The IRS recently issued Revenue Procedure 2022-19, which permits S corporations to remedy certain inadvertent terminations of S corporation status and invalid elections without having to request a costly Private Letter Ruling.  Previously, the IRS permitted such relief without a Private Letter Ruling in only two limited circumstances – (1) failing to timely file Form 2553 (the original S election), or (2) fixing certain failures in obtaining shareholder consent to the S election.  This is welcome relief to taxpayers and their tax professionals.

The Revenue Procedure extends automatic relief under the following six circumstances:

  1. “One class of stock” requirement.  An S corporation can only have one class of shares.  In certain situations, such as the execution of buy-sell agreements, agreements restricting the transferability of stock or redemption agreements, shareholders risk creating a deemed “second” class of stock inadvertently terminating the S election.  Under the Revenue Procedure, if entering into these agreements did not have a principal purpose of circumventing the one class of stock rule, then the S election will not be invalidated.
  2. Disproportionate distributions as to timing or amount.  Disproportionate distributions can violate the one class of stock rule described above.  The Revenue Procedure eliminates this risk, provided the governing documents confer identical rights to distributions and liquidation proceeds.
  3. Non-identical governing provisions.  Similarly, non-identical rights and entitlements for different classes of shares can also lead to an inference that the one class of stock rule is violated.  The Revenue Procedure rewards proactive taxpayers by providing that as long as the taxpayer identifies and fixes any non-identical governing provisions before they are identified by the IRS, the S election will not fail.
  4. Inadvertent errors or omissions on the election form (Form 2553, or for a Qualified Subchapter S Subsidiary, Form 8869).  The Revenue Procedure repeats prior IRS guidance permitting certain mistakes on Forms 2553 and 8869to be rectified within a definite time frame (generally not longer than three years and 75 days from the start of the year for which the election takes effect).
  5. The taxpayer does not have (or cannot locate) the administrative acceptance letter (CP261, CP279, or CP279A), reflecting acknowledgment of the S election by the IRS service center.  Recognizing that notices are merely administrative acknowledgments of an election, non-receipt of which has no significance regarding the validity of the election, the IRS has indicated that taxpayers and practitioners may call a hotline to request a second copy.
  6. The taxpayer files a tax return inconsistent with the S election (such as filing a Form 1120, U.S. Corporation Income Tax Return, rather than a Form 1120-S).  Taxpayers can cure an improperly filed return if the taxpayer files an appropriate tax return (Form 1120-S) for open years.

Many of our clients are charitably inclined, and incorporate charitable planning into their overall estate planning.  This can be as simple as making gifts to charities during life or via specific bequests in a Will.  In addition, clients create donor advised funds and family foundations.  They also implement charitable remainder trusts and charitable lead trusts – usually for a specific purpose or expected tax benefit (ie, to generate a tax deduction in a year with unusually high income). 

Some charitable planning is more esoteric.  Paul Newman famously created Newman’s Own, a for-profit food business that is owned by a charity whose objective is “to nourish and transform the lives of children who face adversity.”  Warren Buffett created the “Giving Pledge” – “a movement of philanthropists who commit to give the majority of their wealth to charitable causes…” 

Recently, Patagonia founder Yvon Chouinard joined this group of wealthy philanthropists with unique planning by giving his Patagonia stock to two nonprofit organizations.  Chouinard gave the voting stock of Patagonia (2% overall) to the “Patagonia Purpose Trust,” a trust with a business purpose to protect the company’s mission and values.  He gave the non-voting stock (representing 98% of the company’s value) to a new entity –  the Holdfast Collective.  The Holdfast Collective is structured as a 501(c)(4) organization known as a “social welfare organization,” which is not charitable in nature, but rather is permitted to engage in lobbying and other political activities (in this case, environmental causes and “thriving communities”).  Patagonia is valued at approximately $3 billion, so this was a very substantial transfer of wealth. 

Some takeaways from Chouinard’s unique planning:  First, it is clear that there are not “standard,” “one size fits all,” or cookie-cutter solutions for clients.  Families are all different, and their planning has to reflect that and be tailored to the particular client and situation.  Chouinard’s plan helps further a main family objective to remain politically active and protect nature. 

Second, tax benefits are important.  In Chouinard’s plan, he will not receive an income tax charitable deduction for giving the Patagonia shares to the two nonprofits, since technically a business purpose trust and a 501(c)(4) organization are not “charitable” vehicles.  Also, Chouinard did trigger a gift tax (estimated at $17.5 million) on the transfer of stock to the business purpose trust.  On the other hand, Chouinard does not owe gift tax on the transfer to Holdfast Collective (the 501(c)(4) organization).  He avoided the capital gains tax that would be triggered if he sold the company.  And he removed the value of the Patagonia stock from his estate, saving an estimated $1.2 billion of estate tax (interestingly, a death transfer to a 501(c)(4) organization is subject to estate tax but a transfer during life is not subject to gift tax).

