Report No. 7 (Tue. 1/15 and Wed. 1/16)
As we have done in January for the last eleven years, and again with the
permission of the University of Miami School of Law Center for Continuing
Legal Education, we will be posting daily Reports to this list containing
highlights of the proceedings of the 42nd Annual Philip E. Heckerling
Institute on Estate Planning that is being held January 14-18, 2008 at the
Orlando World Center Marriott Resort and Convention Center in Orlando,
Florida, a new venue for the Institute starting in 2007. A complete listing
of the proceedings will be published here and is also available on the
Institute's Web site at http://www.law.miami.edu/heckerling.
We also will be posting the full text of each of these Reports on the ABA
RPPT Section's Web site, as we have since the 2000 Institute. Those Reports
can be found at URL http://www.abanet.org/rppt/meetings_cle/heckerling. In
addition, each Report can also be accessed at any time from the ABA-PTL
Discussion List's Web-based Archive at URL
http://mail.abanet.org/archives/aba-ptl.html.
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This Report covers Closely-Held Company Deferred Compensation (and
Alternatives) from the Tuesday sessions and Gifting and Selling by Formula
and Transfer Tax Audit Issues from the Wednesday sessions. The next Report
will cover the balance of the Tuesday sessions and more of the Wednesday
sessions.
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Mom & Pop Want to Cut Hours But Not Pay! Closely-Held
Company Deferred Compensation (and Alternatives)
Tuesday, January 15, 2008
Presenter: Donald Jansen
Reporter: Gene Zuspann
Donald. Jansen started by emphasizing that this presentation only focused
on smaller closely held companies which he termed mom and pop operations.
The parents generally do not want to sell the business because the kids are
involved. Usually, there are two situations in which the family wishes to
provide deferred comp - i) where there is a family executive and ii) in the
situation that a key employee is a non-family member. In scenario ii, the
key employee does not have an ownership interest.
What is deferred compensation? It is a plan that allows the family member
or key employee to defer compensation which would be received and taxed in
the current year, to a later year. It is the right to receive money in one
year which is payable at a later date and is subject to a right of
forfeiture.
The advantage of non-qualified deferred compensation is that it avoids most
of the provisions of the Internal Revenue Code and ERISA. Disadvantages
are that it is generally not funded, it is limited on how many people you
can cover and there is no deduction for the employer until it is paid.
Don said non-qualified deferred compensation plans are highly
flexible. The class of persons that can be covered is not limited to
employees, it can be based upon future performance or a benchmark and it
can be an incentive to retain key employees.
He defined three types of plans - an elective deferral plan, a supplemental
executive retirement plan (a SERP), and plans linked to qualified plans (a
401(k) wraparound plan to cover excess contributions over the amount
allowed in the IRC).
There are two plans that avoid current income tax: the vested but unfunded
plan and the funded but not vested plan. Both of these plans work as
non-qualified deferred comp - they are not taxable (nor deductible) until
the employee is paid.
Referring to a prior presentation, he indicated that the IRS has 4 arrows
in its quiver to attack non-qualified deferred comp plans. These are:
1. The constructive receipt doctrine;
2. The economic benefit doctrine;
3. Section 83; and
4. Section 409A
Section 409A has had a significant impact on the constructive receipt
doctrine. To avoid taxation, there must be a substantial limitation or
restriction. It affects the timing of the deferral. The old "haircut
provisions" are not longer effective. These provided that the executive
would receive an amount in the future, but could opt for an early payout at
a reduced price (the haircut).
Section 83 codified the economic benefit doctrine. Section 83 does not
apply if the obligation to pay is an unfunded and unsecured promise to pay
the executive. Under section 83, even if the deferred compensation was
funded, it was still not taxable if the employee was subject to a
substantial risk of forfeiture. Under section 83, there has to be a
transfer of property.
409A has changed the substantial risk of forfeiture rules to make them more
stringent and the rules in 409A override those in section 83.
Section 409A is the most significant change in this area of the law since
1969. 409A has expanded the constructive receipt rules. A deferred
compensation plan must provide that the deferred comp may only be paid upon
the occurrence of one or more of the following events: separation from
service, disability, death, specified time or pursuant to a fixed schedule,
change in ownership or effective control of the entity, or an unforeseen
emergency.
There must be no acceleration of the benefits - the haircut provision is
gone. Don indicated that there are 14 minor exceptions to this rule but
they are minor. There are also new restrictions on the deferral and
redeferral elections.
The funding rules under section 83 have been expanded.
