too? Here’s why:

each partner's capital account is increased by (1) the amount of money contributed by him to the partnership, (2) the fair market value of property contributed by him to the partnership (net of liabilities that the partnership is considered to assume or take subject to), and (3) allocations to him of partnership income and gain (or items thereof), including income and gain exempt from tax and income and gain described in paragraph (b)(2)(iv)(g) of this section, but excluding income and gain described in paragraph (b)(4)(i) of this section; and is decreased by (4) the amount of money distributed to him by the partnership, (5) the fair market value of property distributed to him by the partnership (net of liabilities that such partner is considered to assume or take subject to), (6) allocations to him of expenditures of the partnership described in section 705(a)(2)(B), and (7) allocations of partnership loss and deduction (or item thereof), including loss and deduction described in paragraph (b)(2)(iv)(g) of this section, but excluding items described in (6) above and loss or deduction described in paragraphs


This is one of the magic incantations that will appear in your agreement. If you ask your attorney how that paragraph should be reflected on the partnership’s tax return, he is likely to tell you that he doesn’t prepare partnership returns. That’s what accountants do. Now go to your accountant and ask her what that paragraph means. Among the possible answers are “That’s some stuff the attorneys have to put in the agreement. Why don’t you ask him what it means?”

So what did Sylvia Gore and her advisers do or fail to do that cost the estate $1,071,650 in federal estate taxes. Plus ten years of interest. Not to mention the cost of their fruitless efforts in the Tax Court.

In 1995 Sydney Gore met with his accountant in the hospital where he expressed to her “his concerns about preserving the wealth he had accumulated through his life's work, protecting his assets from waste, and conserving them for future generations”. The accountant had an idea, a very good idea. Form a family limited partnership. She’d never advised any of her other clients to take that step, but it seemed to the right thing to do here. She knew that she had limits, though:

Ms. Bowers had little experience with family limited partnerships and had never recommended one to a client before she made the proposal to the Gore children, so she recommended that Ms. Powell, Mr. Gore, and decedent retain an attorney to further advise them about a limited partnership”

Apparently it didn’t occur to anybody that an accountant with more than a little experience with family limited partnerships might be able to bring something to the table.

What happened from here can hardly be blamed on the accountant. The partnership opened a bank account into which substantial sums were deposited. There was an assignment of marketable securities to the partnership. Unfortunately, title to the securities was not transferred to the partnership. The dividends from the securities were not deposited in the partnership’s bank accountant. When Mrs. Gore’s bills need to be paid they were paid sometimes from her personal accounts other times from partnership accounts.

Eventually returns need to be filed, which is when Ms. Bowers came back on the scene. What she did was what most competent accountants would try to do. Observing that what actually happened was not anything near like what was supposed to happen, she attempted to fix it all with journal entries. This process relies on one of the great intellectual breakthroughs that built the modern world – double entry bookkeeping first documented in a mathematical treatise over 500 years ago. It provides a built-in check that shows that you captured everything. It all has to balance. Debits equal credits.

When a check is written we credit cash. Then we have to debit something. Well the check went to Mary, so we debit Mary’s capital account. Unfortunately, by the terms of the partnership agreement we were not supposed to make a distribution to Mary. So we debit “Due from Mary”. Joe, on the other hand was supposed to get a distribution. Well either we won’t worry about that since it’s reflected in Joe’s capital or, if we want the percentages to be where they should be, we will credit “Due to Joe” and debit his capital account. When it’s all done the amounts on our records will agree to the statements (adjusted for the fact that they may not have the right names on them) and “it will all balance.” Mary will owe the partnership and the partnership will owe Joe. We’ll straighten it out next year or we’ll keep making journal entries to keep it straight.

I have learned a hard lesson that many accountants never quite get. When it comes to this “everything’s in balance” routine, almost nobody else cares. Here is some of what the court had to say about Ms. Bower’s efforts:

“The GFLP accounting records prepared by Ms. Bowers purport to show that decedent transferred ….”

“The accounting records also purport to show that after decedent executed the assignment, decedent allegedly sold the Commercial Federal CD, the savings bonds, a Valley National CD, and one of the Treasury notes to GFLP in exchange for a note payable to her from GFLP …”

The word “purport” or one of its forms (e.g. “purporting”) occurs six times. Here is the problem. You can get into law school with a liberal arts degree. They don’t teach double entry accounting in law school. If it’s taught in high school, it’s to kids not on the college track. You certainly don’t need it for a liberal arts degree. Judges are lawyers. It all balances and they don’t care.

