March 2005

MEMBERS’ CORNER
BY STANLEY TEPPER, CPA, MBA

IRA Contributions – For taxpayer married, but filing separately – per the Commercial Clearing House Master Tax Guide when a married individual files as “married filing separately” and the individual, or the spouse, is covered by an employer’s retirement plan, the IRA deduction begins to phase-out when the individual’s modified adjusted gross income exceeds $0. The deduction is completely phased-out when modified adjusted gross income is $10,000 or more (Code Sec. 219(g)(3)(B)(iii).

Favorable IRS Rule Change for Beneficiaries – The IRS has improved the required minimum distribution (RMD) rules for IRA beneficiaries. Now, if all the entitled beneficiaries of an IRA take separate ownership of their portion of the assets by December 31 of the year following the year of the IRA owner’s death, each individual beneficiary can use his or her own life expectancy, rather than the oldest beneficiary’s, to determine the annual minimum distributions.

The rule change includes beneficiaries of IRA owners who died in 2004. If you are such a beneficiary, you have until December 31, 2005 to take ownership and receive the favorable treatment.

Questionable Form W-4 – The Fall, 2004 Social Security – IRS – Reporter states that if the employee submits a Form W-4 that claims

• Exemption from withholding, and you know that the employee will earn more than $200 per week, or
• More than 10 withholding allowances,

then include a copy of the W-4 when you file your Employer’s Quarterly Federal Tax Return (Form 941). This allows the IRS to review the employee’s tax filing history to see that the employee has generally paid the proper amount of tax and has paid it on time. You only need to submit the copy of the W-4 one time.

Verify Employee’s Name and Number

Even if you saw the employee’s social security card, it’s a good idea to verify the match of the name and SSN, in case of a name change or fraud. Plus, it’s easy and free. You can call the Social Security Administration at 800-772-6270 to verify the information of up to five employees at a time. Be prepared with the employer’s name and federal ID number and the employee’s name, SSN, sex, and date of birth. More information, including ways to check on more than five names and numbers, how to correctly format complex names, and what to do if the employee never gives you a SSN, are available at http://www.socialsecurity.gov/employer/critical.htm.

Estate Issues- The following appeared in the weekly newsletters of Certilman Balin Adler & Hyman, LLP. (516) 296-7000. Steve Silverberg, Esq. & Lisa Hunter, Esq. are the editors. Trust qualifies for marital deduction despite conflicting provisions-

The Tax Court recently ruled that a trust qualified for the estate tax marital deduction despite the existence of trust provisions allowing the trustee to withhold income payments from the surviving spouse if she became disabled. Normally such provisions would cause the spouse’s interest to fail to qualify for the deduction, but since they conflicted with the decedent’s intent to qualify for the marital deduction, the disability provisions were disregarded.

 

Merle Whiting and his wife Vicki executed an estate plan less than a month before Merle’s death. The plan involved a revocable trust in which each spouse had a 50% share. Upon Merle’s death, the trust became irrevocable as to his share, which was split into four separate trusts, including a marital trust. This trust was intended to qualify for the estate tax marital deduction.

In order for a spouse’s interest in property to qualify for the marital deduction,

• the spouse must be entitled to all income from the property for life, payable at least annually, and
• no person can have the power to appoint any part of the property to anyone other than the surviving spouse.

However, Vicki’s marital trust included provisions stating that if she were to become disabled, “the trustee may accumulate the annual net income.” The IRS determined that these provisions created the possibility that Vicki’s income interest would terminate before her death, which would disqualify her interest. The government disallowed the marital deduction and determined a deficiency of $206,612.

Before the Tax Court, the estate argued that the trust’s administrative provisions and disability provisions were in conflict, and that Arkansas law required that the decedent’s intent must rule. Merle’s intent – to qualify the trust for the marital deduction – was well established. The Tax Court agreed and ruled that Vicki’s interest qualified for the marital deduction.

The Court found this case distinguishable from Walsh v. Commissioner (110 T.C. 393, 1998), in which the trust specifically stated that if the surviving spouse were found incompetent, spousal benefits would terminate and the trust would be treated as if the spouse had died.

Estate of Whiting v. Commissioner (T.C. Memo.2004-68, 3-17-04)

Mother Sues Son over Medicaid Transfer- Louise Friar was worried that, should she become incapacitated, nursing home costs might drain away her savings and assets before she could qualify for Medicaid. So she arranged for her residence and two certificates of deposit to be divided between her sons, J.D. and Darrel Friar. Later, however, Louise changed her mind and demanded the assets be returned to her. Darrel complied, but J.D. refused.