What is a covered nonqualified deferred compensation plan? 409A states
that it is any plan that provides for the deferral of compensation. The
final regs become effective on January 1, 2009. There are a number of
items excluded by the final regs. One item Don discussed is the short term
deferral, which is two and one half months after the end of the period in
which the amount is no longer subject substantial risk of forfeiture. His
example is a restriction that expires in 10 years (2018). The deferral
would be March 15, 2019.
The transition rules allow amending plans. Employers must make sure that
the plan is amended this year if the plan is intended to qualify in 2009
because the final regs become effective on January 1, 2009.
Deductions by the employer. The compensation must meet the section 162
tests. They must be ordinary, necessary and reasonable. The employer can
justify the amount of the deferred compensation by reference to the
compensation in prior years. If the employee was underpaid in prior years,
the plan can make up the deficiency.
An s-corp can have a problem in this area if it has been compensating the
employee/stockholder with an specific amount and treating the excess as a
dividend. Basically, the employee and the employer have documented that
the amount previously paid was reasonable compensation and the employee has
not paid self employment tax on the difference. To allege that the prior
compensation was too low would be contrary to the prior position.
Funding
A plan is funded if the creditors of the employer can no longer reach the
funds. If the plan is funded and secure from the employer's creditors, it
is taxable at that point. A Rabbi trust can be used because the funds are
not available to the employer, yet are still subject to claims by the
employer's creditors.
However, plan may also have to meet the ERISA top hat plan exception. A
top hat plan maintained by the employer is still subject to claims under
ERISA. ERISA does not define "unfunded." A top hat plan must be for a
select group of managmeent or highly compensated employees. It is limited
so that the plan cannot cover a large group of people.
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Gifting and Selling by Formula - Shield Against Gift Tax Valuation Risk or
Invitation to Audit Exposure
Wednesday, January 16, 2008
Presenter: Carlyn McCaffery
Reporter: Ronda Martinez
Lifetime transfers by gift or sale are powerful estate planning tools but
it is not easy to predict how the value will determined for gift or GST
purposes. The risk is that the IRS will not accept the value. The
valuation risk can be particularly a problem with fractional shares of
artwork and real estate. The risk subjects the taxpayer to additional gift
tax and interest, and possible penalties. There are 3 available methods to
reduce or avoid valuation risk through the use of GRATs, uncompleted gifts,
or the formula clause.
The discussion emphasized formula valuation.
There are 4 aspects of the formula to consider: how reliable it is; how to
craft it; how to administer it; and how to achieve certainty of the valuation.
There are 2 types of formulas. The adjustment, or fix up, clause makes a
retroactive adjustment to the amount of the transfer after it is made. It
provides for a give back of the gift or revocation of sale. The IRS
successfully rejects this formula as a matter of public policy.
The definition clause works simultaneously with the transfer and works to
define the amount of the gift or consideration. These clauses that define
a gift or sale in terms of the value are known as value definition
clauses. Clauses that define the consideration to be paid are known as
consideration definition clauses.
Mathematically the definition clause always equals $1 million. The
downside may be that this limits the value for a rapidly appreciating asset.
The consideration definition clause requires the existence of a funded
trust with sufficient assets to purchase the transferred property. The
formula is fraction with the numerator being the consideration to be paid
and the denominator being the value as finally determined for federal gift
tax purposes.
Although there is no success rate yet with the consideration definition
clause, there has been one judicial test that worked for the taxpayer,
McCord v. Commissioner. That case, however, left unanswered several
issues. Still the value definition and consideration definition clauses
are similar to those sanctioned under CRAT requirements and disclaimer
regulations.
The use of trusts in implementing the transfers of legal title best
protects any excess value and will eliminate income tax reporting issues
for grantor trusts. Escrow arrangements also are effective where the
escrow agent holds the property until final valuation is determined.
There are 3 methods to achieve a final valuation. Transferring property
with an appraised value may present a risk of additional gift tax. Having
no method simply moves the risk to a later date. Providing a value that can
be "finally determined" is the best approach.
Section 2001(f) provides a definition of "finally determined". It requires
adequate disclosure, may be specified by the IRS or the court, or may
agreed upon by the IRS and the taxpayer.
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Special Session 1-A - Transfer Tax Audit Issues - What's Hot
Wednesday, January 16, 2008
Presenters: John Porter, Martin Basson and Alleen Condon
Reporter: Kimon Karas
The panel consisted of one tax practitioner, JB, and IRS representatives,
AC, Chief, Estate and Gift Tax Program with national responsibility for
Estate and Gift tax field operations policy, and MB, Supervisory Attorney,
Estate and Gift Taxes, for South Florida.
The program commenced with AC giving a broad overview of what is happening
at the IRS with commentary by JP and MB. AC reported many changes in the
E&G area including that all field attorneys were placed into one area
starting in 2004.
