On November 2, 2015, new partnership audit rules, repealing existing TEFRA rules, were enacted in Section 1101 of the Bipartisan Budget Act (“BBA”).  On August 15, 2016, Treasury published temporary regulations (TD 9780, 81 FR 51795).  The BBA will become effective on January 1, 2018, although partnerships can elect into the new rules retroactively to November 2, 2015.

The new rules have created quite the excitement among certain tax professionals because they shift both the audit and the collection of partnership taxes to the partnership.  Since 1982, partnership audits have been governed by the Tax Equity and Fiscal Responsibility Act (“TEFRA”).  Partnerships with 10 or fewer partners (with some exceptions, such as tiered partnerships) were exempt from TEFRA rules, and were governed by the default partner-level audit regime that existed prior to TEFRA.  What that means is, such small partnership audits were of the K-1’s of the partners who owned interest in the partnership in the years under audit, and correspondingly any adjustments were paid by those “review-year” partners.  For all other partnerships, TEFRA now required that the audit be conducted at the partnership level, which means adjustments were to be made to partnership income and deductions, with amended K-1’s then issued to the review-year partners.  The regime was now partnership-level audits with partner-level assessments.  In other words, those partners whose actions caused the additional tax were the ones responsible for paying it.

In addition, under TEFRA, over-100 partner partnerships could elect to have partnership-level assessments, that is, additional tax paid not by review-year partners but by current, “audit-year” partners (under the Electing Large Partnership Audit rules that were also repealed by the BBA).  This would result in a partnership-level audit and partnership-level assessment.

Unfortunately, over the years the IRS found partner-level collection difficult, and Congress has now responded by consolidating not only the audit but also the collection of tax at the partnership level.  In other words, the collection of tax is now made from audit-year partners, or partners having interest in the partnership in the year it is being audited.  This may be fine for small static family partnerships whose partners do not change, but it is not fine for large dynamic partnerships with ever-changing ownership interests.

A partnership representative (PR), rather than TEFRA’s Tax Matters Partner (TMP), now controls the conduct of the audit at the partnership level.  Neither the IRS nor the PR is statutorily obligated to give notice or audit rights to the other partners, a response to the IRS’ desire to streamline the audit without too many administrative hurdles.

An additional change in IRS’ favor is that there is no longer an automatic exemption from the consolidated audit for under-10 partnerships.  Now the burden is on the partnership to make an annual election out of the BBA rules under Section 6221 of the Internal Revenue Code.  The election can only be made by partnerships having fewer than 100 partners and those partners have to be individuals, C corporations, S corporations, tax-exempt entities or estates of partners.  When such an election out of the BBA is made and an audit arises that year, the partnership will essentially have a pre-TEFRA audit at the partner-level (as had been the case for under-10 partnerships under TEFRA).  The catch?  If the partnership has other partnerships or trusts as partners, it cannot elect out of the BBA consolidated rules no matter its size or preference.

If a partnership cannot elect out of the BBA rules because of its size or composition of its partners, it can still elect under Section 6226 to “push-out” payments of the additional tax assessed from the audit-year to the review-year partners.  The push-out election essentially replicates the TEFRA regime of partnership-level audit and partner-level payment.

Note that the rules are not clear on whether multi-tier partnerships can push-out payment to the ultimate partners.  The IRS has indicated the push-out will not automatically reach the ultimate partners unless the partnership can provide sufficient information about the tiers of income and loss allocations.

The new rules upend the status quo, affect countless existing partnership agreements, and create additional liability for purchasers of partnership interests.  At the same time, the new rules potentially create additional leverage for controlling partners.  All these considerations need to be reviewed on a case-by-case basis to amend existing agreements and draft robust new ones for the future under the new regime.

On June 9, 2017, the Internal Revenue Service issued Revenue Procedure 2017-34, which is effective immediately and provides a simplified method to obtain permission for an extension of time under Reg. 301.9100-3 to file Form 706 (Federal Estate Tax Return) and elect portability without the need to apply for a private letter ruling and pay the associated user fee.

Revenue Procedure 2017-34 applies to estates that are not normally required to file an estate tax return because the value of the gross estate and adjusted taxable gifts is under the filing threshold.

Portability of the estate tax exemption means that if one spouse dies and does not make full use of his or her $5,490,000 (in 2017) federal estate tax exemption, then the surviving spouse can make an election to utilize the unused exemption (deceased spousal unused exclusion (DSUE)), add it to the surviving spouse’s own exemption.  The DSUE is also available for application to the surviving spouse’s subsequent gifts during life.

In February 2014, the IRS issued Revenue Procedure 2014-18 that provided a simplified method for obtaining an extension of time under the “9100 relief” provisions to make a portability election that was available to estates of decedents dying after 2010, if the estate was not required to file an estate tax return and if the decedent was survived by a spouse.  This simplified method was available only on or before December 31, 2014.

