Citing to an article I published in 2003,* Judge Lauber of the US Tax Court in Webber v. Commissioner, 144 T.C. No. 17 (June 30, 2015) found that the taxpayer, the owner through a grantor trust of private placement life insurance policies, was taxable on all income earned by the policies because he exercised too much control over the investments owned within the policies.

While an important case given the rarity of guidance in this area, it is also a fairly obvious result. There are two types of investor control:

(1)    one is the type of direct control over the investment assets and decisions exercised by Mr. Webber,

(2)    the other derives from an interpretation of more oblique factors (such as whether the underlying investment funds are publicly available) that may or may not indicate investor control and, depending on who you believe, may be largely supplanted by section 817(h).

In finding that Mr. Webber made the investment decisions that should have been reserved to the investment manager employed by the insurance company--the first test recited above--the Court held that the taxpayer was clearly in violation of the investor control doctrine. Judge Lauber called this “the bedrock ‘investor control’ principles enunciated in Revenue Ruling 77-85.” No surprise there; the fact that the case was litigated is more surprising.

What was not at issue in this case and was not addressed, except in footnote 19, where my article was cited, was the second type of investor control and the type I have written about repeatedly. While neither adopting nor rejecting the rationale in the article, Judge Lauber’s dicta lends support to my conclusion by stating that “the section 817(h) diversification standards may supersede some aspects of the pre-1984 revenue rulings that discuss publicly available investments held by segregated asset accounts.”

Whether the IRS' rulings delineating the second type of investor control has survived enactment of section 817(h) still awaits a case addressing that issue.

*David S. Neufeld, "The 'Keyport Ruling' and the Investor Control Rule: Might Makes Right?," 98 Tax Notes 403, 405 (2003) available in the Articles page

I was honored to be asked by Kurt Baker of Certified Wealth Management & Investment LLC ( here in Princeton, NJ to appear on his weekly radio program broadcast/webcast/podcast on 107.7 FM "The Bronc"...Master Your Finances. For the entire hour we spoke about the issues that folks have when they have homes in multiple states and want to be sure that the state with the lowest tax cost is considered their tax residence. The recording of the interview is here.
Neufeld radio interview: state tax residency
David Neufeld with Kurt Baker (left)
Neufeld Radio Interview: State tax residency
David Neufeld (left) with Kurt Baker
On May 29, 2015, the New York State Department of Taxation and Finance issued an Advisory Opinion that a membership interest in a single-member LLC (SMLLC) which is disregarded for income tax purposes is not “intangible property” for New York State estate tax purposes. Thus the New York real estate (in this case a condominium) owned by the SMLLC will be included in a of New York State estate of the non-resident decedent who was the LLC member.

Where a SMLLC is disregarded for Federal income tax purposes, it is treated as owned by the individual owner.  However, where a SMLLC makes an election to be treated as a corporation, rather than being treated as a disregarded entity, such ownership interest would then be considered intangible property for New York State estate tax purposes and excluded from the estate of a non-resident. (TSB-A-15(1)M)

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As the author of Nevis’ limited liability company law in 1995 it is gratifying that it has long been highly regarded as the standard among LLC laws, blazing new trails that other jurisdictions, even in the US, took years to follow. Even as the years have passed and other jurisdictions enacted similar laws, the Nevis LLC continued at the forefront. But with external legal developments, no law can go without a face lift to avoid looking old and irrelevant.

On May 27, 2015 the Nevis Assembly enacted the Nevis Limited Liability Company (Amendment) Ordinance, 2015, based on a draft I provided at the request of the Nevis government, with the help of Jan Dash, a lawyer in Nevis with Liburd & Dash. Along with several important as well as housekeeping provisions, principal among the provisions as enacted are updated judgment creditor, including charging order, provisions and a new fraudulent transfer section. It is effective July 1, 2015. An unofficial version appears at the top of this blog. This was one of three ordinances passed that day; the others are amendments to Nevis international corporation law and to its international trust law.

Section 43 contains the provisions addressing the rights of a judgment creditor.  This is commonly referred to in the US as a charging order provision, although it goes further than simply charging orders. In 1995 this was a state-of-the-art provision limiting the ability of certain creditors of limited liability company members from obtaining rights to property of the limited liability company. The NLLCO is one of the few (and certainly one of the first) to provide that this charging order provision is the sole remedy available to the creditor. Over the years issues have developed concerning how this provision works in the context of foreclosure and other equitable remedies and single member LLCs, among others.

