• Final regulations issued under Internal Revenue Code Section 67(e) regarding miscellaneous itemized deductions—In Treasury Decision 9664 (May 9, 2014), the Internal Revenue Service issued final regulations regarding which costs incurred by estates or non-grantor trusts are subject to the 2 percent floor for miscellaneous itemized deductions. These final regulations, to be added as Treasury Regulations Section 1.67-4, only made a few minor modifications to the proposed regulations issued in 2007.
Under IRC Section 67(e), expenses relating to estate or trust administration that wouldn’t have been incurred if the property weren’t held in an estate or trust aren’t subject to the 2 percent floor of IRC Section 67(a). The regulations require the taxpayer to determine whether a hypothetical individual holding the same property would commonly or customarily incur the cost. The type of the product or service is the determinative factor. For example:
Bundled fees: These must be allocated to both costs that are subject to the 2 percent floor and those that aren’t. If the fee isn’t billed on an hourly basis, only the investment advice portion is subject to the 2 percent floor. Otherwise, any reasonable method may be used to allocate a bundled fee between those costs that are and aren’t subject to the floor. Factors to consider include (among others) the percentage of the corpus subject to investment advice and the amount of the fiduciary’s attention to the trust or estate devoted to investment advice.
Ownership costs: Costs chargeable or incurred by an owner of property simply because he owns the property (such as condominium fees, insurance premiums, maintenance and landscaping services) would be subject to the 2 percent floor. The final regulations note that these costs may be fully deductible under other IRC sections.
Tax returns: The costs of preparing gift tax returns are commonly incurred by individuals, so they’re subject to the 2 percent floor. However, tax preparation fees relating to estate and generation-skipping transfer tax returns, fiduciary income tax returns and a decedent’s final individual income tax returns aren’t.
Appraisal fees: Costs of obtaining an appraisal related to insurance or other purposes commonly incurred by individuals are subject to the 2 percent floor. Appraisal fees related to fair market value (FMV) determinations for estate tax purposes, distribution purposes or to prepare estate or trust tax returns aren’t.
Fiduciary expenses: Those costs related to probate court fees, fiduciary bonds, legal publications and accounts aren’t subject to the 2 percent floor.
Investment advisory fees: Generally, investment advisory fees are subject to the 2 percent floor. However, additional costs beyond what would typically be charged to an individual investor, due to the nature of the property being held in an estate or trust, aren’t. For example, these fees could be due to an unusual investment objective or the need to balance the interests of various parties beyond the usual balancing of the interests of current beneficiaries and remaindermen.
• Tax Court denies IRS’ motion for summary judgment regarding valuation of Madoff investment account—In Estate of Bernard Kessel, T.C. Memo. 2014-97 (May 21, 2014), the Tax Court held that there were issues of material fact that needed to be resolved regarding how an investment account held by the decedent, Bernard Kessel, and managed by Bernie Madoff’s firm, should be valued for estate tax purposes.
Bernard opened a personal pension plan in 1982 (the plan). The plan invested with Bernard L. Madoff Investment Securities, LLC (Madoff Investments) in 1992. Bernard was the sole participant in the plan and designated his fiancée (70 percent) and son (30 percent) as beneficiaries.
Bernard died in July 2006. The estate filed a timely estate tax return in 2007 and reported the value of the plan’s account based on a list of the securities, funds and options provided by Madoff Investments. The total value of the account as reported on the Form 706 was over $4.8 million. With the estate tax return, the executor paid about $2.3 million in estate tax.
Bernard’s fiancée and son made seven withdrawals from the account after Bernard died, totaling over $2.8 million. Then, in 2008, Madoff was arrested. The plan tried to recover the assets held in the account, which records in the month prior to Madoff’s arrest showed to be about $3.2 million. After it was unable to recover the assets, the estate submitted Form 843, Claim for Refund and Request for Abatement, requesting a refund of over $1.9 million. The IRS denied the request, and the estate filed a petition, claiming the value of the plan’s account was zero.