AC reported current attention and focus is:
1.Consistent treatment of taxpayers throughout the country;
2.Engaged and motivated work force; and
3.Efficient operation in conducting audits.
Goals of exam are:
* Increase compliance
* Support and assistance in collection
* Input with forms and publications
* Assist in published guidance for both IRS and public.
AC reported although there is a reduced staff (because of anticipated
decrease in filings) IRS is maintaining same audit levels as in the past.
Exam process is to:
1.Identify cases to auditAC and MB both clear to point out there is not
set criteria of what is to be auditedlooking for cases where there is
revenue potential;
2.Case is selected and then sent to the field where another level of
review/decision is made whether to proceed with an audit and finally the
E&G attorney having a final review of whether to proceed with audit.
AC emphasized because of reduced staff there is a national workload. There
is not the same percentage of E&G attorneys in an area that corresponds
with the filings. JP reported that he is involved with a case where the
group manager is in Boston, the agent in Maine, and the taxpayer in
Florida. AC emphasized that location is not a hindrance to the
audit. Audits will occur with information being supplied by phone,
conference calls, in writing and IRS traveling to the location of the taxpayer.
MB stated local law issues are important and irrespective of the location
of the audit, IRS examiners have access to all local law experts throughout
the country for local law issues.
AC stressed the important on exam for the taxpayer to make contact and
learn of the group manager at the outset not just when a possible
disagreement arises. MB mentioned that in all difficult cases he is
involved with the case. AC said she would like to say that applies across
the country but is not sure of that.
AC stated at the commencement of an audit there should be a "mutual
commitment date" although informal as it may be where the parties agree on
exchange of information, timing, projected closing date to assist in
communications and expectations.
AC stressed the key elements of an effective exam:
* Communication
* Planning
* Risk Analysis
* Documentation
AC IRS is striving to attain a "quality audit." Surveys have reflected
the IRS generally does well in identifying issues/technical determinations
and courtesy to taxpayers but needs to do a better job in timeliness of
action and time span of exam.
The panelists then discussed the mechanics of exam. All stressed the
importance of an open and cooperative dialogue. JP said produce
information that the government could otherwise obtain through subpoena or
summons. Establish credibility with the agent. JP suggested taxpayer's
rep keep a log of all documentation provided to reduce multiple requests
for the same information and also assist in a burden of proof shift if
appropriate under Section 7491.
On case selection for audit MB indicated there is no "list" but that as a
person who does classification of returns he certainly will examine more
closely cases submitted by a preparer/appraiser who might have a track
record of being overly aggressive on valuations,etc.
AC stated that agents have been reminded and are following Treas.Reg.
601.506, that all communications are sent to the taxpayer with a copy to
the representative. IRS will bypass taxpayer on communications only with a
formal written request or waiver from the taxpayer.
Both AC and MB encouraged a manager conference at exam's conclusion. A
case will not be accepted by appeals if there is less than 210 days
remaining on a statute of limitations. In effect taxpayer will receive
that right if taxpayer proceeds to court as the case once docketed either
in Tax Court of District Court will be returned to appeals for appeals
consideration.
AC reported that in a complex case there may be discussions with appeals
but not exparte. The taxpayer will be included in those discussions.
AC mentioned in order to better prepare cases, there was a meeting between
exam, appeals and engineers reviewing closed cases with the goal of how can
exam better prepare cases for appeals.
AC reviewed future agenda items being:
* Identify and bring into compliance non filers in the E&G area;
* Near taxable and nontaxable gifts;
* E strategy.
AC summarized the IRS audit focus today as:
* Identify audit worthy returns;
* Quality audits
* Use of enforcement tools to enhance compliance.
AC also mentioned IRS is training different divisions within the IRS to
address and refer issues, such as FLP cases that have income tax issues to
be referred to income tax division and income tax division review of cases
with E&G implications being referred to the E&G division.
Next the discussion dealt with FLP cases/settlement. FLP is a national
coordinated issue and appeals has settlement guidelines. As a coordinated
issue appeals cannot settle a case without the approval of the national
coordinator. Those guidelines do not apply or exam does not consider them
in evaluating a case. It may do so in the future but as of now it is
not. Each case is determined and reviewed on its own facts by agent.
Outside of Section 2036 appeals is relying on McCord, Lappo and
Perrachio. Based on that authority marketable securities, liquid asset
partnerships are settling on a lack of control (using a closed end fund
analysis) and lack of marketability in the 28-32% range with real estate
partnerships somewhat more of a discount.
All the panelists stated that the majority of cases are settled at exam,
appeals or prior to litigation. Goal for the taxpayer is to settle/resolve
its case at the lowest level.
AC addressed some "hot issues."
