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.

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David Neufeld today published his latest article in the Leimberg Information Services Inc. Income Tax Newsletter. The article discusses the recent Tax Court decision in Yari v. Commissioner that found that the first filed return is used to calculate the listed transaction penalty even when that return is replaced with a corrected return showing zero tax liability and zero impact from the listed transaction.  Accordingly this taxpayer had a $100,000 penalty in a year when he had zero tax liability.  The article is reproduced below.

Steve Leimberg's Income Tax Planning Email Newsletter - Archive Message #75
Date: 08-Oct-14
From: Steve Leimberg's Income Tax Planning Newsletter
Subject: David Neufeld on Yari v. Commissioner: When a Return is Not the Return for Purposes of Calculating the Section 6707A Penalty

David Neufeld provides members with his analysis of Yari v. Commissioner. David S. Neufeld is a tax and T&E lawyer in Princeton, NJ. He represents clients throughout the world, doing both planning and controversy work (administrative and Tax Court). David is also an expert witness in civil cases around the country arising from 419 plans. Most notably, David represents the government of the Island of Nevis, for which he has drafted several laws, including the Nevis LLC Ordinance and recent proposed amendments to permit series LLCs and cell captive insurance companies. For more, go to

Now, here is David Neufeld’s commentary:

In Yari v. Commissioner, the Tax Court sided with the Service in upholding a$100,000 penalty under Section 6707A(b)(2)(A) assessed against Yari for failing to report a listed transaction, despite the fact that during the course of the case, Congress passed the Small Business Jobs Act of 2010 that retroactively modified how the penalty should be calculated. Yari is significant for a number of reasons, not the least of which is that is a case of first impression dealing with the proper calculation of penalties under Section 6707A(b).  [TO READ MORE CLICK ON "READ MORE" TO THE RIGHT]

If you are an individual or business who owes New Jersey taxes and would like to clean the slate potentially at a reduced cost, then the recently announced 2014 Tax Amnesty program is worth considering.

Until November 17, 2014 the New Jersey Division of Taxation is offering businesses and individuals that have unpaid tax liabilities and unfiled returns from tax periods 2005 through 2013 a way to request and enter into a closing agreement with the Division in order to satisfy outstanding tax liabilities with no or reduced penalties.

According to the New Jersey Division of Taxation, most penalties can be reduced to zero. The exception would be an Amnesty Penalty imposed on taxes due on or after 1/1/2002 and before 2/1/2009. This reduction can mean a 5% to 30% decrease in liabilities. Interest will be calculated only on the tax and reduced penalties. Recovery fees may be waived and costs of collection eliminated.  [TO READ MORE, CLICK ON "READ MORE" TO THE RIGHT]

Earlier this summer I posted an article and flow chart describing the newest version of the IRS compliance program for non-compliant resident and non-resident taxpayers with foreign accounts and assets, giving a virtual amnesty to some.  The IRS has now published forms to be used by those entering this program.
Form 14653--Streamlined Certification-Outside US.pdf
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Form 14654--Streamlined Certification-Inside US.pdf
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