South Florida Estate Planning Law : Florida Estate Planning Lawyer & Attorney : David Shulman Law Firm : South FL Wills & Trusts

The sports world is a-twitter (as is Twitter itself), about the news that LeBron James is coming to play for the Miami Heat. In the days leading up to the decision, there was much discussion about how much he would be paid in Miami vs. Cleveland. Because Florida does not have a state income tax (and no city in Florida has a local income tax), the Heat could actually pay him less than other teams, and he would end up taking home more.

In order for a state or local jurisdiction to impose an income tax on someone, there has to be some connection between the individual and the jurisdiction.  There are basically two ways that this can happen. First, a state or city can impose an income tax on their residents.  If you live somewhere, that place can tax your income, regardless of where you work.  Second, a state or city can tax people who work in and generate income there, regardless of where they live.  Living in South Florida, the next state is 400 miles away.  But there are millions of people who live in one state and work in another (or even live outside of a city and work in that city).

Generally, if you live in one state in which there is a state income tax and work in another state that has a state income tax, your home state will give you a tax credit towards the taxes paid to the state where you work, or the two states will have a reciprocal tax agreement so that you are only taxed in your home state.  Either way, there should only be one level of tax and not a double tax.  For professional athletes, this is often an accounting nightmare.  Athletes have to pay taxes not only to their home state if there is a state income tax, but a proportional tax for each away game they play in a state with an income tax.   So a baseball player has to keep track of 81 away games (plus playoffs) and has to make proportional payments for all of them.

Now that LeBron is coming to play for the Miami Heat, it's possible that he can save on the Ohio state income tax that he had to pay for (1) his home games, (2) his significant endorsement income, and (3) the away games in states that did not have an income tax (such as when the Cavaliers played the Heat).  Of course, there is one "simple" question he has to answer to avoid the Ohio income tax.

Where does he live?

Remember, as I said above, if he's an Ohio resident, then Ohio can asses the income tax against all of his income, regardless of what team he plays for, and because there is no Florida state income tax, there is no credit or reciprocal tax agreement.

LeBron has to establish Florida residency.

I often speak with clients from up north, usually from New York and New Jersey who want to move to Florida in order to lessen their state tax burden.  They ask if there is a form that they can fill out that says that they live in Florida, and then they want to go back to their job and home in New Jersey where they spend most of their time.  They think that this will save them on state income taxes.

That doesn't work.

There is no "form" to fill out to truly establish Florida residency, and there is no bright-line test.  It is a question of facts and circumstances.  And, it's not Florida that LeBron has to convince (except for the purposes of the Homestead tax exemption), but Ohio.

So what advice would I give to LeBron about establishing Florida residency?  He should do as many of the following as he can, preferably all of them:

• Buy or rent a home as quickly as possible (obviously the most important)
• Apply for the Florida Homestead Exemption (if he chooses to buy)
• Get a Florida Driver's License
• Register to vote in Florida
• Have all of his mail go to his Florida home
• Move his family down here and have his kids go to Florida schools
• File his Federal Income taxes from Florida
• Actually live here during the off-season
• Sell his Ohio home if he can
• Spend more time in his Florida home than he does anywhere else

Again, it's a facts and circumstances test.  The question isn't "did you fill out the correct form."  The question is, "where do you truly consider your home?"  It's understood that wealthy businessmen, actors, and basketball players making $20 million a year will probably have multiple homes in multiple places.  He can have a home in the Hamptons and the South of France if he really wants.  But there is only one place that he truly lives, that he considers his primary domicile.  If he wants to avoid the Ohio state income tax, he needs to get it into his mind that it's now Florida.

Welcome to South Florida, LeBron.  I hope you win us some championships.  Just make sure you remember that this is truly your new home.

