Federal tax liens - failure to pay the estate taxes

Homes sold by estate beneficiary remained subject to federal estate tax liens

First American Title Insurance Co., et al. v. U.S. (CA9 3/27/2008) 101 AFTR 2d ¶ 2008-622

Mike Habib, EA

MyIRSTaxRelief.com

The Court of Appeals for the Ninth Circuit, affirming a district court, has held that title companies couldn't recover estate taxes that they paid after distressed homeowners informed them of IRS's threats to seize their homes based on an increased tax assessment on the estate from which they'd acquired their properties.

Facts. Roberta C. Smith died in '91 leaving an estate primarily consisting of three houses and stock in Frisko Freeze, a drive-in restaurant in Tacoma, Washington. A court admitted her will to probate, named her daughter, Penny Jensen, as the estate's personal representative, and gave Ms. Jensen the power to transfer the estate's real and personal property without further court order (a so-called non-intervention probate order).

Ms. Jensen deeded the three houses in the estate to herself and her husband. She filed a federal estate tax return and paid the estate tax. The Jensens later sold the houses to purchasers who obtained title insurance policies issued by the taxpayers in this case: First American Title Insurance Company, Commonwealth Land Title Insurance Company, and Chicago Title Insurance Company (“the Title Companies”).

IRS audited the estate and increased the value of the Frisko Freeze stock by almost $150,000 more than was reported. After the estate failed to make installment payments on the estate taxes owed, IRS sent letters to the purchasers of the three houses threatening to seize and sell the houses unless they paid the remaining estate tax owed.

The homeowners gave the IRS letters to the Title Companies who paid about $189,372 in estate taxes under protest. They then filed refund claims. After IRS denied the claims, they brought their case to a district court. Specifically, they sued under 28 USCS 1346 to recover federal estate tax erroneously or illegally assessed and collected. The district court held in favor of IRS.

Background. Code Sec. 6324(a)(1) creates a special estate tax lien that attaches to the gross estate of a decedent for ten years from the date of death. Under the holding of U.S. v. Vohland, Lewis, (1982, CA9) 50 AFTR 2d 82-6112, probate property (which the three homes in the current case were) retains the special estate tax lien upon transfer to a purchaser unless IRS discharges the personal representative of the lien under Code Sec. 2204 . The gross estate is divested of the special estate tax lien to the extent that the gross estate is “used for the payment of charges against the estate and expenses of its administration, allowed by any court having jurisdiction thereof.” (Code Sec. 6324(a)(1))

Failed arguments in district court. Before the district court, the Title Companies agreed that a special estate tax lien attached to the gross estate of Roberta Smith at her death in '91. They also acknowledged that Ms. Jensen, the estate's personal representative, didn't obtain a discharge of liability under Code Sec. 2204 before selling the properties in question. Rather, the Title Companies contended that the proceeds from the sale of the three homes were used to pay charges against the estate and expenses of its administration, thereby divesting the lien under Code Sec. 6324(a)(1). The court said that to prove that divestment occurred under Code Sec. 6324(a)(1), the Title Companies had to show that: (1) the sale proceeds satisfied charges against the estate or expenses of its administration; and (2) a court with proper jurisdiction allowed the satisfaction.

The Title Companies contended that they used the proceeds from the house sales to pay encumbrances, taxes, title insurance premiums, and real estate commissions and that these payments qualify as “charges against the estate or expenses of its administration.” For example, the Title Companies said that one of the three houses was encumbered by a $124,000 deed of trust in the name of Roberta Smith. After the sale, First American Title paid $122,829.98 from the sale proceeds to the company owning the deed of trust. The Title Companies argued that if the deed of trust “was paid out of the proceeds of the sale of the property, the special lien was automatically divested.” The Title Companies also claimed that a portion of the sale proceeds from the homes was used to satisfy loans Ms. Jensen may have incurred in “expenses of the estate” after her mother's death.

The court said that the arguments were too hypothetical to show that a material issue of fact was in dispute that would warrant denying summary judgment. However, the court said, even if it is assumed that the Title Companies used the sale proceeds from the three homes to satisfy the charges or expenses of the estate, the Title Companies still could not prevail because they did not establish that a court with proper jurisdiction allowed the payments.

The Title Companies contended that the state court non-intervention probate order met this second prong of the test. However the district court disagreed.

Ninth Circuit. The Ninth Circuit noted that 28 USCS 1346 is the general statute providing jurisdiction in the district courts for taxpayer suits against IRS. It said, however, that Code Sec. 7426 is the statute providing jurisdiction for suits by persons other than taxpayers. According to the Appeals Court, the problem for the Title Companies is that Code Sec. 7426(c) does not let them challenge the assessment of how much Frisko Freeze was worth, and the assessment is what they claim makes the taxes they paid too high.

The Ninth Circuit stressed that justice does not require that 28 USCS 1346 be embraced to avoid the Code Sec. 7426 limitation on challenges to assessments. Had Jensen paid the estate taxes when due, or paid the installments and not gone bankrupt, she could not have challenged the assessment, because she had agreed to it. There is no good reason why her failure to pay the estate's taxes should reopen the valuation of Frisko Freeze, Inc. True, the homeowners and the title insurers that stepped into their shoes did not have a chance to challenge the assessment. But the assessment was not really their problem. Their problem was that the real estate chain of title included an estate that had not paid its taxes. A third party that pays a tax to eliminate a tax lien on the third party's property is, under Code Sec. 7426(c), bound by the assessment on the property.

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Non-profit exempt organization tax problems

IRS Regs clarify Code Sec. 501(c)(3) exempt status and impact of excise taxes

Mike Habib, EA

MyIRSTaxRelief.com

T.D. 9390, 03/27/2008; Reg. § 1.503(c)(3)-1, Reg. § 53.4958-2

IRS has issued final regs clarifying the substantive requirements for tax exemption under Code Sec. 501(c)(3) and the relationship between those requirements and the imposition of Code Sec. 4958 excise taxes. The final regs adopt proposed regs issued in 2005 with some modifications.

Background. To qualify for tax exemption under Code Sec. 501(c)(3), an organization must be organized and operated exclusively for religious, charitable, scientific, or educational purposes. In addition, no part of its net earnings may inure to the benefit of any private shareholder or individual, no substantial part of its activities may include attempts to influence legislation, and the organization may not intervene in political campaigns. Under preexisting regs, an organization isn't exempt under Code Sec. 501(c)(3), if it is organized or operated for the benefit of private interests such as designated individuals, its creator or his family, the organization's shareholders, or persons controlled, directly or indirectly, by such interests. (Reg. § 1.501(c)(3)-1(d)(1)(ii))

Code Sec. 4958 imposes excise taxes on transactions that provide excess economic benefits to disqualified persons with respect to public charities and social welfare organizations described in Code Sec. 501(c)(3) and Code Sec. 501(c)(4) (certain social welfare organizations), which are collectively referred to by Code Sec. 4958(e) as “applicable tax-exempt organizations.”

