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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 introduced 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 will 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, choose or comparable 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, must be famous. A “good” appraisal is usually one by a professional appraiser.
Given the various ends in case regulation associated to hard-to-value belongings like carefully held entities, worth adjustment formulation clauses can be utilized to take away valuation uncertainty from transactions. Porter detailed the varied sorts of formulation 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 value 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.second 824 (4th Cir. 1944). Porter famous that the place a formulation clause is used, the instrument ought to embody an outline of find out how to reallocate shares whether it is decided that the shares are of a higher or lesser worth than the appraised worth.
For a formulation clause to achieve success, the quantity in extra of the outlined worth should cross to an individual or entity that won’t end result within the imposition of switch taxes. McCord, Hendrix, Petter and Christiansen all concerned transfers of the surplus quantity to charity. Purchasers who are usually not charitably inclined can look to Wandry, which concerned the switch of a specified greenback quantity of belongings, with any “overage” being retained by the transferor, or can take into account QTIP trusts and GRATs as recipients of the nontaxable portion of the switch.
Porter then turned to areas during which the IRS is concentrated on, together with QTIP terminations that contain a surviving partner and installment gross sales. Porter targeted on the next areas:
- Sufficient Disclosure for Statute of Limitations. I.R.C. § 6501(a) supplies {that a} three-year statute of limitations usually 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 subsequently come up at a taxpayer’s loss of life on reward taxes filed years in the past however which the IRS says sufficient disclosure was not happy. Happily, the Tax Courtroom’s current determination in Schlapfer v. Commissioner offered steering that sufficient disclosure requires substantial compliance quite than strict compliance with the sufficient disclosure guidelines.
- Promissory Notes. The IRS generally takes the place that loans on the AFR charge will 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 during 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 embody quotation of PLR 9535026, during which the Commissioner acknowledged {that a} be aware bearing curiosity on the relevant Federal charge doesn’t end in a present topic to reward tax, and of the proposed rules for § 7872, which give a secure harbor for notes bearing curiosity on the relevant Federal charge. Outdoors of the rate of interest context, courts will respect an intra-family mortgage as debt if the events meant the mortgage to be a debt, and the events had an affordable expectation of reimbursement. The IRS will overview 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 is necessary 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 rules; (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, significantly the place arduous to worth belongings 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 below 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 did not respect the integrity of the entity. The place the IRS is profitable, the belongings 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 end result, together with satisfying the bona fide sale take a look at, 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 must be used the place a member of the family is performing as normal associate, and that particular person mustn’t have unfettered discretion with regard to distributions from an entity. He steered use of a “greatest enterprise judgment” or comparable normal the place a member of the family have to be in that position.
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) supplies an affordable trigger exception the place the taxpayer acted in good religion and with cheap trigger in reporting the worth of transferred belongings.
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 must be heeded.
Sarah M. Roscioli is an affiliate at ArentFox Schiff, LLP, in Chicago.
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