Tax News & Comment — May 2016 View or Print

Federal Courts

United States v. Stiles, 114 AFTR2d 2014-6809, 2014 BL 338556 (W.D. Pa. Dec. 2, 2014) held a personal representative liable for distributing estate assets before paying the decedent’s outstanding tax debt. Distributions made to the fiduciary and his siblings nearly approximated the estate tax liability. The District Court, in granting summary judgment to the government, rejected as irrelevant reliance on the advice of counsel, reasoning that personal liability may be imposed upon a fiduciary of an estate in accordance with IRC § 6901(a)(1)(B) and 31 U.S.C. § 3713(b).  The defendants were held personally liable for the unpaid taxes because (i) they distributed assets of the estate; (ii) the distribution rendered the estate insolvent; and (iii) the distribution took place after the fiduciary had actual or constructive knowledge of the liability for unpaid taxes.

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In Specht v. United States, 115 AFTR2d 2015-357 2015 BL 1651 (S.D. Ohio Jan. 6, 2015), the Court sustained penalties and interest assessed against an estate despite reliance on the advice of counsel concerning when or whether to file or pay.  The executor who retained the decedent’s attorney to assist her was unaware that the attorney had brain cancer. (The attorney was later declared incompetent and voluntarily relinquished her law license.) The attorney incorrectly advised the executor that the estate tax return was due on September 30, 2009. Nevertheless, prior to that date, the executor received several notices from the probate court warning her that the estate had missed probate deadlines. In response to inquiries posed by the executor, the attorney advised that the estate had been granted an extension. In July 2010, another family which had engaged the attorney for a probate matter informed the executor that they were seeking to remove the attorney as co-executor for incompetence.  Ultimately, the estate tax return was not filed until January 26, 2011.  The District Court held that the “failure to make a timely filing of a tax return is not excused by the taxpayer’s reliance on an agent, and such reliance is not ‘reasonable cause’ for a late filing.”

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Similarly, the District Court for the Eastern District of Virginia sustained late filing and late payment penalties for estate tax in West v. Koskinen, No. 1:15-cv-131, 2015 BL 343234 (E.D.Va. 2015) despite claims by taxpayers of reliance on erroneous advice by counsel. The Court held that “reasonable cause” did not exist since counsel had never advised the taxpayers regarding filing deadlines.

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In Mikel v. Comm’r, T.C. Memo 2015-64 (Apr. 5, 2015), the Tax Court allowed the use of Crummey powers given to sixty beneficiaries in a situation where an irrevocable trust contained a no-contest clause and a mandatory arbitration clause. The Court held that neither clause deprived the beneficiaries of a present interest required to qualify for the gift tax annual exclusion. The no-contest clause did not invalidate the Crummey power because it applied only to disputes over certain discretionary distributions by the trustees. The mandatory arbitration clause did not invalidate the Crummey powers because the trust explicitly stated that an arbitration panel was to apply New York law in granting the beneficiaries the same rights they would have under New York law. The Court also noted that any beneficiary disagreeing with the decision of the arbitration panel could still commence legal proceedings.

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Estate of Redstone v. Comm’r, 145 T.C. No. 11 (Oct. 26, 2015) held that the transfer of stock of a family business into a trust for the benefit of the shareholder’s children in settlement of litigation was a bona fide business transaction rather than a taxable gift. In so concluding, the Court cited to the oft-cited Treas. Reg. § 25.2511-1(g)(1) which provides that “[t]he gift tax is not applicable to a transfer for a full and adequate consideration in money or money’s worth, or to ordinary business transactions.” The fact that the children were not parties to the settlement agreement was irrelevant in determining whether the shareholder received full consideration in settlement. As part of the settlement, the Company agreed that it would (in consideration of the stock transfer) recognize that the shareholder was the outright owner of his remaining shares, which it would redeem for $5 million. In determining that the transfers made pursuant to the settlement were made in the ordinary course of business, the Court found (i) that the transfers were “bona fide, at arm’s length, and free from any donative intent;” (ii) that a genuine controversy existed; (iii) that the parties engaged in adversarial negotiations and were represented by counsel; and (iv) that the settlement was motivated by the desire to avoid litigation.

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SEC v. Wyly, 56 F. Supp. 3d 394 (S.D.N.Y. 2014), held that two sets of trusts were grantor trusts and that the settlors (the “Wyly brothers”) should have been taxed on the gain and income of the trusts. The Court emphasized that although the trusts had unrelated corporate trustees, the trust protectors had too much control over the corporate trustees. The first set of trusts (the “Bulldog Trusts”) were created by the Wyly brothers for the benefit of their wives, children, and several charitable organizations. Trust protectors could add to or substitute the charitable organizations. The second set of trusts (the “Bessie Trusts”) were nominally funded by foreign individuals. The beneficiaries of the Bessie Trusts were the Wyly brothers and their families. Offshore professional management companies acted as trustees of both sets of trusts. There were three trust protectors of each trust with the power to remove and replace trustees of all of the trusts. The trustees always followed the investment directions of the trust protectors, who in turn followed the investment directions of the settlors. The basis for the Court’s holding that all of the Bulldog Trusts were grantor trusts was that in reality, the trustees were acting at the direction of the settlors, so the independent trustee exception of Section 674(c) was inapplicable. With respect to the Bessie Trusts, the Wyly brothers were deemed to be the true grantors of the trusts and the named nominal settlors were found to have made no gratuitous contributions to the trusts.