 

 

 

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On February 3, 2010, the Tax Court released it's decision in Estate of Shurtz v. Commissioner,

This case is interesting for a number of reasons.  First, even though it involves a family limited partnership, the case is not about the estate taking substantial discounts.  In fact, the word "discount" is not even mentioned in the decision.  Here, the IRS tried to argue that under section 2036, the full value of all the underlying assets contributed by the Decedent to the partnership should be included in the Decedent's gross estate, and not the value of her proportionate, possibly non-discounted partnership interest.  Additionally, this case involves the value of the partnership interest after the death of the first spouse, in which the entirety of the estate was transferred to either a credit shelter trust or a marital deduction trust, thus resulting in no tax due.  

I'm a bit surprised that the IRS took this, a pure 2036 non-discount case to trial, as the evidence of a non-tax business purpose is so clear.

Background

 

The Decedent, Charlene B. Shurtz, was an heir to a very wealthy and religious family, the Barges, (not related to El or Chico De Barge).  The Barge's assets primarily consisted of timberland in Mississippi.  In 1993, at least 14 members of the Barge family owned separate undivided interests as tenants in common in thousands of acres of timberland, either outright or in trust.  Even if the estate tax didn't exist, any competent business or probate attorney would advise the family that this type of ownership is a serious mistake, fraught with risks.  The property could be subject to the creditors of individual owners.  Plus, the joint management of property owned by so many people is burdensome and unwieldy.  Thus, based on an attorney's (correct) advice, they established Barge Timberlands, L.P., a limited partnership, to operate the family timber business.  The Decedent owned a 16 percent interest in the Timberlands LP and also 1/3 of the shares of the Corporation that served as the general partner.

The Timberland partnership agreement provided that the partnership would distribute 40 percent of its income each year to the partners, so that the partners would have funds to pay the taxes on their distributive share of flow through partnership income.  

The Decedent, along with her siblings and fellow partners were still concerned that individual family members could, due to Mississippi "Jackpot Justice," lose their interest in the Timberland Partnership, and control of the family business.  The various family siblings were advised the if each of them contributed their Timberland Partnership interests to a separate partnership, then that would provide better creditor protection because the distributions could be locked into the new partnership, and a creditor would not be entitled to receive anything but a charging order.  In addition, the Decedent wanted to make gifts of the family timberland business to her children.

The Doulos Family Limited Partnership

 

Thus, she and her husband formed a new limited partnership, Doulos LP, in November 1996.  The purpose of Doulos LP was to reduce the estate, provide asset protection, provide for heirs, and in this deeply religious and charitable family, "provide for the Lord's work."  The Doulos LP agreement had language that restricted an outsider from owning an interest, language that was presumably absent from the Timberland LP Agreement.  In addition, the Decedent still owned 748.2 acres of Timberland outright and in her own name only that was not contributed to the Timberland LP, which held previously jointly owned Timberland only.

Before the Doulos Partnership could be established though, there was a problem.  The Decedent owned 100% of everything that was going to be transferred to the Partnership.  Thus, she first transferred a 6.6 interest in her 748.2 acres to her husband, and then the two of them contributed their interests in the timberland, plus her interest in Timberland LP to the Doulos Partnership.

Over the next four years, she made a total of 26 gifts of .4 percent limited partnership interests to her children and to trusts for her grandchildren.  Each gift was valued at $19,700 or less. The Doulos partnership maintained accurate capital accounts for each of its members and filed a Form 1065, a partnership tax return every year.  The entire family actively participated in managing the Timberland LP and the Doulos LP, having annual meetings and consulting family members before any major decisions were made.

The Decedent's Estate

 

Upon Mrs. Shurt's death, her gross estate was valued at $8,768.05.03, with $7,674,143.03 going to trusts qualifying for the marital deduction, and according to the decision, $345,800 going to a credit shelter trust.  Her Form 706 was filed eight months late, but as there was no tax due because of the use of credit shelter/marital deduction trusts, her lawyers were not that concerned.

The IRS argued that the full value of all of the assets contributed by the Decedent to the Doulos Partnership are included in her estate under section 2036, and not the value of the Partnership interest itself, despite the gifts of partnership interests to her children and grandchildren because the IRS contented that she retained control, use, and benefit of the assets within the meaning of section 2036 and 2035 (some of the transfers were within 3 years of her death).

