Donations of Closely-Held Business Interests

A charitable donation of long-term capital gain property is a useful tax-planning technique for charitably-inclined individuals. The reason this works is because the donor (1) receives a deduction for the fair market value of the donated asset and (2) avoids paying tax on the built-in gain of the asset. However, in the case of a donation of an interest in a closely-held business taxed as a partnership, two issues often arise which impact this strategy: Business liabilities and ordinary-income property.

Because relief of debt is considered taxable income, a donor who has been allocated a share of a partnership's liabilities and who transfers the interest to a charity is deemed to have engaged in two separate transactions. First, a sale transaction has occurred, whereby the donor realizes income equal to the amount of debt relief. Second, a donation has occurred, whereby the donor makes a contribution equal to the fair market value of the interest less the amount of debt relief. The donor's basis is allocated pro-rata between the two transactions, meaning the donor will recognize and pay tax on the gain arising from the "bargain sale."

The donation is further complicated if the partnership owns ordinary-income property. This is because I.R.C. § 170 requires the amount of a charitable deduction to be reduced to the extent that a sale or exchange of the contributed property would generate ordinary income.

Chapter 7 of the IRS's Partnership Audit Technique Guide contains an example addressing the impact of the debt-relief issue, which I've modified below so that it also illustrates the impact of ordinary-income property, or "hot assets." In this example, an individual donor contributes a partnership interest valued at $50,000 to a public charity. The donor's basis in the interest is $40,000 and the donor is allocated $30,000 of partnership liabilities. In addition, the partnership owns a fully-depreciated piece of equipment which, if sold, would result in $2,000 of ordinary income allocated to the donor. The consequences of this donation on the donor should be as follows:

Bargain Sale:			Footnotes:
	Deemed Proceeds:	30,000	1.
	Allocated Basis (pro-rata):	-24,000	2.
	Gain on Bargain Sale:	=6,000
	Ordinary Income Portion:	1,200	3.
	Capital Gain Portion:	4,800
Donation:
	Gross Donation:	20,000
	Ordinary Income:	-800	4.
	Allowable Deduction:	=19,200

1. Rev. Rul. 75-194, 1975-1, C.B. 80.
2. Treas. Reg. § 1.1011-2(c).
3. The proper allocation of the gain on the bargain sale between ordinary income and capital gain is not clear. See Jonathan G. Tidd, Charitable Gifts of Limited Partnership and Limited Liability Company Interests, Trusts & Estates, October 2015.
4. I.R.C. § 170(e)(1)(A).

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50 States' Health Care Directive Forms

All states have statutes allowing individuals to (1) express their health care wishes and/or (2) appoint an agent to see that those wishes are carried out in the event of incapacity. A standard form or set of forms is available in each jurisdiction for the public to use; this post provides a link to a health care directive form or forms from an authoritative source in every state. This post will be updated as better sources become available; please comment below if you come across broken links or better forms or resources than what I currently have:

Alabama	Illinois	Montana	Rhode Island
Alaska	Indiana	Nebraska	South Carolina
Arizona	Iowa	Nevada	South Dakota
Arkansas	Kansas	New Hampshire	Tennessee
California	Kentucky	New Jersey	Texas
Colorado	Louisiana	New Mexico	Utah
Connecticut	Maine	New York	Vermont
Delaware	Maryland	North Carolina	Virginia
District of Columbia	Massachusetts	North Dakota	Washington
Florida	Michigan	Ohio	West Virginia
Georgia	Minnesota	Oklahoma	Wisconsin
Hawaii	Mississippi	Oregon	Wyoming
Idaho	Missouri	Pennsylvania

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Trusts as Beneficiaries of Retirement Plans

In order to qualify as a "retirement plan" under the Internal Revenue Code, 401(k)s, individual retirement accounts, and other retirement arrangements must be distributed to the employee that owns the plan or that employee's designated beneficiaries pursuant to I.R.C. § 409(a)(9) and the accompanying regulations. For purposes of these rules, only individuals are permitted to be designated beneficiaries of a retirement plan. One reason for this is so that required minimum distributions can be calculated.

However, if certain requirements are met, a trust may be named as the beneficiary of an employee's retirement plan, and the individual beneficiaries of the trust will be treated as having been designated as the plan beneficiaries. For an excellent breakdown of how the required minimum distribution rules work where a trust is a beneficiary, see the chart prepared by Keebler and Associates located here. Naming a trust as a beneficiary of a retirement plan can be a useful estate planning technique, but after the employee passes away, the custodian of the retirement plan will need assurance that the requirements described in Treas. Reg. § 1.401(a)(9)-4 are satisfied.