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In Estate of Pulling v. Comm’r, T.C. Memo 2015-134 (July 23, 2015) the Tax Court found in favor of the taxpayer in a dispute concerning the valuation of land held by the estate.  The estate held three undeveloped agricultural parcels of land. All three parcels were contiguous with each other and with two other parcels of land (one of which was also undeveloped).  The three parcels held by the estate were situated such that they could only be developed if developed together with the other two parcels.  The Court held that joint development was not reasonably likely and that the three parcels should be valued independently.

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Estate of Badgett v. Comm’r, T.C. Memo 2015-226 (Nov. 24, 2015), held that a pending income tax refund was includable in the decedent’s gross estate. The Tax Court reasoned that “[t]he status of the tax refund is more than a mere expectancy; the estate has the right to compel the IRS to issue a refund for the years for which decedent overpaid his tax.”  The Court distinguished this case from those in which the taxpayer had undisputed and unpaid tax liabilities which offset tax overpayments. In those cases, estate inclusion was not required since the estate had offsetting current tax liabilities.

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The Seventh Circuit found in Billhartz v. Comm’r, 794 F.3d 794 (July 23, 2015), that the Tax Court had not abused its discretion in refusing to set aside a settlement between an estate and the IRS. The settlement involved a deduction claimed by the estate as payments for a debt. The payments were made to the children of the decedent pursuant to a divorce settlement agreement. Under the settlement, the IRS recognized 52.5 percent of the claimed deduction.  However, the children later sued the estate for failing to pay to them the full amount to which they were entitled. As a result, the estate moved the Tax Court to vacate the settlement since it would prevent the estate from claiming an estate tax refund for any additional amount paid to the children. By settling, the appeals court held that the parties “close the door to new information.”

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In Estate of Sanfilippo v. Comm’r, T.C. Memo 2015-15 (Jan. 22, 2015), the Tax Court held that an illiquid estate liable for $15 million in taxes had been denied a fair hearing with respect to the extension of estate tax payments. Appeals based the decision to sustain a levy on “incorrect and illogical factual and legal assumptions” in that it failed to consider the discussions between the estate beneficiary and the prior Appeals Office regarding collection alternatives. Moreover, the decision to sustain the levy was based primarily on an analysis ignoring the fact that the beneficiary owned a majority interest in certain property before inheriting an additional ten percent interest.

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Windford v. United States, 587 F. App’x 207 (5th Cir. 2014), aff’g 970 F. Sup. 2d 548 (W.D. La. 2013), demonstrates the importance of distinguishing between a tax payment and a tax deposit. The executors were unable to determine the amount of estate tax in a timely manner because of ongoing litigation. A remittance was sent to the IRS, which treated it as a “payment” rather than as a “deposit.” After litigation had concluded, the executors requested a tax refund. The IRS denied the refund stating that the three year statute of limitations for refunds of tax payments had expired. While remittances designated as  tax deposits were refundable, those remittances designated as tax payments were not. Utilizing a “facts and circumstances” approach, the Court held that the remittance was a payment and not a deposit. First, it was not “disorderly” since it was a good faith approximation of the estate’s tax liability. Second, the executors did not dispute the tax liability. Finally, the executors did not designate the remittance as a deposit and the IRS did not treat the remittance as such.

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The Tax Court denied charitable deductions in Beaubrun v. Comm’r, T.C. Memo 2015-217 (2015), because the taxpayer had not obtained sufficient substantiation. To take a charitable deduction of an amount exceeding $250, taxpayers must have a contemporaneous written acknowledgment. The acknowledgment must include a description of any property contributed, a statement concerning whether any goods or services were provided in consideration by the donee, and a description and good-faith estimate of the value of any goods or services provided in consideration. Here, the written statement obtained by the taxpayer was not contemporaneous because it was not written prior to the earlier of  the date on which the taxpayer filed a return, or the due date (including extensions) for filing a return.

