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IN THIS ISSUE
WHAT WOULD AMANDA WANT?
GIFT VALUES DURING A PANDEMIC
THE FBAR PENALTY
ARTICLES OF INTEREST
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Here's to a very Happy, Prosperous and above all a Healthy 2021! Hopefully before mid-year 2021 the Pandemic will be under control and we can return to a sense of normality.
Many of you who are working have had to adjust work schedule to accommodate the effects of COVID-19. At Garden State Trust Company, we have had to adjust our work schedules, limiting the number of team members that can be in the office at any one time, while those not in the office work home. Thank goodness that technology allows us to function seamlessly from anywhere so that I am able to prepare this Newsletter from my home.
Our Blog for this month addresses the issues States are facing as how to manage spending given declining tax revenue due to the pandemic, so they are taking another look at the taxation of residents and non-residents. In particular, New Jersey residents who are used to commuting into New York City but who now are working from home and may continue to work from home after the Pandemic.
According to a recent article from the Wall Street Journal, the tax amounts being discussed are substantial:
"The fiscal implications of changing the taxation rules run in the billions of dollars, according to budget officials from several states. In 2018, around 434,000 New Jersey residents paid $3.7 billion in New York income taxes, according to the New York State Department of Taxation and Finance."
In our Blog that you can read in its entirety we discuss how residency is determined for tax purposes. One test for example, is Where is your teddy bear? And, for those of you that are thinking of changing your residency in 2021, read Steps to Establish a New Residency.
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CLICK THE NAME TO READ
CLICK THE NAME TO READ
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In this month's Informational Articles read What Would Amanda Want? Careful wording of trust agreements can help prevent disagreements down the line. In another article, Gift Values During A Pandemic read how COVID-19 has caused valuation discounts for some assets to soar. Economic pain and uncertainty can reduce values dramatically. According to one report, the value of some commercial real estate in New York City is down as much as 75% because many tenants are no longer able to pay their rents.
As we leave 2020 behind, there is hope for 2021. "Learn from yesterday, live for today, hope for tomorrow." - Albert Einstein
Sincerely,
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One reason for using a trust for protection and management of assets is that the desires of the trust creator will continue to be respected after the creator dies. However, those desires can be tricky to discern, as it is not easy to predict what the future holds and how the trust creator would have reacted. This is a true story, taken from a recent court case.
In 2008 Amanda Ochse created a family trust for the management of her wealth. The initial trustee identified for the trust was her only living son, William. The named successor trustees should William be unable to serve were William's wife, Cynthia, and someone named Jack Hebdon, Jr., perhaps a lawyer or family friend. The trustee had the discretionary power to distribute income and principal to the beneficiaries of the trust.
However, the trust did not identify those beneficiaries by name, but instead stated it was "for the benefit of her [Amanda's] son, her son's descendants, and her son's spouse." That may not seem ambiguous at first, but it turned out to be so.
William divorced Cynthia in 2012, after some 30 years of marriage. He married Carol in 2015. In 2018 William's children from his first marriage filed a lawsuit alleging that he had breached his fiduciary duties and obligations as trustee. The children named Cynthia as an interested party to the litigation.
Second wife Carol then intervened in the lawsuit, seeking a declaration that the terms "son's spouse" and "primary beneficiary's spouse" as used in the trust document meant that Cynthia's trust interest was terminated by the divorce, and Carol succeeded to that interest upon her marriage to William. Why else would Amanda have identified Cynthia by name in one section of the trust but only generically as the spouse in another section?
The Texas courts rejected that trust interpretation. Class gifts, such as "to my descendants," are needed when the members of the class might not be identifiable when the trust is executed. The son's spouse was clearly identifiable when this trust was executed. The court held that the trust language was unambiguous, and that Amanda wanted Cynthia as a permanent trust beneficiary, not any subsequent spouse.
Careful wording of trust agreements can help prevent disagreements down the line.
(January 2021)
© 2021 M.A. Co. All rights reserved.
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Gift Values During a Pandemic |
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The value for federal gift tax purposes of a gift of $100,000 in cash is $100,000, and the same is true for the value of $100,000 worth of publicly traded stock. Those are the easy cases. The hard cases concern assets that are harder to value, such as real estate or interests in a closely held business. Those situations start with a baseline estimate, and then discounts may be applied in accordance with any restrictions on the property. COVID-19 has caused valuation discounts for some assets to soar. Economic pain and uncertainty can reduce values dramatically. According to one report, the value of some commercial real estate in New York City is down as much as 75% because many tenants are no longer able to pay their rents. With such large discounts in place, the $11.7 million lifetime exemption from federal gift tax will shelter far more in assets than would have been true one year ago.
That might mean this is a good time for making a taxable gift.
Careful appraised values are critical
The Tax Court recently ruled on a gift tax case that arose from a gift in 2009, after the last economic downturn and during period of similar grave uncertainty.
Aaron Jones founded the Seneca Sawmill Company (SSC) in Oregon in 1954. The company prospered and expanded over the years. In 1989 Jones became convinced that emerging environmental rules would restrict his access to timber from federal lands. He established the Seneca Jones Timber Company (SJTC) to purchase and manage privately held forest land, and that company became a primary supplier of logs to the sawmill. Over the years 150,000 acres of forest was acquired. Although the two companies were legally separate, their ownership and management were closely intertwined. SJTC could not sell timber to third parties without the approval of SSC.