The Court's Decision

 

The decision does not state what evidence the IRS used to argue that assets should be included in the Decedent's estate under 2036, probably because there was not much there.  The Court pointed out that section 2036 causes property to be included in a decedent's gross estate if three conditions are met:

1. The decedent made an inter vivos transfer of property;
2. The decedent's transfer was not a bona fide sale for full and adequate consideration; and
3. the decedent retained the possession or enjoyment of, or the right to the income from the property, or the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or income therefrom.

The Court, citing Estate of Bongard and Estate of Bigelow, pointed out that, "the bona fide sale for adequate and full consideration exception is met where the record establishes the existence of a legitimate and significant nontax reason for creating the family limited partnership, and the transferors received partnership interests proportionate to the value of the property transferred. The objective evidence must indicate that the nontax reason was a significant factor that motivated the partnership’s creation."

As the facts provided, there were several non-tax reasons for establishing the Doulos partnership, including protection of assets and providing centralization of management.  Additionally, these were not deathbed transfers, and the Decedent maintained sufficient assets outside of the partnership to live her life.  Additionally, in order to satisfy the "full and adequate consideration" prong, she had to receive a proportionate partnership interest in exchange for her contribution.  This she did.  Both she and her husband each received partnership interests that were valued in proportion to what they separately contributed to the partnership.

Because the transfer of the assets to the partnership were a bona fide sale for fair and adequate consideration, they were not includable in her gross estate under section 2036.

Take-away

 

The IRS is still actively pursuing family limited partnerships, discounts or not.  Family limited partnerships that are shams will not stand up in court.  However, as long as taxpayers have legitimate non-tax business purposes for establishing the partnership, and they make sure that they keep adequate records in both the formation and operation of the entity, then section 2036 should not apply to the transfers. 

 

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Taxgirl is running an interesting experiment in which she lets her readers post blog entries answering the question, "Hey Congress why don't you. . .?"  There are lots of thoughtful comments.  Sometimes, we attorneys and CPAs get mired in the overly technical and complex details of the Internal Revenue Code, and fail to see the big picture that the public does.

So check it out -- Start Here.

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One of the blogs on my daily reading list is the “Tax Girl” (a/k/a Kelly Phillips Erb, a Philadelphia tax attorney).  She has a regularly occurring feature on her blog called “Ask the Tax Girl” which she uses to answer readers’ tax questions (and sometimes, when necessary, gives her readers the motherly advice that they deserve ).  She recently tweeted that she had received a tax question about Michael Jackson, and I replied that I’ve been blogging about the estate tax issues involved in the case and that I would be happy to answer her reader’s question.

Sigh.  Me and my big mouth. 

Note to self: Never underestimate the sophistication and intelligence of Taxgirl’s readers.  While I was expecting a rather basic, easy to answer, yes or no question, what I got instead was:

• Are Michael Jackson’s funeral costs ordinary and necessary and are they deductible on his estate tax return?

Not necessarily the easy yes or no answer that I had hoped for, but hey, if it were an easy question, the reader wouldn’t have had to ask it.  First some background information.

• As I previously blogged, the estate tax is imposed upon the “taxable estates” of citizens or residents of the US.  Each estate is entitled to a lifetime exemption of $3,500,000, which generally means that the first $3,500,000 of assets are not subject to the tax.  I am not going to explain it again in this post, but please read my previous posts here, here, and here for more detail.
• The term “taxable estate” is defined in Internal Revenue Code Section 2051 as the “gross estate” (which is the net value of the property in the estate) minus “the deductions allowed.”  Just as an individual is entitled to deductions on their income tax return, for example, the charitable deduction and the mortgage interest deduction, an estate is also entitled to deductions that reduce the gross estate, and thus the amount of estate tax owed.
• Section 2053(a)(1) of the Code provides, in part, that one of the deductions allow is that for “funeral expenses.”