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The Court in Hughes v. Comm’r, T.C. Memo 2015-89 (2015), rejected the taxpayer’s position that a gratuitous transfer to a non-U.S. citizen spouse would receive a basis step-up to fair market value, and that there would be no income tax on the transfer itself.  The basis for the taxpayer’s position that a transfer to his wife would be considered a gain rather than a gift was that § 1041(d) denies nonrecognition on spousal transfers where one of the spouses is a nonresident alien. Further, the taxpayer argued that under United States v. Davis, 370 U.S. 65 (1962), the Supreme Court held that  that a taxpayer recognized a gain on the exchange of assets with a spouse pursuant to a divorce settlement agreement. The taxpayer argued that an income tax treaty with the United Kingdom exposed him subject to capital gains tax only in Britain. The Tax Court rejected all of the arguments advanced, finding that Davis applies only in cases of an exchange of assets. Here, since the transfer constituted a gift, the done took a zero basis. In upholding the imposition of penalties, the Court appeared perturbed, commenting that “[g]iven his extensive knowledge of and experience with U.S. tax law, Mr. Hughes should have realized” that his conclusion was incorrect.

NYS Courts & Tax Tribunals

 In Matter of Gaied, 2014 NY Slip Op 01101, the Court of Appeals narrowed the scope of those persons held to be a New York resident for tax purposes. Gaied was decided in 2014. Residency disputes often arise between New York and part year residents, and the Department of Taxation is aggressive in this area.

Gaied Decision

The statutory interpretation at issue involved the asserted imposition by New York of income tax on commuters (or those present in New York for more than 183 days) who also “maintain a permanent place of abode” in New York. The high New York State Court — without extensive discussion — observed that the erroneous interpretation of the lower administrative tax tribunals found no support in the statute or regulations, and consequently lacked a rational basis. Mr. Gaied owned a multi-family residence in Staten Island in which his elderly parents resided. Mr. Gaied commuted to an automotive repair business in Staten Island form New Jersey, but did not reside in the residence. Since Mr. Gaied concededly spent more than 183 days in New York, under the statute his New York State income tax liability hinged on whether the residence constituted a “permanent place of abode” maintained in New York. The Court of Appeals observed that the Tax Appeals Tribunal had interpreted the word “ ‘maintain’ in such a manner that, for purposes of the statute, the taxpayer need not have resided there, A unanimous Court held that this interpretation had “no rational basis.” Both the legislative history and the regulations supported the view that in order to maintain a permanent place of abode in New York, the taxpayer “must, himself, have a residential interest in the property.” The Court declined to speculate as to the amount of time that a nonresident would be required to spend in the New York Resident — or to elaborate upon any other factor justifying the conclusion that a taxpayer “maintained” a permanent place of abode in New York — since that issue was not before the Court. However, given the tenor of the language of the Court, it might appear reasonable to infer that a nonresident taxpayer spending only a de minimis amount of time in a dwelling maintained in New York might not thereby become subject to New York income tax.

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In 2015, the Court of Appeals again had occasion to reconsider the residency rules in Matter of Zanetti, 2015 NY Slip Op 3894 (3rd Dep’t, 2015). This time the issue concerned the effect of the taxpayer spending only partial days in New York. The Third Department in Zanetti held that partial days spent in New York constitute a full day for the purpose of determining New York residency. The determination resulted in the taxpayer being a resident of New York for income tax purposes.

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The taxpayer in Matter of Ryan, 2015 NY Slip OP 8012 (3rd Dep’t  2015), requested a conciliation conference in response to receiving a notice of deficiency.  As instructed in the notice, the taxpayer made the request within 90 days. The request was denied because it was required to have been made within 30 days.  The shorter statute of limitations applies where a fraud penalty is the subject of the requested conciliation conference. The Court held that the Division was not estopped from enforcing the 30-day statute of limitations.

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The Court of Appeals recently considered a civil enforcement action in which the Attorney General alleged that Sprint knowingly submitted false tax statements in violation of the New York False Claims Act. People v. Sprint Nextel Corp., 2015 NY Slip Op 7574 (NY 2015). The tax law at issue was Section 1105(b), which imposes a sales tax on flat-rate plans for voice services to customers whose “place of primary use” is in New York. The Supreme Court denied a motion made by Sprint to dismiss the complaint for failure to state a cause of action. The Appellate Division affirmed the decision of the Supreme Court. The Court of Appeals also affirmed, finding that the statute is unambiguous, that the statute is not preempted by federal law, and that the complaint sufficiently pleads a cause of action.

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 In Exxon Mobil Co. v. State, 2015 NY Slip Op 1840 (3rd Dep’t 2015), the issue was whether required environmental testing and monitoring services relating to petroleum spills are subject to New York sales tax as services relating to “maintaining, servicing and repairing” real property or land. The taxpayer argued that these services were not taxable since the intention was only to assess the condition of property, rather than to remediate petroleum spills. The Tax Appeals Tribunal disagreed with the taxpayer, holding that monitoring and testing services, whether performed before or after remediation work, if any, would be taxable as standalone services because they are necessary for the properties to be in compliance. In an Article 78 proceeding, the Third Department affirmed the decision of the Tax Appeals Tribunal.