Final regs. Adopting the proposed regs, the final regs add several examples to illustrate the requirement that an organization serve a public rather than a private interest. They show that prohibited private benefits may involve non-economic benefits as well as economic benefits. In addition, they indicate that a prohibited private benefit may arise regardless of whether payments made to private interests are reasonable or excessive. (Reg. § 1.501(c)(3)-1(d)(1)(iii))

The proposed regs provided guidance on certain factors that IRS will consider in determining whether an applicable tax-exempt organization described in Code Sec. 501(c)(3) that engages in one or more excess benefit transactions continues to qualify for exemption. Two comments voiced the need to clarify the terms “significant” and “de minimis” as used in the proposed regs. One comment suggested adding examples combining potential de minimis values with other abating or negative factors and/or examples containing values that are not de minimis. The final regs contain a new example that illustrates the application of the revocation factors to an excess benefit transaction that is neither significant in comparison to the size and scope of the organization's exempt activities nor de minimis. (Reg. § 1.501(c)(3)-1(f)(2)(iv), Example 6)

One comment requested clarification of the term “repeated” as used in Example 3 of Prop Reg § 1.501(c)(3)-1(g). IRS says the term was used in that example to correspond to the third factor in the proposed regs, which looked to “whether the organization has been involved in repeated excess benefit transactions.” In response to this comment, the third factor of the proposed regs has been revised to substitute the term “multiple” for the word “repeated.” (Reg. § 1.501(c)(3)-1(f)(2)(ii)) The term “multiple” refers to both (1) repeated instances of the same (or substantially similar) excess benefit transaction, regardless of whether the transaction involves the same or different persons; and (2) the presence of more than one excess benefit transaction, regardless of whether the transactions are the same or substantially similar and regardless of whether they involve the same or different persons. (T.D. 9390, 03/27/2008)

The fourth factor under the proposed regs has been revised to make clear that implementation by an organization of safeguards that are reasonably calculated to prevent excess benefit transactions will be treated as a factor weighing in favor of continuing to recognize exemption regardless of whether such safeguards are implemented in direct response to the excess benefit transaction(s) at issue or as a general matter of corporate governance or fiscal management. (Reg. § 1.501(c)(3)-1(f)(2)(ii)) Thus, an organization may be treated as having implemented safeguards reasonably calculated to prevent excess benefit transactions even though the organization is contesting the existence of the excess benefit transaction(s) at issue. (T.D. 9390, 03/27/2008) An example is added to illustrate how implementation of safeguards, including preexisting safeguards, will be taken into account in determining whether to continue to recognize an organization's tax-exempt status. (Reg. § 1.501(c)(3)-1(f)(2)(iv), Example 6)

Observation: Thus, affected organizations should consider implementing such safeguards to help preserve exempt status should they engage in an excess benefit transaction.

Two comments suggested adding an example specifically addressing reasonable compensation. The new example added by these final regs does that. (Reg. § 1.501(c)(3)-1(f)(2)(iv), Example 6)

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Dependent deductions tax problem

Tax breaks for qualifying relatives are limited - what you should know
Internal Legal Memorandum 200812024

Mike Habib, EA
myIRSTaxRelief.com

An Internal Legal Memorandum (ILM) explains that various tax breaks are not allowed for qualifying relatives. Specifically, the ILM concludes that, apart from a dependency exemption, a taxpayer's qualifying relative may not qualify him for the earned income credit, head of household filing status, or the child tax credit, but in limited circumstances may qualify the taxpayer for the child and dependent care credit.

Background. A taxpayer is entitled to a deduction equal to the exemption amount for each person who qualifies as his “dependent.” (Code Sec. 151(c))

A person qualifies as the taxpayer's dependent if the person is the taxpayer's qualifying child or qualifying relative. (Code Sec. 152(a)) The terms “qualifying child” and “qualifying relative” were added to Code Sec. 152 by the Working Families Tax Relief Act of 2004 (WFTRA), effective for tax years beginning after 2004. WFTRA established a uniform definition of a “qualifying child” for determining whether a taxpayer may claim certain child-related tax benefits. It established the term “qualifying relative” to identify individuals (other than a qualifying child) for whom a dependency exemption deduction may be allowed.

A “qualifying child” of a taxpayer is an individual who: (A) bears a certain relationship to the taxpayer, (B) has the same principal place of abode as the taxpayer for more than one-half of the tax year, (C) meets certain age requirements, and (D) has not provided over one-half of his or her own support for the calendar year. (Code Sec. 152(c)(1))

A “qualifying relative” is an individual: (A) who bears a specified relationship to the taxpayer (Code Sec. 152(d)(1)(A)); (B) whose gross income for the calendar year in which that tax year begins is less than the exemption amount (Code Sec. 152(d)(1)(B)); (C) with respect to whom the taxpayer provides over one-half of his or her support for the calendar year in which that tax year begins (Code Sec. 152(d)(1)(C)); and (D) who isn't a qualifying child of that taxpayer or of any other taxpayer for any tax year that begins in the calendar year in which that tax year begins. (Code Sec. 152(d)(1)(D))

Observation: An individual need not be technically related to a person to qualify as the person's qualifying relative. That's because, the specified relationships include in-laws and an individual who, for the tax year of the taxpayer, has as such individual's principal place of abode the home of the taxpayer and is a member of the taxpayer's household. (Code Sec. 152(d)(2))

Notice 2008-5, 2008-2 IRB, provides guidance on individuals who may be qualifying relatives of a taxpayer under Code Sec. 152(d). Specifically, it clarifies that, solely for purposes of Code Sec. 152(d)(1)(D), an individual is not a qualifying child of “any other taxpayer” if the individual's parent (or other person with respect to whom the individual is defined as a qualifying child) is not required by Code Sec. 6012 to file an income tax return and (i) does not file an income tax return, or (ii) files an income tax return solely to obtain a refund of withheld income taxes. Notice 2008-5 clarifies that a taxpayer may claim a dependency exemption deduction for an unrelated child of an unrelated individual who lived with the taxpayer as a member of the taxpayer's household for the entire year.

Illustration: Andrew supports as members of his household for the tax year an unrelated friend, Betty, and her 3-year-old child, Carole. Betty has no gross income, is not required by Code Sec. 6012 to file an income tax return, and does not file an income tax return for the tax year. Accordingly, because Betty does not have a filing requirement and did not file an income tax return, Carole is not treated as a qualifying child of Betty or any other taxpayer, and Andrew may claim both Betty and Carole as his qualifying relatives, provided all other requirements of Code Sec. 151 and Code Sec. 152 are met. (Notice 2008-5)

Earned income credit. An eligible individual may be allowed an earned income credit under Code Sec. 32 . In general, an eligible individual is (i) any individual who has a qualifying child for the tax year, or (ii) any other individual who does not have a qualifying child for the tax year, if certain requirements are met, such as age and residency, and that the individual is not a dependent of someone else. The ILM says that a taxpayer who may claim an individual as his or her qualifying relative under Notice 2008-5 , may not use that individual for purposes of claiming the earned income credit because the credit requires that the dependent be a qualifying child, not a qualifying relative, of the taxpayer.

Head of household filing status. Under Code Sec. 2(b)(1), an individual is a head of a household if, and only if, he is not married at the close of his tax year, is not a surviving spouse, and either (1) maintains as his home a household which constitutes for more than one-half of the tax year the principal place of abode, as a member of such household, (i) a qualifying child of the individual, or (ii) any other person who is a dependent of the taxpayer, if the taxpayer is entitled to a deduction under Code Sec. 151 for the tax year, or (2) maintains a household which constitutes for such tax year the principal place of abode of the father or mother of the taxpayer, if the taxpayer is entitled to a deduction for the tax year for such father or mother under Code Sec. 151. A taxpayer cannot be considered a head of a household by reason of an individual who would not be a dependent for the tax year but for (i) Code Sec. 152(d)(2)(H) or (ii) Code Sec. 152(d)(3), relating to multiple support agreements. Thus, the ILM concludes that a taxpayer who may claim an individual as his or her qualifying relative under Notice 2008-5 because that individual was a member of the taxpayer's household, but who does not have a specified familial relationship to the individual, may not claim head of household filing status.

Child tax credit. Under Code Sec. 24(a), a taxpayer may be allowed a credit of $1,000 for each qualifying child of the taxpayer. The ILM concludes that a taxpayer who may claim an individual as his or her qualifying relative under Notice 2008-5 may not use that individual for purposes of claiming the child tax credit because the credit requires that the dependent be a qualifying child, not a qualifying relative, of the taxpayer.