After 2014, the IRS issued “numerous letter rulings” granting an extension of time to elect portability under §2010(c)(5)(A) when the decedent’s estate was not required to file an estate tax return.

The IRS acknowledged in Revenue Procedure 2017-34 that it has determined that the “considerable number of ruling requests” for an extension of time to elect portability “indicates a need for continuing relief for the estates of decedents having no filing requirement.”   Accordingly, Revenue Procedure 2017-34 allows for use of a simplified method to obtain an extension of time under the 9100 relief provisions to elect portability (provided that certain requirements are satisfied).

The IRS has made this simplified method available for all eligible estates through January 2, 2018, or the second anniversary of the decedent’s date of death.  The simplified method provided in Revenue Procedure 2017-34 is to be used in lieu of the letter ruling process.  No user fee is required for submissions filed under this revenue procedure.

Anyone who has seen the current Broadway hit Hamilton knows that we are a nation of immigrants. Moreover, many U.S. persons who moved here from elsewhere have parents back in their home country.

When those “foreign” parents pass away and leave assets to their U.S. children, those assets become subject to the U.S. estate tax system in the children’s estates, where ultimately they can be taxed at a 40 percent federal tax rate (plus state estate taxes) when a child dies.

The adverse tax result that follows from foreign parents leaving their assets outright to U.S. children can be avoided with advance planning. Often, foreign parents can incorporate trust planning into their own estate planning documents. If assets pass to a properly structured trust for the benefit of a child rather than outright to the child, the assets in the trust may not be subject to estate tax in the child’s estate.

New York estate tax practitioners often consult with foreign advisors to effectuate this kind of planning, and it is becoming more important given the amount of immigration and investment in the New York area in recent years.

A parent can incorporate this type of trust planning—often called “dynasty trust” planning—in a Will that is valid in his or her home jurisdiction. The Will would include provisions to create the dynasty trust upon the parent’s death. To accomplish this, the U.S. trusts and estates lawyer can work with foreign counsel to (1) confirm that the “home country” law allows such a structure and (2) provide the dynasty trust language that will reflect the client’s goals and satisfy U.S. tax law requirements. For example, the trust can allow the child to be sole trustee of the trust created for his or her benefit, and permit distributions to the child and his or her descendants subject to ascertainable standards (i.e., health, education, maintenance and support) so that the trust assets are not included in the child’s estate. The trust can include powers of appointment and several other tools that allow for greater flexibility in the trust.

As an alternative to including the dynasty trust plan in a foreign parent’s Will, the parent could establish and fund a trust during lifetime to carry out his or her objectives. The U.S. tax practitioner can assist with the U.S. tax advice relating to such a trust.

If established outside the United States, such a trust usually will be structured to be a “foreign grantor trust.” This is a trust that, under the U.S. grantor trust rules (Internal Revenue Code §§671-679), is not treated as a separate taxpayer from the grantor. The trust is disregarded for U.S. income tax purposes, and the foreign grantor reports all items of income, deduction, gain, loss, credit, etc. on his or her own tax return, if any.

It is often simpler to structure this type of trust as a foreign grantor trust, rather than a foreign non-grantor trust that is treated as a separate taxpayer. A foreign non-grantor trust with U.S. beneficiaries has a number of tax reporting requirements, and also can be subject to punitive income tax rules (known as the throwback rules) when funds are distributed to U.S. beneficiaries. Thus, the parent’s trust is often best structured as a foreign grantor trust while the parent is alive. When the parent dies, the trust becomes a non-grantor trust, and the U.S. children generally will move the trust to the United States at that time (pursuant to a “change of situs” provision in the trust) so that it becomes a domestic, U.S.-situs trust.

In order to qualify as a foreign grantor trust, the trust must be fully revocable by the grantor. Internal Revenue Code §§672(f)(1) and (2). (Note that foreign trusts do not qualify as grantor trusts under the same rules as domestic trusts). This is often a desirable structure for U.S. children and their foreign parents. The foreign parent is committing to a structure that he or she can revoke or change at any time, while the U.S. child has the benefit of the parent’s proactive tax planning.

The foreign trust generally will have a bank or trust company acting as trustee in the jurisdiction of choice (e.g., BVI or Cayman Islands). The trust may have a family member named as a “trust protector” who has the right to remove and replace the trustee and make other changes to the trust. The trust may own the stock of an investment company that holds the assets transferred into this structure, and a family member can act as director of the company to manage the investments.

The substantive provisions of the trust permit distributions to children and grandchildren in the discretion of the trustee (which provides an asset protection benefit to the beneficiaries). The trust can continue in this fashion for many generations, and should not be subject to U.S. estate or generation-skipping tax.

As the parent/grantor of the trust is also included as a trust beneficiary, distributions from the trust can be made to the parent during his or her lifetime. In practice, if the parent wants funds in the trust to be distributed to a child, it is often best for the parent to withdraw funds from the trust and distribute them directly to the child. Among other things, this makes the U.S. tax reporting of the gift on a Form 3520 simpler.