For “ordinary run-of-the-mill” estates, the estate deducts the costs of the funeral from the gross estate on the estate tax return.  But in death, as in life, there is nothing “ordinary run-of-the-mill” about Michael Jackson.  What the reader is asking is whether Michael Jackson’s estate can deduct the millions of dollars associated with not just the funeral, but with the memorial service that was held yesterday. 

Section 20.2053–2 of the Treasury Regulations provides that for an estate to take a deduction for funeral expenses, the amounts paid must actually be expended out of property subject to claims.  In other words, in order to take the deduction, the estate itself has to pay the costs. Also, those costs must be out of property that are “subject to claims,” that is property that can be used to pay creditors under local law.  So first of all, any of the costs involved that were not paid by the estate but instead was paid by the taxpayers of the state of California or the city of Las Angeles are obviously not deductible.

The regulation continues, “A reasonable expenditure for a tombstone, monument, or mausoleum, or for a burial lot, either for the decedent or his family, including a reasonable expenditure for its future care, may be deducted under this heading, provided such an expenditure is allowable by the local law. Included in funeral expenses is the cost of transportation of the person bringing the body to the place of burial.”

While there is a requirement for the costs to be “reasonable” that determination is made on a case by case basis.  Reasonable for you and me is not necessarily reasonable for someone with a few hundred million dollars.  So will the costs be deductible?  Like many other tax questions, and many other questions about Michael Jackson, the answer is going to be — it depends. 

Here is my take:

1. Everything involved with the funeral (not the public memorial but the private funeral) itself, no matter how extravagant or expensive will be allowed as a deduction.
2. Everything involved with purchasing and maintaining the burial site itself should also be deductible, even if they build a monument to him.  In a 1927 case a $21,000 mausoleum was deemed reasonable.  That’s over $250,000 in today’s dollars.
3. The costs of transporting Michael Jackson’s body from the hospital, to the funeral home, to the memorial, to wherever his final resting place may be will probably also be deductible.  This includes any costs that the estate reimburses any local jurisdiction for police escort, shutting down city streets, extra security, etc.  Even though the public memorial location is not technically included, I think it would be allowed. 
4. Any other costs paid for by the estate for the public memorial which was not part of the funeral should not be allowed as a deduction.  The public memorial, while touching, was not really part of the funeral, and the IRS would have a strong argument if they chose to disallow the deduction.  However, that being said, I wouldn’t be surprised if the estate took the deduction, and the IRS allowed it.  The larger estate tax battle is going to be over the valuation of Michael Jackson’s intangible intellectual property and the actual size of his liabilities.

Phew.  Thanks for letting me assist, Taxgirl.  I think.

 

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In my previous post, I wrote that contrary to media reports, that it was highly likely, if not impossible that the Michael Jackson Family Trust (which has not yet been released) distributed his assets to his mother and his children outright.  (Various sites are reporting that the mother “gets” 40%, the three children receive 40% between them and that various charities will receive 20%).  I showed that his estate has to pay an estate tax of 45%, and if a distribution was made outright to his 79 year old mother of 40% of his assets (which could possibly be over $100 million) then when she dies, there would be another tax of 45% on the value of her estate.

Again, as the Trust has not yet been released, everything I write is pure speculation.

Most people don’t expect to die before their parents, and I can assume that when drafting his Will and Trust, Michael Jackson felt the same way.  However, he loved his mother and wanted to take care of her for the rest of her life should he pre-decease her. But giving her the money outright would be a tax disaster (and a bad idea for other reasons that I will discuss in later posts).  The solution?  Leave the property to her in a trust with certain rules.

Without going into too many technical details, when a person dies their estate is subject to tax on property they own, and ownership is largely determined by control.  If Katherine Jackson is distributed the property directly, she certainly controls it.  Also, if it is distributed to her in a trust in which she is the sole trustee and has unfettered access to the principal, she is in control.

However, if the property is distributed to a trust in which an Independent Trustee is responsible for determining when, and for what purposes, the trust assets are distributed to her, then upon her death, the property in the Trust will not be subject to the estate tax a second time.  In fact, Katherine Jackson can even be the Trustee herself and make distribution decisions, if the reasons for the distributions are limited to what are known as certain “ascertainable standards.” This means that a trust could be created in which she has the power to withdraw property for her health, education, support, and maintenance.  Upon her death, the property in the trust would not be subject to the estate tax, however, anything that she withdrew from the trust and still owned would be.