Observation: The ILM does not point out that an individual can be a taxpayer's qualifying child for child tax credit purposes without necessarily being the taxpayer's actual child. That's because, for this purpose, a qualifying child is defined to include a brother, sister, stepbrother, or stepsister of the taxpayer or a descendant of these relatives. (Code Sec. 26(c)(1), Code Sec. 152(c)(2))

Dependent care credit. A taxpayer with one or more qualifying individuals may be allowed a dependent care credit under Code Sec. 21. A “qualifying individual” is (1) a dependent of the taxpayer (as defined in Code Sec. 152(a)(1) who has not attained age 13, (2) a dependent of the taxpayer (as defined in Code Sec. 152 determined without regard to Code Sec. 152(b)(1), Code Sec. 152(b)(2), and Code Sec. 152(d)(1)(B)) who is physically or mentally incapable of caring for himself or herself and who has the same principal place of abode as the taxpayer for more than half of the year, or (3) the spouse of the taxpayer, if the spouse is physically or mentally incapable of caring for himself or herself and who has the same principal place of abode as the taxpayer for more than half of the tax year. The ILM states that Code Sec. 152(a)(1) provides that a dependent is a qualifying child, and as a result, the dependent care credit is limited to taxpayers with one or more qualifying children under the age of 13. A taxpayer who may claim an individual as his or her qualifying relative may not claim the dependent care credit, unless that qualifying relative is physically or mentally disabled.

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Trust fund penalty responsible person for the Code Sec. 6672(a)

Tax-exempt hospital's chairman of the board was liable for trust fund penalty - have a tax professional on your side

Mike Habib, EA

myIRSTaxRelief.com

Stephen Verret v. U.S. (DC TX 2/14/2008) 101 AFTR 2d ¶2008-572

A district court has found that the chairman of the board of a tax-exempt hospital was a responsible person liable for the Code Sec. 6672(a) trust fund penalty. The chairman, who played an active role in various aspects of the hospital's operation and could have ensured that the hospital paid its taxes, chose instead not to exert any authority over these business affairs. Further, since the chairman wasn't serving solely in an honorary capacity, he didn't qualify for the protection given voluntary board members under Code Sec. 6672(e).

Observation: The case once again demonstrates the perils faced by a taxpayer who becomes involved in a financially distressed company. As this case illustrates, the fact that a company is a tax-exempt entity will not shield a taxpayer who fails to carefully exercise his duties to make sure employment taxes are paid to IRS.

Background. Where an employer fails to properly pay over its payroll taxes, IRS can seek to collect a penalty equal to 100% of the unpaid taxes from a “responsible person,” i.e., a person who: (1) is responsible for collecting, accounting for and paying over payroll taxes and (2) willfully fails to perform this responsibility. (Code Sec. 6672(a))

Unpaid volunteer board members of tax-exempt organizations who are solely serving in an honorary capacity, aren't involved in day-to-day financial activities, and don't know about the penalized failure are exempt from the penalty, unless that results in no one being liable for it. (Code Sec. 6672(e))

Facts. The primary business of Community Healthcare Foundation (Foundation), a Code Sec. 501(c)(3) tax-exempt organization, was the operation of Doctors Hospital. Under the hospital's by-laws, the Foundation provided that the Board of Trustees, which was comprised of voluntary and unpaid members of the community, would act as the governing body of the hospital. The by-laws also provided for a Chairman of the Board and a Chief Administrative Executive Officer (CEO).

Stephen Verret served in various capacities on the hospital's board during a 26-year tenure, including as Chairman of the Board from '99 until his departure in 2002. In addition, a company in which Verret was a majority stockholder performed electrical services for the hospital, and his wife was employed by the hospital as Chief Operating Officer from January through March 2001. Verret also contracted with, and was paid by, a business involved in the operation and management of hospitals to help recruit specialized physicians and increase the hospital's revenues.

Because of a steadily deteriorating financial situation, the hospital failed to remit employment withholding taxes during the first part of 2001. While the outstanding tax liability was ultimately satisfied with borrowed cash appropriated to buy medical equipment, the hospital's Executive Director David Cottey was informed by Verret, individually, and by the Board, collectively, that the payment of employment withholding taxes was of paramount importance. Under no circumstances, he was told, was he to fail to pay these taxes again. However, contrary to his repeated assurances throughout 2001, in November of 2001, Cottey told Verret and the Board that the income and FICA taxes for the employees were delinquent for the third and fourth quarters of 2001.

IRS found Verret and the hospital's Controller and Chief Financial Officer to be liable as responsible persons. Verret paid $407,098 in tax (and $1,821 in interest), and sought a refund in the district court. IRS responded by seeking a summary judgment against Verret.

Taxpayer is responsible person. The district court concluded that Verret clearly qualified as a responsible person under Code Sec. 6672. The court rejected his contention that he wasn't responsible for the hospital's day-to-day operations and that he didn't have the authority to decide what bills (including taxes) were paid. The by-laws clearly stated that the Board of Trustees had the final responsibility for the hospital's administrative activities and professional services and for the operation of the hospital. The uncontested facts showed that Verret: (1) served approximately 26 years in various capacities on the hospital's Board; (2) held the position of Board Chairman during the relevant periods; (3) negotiated and personally guaranteed a $500,000 working capital loan for the hospital; (5) took steps to ensure payment of delinquent withholding taxes on the previous occasion after Cottey had failed to do so; (6) actively participated in recruiting physicians and developing a new source of revenue for the hospital; (7) conversed with Cottey on almost a daily basis; (8) signed the hospital's Form 990 for '99 and 2000; (9) possessed, along with the Board, the authority to hire and fire high level employees; and (10) was a signatory on all of the hospital's checking accounts.

The district court also concluded that his failure to pay taxes was willful. The court reasoned that it was inconceivable that Verret, who spent significant amounts of time visiting the hospital and conversing with Cottey on a daily basis, was unaware of Cottey's failure to pay the employment taxes. If Verret didn't know of Cottey's failure to pay the tax liability during the third and fourth quarters of 2001, it was because he chose not to know. Verret could have exercised substantial control over the decision-making process to ensure that the hospital paid its taxes, but instead of verifying that the taxes were paid, he chose not to exert authority over Cottey or the hospital's business affairs. The court reasoned that this inaction, at a minimum, constituted gross negligence or reckless disregard and so a willful failure to collect, account for, or pay over the hospital's taxes.

The court also found that Verret didn't qualify for the protection afforded a voluntary board member under Code Sec. 6672(e). He wasn't serving solely in an honorary capacity as the Chairman of the Board. Rather, he played an active role in the management of the hospital, attending board meetings, negotiating and guaranteeing a loan, recruiting physicians, and signing the hospital's Form 990 for '99 and 2000.

2004 Unfiled tax returns Back Taxes Past Due Tax Return

IRS Has $1.2 Billion for People Who Have Not Filed a 2004 Tax Return

Mike Habib, EA

MyIRSTaxRelief.com

IRS-2008-46, March 19, 2008

IRS WASHINGTON — Unclaimed refunds totaling approximately $1.2 billion are awaiting about 1.3 million people who failed to file a federal income tax return for 2004, the Internal Revenue Service announced today. However, to collect the money, a return for 2004 must be filed with an IRS office no later than Tuesday, April 15, 2008.

Those due a refund who did not file a 2004 tax return could collect even more money by also filing a 2007 tax return to claim the economic stimulus payment. To receive a payment, taxpayers must have a valid Social Security number, $3,000 of qualifying income and file a 2007 federal tax return. Millions of retirees, disabled veterans and low-wage workers who usually are exempt from filing a tax return must do so this year in order to receive the stimulus payment. Eligible people will receive up to $600 ($1,200 for married couples), and parents will receive an additional $300 for each eligible child younger than 17.

The IRS estimates that half of those who could claim refunds for tax year 2004 would receive more than $552. In some cases, individuals had taxes withheld from their wages, or made payments against their taxes out of self-employed earnings, but had too little income to require filing a tax return. Some taxpayers may also be eligible for the refundable Earned Income Tax Credit.

In cases where a return was not filed, the law provides most taxpayers with a three-year window of opportunity for claiming a refund. If no return is filed to claim the refund within three years, the money becomes property of the U.S. Treasury. For 2004 returns, the window closes on April 15, 2008. The law requires that the return be properly addressed, postmarked and mailed by that date. There is no penalty assessed by the IRS for filing a late return qualifying for a refund.