These so-called "see-through" rules for a trust will be satisfied after the employee's death if the beneficiaries of the trust with respect to the retirement plan, if not specified by name, are identifiable from the trust instrument and certain documentation is provided to the custodian. The documentation requirements include (1) a list of all of the current beneficiaries of the trust, (2) a list of all the contingent and remainder beneficiaries of the trust as well as a description of the conditions on their entitlement, (3) a certification that this beneficiary list is correct.

Finally, the trust must be valid under state law and be irrevocable, and the trustee must agree to provide a copy of the trust instrument to the custodian upon demand. The trust agreement should be drafted with these rules in mind by restricting distributions of any retirement plan assets to individual trust beneficiaries and requiring that such assets be distributed in accordance with I.R.C. § 409(a)(9) and the regulations. Compliance with these rules will allow a trust to be a designated beneficiary of a retirement plan.

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Updated: Fixing Problems with Online IRS EIN Applications

This post is an update to a prior post, with updated information about fixing rejected online EIN applications submitted on the IRS's website. Consider the following potential causes:

Every EIN application requires a responsible party name and matching tax ID number. Often, this will be an individual and their social security number, but sometimes the responsible party is another business with another EIN number. The IRS will not process online EIN applications if the responsible party is an entity with an EIN previously obtained through the internet. In other words, unless the responsible party is an individual with a social security number or an entity with an EIN that was not obtained through the internet, the online EIN application will always return an error.

If the first two numbers of the entity's EIN Number begin with 20, 26, 27, 45, 46, or 47, that EIN number was obtained through the online EIN application. Accordingly, that entity can never be a responsible party for another online EIN application; you will have to apply over the phone or list another responsible party on the online application, such as the individual who owns the entity. If the responsible party's EIN begins with 30, 32, 35, 36, 37, 38, 61, 80, 84, 90, or 91, that EIN number was not obtained through the online EIN application, and that entity should be able to be a responsible party on another online EIN application.

The IRS will only issue an EIN to one responsible party per day. This limitation applies to all requests for EINs, whether through the online EIN application or by phone, fax, or mail. If an EIN has been issued to any entity by any application method on a particular day, the responsible party on that EIN application must wait until the next day before being the responsible party on another EIN application.

A rejected EIN application indicating Reference Number 101 has a name conflict. The IRS requires a unique entity name before it will issue an EIN, similar to how the secretary of state requires a unique entity name within that state before Articles or Certificates of Formation may be successfully filed. However, because the IRS is a federal agency issuing EINs for entities in all 50 states, it potentially checks for duplicate entity names across multiple states. There are numerous references to a state on the online EIN application, such as the physical location state, mailing address state, and the state where the Articles are or will be filed.

If all of these state references are the same, the IRS will only check for previously-issued EINs with that entity name in that one state. If multiple states are reported, for example, if the Articles were filed in a different state than the business's physical address, the IRS will check both states for name availability before issuing an EIN, even though filing the Articles only requires a unique entity name in the one state where the Articles are being filed. Applying for an EIN over the phone may be required in these name conflict situations; often, the IRS agent will ask to see a copy of the Articles before issuing an EIN.

Reference numbers 102, 103, 105, or 108 indicate that the name and tax ID number of the responsible party do not match IRS records. Reference number 104 means a third-party designee's contact information cannot be the same as the address or the phone number of the entity that is applying for an EIN. Reference numbers 109, 110, 112, or 113 mean that the online application is temporarily unable to assign EINs; try again later. Reference number 114 indicates that only one EIN will be assigned per day per responsible party.

Reference Numbers 109 and 110 indicate technical problems and an EIN may still be obtainable using the exact same information that resulted in the error. The error might result from too many people trying to obtain an EIN at the same time. Try again later, or try closing and reopening the browser, using a different browser, using a different computer, clearing cookies, restarting the computer, or adjusting your security settings. Or, feel free to contact me; I would be happy to try and help.

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Utah's New Uniform Power of Attorney Act

Utah's new Uniform Power of Attorney Act went into effect on May 10, 2016. A power of attorney is a document with which an individual, known as the principal, grants authority to an agent to act in his or her place and is an important component of an estate plan.