By engaging in proper estate planning, Michael Jackson could take care of his mother so that she lives not just comfortably, but in absolute luxury for the rest of her life, and then upon her death, those assets would not be subject to the estate tax a second time.

In a future post I’ll discuss the non-tax reasons why this type of planning is a good idea for everyone, even if you do not have millions of dollars.  This involves protecting the assets from your heir’s potential creditors, and controlling the ultimate disposition of them. 

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I have previously written in the blog about the Estate Tax, but I’d like to revisit the subject using the real life example of the Michael Jackson estate.  First, some review of the basics.

The estate tax, which is often, but inaccurately called the “death tax” by people who oppose it, is not an income tax.  It is an excise tax on the value of assets transferred by an individual at the time of their death.  This includes not just money in the bank, but all assets owned by the individual, i.e. cash, stocks, bonds, real estate, Beatles songs, and Elephant Man bones.

A person dying in 2009 has a lifetime exemption, that is the amount of assets they can transfer at death before the estate tax applies, of three million five hundred thousand dollars ($3,500,000).  After that, the rate of tax on that person’s assets is 45%.  Interwoven with the estate tax is the gift tax which is a tax based on inter vivos (which means lifetime) transfers.  However, for the sake of simplicity, I will assume that Michael Jackson did not make any taxable gifts, that is, he did not make any gifts that would affect the estate tax.

Much of the public debate over the estate tax involves the lifetime exemption.  The higher the exemption is, the fewer people there are that would be subject to the estate tax.  A decade ago, the lifetime exemption was only $600,000, so a great many people were subject to the estate tax.  As it is now, very few Americans have estates that are worth $3,500,000 (especially with the stock market and real estate crash).  A married couple that engages in proper estate planning can leave $7,000,000 to their children (or to anyone they want) tax free. 

But for the Michael Jackson’s of the world, the amount of the exemption is irrelevant.  When you have hundreds of millions of dollars in assets, it does not matter whether the lifetime exemption is $1,000,000 or $3,500,000 or even $10,000,000.  What really matters is the rate, that is what percentage of the assets will be subject to the tax.  As I wrote earlier, Michael Jackson’s estate is looking at a possible estate tax liability of 45% on his taxable estate.  And the IRS doesn’t take payments of Red Zippered suits.  Cash only please.

There are a few things that should lessen the amount of the estate tax that he owes however.  First, the tax is only imposed on the net value of his assets.  The estate can deduct from the value of the assets any liabilities that the decedent had at the time of his death.  And according to published reports, Michael Jackson had very significant liabilities.  In fact, his liabilities may be so large that his estate could be worth far less than anyone would expect.  Second, just like there is an income tax charitable deduction, there is also an estate tax charitable deduction.  Any money that Michael Jackson left to charity will be deducted from the value of his taxable estate, and thus reduce the amount of estate tax that he owes.  Third, the estate may deduct the costs involved in administering the estate, which I also suspect will be substantial.

Although news reports say that it will take years and years to sort all of this out, the estate tax is due and payable nine months after death before interest and penalties (which are substantial) start kicking in.  So whoever is in charge of the Form 706 Estate Tax Return has their work cut out for them.

In a future post I will talk about the essential question of valuation, that is how do you determine what an asset is worth.  Cash and stocks and bonds are easy to value and even real estate has comps.  But how do you value the future income stream of the Beatles catalog?  What is the likeness and image of Michael Jackson himself worth?

Tough questions.  Stay tuned.

 

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I'll write more on this myself as it develops, but here are some articles to check out:

Smart Money: Michael Jackson's Death and Your Estate Plan

Reuters: Hello Goodbye: Jackson's Beatles rights at risk

Wall Street Journal: Getting Personal: Jackson Estate a Tangled Affair

Business Week: Settling Michael Jackson's Estate may be a Thriller.