Although the two companies were prosperous, the 2008 recession had a major impact on them. Housing starts fell from an annualized rate of 2.3 million in early 2006 to just 490,000 in early 2009, sharply reducing the national demand for lumber. SSC had to reduce employee hours to avoid layoffs. Lumber companies in the area that did not own their own timberlands did not survive. New financial projections were done in April 2009, and additional steps had to be taken by SSC to comply with loan covenants.
Mr. Jones began his estate planning in 1996, hoping to keep his companies in the family and operating in perpetuity. In accordance with that plan, in May 2009 Jones established seven trusts to have partial ownership interests in SSC and SJTC. Jones reported the funding of the trusts as a taxable gift worth more than $7 million, and paid the gift tax on it.
After Jones died in 2014, the IRS challenged the gift tax valuation.
The IRS pounces
As so often happens, the case before the Tax Court became a battle of appraisal experts. The estate's expert valued the companies as a going concern, using the discounted cash flow method of valuation. That produced a total value for the firms of $21 million before discounts. In contrast, the expert testifying for the IRS used a net asset value approach, treating the companies as a natural resource holding company rather that an operating business. He came up with $140 million as the total value of the firms.
The Tax Court felt that each approach should be given some weight, given that the firms were in fact both operating companies and resource owners. However, given the severe restrictions on SJTC's ability to independently sell its logs, that factor had to be significantly discounted.
The estate argued that tax effects needed to be taken into account in the valuation, because a willing buyer would certainly do so. The IRS argued that tax effects should be ignored, because the companies were structured as pass-through entities, but the Court pointedly observed that none of the IRS' valuation experts backed up that theory. The tax effects were allowed. Also, the estate successfully defended a 35% discount for lack of marketability of the interests.
The element that makes this case especially relevant in these times is that the estate argued for using the April 2009 financial projections in determining the value of the gifts one month later. The IRS considered those projections to be overly pessimistic and unreliable, given the economic uncertainty. However, that uncertainty was precisely why the management had done the additional April projections, using the same methodology as had always been employed in earlier years. The Court accepted the April data as proper.
This decision suggests that appraisals done in the shadow of the COVID-19 pandemic can be successfully defended before the IRS.
(January 2021)
© 2021 M.A. Co. All rights reserved.
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Margaret was born in Canada in 1928. When she was in her 20s Margaret met and married Jeffrey, who was a New Zealand native. The couple moved to New York and then to California in 1954, where they resided ever since. In 1969 they became American citizens.
Because of their background, both Margaret and Jeffrey had foreign bank accounts in Canada and New Zealand, individually and jointly. They did not have an affluent lifestyle but lived modestly. Jeffrey died in 2013, and Margaret was the executor of his estate. At that point she learned for the first time that Jeffrey had secret bank accounts in New Zealand worth millions of dollars, possibly from an inheritance.
Margaret also then learned for the first time about the Foreign Bank Account Report (FBAR) that is required of all U.S. citizens who have foreign bank accounts with an aggregate value of $10,000 or more. To comply with those requirements, Margaret filed a timely FBAR for 2012 and also filed amended income tax returns for tax years 2011 and 2012, properly reporting all the foreign income from all the accounts.
About one year later Margaret learned of the IRS's "Streamlined Domestic Offshore Procedures" for correcting delinquent FBAR filings. She filed FBARs for tax years 2008 through 2013 and included a certificate stating that her failure to file was due to her negligence or mistake and was not willful. She also paid a 5% penalty of $156,795.26 on the highest balance of all the accounts. The penalty for willful failing to file is 50% of the highest balance.
All these actions were taken at Margaret's initiative. However, she did not file FBARs for Jeffrey's secret accounts (but she did disclose the accounts to the IRS on his estate tax return). Margaret did not know her husband's state of mind and was reluctant to swear to it under penalty of perjury. What's more, the IRS offered no official guidance on the filing of FBARs for a deceased person.
Margaret's good-faith effort to comply with FBAR requirements was rewarded with a two-year audit and an IRS assessment of over $3 million in penalties for Jeffrey's willful failure to file. Her attorneys took the matter to District Court, and estate planners were hoping that the case would provide some enlightenment on what constitutes "willfulness" regarding FBARs.
We won't soon know the answer to that, because the IRS settled the case for "a fraction of the original FBAR penalty," according to Margaret's attorneys. Perhaps the bad optics of the IRS going after a 90-year-old widow affected their decision to settle.
Nevertheless, foreign bank accounts will continue to be a major tax headache for those who own them, and the penalties for failure to file should be taken very seriously.
(January 2021)
© 2021 M.A. Co. All rights reserved.
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Because of the rapidly changing nature of tax, legal or accounting rules and our reliance on outside sources, Garden State Trust Company makes no warranty or guarantee of the accuracy or reliability of information contained herein nor do we take responsibility for any decision made or action taken by you in reliance upon information provided here or at other sites to which we link. ©2021. All rights reserved. |
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