* Section 6166. In light of Estate of Roski, IRS is exercising
discretion in requiring a bond/lien. IRS will not automatically terminate
election (as it would before Roski) if taxpayer fails to allow a lien or
post a bond. It is a work in process with the IRS goal to protect its
revenue.
* Appraiser penalty under Section 6695A.
* Preparer penalty under Section 6694. In Section 6694 she referenced
Notices 2007-54, 2008-11,12 & 13 providing transitional relief.
Both AC and MB stated that penalties will be looked at not as a "focus"
but where as appropriate. Exam has been directed by both appeals and
Counsel not to trade off penalties for other issues.
In reviewing FLPs and Section 2036 both AC and MB reported there has been a
fair amount of noncompliance in the FLP area both with respect to discounts
and Section 2036. JP referred to the exhibit in his outline being the IRS
audit request in an FLP audit situation.
Taxpayers need to address the following questions:
Why was the entity created?
Decedent's health at the time of formation
How was entity operated?
MB stated that at the audit level IRS is seeking to interview surviving
adult partners. This interview is taking place with government
counsel. JP treats this "interview" as a deposition as the first stage of
litigation. Consider all issues such as privilege and whether it should be
asserted. JP suggests having a court reporter present. MB stated that
must give government 10 days prior notice if there is to be a court
reporter and the government must be given a copy of the transcript.
In Section 2036 case MB indicated the IRS is looking for a disguised
conveyance. Was there a legitimate and significant non tax reason for the
entity? JP stated that the first hurdle to overcome is the retained
right. If the partnership formalities are not followed and assets end up
in the creator's hands then the implied agreement arises and Section 2036
is triggered. JP states there must be a retained right before one can get
to the next step of bona fide sale.
JP indicated that he sensed IRS was getting valuation assistance earlier in
the audit process. MB indicated that it depended somewhat on where in the
country the audit is being conducted. Both MB and AC stated they encourage
outside appraisal support where there is the need. The other issue the
government has to content with is that courts do not seem to give the same
deference to IRS's own engineers as it does to outside persons.
Next the panel discussed post death claims against the estate. MB
indicated the IRS is following the current law, except in the 8th Circuit,
valuing claims on a "snap shot" basis as of the date of death. Until the
regulations are finalized IRS is not following the proposed
regulations. MB acknowledged the proposed regulations create a number of
issues but also recognizing that this is a difficult area.
Next the panel discussed Jelke and the discount granted to a C corporation
for unrealized built in gains. There has been a motion filed for the
entire court's reconsideration of the case granting a dollar for dollar
discount for the potential built in gains as of date of death.
The panel concluded with a discussion of defined value formula clauses. JP
reported on two cases, one that was tried in 2006 relating to a defined
value disclaimer and a recent case tried in Seattle on a defined value
gift. MB stated the IRS is adamant on this issue on the public policy
argument and IRS will assert the issue and counsel will litigate the issue.
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THE REPORTERS
Our on-site local reporters who are present in Orlando this year are Gene
Zuspann Esq. of Zuspann & Zuspann in Denver, Colorado; Joanne Hindel Esq.
of Fifth Third Bank in Cleveland, Ohio; Jason Havens Esq. of Howard, Mobley
& Havens PLLC in Florida and Tennessee; Kimon Karas Esq. of McCarthy,
Lebit, Crystal and Liffman Co., LPA in Cleveland, Ohio; Bruce Stone Esq. of
Goldman, Felcoski & Stone, PA in Coral Gables, Florida; Craig Dreyer Esq.
of McDonald Hopkins LLC in Cleveland, Ohio; Carol Sobczak Esq. of The Law
Offices of Carol A. Sobczak in St. Helena, California; Ronda Martinez Esq.
of Fifth Third Bank in Southfield, Michigan; and Mike Stiff Esq. of
Hutchins & Stiff LLC in Denver, Colorado. The editor again this year will
be Joseph G. Hodges Jr. Esq, a solo practitioner in Denver, Colorado, who
also is the Chief Moderator of the ABA-PTL List.
_________________________________________
GENERAL INFORMATION ABOUT INSTITUTE:
Inquiries/Registration:
Philip E. Heckerling Institute on Estate Planning
University of Miami School of Law
Center for Continuing Legal Education
P.O. Box 248087
Coral Gables, FL 33124-8087
Telephone: 305-284-4762 / FAX: 305-284-6752
Web site: www.law.miami.edu/heckerling
E-mail: heckerling@law.miami.edu
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NOTICE: Although audio tapes of all of the substantive session at the Miami
Institute currently are only made available to Institute registrants for
purchase, the entire proceeding of the Institute are published annually by
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proceedings is also available on CD ROM from Authority On-Demand by
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