The IRS moved for partial summary judgment, asking the court to rule that the Madoff account, and not its holdings, is the property to be valued for federal estate tax purposes. The IRS also requested that the court rule that a hypothetical willing buyer/willing seller of the Madoff account wouldn’t reasonably know or foresee that Madoff was operating a Ponzi scheme.
The court denied both motions, holding that the parties need to develop the facts at trial. It held that it couldn’t determine, without trial, whether the contractual rights to the account, rather than the assets purportedly held in the account, were the property interests to be valued.
In addition, it held that there were disputed facts as to whether a hypothetical willing buyer/willing seller would have had access to information showing that the returns Madoff Investments purportedly showed were “too good to be true” and, if so, whether such information would affect the FMV of the account or the assets allegedly held in the account.
• Private letter ruling provides that transfer of an LLC interest to a private foundation won’t constitute self-dealing under IRC Section 4941—In PLR 201407023 (Nov. 18, 2013), the taxpayer established a limited liability company (LLC) of which he was the sole member. Those members owning voting units (managing members) managed the LLC. Managing members could invest LLC property, generally exercise the rights of a general partner and determine whether to make distributions (which would be made pro rata to the members, in proportion to their unit ownership). The LLC could be dissolved only with the written approval of members holding at least 50 percent of the units in each member class, voting and non-voting.
The LLC’s sole asset was a promissory note issued by the taxpayer’s daughter. The note was the LLC’s only source of income. The LLC was to be engaged solely in passive activities and not in any business enterprise.
The taxpayer wished to leave non-voting units in the LLC to the private foundation (PF) he established at his death. He requested a ruling on whether the PF’s ownership interest in the LLC would be self-dealing.
Under IRC 4941(d)(1), self-dealing includes the lending of money or other extension of credit between a PF and a disqualified person. Among others, a disqualified person includes a substantial contributor, a PF director or officer and any spouse, ancestor, child, and grandchild of the contributor, director or officer.1 Treas. Regs. Section 53.4941(d)-2(c) provides that an act of self-dealing occurs when a note, the obligor of which is a disqualified person, is transferred by a third party to a PF that becomes the creditor under the note.
Under the regulations, a PF is deemed to control an organization if it or one of its managers may, by aggregating their votes or positions of authority, require the organization to engage in a transaction that would constitute self-dealing.2 Under the examples in the regulations (Treas. Regs. Section 53.4941(d)-1(b)(8), Example 1) and PLRs, a transaction between an entity controlled by a PF and a disqualified person may constitute indirect self-dealing if the transaction would be self-dealing if it were between the PF and disqualified person directly.
The IRS found that the taxpayer and his daughter were disqualified persons with respect to the PF. However, it held that the PF’s ownership of non-voting units in the LLC wouldn’t constitute an act of self-dealing because the PF wouldn’t have “control” over the LLC for the purposes of the regulations. It found that the PF’s non-voting interest lacked any power to control the operation or management of the LLC. The court didn’t find the PF’s power to participate in a vote for dissolution a necessary veto power that could constitute control. It noted that, because the PF would only receive distributions if the managing members authorized distributions to the members or if the LLC dissolved (which could only be compelled by the other members), it had no right to any distributions of income from the LLC (that is, the income from the note).
Ultimately, the IRS determined that, because the PF didn’t control the LLC, the creditor status of the LLC couldn’t be imputed to the PF, and the PF wasn’t deemed to be making a loan to a disqualified person. Because the loan wasn’t between the PF and a disqualified person, it didn’t constitute self-dealing, direct or indirect. The PLR does note that the liquidation of the LLC, however, could result in a self-dealing transaction, presumably because at that time, the PF would hold a direct interest in the note.
Self-dealing encompasses many types of transactions, and indirect self-dealing expands the scope of what may constitute an impermissible transaction. However, if a PF has a non-controlling interest in an entity, it may not necessarily step into the entity’s shoes for the purposes of the self-dealing rules. This PLR indicates that an LLC could be a useful tool when a PF is involved; if the PF doesn’t control the LLC, it’s possible that the LLC’s transactions may not be imputed to the PF—at least in a loan transaction.
1. Internal Revenue Code Section 4946(a)(1).
2. Treasury Regulations Section 53.4941(d)-1(b)(5).