Under certain circumstances, the foreign parent may wish to establish a U.S.-situs grantor trust rather than a foreign trust. This may make sense, for example, if the foreign parent has U.S. assets that will be transferred to the trust.

This article provides just a brief treatment of this issue and of course there are many additional complexities. The trusts and estates practitioner must consider, among other things, (1) whether home country law allows foreign parents to leave assets in this manner, (2) various reporting requirements for foreign trusts with U.S. beneficiaries, (3) trustee selection and fees, (4) numerous drafting issues to build maximum flexibility into long-term trusts, and (5) compliance with U.S. income and estate tax laws. Yet the tax saving opportunity for clients in this situation is substantial, and should be considered by all foreign parents leaving significant assets to U.S. children.

Reprinted with permission from the January 17, 2017 edition of The New York Law Journal© 2017 ALM Media Properties, LLC. All rights reserved.  Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 – reprints@alm.com

The New Jersey Tax Appeal Filing Deadline is April 3rd.

In the upcoming weeks property owners will be receiving their annual property tax assessment notices (postcards) from the municipal assessor’s office. Receipt of these assessment notices indicates that the time has arrived to determine whether a tax appeal is warranted for the 2017 tax year.  Despite what can best be described as uneven improvement in the real estate market across various commercial segments, the need to carefully evaluate property tax relief opportunities continues as commercial property taxes remain the largest single expense component affecting a property owner’s bottom line. The 2017 tax appeal filing deadline is April 3, 2017, unless a town-wide reassessment or revaluation is in place, in which case the deadline is May 1, 2017.

Consequently, it behooves commercial property owners to review their property tax assessments with experienced professionals now in order to ensure that these assessments are in line with the property’s true value.  Because New Jersey law “freezes” assessments for a period of two (2) years, at levels agreed to between property owners and municipalities in resolution of appeals filed with the County Tax Boards or State Tax Court, or alternatively as a result of judgments reached by these bodies on the merits, the tax appeal vehicle can be an effective means of fixing assessments while the market is trending in an upward direction. In addition, because assessments are generally not disturbed until a town-wide revaluation or reassessment program is implemented (usually every 5-10 years) there is a real prospect that a lower assessment achieved as a result of a successful appeal this year could have real lasting value and actually provide savings to taxpayers for many additional years beyond the two (2) freeze years guaranteed by law.

As a result, there continues to be real opportunities for property owners to realize significant tax savings and lock in present values for the foreseeable future.  Commercial property owners are therefore encouraged to consult with their real property tax professionals to determine if a tax appeal would be warranted in their particular case in 2017.

Please feel free to contact Carl A. Rizzo at crizzo@coleschotz.com or by telephone at (201) 525-6350 with any questions.

 

On October 14, 2016, Governor Christie signed into law a transportation funding bill that also included the repeal of the New Jersey Estate Tax. Here is what you need to know:

  • The New Jersey Estate Tax repeal will be effective as of January 1, 2018. The current $675,000 exemption will increase to a $2 million exemption on January 1, 2017. The Estate Tax will be eliminated as of January 1, 2018.
  • The New Jersey Inheritance Tax is still in effect. This is a tax imposed on transfers to beneficiaries who are not spouses, parents, children or grandchildren (i.e., nieces, nephews, siblings, friends, etc.) New Jersey Inheritance Tax rates start at 11% and go as high as 16%.
  • As part of the new law, there is a tax break for retirees. There will be an increase in the New Jersey gross income tax exclusion on pension or retirement income over four years (in 2020) to $100,000 for couples, $75,000 for individuals, and $50,000 for married taxpayers who file separately.
  • On January 1, 2017, the sales tax will be reduced from 7% to 6.875% and will be further reduced to 6.625% on January 1, 2018.

Now that the repeal has been enacted, is New Jersey an attractive state to die in? We have counseled many clients over the years that moving to Florida could save significant estate taxes. With the New Jersey Estate Tax repeal (effective in 2018), some of the advantages enjoyed by Floridians can now also be enjoyed by New Jersey taxpayers (namely, no estate tax in either state).

However, moving to Florida also saves income tax, as Florida does not impose state income tax. New Jersey still does, so this remains a major advantage when moving to Florida. All income from sources outside New Jersey will not be taxed in New Jersey if you reside in Florida. If you reside in New Jersey, you will still pay state income tax on all income.

Also, if you bequeath assets to beneficiaries who are not descendants and you reside in New Jersey, you still will trigger a New Jersey Inheritance Tax, as this tax was not repealed.

Despite the New Jersey Estate Tax repeal, it is still very important to make sure your estate is in order if you reside in New Jersey. There are significant federal estate tax issues to plan for, and many non-tax issues which need to be considered and properly addressed.