 

At this point, all anyone is doing is speculating.  No one knows if he had a will or where it is.  At least no one who is talking.  There is a "rumor" going round the internet that "Michael Jackson willed his control of the Beatles songs to Paul McCartney."  That is almost certainly not true.

First, unless MJ specifically said this somewhere, how would anyone know it?

Second, the asset is highly leveraged with many secured creditors.

Finally, it's probably the most valuable thing that he owns.  Why would he do that to his children?

This is going to be fascinating from an estate planning and tax and administration perspective.  And I haven't even talked about what happens to his children yet.

Stay tuned.

 

 

 

 

 

 

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In writing a blog, or in writing anything, the most important question is "Who is your audience?"  So far, my posts have been aimed towards what I call "the sophisticated layman."  I have been writing for the educated reader who is not an expert in matters regarding estate planning or tax, and is interested in learning more. 

But every now and then there is "breaking news" in the estate tax world, that most laymen, sophisticated or not, probably would not be interested in, but would be of interest to estate planning and tax experts. This is one of those times. 

Yesterday, the US Tax Court's issued its opinion in Estate of Jorgensen v. Commissioner, ruling that the entirety of assets transferred to a family limited partnership were included in the gross estate of a decedent under s. 2036(a)(1) of the Internal Revenue Code.

Like many other cases in which there is a complete victory for the Government, the most important lessons in this case for Estate Planning attorneys is "Don't do this." 

More after the jump

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For most people, taxes are relatively straightforward.  Not easy, not pleasant.  But straightforward.  If you have a bank account that earns interest during the year, then at the beginning of the following year your bank sends you a Form 1099-INT reporting the interest that you earned, and sends a copy of that same form to the IRS.

Now there are some people out there who aren't big fans of the whole "bank sends 1099 to the IRS" regime.  Or, in some circumstances they don't want the IRS to know about where the original money came from at all.  Many of these people place their money in banks located in other countries or "offshore" accounts.  Since these banks are in foreign countries, they generally do not report interest earned on their accounts to the IRS.

Before going further I want to point out that there are plenty of legitimate reasons to open an offshore account and that most people who do open offshore accounts properly report and pay their tax obligations.  But there are some that don't.  UBS has been in the news lately for the 52,000 "secret" accounts that it holds for US taxpayers.  How many of them are owned by people who haven't been properly reporting their income?  No one knows.

The IRS and UBS have been wrangling over whether or not UBS will be required to turn over the information to the US government, or whether Swiss Banking laws prohibits it from doing so.  People who have these accounts and have not reported their income or paid their taxes are subject to massive civil and criminal penalties and possibly criminal prosecution.

Today, the IRS is offering the carrot instead of the stick.  Or maybe just a very sharp carrot.  IRS Commissioner Douglas Shulman [no relation] announced that for taxpayers who "voluntarily disclose" their accounts (before the IRS catches them first), the IRS is willing to reduce some of the penalties.

From the Wall Street Journal Article:

In its definition of "voluntary disclosure," the IRS says taxpayers must come forward before the IRS has been given their name by a third party. However, in a call with reporters, IRS spokesmen said that UBS customers whose names already have been divulged to the IRS may still qualify under the "voluntary disclosure" guidance issued Thursday.

 

Taxpayers who come forward voluntarily will face a 20% penalty on their foreign account assets in the year with the highest account value, down from the current 50% penalty levied on account assets in each year the taxpayer failed to disclose the account.

 

Other penalties continue to apply for people who come forward, including either a failure to file penalty of 25% or an accuracy penalty of 20%. Taxpayers will also be responsible for back taxes and interest going back six years, the IRS said.

These rules, in effect for six months, "make sure that those who hid money offshore pay a significant price, but also allow them to avoid criminal prosecution if they come in voluntarily," Shulman said.

Of course, for the average person who doesn't have millions in an offshore account, the IRS is just as friendly as ever with regards to penalties imposed.