The section is completely revised; the changes are as follows:
  • —Acknowledges that a judgment creditor of a member of the limited liability company or of a segregated series has the ability to charge such member’s interest in the limited liability company or series, as the case may be and receive distributions otherwise going to the member;
  • This applies to bankruptcy trustees as well;
  • It ignores punitive damages and multiplied damages, such as treble damages that might apply under certain laws of some jurisdictions, and fines and penalties;
  • Permits redemption of a charged interest;
  • Acknowledges that this remedy is, as always, the sole and exclusive remedy, legal or equitable, and also clarifies that it extends to single member limited liability companies;
  • Clarifies that the order is not a lien;
  • Changes the existing law to provide that the creditor does not become an assignee but maintains the operation that prohibits the creditor from interfering in the business of the limited liability company;
  • The charged member may continue to exercise his rights;
  • The order shall be non-renewable and shall expire after three years;
  • The company may make a call for further investments from its members and may retain a distribution that would otherwise go to the charged member as such member’s satisfaction of the call. 

New Section 43A deals with fraudulent conveyance issues as they relate to transfers to an LLC, i.e. the ability of creditors of a member to recover a claim against such member from property contributed to the company; this is derived from §24 of Nevis’ international trust law (the Nevis International Exempt Trust Ordinance). This essentially provides that the creditor must prove beyond a reasonable doubt that such transfer was intended to defraud the creditor and that the member was thereby rendered insolvent, considering all of his assets including the full fair market value of the LLC interest.  The claim must be made within a two year window.

What is not in the amended law is as important as what is included. The draft amendments included provisions that would have permitted Nevis LLCs to have series, making what is already a primary offshore entity law even more formidable. In addition, the Nevis government has draft amendments to its insurance laws permitting cell captives. These series provisions were excluded as were the cell captive amendments to Nevis’ insurance laws at the same time as other jurisdictions have seen value in enacting such provisions. 
An estate tax rule that income tax practitioners NEED to know…

The IRS just released proposed regulations implementing the modified carry over basis rules for decedents that died in 2010. If you think this is narrow and limited, you may be right in some sense, but every asset that passed during 2010 under these rules will be affected for many years to come.

In 2010 the estate tax went away. But with the 2010 Tax Act (the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Public Law 111-312 (TRUIRJCA)) (we’re just going with the 2010 Tax Act since I cannot with a straight face use the term TRUIRJCA) it came back. That 2010 Act retroactively reinstated the estate tax, except for those lucky souls dying in 2010.

With an estate tax, as before 2009 and since 2011, the basis of property passing from a decedent is stepped up or down, as the case may be, to the fair market value. However, with the 2010 Act things got more complicated: the executor of the estate of a decedent who died in 2010 was permitted to elect a modified carry over basis (the Section 1022 Election). Under these rules the basis of property in the hands of a person acquiring the property from that decedent is treated as having been transferred by gift. Thus if the decedent's adjusted basis is less than or equal to the property's fair market value (FMV) determined as of the decedent's date of death, the recipient's basis is the adjusted basis of the decedent (i.e. the lower of the two). If the decedent's adjusted basis is greater than that FMV, the recipient's basis is limited to that FMV (i.e. again, the lower of the two). In the former case, where the decedent’s 


Ethincs of Tax Planning: The Big Debate (Neufeld Essay)--IFC Economic Report Spring 2015
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The Spring 2015 issue of the UK publication IFC Economic Report focuses on the balance between tax planning to the letter or to the spirit of the law and examines the ethical issues surrounding tax planning in the current legal environment. In that spirit, the publication asked six lawyers, academics and policy advocates from around the globe to revisit Judge Learned Hand's oft quoted statement that one may structure one's affairs to minimize taxes. They call this the "Big Debate." Here is my essay as contained in that issue.
#IFCEconomicReport #BigDebate #JudgeLearnedHand #TaxPlanningEthics
Saying that Bitcoins and other virtual currencies are more akin to property than to currency, the Department of Taxation determined that any use in New Jersey of Bitcoins to acquire any other property will be treated as barter and will subject both sides to sales tax. TAM-2015-1 (March 10, 2015). As property that changes in value a party holding and using Bitcoins may also have income tax liability arising from them.