Third, many clients care about “legacy planning” as much as they do about tax planning.  Advisors can do a better job covering this topic with clients.  We generally are focused on trust structures, fiduciary choices, income and estate taxes.  But we also should ask clients how they would like to implement planning with respect to family legacy, which can include letters of wishes, family-based charitable giving, and/or a “family purpose trust” established to ensure that funds are available for family legacy purposes.  Yvon Chouinard’s “outside the box” planning with Patagonia underscores the importance of this interesting issue.

The IRS has announced the official estate and gift exclusion amounts for 2023.    

For an estate of any decedent dying during calendar year 2023, the applicable exclusion is increased from $12.06 million to $12.92 million.  This change increases not only the applicable exclusion amount available at death, but also a taxpayer’s lifetime gift applicable exclusion amount and generation skipping transfer exclusion amount.  This means a husband and wife with proper planning could transfer $25.84 million estate, gift and GST tax free to their children and grandchildren in 2023.   If no new tax law is passed, the increased exclusion amounts are scheduled to expire on December 31, 2025, which would mean a reduction in the exclusion amounts to $5 million plus adjustments for inflation.

While the estate, gift, and GST tax rate remains the same at 40%, the gift tax annual exclusion in 2023 will increase $1,000 to $17,000.

The gift tax annual exclusion to a non-citizen spouse has been increased from $164,000 to $175,000. While gifts between spouses are unlimited if the donee spouse is a United States citizen, there are restrictions when the donee spouse is not a United States citizen.

The New York exclusion amount was changed as of April 1, 2014, and does not match the federal exclusion amount.  In 2022, the New York exclusion amount is $6.11 million.  The 2023 New York exclusion amount has not yet been determined.  It is important to note that, unlike the Federal exclusion amount, the New York exclusion amount is not portable, meaning if the first spouse to die fails to utilize his or her full exclusion amount, the surviving spouse will not be able to utilize the first spouse to die’s unused New York exclusion amount.

This fall, the Supreme Court is set to hear an important case regarding the interpretation of the law that provides for penalties for failing to file an FBAR.  The case will impact many taxpayers who have already been penalized and many more in the future.

In 1970, the Bank Secrecy Act was enacted to curb the use of foreign financial accounts by U.S. persons to evade taxes.  The BSA requires a U.S. person who has a financial interest in one or more foreign financial accounts with an aggregate value greater than $10,000 to report such foreign accounts on FinCEN Form 114, commonly known as an “FBAR.”

While a U.S. person is not required to pay any tax in connection with the filing of an FBAR, a U.S. person will be subject to civil penalties for the failure to file a FBAR under 31 U.S.C. § 5321(a)(5).  The amount of the penalty will depend on whether the violation was willful (i.e., a conscious violation of a known legal obligation) or non-willful (which includes negligent conduct).  If the failure was willful, the maximum civil penalty is the greater of 50% of the account balance or $100,000.  If the failure to file was non-willful, the law prescribed a $10,000 penalty per violation.  The non-willful penalty is adjusted for inflation annually, and for 2022, the penalty amount is $14,489.

The IRS and taxpayers differ as to how the non-willful penalties should be calculated.  The IRS takes the position that non-willful FBAR penalties are determined per account and not per unfiled FBAR, whereas taxpayers have taken the position that non-willful FBAR penalties should be applied on a per FBAR basis.  When an FBAR reports many accounts, the gap is significant.

In United States v. Boyd, 991 F.3d 1077 (9th Cir. 2021), the defendant had failed to report 13 foreign accounts on an FBAR during a single year.  The IRS argued that the taxpayer had committed 13 non-willful violations by failing to report all 13 accounts.  The taxpayer argued that the maximum penalty should be $10,000 for a single non-willful violation.  The Ninth Circuit held that the non-willful penalty applies on a per form basis and not based on the number of foreign accounts.

However, in United States v. Bittner, 19 F.4th 734 (5th Cir. 2021), the Fifth Circuit adopted the IRS’s position.  In Bittner, the taxpayer failed to report 272 foreign accounts during the 2007-2011 tax years.  The IRS assessed a $10,000 penalty per account, which resulted in a $2.72 million penalty.  The taxpayer argued that the maximum penalty should be $50,000.  The Fifth Circuit disagreed with the Ninth Circuit and held that the non-willful FBAR penalty applies on a per account basis.

Due to these conflicting holdings, the U.S. Supreme Court granted certiorari in the appeal of Bittner.