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I found this article from Newsday interesting.  They list six ways to save taxes, based mostly on depressed asset values, something that I've written about before.

1. Convert your traditional IRA to a Roth IRA.
2. "Undo" or recharacterize a Roth IRA conversion if your initial conversion was in 2008 when values were significantly higher.
3. If you have begun taking Required Minimum Distributions from your IRA, don't take one in 2009.
4. Take what the articles calls "inherited IRA deductions" which is an income tax deduction for the estate taxes paid on an inherited IRA for something that is known as income in respect of a decedent (IRD).
5. "Get ready" for higher taxes rates that are coming.
6. Transfer assets out of your estate while they are at a low value. 

Each of these may be a good idea depending upon your individual situation.  Before going through with any of them you should see an expert -- a tax attorney, CPA, or financial planner that specializes in this area.

 

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In testimony before Congress this morning, IRS Commissioner Douglas Shulman [No Relation] testified that the Service will be issuing guidance as to how victims of Ponzi schemes can treat their losses for tax purposes.  According to the New York Times:

The plan, which applies to victims of all Ponzi schemes, is likely to provide major relief to the victims of Mr. Madoff, who pleaded guilty last week to orchestrating what prosecutors say is the largest Ponzi scheme ever — one that could reach $65 billion and cover 13,000 investors.

The plan would ease existing rules governing what are known as theft-loss deductions, which are losses claimed by investors who are cheated by their investment advisers and others in Ponzi schemes and other frauds.

Under the plan, which has been reviewed by the congressional offices, the I.R.S. will allow investors who are not suing Mr. Madoff to claim a theft-loss deduction equal to 95 percent of their investments, minus any withdrawals, reinvested gains and payouts from Securities Investor Protection Corporation, the government-chartered fund set up to help protect investors of failed brokerage firms.

Investors who are suing Mr. Madoff, and who thus may have some prospect of recovery, can claim a deduction equal to 75 percent of their investments.

The I.R.S. is also relaxing the rules on how far back the losses can be carried. Current theft loss rules typically allow loss to be carried back 2 years and forward 20 years, but under the plan, the I.R.S. will allow losses to be carried back 5 years as well as forward 20 years.

Under the plan, investors must claim the loss as having happened in 2008.

 I will post any original sources when I find them.

UPDATE: The IRS has issued a Revenue Ruling (Rev. Rul. 2009-09) and a Revenue Procedure (Rev. Proc. 2009-20) (Thanks to Joe Kristan of Roth CPA for the links). Joe did his own reading and analysis of the releases.  My quick read is as follows:

First, the Service issued both a Revenue Ruling and a Revenue Procedure.  A Revenue Ruling generally states what the Service's posistion is on a specific area of law.  A Revenue Procedure sets forth methods for Taxpayers to comply.

Rev. Rul. 2009-09 answers the following questions:

1. Is a loss from criminal fraud or embezzlement in a transaction entered into for profit, a theft loss or a capital loss under s. 165 of the Internal Revenue Code? (The Service ruled it was a theft loss and not a capital loss)
2. Is such a loss subject to either the personal loss limits in 165(h) of the Code or the limits on itemized deductions in 67 and 68? (The Service ruled that the deduction that can be taken pursuant to the answer to 1 above is not subject to the limits of 67 and 68.
3. In what year is the loss deductible? (The Service ruled that a theft loss is deductible in the year in which the taxpayer discovers the loss, which is 2008 and should be deducted on 2008 returns filed in 2009.)
4. How is the amount of the loss determined. (The Service ruled that the amount of the deduction is the initial amount invested plus any additional amounts invested, reduced by any amounts withdrawn, and reduced by claims as to which there is a reasonable basis for recovery.  Therefore, for a Madoff investor, their loss is the initial investment, plus any additional investment, plus any amount that they reported on their income tax returns as gross income over the time of the investment, reduced by any money that was distributed to them. Also, if the Taxpayer has a reasonable chance of recovery of any property, they can not deduct that amount either.)