One the most notable features of the new act compared to Utah's old act is that the new act provides an optional statutory power of attorney form, located here. Even though a power of attorney is valid even if it does not conform to the statutory form, the statutory form will likely become the standard form in Utah and for that reason, may attorneys will likely adopt some version of the statutory form.

Existing powers of attorney are still valid under the new act, assuming they were valid under the old act, and they may actually be more effective now than under the old act. This is because under the new act, a third party must generally either accept an acknowledged power of attorney or request a certification or an opinion of counsel regarding the power of attorney. As long as the certification or opinion is provided, the third party is generally liable for refusing to accept the power of attorney. A statutory form certification is part of the new act. In other words, there is less opportunity for a third party to reject a power of attorney under the new act as there was under the old act, an issue I discussed in a prior post.

On the other hand, existing powers of attorney may no longer be sufficient to grant the agent the same powers that the agent would have had under the old act. This is because under the new act, an agent can take certain actions on behalf of the principal only if the power of attorney expressly grants the agent that authority. For example, the power to make gifts on behalf of an incapacitated principal is occasionally useful as an estate tax reduction strategy, but any existing power of attorney that doesn't specifically grant this power will not be effective in giving that authority to the agent.

The new act provides a good opportunity for Utahans to pull our their estate planning documents and consider whether their existing power of attorney is appropriate for their needs. A well-drafted power of attorney will provide peace of mind and pay for itself many times over if it negates the need for a conservatorship or prevents waste of an incapacitated principal's assets.

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IRS Imposter Phone Scam

I've been contacted multiple times in the past few months by individuals who have received calls from someone purporting to be with the IRS and demanding immediate payment of an outstanding tax liability. Such phone calls are scams, and have been occurring for years. Based on my recent experience and information published by U.S. government agencies, I'm offering the following ways to recognize these phone scams:

• The caller says they are from the IRS or Treasury Department and demands payment of a tax bill over the phone immediately. 
• The IRS will never call to demand immediate payment over the phone. 
• The caller demands payment via a prepaid debit card, a money order, or a wire transfer.
• The IRS will never call and ask for credit card numbers or bank information over the phone. The IRS does not need this information; any taxpayer can initiate a payment to the IRS for any federal tax at any time using the EFTPS System.
• The caller threatens those who don't pay with criminal charges, a grand jury indictment, immediate arrest, deportation, or loss of a passport or driver’s license.
• The IRS will never take or threaten to take any of these actions if payment is not made during the course of a phone call. Certainly, criminal penalties are possible in certain circumstances, but not before due process. As IRS Commissioner John Koskinen put it, "If you are surprised to be hearing from us, then you're not hearing from us."

The IRS will always send notices and bills in the mail and follow their standard collection and appeals process, which I described in a previous post. If you do receive a call from an individual claiming to be with the IRS and demanding money immediately, hang up the phone. The Treasury Inspector General for Tax Administration has an online form that can be filled out to report the scam.

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Bequests to Charity and Tax Apportionment

Many individuals wish to leave a specific amount of money or particular property to their heirs and the rest of their estate to charity. While this seems straightforward, administering this plan can become complicated when the estate is subject to the estate tax.

The reason is explained in Treas. Reg. § 20.2055-3(a)(1): "If a residuary estate... is bequeathed to charity, and by the local law the Federal estate tax is payable out of the residuary estate, the deduction may not exceed that portion of the residuary estate bequeathed to charity as reduced by the Federal estate tax... [T]he resultant decrease in the amount passing to charity will further reduce the allowable deduction."

Stated differently, the estate tax deduction is based on the amount actually available for charitable uses, which amount is reduced by estate taxes. This "results in a circular, or interrelated, computation because the reduction in the charitable deduction in turn increases the taxes payable that again reduces the charitable deduction and so forth. The calculation must be run until the additional taxes zero out."

This problem can be avoided through careful drafting by either "structuring the charitable bequest as a pre-residuary rather than a residuary bequest" or not allowing for the apportionment of the estate tax on any property set aside for charity. Under the Uniform Estate Tax Apportionment Act, which has been adopted by a handful of states, "charitable beneficiaries generally are insulated from bearing any of the estate tax;" however, this is generally overridden by a tax apportionment clause in a will or trust. Every client must understand their options for apportioning estate taxes (not to mention other inheritance taxes) and the impact the apportionment will have on their distribution scheme.

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