I have no reason to doubt that if I looked at all the statements and agreements, I’d have concluded that Ms. Bower’s journal entries straightened things out. Likely most other accountants would reach a similar conclusion when they see that the cash ties and “it balances”. Much to our professional frustration, almost nobody else, but especially the judge, cares. The meticulous journal entries that “straighten” everything out in our minds, in the mind of the judge “purport”.

Also this year, the Estate of Concetta Rector lost to the tune of $1,633,049 plus about five years of interest. Here is an excerpt:

The estate attempts to downplay the significance of the direct use of RLP funds to pay decedent's personal expenses by attributing that use to “errors”. In the light of John Rector's extensive financial expertise and his testimony that it never occurred to him that RLP should be reimbursed for such “errors” after they were discovered, we find that this argument lacks credibility
This is nothing new. If you study the cases where taxpayers lose FLP cases, you will, almost always, if not inevitably, find that the failure was not one of a flawed plan. The failure was not following the steps transaction by transaction. If somebody is entitled to a distribution and has bills to pay, you distribute to them and let them pay their own bills. All entities have accounts and the payments in and out are the ones that belong to that entity. If a mistake is made it is fixed by a transfer of funds, not a journal entry that creates an indefinite “Due to”.
The moral of the story is that in order for the plan to work you must have coordination between the attorney who prepares the plan and the accountant who will be preparing the relevant returns. If you don’t want to trouble yourself with what entity should pay what bill or accept what deposit, etc, let that piece be handled by your professionals, also, but again in an integrated manner. There has to be somebody who cares what account is used, because that is their job.

All That Glitters is Not Taxed. Or is It ?

Originally published on PAOO December 28, 2009.

Given any thought to the tax implications of virtual transactions ? I didn't think so. Do you want some thoughts ? If not stop reading.

The IRS has not issued any guidance on the tax issues on virtual transactions. The issues will become more pressing as time goes on. Some of them are

Income Realization - When do you recognize income from virtual transactions? The simple answer seems to be when receiving some real money. This would be based on the theory that all you’re doing is playing a game and that trading with other players is part of the game. Given Blizzard’s terms of service, there is some merit in this argument. You don’t really own anything. There are however public companies more thinly traded than your WOW gold.

The approved market in Linden dollars trades a few hundred thousand real dollars per day. The price, which is market determined, has been hovering around 250 Linden dollars. Linden Labs plays the role of the central bank having the power to increase or decrease the money supply. It is interested in keeping the rate stable. Bottom line -The exchange rate between dollars and euros is much less stable than that between Lindens and dollars.

The only possible guidance on the realization of transactions within a virtual world are cases about whether casino gamblers recognize income before they cash in their chips (literally). Big help. There aren’t many cases and they go both ways.

As long as virtual items are in demand and companies are careful about controlling the money supply, virtual worlds have the potential to become tax havens.

Recognition – Assuming a virtual world transaction is realized could it avoid recognition because all virtual items, including gold or platinum or linden dollars, are of like-kind to all other virtual items? This entertaining thought experiment would be of limited relevance though since it would only apply to investors, not to hobby players or dealers (except in limited circumstances).

Nexus – Where do virtual world transaction take place? – Yuan, a free lance professional WOW player in China raids several tough dungeons and earns 10,000,000 gold. He sells it to a wholesaler for $10,000 who will sell small lots of 500 gold to recreational players in every state in the United States for them to buy better armor or epic mounts within the game. Where did this happen? Can the US tax Yuan? Can Massachusetts tax the wholesaler who is located in Texas? Can Illinois, where the server is located, tax everybody?

Nature of property - Can you invest your IRA funds in Linden dollars? Why not? Because it is a collectible? Collectibles are by definition tangible.

Transfer Taxes – Even WOW’s strict terms of service allow an account to be shared by a parent and a child. A dedicated player could create many avatars worth thousands of dollars (perhaps with dad buying a little gold now and then). Is the value of those avatars includible in dad’s estate since he paid the subscription fees, while junior did most of the monster killing that built the avatars ?