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.

Effective July 8, 2022, the IRS issued Revenue Procedure 2022-32 to supersede Revenue Procedure 2017-34 and now allow for a late estate tax exemption portability election to be made up to five (5) years from a deceased spouse’s death.  Previously, this window was only two (2) years from the deceased spouse’s death.  Revenue Procedure 2022-32 allows a wider window for a surviving spouse who may have missed or just been unaware of the ability to transfer (or “port”) the deceased spouse’s unused estate tax exemption (the “Deceased Spousal Unused Exclusion Amount” or “DSUE”) by filing a Form 706 (United States Estate (and Generation-Skipping Transfer) Tax Return) (“Estate Tax Return”) with the Internal Revenue Service (“IRS”).  The requirements are the same as under the prior Revenue Procedure and include the following: (A) the decedent: (i) was survived by a spouse; (ii) died after December 31, 2010 and (iii) was a citizen or resident of the United States on his or her death; (B) the estate must not be required to file an Estate Tax Return; (C) an Estate Tax Return was not timely filed; and (D) all the requirements for relief under Revenue Procedure 2022-32 are satisfied.

The requirements for relief under the Revenue Procedure 2022-32 are that an executor must file with the IRS a complete and properly prepared Estate Tax Return on or before the fifth (5th) anniversary of the decedent’s death and the executor filing the Estate Tax Return on behalf of the decedent states at the top of the Estate Tax Return that the return is “FILED PURSUANT TO REV. PROC. 2022-32 TO ELECT PORTABILITY UNDER § 2010(c)(5)(A).”

This streamlined late election procedure is important because since January 1, 2011, federal law has allowed a deceased spouse’s estate to port any DSUE to the surviving spouse for his or her future use.  Before this enactment of estate tax exemption portability, the unused estate tax exemption of the first spouse to die was a “use it or lose it” proposition.  A married couple that fails to utilize a first spouse to die’s estate tax exemption either because the assets pass outright to a surviving spouse or there are not sufficient assets in the first spouse to die’s estate to utilize the deceased spouse’s available estate tax exemption will not necessarily lose the benefit of the DSUE.  Through a portability election to port the DSUE on a timely filed Estate Tax Return or an Estate Tax Return filed late consistent with the terms of Revenue Procedure 2022-32, the DSUE can be ported to the surviving spouse.

Importantly, the surviving spouse can use the DSUE for future gifting and/or to be applied to testamentary transfers on his or her eventual death.  With the enhanced five (5) year window, there will be more opportunities to take advantage of late filed portability elections under Revenue Procedure 2022-32 for taxpayers who may have overlooked this potential benefit or potentially not qualified under the previous two (2) year window.

However, if the five (5) year window in Revenue Procedure 2022-32 has passed, the surviving spouse can still request late election relief in a Private Letter Ruling (“PLR”) from the IRS.  Of course, the PLR involves a high user fee, more time, and legal fees.

In our busy practice, we tend to see certain recurring errors. In particular, we see planning errors that arise during the estate administration process after someone dies. Below are a few of these common errors, and, in the spirit of, “An ounce of prevention is worth a pound of cure,” we also discuss steps that you can take to prevent them.

  1. Joint ownership and disclaimers. Spouses frequently title property they own (or savings, checking and investment accounts) as “joint tenants with right of survivorship.” Legally, this means that, upon the death of the first joint tenant, the asset passes by operation of law to the surviving joint tenant.

This type of ownership can be desirable, but it also means that property bypasses the Will, which can lead to adverse tax results. If a couple owns assets in excess of the federal exemption amount (currently $12.06 million but scheduled to be cut in half as of January 1, 2026), having all assets pass into the surviving spouse’s name can lead to an unnecessary estate tax at the surviving spouse’s death. This issue also arises in states that have a state level estate tax, such as New York.

The classic solution to this issue is to have the assets of the first spouse to die pass to a trust (often known as an “exemption trust” or “credit shelter trust”) so as to use the first spouse’s estate tax exemption. If assets are held jointly, however, the surviving spouse frequently has to “disclaim” the deceased spouse’s half of the assets so that they pass to this trust.

A disclaimer must be completed and filed within nine months of the deceased spouse’s date of death. It is easy to miss this deadline, or misunderstand what is at stake – ie, generally a 40% tax on one’s assets. The current law also allows for a surviving spouse to elect to take the deceased spouse’s estate tax exemption, which complicates the decision-making around this issue. The prudent planning step here is to be aware of the relevant deadlines and speak with a tax advisor to make the optimal decision.

  1. POD or TOD accounts. There is an appeal to “payable on death” or “transfer on death” account designations, and many financial advisors recommend them to clients. Accounts with this designation typically bypass the probate process and transfer on death to the named beneficiary.