“Time is getting short for claiming the tax refund you may be entitled to,” said acting IRS Commissioner Linda E. Stiff. “But you can’t get it unless you file the tax return. Don't take a chance on losing your tax refund. And this year, remember that you need to file a 2007 tax return in order to receive an economic stimulus payment.”

The IRS reminds taxpayers seeking a 2004 refund that their checks will be held if they have not filed tax returns for 2005 or 2006. In addition, the refund will be applied to any amounts still owed to the IRS and may be used to satisfy unpaid child support or past due federal debts such as student loans.

By failing to file a return, individuals stand to lose more than refunds of taxes withheld or paid during 2004. Many low-income workers may not have claimed the Earned Income Tax Credit (EITC). Although eligible taxpayers may get a refund when their EITC is more than what they owe in tax, those who file returns more than three years late would be able only to apply it toward the taxes they owe (if any). They would not be able to receive a refund if the credit exceeded their tax.

Generally, unmarried individuals qualified for the EITC if in 2004 they earned less than $34,458 and had more than one qualifying child living with them, earned less than $30,338 with one qualifying child, or earned less than $11,490 and had no qualifying child. Limits are slightly higher for married individuals filing jointly.

PPA Pension Protection Act Tax Issues

IRS issues proposed regs reflecting PPA changes and guidance for notice of retroactively effective plan amendments

Mike Habib, EA

myIRS.TaxRelief.com

Prop Reg § 1.411(d)-3(a)(1); Prop Reg § 54.4980F-1, Q&A 8(d); Prop Reg § 54.4980F-1, Q&A 9(f); Prop Reg § 54.4980F-1, Q&A 9(g); Prop Reg § 54.4980F-1, Q&A 11(a)(7); Prop Reg § 54.4980F-1, Q&A 18(a)(4); Prop Reg § 54.4980F-1, Q&A 18(a)(5); Prop Reg § 54.4980F-1, Q&A 18(b)(3); Preamble to Prop Regs 3/20/2008)

IRS has issued proposed guidance setting out when notice of a plan amendment that significantly reduces future benefit accruals must be sent to affected parties. The proposed regulations would amend previously issued Question and Answer-format regs on Code Sec. 4980F, and would largely provide guidance for changes made to Code Sec. 4980F by the Pension Protection Act of 2006 (“PPA,” P.L. 109-280). The proposed regs would also establish timing rules for providing a section 204(h) notice for retroactive plan amendments, and would attempt to harmonize various other Code and ERISA notice requirements with those of Code Sec. 4980F.

Typically, the anti-cutback rules of the Code (Code Sec. 411(d)(6)) and ERISA (ERISA § 204(g)) protect the accrued benefit of a participant in a defined benefit plan by providing that this benefit cannot be reduced by plan amendment, except under very limited circumstances. Further, before a plan amendment providing for a significant reduction in future benefit accruals can take effect, Code Sec. 4980F generally requires that notice of the amendment be sent to the affected parties at least 45 days before the amendment's effective date.

ERISA § 204(h) contains parallel rules to Code Sec. 4980F, and the notice required to be sent to affected parties is called the “section 204(h) notice.”

Other Code and ERISA notice requirements. Code Sec. 436 provides rules for limiting benefits and benefit accruals for single-employer plans with certain funding shortfalls. ERISA § 101(j) generally requires the plan administrator to provide written notice to plan participants and beneficiaries within 30 days after the plan becomes subject to this benefit limit.

ERISA § 4244A provides that a multiemployer plan in reorganization may adopt an amendment reducing or eliminating certain accrued benefits attributable to employer contributions. However, an amendment reducing or eliminating benefits may not be made unless notice is provided to plan participants, beneficiaries, and other affected persons at least 6 months before the first day of the plan year in which the amendment reducing benefits is adopted.

Similarly, ERISA § 4245 requires the suspension of benefits under insolvent multiemployer plans if the benefit payments exceed the plan's resource benefit level for the plan year. Again, plans subject to benefit suspensions must notify plan participants and beneficiaries that certain non-basic benefit payments will be suspended.

ERISA § 4281 provides rules requiring a terminated multiemployer plan to reduce benefits if the value of nonforfeitable benefits exceeds the value of the plan's assets. If benefits are to be reduced, the plan sponsor must notify PBGC, the plan participants, and the beneficiaries of the amendment reducing benefits. The notice must be provided no later than the earlier of (i) 45 days after the amendment is adopted, or (ii) the date of the first reduced benefit payment. To eliminate the need for a plan to provide multiple notices with substantially the same function and information to affected persons, the proposed regulations would provide that if a plan issues one of the above notices and meets the applicable standards for such notices, the plan would be treated as having complied with the requirement to provide a section 204(h) notice. (Prop Reg § 54.4980F-1, Q&A 9(g)(3); Preamble to Prop Regs 3/20/2008)

Pension Protection Act notice requirements. Section 502(c) of the PPA amended Code Sec. 4980F(e)(1) (and ERISA § 204(h)) to add as a recipient of a section 204(h) notice any employer that has an obligation to contribute to the plan. This new disclosure requirement is effective for plan years beginning after December 31, 2007.

The proposed regs would reflect this requirement by adding contributing employers to the list of parties to receive 204(h) notice, and would provide a definition of contributing employer. (Prop Reg § 54.4980F-1, Q&A 1(a); Prop Reg § 54.4980F-1, Q&A 10(a); Preamble to Prop Regs 3/20/2008)

Commercial airlines. Section 402 of the PPA provides special funding rules for plans maintained by commercial passenger airlines or by airline caterers. These funding rules generally allow the airlines and airline caterers to restrict benefit accruals. If a plan amendment is adopted to comply with these special funding rules, any notice required under Code Sec. 4980F (or ERISA § 204(h) ) must be provided within 15 days of the amendment's effective date. The proposed regs would clarify that, consistent with the Joint Committee on Taxation's Technical Explanation to section 402 of the PPA, the section 204(h) notice must be provided at least 15 days before the plan amendment's effective date. (Prop Reg § 54.4980F-1, Q&A 9(f) ; Preamble to Prop Regs 3/20/2008)

Minimum present value rules. Code Sec. 417(e)(3) provides that, in determining the present value of a participant's accrued benefit for distribution, the present value of the benefit cannot be less than the present value determined using the applicable mortality table and the applicable interest rate. Section 302(b) of the PPA provided new actuarial assumptions for calculating the minimum present value of a participant's accrued benefit. Rev Rul 2007-67, 2007-48 IRB 1047, which included guidance on plan amendments adopting the new interest rate and mortality table, provided that amendments reflecting the new interest rate or mortality table for an annuity starting date in 2008 or later would not violate the anti-cutback rules.

The proposed regs would provide that a reduced single-sum distribution that's caused by an amendment to a traditional defined benefit plan adopting the new interest rate and mortality tables does not require a section 204(h) notice. (Prop Reg § 54.4980F-1, Q&A 8(d); Preamble to Prop Regs 3/20/2008)

Section 204(h) notice timing rules for retroactively effective amendments. Reg. § 1.411(d)-3(a)(1) generally provides that a plan is not qualified if a plan amendment decreases the accrued benefit of any plan participant. These rules are generally based on the “applicable amendment date,” which is defined as the later of (i) the amendment's effective date, or (ii) the date the amendment is adopted.

While the general rule under Reg. § 1.411(d)-3(a)(1) prohibits plan amendments that reduce a plan participant's accrued benefit, certain exceptions exist, such as those under Code Sec. 412(d)(2), providing special rules for retroactive plan amendments. Rev Proc 94-42, 1994-1 CB 717, sets forth the procedures that a plan sponsor must follow in filing notice with, and obtaining approval from, IRS for a retroactive amendment that reduces accrued benefits.

The proposed regulations would provide special timing rules for when a section 204(h) notice must be provided to affected parties where the amendment is permitted to reduce benefits accrued before the plan amendment's applicable amendment date. Specifically, the proposed regulations would clarify that the date on which these plan amendments are effective is the first day that the plan is operated as if the amendment were in effect (the date the amendment is put into effect on an “operational basis”). Thus, a section 204(h) notice must generally be provided at least 45 days (15 days for a multiemployer plan) before the amendment is effective (even if the amendment is not adopted until a later date). (Prop Reg § 54.4980F-1, Q&A 9(g); Preamble to Prop Regs 3/20/2008)

The same rules would apply to retroactive amendments made under the PPA's remedial amendment period (Section 1107), Code Sec. 418D, Code Sec. 418E, and ERISA § 4281.