Virtual currency is a form of digital money that can be used as a medium of exchange or as a form of digitally stored value. Taxpayers may use it to pay for goods or services, or hold it for investment. Virtual currency that has an equivalent value in real currency or that acts as a substitute for real currency is “convertible” virtual currency. The sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services, may have sales, use and income tax consequences as well as reporting requirements.

According to the IRS in Notice 2014-21, convertible virtual currency is treated as property for federal tax purposes. New Jersey conforms to the federal tax treatment of virtual currency.

Sales and Use Tax

New Jersey imposes tax on the receipts from retail sales and barter of certain tangible personal property and services. NJSA 54:32B-3(a) and 2(f). A barter transaction is comprised of two separate sale transactions. Each party to a barter transaction gives something of value to the other in order to receive something of value in return and sales or use tax is due from each party based on the value of the property or services given in trade if what is received in exchange is otherwise subject to sales tax.

According to the New Jersey Division of Taxation, since Bitcoins are property and not currency, when a customer uses Bitcoins to pay for property it is a barter of one type of property, the Bitcoins, for another type of property, and both seller and customer must pay sales tax.

Using an automobile as an example, if the seller of the automobile accepts Bitcoins as consideration, sales tax is due from the automobile seller based on the “amount allowed in exchange for” the Bitcoins, basically what the car would have sold for if sold for dollars. The seller must retain documentation of the amount for which they regularly sell the same or similar car to customers when the payment is in U.S. dollars and must record in their books and records the value of the Bitcoins accepted at the time of each transaction, converted to U.S. dollars, and the amount of sales tax collected at the time of each transaction, converted to U.S. dollars. Sellers must remit any sales and use tax due in U.S. dollars.

The customer that used the Bitcoins to acquire the car also owes sales tax based on the market value of the Bitcoins at the time of the transaction, converted to U.S. dollars, as if he had sold the Bitcoins outright. Since customers typically bear the sales tax on what they buy, it is likely that sellers, such as our automobile dealer, will require the Bitcoin using customer to pay both sides of the sales tax, unless special arrangements are made.

Corporation Business Tax and Gross Income Tax

New Jersey will follow the federal treatment of Bitcoins to the extent that the Corporation Business Tax Act and Gross Income Tax Act follow the federal tax treatment of gain or loss from the sale or exchange of property. Accordingly, a taxpayer will realize gain or loss on the sale or exchange (including the use in a barter transaction) of Bitcoins. The basis is the cost to acquire them and the gain or loss is based on the amount received when disposing of them. Using the automobile transaction as an example, in addition to the sales tax issue discussed above, if the Bitcoins used to acquire a $30,000 car originally cost the customer $20,000, he has a $10,000 gain from the transaction.

If Bitcoins are paid to an employee as wages or to an independent contractor for services, the fair market value of the Bitcoins must be measured in U.S. dollars on the date the employee or contractor receives it; in addition the employee is subject to New Jersey gross income tax withholding.

Finally, a payment made using Bitcoins is subject to information reporting requirements to the same extent as any other payment made in property.

In a case released by the US Tax Court yesterday, January 29, 2015, the Court handed a victory to a taxpayer utilizing the US Virgin Islands Economic Development Credit (EDC).

In Estate of Sanders, v. Commissioner, 144 T.C. No. 5 (2015) the Court found that the taxpayer was a bona fide resident of the USVI, and that when he filed his USVI tax returns for 2002 through 2004 in lieu of federal tax returns he had complied with all his filing requirements. As such the Notice of Deficiency issued in 2010 was too late based on the statute of limitations, notwithstanding the IRS’ argument that the claimed USVI residency was a sham and therefore no valid returns were ever filed and the SOL never began, i.e. filing of the USVI returns was not a substitute for the federal returns.

Mr. Sanders had become a limited partner of a partnership formed specifically to provide consulting services in the US through those who purchase LP interests. The Service basically took the position that this partnership sold LP interests to individuals such as Mr. Sanders who wished only to contrive a patina of a USVI presence solely to access the 90% USVI economic development credit, and that it otherwise had no true economic substance. Since, in the Commissioner’s view, this was a sham, the residence was not bona fide and any filing of USVI returns in lieu of US federal returns was inadequate and without effect.

The Court rejected this argument, reviewing the 11 factors that it looks to in order to ascertain residency and was satisfied that Mr. Sanders had done all he needed to do.