However, such account designations are often undesirable. If a Will creates a trust or trusts for children, for example, the POD account will never go to the trust, frustrating the decedent’s intent. The POD beneficiary can have a creditor who will then be able to assert a claim against the account or asset. Also, the estate can owe taxes or have other expenses, and the POD accounts may not be available to be used for these obligations.

We frequently find that POD account designations have unintended consequences. The prudent step here is to be wary of POD designated accounts, carefully think through their effects in the overall estate, change them where necessary, and do not take title to the decedent’s assets until final decisions have been made.

  1. Not updating fiduciaries. Relationships change. People age. People move. These are just some of the reasons that the fiduciaries you chose a few years ago may no longer be appropriate in your estate planning documents. Examples: Mom names the oldest child as a fiduciary but late in her life, it turns out a caregiver child is the better choice. Husband names wife’s brother as a fiduciary, but then husband and wife get divorced and wife’s brother is no longer a good choice.

The prudent step here is that you should review your estate planning documents every few years and fiduciary choices should be kept current.

  1. Lack of immediate liquidity. Getting a Will admitted to probate and the executor appointed can take time. Some state courts are notoriously slow. If all of the decedent’s assets are frozen because the executor has not been appointed, there can be a cash or liquidity crunch in the estate. There are usually immediate bills to pay, including funeral expenses, medical bills, maintenance for a home, and more.

It is important to have some liquidity. Accordingly, the prudent step here is to think through the practicalities of what will occur if you pass away and whether your spouse, child or others have immediate access to funds. This can be accomplished, for example, by having a co-trustee on a revocable trust account, or having a small joint account that a family member or loved one can access.

  1. Digital records and passwords. At this point, we all have seen the stories of cryptocurrency owners who pass away without anyone knowing how to access their crypto account or digital wallet. Just like that, the value of the asset goes to zero. In addition, many people now choose paperless statements and only access their bank and investment accounts online. It is no longer effective that the family can scan the decedent’s mail for a few months and be confident that they have knowledge of all of the decedent’s assets.

The prudent step here is to keep an up-to-date list of accounts, including information such as the institution name, account number, title on the account, approximate balance and account passwords. In the age of two-factor authentication, it also may make sense to give a spouse or agent under a power of attorney his or her own access to the account. It also may make sense to maintain a list of other digital property, like e-mail accounts or photo storage (with passwords), which may have little monetary value but great sentimental value, so loved ones can access them.

We hope this discussion of some common errors we see in the estate administration process can help you avoid them.

In a recently decided case 3 University Plaza SPE, LLC v. City of Hackensack 5002-2014, 1670-2015, 3553-2016, 1163-2017, 3768-2018, 12891-2019 – 3 University Plaza SPE LLC, et al. v. Hackensack City (njcourts.gov) concerning a large 225,000 square foot class A office building, the Tax Court addressed the valuation community’s on-going debate as to whether certain reoccurring expenses (such as tenant improvement allowances and brokers’ commissions) should be treated as so called “above” or “below” the line adjustments when calculating the all-important net operating income of an asset.  Due to the fact that the Income Approach to value is the well-recognized leading methodology employed when dealing with income-producing properties, the determination of a property’s stabilized net operating income is critical to arriving at an appropriate and supportable fair market value determination.

Because the 3 University Court concluded that these categories of expenses are “in the competitive market” “annually reoccurring” operating expense and “needed to stabilize occupancy and preserve the value” of the property, they must be treated as “above-the-line” adjustments affecting net operating income.  In addition, because the Tax Court recognized that the major industry surveys report capitalization rates based upon the survey participants’ treatment of tenant improvement allowance and brokers’ commission expenses as “below-the-line” adjustments, (therefore not impacting net operating income), these surveys (e.g., American Council of Life Insurers Investor Bulletin Tables and PwC Real Estate Investor Survey) cannot be relied upon in concluding appropriate capitalization rates for use in the Income Approach valuation method.

On the other hand, the Band of Investment technique for deriving capitalization rates is a method that relies upon market determinations of appropriate mortgage interest rates and equity dividend rates, neither of which are directly impacted by a property’s net operating income and the divergent treatment of tenant improvement allowance expenses or brokers’ commissions.  As such, the Court concluded that the Band of Investment technique “provides the most accurate and reliable method of deriving a capitalization rate because it is not polluted or impacted by questions of how potential survey recipients perceived hypothetical transactional questions or how a market perceives an annually reoccurring operating expense.”

As a result, the Tax Court’s holding in this case, although a trial level decision and not binding on other courts, does provide a well-reasoned analysis and approach that should serve to better guide the valuation community as to best practices when determining stabilized net operating income and fixing appropriate capitalization rates  — two integral components of the Income Approach to value.