For the last several years, the IRS has calculated the non-willful penalty on a per account basis, except in the Ninth Circuit (generally, the West Coast).

If a taxpayer has recently made payment for non-willful FBAR penalties on a per-account basis, it is important to file a suit for refund within the applicable statute of limitations.  If Bittner is decided against the IRS, a refund for the overpaid penalty will only be available if a timely suit had been filed.

For those who have unfiled FBARs, the IRS offers different programs, including the Voluntary Disclosure Program, the Streamlined Domestic and Foreign Offshore Filing Procedures, and the Delinquent FBAR Filing Procedures, to file the late FBARs and in some cases, mitigate the penalty exposure.

The overall goal of FBAR penalties is to encourage compliance.  No matter how Bittner is decided this fall, we expect the IRS to not let up its scrutiny of FBAR and international tax issues.  The time is now for noncompliant taxpayers to carefully consider how to return to compliance.

When business owners have partners and consider their succession planning, the topic of a buy-sell agreement comes up.  This post discusses the possible use of an “insurance-only LLC” as part of a buy-sell.

A buy-sell agreement sets the terms of a buyout of one partner by another partner or partners if one partner leaves the business.  The buy-sell almost always addresses the death of a partner, and may also address disability, retirement or other exit of a partner.  Some of the key terms in a buy-sell include (1) what are triggering events for a buyout, (2) whether the buyout is mandatory or optional, (3) the terms of the buyout (eg, all cash, an unsecured note, or a secured note) and (4) how to value the business and establish the purchase price for the buyout.

It is common for business owners to purchase life insurance in order to fund a death buyout.  In a “cross purchase” agreement, each owner owns a policy on the other owner(s)’ lives and the buy-sell provides that the remaining owner(s) will purchase the deceased owner’s equity.  In a “redemption” agreement, the company owns the life insurance policies and the buy-sell provides that the company will purchase the deceased owner’s equity.

Cross purchase agreements are more common than redemption agreements.  Generally, in a redemption agreement, the buyer doesn’t get a step-up in basis, the policy value may be exposed to the creditors of the business and there can be alternative minimum tax issues.  On the other hand, if there are multiple owners, a traditional cross purchase requires many insurance policies since each owner owns a policy on all the other owners.

A “trusteed buy-sell agreement,” is a cross-purchase agreement where a trust is created to own the life insurance policies.  The trust owns one policy on each owner, which solves the “multiple policies” problem.  The trustee manages and maintains the policies, which centralizes the management of the arrangement.  There are, however, potential issues with trusteed buy-sell agreements, such as (1) whether the trust is a bona fide trust arrangement (or is it more accurately an escrow arrangement), (2) how premiums are paid and allocated (especially when there is a substantial disparity in the premium amounts for the policies), and (3) a potential transfer-for-value rule issue when the first owner dies.

The “insurance-only” LLC is a potential solution to the above issues.  The insurance-only LLC essentially is a cross purchase arrangement where an LLC is created to own the life insurance policies on the business owners.  The LLC has a third-party manager so there is centralized management of the group of policies.  The LLC elects to be treated as a partnership for tax purposes.  Usually, the operating business will make distributions to the owners, and they can make capital contributions to the LLC so the LLC can pay premiums (this also may be structured as a split-dollar arrangement).

When one of the owners dies, there are several steps.  First, the LLC redeems the membership interest that was owned by the deceased member (ie, from the deceased member’s estate).  Then, the life insurance proceeds are collected and distributed to the remaining members of the LLC.  Finally, the remaining members (eg, the other business owners) use the proceeds to purchase the deceased business owner’s equity in the business.

The insurance-only LLC thus solves certain issues posed by a trusteed buy-sell agreement, including how premiums are paid and the potential transfer-for-value rule issues.  Moreover, the insurance-only LLC may be structured so that each owner’s irrevocable insurance trust is a member of the LLC rather than the owner himself or herself, so that the equity purchased from the deceased owner is not included in the surviving owners’ estates.

It should be noted that the arrangement is technical to draft and not risk-free.  The IRS has a “no rule” policy on whether an insurance-only LLC will be treated as a partnership for tax purposes and whether the transfer of policies to the insurance-only LLC is exempt from transfer-for-value issues.  See, eg, Revenue Procedure 2022-3.  Some state statutes on LLCs and LPs require a profit motive for an entity.  Planners also should consider asset protection issues, such as whether a creditor could reach the assets in the insurance-only LLC (remedies vary among states) and whether a creditor of a deceased owner could reach the death benefit.

In sum, it is very important that business owners maintain technically sound and up-to-date buy sell agreements.  The insurance-only LLC can be a creative approach for an advanced buy-sell.