Cash balance plan conversions. The proposed regulations provide a special timing rule for section 204(h) amendments to an “applicable defined benefit plan,” as defined in Code Sec. 411(a)(13)(C)(i).

Observation: These plans are also called “statutory hybrid plans” in IRS guidance under Code Sec. 411 , and are more commonly known as cash balance plans.

The proposed regs would provide that any section 204(h) notice required to be provided for an amendment converting a traditional defined benefit plan to a cash balance (or other hybrid) plan that's first effective before Jan. 1, 2009, and that limits the amount of the distribution to the account balance as permitted under Code Sec. 411(a)(13)(A), will be considered timely if provided at least 30 days before the date the conversion amendment is first effective. This special timing rule reflects the 30-day timing rule described in Notice 2007-6, 2007-3 IRB 272, and may be used through the end of 2008. Thereafter, the general 45-day timing rule would apply to these conversions. (Prop Reg § 54.4980F-1, Q&A 18(b)(3)(iii); Preamble to Prop Regs 3/20/2008)

Multiemployer plans in endangered or critical status. Code Sec. 432 , relating to multiemployer plans that are in endangered or critical status based on their level of underfunding, permits a plan amendment to be adopted that reduces prior accruals under certain circumstances. For amendments for a plan in critical status, Code Sec. 432(e)(8)(C) requires that notice of the plan amendment be sent to, among other parties, plan participants and beneficiaries, at least 30 days before the general effective date of the reduction. Reg. § 54.4980F-1, Q&A 9(c) provides that a section 204(h) amendment made in the case of a multiemployer plan must be provided at least 15 days before the amendment's effective date. The proposed regs would provide that complying with the 30-day timing rule for the Code Sec. 432(e)(8)(C) notice would also satisfy the 15-day timing rule for the 204(h) notice. (Prop Reg § 54.4980F-1, Q&A 11(a)(7); Preamble to Prop Regs 3/20/2008)

However, for an amendment to which Code Sec. 432 applies for a multiemployer plan in endangered (as opposed to critical) status, the normal timing and content rules for a section 204(h) notice under Code Sec. 4980F would apply, so that any required section 204(h) notice would have to be provided at least 15 days, instead of 30 days, before the amendment's effective date. (Preamble to Prop Regs 3/20/2008)

Effective date. The regs are proposed to apply to 204(h) amendments effective after 2007. The 204(h) notice rules of Prop Reg § 54.4980F-1, Q&A 9(g)(2), regarding plan amendments with retroactive effective dates, apply to plan amendments that are effective after June 30, 2008. Finally, the 204(h) notice rules for cash balance (and other hybrid) plan conversions apply to amendments made effective after December 21, 2006, but not later than December 31, 2008.

A public hearing regarding the proposed regs will held July 10, 2008, at 10 a.m. in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, N.W., Washington, DC. Written or electronic comments regarding the proposed regs must be received by June 19, 2008. Outlines of topics to be discussed at the public hearing must be received by June 20, 2008.

Lower interest rate could result in higher taxes

How falling interest rates and the declining stock market affect tax and estate planning

Mike Habib, EA

myIRSTaxRelief.com

Interest rates have dropped significantly in recent months and may drop even more given the state of the economy. Sagging rates can have a significant impact on many tax and estate planning strategies. Lower interest rates affect the income, estate and gift tax value of many types of transfers. In many cases, the drop in rates produces more favorable results for clients engaging in certain types of transactions. In other cases, however, the lower rates result in higher tax costs. Likewise, stock values generally have declined significantly in recent days. This article examines how falling interest rates and the declining stock market affect key tax and estate planning transactions and strategies.

IRS valuation tables. The value of annuities (other than commercial annuities), life estates, term interests, remainders and reversions for estate, gift and income tax purposes is determined using tables issued by IRS under Code Sec. 7520. The value in a given month under the tables may be higher or lower than the value in an earlier or later month because the interest factor under the tables changes monthly. For charitable transfers, the interest rate for the month of the transfer or for either of the two preceding months may be used. (Code Sec. 7520(a))

The Code Sec. 7520 interest rate for April 2008 is 3.4%.

Observation: Over the past nine months from August 2007 to April 2008, the Code Sec. 7520 interest rate has ranged from a high of 6.2% (August 2007) to a low of 3.4% (April 2008). The rate hit an all-time low of 3.0% for transfers in July 2003 and has been as high as 11.6% (Apr. and May '89).

How falling rates affect various noncharitable planning strategies. The discussion that follows explains various noncharitable financial and estate planning strategies and shows how they stack up under current falling rates.

Private annuity. Historically, private annuities have offered a number of income, gift and estate tax advantages. They also can save estate administration expenses and offer other nontax advantages as well. In the typical private annuity transaction, a parent transfers property to his child in return for that child's unsecured promise to pay the parent a fixed, periodic income for life. If the fair market value of the property transferred equals the present value of the annuity under the Code Sec. 7520 valuation tables, there is no gift tax due.

Observation: Historically, one huge advantage of a private annuity has been the opportunity to transfer highly appreciated property, and spread, and pay tax on, the gain over several years as annuity payments are received. Additionally, there was the prospect of being taxed on less than the entire gain if the annuitant died before the expiration of his tabular life expectancy. However, in 2006, IRS issued proposed regs that would knock out the income tax advantages of selling appreciated property in exchange for a private annuity. They would do this by causing the property seller's gain to be recognized in the year the transaction is effected rather than as payments are received. The regs generally would apply for transactions entered into after Oct. 18, 2006. However, certain transactions effected before Apr. 19, 2007 would continue to be subject to the historical rules.

Entering into a private annuity when interest rates are lower results in a lower annual payment amount that the younger family member will have to make to the older family member to prevent a gift from arising on the transfer.

Observation: Even though the lower interest rate results in a lower annual payment to the senior family member, that person often will prefer a lower rate so as to be able to transfer property at the lowest possible cost to the younger family member.

illustration 1: In April 2008, Jones, age 70, transfers property worth $1 million to his daughter in exchange for a private annuity. She must make an annual payment of $96,752.97 to prevent a gift from arising on the transfer. This figure is determined by dividing $1 million by 10.3356, which is the annuity factor from Table S of IRS Publication 1457 for a 70-year old and an interest rate of 3.4%, which is the Code Sec. 7520 rate for April 2008.

illustration 2: By way of comparison, had the transfer occurred when the interest factor was 6.2% as it was for August 2007, the annual payment to prevent a gift would have been $119,323.20.

Observation: Those contemplating a private annuity and anticipating a further big drop in rates may want to wait before proceeding.

Observation: A private annuity may be a good strategy for an individual with a short life expectancy who is not expected to survive for too many years. However, the mortality component of the valuation tables cannot be used to determine the present value of an annuity if the person with the measuring life is terminally ill when the gift is completed. Under Reg. § 25.7520-3(b)(3) , an individual who is known to have an incurable illness or other deteriorating physical condition is considered terminally ill if there is at least a 50% probability that he will die within one year.

Observation: Stock values generally have been declining lately. Someone who is considering setting up a private annuity may want to fund it with stock that has undergone a steep decline in value from its high back to near its original purchase price. Such stock may be a good candidate for funding a private annuity because there would be little or no gain to report in the year of the transfer under the proposed regs if they take effect. Also, if the market turns around as it has often done in the past after steep downturns, the transaction can achieve considerable transfer tax savings. That's because, the child will end up with a sizeable amount of property with no gift or estate tax cost imposed on the post-transfer appreciation in its value.