Louise then sued her son for fraud and coercion. The trial court granted her a partial summary judgment, ruling that the evidence established liability but leaving damages to be determined by a jury at a later time. J.D. appealed.

The Georgia Court of Appeals reversed and remanded, pointing to the fact that both Louise’s bank and her attorney testified that they had advised her the transfer was irrevocable and that she appeared to be in control of her faculties and under no coercion or duress when she signed the forms. Also, the summary judgment had been based solely on her testimony that her sons had agreed to return the assets to her upon request, even though J.D. was never deposed about whether such an agreement existed. Therefore, the appeals court ruled that there was evidence Louise made the irrevocable transfers knowingly and willingly and that the summary judgment had been inappropriate.

Friar v. Friar,

(GA CT. App.,No.A03A2329, 2-18-04)

Execution of LLC Amendment Does Not Invalidate Disclaimer- The IRS recently ruled that an individual’s disclaimer of LLC interests was a qualified disclaimer despite the fact that the individual must execute an amendment to the LLC agreement in a fiduciary capacity.

A woman died intestate, survived by her mother and other relatives. Under state intestacy laws, her entire estate, including her interest in a limited liability company (LLC) passed to her mother. The mother, who did not previously own an interest, was the LLC’s co-manager and proposed to disclaim the interest she was inheriting from her daughter.

However, the other LLC members wanted to make changes to how the LLC was managed, including designating a sole manager and providing that certain actions required an affirmative vote of members holding more than 67% of the outstanding shares. These actions would require an amendment to the LLC agreement, as well as removal of the mother as co-manager, which would require the mother, as co-manager and as co-personal representative of her daughter’s estate, to acquiesce.

The mother proposed to disclaim her interest and then to execute the amendment as co-personal representative of her daughter’s estate. Then she would resign as co-manager. At that point, no LLC member would hold more than 50% of the membership units.

The IRS ruled that the mother’s execution of the LLC amendment would not constitute the acceptance of benefits of the LLC interest (which would have precluded her disclaimer). The proposed disclaimer, therefore, will be a qualified disclaimer under § 2518. For gift and estate tax purposes, the disclaimed interest will pass as though the mother had predeceased her daughter.

PLR 200406038

 

No Installment Payments Allowed for Estate Tax- The IRS recently ruled that an estate could not make installment payments to pay estate taxes related to a corporation that managed investment assets to obtain rent income.

The decedent was the sole owner of three corporations, two of which owned majority interests in real properties. The third owned minority interests, and received ground rent from the first two corporations for the use of the land upon which their various commercial activities were conducted.

The IRS concluded that the decedent’s ownership of stock in the third corporation constituted an interest in a passive asset (§6166(b)(9)) and did not qualify as an interest in a closely held business. Therefore, the estate could not pay the estate tax attributable to the third corporation in installments under §6166.

The IRS declined to rule on whether or not the decedent’s interest in the third corporation could be aggregated with those of the other two corporations.

PLR 200339047, 9-26-03

www.irs.gov/pub/irs-wd/0339047,pdf

Estate Can’t Claim Income Tax Discount on Retirement Accounts- In determining the estate tax value of retirement accounts, an estate cannot claim a discount to reflect income taxes that would be payable by beneficiaries on distributions from the accounts, the 5 th Circuit has confirmed.

John David Smith is the executor of the estate of his father, who died in 1997. The estate timely filed an estate tax return and paid tax due of $140,358. The return reported the decedent’s interest in two retirement accounts (valued at $725,550 and $42,809) comprised of marketable stocks and bonds.

In 1999, the estate filed a claim for refund of $78,731 of estate tax on the grounds it overvalued the retirement accounts. Specifically, the estate discounted the value of the retirement accounts by 30% to reflect the income taxes beneficiaries would pay on distributions from the accounts.

The IRS denied the refund and the estate sued in district court, where it lost in summary judgment. On appeal, the Fifth Circuit addressed the estate’s concern over double tax, noting Code Sec. 691(c) already allows the decedent’s beneficiaries an income tax deduction in an amount equal to the estate tax paid on the retirement accounts.

Further, the court pointed out all property owned at death is included in a decedent’s gross estate at its fair market valued, defined as “the price at which the property would change hands between willing buyer and willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.”

Applying the “willing buyer-willing seller” test, the court said, demonstrates a hypothetical buyer of the assets in the retirement accounts would not consider the income tax liability since the buyer is not the beneficiary and would not be paying the income tax.

Source: Smith v. United States, No.04-20194

(5 th Cir. 11-15-04; as amended 12-8-04)