Decedent had the intent to be a bona fide resident because he intended to remain indefinitely or at least for a substantial period. See Vento, 715 F.3d at 470. He had a physical presence in the USVI and was employed by a USVI business and listed as a partner on their Schedules K-1 for tax years 2002-04. He conducted banking in the USVI and had checks with a USVI address. Decedent was married in the USVI and reported his address as the USVI on his marriage license. Decedent identified himself as a resident of the USVI and paid USVI taxes. At 34.

Thus, having complied with his tax filing requirement, the IRS had only until sometime in 2008 to assess a deficiency; 2010 was way too late.

It seems the Service cherry picked the wrong case.

An irrevocable trust that is designed as an “intentionally defective grantor trust” (“IDGT”) is a key estate and gift planning tool. Often a key component to blunt the impact of irrevocable gifts to the trust (and for other reasons, such as qualifying it as an IDGT) is to permit the settlor of the trust to substitute property in the trust with other property of equal value. This power is sometimes referred to as the “power to reacquire” or the “power to substitute.” For purposes of both federal and New York income tax, transactions between an IDGT and its settlor are disregarded, as they are treated for these purposes as the same person.

In an Advisory Opinion released December 22, 2014 (TSB-A-14(2)R, Dec. 4, 2014) the New York State Department of Taxation and Finance determined that “the conveyance of a New York condominium apartment by [the trust settlor] to the [IDGT in which the settlor retained a power to reacquire] in exchange for cash equal to the value of the apartment is a conveyance, subject to the New York Real Estate Transfer Tax [Tax Law §1402(a) (“RETT”)].” The tax would be based on the cash received from the trust.

Not feeling compelled to view the IDGT and the settlor as separate pockets in the same pair of trousers for purposes of the RETT, the Department held that the transaction was between two separate parties:
Once the apartment is substituted for the cash as an asset of the IDGT, under the terms of the IDGT, [the settlor] would no longer hold any beneficial interest in the real estate. This transfer of the [settlor’s] condominium apartment to the IDGT fits within the statutory definition for RETT purposes of a conveyance of real property or interest therein.

This is consistent with other positions recently taken by the Department. Previously, in January, 2014, the Department issued an advisory opinion (TSB-A-14(6)S, Jan. 29, 2014) that the exercise of this power of substitution by transferring tangible personal property to the trust in exchange for intangible assets of the trust was subject to the New York sales tax (Tax Law §1105(a)) notwithstanding that the trust and the settlor are treated for income tax purposes as the same person. In fact the Department said this would be the case regardless of whether it is a grantor trust or a revocable living trust (citing TSB-A-99(22)S), as a sale for state sales tax purposes occurs if the assets transferred would be subject to sales tax if the parties were unrelated. According to the Department “[i]f there is consideration given in any form in connection with the transfer, a retail sale of tangible personal property occurs and sales tax is imposed. . . .” The Advisory Opinion hints that there may be “other exemptions” to the application of New York sales tax, perhaps referring to situations where there is a substitution of tangible personal property for tangible personal property between the irrevocable trust and its settlor.

The moral? Great estate and gift tax planning often butts up against other taxes. Don’t be caught unaware. Seek advice before taking irreversible actions.

On Jan. 1, 2014, a new law came into effect in Israel that for the first time taxes foreign trusts (i.e. trusts with non-Israeli settlors, such as trusts created by US persons with at least one Israeli resident beneficiary) and/or their Israeli resident beneficiaries, and subject then to new reporting obligations.  

Basically these “Israeli beneficiary trusts” are classified in one of two ways with each taxed differently:
  • If it is what is being called a “Relatives trust,” meaning a trust under which the settlor is alive and has a specified family relationship to the beneficiary, then the trustee must notify the Israeli tax assessor of the trust’s existence by December 31, 2014 (or within 60 days of creation). At that time the trustee may make an irrevocable election to have the Israeli resident beneficiary taxed at 30% but only upon actual distributions of trust income.  If no election is made in time then the trust will be taxed annually at 25% on all trust income allocated to Israeli beneficiaries as earned by the trust.  In other words, if the trust intends to accumulate income and not distribute all of it annually, the election permits a deferral which, even at the 5% incremental tax, can represent substantial savings.
  • If it is what has been referred to as a “Non-Relatives trust” the portion of trust income allocable to Israeli beneficiaries is taxed annually rates ranging from 25% to 52%. 
Other provisions include a tax credit for foreign (i.e. US) taxes paid on this income.

Time is quickly running out if this applies to you and you have not yet made the appropriate arrangements.