Observation: Even individuals who lack the means to set up a private annuity should consider that now may be a good time to transfer stock to a junior family member. With prices as depressed as they are, in many cases blocks of stock can be transferred completely free of gift tax under the umbrella of the $12,000 annual exclusion. For example, 300 shares of stock that was previously worth, for example, $100 per share and that is now trading for $40 per share can be transferred to a single individual at no gift tax cost by virtue of the $12,000 annual exclusion. Here, too, if the stock bounces back to its earlier highs or beyond, the post-transfer appreciation will escape transfer tax costs.

Grantor retained annuity trust (GRAT). An individual can save transfer tax by setting up a GRAT. The individual retains an annuity interest for a specified term at the expiration of which the trust property goes to a child or other individual named at the outset. Gift tax is payable but only on the present value of the remainder interest, which is the value of the property transferred to the trust less the value of the retained annuity interest. A lower interest rate increases the value of the annuity retained by the grantor and thus reduces the value of the gift of the remainder in a GRAT.

The post-transfer appreciation in the value of the trust assets will escape transfer tax. However, this is so only if the grantor survives the trust term. If the grantor dies during the trust term, the trust property will be included in his gross estate under Code Sec. 2036(a) , which provides that property transferred by an individual during his lifetime is includible in his estate if he retains an interest for any period that does not in fact end before his death. But an individual who sets up a GRAT and dies before the end of the term would be no worse off than if he had not entered into the transaction except that he will have incurred the costs of setting up and administering the trust.

illustration 3: In April 2008, Smith transfers $1 million to a trust, which is to pay him an annual annuity of $80,000 for 10 years. At the end of the 10 years, the trust property is to go to Smith's daughter. The value of Smith's retained annuity is $668,696. This figure is determined by multiplying $80,000 by 8.3587, which is the annuity factor from Table B of IRS Publication 1457 for a 10-year term and an interest rate of 3.4%. The value of the gift of the remainder to Smith's daughter is $331,304.

Observation: Because a GRAT requires the grantor's survival of the term to be effective to reduce estate tax, it may not be suitable for use by an individual with a short life expectancy as a hedge against failing to survive until greater estate tax relief is phased in. However, such an individual may be able to realize some estate tax savings by establishing a GRAT with a relatively short term that he can be expected to survive.

illustration 4: By way of comparison, had Smith made the transfer when the interest factor was 6.2%, the value of the gift would have been $416,736.

observation: If interest rates decline more, gift tax costs of setting up a GRAT could be lowered. On the other hand, if they rise, gift tax costs could be increased.

Grantor retained income trust (GRIT). A GRIT is like a GRAT except that the grantor retains an income interest instead of an annuity interest. Code Sec. 2702 generally treats the grantor as making a gift of the full value of the property. However, the value of the gift of the remainder is determined under the valuation tables where the trust is funded with a personal residence of the grantor or the remainder goes to someone falling outside of the definition of family member, such as a nephew or niece. A lower interest rate results in a lower value for the retained interest and a higher value for the gift of remainder interest in a residence GRIT or other GRIT excepted from the Code Sec. 2702 rules.

illustration 5: Bailey establishes a personal residence GRIT in April 2008, retaining a ten-year term interest. At the end of the 10-year period, the residence is to go to his son. The value of the residence at the time of the initial transfer to the trust is $400,000. The remainder factor from Table B of IRS Publication 1457 is .715805 at the current interest factor of 3.4%, making the value of the gift $284,195.

illustration 6: Had Bailey engaged in the same transaction when the interest factor was 6.2%, the value of the gift would have been $219,187.

Observation: Thus, higher rates actually produce a better result for this strategy than when interest rates are lower. So one may want to wait until interest rates rise before engaging in this type of transaction. It should be noted, however, that lower home values also make this a good time to establish a personal residence gift because the gift tax cost will be lowered by the decline in the home's value relative to where it was during the housing boom. Thus, in holding out for a higher interest rate, taxpayers should consider how real estate values affect the decision of when to proceed with this strategy.

Grantor retained unitrust (GRUT). The interest factor does not affect the value of a gift of a remainder interest in a GRUT because the retained unitrust interest is the right to receive a fixed percentage of the trust's assets and changes in rates inure uniformly to the benefit of the unitrust holder and the remainderperson.

How declining rates affect various charitable planning strategies. The discussion that follows explains various charitable planning strategies and shows how they stack up under current declining rates.

Charitable remainder annuity trust (CRAT). With a charitable remainder annuity trust, the donor retains an annuity interest for himself or someone else such as a family member and names a charity to receive the remainder at the end of the annuity term. The donor gets a current income tax deduction for the present value of the charity's remainder interest. Now may not be a good time to establish a CRAT. That's because, a lower interest rate produces smaller income, gift and estate tax charitable deductions and a higher gift tax value for a gifted annuity interest.

Charitable remainder unitrust (CRUT). A change in the rate does not affect income tax deductions for charitable remainder unitrusts or gift tax costs in connection with them.

Charitable lead unitrust. Estate and gift tax factors are essentially unaffected by changes in the rates.
Charitable lead annuity trust. A lower interest rate results in a larger gift or estate tax deduction for the annuity interest going to the charity and a smaller value for any gift of the remainder interest going to a private beneficiary. Thus, it may be a good time to establish a charitable gift annuity if the grantor is going to give the remainder interest to a family member. If rates decline further, more savings can be realized by waiting. And remember, with a charitable transfer, the interest rate for the month of the transfer or for either of the two prior months can be used. Thus, one can wait and still be afforded some protection if rates unexpectedly rise instead of dropping further.

Charitable transfer of remainder interest in residence or farm. A lower interest rate provides higher income, estate and gift tax deductions for a transfer of a remainder interest in a residence or farm. Conversely, a higher interest rate provides lower income, estate and gift tax deductions for a transfer of a remainder interest in a residence or farm.

Pooled income funds in existence for more than 3 years. Charitable income, gift and estate tax deductions for transfers to pooled income funds that have been in existence for more than 3 years are not affected by changes in interest rates because values of respective interests are determined with reference to the funds' own rates of return. Any personal gift arising from the transfer also is not affected.

Credit card debt triggers tax problems - know your options

Did you know that forgiven credit card debt triggered taxable income

Mike Habib, EA
myIRSTaxRelief.com

A new Tax Court case illustrates how a taxpayer generally has taxable income when a credit card company agrees to accept a reduced payment in settlement of his or her account.

Background. A solvent debtor usually realizes income from the discharge of a debt. (Code Sec. 61(a)(12)) Debtors who are insolvent, in bankruptcy, or (in certain cases) farmers and noncorporate debtors whose debt is qualified real property business indebtedness do not recognize income on a cancellation of a debt. (Code Sec. 108(a)) Instead, they must reduce their loss or tax credit carryovers or the basis in their assets. (Code Sec. 108(b)) These reductions can cause the debtor's taxes to increase in future years.

In addition, cancellations of up to $2 million of mortgage debt on an individual taxpayer's main home in 2007 through 2009 are excluded from income, but the taxpayer's basis in the home must be reduced. (Code Sec. 108(a)(1)(E), Code Sec. 108(h))

The amount of COD income where indebtedness from a credit card account is discharged is the difference between the entire amount due on the account—including interest, balance transfers, credit card charges, checks, operation charges, and penalties—and the amount paid for the discharge. If no consideration is paid for the discharge, the amount of COD income is equal to the entire amount due on the account.

Code Sec. 108(e)(5) provides an exception to Code Sec. 61(a)(12) where the buyer of property negotiates with the seller/creditor for a discharge of all or part of the purchase money indebtedness. Commonly such a discharge reflects a decline in the value of the property. The resulting discharge of indebtedness is characterized not as taxable income but in effect as a retroactive reduction of the purchase price.

Facts. Ancil Payne used his credit card with MBNA America Bank to pay hospital bills and receive cash advances during periods of unemployment. By Apr. 26, 2004, he accumulated $21,407 of debt on the card. Later in 2004, Mr. Payne and MBNA entered into an agreement whereby MBNA agreed to accept $4,592 as a full settlement of the account balance of $21,270, payable in installments over 4 months. Mr. Payne made the necessary payments, and MBNA issued him a Form 1099-C, Cancellation of Debt, reporting $16,678 of discharge of debt income.