The Revenue Ruling also discussed Net Operating Losses, the Claim of Right doctrine, and the Statute of Limitations.  It provides that a taxpayer can treat these losses as a NOL, that there is NOT a benefit under s 1341 (the Claim of Right Doctrine), and that a Taxpayer can take a decution in 2008 for amounts taken into income for past years, even if the statute of limitations has expired.

The Revenue Procedure provides a "safe harbor" for Taxpayers -- meaning that if Madoff victims follow it, their returns will not be challenged by the IRS.  It provides for a deduction of 95% of the "qualified investment" a term defined in the Rev. Proc, if the taxpayer is not going to sue Madoff, and 75% if they are going to sue Madoff (or other Ponzi promoters).

 

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One of the issues in drafting estate planning documents is that if there is a mistake in the will or the trust, it is often not discovered until many years later after the testator or grantor has passed away. Sometimes these errors are glaring, such as naming the wrong person in the will. But ofttimes, the mistake is subtle and ambiguous, and might not even be a mistake at all. However, due to the massive amount of estate and generation skipping transfer tax that could be imposed if there is a mistake, it's best to get it correct the first time. Luckily, mistakes can often be corrected, both under state law and through the Internal Revenue Service (IRS) through a process known as reformation. In Florida, the Florida Trust Code provides for Trust modification. This can be done with our without judicial approval depending upon when the Trust was executed, whether the Grantor is still living, whether the Qualified Beneficiaries consent and other factors. See Florida Trust Code Section 736.0410 - 736.04113 for more information. Even though a mistake can be modified for state law purposes, there is often the concern as to what the Federal Estate and Generation Skipping Transfer Tax consequences will be. In many estates, the tax consequences are irrelevant because the amount of money is too small. But Private Letter Ruling (PLR) 200910003 (text not yet available online), which was issued by the IRS on November 17, 2008, and per their records policy released approximately four months later is a good example of the interplay between state law modification and the tax results thereof. In PLR 200910003, the Grantor established a Trust that provided upon her death, the trust assets would be split into a Trust that was exempt from the Generation Skipping Transfer Tax or GST (Exempt Trust) and Trust that was not exempt from the GST (Non-Exempt Trust). The Exempt Trust was for the benefit of the Grantor's Daughter's descendants. The Non-Exempt Trust was for the benefit of the Grantor's Son and Daughter if living, and if not then their issue per stirpes. The Non-Exempt Trust allowed the Grantor's children to withdraw all of the Trust property at any time, which both of them did (in a future post, I'll talk about why that was a horrible decision by the Grantor's children). According to the PLR, the Exempt Trust provided that upon the death of a Primary Beneficiary (which was initially a child of the Grantor's Daughter):

The Trustee shall distribute the principal. . . of any Exempt Trust and any part of the principal of the Non-Exempt trust not otherwise subject to appointment to or in trust for the benefit of such of my descendants as the Primary Beneficiary may appoint under Will bey specific reference to this power. (Emphasis Added)

The "mistake" if there even is one is subtle. Because the Primary Beneficiary is one of the Grantor's descendants, then this paragraph may be interpreted as giving the Beneficiary a General Power of Appointment (which would cause estate tax inclusion) as opposed to a Limited Power of Appointment. The PLR stated that the Trustee would petition a local court to modify the Trust to clear up this ambiguity. The Trustee also asked the IRS for a ruling stating that as a result of the reformation, the Primary Beneficiaries will not possess nor will have ever possessed a general power of appointment with respect to the Exempt Trusts, and that as a result of the judicial reformation the exempt status of the Exempt Trusts for GST purposes will not be affected. The IRS ruled favorably. While that is all well and good, note that the user fee for a private letter ruling is $10,000; plus the costs involved paying the attorneys to prepare the PLR and petition the court for modification. The lesson is that it is important to make sure the documents are correct the first time; and to be careful, because even innocent "mistakes" could result in serious consequences.

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 Taxgirl, the nom de blog of Kelly Phillips Erb, an attorney and tax blogger and among my daily tax must reads, is twittering tax tips between now and April 15.  Tip #1, Sign your Return. 

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