On his 2004 joint return, he and his wife did not report any debt discharge income. Instead, they attached a statement to their return which disclosed that they received a Form 1099-C from MBNA that reported discharge of debt income of $16,678. The statement also explained that they believed the amount disclosed on the Form 1099-C was not subject to income tax.

IRS determined a deficiency for the Paynes' failure to report debt discharge income. The couple petitioned the Tax Court for a redetermination of the deficiency.

Failed argument. Before the Tax Court, the Paynes contended that their settlement with MBNA did not result in the discharge of indebtedness but was rather a retroactive reduction of the rate of interest charged by MBNA and thus a reduction of the “purchase price” of the loans under Code Sec. 108(e)(5). The Paynes argued that the lending of money in a generic credit card transaction constitutes the sale of property under Code Sec. 108(e)(5).

The Tax Court said that the Paynes were mistaken. It stressed that MBNA effectively lent them money to be used for health care costs and general living expenses. The only relationship between the parties was that of debtor and creditor, and thus the Tax Court held that Code Sec. 108(e)(5) did not apply.

Observation: Many individuals may be in a similar situation of needing a credit card workout. While getting the bank to agree to a big reduction in the debt is obviously a plus, as shown in this case, the debt discharge can trigger income. For some, however, the debt discharge income may not have practical tax consequences. For example, if the discharge occurs during a period of unemployment when the individual has little or no income from other sources, the individual effectively may owe little or no tax on it. While there probably is not much latitude to time a settlement, to the extent possible, individuals should try to arrange it during periods when the income from the discharge won't have severe tax consequences.

IRA Tax Problem? What options you have

“Makeup” required minimum distributions salvage lifetime payouts to nonspouse IRA beneficiary

Mike Habib, EA
myIRSTaxRelief.com

A private letter ruling allows the nonspouse beneficiary of an IRA to salvage lifetime payouts even though she failed an essential rule requiring distributions to begin by the end of the year following the year of the IRA owner's death. She made up missed annual required minimum distributions (RMDs) and paid a penalty excise tax, but by doing so she avoided a tough 5-year payout rule.

Background. If an IRA owner dies before his required beginning date (RBD), namely Apr. 1 of the year following the year in which age 70 1/2; is attained, then as a general rule his entire interest must be distributed within 5 years of his death. (Code Sec. 401(a)(9)(B)(ii)) However, if any part of the IRA is (1) payable to (or for the benefit of) a designated beneficiary, (2) that part is to be distributed under regs over the life or life expectancy of the designated beneficiary, and (3) the distributions begin not later than 1 year after the date of the deceased's death (or a later date as prescribed by regs), then that part is treated, for Code Sec. 401(a)(9)(B)(ii) purposes, as paid out when distributions commence. (Code Sec. 401(a)(9)(B)(iii))

Reg. § 1.401(a)(9)-3, Q&A 3(a), says that where there's a nonspouse beneficiary for the IRA (or a qualified plan account), in order to satisfy the life expectancy payout rule in Code Sec. 401(a)(9)(B)(iii), “distributions must commence on or before the end of the calendar year immediately following the calendar year in which the [IRA owner or employee] died.”

The determination of whether the five-year or lifetime payout rule applies depends on the provisions of the IRA. It may be silent as to which rule (5-year or lifetime payout) applies, specify which rule applies, or it may allow the owner (or beneficiary) to elect which rule applies. (Reg. § 1.401(a)(9)-3, Q&A 4)

(1) If the IRA does not contain one of the optional provisions described in (2) or (3), below, specifying the methods of distribution if an IRA owner dies before required distributions begin, then payouts are made over the life of the designated beneficiary (or over a period which doesn't extend beyond the life expectancy of the designated beneficiary). (Reg. § 1.401(a)(9)-3, Q&A 4(a)(1)) The lifetime payout also applies if neither IRA owner nor beneficiary make the choice in (3), below. (Reg. § 1.401(a)(9)-3, Q&A 4(c))

(2) The IRA may adopt a provision specifying either that (a) the 5-year payout rule applies to certain distributions even if there's a designated beneficiary for the IRA, or (b) that payouts in every case will be made under the 5-year rule. (Reg. § 1.401(a)(9)-3, Q&A 4(b))

(3) The IRA may allow the owner or beneficiary to choose between a 5-year or lifetime payout and may specify one or the other payout method if the choice isn't timely made. (Reg. § 1.401(a)(9)-3, Q&A 4(c)) Where the IRA calls for a choice to be made between 5-year and lifetime payouts, it must be made by the earlier of:

• Dec. 31 of the calendar year in which the distribution would have to start in order to meet the lifetime payout rule under Code Sec. 401(a)(9)(B)(iii) and Code Sec. 401(a)(9)(B)(iv) (i.e., for nonspouse beneficiaries, by Dec. 31 of the year following the year of the IRA owner's death), or
• Dec. 31 of the calendar year that includes the fifth anniversary of the IRA owner's death. (Reg. § 1.401(a)(9)-3, Q&A 4(c))

Any failure (by the IRA owner or beneficiary) to take the RMD for a tax year is subject to an excise tax equal to 50% of the amount by which the RMD exceeds the actual amount distributed during the tax year. (Code Sec. 4974(a))

Facts. A taxpayer we'll call Rachel Smith is the only child of a taxpayer we'll call Leonard Smith, who died in 2002 when he was 66 years old. Rachel, named as the sole beneficiary of Leonard's IRA X and IRA Y, was 30 years old when Leonard died. After Leonard's death, the IRAs were retitled “IRA X- Leonard Smith, Decedent IRA, Rachel Smith, Beneficiary,” and “IRA Z (formerly IRA Y), Leonard Smith, Decedent IRA, Rachel Smith, Beneficiary.” No distributions were made from either IRA in connection with their retitling.

IRA X provides, that where a required distribution has not commenced before the owner's death, the balance of the IRA must be distributed to the owner's nonspouse designated beneficiary over his or her life expectancy starting by Dec. 31 of the year following the year of the IRA owner's death. A nonspouse beneficiary may elect to receive distributions in accordance with the 5-year rule. IRA Y provides that if the owner dies before his RBD, his nonspouse beneficiary may receive distributions over his or her life expectancy beginning no later than the end of the year following the year of the IRA owner's death. The nonspouse beneficiary may choose to receive RMDs in accordance with the 5-year rule.

Rachel should have, but failed to, start taking RMDs over her life (or life expectancy) for 2003 (the year after her father died), and for 2004. However, the RMDs for 2003, 2004, and 2005 were taken in the aggregate in 2005, based on Rachel's life expectancy for each year using the distribution period spelled out in Reg. § 1.401(a)(9)-5 , Q& A 5(c)(1). In 2007, Rachel paid the Code Sec. 4974(a) penalty tax for her failure to timely receive RMDs for 2003 and 2004. The ruling says that Rachel represented, and evidence submitted in conjunction with the ruling request supported the representation, that she had not elected the Code Sec. 401(a)(9)(B)(ii) 5-year distribution rule for either IRA X or IRA Y (as retitled).

The essential question in PLR 200811028, was whether Rachel's failure to timely take RMDs for 2003 and 2004 resulted in her having to receive the balance from the two IRAs under the 5-year rule, or whether she could take RMDs from the IRAs over her life or life expectancy.

Favorable ruling. IRS concluded that Rachel could take RMDs from the two IRAs for 2003 through 2006, and all subsequent years, over her life expectancy. IRS reasoned that the “default” required distribution rule for both IRAs where the owner dies before his RMD and has designated a beneficiary is the life-expectancy rule and not the 5-year rule. In Rachel's case both IRAs provide that where an IRA owner dies before his RMD, distributions to a beneficiary are to be made under the life-expectancy rule unless the designated beneficiary chooses otherwise. Rachel hasn't elected the 5-year rule for either IRA and has paid the 50% excise tax on the distributions she should have but didn't receive in 2003 and 2004. Thus, IRS concluded that “the life-expectancy rule of Code Sec. 401(a)(9)(B)(iii) , the “default” rule, applies to distributions from both IRA X and IRA Y.”

Observation: PLR 200811028 arrives at an extremely favorable result. It allows Rachel to spread out RMDs from the IRAs over 52.4 years (her life expectancy under the Single Life Table of Reg. § 1.401(a)(9)-9, Q&A 1, for the year following the year of her father's death), and to keep the tax-deferred earnings feature of the IRAs alive for that period of time. Had IRS ruled that the 5-year payout rule was triggered by her failure to timely begin making distributions, she would have had to deplete both IRAs by Dec. 31, 2007 (the end of the calendar year containing the fifth anniversary of Leonard's death).

Observation: Although private letter rulings can't be relied on by a taxpayer other than the one who requested it, those who are in a situation like Rachel's would appear to be in a strong position to request similar, favorable treatment from IRS.

Observation: The ruling illustrates the hazards of not receiving expert tax advice when dealing with post-death IRA distributions. In Rachel's case, she wound up having to take three-years' worth of RMDs in one year, quite possibly having to pay a higher marginal tax rate and claiming smaller writeoffs for deductions that are subject to AGI-based phaseouts, and paying a 50% excise tax to boot.

IRS Tax Problems? Get Resolution today - here's why

If you owe the IRS, you're better off resolving your tax debt now. As you know, tax problems do not go away by themselves! Stop IRS wage garnishment today, stop IRS bank levy today, and release IRS tax lien today.

As you can see from the statement below by Mr. Douglas H. Shulman, the new IRS Commissioner, he will first concentrate on Enforcement, then secondly its Service! Are you saying where is the kinder and gentler IRS?

Contact us today to resolve your tax problems.

Statement of Commissioner Douglas H. Shulman

I want to extend my thanks to the members of the Senate and the Senate Finance Committee, especially Chairman Baucus and Senator Grassley. I also want to thank President Bush for nominating me and Treasury Secretary Paulson for his support.

The Internal Revenue Service touches virtually every adult, every business and every non-profit organization in America. It is an honor to assume the leadership of this critical agency. I recognize the great responsibility I have been given and will work to ensure that the IRS is fair, impartial and respects the rights of all taxpayers.

As Commissioner, I will concentrate on both enforcement and service. For the majority of Americans who pay their taxes willingly and on time, there must be clear guidance, accessible education and outstanding service. Our aim should be to make it as easy as possible for citizens to pay the correct amount of taxes in the most efficient and least burdensome manner possible.

For taxpayers who intentionally evade paying taxes, there must be rigorous enforcement programs.

I am looking forward to working with the dedicated and talented IRS workforce, along with the broader tax community and important stakeholders to continue to build an efficient, effective and respected IRS.

Contact us today to resolve your tax problems.

Don't compromise on your representation! We represent taxpayers before the IRS and any taxing authority.

Mike Habib, EA

As an IRS licensed Enrolled Agent (EA) specializing in IRS Tax Problem Resolution, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

Are you being audited? IRS audits you need to know

What are your chances for being audited? IRS's 2007 data book provides some clues


Mike Habib, EA

myIRSTaxRelief.com

IRS has issued its annual data book, which provides statistical data on its fiscal year (FY) 2007 activities. As this article explains, the data book provides valuable information about how many tax returns IRS examines (audits), and what categories of returns IRS is focusing its resources on, as well as data on other enforcement activities, such as collections.

What are the chances of being examined? A total of 1,384,563 individual income tax returns were audited during FY 2007 (Oct. 1, 2006 through Sept. 30, 2007) out of a total of 134.5 million individual returns that were filed in the previous year This works out to 1.0% of all individual returns filed (slightly higher than the 0.97% audit rate for the preceding year).

Of the total number of returns audited, 503,267 (36.5%) were selected on the basis of an earned income tax credit (EITC) claim (down slightly from the 40.3% rate for FY 2006).

Only 22.49% of the audits were conducted by revenue agents, tax compliance officers, and tax examiners; the bulk of the audits (about 77.5%) were correspondence audits. These percentages are about the same as they were in FY 2006.

About 1.5 million individual returns were farm returns that showed gross receipts from farming (Schedule F). Of this group, only 5,705 (0.4%) were audited in 2007.

The no-change rate (returns accepted as filed after examination) was 12% for returns examined by revenue agents, tax compliance officers, or tax examiners, and 16% for correspondence exams.

Here's a roundup of selected audit rates from IRS' latest databook. Because the audit categories aren't organized the same way for individuals as they were for FY 2006, comparisons to the rates for the previous fiscal year aren't possible.

Following are the audit rates for individual nonbusiness returns that didn't claim the earned income tax credit:

• For “selected nonbusiness returns” (includes returns without a Schedule C (nonfarm sole proprietorship), Schedule E (supplemental income and loss), Schedule F (profit or loss from farming), or Form 2106 (employee business expenses), 4%.
• For returns with Schedule E or Form 2106 (excludes returns with a Schedule C, nonfarm sole proprietorship, or Schedule F, profit or loss from farming), 1.2%.
• For nonfarm business returns by size of total gross receipts: under $25,000, 1.3%; $25,000 under $100,000, 2%; $100,000 under $200,000, 6.2%; and $200,000 or more, 1.9%.

For returns with total positive income (TPI) of at least $200,000 and under $1 million, the audit rate was 2% for nonbusiness returns and 2.9% for business returns. For returns with TPI of $1 million or more, the audit rate was 9.3%.

The audit rates for entities were as follows:

• Fiduciary (estate and trust income tax returns), 0.1% (the same as for FY 2006);
• Corporations with less than $10 million of assets, 0.9% (up from 0.8% for FY 2006);
• Corporations with $10 million or more of assets, 16.8% (down from 18.6% for FY 2006);
• S corporations, 0.5% (up from 0.38% for FY 2006);
• Partnerships, 0.4% (up from 0.36% for FY 2006);
• Estate tax returns, 7.7% (down from 9.66% for FY 2006); and
• Gift tax returns, 0.6% (down from 0.77% for FY 2006).

IRS activity on other fronts. Here's a roundup of over valuable information carried in the new IRS Data Book.

Penalties. In fiscal year 2007, IRS assessed 27.3 million civil penalties against individual taxpayers, up from 25.9 million civil penalties assessed in the previous year. Of the FY 2007 assessments, 15.17 million (55%) were for failure to pay, followed by 7.72 million (28.2%) for underpayment of estimated tax. There were 327,822 assessments (1.1%) for “accuracy penalties”—assessments of penalties under Code Sec. 6662 for negligence, substantial understatement of income tax, substantial valuation misstatement, substantial overstatement of pension liabilities, and substantial estate or gift tax valuation understatement, and understatement of reportable transactions under Code Sec. 6662A .

On the corporation side, there were a total of 762,718 civil penalty assessments (up from 701,785 for FY 2006), 82.9% for either failure to pay or underpayment of estimated tax.

Offers in compromise. In FY 2007, 46,000 offers in compromise were received by IRS, and 12,000 (26%) were accepted. Over recent years, these numbers have been dropping; in 2006 for example, 59,000 offers in compromise were received by IRS, and 15,000 (25.4%) were accepted.

Criminal cases. IRS initiated 4,211 criminal investigations in FY 2007. There were 2,837 referrals for prosecution and 2,155 convictions. Of those sentenced, 98.5% were incarcerated (a term that includes imprisonment, home confinement, electronic monitoring, or a combination thereof). By way of comparison, in FY 2006, IRS initiated 3,907 criminal investigations, there were 2,720 referrals for prosecution, and 81.7% were incarcerated.

Information returns. IRS received a total of 1.825 billion information returns in FY 2007, including Forms 1098 (mortgage interest, student loan interest, and tuition), 1099 (interest, dividends, etc.), 5498 (individual retirement arrangement and medical savings account), W-2 (wages), W-2 (gambling winnings), and Schedules K-1 (pass-through entities). Of the total, only 3.1% were submitted on paper.

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